Handy hints for account holders at Latvijas Krajbanka

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At their sitting of 21 November 2011 the Council of the Financial and Capital Market Commission (FCMC) made the decision to stop the provision of all financial services by Latvijas Krajbanka AS (LKB). This article offers a few practical suggestions to persons whose money was kept at LKB and has become unavailable as a result of that decision.

Guaranteed deposits

Under the Deposit Guarantee Act, a guaranteed deposit is cash in any currency held in a customer’s account which the bank must repay in line with contractual or statutory provisions. So the deposit protection mechanism applies not only to deposits, savings accounts and their interest, but also to current accounts, escrow accounts, and cash balances held in them.

Since 1 January 2011 the guaranteed compensation in the event of unavailability of deposits (FCMC decision of 23 November) has been up to EUR 100,000 or LVL 70,000. If a deposit with LKB is less than this amount, the customer will receive their deposit in full. If a deposit is greater than this amount, the excess is not covered by the guarantee. With respect to any remaining non-guaranteed amount, the depositor joins the line of LKB's other unsecured creditors, hoping to recover their property from LKB’s assets sold in the insolvency process.

The guaranteed compensation is available to individuals and entities regardless of their country of residence. Any deposits made by other banks, financial institutions, state-owned and municipal companies and agencies are not protected. Deposits are not guaranteed for LKB’s shareholders, council and board members, and some other senior officers employed by LKB, as well as in other special cases.

How is the guaranteed compensation paid out? The Deposit Guarantee Act provides that cash should be paid out through one or more banks appointed by the FCMC within 20 working days (this time limit may be extended for a further ten working days). Following an FCMC announcement of guaranteed compensation payments, a person should bring their passport (and a power of attorney if necessary) to a bank selected by the FCMC and receive their cash there. There is no need to file any application with anybody. All the required information will be obtained from LKB’s accounting records.

Loans

LKB’s financial services have now been suspended, but its insolvency has not been announced yet. Judging from the announcements published in the mass media over the past few days, the possible scenario is that LKB will first be declared insolvent and then bankrupt. If things develop this way, what will happen to the borrowers? Are they going to have to repay their loans before the due date stipulated in their contract?

It should be stressed that the insolvency procedure for credit institutions is specifically governed by the Credit Institutions Act, and the general provision of the Insolvency Act are not applicable in this case. Under the Credit Institutions Act, LKB’s estate will comprise all of its assets, including its receivables from other persons under its loan agreements, such as mortgage loans, credit lines and consumer loans. Like its other assets, LKB’s receivables must by law be sold at public auctions. The new owner of the assets will take over the bank’s receivables in the amount stipulated in each particular loan agreement. So the contract expiry, loan amount, interest rate and other conditions cannot be altered without reaching a special separate agreement with the borrower, yet the other party (lender) will be another bank or some consumer credit service provider.

It is important to continue loan repayments in line with the loan agreement to prevent its termination and full collection of the money. At the moment it is impossible to make loan repayments or interest payments because of the suspended financial services; however, as soon as a solution is announced, you should make all the payments that have fallen due, and continue your next payments when they fall due.

Mandatory tax payments

Sadly the time frame for cash payouts may reach 30 working days, so the deadline is 4 January 2012. As this year does not pamper us with extra holidays at Christmas and New Year, the cash payout will not be delayed. In the meantime, the obligation to make mandatory tax payments remains. Additionally, the State Revenue Service (SRS) has announced that the letter of the law does not allow them to postpone any tax payments or not to assess late charges on taxpayers due to the unavailability of their deposits.

In this respect we would note section 24 of the Taxes and Duties Act, which gives several options to a taxpayer whose cash is currently locked up in LKB:

• If a tax payment is not yet due, the taxpayer has a right to file a motivated request that the time limit should be extended for three months.
• If a tax payment is overdue, the taxpayer may file a motivated request that the late payment should be split into instalments or postponed for a year if the due date was missed because of force majeure circumstances. In that case the taxpayer will have to pay not only the principal amount of tax but also a late charge of 0.05% for each day overdue unless the particular tax law provides otherwise.

