Latvia Survey on: Claw-back of security in insolvency Questionnaire 1. Introductory questions 1. Please briefly describe the main type of security in your jurisdiction (per type of asset; per perfection technique; per type of secured obligation). Security interests in assets can generally be established by way of creation of a pledge. Pursuant to Latvian law, the subject matter of a pledge may be all assets regarding which transfer of title is not specifically prohibited. Furthermore, Latvian law allows creation of a pledge over both tangible and intangible assets, as well as over both existing assets and assets which will come into existence in future. In the latter case, however, the pledge will become enforceable only when the respective assets have come into existence and, if applicable, the pledge has been duly perfected. There are five types of pledge under Latvian law: (i) mortgage (hipotēka), (ii) commercial pledge (komercķīla), (iii) financial pledge (finanšu ķīla), (iv) possessory pledge (rokas ķīla) and (v) usage pledge (lietošanas ķīla). Of these, the first three are the most commonly used. In addition, certain assets may be subject to title transfer financial collateral arrangement. a. Mortgage Immovable property can become the subject of security interests by way of a mortgage. The mortgage is typically established by the parties entering into a mortgage agreement. In certain cases, however, it may also be established by virtue of a judgment. In order to take effect against third parties, the mortgage must be registered with the Land Register. b. Commercial pledge With a few exceptions, a commercial pledge can be established over any assets of a commercial undertaking, such term to include companies, partnerships and individual entrepreneurs. In addition, a commercial pledge can be established over movable assets which are subject to registration, undertakings as aggregate of assets, as well as shares and bonds of closed issues irrespective of who is the owner of such assets. A commercial pledge cannot be established over vessels, financial instruments (including shares of public issues), cash and claims under cheques and bills of exchange. A commercial pledge is typically established by the parties entering a pledge agreement. In certain cases, however, it may also be established by virtue of a judgment. In order to take effect against third parties, the commercial pledge must be registered with the 1
Commercial Pledge Registry. No transfer of the pledged property under the possession of the pledgee is required for the purposes of perfection of the commercial pledge. c. Financial collateral Security interests in financial instruments and cash in bank accounts can be established by means of a financial collateral, albeit only where at least one of the parties belongs to one of the categories listed in the Financial Collateral Law 1. Financial collateral can be created in the form of a financial pledge or in the form of a title transfer arrangement. A financial pledge needs to be perfected by a respective entry in the records of the custodian holding the respective account. Title transfer arrangement is perfected by transfer of the shares to the creditor s account. d. Possessory pledge A possessory pledge is an outdated type of security over movable property which has lost its importance due to the availability of the commercial pledge and financial collateral. A possessory pledge is perfected by transfer of the subject matter of the pledge into the possession of the pledgee which makes it cumbersome to use such type of pledge in commerce. Furthermore, any types of property which may be subject to a commercial pledge may not be pledged by way of establishing a possessory pledge. e. Usage pledge A usage pledge is also an outdated type of security which is practically no more used. A usage pledge is a possessory pledge over movable or immovable property bearing fruits where the pledgee not only has the right, but also the duty to reap fruits and income from such property. 1.2 Please briefly describe whether your jurisdiction provides for a procedure of protection against creditors (usually initiated by a debtor at a time when the debtor is yet not insolvent) and if so what are its basic assumptions? Pursuant to the Insolvency Law, a company experiencing short-term financial difficulties may apply for a grant of the judicial protection process (tiesiskās aizsardzības process) resulting in a general stay of creditor action for the period of such process. In order to initiate the judicial protection process, the company must apply to the court for opening of the judicial protection process case. The opening of the case results in: 1) suspension of enforcement of judgments on recovery of any amounts adjudged from the company; 1 The categories listed in the Financial Collateral Law repeat those in Article 1(2) of Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements. 2
