- What is an action of rescission in bankruptcy law?
- Is it necessary that insolvency exists for the action to be exercised?
- Isn’t bad faith necessary in order to exercise rescission?
- Are all acts harmful to the estate rescindable?
- What is detriment?
- What are its effects?
- Differences with revocation or Pauline action
- What is the procedure?
- Who can exercise the rescission?
- Against whom should the action be filed?
- Commencement and expiry of the action
What is an action of rescission in bankruptcy law?
It is the possibility of rescinding acts carried out by the debtor that are detrimental to the estate of the bankrupt. It is included in Article 71 of the Spanish Bankruptcy Law (Ley Concursal, hereinafter, LC). There are two requirements to be able to exercise this action:
- That the acts had been carried out within the two years prior to the declaration of the bankruptcy.
- That the act is detrimental to the estate.
As can be seen, it is not necessary that the act has a fraudulent purpose or there is bad faith. It is sufficient that the act be detrimental to the insolvency estate.
The purpose of this action is to prevent the debtor, in anticipation of the bankruptcy, from safeguarding assets to the detriment of creditors. This is usually done through contracts or acts of disposition prior to the declaration of bankruptcy procedure. In addition, they are usually free of charge and are concluded with persons in the debtor’s circle.
However, it is also possible that such acts are carried out in favour of one of the creditors. The legislator is thus seeking a second objective with this rescission action: compliance with the “par conditio creditorum”. That is, that all creditors are in an equal position to recover their credit.
Thus, there are two objectives of this action. One objective is to preserve the integrity of the bankrupt’s assets. Another is to avoid arbitrary discrimination between the different creditors.
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Is it necessary that insolvency exists for the action to be exercised?
No. As said, the aim is to protect the assets in favour of the creditors. Therefore, acts carried out up to two years before the declaration of insolvency can be challenged. Therefore, acts of the debtor carried out when the state of insolvency did not exist can be terminated, in order to protect the rights of the creditors.
Isn’t bad faith necessary in order to exercise rescission?
There is a large body of case law that establishes that there is no need for fraudulent intent in the act in order to exercise rescission. This is demonstrated by the Supreme Court’s Ruling 185/2012 or Ruling 41/2012 of the Provincial Court of Álava, among others. The only requirements for the act to be rescinded are those set out above. That it is carried out within the 2 years prior to the declaration of the competition and that it is detrimental to the estate. It is therefore important that there is damage to the estate.
Are all acts harmful to the estate rescindable?
No, the Spanish Bankruptcy Law (Article 71.5) leaves out certain acts, which cannot be subject to termination. These acts are:
- Ordinary professional acts performed by the debtor under normal conditions.
- Acts falling within the scope of payment systems and the clearing and settlement of derivative instruments.
- The guarantees constituted in favour of FOGASA and in favour of public law credits.
On the other hand, in its articles 71. 2 and 71.3, the Spanish Bankruptcy Law establishes two presumptions of damages. On the one hand, the following acts are presumed “iure et iure” (Do not admit evidence to the contrary) to be detrimental to the estate:
- Provisions free of charge (except for gifts); and
- Payments or extinctions of obligations that are due at a later date (unless they have security interests, which can be proved to the contrary).
On the other hand, “iuris tantum” is presumed (evidence to the contrary is admitted):
- Provisions for valuable consideration made in favour of related natural or legal persons;
- Establishment of security interests in pre-existing obligations; and
- Payment or termination of secured obligations falling due after the declaration of the insolvency proceedings.
If it does not fall within these acts, the damage must be proven by the person bringing the action.
What is detriment?
As indicated in Supreme Court (SC) Decision 210/2012, harm to the assets means their unjustified reduction. In this sense, the SC points out that it is necessary to retrograde the situation of insolvency to the moment of execution of the act. In other words, it must be assessed whether the act would be considered harmful to the assets if the insolvency existed at that time.