The above implies that a request should be made to the SRS immediately in order to prevent any late charges from being assessed.

Taxpayers who are due any overpaid tax amounts should open a current account with another bank and notify the SRS accordingly. Since all of LKB’s financial services have been stopped, no incoming payments are being accepted either. So stating another bank account may only slightly improve the taxpayer’s cash flow, but no longer should any cash be kept or lost at LKB.

Set-off options

The lending process frequently involves situations where a deposit at the same bank serves as security for a loan. The sad fact is that in the event of LKB’s insolvency the Credit Institutions Act prohibits the use of a deposit to repay a loan.

So a situation may arise where a deposit serving as security is partly lost, but the loan repayment obligation remains in full.

More often than not it is real estate, securities or a company’s current assets that serve as security for a loan. In that case the property serving as security is governed by a different statutory treatment, meaning that LKB’s insolvency does not affect the validity of a mortgage, financial pledge or commercial pledge, and it will pass to the next lender together with the loan in full.

Securities accounts

A special exception applies to financial instruments (securities) held with LKB. Under the Financial Instruments Market Act, financial instruments of the bank’s customers must be held and recorded separately. Under this same law none of the financial instruments of LKB’s customers may be used for settlement with LKB’s creditors. This rule stands even if the bank is declared insolvent.

The FCMC already announced on 24 November that the holders of securities accounts have the right to transfer their financial instruments to any other bank or investment brokerage firm. No restrictions have been imposed on the number or value of financial instruments, yet such transfers may attract LKB’s charges.

Force majeure

What should be done if payments to suppliers are delayed because of LKB’s suspended payments? Many will reply that this situation has the characteristics of force majeure, and so the party cannot be held liable for default.

Force majeure is a very broad term that is widely used in many contracts. If a contract includes a force majeure clause, then that should be used for determining whether there are any grounds for invoking force majeure in dealings with the other party and avoiding liability for failure to carry out an obligation.

If your contractual relationship is not detailed in writing, then you should resort to laws and regulations. For example, international transactions may be governed by the United Nations (Vienna) Convention on Contracts for the International Sale of Goods of 11 April 1980. Under its article 79, a party cannot be held liable for default if it is proved that

• the default was caused by an obstacle beyond the party’s control;
• the party could not be reasonably expected to have considered or avoided the obstacle at the time of entering into the contract, nor to have overcome the obstacle or its consequences; and
• the obstacle was not caused by any action of the party or any person it controls.

Transactions between Latvian companies and individuals may benefit from ruling No. SKC-11/2011 issued by the Civil Division of the Supreme Court Senate on 26 January 2011. In this ruling the court has summarised the force majeure rules included in various sections of the Civil Code, recognising as such any circumstances that

1. were unknown to the parties at the time of entering into the contract;
2. make performance of the contract impossible in general, not for one party only;
3. did not occur through the fault of the debtor; and
4. could not be avoided or prevented despite all the efforts made by the debtor.

This implies that the majority of LKB’s circumstances match the force majeure characteristics. The second feature above (performance generally impossible) is open to debate, given that in a business contract the obligation to pay money usually arises after receipt of the service. So one party has performed the contract, but performance of the other party’s obligation becomes impossible.

In this situation another necessary condition is that written notice of the force majeure circumstances should be given to the other party immediately. In subsequent communication it is advisable not to rely on the force majeure concept alone, but to negotiate with the other party. It is also important to remember that each case should be judged on its own merits, and one solution may not be suited to all of LKB’s customers.

In future the customers of LKB and other banks should learn a lesson from this situation and adapt their actions when choosing a bank for payments, placing cash at one or more banks, selecting investment targets, and negotiating the terms of a contract with the other party.