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Policy and Legal Environment for the Growth of the SME Sector in Bulgaria - Draft Policy Paper, November 1996
 

November 29, 1996
Sofia

INTRODUCTION

1. General Orientations

The Policy Forum aims to identify those factors that will improve the economic and legal environment for the growth of the small and medium sized enterprise (мSMEо) sector in Bulgaria. The forum is designed to bring together some of the countries most influential individuals, representing various institutional and independent bodies, to discuss the constraints that are hindering the development of the SME sector and to propose and review various recommendations to overcome these obstacles.

The background paper attached hereto, outlines the basic problems that will be discussed at the forum. Recommendations prepared by participants and discussed at the forum will be incorporated into the final paper. By preparing recommendations in advance based on the topics to be discussed, participants will provide a greater number of feasible recommendations for the development of the SME sector. By discussing the recommendations in an open forum, immediate feedback will be provided for proposals and will create wider support and acceptance of the report.

2. The Background Paper

The background paper is broken into three main sections. Section 1 discusses the actions needed to improve the economic climate to support the SME sector. Section 2 discusses the actions needed to improve the institutional and legal environment for SMEs. Section 3 describes a monitoring system to determine whether or not the proposed actions from Sections 1 and 2 have been implemented with the desired results obtained. Each section is further divided into ACTION LINES. BACKGROUND information is given under each Action Line followed by its OBJECTIVES. Then, specific ACTIONS are described to achieve the objectives of the Action Line.

3. The Importance of the SME Sector

The success of Bulgariaнs SME sector is essential to the development of the economy as a whole. Foremost, SMEs are labor intensive and capable of creating many new jobs at low costs. These jobs will be necessary to absorb new unemployment created by restructuring former State Owned Enterprises (мSOEsо). Among other important SME contributions to the economy are:

· SMEs service the needs of larger corporations and provide services that facilitate business. One role that SMEs can play is as suppliers to larger companies thus contributing to the external competitiveness of these firms.

· SMEs are a source of innovation on the basis that they are more flexible, more dynamic and more sensitive to shifts in demand than larger firms.

· SMEs contribute as мSeed-Bedsо from which large companies can grow.

· SMEs will provide an additional market for the purchase of second-hand equipment from SOEs.

· SMEs train entrepreneurs needed to develop the private sector and foster private investment..

As a result of these factors, the larger and more developed the SME sector, the greater the SME contribution to the growth of the economy.

Therefore, it is imperative that during this time of concern, that the Bulgarian authorities take into consideration the role of SMEs in the economic development of the country.

The product of this policy forum will provide a guideline for officials to adhere to when developing the overall plan for the country so that the proper recognition of the important role of SMEs in the development of the Bulgarian economy is included.

1. ACTION LINE 1: IMPROVING THE ECONOMIC CLIMATE, POLICY

AND SUPPORT FOR SMALL AND MEDIUM SIZE ENTERPRISES

1.1 ACTION LINE 1.1: ECONOMIC STABILIZATION AND IMPROVING

OF THE BUSINESS CLIMATE

1.1.1 BACKGROUND

The economic destabilization and deterioration of the Bulgarian business environment has seriously restricted the development of the SME sector. Moreover, not only has the sector experienced serious governmental neglect, but it has also undergone direct evolutionary oppression as a result of various official policies, including the ruining practice of subsidizing the public sector. While such macro-economic failures affect all private enterprises, the impact on the SME sector is compounded due to its general inability to access capital and information.

1.1.2 OBJECTIVES

The objective of this action line is to address the development of the SME sector vis-a-vis the stabilization and improvement of the Bulgarian economy. More importantly, this action line emphasizes the importance of including specific policies and measures in such macro-economic actions that address the specific concerns and needs of SMEs. The purpose is not to propose those specific macro-economic actions necessary to stabilize the economy, but rather to acknowledge conditions that are essential for the development of the SME sector and to stress the importance of addressing SMEs in such macro-economic actions.. These actions are viewed as a function of several parameters, namely, the acceleration and expansion of economic reforms, anti-crisis regulation and stimulation, and the opening of the country to foreign investors and partners.

1.1.3 ACTIONS

The actions foresee:

1. the development of an anti-crisis program in which the place and role of SMEs will be clearly and responsibly stated (ANTI-CRISIS PROGRAM).

2. the development of a strategy for speeded, full-scale privatization, with maximum broadening of the applied privatization techniques (ACCELERATION OF THE PRIVATIZATION PROCESS).

3. the development of a national strategy for attracting foreign investment, including decisive measures for improving the general business climate in the country (FOREIGN INVESTMENT STRATEGY).

4. the implementation of decisive measures (legislative and organizationally-administrative) for establishing steady tax policy and practices (TAX MEASURES)..

5. the implementation of measures for narrowing the perimeter of activity and influence of the shadow economy and the creation of a competitive environment without distortions (ACTIONS AGAINST SHADOW ECONOMIC AND CRIMINAL ACTIVITIES).

ANTI-CRISIS PROGRAM

Background

Since the restructuring of the economy which began in 1989, there has been no consistent and long term strategy for the development of economic priorities. While continuously stating the need for structural reform, the government still cannot point out the sectors it plans to prioritize. All this deprives the private sector, and SMEs in particular, of the ability to work out their own strategy, relevant to national economic policy. In addition, the dialogue between the authorized state institutions and private businesses has been disrupted, which deprives entrepreneurs of the ability to influence national economic priorities.