On the other hand, for the purposes of rescission, detriment must be understood in the broad sense. It is clear that a decrease in the assets is a detriment to the assets and thus to the creditors. However, acts affecting the par conditio creditorum are also to be regarded as detrimental. In other words, acts that create inequality in creditors’ collection rights are to be regarded as detrimental. An example of such acts is the assignment of claims in payment of debts that are already due.
What are their effects?
The acts that are contested through this action are perfectly valid at the time they are constituted. Thus, they bring together the essential elements of contracts, are not contrary to a mandatory or prohibitive rule and are not voidable. What happens is a later event, the bankruptcy procedure, which makes them ineffective.
Therefore, we are dealing with an external inefficiency, which affects the effectiveness of the legal transaction once it has been validly born. One of the means that the creditor has to enforce his right to credit is termination. This is the way in which the unfair consequences of a validly concluded contract can be set aside. Therefore, the effects of the action for restitution will be those of general termination. These effects are:
- The act will be declared ineffective
- It shall order the return of the benefits included therein, in addition to the fruits and interest.
- Once restitution of the creditor’s right to performance has been declared, it shall be deemed to be a claim against the estate. However, if bad faith is proved in the creditor, this credit shall be classified as a subordinate. This means being lower on the collection list, since privileged and ordinary credits will be collected first.
- The goods or rights may not be returned because they have been sold to a third party in good faith. In that case, the party who had been involved will be condemned to hand over the value of the goods when they were sold. In addition, interest must be paid. If it is proved that the third party had bad faith, he will be condemned to pay all damages against the working mass.
The effects of the sentence are ex tunc, i.e. it is effective from the birth of the legal transaction.
Differences with Revocation or Paulian Action
The Spanish Civil Code (CC) regulates a general procedure for terminating valid contracts which is subsequently shown to have unfair consequences. This means is the revocation or Paulian Action. By this means, creditors can protect their claim by challenging fraudulent acts by the debtor. It is regulated by articles 1111 and 1291 3rd of the CC. In this way, creditors, once they have pursued the debtor’s assets, can challenge the fraudulent acts carried out by the debtor.
Therefore, there are two differences between the Pauline Action and the rescission action:
– The Pauline action is subsidiary (the assets in the possession of the debtor must be pursued first), while rescission is direct.
– Rescission does not require that the act be performed by law fraud, while the Pauline action does. To exercise the rescission, it is enough that the damage to the insolvency estate exists.
What is the procedure?
The procedure to exercise the rescission is the claim before the bankruptcy judge. Its processing has its own procedure, the insolvency procedural plea, and it is processed as a separate piece of the contest.
Who can exercise the rescission?
The Receivership is entitled to exercise this action. In addition, creditors may also do so provided that:
- They have requested in writing the Receivership to exercise the action. This writing must contain information on the act to be contested and the grounds for it.
- Two months have passed since the request without the Receivership having exercised the action.
As the creditors are entitled to file a subsidiary action, if the Receivership files an action, they can only support its claims. They may only be interveners.
In the case of groups of companies, the entity that was part of the act to be challenged is entitled to bring the action. Thus, the possibility that any company of a business group can exercise the action is excluded.
In the case provided for in article 71 bis LC, the Receivership will be will be the only one with legal standing to challenge the refinancing acts.
Against whom must the action be filed?
Rescission claims will be filed against the debtor and against those who have participated in the contested act (Article 72.3 LC). If not all the participants in the act are included, the act cannot be contested. But this passive legitimacy only corresponds, in the case of companies, to the company as such and not to the administrator.
Commencement and expiry of the action
The jurisprudence reiterates that the rescission action is born with the bankruptcy procedure and dies with it. In such a way that it is not subject to a further period of expiry, but will be extinguished with the termination of the bankruptcy procedure.
With regard to its beginning, although it is true that it is born with the declaration of the bankruptcy procedure, in practice this is not exactly the case. Since the party entitled to take action is the bankruptcy receiver, it will be necessary to wait for the latter to be appointed.
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