Voiding of payments prior to the opening of bankruptcy

| Insight

In a new ruling from the Norwegian Supreme Court payment of salary, and partially reimbursement of loan, to the managing director and his wife were voided despitebeing in accordance with valid agreements entered into years before the opening of bankruptcy.

Pursuant to The Norwegian Creditors Recovery Act of 8 June 1984 no. 59 (the «Recovery Act») Chapter 5, repayment old of old debt may be declared void and null. However, there is an exception for payments which are deemed «ordinary». Generally speaking, the payment is «ordinary» if it is presumed to be a customary payment which is required to keep the business going, such as electricity, rent, salaries, taxes and merchandise. Such expenses will not be voidable, even though they are made prior to the opening of bankruptcy. Exceptional payments will often be late settlement of debt, and such payments may indicate giving unduly preference to a creditor at the expense of the other creditors in a timeframe where opening of bankruptcy is foreseeable. The Norwegian Supreme Court has expressed that the need for certainty and predictability, justifies that a company in financial distress should in certain circumstances be able to keep their current expenses. By only voiding ‘extraordinary expenses’, an opportunity arises where companies with a long-term survival plan, may keep its going concern despite short term financial distress.

On the 14 February 2017, the Norwegian Supreme Court pronounced a judgement concerning a company who had a strained liquidity over a longer period time. The company entered into an agreement with its managing director regarding postponed payment of salary, and a contract with the managing director’s wife, regarding disbursement of an underwriter’s commission in relation to a security she had given for the company’s legal expenses. Pursuant to the contract, the managing director and his wife were given right of priority once the company once the company was liquid.

The company was awarded compensatory damages in contract, making the company liquid. The company’s bank, DNB (The Norwegian Bank), who were familiar with the agreements, warned the company about making dispositions that essentially would be giving preference to certain creditors at the expense of others. The bank emphasised that given the company’s financial situation, an opening of bankruptcy was likely. The company and the bank were not able to agree upon a division of the assets. Despite this, and without the banks approval, the company made payments to the manging director of NOK 1 500 000 and NOK 144 914 and NOK 1 819 178 and NOK 247 563 to the managing directors wife.  Less than three months later, bankruptcy was opened.

The Norwegian Supreme Court found that the payments were extraordinary payments, given priority at the expense of other creditors, and consequently they were voidable. The fact that the managing director and his wife were closely associated with the company, giving them access and insight to control and assess the company’s liquidity, indicated that the payments were not to be deemed ordinary. The Norwegian Supreme Court also considered that the company lacked liquid assets, had lost its share-capital, and as soon as the company was supplied with liquid assets, a substantial part were given to the managing director and his wife. The Supreme Court emphasized that under these circumstances, it would require a lot for the payments to be considered as ‘ordinary’.

Two of the payments were used to repay old debt granted from the managing director’s wife, and reimbursement of an electricity bill the managing director had floated on behalf of one of the company’s subsidiary. The Supreme Court emphasized that the payments was not connected to the current operations in the company, and found that they rather favored the managing director and his wife, at the expense of other creditors.

Even though the disbursements were done in accordance with valid agreements from 2008 and 2009 and that had been entered into a long time before the bankrupcty proceedings, the Supreme Court held that the agreements themselves were ‘unsual’. The backdrop of the agreements where the company’s  strained liquidity, the clauses were formulated in a way which treated the creditors unfairly, and provided the managing director with a better priority than he normally would have had under the Creditors Recovery Act in case of bankruptcy. The managing director and his wife submitted that the agreements were part of a ‘rescue plan’ aiming to give the creditors maximum coverage.

In previous case-law, the Supreme Court has indicated that the aforementioned payments may be considered ordinary. The determining factor has been whether the payment obligations were usual in the course of busiess based on the situation at which the company was inn.. The Supreme Court found that this was not the case for the payments to the managing director and his wife. The company did not have any employees other than the managing director, and there were no operations to be continued. The work which the company did prior to the bankruptcy was essentially the same work that an curator in a bankruptcy estate would undertake, if bankruptcy proceedings had been opened at an earlier stage. The agreements did not relate to the securing  of further operation and keeping the concern going, and therefore was not deemed a situation at which the Supreme Court has considered payments as a part of a rescue-plan to be ordinary.

The judgement is of importance, as it establishes that even though the managing director and his wife agreed to provide credit to the company and postpone their salary disbursement, repayment of such agreements may not be deemed ordinary, despite being done in order to salvage the company for bankruptcy. The Supreme Court showed that there certain boundaries, even in cases were the ultimate goal is to save the company.