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
Certain transactions can be set aside if the debtor is declared bankrupt and they were carried out during a specific period before the bankruptcy adjudication or before publication of the petition to be admitted to the In-court Settlement procedure (suspect period). These include:
- gratuitous acts or payment of debts not yet due and payable when bankruptcy is declared if carried out in the two-year period before the bankruptcy adjudication. These will be ineffective with regard to creditors by operation of law;
- acts that will be set aside on simple demand by the trustee, unless the third party defendant can prove he entered into the transaction without any knowledge of the debtor's insolvency, including: onerous transactions whose terms and conditions are significantly disadvantageous for the bankrupt debtor, if carried out in the year before the bankruptcy declaration; payment of debts using non-customary means made in the year before the bankruptcy declaration; pledges and mortgages created by contract, if established a year before the bankruptcy adjudication as security for outstanding debts not yet due and payable; and pledges and mortgages, whether created by contract or imposed by court order, if established six months before bankruptcy as security for due and payable debts that have remained unpaid;
- acts, transactions or payments that will be set aside if the trustee proves that the third party defendant knew or could not have ignored the debtor's insolvency at the time the act was performed, including: payments and other non-gratuitous acts of disposition made by the bankrupt debtor in the six months before the bankruptcy adjudication; and security interests, if the contemporaneous creation of the debt and grant of security occurred in the six months before the bankruptcy adjudication.
Certain transactions are expressly exempted from being set aside, including payments for goods and services in the normal course of business on standard terms and payment of employees' wages.
If, during the suspect period, a debtor's property was transferred at an undervalue to a purchaser who then transferred it to a sub-purchaser, the setting aside of the first transaction will affect the sub-purchaser's right: (i) by operation of law where the transfer was gratuitous, or if the sale to the sub-purchaser was not registered in the competent Land Register before registration of the claw-back action by the trustee or (ii) only if the trustee proves the sub-purchaser's bad faith, where the sale to the sub-purchaser was registered in the competent Land Register before registration of the claw-back action by the trustee.
The insolvency administrator can challenge any pre-insolvency transaction carried out by the debtor in the two years before its declaration of insolvency if the transaction or merely the action is considered detrimental to the insolvency estate. Under article 71 of the Spanish Insolvency Act, the general terms in which a claw-back action can be initiated are as follows:
- Temporary requirement: only actions (or omissions) carried out in the two years before the declaration of insolvency can be rescinded.
- Objective requirement: actions or omissions to be rescinded must be detrimental to the insolvency estate.
- Qualitative requirement: even actions carried out without fraudulent intent can be rescinded.
The claw-back action can also be exercised by any creditor who has requested the insolvency administrator to do so, but does not seek the rescission within two months from the date of the creditor’s written request (subsidiary legitimacy).
Actions carried out in the debtor’s ordinary course of business and under market conditions cannot be rescinded. Moreover, some refinancing agreements may receive indemnity for actions of this kind if they meet the requirements set forth under article 71bis – Fourth Additional Disposition Spanish Insolvency Act.
Under the Spanish Civil Code, the debtor’s actions can also be challenged by means of revocatory actions or actions seeking for them to be declared void.
In bankruptcy proceedings, a debtor’s pre-insolvency transactions may be challenged by the trustees. The trustees must exercise this right through court proceedings within two years after the commencements of bankruptcy proceedings.
There are two elements to the grounds for such challenges. The first pertains to the timing of the transactions, and they need to be conducted after the debtor falls into financial crisis. The other is the harmfulness of the transactions to the debtors.
If such challenges are successful, the subject transactions basically become null and void. Bona fide third parties, however, may be protected from such challenges.
In special liquidation proceedings, such challenges are not available, but creditors may challenge transactions which are harmful to creditors based on the Civil Code. This challenge is not special to insolvency proceedings, and may apply to transactions in general.
On certain conditions, the debtor’s pre-insolvency transactions may be avoided by the insolvent estate. Avoidance means that an otherwise valid transaction made by the debtor is reversed if the transaction in question has defeated the assets of the estate or increased the debtor’s debt.
