Konrad Grotowski: The owners of a company threatened by bankruptcy sometimes give in to the temptation to remove assets from the company

An interview with Konrad Grotowski from the Bankruptcy and Restructuring practices at Wardyński & Partners on how creditors can protect themselves against actions by a dishonest debtor.

Litigation Portal: Is removal by shareholders of assets from companies threatened with bankruptcy in order to protect the assets against execution a major problem in Poland?

Konrad Grotowski: Yes. I my practice I often encounter such actions by persons controlling companies. I have even observed it within the capital groups of companies listed on the Warsaw Stock Exchange. In multi-level capital groups comprising a dozen or more companies, it is easier to conceal actions of this type and evade the scrutiny of creditors.

I would hasten to add, however, that it is fairly difficult to conduct transactions of this type in a manner that effectively secures the removed assets from creditors—particularly when there are large claims involved, running to tens or hundreds of millions of zloty, and the assets removed have significant market value. In such cases, it pays off for the creditor to invest in lawyers to attempt to set aside such transactions so that the creditor may obtain satisfaction out of the assets.

Has the economic slowdown increased this problem?

Definitely. During stagnation or recession, debtors’ loyalty to their creditors is severely tested.

And it is difficult to simply walk away from a collapsing company and start a new business, because the competition is high in almost every sector of the market, which means that the costs of entering a new market are significantly greater than when the market is in a growth phase.

What motivates dishonest debtors to take such actions?

From the point of view of a lawyer involved in collecting difficult debts, the debtor’s motivation is very important.

If the owners of a company decide to siphon assets out of the company systematically, at every stage, driving it into bankruptcy and leaving the creditors unsatisfied, such measures are carefully prepared over many months or even years. Such transactions are planned by experienced lawyers. In such cases, obtaining satisfaction for the creditors is indeed difficult.

However, if the debtor has operated its enterprise in good faith, and the problems meeting its obligations arise from, for example, an unforeseen increase in costs rendering contract performance unprofitable, or from the insolvency of one of the company’s own debtors, the debtor’s attempts to remove assets from the reach of the bailiff or the bankruptcy trustee are more ad hoc, but they may still be carefully planned. One could say that the legal awareness of debtors threatened with bankruptcy grows in direct proportion to their difficulty in paying their debts. Thus the creditor should never underestimate what a debtor is capable of doing.

Entrepreneurs who have personally built the business from the ground up have a stronger motivation to protect the assets against execution. It is fairly natural that they will attempt to protect the fruits of their life’s work at any price, often crossing the line set by the law and business ethics.

How may a creditor protect itself from actions of this type by a dishonest debtor?

Firstly, the creditor should protect its interests at the time it enters into a contract with the debtor, by demanding security for its claims against the debtor’s assets, via a mortgage on real estate or a lien on movables or shares in subsidiaries. It is also possible for a seller to reserve title to goods until the entire purchase price is paid.

Unfortunately, not every debtor will agree to these measures. Sometimes the debtor does not have assets worth enough to secure the principal and interest. Or its assets may already be encumbered. In that case, the earlier security will take priority.

The law does allow transactions by a debtor to the detriment of the creditors to be set aside. A creditor may file a fraudulent conveyance claim under the Civil Code. A creditor of an insolvent company may also file a petition seeking the declaration of the debtor’s bankruptcy. After the bankruptcy is declared, transactions injurious to creditors which meet certain conditions become ineffective. The bankruptcy trustee may thus satisfy the creditors out of the assets which were removed from the company or which were supposed to reach the company but did not.

Which creditors are most at risk of loss from dishonest acts by the debtor?

First and foremost counterparties such as suppliers of goods and services, and bondholders whose claims are not secured by encumbrances on the debtor’s assets or by third-party guarantees.

Banks are in a better position because they almost always seek security for loans through mortgages on the debtor’s real estate or liens on movables and shares. But banks cannot rest easy either, because the worsening financial condition of a debtor may spur the debtor’s creativity.

The activity of the debtor and transactions affecting its assets should be monitored on an ongoing basis. In the case of public companies listed on the main market of the Warsaw Stock Exchange or NewConnect, it is important to keep abreast of the debtor’s current and periodic reports. It is also possible for creditors to purchase a few shares of the debtor in order to assure the opportunity to participate in the company’s general assembly where the condition of the company is discussed.

If the creditor notices any disturbing signals, it should consult with a lawyer. Delay in such a situation will work against the creditor—if for no other reason because in the meantime the statutory deadlines for seeking to set aside transactions by the debtor may pass, threatening the creditor’s ability to obtain satisfaction of its claims.