Can a debtor’s pre-insolvency transactions be challenged? If so, by whom, when and on what grounds? What is the effect of a successful challenge and how are the rights of third parties impacted?
Restructuring & Insolvency
Under Australian law, antecedent transactions will only be vulnerable to challenge where a company is in liquidation. A liquidator has the power to bring an application to the court to declare the following types of transactions void:
- insolvent transactions (which includes both unfair preferences and uncommercial transactions) if entered into, in the case of unfair preferences, during the 6 month period ending on the relation-back day (the relation-back day is generally the date of the application to wind up the company or the date of the appointment of a liquidator if the company had previously been in administration) or in the case of uncommercial transactions, during the two-year period ending on the relation-back day;
- unfair loans, which are voidable if entered into any time before the winding up began;
- unreasonable director-related transactions, which are voidable if entered into during the 4 years ending on the relation-back day; and
- transactions entered into for the purpose of defeating, delaying or interfering with creditors’ rights on a company’s winding up, which are voidable if entered into during the 10 years ending on the relation-back day.
Uncommercial transactions and unfair preferences are voidable if the company was insolvent at the time of the transaction or at a time when an act was done to give effect to the transaction. Australian courts have held that a transaction is ‘uncommercial’ if a reasonable person in the company’s circumstances would not have entered into it. An unfair preference is one where a creditor receives more for an unsecured debt than would have been received if the creditor had to prove for it in the winding up. The other party to the transaction or preference may prevent it being held void if it can be shown that they became a party in good faith, they lacked reasonable grounds for suspecting that the company was insolvent and they provided valuable consideration for, or changed position in reliance on, the transaction.
Australian courts have also determined that loans to a company will be ‘unfair’ and thus voidable if the interest or charges in relation to the loan were, or are, not commercially reasonable. This is to be distinguished from the loan simply being a bad bargain. Any ‘unreasonable’ payments made to a director or a close associate of a director are also voidable, regardless of whether the payment occurred when the company was insolvent.
Upon a finding of a voidable transaction, a court may make a number of orders impacting the rights of the third parties to those transactions. Those orders include directions that the offending person pay an amount equal to some or all of the impugned transaction; direct a person to transfer the property back to the company; or direct an individual to pay an amount equal to the benefit obtained.
Certain antecedent transactions may be subject to challenge pursuant to section 99 (avoidance of property dispositions), section 145 (voidable preference), section 146 (avoidance of dispositions at an undervalue) and section 147 (fraudulent trading) of the Companies Law.
Section 99 provides that any disposition of a company's property (or transfers of its shares) made after the deemed commencement of the winding up shall be void, unless validated by the Court. In the event of a successful challenge by a liquidator under section 99, the liquidator will be entitled to seek appropriate relief to require either the repayment of the funds or the return of the asset.
Transactions entered into by a debtor prior to the commencement of the liquidation may be subject to challenge by a liquidator as either a preference or a disposition at an undervalue. In each case, the debtor company must have been unable to pay its debts at the time of, or as a result of, the relevant transaction.
A transaction may be subject to challenge as a preference if it took place in the six month period before the commencement of the winding up and a liquidator can establish a 'dominant intention to prefer' on the part of the insolvent company. If the preferred party is related, there is a presumed intention to prefer. The ability of an official liquidator to assert a clawback claim in circumstances in which a preference is established was recently affirmed in the decision of the Cayman Islands Court of Appeal In Re Weavering Macro Fixed Income Fund Limited (In Official Liquidation) (CICA No.2 of 2016).
If a transaction is set aside as a preference then it is void and the creditor will be required to return the payment or asset and prove in the liquidation for the amount of its claim.
Any disposition at an undervalue made by or on behalf of the insolvent company in the six year period prior to the commencement of the winding up with an intention to defraud its creditors will be voidable at the instance of the liquidator.
If the Court is satisfied that a transferee has not acted in bad faith, the transferee shall have a first and paramount charge over the property of an amount equal to the entire costs properly incurred by the transferee in the defence of any proceedings challenging the relevant disposition, which will be set aside subject to the proper fees, costs, pre-existing rights, claims and interests of the transferee.
If the business of the company was carried on with an intent to defraud creditors or for any fraudulent purpose, section 147 of the Companies Law provides that a liquidator may apply for an order requiring any persons who were knowingly parties to such conduct to make such contributions to the company's assets as the court deems proper.
The following avoidance actions are available to the relevant insolvency practitioner or a creditor (if the relevant rights have been assigned to it):
- Avoidance of gratuitous transactions targets, in particular, all gifts and all dispositions made by the debtor without any or without adequate consideration;
- avoidance for over-indebtedness targets the granting of a security interest for existing debts without a prior contractual obligation, the settlement of a monetary claim in a manner other than by usual means of payment and the payment of a debt which was not yet due, in each case provided that the recipient is unable to prove that it was unaware and must not have been aware of the debtor's over-indebtedness; and
- avoidance for intent targets dispositions and other acts made by the debtor if the disposition was made by the insolvent with the intent to disadvantage its creditors or to prefer certain of its creditors to the detriment of other creditors and if the privileged creditor knew or should have known of such intent.
