Introduction
Subjective and objective recovery
Recovery period for gratuitous transaction
Recovery associated with corporate group
Partial recovery
Companies that participate in major international business often conduct their business as a part of a corporate group. Both the legal and economic definitions of 'corporate group' vary across different jurisdictions and applicable legislation. However, for the purposes of this update, 'corporate group' in general terms refers to a group of companies that conduct business under common administrative or financial control. Under the legislation of many jurisdictions, including Finland, the companies within a group are regarded as being legally distinct from each other, and the natural interlinking of group companies, which does not always diligently follow the corporate benefit maxim, presents interesting legal questions in the field of insolvency, for example in relation to the recovery of assets.(1)
In Finland, the rules regarding recovery of assets and the setting aside of transactions are largely set out in the Act on the Recovery of Assets to a Bankruptcy Estate (758/1991, as amended). In general terms, the principle of recovery is set out to provide the means for creditors of an insolvent debtor to set aside an otherwise binding transaction that constitutes an unfair preference among the creditors or weakens a debtor's financial standing by increasing a debtor's liabilities. In the event of bankruptcy, for example, setting aside a transaction aims to restore the integrity of the bankruptcy estate's assets from which the disbursements may eventually be paid to the creditors. Essentially, the main objective of the recovery legislation is to ensure equality among the creditors of a particular debtor. However, the debtor might well be a part of a corporate group consisting of many companies, some of which may be insolvent, while others are not. In addition, the debtors of various group companies are not necessarily the same.
This update reviews the scope and application of Section 6 of the act, which sets out the rules regarding the setting aside of gratuitous transactions - gifts or gift-like transactions. The specific aim is to understand the impact that this section has on transactions that take place within a corporate group, or are otherwise associated with a corporate group.
Subjective and objective recovery
The rules set out in the act in connection with the setting aside of a transaction may be divided into:
- recovery on subjective grounds (Section 5 of the act, also known as the 'general recovery clause'); and
- recovery on objective grounds (Sections 6 to 10 of the act).
The subjective rules relating to the recovery of assets cover all transactions between an insolvent debtor and a counterparty. Section 5 provides that any transaction may be set aside if the transaction improperly preferred a creditor to the detriment of other creditors, or increased the debtor's liabilities. Furthermore, it sets a prerequisite that the debtor either had already to be insolvent, or subsequently became insolvent as a result of the transaction. Finally, pursuant to Section 5, the creditor must have either known or the creditor should have known of these circumstances – this mala fide prerequisite may be seen as giving rise to the dubbed subjectivity of these rules.
In contrast, the objective rules apply regardless of whether the counterparty in the relevant transaction has acted fraudulently or in good faith. For example, a gift may be set aside even if the recipient had no knowledge of the poor financial position of the debtor-benefactor. Such objectivity is justified by the specific nature of the relevant transactions – transactions such as a gift are deemed categorically inappropriate and detrimental to creditors if entered into during a specific time period before the reference date.(2) Therefore, it is not necessary to prove any fraudulent intent.
Furthermore, the general insolvency prerequisite set out in Section 5 does not apply to recovery under Section 6 of the act: if the gratuitous transaction was entered into less than one year before the reference date, the transaction may be set aside irrespective of the financial position of the debtor-benefactor.
Recovery period for gratuitous transaction
In the event of a bankruptcy, the reference date is the date of filing of the bankruptcy application. Pursuant to Section 6 of the act, the specific time period during which the gratuitous transaction must have been entered into is therefore a period not exceeding one year prior to filing of the bankruptcy application.
If the beneficiary is considered as being connected to the debtor-benefactor, the time period is extended to less than three years before the said reference date. However, the applicability of this extended time period is limited by a provision permitting the presentation of counterevidence to rebut this principle; the respondent may rebut the recovery claim by establishing that the debtor-benefactor was not excessively indebted at the moment of the gift or donation and that the donation did not lead to the debtor's excessive indebtedness. The right to provide counterevidence applies only if the gratuitous transaction was entered into at least one year before the reference date.
The term 'excessive indebtedness' is not the same as the general insolvency prerequisite referred to in Section 5 of the act. Pursuant to Section 4 of the act, 'excessive indebtedness' means that the debtor's debts exceed the debtor's assets. As such, this insufficiency, unlike insolvency, refers only to a momentary financial position of the debtor – insufficiency does relate to a debtor's capability to discharge ultimately its liabilities upon expiry.
Recovery associated with corporate group
Section 6 of the act applies to both natural persons and companies. Consequently, the provision may also be applied to gratuitous transactions affiliated with a corporate group. In this context, two main types of transaction may be identified:
- transactions between group companies, and
- transactions carried out by one group company on behalf of another group company.
Transactions between group companies
The application of Section 6 in connection with a corporate group is practically always based on the fact that the provision defining the 'closeness' or 'connection' of two business entities provides that two companies that have a shared benefit are deemed to be connected (Section 3(2) of the act). This means that the specific recovery period is extended to less than three years before the reference date. Furthermore, a transaction between connected parties is assumed to be gratuitous under Section 8 of the act.
Consequently, a recovery claim towards another group company due to a gratuitous transaction may be rebutted only by establishing that the relevant transaction was entered into against payment or, if the transaction was made a year or more before the reference date by establishing that the debtor-benefactor was not excessively indebted at the moment of the gift or donation and that the gift or donation did not cause the debtor's excessive indebtedness.
Transactions on behalf of a group company
It is not uncommon for a group company to make payments on behalf of another group company. Instead, it is a relatively common practice – for example, to balance the cash in hand by making transactions on behalf of another group company.
Such transaction is not prima facie gratuitous, as the performing group company acquires a claim of recourse towards its group company. This offset might change, however if the claim of recourse proves worthless. This may occur in a case where the group company acting as a beneficiary in the transaction was or has subsequently become insolvent. As set out in a Supreme Court precedent, the relevant transaction may in this case be set aside.(3)
The reversed burden of proof regarding the worthlessness of the recourse lies usually with the group company to which the gift or donation has been made as the possible insolvency of the recourse-debtor is more easily substantiated by it.
The Finnish recovery system does not recognise partial recoveries. As such, a transaction that is deemed detrimental towards the creditors may be set aside only as a whole. If the transaction comprises of several independent legal acts, each act should be considered separately.
For further information on this topic please contact Juho Lenni-Taattola or Lasse Luoma at Hammarström Puhakka Partners, Attorneys Ltd by telephone (+358 9 474 21), fax (+358 9 474 2222) or email ([email protected] or [email protected]).