2) prohibition to the secured creditor to enforce the security interests over the assets of the company; 3) prohibition to the creditors to apply for declaration of insolvency of the company; 4) prohibition to commence liquidation of the company; 5) stop of accrual of interest in excess of the statutory interest or the refinancing rate published by the Bank of Latvia, whichever is higher; 6) stop of accrual of penalties, late payment charges, etc. After the court has opened the judicial protection process case, the company has a period of two months to draft the judicial protection process plan and to approve it with the creditors. Such period may be extended for one more month with the consent of those creditors which need to approve the plan. In order to approve the judicial protection process plan, the company needs to obtain the consent of: 1) the secured creditors representing at least two thirds of the total amount of the principal secured claims against the company; and 2) the unsecured creditors representing more than half of the total amount of the principal unsecured claims against the company. The judicial protection process plan must describe the measures which the company intends to take in order to solve its financial difficulties. Such measures may include, inter alia: 1) deferral of payments due by the company; 2) reduction of the amount of indebtedness of the company (provided that, if the indebtedness is reduced by more than 10%, the creditors may require that the amount for which the indebtedness is reduced is substituted with shares of the company); 3) increase of the share capital of the company; 4) reorganisation of the company. Should the company succeed in obtaining the approval of its creditors, and provided that the judicial protection plan complies with the law, the court allows the company to go on with the process. In such a case, the judicial protection process plan becomes binding towards all creditors including those which have not approved the plan. The maximum 3
term of the judicial protection process is two years. It may, however, be prolonged for an additional two years with the consent of creditors. The judicial protection process is supervised by an administrator appointed by the court. In the following events the court may terminate the judicial protection process and open the company s insolvency proceedings: 1) if the judicial protection process case has been opened with regard to the same company but, for the second time within a year, this has not resulted in the approval of the judicial protection process plan; 2) if the company has provided misleading information to the court at the time of filing the application for grant of the judicial protection process; 3) if the company fails to comply with the judicial protection process plan for more than 30 days and has not filed with the court amendments to the plan; 4) if the company fails to comply with the restrictions set forth by the law which are applicable during the judicial protection process. 1.3 Please briefly describe the types of insolvency proceedings contemplated by your legislation (liquidatory proceedings; reorganization or recovery proceedings). As from 1 November 2010, when the new Insolvency Law took effect, insolvency proceedings of legal entities are essentially liquidatory proceedings aimed at the sale of the company s assets and satisfaction of the creditors claims. In contrast to the previous Insolvency Law, the new Insolvency Law does not provide for an option for the creditors meeting of the insolvent company to select between bankruptcy, settlement or rehabilitation procedures, and the insolvency process now automatically leads to the sale of the company s assets and satisfaction of creditors claims from the proceeds of such sale, followed by the liquidation of the company. The company s representative, the insolvency administrator, the liquidator appointed by a court which has jurisdiction pursuant to Article 3(1) of the Council Regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings, or a creditor or a group of creditors, may, however, apply for the company s judicial protection process also after opening of the insolvency proceedings. The application needs to be accompanied by the judicial protection process plan approved by the proportion of the company s unsecured creditors and secured creditors required under by the Insolvency Law (please see 1.2 above). Should the court decide to open the judicial protection process, this automatically results in termination of the company s insolvency proceedings. 1.4 Please briefly describe the types of claw-back actions available in your jurisdiction. Please address, in particular, any of the following questions: 4
(a) Is claw-back automatic or does it require a positive assessment of the existence of the relevant conditions by the court or receiver? (b) Does your legislation differentiate between transactions (including the granting of security) with consideration and without consideration? (c) Does your legislation differentiate, in cases of security in general, between security taken concurrently with granting of the secured debt and security taken in a different period of time? (d) Are there special provisions for intra-group transactions and transactions between related parties? As a general rule, the following transactions are subject to claw-back: 1) any transaction entered into by the company within three months before declaration of insolvency or thereafter where the transaction has resulted in loss to the company, irrespective of whether the counterparty to the transaction was aware of such loss; 2) any transaction entered into by the company within three years before declaration of insolvency where the transaction has resulted in loss to the company and the counterparty to the transaction was or should have been aware of such loss. Where the company has entered a transaction with a related person or entity, it is presumed that the counterparty to the transaction was aware of the loss to the company unless it proves otherwise. Where the company has entered a transaction whereby the company has donated all or essentially all of its property or, if the transaction has been entered within six months before declaration of insolvency, the terms of the transaction suggest that the company has effectively donated its property, the insolvency administrator may bring a claim for recovery of the company s debts from the transferee(s) by virtue of Article 1927 of the Civil Law. A pledge or a mortgage agreement is subject to claw-back if the pledge or the mortgage has been established after a record has been made in the Insolvency Register on declaration of the company s insolvency. In addition, amounts which the company has paid towards satisfaction of its payment obligations must be returned if: 1) the payment was effected within the last six months before declaration of insolvency or thereafter before the due date and the company did not comply with its other payment obligations which had fallen due, and it is possible to renew the parties rights and obligations as they were before the payment; 5
