Out-of-competition challenging in execution procedure article of Paradigma Legal Group’s lawyer Vadim Shabas in 8th issue of Corporate Lawyer Journal.
The expert: Vadim Shabas
Lawyer at Legal Group Paradigma
Source: Corporate Lawyer journal
Out-of-competition challenging in execution procedure.
The Bill on out-of-competition challenging of debtor’s deals on assets withdrawal has fallen a prey to deserved criticism.
Recall that the document set the way of pre-out-of-competition deals’ challenging without bankruptcy petition. Giving the idea of appearance of institution like that one, let’s examine the reasons why it doesn’t please officials and business.
Bankruptcy is not a cure
Each creditor has a risk to find out debtor ‘back at the bottom of the ladder’. On the threshold of execution procedure debtor often foreseeingly reissues his property to affiliated persons. In chase of debtor’s property creditor is obliged to dispute transactions on assets withdrawal. In the way of challenging the general civil-law procedure doesn’t meet competition against a mechanism of chapter III.1 of the Federal Law of 26/10/2002 №127 FZ “On insolvency (bankruptcy)” (further - The Law №127 FZ). Creditor’s intention of reaching of debtor’s withdrawn assets during execution procedure becomes the sole reason of insolvency procedure start quite often. While initiating bankruptcy creditor is obliged to bear financial expenses on relevant procedures support. Bankruptcy stages sequence makes creditor to run after as usual: during the supervision period debtor and his affiliated persons with the purpose of withdrawn assets’ legalization extend deals on alienation of property which causes bona fide purchasers’ figures made. Possibility of debtor’s deals’ challenging which forms prerequisites for the following withdrawn property recovery is whittled away by voluntary liquidation of bankrupt’s counterparts. Seemingly, instead of pushing the voiding debtors’ deals creditor to the bankruptcy procedure he should be allowed to break debtor’s deals in the general civil-law procedure but due to the same with competition grounds.
The Federal Law of 02/10/2007 № 229 FZ “On execution procedure” (further - The Law №229 FZ) is requested to be supplemented with chapter 17.1 named “challenging of debtor’s deals”, the text of which reproduces regulations of chapter III.1 of the same name of Law №127 FZ (№711269 federal law project “On introduction of changes to the Federal Law “On execution procedure””) (next as The Bill). These changes are supposed to counteract against assets’ withdrawal on threshold and after commencement of execution proceedings.
The challenging of debtor’s out-of-competition deals was expected. Assets withdrawal remains to be creditor’s headache, and stage of execution procedure is still categorized as chronic undercompensation. The current legislation De lege lata has certain suite of tools which allows challenging deals executed by unscrupulous debtor. Nevertheless the effectiveness of the general civil-law procedure leaves much to be desired, as a result of it the articles 10, 168 and 170 of the Civil Code of the Russian Federation don’t serve for claimant as standby. Fails of the latter ones are used to be explained as proof difficulties.
In order to recognize debtor’s deal null and void according to articles 10 and 168 of the Civil Code of the Russian Federation, it is required from claimant to provide court with abuse of law proofs settlement of deal by debtor.
Abuse of a right by contestant must be proved by the other party or be evidently followed of merits of the actual facts arisen between the contestants. For admission of fact as the abuse of a right while making deal both sides’ intention on infliction of damage to third parties must be established (their deliberate, goal-seeking behavior). Abuse of a right must carry an evident and obvious nature which resolves all the doubts about true goals of making the deal. (Moscow district Arbitration tribunal decision of 16/01/2015 № F05 15694/2014 on case №A40 44442/2014, Moscow City court decision of 29/01/2015 № 4g/8509). Admission of deals as mock and fictitious ones (article 170 of the Civil Code of the Russian Federation) is conjugated with the necessity of contract parties’ real intention proof. The standard of proving for both dispute categories is an invariably high so few claimants can meet the requirements.
