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Protection of Business Transactions in Case of Insolvency

One natural consequence of the economic crisis is the steadily growing number of bankruptcy proceedings. An effective means of protecting the interests of creditors in such proceedings is the introduction of the principle of nullity of transactions concluded during the so-called ‘suspicious period', directly following the initial date of insolvency (or, respectively, over-indebtedness).

Such a case is nullity, as provided under the Commerce Act (CA), where the debtor has concluded a transaction against payment after the initial date of insolvency or over-indebtedness, involving assets directly from the bankruptcy estate, in which the items given exceed considerably in value the items received (Art. 646 par. 2, item 4 of the Commerce Act). Accordingly, in order for such a situation to occur, the law requires that three conditions are met simultaneously: (i) the items given in an onerous transaction to exceed considerably in value the items received; (ii) the deal to be closed following the initial date of insolvency, and (iii) the deal to involve assets from the bankruptcy estate.

Whether the real rights alienated from the debtor (for the sake of argument, we assume that the deal involves real estate property, on account of its relatively high value, therefore causing significant pecuniary damages to creditors) exceed significantly in value the price received in the deal, is established by a comparison between the sale price received for the sold property in the deal and the average market price of the same property valid towards the moment of the notarized transfer of title. The average market price is an economic rather than a legal category, determined by the type and nature of the property and the existing mechanism of market supply and demand; therefore, it depends neither on the construction cost of the property nor on its potential value as an income generator. Because of the fact that the matter of the market price requires special knowledge, its clarification necessitates a technical expert evaluation assigned by the court and to be carried out by a licensed appraiser (single and triple), using different methods (e.g. the real value, the revenue value, the value in hard currency, etc.). Based upon such an expert appraisal, the court determines for each specific case whether consideration has been significantly exceeded. Without claiming to have exhaustively studied the relevant court practice, we may summarize that the courts define as significant a manifold (2:1, 3:1, etc.) inequality of considerations.

Whether the other requirement, namely for the deal to have been closed after the initial date of insolvency, has been satisfied is a matter of a simple comparison of the dates. Here it is important to note that the transaction date is the date of the notarized transfer of title, and not the date of the preliminary agreement on the sale and purchase of the property in question. A preliminary agreement does not in itself materialize the deal as far as the transfer of title is concerned; its purpose is to serve as the basis for the conclusion of the final contract. Irrespective of the fact that it contains all elements of the final contract, including the price, the preliminary contract has no effect in terms of transfer of real rights; not before such an agreement is declared final does the agreed deal become translated into a fact. Therefore any possible inequality between the exchanged considerations is to be weighed at the moment when a transaction has been completed in its factual entirety, which is the moment of signing the notarized title deed.

The requirement for the transaction to involve assets from the bankruptcy estate encounters certain discrepancies in the legislative framework which, on top of that, have never been discussed by the courts. The very concept of ‘bankruptcy estate' has its clear legal definition provided under Art. 614 of the Commerce Act, which stipulates that the bankruptcy estate of the debtor includes their real rights towards the date of the court decision to initiate bankruptcy proceedings, as well as any such rights acquired after the given date. Since the cut-off point is presumed to be the date of the decision to initiate bankruptcy proceedings, rather than the initial date of insolvency, then the most natural conclusion would be that towards the relevant date of the court decision to initiate bankruptcy proceedings the property involved in the transaction should not be at all part of the bankruptcy estate. Although such a conclusion is in clear conflict with the very notion of the so-called ‘suspicious period', it still has its basis in the currently applicable legal norms and such an interpretation could be used in preparing a possible defense, seeking to establish the absence of a factual situation as per CA Art. 646 (2), item 4, and on this basis to support the legitimate validity of the sale of the property.

In view of the above, a defense plea should focus on the supportable assertion that the deal involves real rights falling outside the bankruptcy estate, and that even in the case of unequal considerations under the transaction, the extent to which the given value exceeds the received value is not deemed considerable.

Should the above defense plea prove successful, the creditors in bankruptcy still have the option to invoke the so-called ‘annulment action', whereby they would seek to declare null and void certain actions and transactions listed exhaustively under Art. 647 of the Commerce Act. Item 3 of this article explicitly identifies "deals against payment, where the items given exceed considerably in value the items received, effected within two years prior to the institution of bankruptcy proceedings."

In such a scenario, however, there are two substantial differences. Firstly, the duration of the ‘suspicious period' is limited to 2 years and does not overlap with the period starting from the initial insolvency date as defined by the court by virtue of its decision to initiate bankruptcy proceedings. The second difference is that said 2-year period is calculated backwards from the moment of initiation of bankruptcy proceedings, i.e. from the date of the court decision as per Art. 630, par. 1 of CA.

In such circumstances any given transaction (even if we were to assume, purely hypothetically, that the items given in it considerably exceed in value the items received) concluded after the initial insolvency date, but prior to the 2-year period elapsed since the initiation of bankruptcy proceedings, should not be considered risky.


Ivan Markov

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