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)
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).