Insolvent estate had claims against third party whose safety was released as a result of a voidable transaction under Section 74 of the Bankruptcy Act

Date 22 okt. 2010

 

In ØLK no. B-2681-09 of 23 April 2010, the Danish Eastern High Court upheld the city court's judgment regarding whether an insolvent estate had any claims against a third party whose safety was released as a result of a voidable transaction under the Danish Bankruptcy Act Section 74, cf. Section 80(3).

 

The case in brief

A cafe was operated as a private limited company. The company's sole shareholder (hereinafter "A") and his partner (hereinafter "B") guaranteed the company's liabilities towards the company's bank, consisting of two overdraft facilities and a business loan.

 

As security for the company’s debts in the bank, A signed surety, provided transportation in an instrument of debt and security in a life insurance. In addition, B pledged her holiday cottage as collateral for the limited company’s obligations to the bank.

 

On 12 October 2005, the company's debt to the bank was paid with an amount that came from the sale of the cafe. The cafe was the company's only asset. Thereafter, the bank freed A and B of their collateral, so that A and B were released from their obligations as guarantor and mortgagor.

 

On 6 December 2005, the company was declared bankrupt with 1 November 2005 as the ultimate date.

 

The problem

The payment made the bank beneficiary compared to the other creditors. Th bankruptcy estate could not demand payment reversed because the bank had fully satisfactory security for its claim.

 

Since there could be no reversal of the transaction to the bank, the question was then whether the bankruptcy estate under Section 80(3) of the Bankruptcy Act could address its claim against A and B who as third parties had been released from their obligations.

 

A prerequisite for reversal of the transaction was that the payment had been voidable if the bank did not have fully satisfactory security for its claim.

 

The legal foundation

It appears from the Bankruptcy Act Section 80(3), cf. Section 80(1), that if a security from a third party or surety of a debtor's debt has been released as a result of a payment or prosecutions, and that transaction could be reversed, the bankruptcy estate has a claim against third parties if such third parties at the release knew or ought to know the circumstances which might justify reversal of the transaction.

 

There is no legal basis in Section 80(3) of the Bankruptcy Act to provide reversal of a transaction. Section 80(3) of the Bankruptcy Act solely states that the bankruptcy estate may make its claim against third parties who have been released as guarantors in case the release payment was voidable. Reversal of the transaction must be assessed separately under the Bankruptcy Act’s avoidance rules.

 

The court's judgment

It appeared from the company's annual report from 2003/04 that the company had a negative equity capital, and there was no evidence that the company could obtain the necessary liquid assets. Therefore, the Court assumed that the company was or became insolvent when selling cafe as it was the company’s only asset.

 

The Court found that A, as sole shareholder of the Company, and B, as close related, must have been aware of the company’s insolvency. In addition therto, the court assumed that the redemption of the Bank's claim should be deemed an improper disposition, since A hereby freed himself and B as guarantor and mortgagor.

 

The Danish Eastern High Court placed emphasis on whether the company as the debtor became insolvent by paying the debt to the bank and whether the payment was improper, and if A and B knew or ought to know the circumstances that made the payment improper.

 

The terms for using Section 74 of the Bankruptcy Act were thus achieved, and the payment to the bank could be reversed in the event the bank did not have fully satisfactory security for its claim.

 

The court then decided that A and B were obliged to reimburse the bankruptcy estate the amount that came from selling the Café and that the amount at A's disposal had been withheld from the bankruptcy estate to equal satisfaction of creditors.

 

However, B was only liable for an amount equal to security, see Section 76 of the Bankruptcy Act, cf. Section 74.

 

Consequenses

The judgement underlines that a bankruptcy estate may make a claim against a third party that has been released from his/hers obligations as guarantor for a given transaction if the transaction is reversible after Bankruptcy Act Section 74, cf. Section 80(3).

 

The judgement states that it is not a condition that the transaction must be specifically avoidable, it is enough that the conditions for making the transaction voidable after the provisions of the Bankruptcy Act are met. In the case, the bankruptcy estate had a claim against a third party despite the fact that the said transaction was not specifically voidable because the Bank had security for the entire debt.

 

In this particular case, the transaction was voidable under Section 74 of the Bankruptcy Act. Furthermore, it should be noted that the bankruptcy estate could also have claims against third parties if the transaction had been voidable after another of the provisions of the Bankruptcy Act.

 

If you have any questions or need more information about avoidable transactions in connection with bankruptcy, you are welcome to contact Thomas Weitemeyer, Attorney, (twe@mwblaw.dk) or Jesper Reitz, trainee, (jre@mwblaw.dk).

 

 

The above does not constitute legal counselling and Moalem Weitemeyer Bendtsen does not warrant the accuracy of the information. With the above text, Moalem Weitemeyer Bendtsen has not assumed responsibility of any kind as a consequence of a reader’s use of the above as a basis of decisions of considerations.