Insolvent Borrowers Successfully Challenge Security Granted to Banks in Bulgaria

→ Anton Andreev

Banks in Bulgaria are seriously concerned with borrowers fraudulently manipulating their accountancy books with the effect that banks’ security interests are declared invalid and banks are declassed into ordinary (unsecured) insolvency creditors.

Bulgarian legal regime

A debtor is bal­ance sheet insol­vent when it is unable to pay its debts as they become due or it has finan­cial lia­bil­i­ties exceed­ing the val­ue of his assets. Whether and as of which day a debtor is bal­ance sheet insol­vent is a ques­tion of fact to be deter­mined with the sup­port of accoun­tants and val­u­a­tion experts.

If a court deter­mines that the debtor is bal­ance sheet insol­vent, the debtor will be declared “judi­cial­ly insol­vent”.

Pur­suant to a much-crit­i­cised legal pro­vi­sion in Bul­gar­ia, if a bal­ance sheet insol­vent debtor is declared judi­cial­ly insol­vent, this will inval­i­date by oper­a­tion of law: (i) any per­for­mance of a finan­cial oblig­a­tion and (ii) any cre­ation of a secu­ri­ty inter­est over any asset of the insol­ven­cy estate, in each case, made after the debtor became bal­ance sheet insol­vent. Accord­ing­ly all secu­ri­ty inter­ests and pay­ments made by a bal­ance sheet insol­vent debtor, includ­ing those that have been re-sched­uled or restruc­tured, may be declared void if the court opens insol­ven­cy pro­ceed­ings.

In an attempt to elim­i­nate fraud­u­lent pref­er­en­tial treat­ment of cred­i­tors, Bul­gar­i­an law has adopt­ed the void­ance “per se” approach towards all cred­i­tors with­out excep­tions. Cred­i­tors may not rely on defences by prov­ing, for exam­ple, that the pay­ment was made or the secu­ri­ty was cre­at­ed with­out intent to defraud the oth­er cred­i­tors.

There­fore, in such cas­es the insol­ven­cy admin­is­tra­tor of a judi­cial­ly insol­vent debtor may claim repay­ment or request inval­i­da­tion of secu­ri­ty inter­ests. The cred­i­tor is then left only with its claim as an unse­cured cred­i­tor (pari pas­su with all oth­er unse­cured cred­i­tors) in the debtor’s judi­cial insol­ven­cy pro­ceed­ings.

There is no lim­it back­ward in time of the “sus­pect peri­od” (the peri­od by ref­er­ence to which cer­tain trans­ac­tions may be sub­ject to avoid­ance), nor is there a so-called “hard­en­ing” peri­od before or after which a secu­ri­ty inter­est or pay­ments made by a bal­ance sheet insol­vent debtor may be deemed valid and immune from claw-back.

Unfair treatment of creditors

The exact date from which the debtor is to be deemed bal­ance-sheet insol­vent is fixed by the court in its deci­sion for open­ing of insol­ven­cy pro­ceed­ings. The date may be months, even years, before the appli­ca­tion for com­mence­ment of insol­ven­cy pro­ceed­ings is filed with the court. The far­ther back the date is fixed, the more pay­ments and secu­ri­ty trans­ac­tions may be declared void. Accord­ing­ly, there is an increas­ing num­ber of cas­es where unse­cured cred­i­tors, act­ing in con­cert with the insol­ven­cy debtor, are seek­ing to demon­strate that the debtor incurred much debt long in the past. In prin­ci­ple, man­agers of bal­ance sheet insol­vent debtors must file for insol­ven­cy with­in 30 days from when the sta­tus of insol­ven­cy or over-indebt­ed­ness was estab­lished. How­ev­er, as it is often rather dif­fi­cult to prove dam­ages suf­fered by cred­i­tors as a result of delay in fil­ing an insol­ven­cy appli­ca­tion, and as it is easy for direc­tors to escape crim­i­nal lia­bil­i­ty for not time­ly apply­ing for insol­ven­cy, man­agers often agree to take part in schemes to “back­date” insol­ven­cy. Fic­ti­tious and back­dat­ed con­tracts or promis­so­ry notes exe­cut­ed by man­agers and sham cred­i­tors are sub­mit­ted as evi­dence so that the debtor can be found bal­ance sheet insol­vent before the date of cer­tain pay­ments and secu­ri­ty inter­ests, which are chal­lenged. If the sham cred­i­tors suc­ceed, the chal­lenged pay­ments and secu­ri­ty inter­ests is declared invalid.

In a time of con­tin­u­ing glob­al cri­sis, the inflow of “fresh” loans is reduced, the aver­age loan port­fo­lio of banks matures and loan prob­lems become increas­ing­ly appar­ent over time. As of mid-2012, the share of non-per­form­ing loans in Bul­gar­ia was 16.86%, and the share of the cor­po­rate non-per­form­ing loans in par­tic­u­lar was 19.42%. Banks are increas­ing­ly involved in insol­ven­cy pro­ceed­ings against bor­row­ers. So banks are seri­ous­ly con­cerned with attempts of insol­vent bor­row­ers to manip­u­late their accoun­tan­cy books so that secu­ri­ties and pay­ments in favour of the banks are inval­i­dat­ed by oper­a­tion of law. The straight­for­ward appli­ca­tion of the far-reach­ing insol­ven­cy law pro­vi­sion men­tioned above pos­es a real threat to banks, and calls for a leg­isla­tive solu­tion are increas­ing.

Legislative proposal

There is a recent leg­isla­tive pro­pos­al to amend this law pur­suant to which only pay­ments in dis­charge of non-matured oblig­a­tions may be declared invalid. The draft bill would also intro­duce a tem­po­ral lim­i­ta­tion for the sus­pect peri­od, where­by the mak­ing of (non-mature) pay­ments and the cre­ation of secu­ri­ty inter­ests will be void only if they occur with­in one year before the date on which the appli­ca­tion for com­mence­ment of judi­cial insol­ven­cy pro­ceed­ings was filed.

The pro­posed leg­isla­tive amend­ment may need some tech­ni­cal improve­ment, but it is cer­tain­ly a step in the right direc­tion and will help to estab­lish an effec­tive insol­ven­cy regime in Bul­gar­ia.

In a time of continuing global crisis, the inflow of "fresh" loans is reduced, the average loan portfolio of banks matures and loan problems become increasingly apparent over time.