Recommendation

In recent months, structural reform in Bulgaria has been spoken of widely. While a discussion of the proposed currency board extends beyond the scope of this report, SMEs will face serious consequences either as a result of the boardнs implementation, or lack thereof. Furthermore, the board and various other structural reform measures that have been independently mentioned are only one of the essential elements of an anti-crisis program.

In light of these measures, the successful development of the SME sector depends largely on how thoroughly anti-crisis actions embrace the crucial role of SMEs. Specifically, all measures stated below must incorporate objectives designed to better the SME sector. While a basic anti-crisis program that successfully stabilizes the economy will undoubtedly benefit the SME sector as well, such a process, without specific SME consideration, will result in a lost opportunity to concurrently build a strong foundation of SME support and expansion into the strategic industries of Bulgaria.

To establish a favorable working climate in which SMEs can thrive, such a program must contain several key components that also specifically recognize the special needs of SMEs: fiscal and monetary actions to lower interest rates, inflation and taxes (particularly of the profit tax); measures to stabilize and promote the development of the banking system; policies and support for the benefit of strategic industrial sectors; export programs which include financial backing and insurance; and foreign investment strategies that support the overall goals of the anti-crisis program.

In the framework of common measures, the development of a real and expedient structural reform package is of critical importance. In order to finally realize this reform, which for all these years remained in the sphere of promises and political speculation, what is needed is a clear, practical and transparent program for its carrying out.

ACCELERATION OF THE PRIVATIZATION PROCESS

Background

Experts estimate that the percentage of state owned property is still well above 90 per cent. Non-competitive state owned enterprise (мSOEsо) business practices crowd out SMEs from competing in their common industries. SOEs also encumber the success of SMEs in developing industries by creating a deficiency of competitive suppliers, distributors, and industrial consumers. In addition, the slow privatization process has curtailed international interest in the SME sector and the Bulgarian market in general. Failure to carry out privatisation measures has provided fewer opportunities to purchase Bulgarian companies and to form joint ventures. It has also provided an unfavorable investing climate since maintaining significant public ownership goes against the understanding of a free market system.

Further, budget losses continue to pileup from SOE employee benefit payments and foregone tax revenues. Also, maintaining state ownership of companies continues to erode both the value of their assets and their competitiveness. Thus, the longer an SOE is held, the greater the cost to the state and lower the price of the sale.

Recommendation

In addition to accelerating the privatisation process as a whole for the well being of the Bulgarian economy, SME privatisation must be made a priority of the process. While significant attention has been paid to the мgemsо of Bulgarian industry, the privatisation of most state owned SMEs has been neglected. Within the economy, only a relatively small portion of the total national capital assets are мlargeо enterprises(statistically, these companies have constituted only 10-15% of the enterprises of centrally planned economies). SMEs should be sold off quickly and expediently. Consequently, in addition to its importance to the development of the SME sector, selling off such enterprises will make the privatisation of large SOEs easier.

The relevant authorities need to adopt a simple policy for the immediate sale of SMEs and other small properties. Specifically, an accelerated system of sale similar to those implemented in most Eastern European countries must be established. This includes the establishment of a break even cost of holding the businesses and a minimum sales price for the enterprise. Then, following an impartial auction procedure, a competitive bidding situation should be created which would result in prices at least above the break even level. The break even price can be estimated by determining the liquidation value of the assets of the company and subtracting the costs associated with keeping the company state owned, such as welfare benefits for employees, financing and other administrative costs.

However, while emphasis needs to be placed on the SME privatisation, this does not mean that SME privatisation should commence at the expense of an acceleration of large scale privatisation. The need for a fully functioning market economy is not only essential to the development of the SME sector, it is imperative for the success of the Bulgarian economy as a whole.

FOREIGN INVESTMENT STRATEGY

Background

Since developmental aid and government initiated capital formation have become difficult to acquire, equity capital for SME development, and the development of the Bulgarian economy as a whole, must come from the private sector, both indigenous and from foreign investors. As Bulgaria currently has little or no domestic risk capital available, it needs to attract capital from abroad. And therefore, foreign capital must be actively solicited. The Bulgarian banking system can not currently support the development of the SME market and other sources of funds, such as the Ministry of Industryнs Small Business Fund, established in 1991, remain underutilized. Foreign investment in which effective managerial control is established also serves to bring badly needed technologies and managerial techniques to SMEs. Unfortunately, according to data provided by BNB, foreign investments for the first half of 1996 amount to USD 49 million, USD 27.6 million less than the first six months of 1995.

Recommendation

To attract investment in SMEs from abroad, Bulgarian policy makers must make Bulgaria an attractive investment for international investors. This success relies heavily on the creation of a national economic plan that stabilizes the economy and the political system, privatizes existing SOEs, reduces inflation, and basically builds a better economic climate for investing. Recent political and economic events had diverted foreign investors attention to other Central and Eastern European Countries and foreign markets. In the midst of heavy competition from other developing economies for foreign investment, the availability of capital for aiding the SME sector from abroad may be difficult to attract in large quantities. And therefore, concrete actions must be executed under the umbrella of a comprehensive national economic plan.

TAX MEASURES

Background

The most characteristic feature of the widely accepted practice of carrying out state collections (taxes, excises, tariffs, customs duties, and other duties) is its chaotic nature. The inconsistent state policy in this sphere and the actions of the administration bring about tax nihilism, rather than the required tax culture and discipline.

