My debtor is (at risk of becoming) insolvent – Possibilities for securing your claim

Written on 27 Oct 2020

In the event of a bankruptcy, secured creditors have a preferential position compared to "regular" or unsecured creditors, in accordance to their respective rank in the timing of registration. Unsecured creditors have no guarantee of recovering their debt in the event of a bankruptcy of their debtor, as they will only be reimbursed once all preferential creditors have been paid. If there is a remaining balance, regular debtors will be in a position to claim (proportional) reimbursement. In many bankruptcies, such amounts are unfortunately not available.

In general, there are two types of preferential creditors: legal privileges that are conferred by law and privileges that can be contractually agreed upon by the debtor.

Right of privilege

This form of security is usually granted by law to certain (limited) categories of creditors, often being tax administrations, employees or workers. For example, unpaid workers are privileged creditors within a bankruptcy procedure and they will have priority over regular creditors. The same applies to tax administrations or social security debt collectors.
The privilege can also be connected to the debt itself, e.g. in the event of unpaid rent. In this case, the landlord has a right of privilege with regards to the assets located in the rented premises. The law also provides for certain privileges depending on the type of creditor, e.g. certain administrative entities or unpaid seller's privilege.

Mortgage

Although this type of security is widely known among banks related to real estate purchases and financing, it can also be useful in a common B2B setting. A mortgage can be described as a charge or grant by the mortgagor on property in favour of a creditor (mortgagee) to guarantee a certain debt. The security has to be drawn up by a notary public and it must be registered with the mortgage registry in order to be enforceable against third parties.
The advantage of a mortgage is that it constitutes a preferential right over the mortgaged property against other (secured) debtors. The time of the registration will be detrimental in case there are several mortgages applicable to one property (the oldest one will rank highest).
Another main benefit is that the notarial deed containing the mortgage constitutes an executory title (no further requirements to acquire prior court approval for enforcement are needed).
Despite the sometimes high costs (calculated on a percentage of the secured property), the mortgage constitutes a secure protection in potential competition with other creditors.

Pledge

A pledge can be executed through an ad hoc agreement and is valid between parties and enforceable against third parties as from its conclusion. A pledge can therefore be a very effective way to secure a claim against a debtor. It needs to be stressed that the debtors must be notified of the pledge in order to be valid against the debtors of the receivables. Otherwise, a payment to the pledger will be considered valid and the debtor cannot be obliged to make a second payment to the pledgee. For example, in case of a pledge on a bank account, the bank has to acknowledge the pledge in order to protect the pledgee against the rights of other creditors, one of which is often the bank itself.
The law of 11 July 2013, which came into force on 1 January 2018, meant a significant change in the rules concerning the pledge, as it created a new type of security: a pledge on movable assets in an electronic pledge register called the National Pledge Register.. Before the entry into force of this law, in order to be valid, a pledge implied the actual transfer of the moveable assets to the pledgee, so-called "dispossession." This is no longer necessary as the law has established the electronic record in the National Pledge Register).
As such, all moveable assets, tangible or intangible, can be pledged by means of a private agreement and the pledge will be valid as from its conclusion. However, in order to be enforceable against third parties, the pledge has to be registered with the National Pledge Register. The registration applies for a (renewable) period of ten years. This has significant advantages in comparison to the previous situation: a debtor can now hold on to their assets while pledging them to a creditor in order to, for example, acquire funding or extensions in payments.
Depending on the content of the pledge agreement and with the permission of the pledger in that agreement, enforcement of the pledged assets does not require prior court approval.

Guarantees

A much more commonly used security is the guarantee, either personal or corporate. A guarantee does not provide for any preferential rights over certain assets against other creditors, but it creates the right for the creditor to claim against a second entity, the guarantor. As such, the consequences of potential insolvency of the original debtor can be avoided by claiming from the guarantor.

If all else fails

As a preventive measure, appropriate drafting of an agreement between parties allows anticipating some difficult situations and can help in safeguarding the creditor's rights. The common measures are clauses concerning the charging of payments first on interests before on services, termination clauses, retention of title clauses, an option to purchase assets in case of the default, joint and several liability of the director and bank guarantees at first request.
Another good (but costly) way to protect your business is to conclude a trade credit insurance against unpaid invoices.
It should be noted that if all precautions have been taken but there is still no chance of getting relief (e.g. because there simply are no assets to distribute), it could be worth further examining the concrete circumstances that have led to the insolvency. Certain transactions, transfers or payments made by the bankrupt debtor that took place before the liquidation or reorganisation could be set aside or annulled.
For example, transactions effected with fraudulent intent can be annulled, regardless of when the transaction took place. By this means, the transferred assets can be returned to the bankrupted estate.
Transactions made within a certain period preceding the bankruptcy declaration ('suspect period') can also be annulled.
Such claims are usually introduced by the bankruptcy receiver but the creditors themselves are also, subject to certain conditions, entitled to initiate proceedings.

This is the third of three insights offering guidance on insolvent debtors. You can find the introductory article here and the second insight on the signs to watch our for here.

Depending on the situation at hand, a specific course of action can be outlined so that your risks are minimalised as much as possible. Our legal experts are happy to guide you through the respective steps in order to best protect your company against the insolvency of its debtors.