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 (2nd Edition)
A transaction that is entered into by the debtor within a specific period before the declaration of the debtor’s bankruptcy may be nullified by the Commercial Court upon a claim submitted by the receiver in accordance with the provisions of IBL. This legal remedy is known as ‘action pauliana’ suit.
The nullification of a legal action or transaction made by the debtor may be granted by the Commercial Court upon the lawsuit of the receiver if the receiver can prove the following requirements:
a. The legal action being challenged is performed by the debtor before the bankruptcy declaration is rendered;
b. The debtor is not obligated by contract or by law to perform such legal action being challenged, or in other words the legal action is voluntarily conducted by the debtor;
c. The legal action being challenged prejudices the creditors’ interests; and
d. The debtor and the other party with whom the debtor conducts the legal action being challenged know or supposed to know that the said legal action will cause damages for the creditors.
With respect to the last requirement, both the debtor and the third party with whom the legal action being challenged was performed were deemed to know that such transaction was detrimental to the creditors (unless it can be proven otherwise) in the event:
(a) the legal actions or transactions being challenged were conducted within the period of one (1) year before the debtor’s bankruptcy and the transaction was not mandatory for the debtor and such transaction belongs to one of the following three categories:
- a transaction in which the consideration that the debtor received was substantially less than the estimated value of the consideration given;
- a payment or granting of security for debts which are not yet due;
- a transaction entered into by an individual debtor with a certain relative or related parties
(b) the grant transaction being challenged was conducted within the period of one (1) year before the debtor’s bankruptcy
The nullification of the payment of debt that has been due and payable can only be granted if it can be proven that: (i) the recipient of payment (i.e. the lender) know that the petition of bankruptcy against the debtor had been registered; or (ii) in the event that the said payment is made due to the conspiracy between the debtor and the creditor(s) in order to provide the said creditor(s) privilege than the other creditors.
The effect of a successful challenge would cause the legal action or transaction being challenged is considered as nullified (some court decisions deemed such action as unlawful act) and therefore the condition prior to the execution of the legal action or transaction should be restored.
IBL specifically provides the following consequence on the successful challenge:
- Any persons receiving properties/goods that constitute part of the debtor’s assets which are covered by the legal action being nullified (“Goods”) must return the Goods to the receiver and it shall be reported to the supervisory judge. If such person is not able to return the Goods in the condition before the legal action is taken, such person should pay compensation to the bankruptcy estate;
- The right of any third parties over the Goods, which are obtained in good faith and not free of charge, (including the holder of the security rights being imposed on the Goods) should be protected;
- For the goods being received by the debtor under the legal actions being nullified, the receiver should return it or its value to the other party with whom the debtor conducts the legal action, to the extent that the bankruptcy estate is not jeopardized. If there is outstanding difference that needs to be returned to the other party with whom the debtor conducts the legal action, such party may verify such difference as unsecured claim.
The BIA and the CCAA allow for pre-insolvency transactions to be set aside in two situations:
- preference; and
- transactions at undervalue.
Provincial legislation permits the setting aside of preferences and transactions to defeat, delay or defraud creditors and can be used where the applicable BIA time periods have passed.
A trustee (under the BIA), and a monitor (under the CCAA), can initiate proceedings to challenge a transaction as a preference or transfer at undervalue. In situations where the trustee refuses to act, a creditor can initiate proceedings.
In a preferential transaction, one creditor receives payment over another creditor before the initial bankruptcy event, or the date proceedings were commenced under the CCAA, with the effect of the debtor preferring one creditor over another.
For a transaction to be considered a preference:
- If the debtor and creditor are not related, it must have been made within three (3) months of the initial bankruptcy event (or the date proceedings were commenced under the CCAA).
- If the parties are related, such as a family member, it must have been made within twelve (12) months of the initial bankruptcy event (or the date proceedings were commenced under the CCAA).
A transaction deemed preferential is void and will be set aside by the court. The money is then distributed to the bankrupt's estate in the order set out in Question 5.
Transactions at Undervalue
In a transaction at undervalue, if the debtor was insolvent at the time the transaction occurred, or became insolvent as a result of the transaction, and the intent of the debtor was to defeat, delay or defraud its creditors. The transaction must have occurred:
- If the parties are not related, within one year of the commencement of the bankruptcy proceedings (the date that proceedings were commenced under the CCAA); or
- If the parties are related, within five years of the commencement of the bankruptcy proceedings (the date that proceedings were commenced under the CCAA).
When the Court determines that a transaction at undervalue has occurred, the Court can:
- set aside the transaction; or
- order the recipient to pay the difference between what the debtor paid for the property and the actual fair market value of the property.
