How to protect a transaction from an insolvency clawback

Challenging transactions is the main tool for topping up the insolvency estate. The administrator is obliged to review the debtor's transactions, and if he fails to do so, the creditors complain about him. So everything gets reviewed, and the person who has to defend himself is whoever once simply bought a car or received payment under a contract.

The suspect periods

The Insolvency Law sets three horizons, and what you will have to prove depends on which one the transaction falls into.

One month before the petition is accepted, and afterwards. A transaction giving preference to one creditor over others. There is no need to prove intent — the fact of preference alone is enough.

Six months. Preference again, but here you have to prove that the counterparty knew or ought to have known about the signs of insolvency.

One year. A transaction at an unequal counter-performance: sold below market, bought above it, a service taken at an inflated price.

Three years. A transaction that caused harm to creditors, where the other side knew of that purpose. This is the hardest ground to make out and the most common one in large cases.

On top of that there are the general grounds in the Civil Code: sham transactions, simulated transactions, abuse of rights. For these the limitation period is counted differently and may reach back further than three years.

What the administrator looks at first

Transactions with relatives and controlled companies. Transactions at a price differing from the market by more than twenty per cent. Set-offs and transfers of assets in place of payment in money. Early repayment of a loan to a shareholder. The sale of a core asset followed by leasing the same property back. Payments to one creditor during a period when the others were already receiving nothing.

A separate category is cash settlement and payment by a third party. Here the reality of payment is the hardest thing of all to prove.

What makes a transaction hold up

A market price, evidenced as at the date of the deal. A valuer's report, listings for comparable assets, quotes from competitors. Material assembled after the event works less well, but it is better than nothing.

Payment by bank transfer and a traceable chain of money. The payment order, the bank statement, and the entries in both parties' accounts.

The reality of performance. For goods: transport documents, warehouse markings, site passes, correspondence about delivery. For services: a result — a report, a design, a certificate describing what was actually done rather than stating that "the services were rendered in full".

A business purpose. An internal memo, a written justification, a decision to sell a non-core asset, correspondence about the search for a buyer. The court needs to understand why the transaction was needed for any reason other than moving assets out of reach.

Due diligence on the counterparty before the deal. An extract from the register, absence from the register of unreliable suppliers, absence of enforcement proceedings, financial statements. Screenshots with a date. This is what turns you into a good-faith acquirer.

What to do if the claim has already been filed

First, look at the date on which the insolvency petition was accepted and compare it with the date of the transaction. Some of the claims fall away straight away on timing.

Second, gather everything that existed at the time of the deal, not what can be put together now. Correspondence, drafts, quotations, valuation reports.

Third, establish whether, at the date of the transaction, the seller was in default to other creditors and whether that was public. Knowledge of insolvency is proved through publications in the insolvency register, the commercial court case file database, and enforcement proceedings. If the record was clean on the date of the deal, your position is far stronger.

Fourth, assess the consequences. If the transaction is set aside, the asset returns to the estate and your claim for the money back is entered in the register of creditors. In practice this means you will get the money at best in part and only after years. That is why it is sometimes more sensible to negotiate a top-up to the market price than to fight the dispute to the end.

Salaries and shareholder loans in particular

Two storylines that come up constantly.

Paying an increased salary or bonuses to a director in the run-up to insolvency is challenged both as a preference and as an extraction of funds. The only thing that protects you is documentary proof that such payments were ordinary: orders, a bonus policy, comparable amounts for earlier periods.

Repayment of a shareholder loan during a period of insolvency is challenged in almost every case, and the shareholder's own claim in the register is subordinated. Funding a company through loans instead of contributions to capital is a well-known structure, and the courts have learned to take it apart.

This material is for information only and does not replace advice on a specific matter.

If you have received a claim to set a transaction aside, or you want to strengthen the paperwork on a major purchase in advance, write to us — the first consultation is free of charge when you engage us.

Sergey Besedin — partner of Kovalev & Partners LLC, lawyer