If the trustee believes that that debtor’s actions are contrary to the avoidance rules of the Danish Insolvency Act, the insolvent estate must no later than 12 months from the issue of the insolvency order institute legal proceedings against the third party or creditor that was given preference by the debtor’s voidable transaction.
The debtor’s voidable transactions under the Danish Insolvency Act include:
- gifts from the debtor;
- payment of debt,
- transactions giving preference to a creditor over the other creditors;
- transactions that mean that the debtor’s assets avoid being included in the assets of the insolvent estate; and
- transactions that mean that the debtor’s debt increases.
If the trustee is successful in the claim for avoidance against a third party, the third party must give up and return the preference to the insolvent estate that he has obtained through the debtor’s voidable transaction, but not more than the loss of the estate.
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.
Yes, during the Mediation Stage creditors (the “Recognized Creditors”) holding title to recognized claims (i.e. claims recognized and ranked by the Insolvency Court, the “Recognized Claims”) may challenge any pre-insolvency transaction carried out by the insolvent entity when such transaction is deemed or presumed fraudulent pursuant to the Insolvency Law.
Any action consummated by the insolvent entity prior to the date of the Insolvency Judgment will be deemed fraudulent when the insolvent entity is knowingly defrauding its creditors, and the third party participating in any such action had actual knowledge of such fraudulent intent. If the action is gratuitous, the action will be deemed fraudulent even if the third party had no actual knowledge of the fraudulent intent.
As a general rule, the Insolvency Judgment will become effective retroactively on the date that is 270 calendar days (which could be extended in certain particular cases) prior to the date of the applicable Insolvency Judgment (the “Effective Date”).
Any action consummated by the insolvent entity at any time after the Effective Date, (i) will be deemed fraudulent when, inter alia, (a) the insolvent entity receives no consideration, or the consideration received or paid by the insolvent entity, or the terms and conditions of the transaction, are clearly or materially below market, or (b) the insolvent entity makes a payment of indebtedness not yet due, or forgives receivables owed to it; and (ii) will be presumed fraudulent, unless the interested third party proves that it was acting in good faith, when, (a) the insolvent entity grants or increases collateral that was not originally contemplated, and (b) the insolvent entity makes any payments in-kind that were not originally contemplated. In addition, certain transactions among related parties will also be deemed fraudulent.
The effects of challenging pre-insolvency transactions that are deemed or presumed fraudulent is to declare such transactions null and void, thus returning things to their former conditions as though the transactions shall have never existed.
British Virgin Islands
Part VIII of the IA provides a number of voidable-transaction claims by which a subsequently appointed liquidator may seek to recover company funds and property, thereby swelling the assets of the insolvent estate for the benefit of its creditors.
There are four types of voidable transaction that a liquidator may consider upon a company going into insolvent liquidation: unfair preferences, undervalue transactions, voidable floating charges and extortionate credit transactions. In relation to most of these, several defined terms are used: ‘insolvency transaction’, ‘vulnerability period’ and ‘connected person’.
In relation to unfair preferences, undervalue transactions, and voidable floating charges, the liquidator must show that the transaction was an ‘insolvency transaction’: the transaction in question must either have been made at a time when the company was insolvent, or have caused the company to become insolvent. For these purposes, ‘insolvency’ excludes balance-sheet insolvency: only cash-flow insolvency and technical insolvency are sufficient. The liquidator is not required to prove that an extortionate credit transaction is an insolvency transaction, and in relation to other types of voidable transactions, the court will sometimes presume that the transaction was an insolvency transaction, as explained below.
In relation to unfair preferences, undervalue transactions, and voidable floating charges, the ‘vulnerability period’ is the period beginning six months before the onset of insolvency and ending on the date on which the liquidator was appointed. If the transaction was with a person connected to the company, this period is extended to two years. In the case of extortionate credit transactions, the vulnerability period begins five years before the onset of insolvency and again ends with the appointment of the liquidator. In relation to clawback actions brought in the context of liquidations, the term ‘onset of insolvency’ is defined as meaning the date on which the application for the appointment of a liquidator was filed (in the case of insolvent liquidations by order of the court), or the date on which the liquidator was appointed (in the case of voluntary insolvent liquidations).