1. General requirements
According to German law, any transaction or action that harms the creditors as a whole, and which has been executed within certain hardening periods of up to 10 years prior to or after the filing of the petition for the opening of insolvency proceedings, could potentially be subject to contestation/claw-back rights which are executed by the insolvency administrator (or the insolvency monitor in the case of self/DIP-administration).
Voidable “action” is understood in the broadest sense, including, e.g., the granting of collateral or satisfaction, as well as the omission to sue, claim or defend in court.
An action is detrimental to the creditors if it leads to a direct or indirect reduction of the value of the debtor’s estate, or to a complication regarding the enforcement of the estate’s rights.
2. Specific grounds of contestation materialized
In addition to these general requirements, a specific ground of contestation must be realized. Such specific grounds are:
Congruent coverage, Sec. 130 Insolvency Code (Kongruente Deckung)
Pursuant to Sec. 130 Insolvency Code, fulfilling a debt, granting collateral or enabling the other party to seize such fulfillment or collateral can be challenged if the action in question was committed up to three months prior to the filing of the opening petition, the company had been illiquid at that time, and the counterparty was aware of that state of illiquidity.
Incongruent coverage, Sec. 131 Insolvency Code (Inkongruente Deckung)
In contrast, a coverage is deemed incongruent, when a creditor receives something other than agreed upon, according to the (initial) contractual agreement, for example, a granting of collateral or premature satisfaction of a claim, or the creation of a set-up situation that has not been owed. Such actions can be challenged, if, (i) the action was taken one month prior to the insolvency filing, (ii) the debtor was illiquid at the time of the action or (iii) the receiving end knew that the performance would impair the other creditors.
Detrimental actions, Sec. 132 Insolvency Code
Any action on the part of the debtor constituting a direct disadvantage to the creditors may be contested if it was taken (i) during the last three months prior to the insolvency filing, if the debtor was illiquid at the date of such transaction, and if the other party was aware of the insolvency on that date, or (ii) subsequent to the insolvency filing if at the time the legal transaction was made the other party was aware of either the insolvency or of the request for the opening of insolvency proceedings.
Legal acts of willful detriment to the insolvency creditors, Sec. 133 Insolvency Code (Vorsatzanfechtung)
Pursuant to Sec. 133 Insolvency Code, a prerequisite for contestation is that the debtor acted with the intent of impairing its creditors, and that the counterparty was aware of such intent. Sec. 133 Insolvency Code allows for the challenge of a transaction made by the debtor not more than 10 years prior to the filing of the insolvency petition. In the case of actions granting security or satisfaction to the counterparty, this hardening period is shortened to four years.
Granting of gratuitous services, Sec. 134 Insolvency Code
The granting of performances free of charge, falls under the scope of Sec. 134 Insolvency Code, and can be clawed-back up to four years before the filing for insolvency proceedings.
Shareholder loans, Sec. 135 Insolvency Code
Payments the debtor made in order to repay a shareholder loan (or equivalent claim) within one year prior to the filing for the opening of insolvency proceedings can be challenged. The same applies vis-à-vis the shareholder, if a third party loan secured by a shareholder was repaid by the debtor within the one year period.
3. Exemption from voidance in cases of cash-transaction (Bargeschäft, Sec. 142 Insolvency Code)
If an action constitutes a so-called privileged cash transaction as defined by Sec. 142 Insolvency Code, it can be challenged only in accordance with Sec. 133 Insolvency Code provided that the other party recognized that the debtor acted unfairly. A privileged cash transaction requires (i) that performance and consideration be equivalent in value (Gleichwertigkeit) and (ii) a close time connection (Unmittelbarkeit) between performance and consideration, such that they are deemed linked.
4. Consequence in law, Sec. 143 Insolvency Code
In the case of a successful contestation, everything received from the debtor’s estate pursuant to the challenged transaction(s) must be restituted to the insolvency estate. The insolvency estate only has to return the consideration/values received if such are still identifiable and available in the estate (which is rarely the case).
