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SIMPLIFIED PROOF IN LITIGATION AGAINST THE INSOLVENT DEBTOR’S DIRECTORS.

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. In such cases, creditors can start a special court procedure against the director of the company and seek compensation for their outstanding claims. In our article, we examine based on a recent court decision, how can the creditors, who are usually “out in the dark” prove the depletion of the company's assets and other breaches by the director.

1. Liability of the managing director for the debts of the company

Companies are independent legal entities, who are generally liable for their debts with their own assets, 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, as during the operation of the company the payment of the debt can be demanded from the company, 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. In practice, creditors sooner or later request the liquidation of the insolvent company anyway, so this scenario is quite common.

Failure to recover may give rise to liability for wrongful trading on the part of the managing director of the debtor company[2], 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 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 specific procedure specified in the Bankruptcy Act[4].

2. Procedure in connection with the liability of director for wrongful trading

Pursuant to the Bankruptcy Act, liability of the liquidated debtor’s managing directors may be determined in case they failed to exercise their management functions in the interests of creditors in the span of 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: during the liquidation, a declaratory action must be brought first to establish the director’s liability. If this is successful, however, the director can only be ordered to pay the debt in a separate action after the liquidation has been completed, if the claim has not been recovered in the liquidation proceedings.[6]

The practical difficulty of the procedure is that the creditor has to state and prove facts, the information and documents on which are usually only available to the debtor company and are not public to the creditor.

This problem also arose in a recent court case we examined: the applicant sought a declaration of liability of the managing director, however, the debtor company, during the director’s term of office, did not publish its annual accounts; furthermore, the director failed to comply with the obligation to hand over the company documents and assets to the liquidator and to provide information. Due to the above omissions, the applicant had no information about the company's finances.

3. Facilitation of proof by creditors

In the following section, based on a recent court decision[7], we will examine what are the options of the creditors who do not have many information or evidence against the director, in case they decide to initiate the proceeding.

Reversal of the burden of proof in case of non-disclosure of annual accounts

The Bankruptcy Act itself seeks to facilitate proof by the creditor: where a director failed to perform or improperly performed - for reasons within his control - the requirement prior to the opening of liquidation proceedings of having to deposit and publish the economic operator’s annual accounts, or failed to comply with the obligations to draw up the reports and accounts, and to have the relevant documents and assets delivered to the liquidator, and - furthermore - to provide information, the burden of proof that no situation carrying potential danger of insolvency has occurred during his tenure as director, or if such situation has in fact occurred, he has performed his 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.

According to the recent court decision, in case the director failed to comply with the mentioned obligations, it is 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;
  • a conduct detrimental to the interests of creditors (without identifying the specific harmful conduct).

As the burden of proof is reversed, the director has to prove that no situation carrying potential danger of insolvency has occurred during his tenure as director, or if such situation has in fact occurred, he has performed his management functions in due consideration of the interests of creditors[9].

Applicability of the concept of “evidentiary predicament”

In addition, the 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 (e.g. internal documents of the debtor company, bank account statements).

If the party relying on “evidentiary predicament” proves presumptively that evidencing factual claims is beyond his means, however, 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 decision 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 can be established if the director failed to hand over the documents of the debtor company to the liquidator and thereby prevented creditors from proving the abuses by the management.[12]

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

4. Conclusion

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 he has to prove that he did not commit any violation against the creditors.

Furthermore, a recent court decision makes it clear that in case of the above omissions by the director, the creditors can rely on evidentiary predicament, so 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 more effectively and that the procedure will play a greater role in the future.

 

 

[1] Section 3:2 (1) of Act V of 2013 on the Civil Code (“Civil Code”)

[2] Section 3:118 of the Civil Code

[3] Act XLIX of 1991 on Bankruptcy Proceedings and Liquidation Proceedings („Bankruptcy Act”)

[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