Ineffectiveness of acts of a debtor before it is declared bankrupt
Before discussing fraudulent conveyance actions in the context of a bankruptcy proceeding, it should be pointed out that under the Bankruptcy & Rehabilitation Law of 28 February 2003, certain acts by the debtor are ineffective against the bankruptcy estate by operation of law—without the need to file suit. This is the case, for example, with transactions by which the debtor disposed of its assets without adequate consideration within one year prior to filing of the bankruptcy petition. The same treatment is applied to transactions for consideration made by a corporate debtor within six months prior to filing of the bankruptcy petition with the company’s shareholders or their representatives or with affiliated companies. Certain transactions by the debtor may also be held to be ineffective by the judge-commissioner.
Otherwise, challenges to transactions by the debtor to the detriment of creditors are governed by Art. 132–134 of the Bankruptcy Law and, as relevant, by the provisions of the Civil Code on protection of creditors in the event of the debtor’s insolvency (i.e. Civil Code Art. 527 and following, governing fraudulent conveyance actions). These specific regulations (discussed in more detail below) are applicable only to actions involving assets of the bankruptcy estate. But if the action seeks to hold ineffective a transaction by the debtor concerning assets which would not enter the bankruptcy estate, then after declaration of the debtor’s bankruptcy such action may be asserted, under the general rule of Civil Code Art. 527, only by the creditors. This is because bankruptcy has no effect on assets of the debtor that do not become part of the bankruptcy estate.
What enters the bankruptcy estate?
Under Art. 62 of the Bankruptcy Law, all of the property of the debtor as of the date of declaration of bankruptcy generally enters the bankruptcy estate, as does property acquired by the debtor during the course of the bankruptcy proceeding. This covers all of the assets of the debtor with financial value and which are capable of reducing to cash, regardless of whether they are used by the debtor to operate its business or not.
Exceptionally, property that does not belong to the debtor may also enter the bankruptcy estate. For example, if a transaction made by the debtor prior to declaration of bankruptcy to the detriment of creditors is held to be ineffective, whatever was lost from the debtor’s property or did not enter the debtor’s property as a result of the transaction becomes part of the bankruptcy estate.
Property that is exempt from execution under the Civil Procedure Code does not enter the bankruptcy estate, nor do certain assets listed in the Bankruptcy Law (e.g. the debtor’s salary in the portion exempt from garnishment) and assets that are excluded from the bankruptcy estate by resolution of the creditors.
Permissibility of asserting a fraudulent conveyance action after the debtor is declared bankrupt
If the debtor is declared bankrupt, standing to assert a fraudulent conveyance action is vested in the bankruptcy trustee, the judicial supervisor or the administrator, depending on the type of bankruptcy proceeding. Thus, after declaration of bankruptcy, creditors do not have standing to commence such actions. Similarly, they cannot join actions commenced by the bankruptcy trustee, judicial supervisor or administrator as auxiliary intervenors, because the trustee, supervisor or administrator stands in for all creditors and the creditors themselves no longer have a legal interest in joining the case. If a creditor had already commenced an action under Civil Code Art. 527 and following, after the debtor is declared bankrupt the action is subject to dismissal because the plaintiff no longer has standing to pursue the claim.
Transactions by the debtor may not be held to be ineffective more than two years after the declaration of bankruptcy. This limitations period is a rule of substantive law and cannot be extended. Expiration of this period does not restore standing to specific creditors to bring such actions. The ability to challenge a transaction by the debtor is also subject to a limitations period of five years from the date of the transaction.
Effects of declaration of the debtor’s bankruptcy after a creditor has filed a fraudulent conveyance action
If an action seeking to hold a transaction of the debtor to be ineffective was commenced by a creditor before the debtor is declared bankrupt, the bankruptcy trustee, judicial supervisor or administrator may replace the plaintiff who challenged the transaction by the debtor. This may occur at any stage of the proceeding, including on appeal. Entry into a pending case is decided by the trustee, supervisor or administrator and does not require the consent of the parties to the proceeding. If the proceeding is joined, however, the trustee, supervisor or administrator will reimburse the creditor for its litigation costs out of the proceeds recovered by the bankruptcy estate.
If the bankruptcy trustee, judicial supervisor or administrator refuses to join the pending proceeding, the creditor may continue the proceeding in its own name. But even if the creditor obtains a favourable ruling, it will not be permitted to require that the third party who has unlawfully obtained a benefit turn over the benefit to the creditor. Instead, recovery obtained by the creditor after declaration of bankruptcy through a judgment holding a transaction by the debtor to be ineffective must be turned over to the bankruptcy estate.
Ludwina Klein, Dispute Resolution & Arbitration Practice, Wardyński & Partners
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