Yes, it can. South African courts are empowered to set aside, at the insistence of the liquidator, certain transactions entered into, or dispositions (transfer or abandonment of rights to property) made, by an insolvent debtor prior to its liquidation (known as impeachable dispositions), in the following cases:
- dispositions not for value - dispositions of property made:
- more than two years before the liquidation of the insolvent debtors estate were made where (i) immediately following the disposition, the liabilities of the insolvent debtor exceeded its assets; and (ii) the disposition was not made for value; or
- within two years of the liquidation which were not for value;
- voidable preferences - disposition:
- made by an insolvent debtor within six months of the date of liquidation;
- that in fact prefers one creditor over another;
- where, immediately after, the liabilities of the insolvent debtor exceeded its assets; and
- where the debtor’s estate is subsequently liquidated;
- undue preferences - disposition:
- made by an insolvent debtor at any time before the date of liquidation;
- with the intention to prefer one creditor over another;
- where, immediately after, the liabilities of the insolvent debtor exceeded its assets; and
- where the debtor’s estate is subsequently liquidated;
- collusive dealings - disposition where the insolvent debtor, in collusion with another person, disposed of its assets in a manner prejudicing creditors or preferring one over another; and
- fraudulent dispositions –disposition prior to liquidation, if the insolvent and the recipient had the common intention of prejudicing other creditors.
All of the above transactions are voidable by the liquidator but, until the transactions are set aside by the court they stand.
Third party acquirors may lose their rights to property obtained as a result of the impeachable disposition.
According to Article 129 of the BRBL, the following acts can be challenged and will be considered ineffective “whether or not the contracting party was aware of the debtor’s condition of economic and financial crisis and whether or not the debtor intended to defraud creditors:
- payment by the debtor within the legal term of debts not yet fallen due, by any means of extinguishment of the credit right, including by discount of the actual instrument;
- payment made within the legal term of debts fallen due and enforceable, in any way not provided for under the contract;
- constitution of in rem guaranties, including lien, within the legal term, in the case of a debt contracted previously;
- if the assets given in mortgage are the object of other subsequent ones, the bankrupt estate shall receive the part that should apply to the creditor of the revoked mortgage;
- acts performed free of charge during the two years preceding the decree of bankruptcy;
- waiver of inheritance or legacy during the two years preceding the decree of bankruptcy;
- sale or transfer of an establishment without the express consent of, or payment to, all creditors existing at the time, sufficient assets not having remained to the debtor to settle its liabilities, unless, within 30 days, there is no opposition by creditors after being duly notified, either judicially or by deeds and documents registry office;
- registration of in rem rights and of property inter vivos, for a consideration or free of charge, or an annotation of a real property made after the decree of bankruptcy, unless there is a previous annotation.”
In those cases, the ineffectiveness may be declared ex officio by the bankruptcy court and may be alleged in defense or claimed through a specific lawsuit or even incidentally during the proceedings.
Also, any acts performed with the intent to injure creditors may be revoked, as far it is proved the fraudulent collusion between the debtor and the third party contracting with him and the loss suffered by the bankruptcy estate.
The revocation suit can be filed by the trustee, by any creditor or by the Public Attorney’s Office within three years as from the decree of insolvency and the decision that considers the revocation suit well founded shall order that the assets be returned to the bankrupt estate in kind, with all accessories, or the market value, plus loss and damage.
Any action taken by a debtor may be declared “ineffective towards creditors” by an insolvency court, if it were to prejudice the creditors’ rights. Grounds for opposing a transaction arise in the event that (a) a transaction is effected without adequate consideration, i.e., a transaction for which the usual consideration in similar cases would be significantly higher; (b) a transaction results in preferential treatment, i.e., the premature repayment of the obligations of only some creditors, etc.; or (c) a transaction aims to deprive the creditors of certain benefits, provided that the debtor intended to do so and that the counterparty to the transaction had knowledge, or should have had knowledge, of this intention.
The types of transactions under points (a) and (b) above are vulnerable to attack if (i) they were undertaken during a period of one year prior to the commencement of insolvency proceedings, or a three-year period if the transaction was made for the benefit of a person affiliated with the debtor, or (ii) they were undertaken by the debtor when it was insolvent, or caused the debtor to become insolvent. In respect of the transactions listed under point (c) above, a five-year period applies.
The insolvency trustee may commence proceedings against persons who benefited from such transactions within a year from the declaration of insolvency. Individual creditors are not allowed to commence such proceedings, but the creditors committee may instruct the insolvency trustee to do so.
Furthermore, as of the commencement of insolvency proceedings, the debtor is not allowed, among other things, to execute or enforce any security instrument which would be covered by its assets, or dispose of its assets in a way which could substantially alter their composition, or the way in which they are utilized or their designated purpose, or by which their value may be diminished to a non-negligible degree, though certain transactions are exempt, such as transactions pursued in the ordinary course of business or to avert impending damage. Transactions contravening the above restrictions are deemed to be ineffective vis-à-vis creditors.
