When it is mandatory to apply for a declaration of insolvency?

1.- Introduction

1.1. What is a Bankruptcy Procedure? What is a declaration of insolvency?

1.2. Is applying for the Bankruptcy Procedure mandatory? In what situations?

2.- Insolvency as a Bankruptcy Procedure’s requirement.

2.1. What does insolvency means in a Bankruptcy Procedure?

2.2. Current and upcoming insolvency.

2.3. The term “consistently” when it comes to insolvency.

2.4. Disputed claims regarding insolvency.

3.- Conclusions.

1. Introduction

In this article, we will try to define in a practical point of view the meaning of insolvency in the Bankruptcy Procedure. Since our Bankruptcy Procedure came into effect in 2003, there has always been doctrinal discussions surrounding this term. However, nowadays our jurisprudence has agreed in certain points that we shall explain later.

But before that, we have to briefly define what is a Bankruptcy Procedure and its purpose.

1.1 What is a Bankruptcy Procedure?

It is a jurisdictional procedure that starts when a natural or legal person (debtor) can’t fulfill their payment duties. As a procedure, its main purpose, apart of trying to ensure the companies’ existence or survival, is to satisfy the creditors. Thus, the Bankruptcy Procedure tries to fulfill the debtor’s payment commitments by organizing and equally distributing them, avoiding the unfair payment of some credits over others in an unjustified way.

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Who is eligible to apply for a Bankruptcy Procedure?

In the bankruptcy there will be several people with standing to present a bankruptcy. These are included in article 3 of the Bankruptcy Law

1.2 Is the Bankruptcy Procedure mandatory?

The main requirement to start a Bankruptcy Procedure is the debtor’s insolvency. Thus, every natural or legal person that cannot fulfill their payment obligations (that is, and insolvent person) must apply for a Bankrutcy Procedure. Therefore, when the debtor is insolvent, he does not have any right to decide wether he wants to apply for the Bankruptcy Procedure or not. Law forces the debtor to apply.

However, we know that the terms “voluntary Bankruptcy Procedure” and “necessary Bankruptcy Procedure” exist. The word “voluntary” can create confusion when it comes to the debtor’s obligation to apply for the Bankruptcy Procedure when he becomes insolvent. But this terms do not refer to the debtor’s obligational nature. They only refer to the legitimation to apply for this procedure.

• Voluntary: The debtor himself applies for the Bankruptcy Procedure within 2 months since he knew (or should have known) he was insolvent.
• Necessary: In this case, the creditors are the ones who apply for the Bankruptcy Procedure in the name of the insolvent debtor.

Thus, the Bankruptcy Procedure will always be mandatory. The difference between voluntary or necessary lies in who applies for it. The debtor does not have the right to decide wether he wants to apply or not. If the debtor is insolvent, he must apply. Also, the creditors and other entitled people can apply for it too, situation in which the company’s management board may be responsible for not applying for the Bankruptcy Procedure when they had to.

2. Insolvency as a bankrupty procedure’s requirement

Our Bankruptcy Procedure Law talks about insolvency many times. Thus, article 5 states the duty to apply for the bankruptcy procedure within 2 months since the debtor knew (or should have known) he was insolvent.

That’s why we say that insolvency is the triggering factor in the Bankrupty Procedure, and why whe have to analyze the concept and limits of insolvency in a proper way.

2.1 What does insolvency means in a Bankruptcy Procedure?

Bankruptcy Procedure’s Law defines insolvency state in article 2.2. Thus, it determines its meaning by saying that it is a situation in which the debtor cannot fulfill his payment obligations consistently. This definition is going to determine wether a debtor can apply for a Bankruptcy Procedure or not. Assets imbalance, constant profits losses or being in a dissolution cause, among others, are not  Bankruptcy Procedure’s requirements, and they do not allow to apply for it. The reason behind this latest statement is that we can be inmersed in some of this situations without being insolvent.

2.2 Current and upcoming insolvency.

It’s a vital distinction. Current insolvency means the debtor cannot fulfill his payment duties in the present, while upcoming insolvency means the debtor can project the symmetry between his incomes and payment duties over time. The debtor will have to project in the short, médium and long term, in order to determine if the expected incomes allow him to fulfill his payment obligations. In both cases, the debtor is required to apply for the Bankruptcy Procedure in the legally stablished time frame (2 months since the debtor knew the situation). Therefore, the difference between them is merely a temporary matter when it comes to this insolvency situation.

2.3 The term “consistently” when it comes to the insolvency.

As we mentioned before, Bankruptcy Procedure’s Law stablishes insolvency as the impossibility of fulfilling payment duties consistently. However, this term requires additional explanations, because it does not only refers to a temporal scope.

Thus, our Supreme Court Sentence (STS) 122/2014, April 1st, confirms these statements. In the sentence, our Supreme Court stablishes that even when the payment duties have not been unfulfilled, insolvency still can have been produced. For example, when the debtor tries to obtain extraordinary liquidity by resorting to extraordinary means. In the mentioned sentence, the debtor company sells assets in a low Price and in a clear hurry. Our Supreme Court considers that this extraordinary method to try and obtain liquidity does not avoid the fact that the insolvency exists in this case. It’s a logical reasoning: this extreme methods don’t do anything but extend and even aggravate the situation.

2.4 Disputed claims regarding insolvency

Before, we mentioned situations where there isn’t always insolvency, despite appearances. Over the years, jurisprudence has been solving some doctrinal discussions in  this regard.

• Asset imbalance does not always mean insolvency.

There’s asset imbalance when the company’s assets is les than half of their share capital. This current situation, when not solved, implies that the company will be forced to disband, according to our Law on Corporations.

The previously mentioned STS 122/2014, April 1st, makes an essential statement. It states that a company that incurred in asset imbalance does not mean it also incurred in insolvency, because even when experiencing asset imbalance, the company could still be able to fulfill its payment duties. Although frequently both circumstances usually overlap. Thus, no one can apply for a Bankruptcy Procedure when only experiencing asset imbalance, because the necessary requirement to apply will always be the debtor’s insolvency.

• Proving insolvency.

In order to apply for the Bankruptcy Procedure, we must check that we are trully immersed in an insolvency status. We have to mention the upcoming insolvency again. Due to not being effective in the present, it is always surrounded by uncertainty. This means this kind of insolvency can be predicted, but we have to reduce the uncertainty to the lower level in order to make the upcoming insolvency happen in all probability.

To do this, we have to prove it in every possible way. This includes, of course, making a creditors list, obtaining data regarding the sector’s economical situation, justifying failed attempts of getting financial aid from banks and financial institutions, etc. That is, every kind of method that helps proving the upcoming insolvency status. When it’s finally proved, the Bankruptcy Procedure’s application must be approved.

3. Conclusions

As we have seen, to apply for a Bankruptcy Procedure we mus tan essential requirement: being in an insolvency status. This current or upcoming insolvency means the debtor is not able to fulfill his payment duties. This requirement legitimizes the debtor and the creditors to apply for the Bankruptcy Procedure. Thus, we can differenciate between Voluntary Bankruptcy Procedure and Necessary Bankruptcy Procedure. It’s important to keep in mind that regardless of that differentiation, the Bankruptcy Procedure is always a duty. Therefore, if we are in this insolvency status, applying for the Bankruptcy Procedure is a must.