Recommendation

To increase budget revenue, the priority tax policy change must be the creation of a steady and predicable tax environment. It is imperative to finally abolish the practices of back dated taxes and the constant altercation of tax policies. Expedient and decisive measures for tightening the financial discipline must also be carried out, particularly in improving the work of the tax administration and other financial control authorities. Finally, as previously stated with respect to the privatization of SOEs, prompt and resolute cuts in the losses of the public sector must be completed thought mass privatisation.

Specific action must be taken to address the following obstacles SMEs face because of current tax policy:

1. The regulation of the annual taxation results (taxable and nontaxable expenses) is decreed by an act of the Council of Ministers, which allows its easy and perpetual revision;

2. The range of expenses which reduce the annual amount to be taxed constantly diminishes;

3. The use of negative results from previous years is no longer used in the formation of the positive financial result for the current year;

4. A practice of accepting limitations introduced with old dates is being widely accepted;

5. Only 10% of education expenses are accepted as nontaxable expenditure, which is a serious drawback for SMEs, where education is crucial to their survival and stabilization;

6. Expenses common to SMEs, such as the reconstruction and office, machine, and other improvements are not being reduced;

7. The process of advanced payment of taxes must be developed and stabilized;

8. There is an incredibly slow procedure of recovering VAT credit with no interest accumulation for blocked funds;

An additional burden for SME activity is the ineffective and inconsistent work of the tax authorities. In this respect the following problems must be addressed:

1. Arbitrary interpretation of the laws and other normative regulations by public officers;

2. Lack of control mechanisms for the structure of the tax administration to be used by the MF in supporting the interests of the economic entities;

3. In many cases, tax inspectors are hostile and aggressive. Errors are sought deliberately, and a percentage reward is given for every мerred amount.о

ACTIONS AGAINST SHADOW ECONOMIC AND CRIMINAL ACTIVITIES

Background

During the last few years, shadow economies and criminality have gained considerable influence within the Bulgarian economy. Among other problems, inadequate tax policies have pushed SMEs into shadow economics and entrepreneurs are being squeezed between the so-called мpower organizationsо and high-level institutional corruption. Thus, entrepreneurial spirit is being destroyed by pseudo market conditions. These factors are also extremely harmful to the activity of foreign investors. For example, United States Federal racketeering laws prevent American businesses and persons from engaging in activities such as bribery outside the United States. Therefore if local business practices include such activities as part of the modus operandi, American businesses are effectively excluded from the market.

Recommendation

Resources need to be allocated to protect upstanding businesses. The problems of corruption needs to be addressed by both the state and local SME organizations. Educational programs should be implemented within SME associations to inform member companies of the economic benefits created in a business environment which recognizes business integrity and mutual trust among its members. Specifically, credible accounting procedures and legitimate business practices provide opportunities to access additional sources of long-term funding.

1.1.4 EXPECTED RESULTS

This action line will result in governmental recognition of the important role of SMEs in the development of the Bulgarian economy, outline the necessary macro-economic conditions that are necessary for their development, and underline the importance of including measures that specifically address the needs of the SME sector in whatever macro-economic actions are undertaken. The stabilization of the Bulgarian economy through an anti-crisis program and accelerated privatisation program will lay the foundations for the development of Bulgariaнs SME sector. Additional business climate improvements will result from the availability of financing from international sources, consistent and enforced tax laws, and credible and legitimate business practices. Ultimately, The SME sector will become a major contributor to the economic growth of the country. Providing an environment suitable for SMEs to conduct business will lead to the creation of many new jobs necessary to absorb new unemployment created by restructuring former SOEs, and will also serve to redistribute income. SMEs will also provide an additional market for the purchase second-hand equipment from SOEs. They will also contribute to the success and efficiency of Bulgariaнs large corporations by providing services that facilitate business. As a result of these factors, the larger and more developed the Bulgarian SME sector, the greater the SME contribution to the growth of the economy.

1.2 ACTION LINE 1.2: POLICY FOR ENCOURAGING AND SUPPORT OF

THE SMALL AND MEDIUM ENTERPRISES

1.2.1 BACKGROUND

The state administration has not implemented a consistent, long term strategy for the creation of the appropriate environment to promote SME development, and for the attainment of competitive power and European standards. On the contrary, policies are now in place that directly frustrate the development of the SME sector. The ultimate effect of which is the continuous expansion of corruption and lowering of legitimate entrepreneurial goals.

1.2.2 OBJECTIVES

The objective of this action line is to strengthen the SME sector by creating institutions and policies designed to provide direct support, unification, information and guidance currently unavailable for SMEs. In light of the present economic conditions, the needs of SMEs have become more pronounced and this has resulted in an urgent need for the establishment of a competitive environment in agreement with European standards and regulations.

1.2.3 ACTIONS

The actions foresee:

1. the development of a clear definition of SMEs, along the lines of those proposed by the European Union, through which a proper framework of support for the SME sector can be based (SME DEFINITION).

2. the building of an institutional infrastructure for encouraging and supporting SMEs (INSTITUTIONAL INFRASTRUCTURE).

3. the implementation of a consistent policy of support measures and relieves for SMEs (SUPPORT SYSTEM).

4. the development of a program for the financial assistance and relief for the SMEs according to the general economic conditions in the country (FINANCIAL ASSISTANCE AND RELIEF).

5. the development of a foreign economic policy for the attraction of government support for the SME sector (FOREIGN ECONOMIC POLICY).