Under Cayman Islands law, there are certain pre-insolvency or antecedent transactions that may be challenged by the liquidator of a company pursuant to:
- Section 145 of the Companies Law (voidable preferences);
- Section 146 of the Companies Law (avoidance of dispositions at an undervalue); and
- Section 147 of the Companies Law (fraudulent trading); and
- Section 99 of the Companies Law (avoidance of property dispositions and transfers of shares);
Where a debtor has entered into a transaction prior to the commencement of its liquidation, such transaction may be at risk of challenge by a liquidator as either a voidable preference or a transaction at an undervalue in the event that the debtor was unable to pay its debts at the time of or as a result of the relevant transaction.
A transaction will constitute a voidable preference where a company has made a transfer of property or payment to a creditor while insolvent with the 'dominant intention to prefer' that creditor over other creditors and such transfer or payment was made within the six months immediately preceding the commencement of liquidation of the company. Where a preferred party is related, there is a presumed intention to prefer. A liquidator may seek an order from the Cayman Court to declare the payment or transaction void and to order that the property be returned to the company or the payment refunded.
Transactions at an undervalue
A transaction will constitute a disposition at an undervalue where a company has disposed of property at an undervalue with the intent to defraud its creditors (that is, an intention to willfully defeat an obligation or liability owed to a creditor which existed on or prior to the date of the disposition). Any disposition at an undervalue made by the company in the six year period prior to the commencement of the liquidation with an intent to defraud its creditors shall be voidable at the instance of the liquidator. A liquidator may seek an order from the Cayman Court to declare such transaction void and apply for an order for restitution. A creditor prejudiced by such a disposition at an undervalue may also seek such relief under the Fraudulent Dispositions Law (1996 Revision) regardless of whether or not insolvency proceedings have been commenced.
If the transferee can satisfy the Cayman Court that it had not acted in bad faith in respect of a preference or disposition at an undervalue, the transferee will be able to obtain a first ranking charge over the property of an amount equal to the costs reasonably and properly incurred by the transferee in defending any proceedings challenging the relevant disposition which will be set aside subject to the costs, pre-existing rights, claims and interests of the transferee.
Any persons who were knowingly parties to the carrying on of the company's business with the intention to defraud its creditors or for any fraudulent purpose may be held liable to contribute to the company's assets. A liquidator may seek an order requiring any persons who were knowingly parties to such conduct to make such contributions as the Cayman Court thinks proper.
Avoidance of property dispositions and transfers of shares
Section 99 of the Companies Law provides that when a winding up order has been made, any disposition of the company's property and any transfer of shares made after the commencement of the winding up is void, unless the Cayman Court orders otherwise. In the event of a successful challenge by a liquidator, the liquidator will be entitled to seek appropriate relief for the property to be returned.
Under Cayman Islands law, the winding up of a company is deemed to commence at the time of the presentation of the winding up petition for an official liquidation or the passing of the members' resolution in the event that a Cayman Court supervised liquidation commenced as a voluntary liquidation.
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.
Liquidators are able to set aside, or apply to the Court to have set aside, the following transactions:
(a) Voidable transactions – transactions that were entered into while the company was insolvent, within the two year period before the liquidation application was made, and which allow the creditor to receive more than it would have in the liquidation.
(b) Voidable charges – charges that were given while the company was insolvent, within the two year period before the liquidation application was made and which did not secure money actually advanced or paid, or the actual price or value of property sold or supplied to the company, or any other valuable consideration given in good faith by the recipient of the charge.
(c) Transactions at an undervalue – the liquidator may recover from the creditor the difference in value between the value given by the company and the value received by the company as a result of a transaction that occurred while the company was insolvent and within the two years before the liquidation application was made.
(d) Transactions with directors or other related parties for inadequate or excessive consideration – the liquidator may claim back from a director or related party in relation to the transaction, the amount by which the consideration received by the company was exceeded by the consideration it gave, provided the transaction occurred within the 3 years before the liquidation application was made.
(e) Securities and charges given by the company to a director or related party if the Court considers that it is just and equitable to set the transactions aside, taking into account the circumstances in which the charge was created, the conduct of the director or related party and any other relevant circumstances. There is no requirement to prove that the company was insolvent at the time the security or charge was given.
(f) Dispositions that prejudice creditors– dispositions made without receiving reasonably equivalent value in exchange and with the intent of defeating creditors can be reclaimed from a creditor. A six-year limitation period applies from the date the disposition is made.
(g) Distributions to shareholders that were made at a time when the company failed the solvency test.
A six year limitation period applies from the time when the distribution was made.
A transaction will not be set aside if the third party creditor received the payment in good faith, in circumstances when a reasonable person in the creditor's position would not have suspected and the creditor did not suspect that the company was or would become insolvent, and that the creditor gave value to the company (value can be given before or after the creditor received payment) or changed its position in the reasonably held belief that the transfer was valid and would not be set aside.
