The factoring mortgagees' rights when the bankruptcy estate continues the operation of the bankruptcy debtor
Continuing operation following bankruptcy proceedings can be in the interest of the bankruptcy estate, the creditors and the mortgagees. For instance, a ship mortgagee may wish to complete a current charter to avoid claims from the charterer or any cargo owner, or to sail the vessel to a more favourable jurisdiction for a potential sale. However, it is important to note that the rights of the factoring mortgagee will end when the bankruptcy estate operates the business after the commencement of bankruptcy proceedings. In this respect it should be noted that under Norwegian insolvency law, the bankruptcy estate is a separate legal entity from the bankruptcy debtor.
Pursuant to section 4-10, first paragraph of the Norwegian Mortgages and Pledges Act, a factoring agreement only secure claims that arises in the business of the pledgor (in this case the bankruptcy debtor). When the pledgor goes bankrupt, there must be drawn a line between claims that arises from operation of the bankruptcy debtor and claims that arises from the operation of the bankruptcy estate . Claims that arises from the operation of the bankruptcy estate will normally not be covered by a factoring agreement entered into by the bankruptcy debtor. The cut-off time will be the date of commencement of bankruptcy proceedings.
Whether a claim is deemed to have arisen from the operation of the bankruptcy debtor or in the operation of the bankruptcy estate will depend on various factors and may differ depending on the type of contract in question.
A relevant factor is whether the contractual obligation that the payment derives from, in whole or in part, has been fulfilled by the bankruptcy debtor prior to the commencement of bankruptcy proceedings or not.
If the contractual obligation has been fulfilled by the bankruptcy debtor in full, the claim will be deemed to have arisen from the operation of the bankruptcy debtor and thus be covered by the factoring agreement (regardless of whether an invoice has been issued). In the opposite case, where a contractual obligation has been fulfilled in whole by, and as a result of, the bankruptcy estate`s continuous operation, the claim will be deemed to have arisen in the operation of the bankruptcy estate and therefor not covered by the factoring agreement entered into by the bankruptcy debtor.
In cases where the bankruptcy debtor have only partially fulfilled the contractual obligation before the commencement of bankruptcy proceedings and the bankruptcy estate later completes the performance, the question will be subject to a more nuanced and concrete assessment.
In case of an ordinary sale and purchase, it will be crucial to determine whether the contracting party has obtained legal protection for its right before commencement of bankruptcy proceedings. If legal protection has been established before commencement of bankruptcy, the claim will be deemed to have arisen in the operation of the bankruptcy debtor and covered by the factoring agreement, while otherwise it will fall outside accordingly. The same point of view must, in principle, be used as a basis for claims in manufacturing, provided that legal protection is achieved gradually as work progresses.
If the bankruptcy estate steps in to a contract that relates to lease or subscription, it will only be obliged to perform from the date of commencement of bankruptcy proceedings, cf. section 7-4, third paragraph of the Norwegian Creditors Security Act. In such cases, the proceeds from the contract must be distributed proportionally based on the extent of performance of the contract on the date of commencement of bankruptcy proceedings.
Sometimes the business of the bankruptcy debtor is continued by the bankruptcy estate in the sole interest of a mortgagee. In such cases, the liquidator will often require a guarantee and indemnity from the mortgagee as security for any costs and liability that may arise from the continuing operation. In such case, where the mortgagee is carrying all the financial risk, it will be reasonable to request that the liquidator agrees that the earnings from the operation are distributed to the mortgagee accordingly. However, such requests should be clarified in advance and be implemented in the cooperation agreement with the liquidator, and additionally by having the bankruptcy estate entering into a new factoring agreement in favour of the original factoring mortgagee.
Simonsen Vogt Wiig regularly assist with matters related to security, enforcement and insolvency.