LIABILITY OF INSOLVENT DEBTOR'S DIRECTORS – REVERSE BURDEN OF PROOF IN PRACTICE

12 May 2022

A common reason for the failure of debt recovery is that the debtor company's managing director, during years of legal proceedings, takes the company's assets and then bankrupts the company. How does the Hungarian Bankruptcy Act and the provisions of the Civil Code of Procedure support creditors who are usually "in the dark"? This article answers this question by examining a recent Hungarian appellate court judgment.

1. Background

Liability of managing director for debts of company

Under Hungarian corporate law, companies are independent legal entities, which are generally liable for their debts with their own assets, while, in general, members and managers are not liable to pay the debts of the indebted company.(1) In the context of debt collection, the liability of the managing director may arise if the claim cannot be recovered from the company. The recovery can be considered impossible if the company is dissolved without legal successor. This is because, during the operation of the company, the payment of the debt can be demanded from the company. Therefore, there is a theoretical possibility of payment. Management liability for the company's unpaid debts can therefore only be established upon the dissolution of the debtor company.

Failure to recover the claim may give rise to liability for wrongful trading on the part of the managing director of the debtor company.(2) This is because this type of liability is specially linked to the withdrawal of assets from the insolvent company and other conducts detrimental to the interests of creditors, which ultimately results in the failure to recover the debt.

The Hungarian Bankruptcy Act(3) provides that if the dissolution of the legal person without succession is ordered in a liquidation proceeding, the creditors may seek the determination of the managing director's liability and claim pecuniary compensation only in the framework of a specific procedure specified in the Bankruptcy Act.(4)

Procedures in connection with liability of director for wrongful trading

Pursuant to the Bankruptcy Act, liability of the liquidated debtor's managing directors may be determined if they failed to exercise their management functions in the interests of creditors in the three years prior to the opening of liquidation proceedings in the wake of any situation carrying potential danger of insolvency, in direct consequence of which the economic operator's assets have diminished, or providing full satisfaction for the creditors' claims may be frustrated for other reasons.(5)

To hold the director liable, the creditor must initiate and go through a two-step legal procedure. First, during the liquidation, a declaratory action must be brought to establish the director's liability. Second, if the declaratory action is successful and the claim could not be recovered in the liquidation proceedings, after the liquidation has been completed, a second action shall be brought against the director.(6)

The practical difficulty of the above procedures is that the creditor must state and prove facts, while the information and documents are usually only available to the debtor company and not to the creditor.

2. Facts

This problem arose in a recent court case adjudicated on second instance by the Szeged Court of Appeal.(7)

In the case at hand, the creditor sought a declaration of liability of the managing director of a debtor company by alleging that the latter failed to comply with its essential obligations.

First, during the director's term of office, the director failed to publish the annual reports of the company, which, under tax law, must be done each calendar year by 31 May.

Furthermore, after the debtor was declared to be insolvent, the director failed to comply with the obligation to hand over the company documents and assets of the debtor to the liquidator and to provide information.

Due to the above omissions, the applicant had no information about the company's finances.

3. Decision

Reversal of burden of proof based on Bankruptcy Act
The Bankruptcy Act itself seeks to facilitate proof by the creditor where a director has failed to:

• perform, or improperly performed, for reasons within their control, the requirement prior to the opening of liquidation proceedings of having to deposit and publish the economic operator's annual accounts;
• comply with the obligations to draw up the reports and accounts and have the relevant documents and assets delivered to the liquidator; and
• provide information that no situation carrying potential danger of insolvency has occurred during their tenure as director, or if such situation has in fact occurred, they have performed their management functions in due consideration of the interests of creditors lies with such director.(8)

The Bankruptcy Act therefore lays down a rule for the reversal of the burden of proof where the director has prevented creditors from knowing the financial position of the company and from proving the abuses by the management.

In the above-mentioned case, the Court laid down that if the director had failed to comply with the mentioned obligations, it was sufficient for the creditor to allege, rather than prove, the following two elements of fact in relation to the liability of the director:

• the existence of a situation carrying potential danger of insolvency (without identifying a specific date) during the defendant's period of office as a director; and
• a conduct detrimental to the interests of creditors (without identifying the specific harmful conduct).

As the burden of proof was reversed, the director had to prove that no situation carrying potential danger of insolvency had occurred during their tenure as director, or if such a situation had in fact occurred, that they had performed their management functions in due consideration of the interests of creditors.(9)

Reversal of burden of proof based on Civil Code of Procedure
In addition, creditors may generally rely on the legal concept of "evidentiary predicament" introduced by the new Code of Civil Procedure in 2018.(10) The new instrument is intended to deal with situations where the party with the burden of proof does not have access to the evidence, but the other party is likely to have it (eg, internal documents of the debtor company and bank account statements).

However, if the party relying on "evidentiary predicament" proves presumptively that evidencing factual claims is beyond their means, the opposing party can be expected to refute the facts alleged. The court considers the fact alleged to be true and the opposing party has to refute the presumption.(11)

The Court assessed the applicability of the concept of "evidentiary predicament" in connection with the procedure at question. The Court considered the rule on the reversal of the burden of proof in the Bankruptcy Act to be a "special type" of evidentiary predicament and made it clear that the evidentiary predicament could be established if the director had failed to hand over the documents of the debtor company to the liquidator and thereby prevented the creditors from proving the abuses by the management.(12)

4. Comment

The significance of the above findings is that the evidentiary predicament can be applied more widely, so the burden of proof can be reversed, not only in relation to the facts set out in the Bankruptcy Act, but in principle in relation to any aspect that the creditor cannot prove due to lack of information.

Based on this decision, it is likely that the institution of evidentiary predicament will become an effective tool in the hands of creditors in the future.

If the liquidated company's managing director has acted unlawfully in a near-bankruptcy situation, creditors can claim from the managing director the reimbursement of their outstanding claims in a special procedure. Lack of information on the debtor company's internal affairs is a significant difficulty for creditors, making it difficult to prove their claims.

Several rules are already in place to facilitate proof by creditors. If the director failed to publish the company's annual accounts or to comply with the obligation to hand over the company documents and assets to the liquidator, the burden of proof is reversed, and they have to prove that they did not commit any violation against the creditors.

Furthermore, the recent court decision makes it clear that in case of the above omissions by the director, the creditors can rely on the new instrument, introduced by the Civil Code of Procedure: the so-called "evidentiary predicament". Based on that, the creditors may be able to reverse the burden of proof in relation to any fact they cannot prove because the director has obstructed access to information.

Based on the recent decision, it is hoped that creditors will be able to enforce their claims against the managing directors of insolvent debtor companies more effectively.

 

Endnotes

(1) Section 3:2 (1) of Act V of 2013 on the Civil Code.

(2) Section 3:118 of the Civil Code.

(3) Act XLIX of 1991 on Bankruptcy proceedings and liquidation proceedings.

(4) Section 33/A (14) of the Bankruptcy Act.

(5) Section 33/A (1) of the Bankruptcy Act.

(6) Sections 33/A (1), (11) of the Bankruptcy Act.

(7) Judicial decision No. ÍH 2021.25.

(8) Section 33/A (5) of the Bankruptcy Act.

(9) Judicial decision No. ÍH 2021.25.

(10) Act CXXX of 2016 on the Code of Civil Procedure.

(11) Section 265 of the Code of Civil Procedure.

(12) Judicial decision No. ÍH 2021.25.