A similar good faith defence is available to shareholders who did not know that the company failed to meet the solvency test at the time that a distribution was made.
A liquidator also has the power to disclaim onerous property, which includes unprofitable contracts and property of the company that is unsaleable, or not readily saleable, or that may give rise to a liability to pay money or perform an onerous act. Persons suffering loss as a result of the disclaimer can claim for that loss in the liquidation.
Certain antecedent transactions may be unwound by a liquidator or judicial manager upon an application to Court:
a. A liquidator or a judicial manager has the power to set aside undervalue transactions that took place up to five years from the commencement of winding up or judicial management, if the transaction was carried out when the company was insolvent or became insolvent as a result. There is a presumption of insolvency if the transaction was carried out with a related party.
b. The Court may also impugn a transaction intended to prefer one or some of a company’s creditors over others, if the transaction was carried out when the company was insolvent or became insolvent as a result. There is a presumption of an intention to prefer if the counterparty to the transaction is a related party.
c. The liquidator or judicial manager may also set aside a floating charge that has been created six months prior to the commencement of a winding up or judicial management, except to the amount of any cash paid to the company at the time of, or subsequent to, the creation of and in consideration for the charge, together with interest on that amount at the rate of 5 percent per annum.
d. Extortionate credit transactions may also be set aside if the terms of the agreement are exorbitant, unconscionable, or substantially unfair. Such transactions may be set aside or varied by the Court if they are entered into within a period of three years before the commencement of winding up or judicial management.
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’: in order to be an insolvency transaction, the transaction 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. In some contexts, the court will 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 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 the 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 the creditor 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, though these presumptions may be rebutted.
If the grant of a floating charge took place within the vulnerability period and either was 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.
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.
The administrator may request the court to invalidate any transfer of assets for no consideration, transaction for a clearly unreasonable price, provision of security for any unsecured debt, prepayment of any debt that are not due, or waiver of any claim, in each case by the debtor within one year before the court accepts the bankruptcy filing, or any repayment of certain debts within six months prior to the acceptance of the filing. The right to request for invalidation as described above is vested in the administrator, with the debtor being listed as defendant and the third-party victims as beneficiary. The Enterprise Bankruptcy Law of China does not provide a statute of limitation for making the request. If successfully requested, the debtor’s act in question will be deemed void ab initio, and the interests of the third parties will be restored to the state as if the debtor’s act has never taken place.
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, or if the company had previously been in administration, the date of the appointment of the administrator) 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 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.
Upon request of the trustee, certain pre-insolvency transactions must or can be declared unenforceable against the bankrupt’s estate if they were performed by the debtor between the date of cessation of payments and the date of the bankruptcy order (suspect period).
The date of cessation of payments usually coincides with the date of the bankruptcy order. However, the bankruptcy court may determine a suspect period (maximum six months), if sound and objective circumstances show that the debtor already ceased payments before the date of the bankruptcy order.
Given their unusual nature, these actions will be declared unenforceable against the body of creditors if performed during the suspect period: (i) gifts and transfers for no consideration, (ii) sub value contracts, (iii) payments of undue debts, (iv) payments in kind of due debts, and (v) security interest granted for antecedent debts. The court may declare acts unenforceable if they took place during the suspect period and if the third party was aware of the cessation of payments by the debtor. Finally, any fraudulent acts or payments to the detriment of the creditors, whenever performed, can be declared unenforceable (actio pauliana).
Dutch law contains provisions as a result of which certain transactions can be nullified by the trustee on the basis of fraudulent conveyance. A transaction may be nullified on the basis of fraudulent conveyance if:
- it has been voluntarily performed;
- it prejudices the available means of recovery of one or more creditors; and
- the debtor and beneficiary knew or should have known that the transaction would prejudice creditors.
The burden of proof regarding the above in principle rests on the trustee. A successful claim based on fraudulent conveyance renders the transaction void. Outside of bankruptcy, creditors can try to nullify transactions on similar grounds.
Under the U.S. Bankruptcy Code, the debtor or trustee is empowered to avoid preferential, fraudulent, certain security interests, and post-petition transfers made without court authorization.
Preferential transfers are those that are made 90 days before the commencement of the case (or within one year for transfers to insiders) on account of an already existing debt that gives the recipient of the transfer a greater recovery than it would have received through a liquidation process. If the court deems such a transfer an improper preference, it will be unwound and the court will award the plaintiff with a claim for money damages.