SME DEFINITION

Background

Recent definition of SMEs under section 1.1 of the Law for the National Bank for Investing and Development is as follows: Small size enterprises is defined as those enterprises with no more than 50 employees and a balance value of its long-term material assets not exceeding 5,000 times the national average monthly salary. Medium size enterprise is defined as those enterprises with no more than 100 employees and a balance value of its long-term material assets not exceeding 10,000 times the national average monthly salary.

The definition adopted by the European Commission is as follows: SMEs are defined as enterprises which have fewer than 250 employees, and have either an annual turnover not exceeding ecu 40 million, or an annual balance-sheet total not exceeding ecu 27 million. When necessary to distinguish between small and medium sized enterprises, a small enterprise is defined as an enterprise which has fewer than 50 employees and has either an annual turnover not exceeding ecu 7 million or an annual balance sheet total net exceeding ecu 5 million.

Recommendation

The development of a clear and appropriate Bulgarian legal definition of SMEs is needed through which a proper framework of support for the SME sector can be based. This definition needs to also incorporate to a large extent those definitions that have been adopted by international institutions. Such a definition is essential for two reasons. First, from a domestic standpoint, the country needs to clearly define its SME sector so that Bulgarian SME programs, policies and laws can be implemented with distinct constituents. Second, from an international standpoint, there has recently been significant international institutional recognition and interest in the promotion of the SME sector as a means to further development. Therefore, without a definition of SMEs that incorporates international definition, Bulgarian SMEs may be excluded from capital and assistance designated under international definitions for SME development.

INSTITUTIONAL INFRASTRUCTURE

Background

A Bulgarian institutional infrastructure to support and encourage the development of the SME sector is severely lacking. Few public institutions authorized to carry out economic functions have no special policy for SMEs. State and political powers are aimed at creating formal governmental unions; undermining the motivation to create independent unions. Lobbying is either highly fragmented or reduced to serving personal and narrow political interests.

Recommendation

Currently, the most feasible action to create institutional infrastructure is one that demands minimal financial expense but gathers governmental-wide support. The solving of this problem is a question political will. The roles of both state and private institutions must be addressed in the overall formulation of a dependable institutional infrastructure.

A centralized structure requires the governmental addition of an agency or commission to address the needs of SMEs. The primary advantage of this approach is the consolidation of information and resources into one мaddressо for entrepreneurs and international investors to visit. However, the proliferation of Bulgarian agencies has significantly reduced the efficiency of specialized organizations. These problems are the result of competition between the agencies, a lack of synchronized effort and generally deficient agency regulation.

Equally important is the development of self-organized SME associations, institutions and unions. Maintaining independence provides the ability to exercise pressure upon the state and allows them to run more efficiently. In creating such bodies, it will be necessary that clearly defined policies regarding state relations, forms of dialogue and use of their expertise are created. In addition, criteria for the legitimacy of business associations must be formulated and their independence guaranteed.

SUPPORT SYSTEM

Background

From the viewpoint of the process of integration of Bulgaria in the European economic marketplace, and of the weight SMEs have in developed democracies, the formation of a competitive environment has to become a priority in the strategy of the state. This is an essential prerequisite for catching up with the European standards. However, hostility of the state towards private business has been displayed not only in its failure to create adequate, coordinated support systems for the Bulgarian SME sector, but also in its generally insulting political attitude and its lack of desire for dialogue.

Recommendation

Once a clear anti-crisis program and a concrete implementation of structural reform is underway, it will be necessary to outline the spheres in which SMEs will use certain privileges, advantages and concessions. This approach should be legally decreed in the Public Procurement Law.

A common system of concessions and encouragement measures for SMEs must be created which include the creation of мbusiness incubatorsо to provide trade, financial and technological information servicing; relieved procedures of registration, licensing and administrative service; relieves for renting of offices and working premises; training support; assistance in the creation of associations and the creation of мinnovation polesо to transfer technologies and act as mediators between the research centers and SMEs. Appendix #1 lists alternative forms of government assistance and support structures implemented in different countries for the development of SMEs.

FINANCIAL ASSISTANCE AND RELIEF

Background

Although plans for the development of the Bulgarian financial and insurance sectors are in progress, they lack a consistent and coherent strategy for the support of the SME sector. Absent adequate sources of capital, credit guarantees, insurance, and other quintessential financial tools, the development of the SME sector will continue to fail miserably. Fundamental to this system is a viable banking industry, insurance and securities industry, and pension and mutual funds that are capable of supporting the needs of SMEs.

Recommendation

Concurrent with the aforementioned general procedures for financial stabilization under Action Line 1.1, a long-term agenda must be implemented for the financial relief of the starting and strengthening of SMEs in light of a clear program of structural reform.

In addition to the general restructuring of financial institutions in which must exist a strategy to meet the needs of SMEs, a special Fund should be created to provide, among other things, credit guarantees for the SMEs, export insurance and guarantees, partial financing of мbusiness incubators,о partial financing of the innovation centers for SMEs, direct and indirect financial support training and expansion.

In accordance with the already stated principles for guaranteeing the independence of SMEs, this should be a mixed fund with state and private participation. In addition, an active foreign investment policy should focus in part on international development sources of capital which could be designated for the Fund. Concrete Fund policies, objectives and lending guidelines will aid in the attraction of much needed development capital.

The Fund should also be structured on a regional principle, with a certain regulated autonomy of regional structures. This will create a competitive environment at an inter-regional level, and provoke the municipality authorities into providing support for the SMEs. The local social and business structures will also be motivated to contribute for the fund-raising.