The Bill changes execution procedure area’s polarity from obligatory to a bond one. The authors’ idea is utmost clear. Debtor’s deals can be already disputed on bankruptcy matters at the execution procedure stage. Thereby chapters’ III.1 of the Law №127 FZ tools is universal. Chapters’ 17.1 of the Bill mechanism has a mission to become the alternative to debtor’s insolvency mechanism, but to be both less cost-based and more acceptable regarding terms.
Claimant’s bankruptcy tools.
The Bill introduces two categories of deals to execution procedure: queer deals and deals with preference.
Besides, by queer deal it is meant:
• “a deal made by debtor in the course of a year till the moment of apply for an execution procedure and at any moment hereafter apply of an execution procedure can be adjudged as void if there is an unequivalent counter-execution of obligations by the other party, including situation when that deal’s price and (or) other terms are differ for the worse for debtor essentially from price and (or) other terms by which similar deals are made under the comparable conditions” (section 1 article 121.2 of the Bill);
• “a deal made by debtor to cause harm to claimant’s property rights can be adjudged as void if that deal was made in the course of three years before apply of an execution procedure, or after apply of such application if harm to claimant’s property was delivered and the other party of deal had known about such debtor’s purpose by the settlement of deal” (section 2 article 121.2 of the Bill).
Article 121.2 of the Bill poses a threat of challenging to the most typical transactions on withdrawal assets – transactions on alienation of the assets which were made on the threshold of and during lawsuit, and also after apply of execution procedure in case of unequivalent (uneffective) counter-representation.
There is criticism of rules of section 2 of article 121.2 of the Bill in the State Duma Committee on civil law, penal law, arbitral and civil procedure laws conclusion (analog of paragraph 2 article 61.2 of the Law №127 FZ), which supposedly duplicate the challenging mechanism according to articles 10, 168 of the Civil Code of the Russian Federation, and are unnecessary due to this. Prima facie the bankruptcy’s and the general civil-law’s invalidity formal elements are equal indeed. In both cases the harm to creditor’s property, occurrence of harm and knowing the information by debtor’s counterpart about unlawful purpose during settlement of voidable deal are subjects to proof. Multiplying compositions of invalidity in excess of needs, following the Law № 127 FZ the Bill “cuts the cords that bind” – according to forms of voidable deals.
Despite the identity of formal formal elements of invalidity the same deal during challenging on the bankruptcy grounds (section 2 article 121.2 of the Bill, paragraph 2 article 61.2 of the Law № 127 FZ) is subject to be qualified as voidable, and during challenging in general civil-law order – as null and void.
From a procedure point of view deals’ challenging on paragraph 2 article 61.1 of the Law № 123 FZ (as section 2 article 121.2 of the Bill) differs in essence from challenging on articles 10 and 168 of the Civil Code of the Russian Federation by reappointment of the burdens in favor of creditor (claimant).
Sword of Damocles of execution procedure
Usage of construction of deals with preference is fallacious during execution procedure stage. A deal made by debtor towards individual creditor or other person can be adjudicated as void if it entails or can entail favour for creditor against claimant, in particular if there are the next conditions:
• a deal aims to ensure making of debtor’s or third party’s obligation towards individual creditor which has been appeared by settlement of challenging deal;
• a deal has led or can lead to such changes for debtor’s solvency that he will not be able to carry out his execution procedure payment obligations (section 1 article 121.3 of the Bill).
The deal specified in section 1 article 121.3 can be adjudicated as void if it had been made during a year by apply for an execution procedure and at any time after receiving application on its commencement.
State Duma legal department criticized the proposed by the Bill’s authors project of deals with preference. In experts’ opinion paragraph 3 section 1 article 121.3 enacts an advantage for obligation in which creditor exercises his right of claim in compulsory order towards the obligation in which creditor’s rights of claim are exercised in general order. Regardless of liability sequence the prior in tempore claimant is vested with auditor’s “authority” regarding to the other debtor’s deals. It is enough for deal to lead or even if it could lead to so debtor’s solvency changing that he will not be able to carry out of his payment obligations within the execution procedure limits. As a result the future of such deals hangs on claimant’s proceedings activity.