There are two types of fraudulent transfers: constructive and actual. Transfers that are actually fraudulent are made “with actual intent to hinder, delay or defraud any creditor” whereas they are deemed constructive if the debtor received less than equivalent value in exchange, the debtor was insolvent at the time the transfer was made or became insolvent as a result and the debtor was left with unreasonably small capital or the debtor intended or believed it would incur debts beyond its ability to pay. The Bankruptcy Code’s fraudulent transfer look back period is two years, but permits a longer period if available under state law and can extend to six years.
The debtor (or trustee) is empowered under § 544 if the U.S. Bankruptcy Code with the so called “strong-arm powers.” Under § 544(a), a debtor is treated as if it were a judicial lien holder as of the petition date, and as such can avoid the security interest of any creditor that would lose to a lien creditor under nonbankruptcy law. Section 544(b) allows the debtor to step into the shoes of any actual creditor in the case and avoid any transfer that creditor could have voided under applicable nonbankruptcy law.
While avoidance actions are considered the property of the estate, courts are willing to grant standing to third parties to pursue such claims. To be granted standing, the party must show that a valid claim exists, that the creditor has made a demand upon the debtor to pursue a claim but the debtor has refused and that it is in the best interests of all creditors that the claim be pursued.
French law provides for some rules which make it possible to declare certain transactions entered into by the company void or voidable during the so-called “hardening period” which is the period between the date of insolvency (which may be carried back up to 18 months prior to the judgement opening the insolvency proceeding) and the opening of insolvency proceedings.
Some transaction entered into during the hardening period are automatically void and include in particular;
- any deed entered into without consideration transferring title to movable or immovable property;
- any bilateral contract in which the debtor’s obligations significantly exceed those of the other party;
- any payment by whatever means, made for debts that had not fallen due on the date when payment was made;
- all payments for outstanding debts, if not made by cash settlement or wire transfers, remittance of negotiable instruments, or “Daily assignment of receivables”;
- any mortgage or pledge granted to secure a pre-existing debt.
In addition, any payment made or any transaction entered into during the hardening period may be at the discretion of the court, subject to two conditions: (i) the payment or transaction took place during the hardening period and (ii) at the time of the payment or transaction, the contracting party knew that the debtor was insolvent.
The claw-back action is exercised by the administrator, the legal representative, the Commissioner in the implementation of the plan (juge-commissaire) or the prosecutor.
The debtor’s pre-insolvency transactions can be affected by insolvency procedures if they were concluded during the hardening period or “période suspecte”. Such period runs from the moment of the cessation of payments to the date of the declaratory judgement of bankruptcy, though the exact date of the cessation of payment is fixed by the court at a maximum of 6 months and 10 days before the opening of the bankruptcy procedure.
Certain payments made, as well as other transactions entered into or performed during the hardening period can then be subject to cancellation by the court on proceedings initiated by the bankruptcy receiver. The following transactions must be set aside or declared null and void upon request by the bankruptcy receiver :
- contracts entered into by the insolvent company, if its obligations in such contracts are significantly more onerous than the obligations of the other party (similar to transaction at an undervalue risks in English law)
- the payment of debts that have not yet fallen due.
- any payment made in kind (eg. asset transfer) by the insolvent company in respect of debts that are due (excluding cash and negotiable instruments)
- the granting of a security interest for antecedent debts (ie. for post consideration).
Additionally, certain payments made for matured debts, as well as other transactions concluded for consideration, during the hardening period are subject to cancellation by the court if they were concluded with the counterparty’s knowledge that the company was insolvent at the time.
Finally, the insolvency receiver may, without any limitation in time, challenge any transaction or payment made in fraud of the creditors’ rights.
There are a few statutory exceptions to the rules governing the hardening period.
- Security interest qualifying as financial collateral agreements may be enforced at any time, notwithstanding the insolvency procedures (except in cases of fraud);
- Special provisions govern the insolvency of an assignor when future claims are assigned to a securitisation undertaking.
Yes, official receivers or the liquidators may file with syndic judges claims for the annulment of the debtors’ fraudulent deeds or operations, concluded to the detriment of the creditors’ rights, at the latest in the last 2 years prior to the opening of the insolvency procedure, and namely:
a) free transfer deeds
b) operations performed in 6 months prior to insolvency, in which the what the debtor offers obviously exceeds what this receives
c) deeds concluded with all the involved parties’ intention to prevent the creditors from pursuing certain assets or to impair the creditors’ rights
d) deeds for the transfer of the ownership to a creditor for the payment of a prior debt or to its benefit, performed in the 6 months prior to the opening of the procedure, if the amount that the creditor could use in case of the debtor’s bankruptcy is lower than the value of the transfer deed
e) establishing of a security for a receivable that was an unsecured receivable in the 6 months prior to the opening of the procedure
f) anticipated payments of the debts made in the 6 months prior to the opening of the procedure, if their maturity was established for a date that would be prior to the opening of the procedure
g) transfer deeds or assuming of obligations performed by the debtor in a period of 2 years prior to the procedure opening date with the intention to hide/delay the insolvency state or to defraud a creditor.