Other financial support systems for SMEs that need to be incorporated into the national policy for economic development as it emerges are special state assistance for SMEs operating in developing or poor regions; financial and tax concessions for the introduction of technologies, establishment of new working places, and improvement in the qualification of the employees; systems for encouraging and guaranteeing risk enterprises; normalization of the insurance system and the introduction of specialized insurance techniques for SMEs; systems for credit guarantees; and tax provisions that support large corporations that act as мaccidental credit banksо for SMEs.

FOREIGN ECONOMIC POLICY

Background

Another element of public policy which hinders the development of SMEs is the inadequate cooperation with the international financial institutions. For example, the EBRD has provided 90% of its support to the public sector and only 10% to the private sector even though the bank was created to support the two sectors proportionally 40% and 60%, respectively. With that in mind, the European Union has also been reviewing its policies for the support of developing economies and has recognized the importance of allocating resources for the development of the SME sectors. The lack of such a policy is especially emphasized when regional cooperation is considered; SMEs could play an important role in international cooperation.

Recommendation

The support for SMEs should be accented in the countryнs foreign economic policy. Specific areas of concern are as follows:

1. The attraction of aid for SMEs, both technical and financial, should develop on a bilateral and multilateral basis, and focus on international organizations and financial institutions;

2. Special attention needs to be paid to SMEs in the common system for the encouragement of exports (if such priorities exist in the state);

3. Informational provisions and promotion have to be developed such as the use of trade counselors at the diplomatic missions.

4. Special provisions must exist for the inclusion of SMEs in the schemes of international guarantees; and

5. The priority of SMEs in the development of regional and international partnership must be emphasized.

1.2.4 EXPECTED RESULTS

The expected results of these recommendations will be the creation of a support network and the removal of obstacles, common to all private businesses, but particularly relevant to SMEs. By providing SMEs with adequate representation and acknowledgment through the creation of applicable government and private support structures, the implementation of other supporting strategies can commence. Common resource centers, either business incubators or innovation poles, will provide information servicing and coordination activities.

The final expectations of such projects are the creation of a network of support institutions, policies and programs that will make the Bulgarian SME sector competitive, both domestically and in the international market.

2. ACTION LINE 2: IMPROVING THE INSTITUTIONAL AND LEGAL ENVIRONMENT FOR SMALL AND MEDIUM SIZE ENTERPRISES

2.1 ACTION LINE 2.1: IMPROVING THE INSTITUTIONAL FRAMEWORK FOR SMALL AND MEDIUM SIZE ENTERPRISES

2.1.1 BACKGROUND

Bulgaria has completed, by and large, building the institutional framework to implement laws affecting small and medium size enterprises (SMEs). Many government institutions were in place before 1989. Others, such as the Constitutional Court, the Supreme Judicial Council and the Committee on Protection of Competition, have been created in the last several years and are now functioning. Still, there remain gaps many of which are in areas directly related to SMEs.

2.1.2 OBJECTIVES

The objective of this action line is to facilitate the process of institution building and operation, so that a better institutional framework for SMEs be put in place as quickly as possible. Lack of institutions, such as a fully developed court system, creation of a functioning notary public system and development of a nationwide commercial registry system has a great negative impact on the functioning of SMEs.

2.1.3 ACTIONS

The actions foresee:

1. the completion of the structuring of the court system (COURT SYSTEM);

2. the creation of a private notary system (NOTARY SYSTEM);

3. the creation of a nationwide commercial registry system (COMMERCIAL REGISTRY SYSTEM);

4. improvement of the Committee on protection of Competition efficiency (COMMITTEE ON PROTECTION OF COMPETITION POWERS)..

COURT SYSTEM

Background

The Law on the Structure of the Judicial System was passed in 1994. Several Constitutional challenges slightly revised the law, although its major purpose -- to create a tier of courts of appeal -- remains intact. Bulgaria has chosen a four-tier system of courts to implement a three-instance procedure (that is, there are four different courts and everyone is guaranteed a trail and two appellate reviews). The Bulgarian Constitution required the courts to be established by July 1992.

Recommendation

Politicians are responsible for implementing existing court structuring legislation. Creation of the Courts of Appeal should take place as soon as possible, for SMEs suffer the most from the inoperable court system. Implementation of such courts should be preceded, however, by the development of procedural rules (administrative, civil and criminal) tailored to meet the requirements of the new system. The development of procedural rules is possibly an area for which court administrators could work with experts coming from academia, the SME sector, non-governmental organizations, and practicing judges and lawyers.

NOTARY SYSTEM

Background

Like most countries, Bulgaria requires that real estate and automobile transactions, mortgage executions and other transactions take place before a notary public. The law also frequently requires that signatures be notarized, dates or contents of documents be verified or copies of documents be certified. Transactions that require a notaryнes seal are usually invalid if it is omitted.

While most of the rest of the world operates under privatized notary systems, Bulgaria relies on a very limited number of notaries who function as state officials. For example, in the City of Sofia, with a population of 1.5 million and a huge concentration of business, there are approximately one dozen notaries. It is not uncommon to wait weeks or even a month to execute a mortgage or buy real estate and even a simple notarization of a signature usually takes over an hour. The inoperable notary system has a stifling effect on SMEs because of the cost, waste of time and the uncertainty that go with it.

The government introduced to Parliament a Draft Law on Notaries. The draft law follows the model of Austria, Germany and other European countries and provides for the development of a private notary system. This law has been pending in Parliament for more than two years now.