A person is treated as being ‘connected’ to a company if they fall within the list of persons set out in Section 5 IA. This list includes directors or members of a company or of a related company, a different company that has a common director with the company, a company that is a subsidiary or holding company of the company, and relatives of directors.
A company gives an unfair preference if it enters into a transaction that would have the effect of putting a creditor in a better position in the event of the company’s liquidation than the position in which he or she would have been if the transaction had not occurred: section 245 IA. It should be noted that unlike in many other common-law jurisdictions it is not necessary that the liquidator show that the transferor had any intention or desire to achieve this result for the recipient.
The transaction will not be an unfair preference if it was entered into in the ordinary course of business. As stated above, the liquidator must show that the transaction was an insolvency transaction and that it took place within the vulnerability period. If the transaction took place between the company and a connected person, it will be presumed that the transaction was an insolvency transaction and that it did not take place in the ordinary course of business, unless the contrary is proved.
A company enters into a transaction at an undervalue if it transfers an asset to another for no consideration, or sells an asset for consideration that is worth significantly less than the asset’s market value: section 246 IA. Again, and as stated above, the transaction must be an insolvency transaction and it must have taken place within the vulnerability period. The transaction will not be an undervalue transaction if it can be shown that the company acted in good faith and for the purposes of its business, and if at the time of the transaction there were reasonable grounds for believing the transaction would benefit the company. If the transaction is entered into between the company and a connected person, the court will presume that the transaction was an insolvency transaction and that the company did not act in good faith or have reasonable grounds for believing the transaction would benefit the company.
If the grant of a floating charge took place within the vulnerability period and was either made at a time when the company was insolvent or caused the company to become insolvent (ie, was an insolvency transaction), it will be voidable: section 247 IA. If, however, the charge was not created in order to secure an existing debt, but secured new borrowing or liabilities, it will not be voidable. If a charge was created in favour of a connected person, it is presumed that the charge was an insolvency transaction.
Finally, a transaction is an extortionate credit transaction if it is concerned with the provision of credit to the company and either the terms of the credit arrangement require grossly exorbitant payments to be made in respect of the provision of credit (whether unconditionally or on the occurrence of certain contingencies) or otherwise grossly contravenes ordinary principles of fair trading: section 248 IA. It is not necessary to show that the extortionate credit transaction was an insolvency transaction.
Despite this group of liquidator claims coming within the Part of the IA that is headed ‘voidable transactions’, a successful claim by the liquidator does not necessarily result in the transaction being voided or becoming voidable at the liquidator’s election: the court has a very broad discretion as to what relief to grant, and may make any order it deems appropriate. It may order that the transaction be set aside in whole or in part, but it is not required to do so; alternatively or additionally, it may also make such orders as appropriate to restore the parties to their original positions or otherwise.
In addition to these four IA claims that are available to liquidators of insolvent companies, section 81 of the Conveyancing and Law of Property Ordinance of 1961 permits any person prejudiced by a conveyance of property to apply to the court for an order avoiding that conveyance. This cause of action may be used by liquidators to recoup funds, shares, or other assets that have been paid away and unlike the IA claims does not require that the company was insolvent at the time of the transfer.
There are three key types of pre-insolvency transaction that can be challenged:
- Voidable preferences: Any conveyance or other disposition of property made within six months before the commencement of the winding up is void if made with the intention to fraudulently prefer one or more of the company's creditors and the company was insolvent on the cashflow basis at the time (section 237(1) Companies Act 1981).
- Unlawful floating charges: A floating charge is voidable if created within 12 months of the commencement of insolvency proceedings for no consideration (section 239 Companies Act 1981).
- Fraudulent conveyances: An eligible creditor can apply to have a transaction or disposition of property set aside where the company’s dominant purpose was to put the property beyond the creditors' reach (sections 36A to 36G Conveyancing Act 1983).
In addition, any disposition of the property of the company, including things in action, and any transfer of shares, or alteration in the status of the members of the company, made after the commencement of the winding-up, shall, unless the Court otherwise orders, be void (section 166 Companies Act 1981). The “commencement of the winding up” is the date of the resolution in the case of a voluntary liquidation and the presentation of the petition in a compulsory liquidation.