Deeds that the debtor has concluded in the 2 years prior to the opening of the insolvency procedure with certain persons who could hold in a way or another a position of control of the debtor may be also annulled. Nevertheless, the law institutes also exceptions, the deeds of transfer with patrimonial character concluded by the debtor in the normal course of its current business or the deeds concluded in good faith by the debtor in the insolvency prevention procedure, such as the arrangement with creditors or the ad-hoc mandate, not being possible to be annulled. If such a claim is allowed, the third party acquiring the asset will have to return the asset, and, if the asset no longer exists, this will have to return its value. Nevertheless, the acquiring third party acting in good faith who has returned to the debtor’s estate the asset or the value of the asset that has been transferred to it by the debtor will have against the debtor a receivable equal to the paid price, to which value may be added by the possible investments that the third party has made – this amount may be further registered with the lists of receivables and will participate in distributions of amounts. But, if this third person has acted in bad faith, then it will only have a right of claim equal to only the price paid, and this will be considered a subordinated receivable.
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 at the time the transaction was carried out; 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.
Any transaction taking place three months prior to the commencement of liquidation, Arrangement or bankruptcy proceedings, can be challenged, and revoked if found that it was intended to create a preference of any creditor, or made out of illegal constraint or pressure. The court uses the "ordinary course of business" test in order to determine the nature of such transaction.
This will not affect, however, the rights of a person who purchased an asset in good faith and appropriate value from a creditor.
Additionally, conveyance of property may be invalid if performed within two years of the bankruptcy, or between 2-10 years, unless the conveyance beneficiary proves the person was solvent at such time without the property conveyed.
The new Insolvency Law generally adopts such provisions with certain adjustments, while determining stricter terms for the obligor relatives and revoking the requirement of intention to prefer a creditor (focusing on the outcome of such action).
The following transactions entered into by a company that subsequently becomes insolvent can be set aside, with the aim of clawing back the proceeds to restore the company to the position that it was in before the transaction:
- Fraudulent preferences (section 237, CA). Any conveyance or other disposition of property (including any inter-group disposition) made within six months before the commencement of its winding-up is void if it was made:
- with the intention to fraudulently prefer one or more of the company’s creditors;
- at the time that the company was unable to pay its debts as they became due.
In addition, a conveyance or assignment by a company of all its property to trustees for the benefit of its creditors is effectively void. Applications concerning fraudulent preferences are most likely to be brought by the liquidator.
- Invalid floating charges (section 239, CA). A floating charge is considered invalid in a liquidation where it can be shown that it was created:
- within 12 months of the commencement of insolvency proceedings; and
- immediately following the creation of the charge, the company was insolvent,
except to the amount of cash paid to the company at the time or subsequently, in consideration of the charge, plus statutory interest.
- Fraudulent conveyances (sections 36A to 36G Bermuda Conveyancing Act 1983). An eligible creditor can set aside a transaction or disposition of property at an undervalue where it can be shown that the transferor’s dominant purpose was to put the property beyond the creditors’ reach. An eligible creditor is a person who:
- is owed a debt by the transferor on, or within two years after, the transfer;
- on the date of the transfer is owed a contingent liability by the transferor, where the contingency giving rise to the obligation has occurred; or
- on the date of the action to set aside the transfer is owed an obligation arising from a cause of action that occurred before, or up to two years after, the date of the transfer.
- Disclaimer of onerous/unprofitable contracts (section 240 Companies Act 1981). The liquidator of a company can, with the court’s permission, disclaim any property or contracts that it considers to be onerous, unprofitable or unsaleable.
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). In a voluntary liquidation any transfer of shares or alteration in the status of the members made after the commencement of the winding up will be void unless sanctioned by the liquidator.
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.
The Companies Act 2014 provides that any conveyance, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against an insolvent company within 6 months of the commencement of its winding up (or two years in the case of a connected person) with a view to preferring that creditor over others, shall be deemed to be an unfair preference and accordingly, the transfer is void and the property must be returned to the company. Where the transaction involved a connected person, there is a rebuttable presumption in law that the intention was to unfairly prefer that connected party.