Recommendation

The Law on Notaries has been passed by the National Assembly. With a private notary system transaction costs will decrease, a private administration system will develop and government will dispense with a burdensome responsibility. Now that the law has been passed, the government should with experts coming from academia, the SME sector, non-governmental organizations, and practicing notaries and lawyers to expedite the implementation of the law and education of notaries in working under a private notary system.

COMMERCIAL REGISTRY SYSTEM

Background

To determine who owns what property, its type, size or shape, or whether it is encumbered and to put people on notice of these facts, governments create property registries. Like most countries, Bulgaria requires that properties and information about them be registered. While registries exist in Bulgaria, there is no central system.

Information on real estate, for example, can be found in any of over 100 registries located throughout Bulgaria. To locate all property of a bankrupt debtor or learn of all property owned and encumbered by a prospective borrower, creditors -- to do their job properly -- are required to check each registry by physically visiting each location. Do most creditors do their job properly? No. It is nearly impossible, and thus, they are required to accept additional risk.

There are also 29 commercial registries located throughout the country. To conduct due diligence on the legal standing of a prospective partner or purchase, one might be required to visit a registry in Varna, Blagoevgrad, Russe -- or almost anywhere else. This inconvenience makes conducting necessary due diligence difficult and time consuming; the result is that the due diligence is often not completed. Such inconvenience is not necessary in a country the size of Bulgaria and in a modern era of computer technology.

Recently, Parliament passed the Law on Registered Pledges. It is a law critical to the development of SMEs, for it increases their capability to provide collateral of higher value to their possible creditors, thus increasing their access to credit. The Law on Registered Pledges provides for a central pledges registry with the Ministry of Justice. Creating the registry institution is critical for putting the new law in operation. Through the central registry both debtors and creditors will be able to make security interests public, secure priority of security interests and safeguard against relying on property already encumbered by third partiesн security interests.

In general, registry information is difficult to obtain. Officials do not have proper understanding of the concepts of freedom of information and oftentimes create (voluntarily, or not) obstacles to free acces to information. That has worst effect on SMEs who often lack the capacity to hire lawyers and consultants and have to fight the bureaucratic obstacles themselves.

Recommendation

Ultimately, Bulgaria should create a system of computerized central registries. Such a project is ambitious and will take time and money. Focus should be placed first on creating the central pledges registry as a fully computer-based registry with a central database and numerous terminals, and operating under a simplified administrative procedure. The experience from creating and operating this registry should be studied carefully and carried over to other existing or future registries.

One action that can be taken in the short term, however, is to create uniform formats for national computer databases. When such formats are developed, they can be made available to local registries that can begin recording information according to the standardized national form. When a national computer system is developed, the locally produced information should be easily transferred to the national system.

In general, free access to information should be adequately provided for by law, so that looking for and finding publicly available information is made quick and easy. EU First Council Directive of 9 March, 1968, regarding public availability of commercial registry information needs to be observed.

COMMITTEE ON PROTECTION OF COMPETITION POWERS

Background

The Committee on protection of Competition has been in existence for over five years now. Unfortunately it has demonstrated a high level of inefficiency, for the powers provided to it by law are insufficient to let it tackle problems like counterfeiting of goods, monopoly position, IPRs infringements, etc.

Recommendation

The Committee on Protection of Competition must be provided with more and more clear-cut powers which would allow it to take direct action against agents of unfair competition practices. The current approach, where the Committee is only authorized to take court action against violators, must be abandoned and substituted for by direct administrative powers. Thus, SMEs will be better protected against strong monopolies remaining from the communist economy period and against producers and importers of counterfeited goods.



2.1.4 EXPECTED RESULTS

Implementing institutional reform will have a boosting effect on the development of SMEs. The cost of running business will be significantly decreased by reducing the time and effort necessary to resolve legal disputes or to perform routine operations, such as notarizations and due diligence on registry information.

2.2 ACTION LINE 2.2: IMPLEMENTING EXISTING LAWS AFFECTING SMALL AND MEDIUM SIZE ENTERPRISES

2.2.1 BACKGROUND

Bulgarian Parliament has passed a number of laws relevant to the activity of SMEs that have not been effectively implemented yet. Some times this is due simply to lack of relevant experience among implementing officials and representatives of SMEs (e.g., bankruptcy). Other times implementation also requires some institution building beforehand (e.g., registered pledges). In a number of cases legally fixed implementation procedures slow down the implementations (e.g., privatization). In all such cases SMEs suffer due to the inability of institutions and private sector to implement, or act under, laws that are the result of already existing political consensus in society. Such laws are national capital that is being wasted by failure to use, resulting in loss of thousands of opportunities for SME development.

2.2.2 OBJECTIVES

Appropriate actions should be taken towards implementing existing and non-implemented legislation. Each sector, private and public, must go their part of the way and get educated about how new laws function in order to obtain the desired results. A lot of joint work needs to be done, as well, if interaction among SMEs and public institution is to appear and bring to life new social mechanisms and functions.

2.2.3 ACTIONS

The actions foresee:

1. the implementation of bankruptcy legislation (BANKRUPTCY LEGISLATION);

2. the implementation of registered pledges legislation (REGISTERED PLEDGES LEGISLATION);

3. the implementation of privatization legislation (PRIVATIZATION LEGISLATION);

4. the implementation of intellectual properties rights legislation (IPRs LEGISLATION);

5. the implementation of securities regulation legislation (SECURITIES REGULATION LEGISLATION).

