Konrad Grotowski

The creditor’s dilemma: Join forces or go it alone?

When assets are being removed from a debtor threatened with insolvency, the creditors face a choice of seeking to set aside such transactions independently, or filing a bankruptcy petition and relying on the actions of the bankruptcy trustee.

Assets which should be used to satisfy creditors are often removed for a fraction of their true value from companies threatened by bankruptcy. Then the creditor faces a dilemma: Should it use its own efforts to seek to set aside such transactions, or file a bankruptcy petition against the company and leave it to the bankruptcy trustee to recover the assets? Which option is more beneficial to the creditor is not easy to determine and depends on numerous factors.

Transactions by a debtor (e.g. disposal of real estate at a reduced price or for free) may be challenged pursuant to a fraudulent conveyance action as provided in Art. 527 of the Polish Civil Code. Through such an action, the creditor may obtain a judgment enabling it to execute its claims against the debtor company from the assets of a third party, i.e. the individual or legal entity which has obtained the assets removed from the debtor. The transaction between the debtor company and the third party will remain valid (the parties will not be required to restore the consideration exchanged between one another), but pursuant to the judgment the transaction becomes ineffective against the creditor. But in order to begin execution, the creditor must hold an executable writ, authorising execution by the bailiff against the debtor. Typically this is a legally final judgment ordering the debtor to pay money to the creditor. But it may also be an unperformed settlement concluded with the debtor before the court, or a confession of judgment (a notarial deed in which the debtor submits to execution). If the creditor does not hold an executable writ, then alongside the fraudulent conveyance action against the third party it must also file a claim for payment against the debtor. Both of these proceedings may cost time and money. When filing each statement of claim, the creditor will have to pay a court fee equal to 5% of the amount in dispute (but no more than PLN 100,000).

Here is where the dilemma arises. Art. 127 and following of the Bankruptcy & Rehabilitation Law provide for the ineffectiveness of certain transactions by the debtor by operation of law, i.e. automatically, without the need to obtain a judgment (following possibly protracted litigation). This applies, for example, to transactions by the debtor within one year prior to filing of the bankruptcy petition in which the debtor disposed of its assets for no consideration or for consideration grossly below the value of the consideration provided by the debtor. After the debtor’s bankruptcy is declared, certain transactions by the debtor for consideration within 6 months prior to filing of the bankruptcy petition will also become ineffective against the bankruptcy estate. In the case of an individual debtor, this applies to transactions with the debtor’s spouse or relatives, and in the case of a corporate debtor, transactions with its shareholders or affiliates, shareholders of affiliates, or a parent or subsidiary. If transactions detrimental to the creditors were conducted earlier than the times indicated above, they do not become ineffective by operation of law, but the creditors can cause the bankruptcy trustee to seek to set aside the transactions. This is relatively inexpensive, because the bankruptcy trustee is exempt from court fees.

It should be borne in mind that after a declaration of bankruptcy, the bankruptcy trustee may step into the shoes of a creditor who has been acting on its own to seek the ineffectiveness of a transaction by the debtor, in the interest of all the creditors. If the trustee decides to do so, the other creditors will, in a sense, benefit from the litigation commenced and paid for by one creditor. The Bankruptcy Law provides, however, that in that case the bankruptcy trustee must apply the proceeds obtained to reimburse the creditor’s litigation costs (court fee and attorney’s fees). The right to reimbursement of such costs is an independent claim and does not require a proof of claim, and is subject to satisfaction out of the proceeds of the action with priority over other costs of the bankruptcy proceeding.

The creditor may thus come to the conclusion that instead of litigating with the debtor itself, paying court fees and risking replacement by the bankruptcy trustee, it is better to file a bankruptcy petition against the debtor and leave the issue of the ineffectiveness of the debtor’s transactions to the bankruptcy trustee. This could be an even more attractive option if there are grounds for the debtor’s transactions to be regarded as ineffective by operation of law. Moreover, holding a legally final judgment ordering the debtor to pay money is not a condition for filing a bankruptcy petition or allowance of the claim.

But compared to a freestanding fraudulent conveyance action by the creditor against the debtor, a drawback to the bankruptcy petition is that the proceeds executed against the other party to the transaction with the debtor do not go into the pocket of the creditor who has fought the fight, but into the bankruptcy estate—a common fund for satisfaction of all the creditors. And priority first goes to payment of (i) costs of the bankruptcy proceeding (typically in the tens of thousands of zloty at least), (ii) employees’ salary claims arising prior to the declaration of bankruptcy, (iii) social insurance claims for the two years preceding the declaration of bankruptcy, and (iv) taxes. It may thus turn out that after satisfying secured creditors and claimants with statutory priority, there will little or nothing left to pay trade creditors.

This all leads to the conclusion that the creditor’s lawyer must carefully analyse all the pros and cons before drawing up a precise action plan to suit the specific factual situation.

Konrad Grotowski, Bankruptcy and Restructuring practices, Wardyński & Partners