Where a person acting with bona fides has acquired an interest in the assets of the company for value, that person’s rights are not affected by a determination that the transaction concerned was an unfair preference.
Improperly transferred assets
Under the Companies Act 2014, if it can be shown to the satisfaction of the High Court that company property was disposed of (which would include by way of transfer, charge, security assignment or mortgage) and the effect of such disposal was to “perpetrate a fraud” on the company, its creditors or members, the High Court may, if it deems it just and equitable, order any person who appears to have “use control or possession” of such property or the proceeds of the sale or development thereof, to deliver it or pay a sum in respect of it to the liquidator on such terms as the High Court sees fit.
There is no requirement to prove fraud – it must merely be proven that the effect of the disposition was to perpetrate a fraud. It is not necessary for the company to be insolvent at the time of the disposition, although the application can only be made in respect of a company that is being wound up. In addition, there is no time limit specified under the section, therefore, theoretically at least, any transaction could be challenged.
The Court, in making any order with regard to property that has been improperly transferred, must have regard to the rights of person who have bona fide and for value acquired an interest in the property concerned.
Breach of fiduciary duty to preserve the assets of the Company
Where a company is insolvent, that company ceases to be the beneficial owner of its assets and the directors no longer have the power to dispose of the assets. The Irish Supreme Court has held that in such a situation, the directors owe a duty to the creditors to preserve the assets to enable them to be applied in discharge of the company’s liabilities. Where directors of an insolvent company are aware or ought to be aware of its insolvency, they hold the assets of that company in trust for the benefit of the company’s creditors.
The rights of a person that bona fide and for value acquires an interest in the property of a company that is insolvent, and who is not on notice of that insolvency, will not be affected by the lack of capacity of the directors.
When a company has entered a formal insolvency process, certain transactions entered into by the company before the start of the insolvency may be challenged under provisions in the Insolvency Act 1986.
Possible grounds for challenge include transactions at an undervalue, preferences, extortionate credit transactions, avoidance of floating charges, and transactions defrauding creditors. Each of these grounds aim to unwind transactions that would otherwise have frustrated or otherwise allowed the company to avoid the payment of creditors on insolvency in accordance with the statutory priority of claims. In most cases, only an administrator or liquidator of a company may bring a claim challenging a reviewable transaction; however, where there is fraud, any party that is a victim of the transaction may make a challenge.
A successful challenge will result in the offending transaction being unwound by a court order. The court order will not affect third parties who acted in good faith and for value. The look back period ranges between two years for connected parties (including directors, shadow directors, and associated persons and companies) to six months for other parties. Penalties for these transactions can include: accounting for profits for proceeds to the company or the transaction being voided.
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.
Article 71 of SIA regulates the reintegration action. This legal action aims to revoke acts that are detrimental to the aggregate assets of the debtor or the acts that distort the par condition creditorum performed by the debtor within the 2 years before the date of DIP. Once the insolvency proceeding is initiated, this detrimental acts, may be revoked, even though there may not have had with a fraudulent intention. The SIA determines some cases when the presumption of detriment accepts evidence to contrary and when the presumption is not rebuttable (art. 71.1 and 71.2 SIA). However, there are some acts that under no circumstances can be revoked, as the ordinary acts of the professional or business activity of the debtor performed under normal conditions (art. 71.5 SIA).
The reintegration actions shall be processed by an insolvency procedural plea (art. 72.4 SIA) and it could be initiated in any phase of the insolvency proceeding.
Regarding the legitimacy of the action, only the IA will be legitimized to file a reintegration actions. Nonetheless, the creditors that have required to IA in order to he file a revocation action, they will be entitled to exercise this action if the IA do not apply for it within the 2 month following the requirement (art. 72.1 SIA).
As a consequence of the revocation of these acts, the appealed acts shall declared ineffectiveness and the involved party shall be condemned to return the service or goods which were thereof with their fruits and interests (art. 73 SIA). The returned good shall liquidate accordance to the liquidation plan.
Once insolvency proceedings have commenced, transactions that unfairly favour one creditor over the others or any acts that reduce, make it more difficult or impossible, jeopardise or delay payment to the creditors can be set aside by the insolvency administrator.
Two requirements must be fulfilled: the acts must have been carried out in bad faith (with the knowledge of the debtor’s insolvency or of the damage that act could cause) and within the two years prior to the initiation of the insolvency proceedings.
The insolvency administrator can terminate contracts that fulfil these criteria by means of a registered letter within six months as of the knowledge of their existence. The termination has retroactive effects. The insolvent debtor or the third party which received the communication of termination can challenge it, filling a judicial action within three months after receiving the communication.