BANKRUPTCY LEGISLATION

Background

Liquidation and reorganization procedures are common features of developed market economies and are viewed as essential to the functioning of an efficient economy. Such procedures can also be used as methods of privatization. In August 1994, the law on bankruptcy came into force. The law allows for restructuring or liquidating insolvent companies.

Bulgarian courts and practitioners are somewhat experienced in insolvency law. Reorganization, however, is different. Few reorganization cases have been filed under the new law (and were not provided for under the old) and courts, practitioners, creditors and debtors will likely suffer because of initial inexperience.

Implementation of the law is often hindered by judicial and practitioner inexperience and government attempts to save some large companies whose liquidation or even reorganization will boost social discontent and unemployment.

Recommendation

Bankruptcy courts and practitioners need to be trained in the intricacies of reorganization law. This training could be accomplished by traditional seminars and the мнhands-onом experience of participating in test reorganization cases. An appropriate company could be identified for reorganization and taken through the process with training teams of appropriate judges, lawyers, trustees, creditors and debtors.

A large number of expected bankruptcies will most likely inundate Bulgariaнпs fledgling bankruptcy court system. To prevent overwhelming of the system -- and accompanying delay -- steps should be taken now to develop court technology including databases to inform courts, practitioners and the public of the status of pending bankruptcies. If such information is readily available, courts and practitioners will be able to better perform their jobs and public resistance to bankruptcy may decrease as some of its benefits become apparent.


REGISTERED PLEDGES LEGISLATION

Background

In early November Parliament passed a new Law on Registered Pledges. Undoubtedly, this Law will greatly enhance the development of bank financing and other credit which will, in turn, positively affect SMEs. The implementation of this Law, however, is going to require hard and extensive preparatory work: designing of a registry institution; designing of a fully computerized, paperless registry system; implementing a reliable telecommunications system connecting the central database with local terminals; training registry officials into the implementation of a registry system run by administrators, not by judges. In this effort, the government will have to rely a lot on private businesses in the fields of telecommunications, computers, information technologies, personnel management and others. The successful implementation of the central pledges registry will not only enable the implementation of the Law on Registered Pledges -- it will also serve as a pattern in designing future registries and reforming existing registries. The central pledges registry might become the core institution of a future merged registry for registering real estate transactions, commercial companies and other elements of a healthy SME legal environment.

Recommendation

The Government, in the face of the Ministry of Justice, should invite proposals from relevant experts from business and academia, in order for it to design a modern and workable registry which could also serve as a model in reforming the registry system of Bulgaria. Legal experts drafting the secondary legislation which will govern the registry institution and procedures must work closely with technical experts. Once the technical facilities and the proper legal framework are in place, future registry officials and staff must be trained into running the registry. SMEs, banks and other private entities possibly to be affected by the new system should be educated, as well. The efforts of the Government, the SME sector and non-governmental organizations need to be coordinated to achieve a maximum effect of training.

PRIVATIZATION LEGISLATION

Background

Bulgaria adopted a system of mass privatization in June 1994. This supplements a market privatization scheme that was adopted in April 1992. However, Bulgaria has become known internationally for its slow and insignificant progress towards privatizing its industry. Obviously, an efficient privatization system will increase opportunities for SME creation and development. The undergoing first round of mass privatization demonstrated what a potential there is in converting existing state owned medium and small businesses into private SMEs. Market privatization holds the same potential. Successful implementation of privatization legislation will result in a big step towards creating a strong and significant SME sector in Bulgaria.

Recommendation

This paper will suggest the rather obvious point that Bulgaria should pursue all privatization options including mass privatization, market privatization, combinations of the two and other methods such as bankruptcy liquidation. Special attention needs to paid to implementing secondary legislation which oftentimes has the effect of stalling the privatization process. Special rules need to be designed for shortening the duration of privatization transactions development and completion. An open public dialogue needs to be initiated where SMEs, lawyers and economists from the private sector may discuss expedition techniques with the government.

INTELLECTUAL PROPERTY RIGHTS (IPRs) LEGISLATION

Background

Bulgaria had become known for its lack of support and protection of IPRs. However, the government took quick and adequate action and nowadays Bulgaria is among the countries with most modern and complete legal framework for the protection of IPRs. Dspite new legislation, the rate of IPRsн violation still continues to be high.

Recommendations

IPRs legislation needs proper enforcement. Officials in IPRs enforcement agencies need to be traind in how to act in a more eficient manner against violators. Owners of IPRs need to be educated in the field of applying protection measures against violators. Better protection of IPRs will help the SME sector in two ways. SMEs which are owners of IPRs will receive protection. The image of the emerging SME sector as a generator of IPRs violation will radically improve.

SECURITIES REGULATION LEGISLATION

Background

New securities regulation legislation has been passed. Its first year of implementation demonstrates that the greatest hardships in its implementation are sourced in the lack of proper infrastructure of the capital market.

Recommendation

Work for the creation of a proper infrastructure of the capital market. The creation and proper provision for a central depository for securities is critical to setting up the markt. Same is true about securities exchanges. Well developed capital markets are vitally important for SMEs and the SME sector will strongly benefit from a developed capital market.

