CAN YOUR DEBTOR ESCAPE LIQUIDATION BY SETTING OFF CLAIMS IN HUNGARY?

26 June 2019

The initiation of a liquidation procedure is an effective debt collection method, since the debtor may only avoid being liquidated by paying the claim if the conditions specified in the Act on Bankruptcy Proceedings and Liquidation (Bankruptcy Act) are met. For this reason, in the case of liquidation, one of the most common defences of the debtor is the reference to offsetting. But can the debtor refer to offsetting without limitation during liquidation? In our short article we answer this question.

Setting off claims according to the Civil Code

According to the Civil Code, in case of mutual (opposing) payment obligations between two companies, the debt can be settled not only by paying it, but also by setting off the other party’s claim, in other word, by “compensating” it. In this case the offsetting debtor does not pay his own debt and does not require the other party to pay their debt up to that amount.

Setting off claims during liquidation

In the liquidation proceedings, the debtor often refers to the fact that he has not paid the invoices of the creditor requesting the liquidation, because he also has a claim against the creditor that he intends to set off.

In the liquidation procedure, however, the rules of the Bankruptcy Act apply to offsetting, which rules allow offsetting only in a narrow scope compared to the Civil Code.

Setting off executed following the request of liquidation

The debtor often starts to refer to the offsetting only when the creditor initiates the liquidation procedure, so the debtor exercises his right of set-off only after the Court has sent him the request.

Since this often meant that the debtor tried to set-off non-existent or unfounded claims in order to avoid being liquidated, the Bankruptcy Act tightened the admissibility of setting-off. As a result, currently the debtor is only able to do so in the following three cases:

1. A Debtor can set-off a claim that arose prior to the receipt of the payment notice sent by the creditor before the liquidation, but became due only after the deadline for disputing the creditor’s claim. Such claim can be one with longer delivery period so there is a longer time between the incurrence and the due date of the claim.
2. If the Debtor becomes aware that he has existing claim against the debtor or that his claim is overdue, only after the receipt of the payment notice sent by the creditor. An example of this can be a claim the debtor is not aware of, such as a claim for damages based on a breach by the creditor.
3. In case the creditor recognises the claim.

In addition, in cases (a) to (b), the debtor's claim must be evidenced by a public document or a private document of full probative value, so the attachment of an invoice will not be sufficient.

The reason for the restrictions is that the legislator wanted to sanction the negligence of debtors who do not enforce their claims already due before the liquidation request in a reasonable time but obstructs the liquidation procedure with the offsetting.

Setting off declared prior to the request of liquidation

What if the debtor argues that he has not paid the claim because he has already set-off the claim against a debt the creditor had? The Bankruptcy Act and the jurisprudence do not clearly clarify the situation, it is questionable whether the above rules or the Civil Code are applicable regarding set-off declared prior to the liquidation request, when the court assesses the insolvency.

What is certain is that the court of liquidation conducts more formal demonstration, in fact, confines itself to examining the existence of the criteria set out in the Bankruptcy Act. For this reason, they leave no room to the in-depth exploration of the facts and the background of the case. Thus, from a procedural point of view, deciding on the legality of an earlier offsetting is not the subject matter of a liquidation but of a civil litigation.

In conclusion, according to the practice, the debtor cannot escape from the procedure by referring to a previously reported offsetting if the creditor disputes the claim to be set off.

"Forced Payment" and Recovery

If the debtor is unable to set off his claim during the liquidation but wants to avoid being liquidated, he has only one option: to pay the creditor the claim. In this case the creditor will be in possession of the amount.

However, according to the Bankruptcy Act, such "forced payment" by the debtor does not constitute recognition of the debt, and the paid amount may be reclaimed from a creditor in a separate civil lawsuit, whereby full demonstration may also be conducted.

Conclusion

As you can see, in a liquidation procedure the debtor may only refer to offsetting within a limited scope. The reason for this is, firstly, that the debtor has to bear the consequences of not enforcing his claim already due in time and to prevent him from obstructing the liquidation procedure.

Although the creditor may not become entitled to the claim permanently in case of “forced payment”, he will certainly be in the possession of the money, which can give him a stronger bargaining position to close the dispute.

To sum up the above, if your debtor tries to escape the liquidation by setting-off alleged or real claims, you should check whether he can actually set off the claims under the rules of the liquidation procedure.