Under the aegis of deals with preference the problem of debtor’s undercompensation during the stage of execution procedure is risked to be solved not for account of debtor but counterparts of the latter.
Following bankruptcy commissioner’s example.
The Bill vests officials of Federal Bailiffs’ service with function on debtor’s deals revealing. Bailiff in the course of 2 months from the date of apply for an execution procedure is obliged:
• to make arrangements on deals revealing, noted in section 1 and 2 articles 121.2 and 121.3 of the Bill;
• to report received data to claimant; to make arrangements on appealing of mentioned deals (section 5 article 121.1).
At the same time the revealing is supposed for deals which were made over the past 3 years.
It is interesting that the document supposes none special authority to reveal debtor’s deals. In case of enacting of the Bill in current version, bailiff will be obliged to confine himself to usual set of legal means – requests to registry and to the debtor himself. Strange as it may seem but the Bill makes no provision for debtor’s responsibility on information disclosure about executed deals unlike the similar responsibility on providing information about property rights (section 7 article 69 of the Law № 299 FZ). That prejudices prospects of information extraction and imposing administrative liability towards unscrupulous debtor. The necessity of such bailiff’s authority can be proved with the help of systematic interpretation of rules of law – section 5 article 121.1 of the Bill and section 6 of the Law № 229 FZ.
On a par with the claimant the Bill vests bailiff with authority on appealing of debtor’s deals (article 121.8 of the Bill). In the version of the Bill bailiff is not an ordinary executor anymore, which is pointed out in State Duma Committee’s on constitutional legislation and capital construction conclusion. The functions of analysis and of following challenging of debtor’s deals are mismatched with bailiff’s status, his education and material security. Besides, they create significant corruption risks.
Bailiff’s authority on deals challenging is limited to bankruptcy grounds. Debtor’s deals challenging according the rules of paragraph 2 article 9 of the Civil Code of the Russian Federation should be an exclusive prerogative of private individuals as usual.
Implementation of the right to challenge deals
According to the text of the Bill’s explanatory memorandum the authority on debtor’s deals challenging can be carried out by bailiff “only due to debtor’s shortage of means, lack of property which could be the object of levy execution, and all bailiff’s taken legal measures of property revealing have turned out unsuccessful”. However in the Bill itself (section 4 article 121.1) claimant’s right of realization of debtor’s deals is not defined concretely. The document doesn’t include restrictions like the need of preliminary setting of debtor’s qualified for levy execution property. A formal reading allows to do conclusion on possibility of deal’s challenging initiation after apply for execution procedure and without proofs of debtor’s lack of property.
It can cause many abuses. Let’s suppose that debtor has low liquidity property of 100 rubles worth. High liquidity property is alienated by him for 50 rubles on the threshold of execution procedure. The deal formally meets the criteria of the Bill’s chapter 17.1 at the same time. For example it has made at differ price than the market’s one. After getting writ of execution of 50 rubles claimant is interested in forthcoming satisfaction of claims at the expense of the most liquid property, what creates incentives for him to challenging of deal between debtor and his counterpart, and to receive satisfaction at the expense of proceeds from public auction high liquid contract realization.
And that with initial sufficiency of debtor’s property. Of course, in such situation it will be hard to prove the fact of his rights or legitimate interests depreciation by deal (paragraph 1 article 3 of the Civil Procedural Code of the Russian Federation and section 1 article 4 of the Arbitration Procedural Code of the Russian Federation), but technically he can make an attempt.
Debtor as subject of challenging
The list of persons authorized to debtor’s deals challenging is not limited by bailiff or even by claimant. The appropriate application can be applied to court by debtor himself (article 121.8).
The armament of debtor by the right of “torpedoing” his own deals doesn’t meet aims of the Bill. At the stage of execution proceeding he’s not interested in using of “creditor’s club“ as intended at all. On the contrary, the realization of right of deals challenging by debtor can cause nothing but abuses.