2.2.4 EXPECTED RESULTS

A lot of time, public energy and capital has been invested in creating new modern legislation. This investment continues to stay dormant while the Bulgarian SME sector suffers from lack of appropriate legal framework. This results in a multiplication of the loss to society as a whole. Bringing to life newly passed legislation as soon as possible will utilize a lot of investment that has been made by Bulgarian society and will sharply improve the legal conditions for SMEs and will increase the size and vitality of the emerging SME sector.

2.3 ACTION LINE 2.3: DRAFTING ADDITIONAL LAWS AFFECTING SMALL AND MEDIUM SIZE ENTERPRISES

2.3.1 BACKGROUND

Many steps have been taken towards creating an enabling environment for SMEs, many of which have been completed and some of which still need to be finalized. However, there is still a number of laws that need to be drafted in the near future.

2.3.2 OBJECTIVES

This paper does not have the purpose to propose an exhaustive list of laws that need to be drafted in order for the legal framework for SMEs to be completed. It just suggests certain important pieces of legislation which, no doubt, are necessary for the development of the SME sector.

2.3.3 ACTIONS

The actions foresee:

1. the drafting modern foreclosure legislation (FORECLOSURE LAW);

2. the drafting amendments to leasing law (LEASING LAW);

3. the drafting consumer protection laws (CONSUMER PROTECTION LAW);

4. the drafting electronic commerce legislation (ELECTRONIC COMMERCE LEGISLATION);

5. the drafting modern currency exchange legislation (CURRENCY EXCHANGE LEGISLATION);

6. passing specialized legislation on SMEs (SME LEGISLATION)

FORECLOSURE LAW

Background

Foreclosure is a difficult process in Bulgaria. Confidence in the legal mechanism for enforcing rights is low and private мнenforcementом and racketeering groups flourish. The result of the difficult foreclosure process is that commercial turnover slows down. Businesses attempt to avoid situations where money would be owed to them for fear that commitments will not be honored and enforced.

The existing foreclosure law does not recognize or allow for non-judicial methods of foreclosure (with the exception of the newly passed Law on Registered Pledges which, when it takes effect, will only allow out-of-court foreclosure on pledged movable property). Every creditor who has procured a writ of execution, regardless of whether it is a secured creditor, must go through a lengthy judicial process. Sale of a debtorнпs assets must be effected at a court appointed auction. The initial auction price must be determined by a court appointed expert. If a creditor must foreclose on a combination of real estate and chattel, this must happen in two different procedures which do not necessarily run parallel in time. Debtors are not allowed to bid and creditorsнп rights to bid are limited. Foreclosure on bank accounts is practically unworkable. Steps need to be taken so that the law will enable creditors to easily obtain information about the existence and location of bank accounts.

The foreclosure playing field is tilted in favor of the debtor. Debtors have numerous opportunities to prolong the procedure. Fines for violation of procedural rules are outdated and low and do not deter procedural violations. Even when, after a lengthy process, the court has scheduled an auction, a debtor -- whose assets may exceed the value of the creditorнпs claim -- may delay the process by another two years. If before the auction occurs the debtor pays 20 percent of the claim and commits to pay ten percent every quarter, foreclosure is stopped. The result can be that a poor creditor is forced to accept payments over a two-year period from a wealthy debtor.

Written to service a 1952 command economy, the law is unsuited for 1994 market. It is true that SMEs will appear mostly as debtors and an efficient foreclosure procedure at first sight appears to be detrimental to their interests. However, an efficient foreclosure procedure will enhance lending and SMEs will ultimately benefit from a more stringent legal framework applicable to them.

Recommendation

Organize a working group to draft and lobby for passage of a modern foreclosure law. The government will perform much better in providing a workable foreclosure legislation if it works closely with banks and other private businesses. By far, private businesses and banks are the ones who suffer most from the current foreclosure framework and could propose suitable solutions to most of the existing problems. In this way it will be guaranteed that no problems will be left unresolved, as well.

LEASING LAW

Background

Leasing is used in western economies as an effective means of мpay as you goо financing. It is particularly attractive for SMEs. Bulgaria has a long tradition -- over ten years -- of leasing relative to its Central European neighbors.

Leasing transactions were recently provided for in a newly passed division of the Law on Commerce. Still, certain problems remain which inhibit the development of leasing as a financial method.

Under VAT, finance transactions are tax exempt. Finance leasing transactions (where, simply put, money is borrowed to finance the purchase of equipment), however, are not classified as finance transactions under Bulgariaнпs VAT law. The result is that a finance lease cannot compete with a finance loan. This is because when a buyer makes a purchase with a loan, it pays VAT on the purchase price of the product, but it does not pay VAT on the мнcostом of the loan (the lenderнпs interest rate). When a buyer (or lessee) makes a purchase with a lease, however, it pays VAT on the мнcostом of the lease (the lessorнпs profit).

Furthermore, a lender is not required to acquire the financed product and pay VAT on the purchase price. A lessor is. It pays 18 percent of the price of the goods to VAT. While the lessor eventually gets a refund, it is not paid interest on its refund and it must go through a complicated refund process which costs it (and the state) time and money. The process is complicated and expensive for both the lessor and the state and the cost is not justified because the state cannot expect to make a gain.

Demand for financial leasing should be high in Bulgaria primarily because (1) the country faces a lack of financial resources for starting businesses, (2) suitable financing is difficult to obtain from Bulgarian banks and (3) the process for obtaining bank loans is usually long and arduous.

Leasing has been used in Bulgaria since 1989 as a quasi method of privatization. In typical a rendre agreements, state-owned properties -- most of them green grocers or other retail outlets -- are leased -- usually to business employees.

 
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