Graham Stack in Kyiv -

With Ukraine's economy turning round, a host of businessmen who are seeing their businesses start to recover are taking determined and often fraudulent action to rid themselves of their bank debt.

Mykola Orlov, partner at the law firm Orlov, Mikhailenko & Partners, says what Ukraine is witnessing is the result of omissions in the past: banks' failure to identify the real owners of companies and link them to loans that those companies took out. "It is not retail clients, but the failure to pay on loans of well-connected corporate clients that is currently driving banks down. If this situation is not resolved, if the court system fails to deliver, it could bring a collapse or meltdown in the banking system," warns Orlov, who calls the situation "a stress test" for Ukraine's court system and law enforcement. "Banks have gone from giving out money to anyone, to giving out money to no-one."

According to Yaroslav Kolesnik, CEO of Bank Forum, Commerzbank's Ukrainian subsidiary, which is wrestling with a number of large fraudulent borrowers, the most popular schemes to evade paying back loans are either a fictive bankruptcy or the multiple resale of property pledged as collateral, both of which leave shell companies behind loaded with debts, with the assets elsewhere. "The biggest problem is that not a single offender has yet been prosecuted, although the offences are obvious," says Kolesnik.

While banks have until now mostly tried to regulate these disputes using civil litigation in the hope of getting the loaned money back or the collateral, one of Orlov's cases has now resulted in public prosecutors opening a criminal case of fraud against unknown persons. This cause celebre relates to a dispute between Ukrsotsbank, the Ukrainian subsidiary of UniCredit Group, and the owners of the Puzata Khata chain of budget diners specializing in cheap Ukrainian cuisine beloved of students.

Diner debts

According to Ukrsotsbank CEO Boris Timonkin, who went public with the case in June, the Puzata Khata companies - operating company and companies holding certain key premises leased by the chain restaurants - had taken out a total of $69.3m in the run-up to the crisis, mostly using the properties as collateral. When the debt ceased being serviced early this year, bank investigations then revealed that all the Puzata Khata companies had filed for bankruptcy over the course of February and March.

During the bankruptcy proceedings, it transpired that Ukrsotsbank was not the only creditor of the restaurant chain, nor even the largest. In fact, it transpired that the $69.3m debt constituted less than 30% of the total debt that Puzata Khata claimed to have ratcheted up from unknown companies. The suspicion is that these unknown companies who claimed to have amassed debts of the chain many times in excess of the value of the collateral on offer are all linked to the original owners of the restaurant chain - a classic case of fictive bankruptcy. Sure enough, the bustling restaurant chain acquired new operators, while the bank looked on powerless.

It also transpired that three restaurant premises pledged to Ukrsotsbank as collateral for the credit line had been transferred to other parties without either the consent or knowledge of the bank. This is the point at which Ukrsotsbank decided to bring criminal charges in the hope of proving that the resale and other disposition of property pledged as collateral had been fraudulent and thus void.

But against whom to proceed? Conventional wisdom always held that the "real" owners of Puzata Khata were the shareholders of the large construction company Kyiv Donbass Development, which floated on the London stock market as KDD. They include the Konstantinovskie twin brothers, Vyacheslav and Oleksandr, Alexander Levin, Olena Topolov (wife of the former fuel and energy minister, Viktor Topolov) and Petro Slipets. But KDD denies having anything to do with Puzata Khata, although the KDD prospectus for the IPO lists Puzata Khata as a group project. "The reality of the situation," explains Orlov, "is that formally these people [KDD] have no direct involvement in Puzata Khata, although there is certain evidence linking them."

Kolesnik's Bank Forum says it has an identical problem concerning the politically well-connected developer Sparta Group from Dnipropetrovsk, widely regarded as linked to the Privat Group around Privatbank owners Ihor Kolomoisky and Gennady Bogolyubov.

According to Kolesnik, Sparta Group, which was co-founded by Gennady Axelrod, Oleg Levin and Miron Snosnovsky, owes Bank Forum around $38m and is using fraudulent means to avoid repaying the debt. Sparta Group representatives refused to comment.

Kolesnik says that Sparta Group pledged a shopping mall in Dnipropetrovsk as collateral for the $38m loan. But in an attempt to avoid the collateral being seized, the part of the street on which the building is located has since been renamed, so that the address of the property specified as collateral no longer corresponds to the current address. The building was then resold a number of times via offshore structures. In April, Levin and Axelrod formally exited the business, succeeded by another Privat Group bigwig, Vitaly Timshin. Bank Forum realized the game was up, and went public with a lawsuit.

It's not just western banks that are having these problems. Russian VTB Bank's Ukraine subsidiary went public over the summer with complaints that LSE-listed egg producer Avangard was trying to wriggle out of a total $27m debt held by a number of subsidiaries. Avangard is owned by Oleg Bakhmatyuk, former deputy chairman of gas monopolist Naftogaz. "VTB Bank is considering appealing to the London Stock Exchange and the British Financial Services Authority to exclude the shares of Avangard from the listing, as a company violating the principles of civilized conduct of business," the company threatened June 22. But VTB now says it has refrained from appealing to the LSE after Bakhmatyuk returned to the negotiating table. Bakhmatyuk disputes the debts.

According to Pavel Cetkovsky, CEO of Erste Bank's Ukrainian subsidiary, "problematic borrowers throttle any resumption of lending, by making banks apply strict policies even for good customers, as keeping the price of loans high."

Among Erste's most colourful cases is a $1.8m debt owed by an election campaign adviser to President Viktor Yanukovych, Valery Paschenko, who the bank claims put his business through fictive bankruptcy.

Ironically, Paschenko is leader of the public movement called "Trust in the future". Indeed, in a rating compiled from public sources by the weekly Zerkalo Nedeli , of Ukraine's 25 worst debtors according to volume and extent of bad faith, six of the top 25 are Party of Regions deputies at a national or local level, and another 10 have close links to other political parties or organisations. The top 25 together owe a total of $3bn.

The number-one spot in the ranking is major machinery plant Azovmash, owned by Party of Regions parliamentary deputy, Aleksandr Savchuk. The company owes around $550m-750m to a range large banks. A local court decision in June found that loan guarantees originally accepted by the banks had not been valid and could not be called in. Their position weakened by the verdict, banks restarted negotiations on restructuring in August.

Tip of the iceberg

Banks admit the scale of the debt problem is much larger than suggested by the number of conflicts that have gone public. As a rule, banks stay mum about their largest problems, since they do everything to avoid a breakdown in relations with big and protected debtors, hoping to get at least some of their money back.

Last year, banks proved happy enough taking cars and apartments off punters tricked by the 60% hryvnia devaluation and at whom the banks had been throwing dollars right up until the crisis struck. But regarding corporate clients blatantly acting in bad faith, they act very cautiously. Ukrsotsbank CEO Timonkin says that his bank would continue to work with the developer KDD despite the suspicions about their shareholders being involved with the restaurant chain Puzata Khata. "Their behaviour in relation to the company KDD shows that they are capable of acting properly," he says.

The irony is that many of the companies that banks accuse of ripping them off are doing good business. Avangard post-IPO is full of plans for expanding egg exports; Puzata Khata's restaurants are full; and the KDD shareholders apparently launched the Domino's Pizza franchise in Ukraine. Moreover, KDD signed an agreement in June with Swissotel to build a twin-skyscraper five-star hotel in time for the Euro 2012 football championships.

It all goes to prove true the old adage: if you owe the bank a little, the bank owns you; if you owe the bank a lot, you own the bank.