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A Fly-By-Night Counterparty: Why It Harms Business and How to Detect It

4 November 2020

A Fly-By-Night Counterparty: Why It Harms Business and How to Detect It

A counterparty may turn out to be not the one who it claims to be. A company can be with a nominee director, without staff and equipment. Such counterparties create problems for business, because cooperation with them threatens problems with the tax service and imposition of fines.


What Does a Fly-By-Night Company Mean?


The law of Ukraine does not explain this, but the term is used “in everyday speech”. Usually a “fly-by-night firm” refers to a company that is registered for specific business transactions and to a fictitious person. The purpose of its creation is illegal activities or money laundering.


At the same time this type of companies is often referred to as fictitious entrepreneurship. And although in 2019 the article of the Criminal Code of Ukraine on fictitious entrepreneurship was decriminalized, “fictitious activity” is still recorded in the Economic Code of Ukraine. So it can still be punishable.


According to the Economic Code of Ukraine, the activity is fictitious when a company is registered to a fictitious person, forged or “lost” documents or not registered at all (an egregious case).


Prior to the decriminalization of the article of Criminal Code in 2019, the Prosecutor General’s Office of Ukraine initiated 469 criminal proceedings for fictitious entrepreneurship. It should be understood that the PGO speaks only about those companies that are known.


Read more: “Headless” Companies: Legal Entities and Individual Entrepreneurs without Heads and Types of Activity Still Exist in Ukraine


To What Extent Is a Fly-by-Night Counterparty Dangerous


Tax inspections


If the tax service suspects a company of fictitious activities, it will conduct cross-inspections of it and of its counterparties (order of the State Fiscal Service of Ukraine №511).


Please, note that if a company suspected of fictitious entrepreneurship is engaged in illegal activities, the act of tax inspection may become the evidence of a crime. Its officials may obtain the status of accomplices in a criminal offense.


It is also possible that the tax service will charge extra VAT and fines based on the results of cooperation with the company whose activities are considered fictitious. For example, for the company “ADM Ukraine” the tax service increased financial obligations concerning the payment of VAT by 12 777 UAH and imposed a fine of 3 194 UAH as a result of an audit of its relations with “AN-Trans”. The activities of the latter turned out to be fictitious. “ADM Ukraine” could not appeal the decision of the tax service, the court decided that, due to the fictitious activities of the counterparty, any of its transactions cannot be legal.


Wrecked Agreements


A company may be a sub-counterparty of a dishonest executor under a state contract. In this case there is the risk that the contract won by the main counterparty will be canceled due to its fault. For example, because the documents on the part of the executor were signed by a disqualified director.


There will also be problems if the main counterparty is suspected of laundering state money. For example, the State Fiscal Service of Ukraine has recently detected a scheme of state money laundering by a company with signs of fictitiousness.


In this case counterparties of a “fictitious” company usually fall under the role of possible accomplices.


Driving into Bankruptcy


Due to the signs of transaction dishonesty, they can be considered fictitious and aimed at the accumulation of artificial debts. This scenario can occur if a counterparty is created shortly before the bankruptcy of the company, it has no office, employees or there are other signs of a fly-by-night company. Driving into bankruptcy is punishable by the Criminal Code of Ukraine. A partner of such a counterparty can easily become an accomplice.


How to Recognize?


The State Fiscal Service of Ukraine listed the following features of fictitious companies:


- activities on behalf of the company can be carried out not by the founders and participants, but by its initiator, who legally may even be “out of business”;

- the company is not located at the registration address;

- the company does not submit tax returns or submits them blank;

- there are no data about employees;

- there are no conditions for carrying out activities. For example, there is no office, no equipment.


In addition, you can also check:


- originals of the documents that establish the identity of the head;

- availability of the authorized capital;

- whether the director is the founder of dozens of other companies.


The presence of these signs is not a final verdict, of course. For example, if a company does not have an office, it does not mean that it is immediately a fly-by-night company. Maybe people work at some coworking space. But paying attention to these aspects is important to make sure. This is a kind of checkup of a counterparty.


To check a counterparty in detail, you will have to use more than one open source, for example, to find it in the Unified State Register, to check the presence of court cases of the company. You also need to make sure that the counterparty is not in a state of bankruptcy, to find out whether its activities generate profits, whether it fulfills its obligations to other companies. You can do all this by yourself, but you will have to spend at least a day.


After that the director, a lawyer or an assistant needs to meet the representatives of the future counterparty in person to make sure of their reality.


You can spend a day checking a counterparty if there is one counterparty. But companies work with many suppliers and buyers.


To speed up checking, use YouControl tools, especially the Compliance Expertise. You simply order an analysis of a counterparty, and in 24 hours you receive a detailed profile with the analysis from lawyers that meets your business goals. Whether it is working with a supplier, buying a company, an agreement with a permanent partner or other purposes of working with a counterparty.


Order the Compliance Examination.

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