Targeted transactions must have occurred during certain look-back periods: Avoidance of gratuitous transactions and avoidance for over-indebtedness is available where a relevant act has occurred during the year prior to the opening of bankruptcy proceedings, the granting of a moratorium or the seizure of assets. A five years period applies to avoidance for intent. Following the opening of bankruptcy proceedings or the conclusion of a composition agreement with assignment of assets, the avoidance claims must be pursued within two years (statute of limitations).
For all challenges, it is further required that the challenged transaction has caused damages to other creditors of the debtor. In addition, it is noteworthy that the rules regarding avoidance for intent as well as avoidance of gratuitous transactions provide for an inversion of the burden of proof whenever these transactions are entered into by related parties (including affiliated entities).
If all requirements are met, the court orders the defendant to return the specific assets to the estate. If this is no longer possible, the court may order the defendant to compensate the estate in cash. The defendant has a return claim for its own performance which is to be performed in kind as an obligation of the estate or, if no longer possible, by admittance of an unsecured and non-privileged insolvency claim.
German insolvency law entitles an insolvency administrator or trustee in self-administration cases to claw-back certain transactions made by the debtor prior to insolvency.
The insolvency administrator is only able to challenge transactions that prejudice the creditors as a whole by reducing the insolvency estate. Furthermore, at least one or more of the specific statutory requirements set out in Sec. 130 et seq Insolvency Code must be met in order to challenge a transaction.
Transactions may only be avoided if they were effected during certain “hardening periods”, i.e. certain periods before insolvency proceedings were opened. The respective hardening period varies between three months prior to the filing of an insolvency petition and up to ten years before filing, dependent upon the specific grounds for the challenge.
Cash transactions (Bargeschäfte), however, provide a notable exception for certain transactions that could otherwise be successfully challenged: Transaction under which (i) the consideration received is equivalent to the consideration given and (ii) the time span between both is no longer than (in most cases) two weeks are generally not subject to the avoidance rules because they are not detrimental to the estate (Sec. 142 Insolvency Code).
The terms congruent acts (kongruente Deckungen) and incongruent acts (inkongruente Deckungen) generally refer to conveyances of parts of the debtor’s estate during the three month hardening period prior to the insolvency petition or thereafter up until the insolvency proceedings are opened. Under German law, insolvency proceedings do not automatically commence with filing (see Question 4), however, transfers made in the period between filing and the commencement of proceedings are liable to avoidance by the insolvency administrator.
An act is generally termed to be congruent (Sec. 130 Insolvency Code) if the creditor receives payment on his claim or security for his claim in strict accordance with the existing contractual obligations. On the other hand, a conveyance is generally deemed incongruent (Sec. 131 Insolvency Code) if the creditor receives payment or collateral in a manner other than that contractually specified (eg, security instead of payment), at a point in time other than specified (eg, before the payment was due), or if the creditor did not have a right to demand satisfaction at all (eg, the claim was time barred).
Congruent acts during the hardening period may only be challenged if the creditor was aware that the debtor was unable to pay its debts as they fell due at the time of the transactions. If the transaction took place after filing, then it suffices that the creditor was aware of either (i) the filing or (ii) the debtor’s inability to pay its debts as they fell due. The cash transactions rules are applicable. Accordingly, when restructuring financing is provided, collateral should be taken in a timely fashion and only in respect of any new money.
Any transaction which is an incongruent act and is concluded in the month prior to the filing for insolvency is liable to be avoided by the insolvency administrator. Incongruent acts concluded during the three month hardening period prior to filing for insolvency, but not in the month prior to filing, are liable to be avoided if either (i) the debtor was unable to pay its debts as they fell due at the time of the transaction or (ii) the creditor knew that the transaction would be prejudicial to the creditors as a whole. The cash transaction rules are not applicable to incongruent acts.
An insolvency administrator can also void a transaction as a “deliberate impairment” (Sec. 133 InsO) by alleging that the transaction was made with the intent of prejudicing creditors by reducing the value of the estate. Such fraudulent conveyances that take place within the 10 years (!) preceding filing for insolvency are liable to claw back. The cash transactions rules do not apply, as the reason for avoidance is the debtor’s intent to defraud. For such challenge (i) the debtor must have intended to prejudice its creditors and (ii) the transaction counterparty must have had knowledge of such intent. Such knowledge is deemed to exist if the counterparty knew that there was a threat of the debtor becoming unable to pay its debts as they became due and that the transfer would be detrimental to the creditors. For the debtor to have the requisite intent it must be at least reckless as to whether the transaction is to the creditors’ detriment. In litigious cases, the burden of proof regarding such circumstances generally lies with the insolvency administrator. The provision has recently gained more practical relevance due to an extensive interpretation by the German Federal Supreme Court (Bundesgerichtshof). As actual intent is difficult for an insolvency administrator to prove, various circumstantial evidence will be considered by German courts in determining a debtor’s intent to prejudice its creditors. As the 10 year period is deemed to be too long, the German legislator has most recently started an initiative to reduce this time frame to four years only. It is likely that the relevant provision will be changed in 2017.
Gratuitous transfers if they take place within the four years preceding filing for insolvency can be clawed back by the insolvency administrator.
Where a repayment is made in respect of a debt owed to a shareholder and that payment is made in the year prior to filing for insolvency, it can be clawed back under Sec. 135 Insolvency Code. Where security has been granted in respect of such debt, it can be avoided if it was granted in the decade prior to filing for insolvency.