2) the payment was effected within the last six months before declaration of insolvency or thereafter to, or recovered in favour of, a related person or entity and the company did not comply with its other payment obligations which had fallen due before the payment obligations towards the related person or entity; 3) the payment was effected to a creditor of the company within the last three months before declaration of insolvency with an aim to avoid declaration of the company s insolvency upon the petition submitted by that creditor. As regards the procedure, the insolvency administrator is required to assess the company s transactions and to bring a claim at court for voidance of the company s transactions if, in the administrator s view, any of such transactions are subject to clawback. If any such claim is brought, the existence of the relevant conditions for claw-back is assessed by the court in regular inter partes proceedings. If the company has effected payments which may be subject to return as per the above, the insolvency administrator must bring a claim for recovery of such payments 2. Specific questions 2.1 Is claw-back subject to specific rules with respect to any type of security available in your jurisdiction? If so, please describe any such rules. Pursuant to the Financial Collateral Law, a financial collateral agreement may not be subject to claw-back in cases of insolvency of the grantor of financial collateral merely due to the reason that such agreement was entered into any time before publication in the Insolvency Register of a notice on declaration of insolvency of the grantor of financial collateral. A financial collateral agreement entered into after such publication may also not be subject to claw-back provided that the grantee of the financial collateral proves that it was not, and could not be, aware of the opening of the insolvency proceedings of the grantor of financial collateral. 2.2 Are there any total or partial exemptions from claw-back, depending on (for example): (a) (b) (c) (d) (e) the type of security; the type of transaction secured (including its legal form); the type of (wider) transaction within which the financing is granted and the relevant security is taken (e.g. financings granted in the context of certain reorganization proceedings); the nature of the grantor of security; the nature of the beneficiary of security; 6
(f) other? Please see 2.1 above. 2.3 How does your legal system address the claw-back of quasi-security transactions, e.g. a sale of a property in return for a price payable in instalments may hide a financing transaction secured by the property); which legal regime applies in this case: that of the claw-back of security, or that of the termination of pending (sale and purchase) agreements? There are no specific provisions in the Insolvency Law with regard to quasi-security transactions. As a general rule, quasi-security transactions would fall under the general claw-back regime. The administrator may, however, attempt to recharacterize the transaction in order to demonstrate that the transaction has resulted in a loss to the company. 2.4 What are the legal consequences of the claw-back for the parties involved? For example: (a) (b) Is an agreement, deed or transaction subject to claw-back invalid or just ineffective between the debtor and the party to the agreement? To what extent can claw-back affect the successful exercise or enforcement of security rights as may have occurred prior to the adjudication in bankruptcy (e.g. claims cashed by the secured lender under a security assignment of receivables prior to the adjudication in bankruptcy)? Is there any difference between the case of self-enforcing security (e.g. the cashing of claims referred to above) and a court-driven enforcement (e.g. the enforcement of a mortgage)? Provided that the court satisfies the administrator s claim for voidance of an agreement which is subject to claw-back, the agreement becomes void and the parties are obliged to return whatever they have received from each other under the agreement. Should the voidance of an agreement result in an obligation of the insolvent company to return to the counterparty to the agreement a certain amount paid under the agreement, such obligation falls under the general procedure for satisfaction of creditors claims in the insolvency process. As a general rule, claw-back cannot affect enforcement of any security rights prior to declaration of the company s insolvency provided that the security itself is not subject to claw-back. 2.5 What are the rights of the parties involved once the claw-back had been enforced (as a result of operation of law or court ruling)? 7
Please see 2.4 above. 2.6 What is the claw-back regime for security granted by the third parties/in respect of third party indebtedness? Please analyse from the perspective of the insolvency of the debtor and of the insolvency of the third party grantor of security. Does the possibility for the third party grantor to act in recourse against the insolvent debtor make a difference? Where security has been granted by a third party to secure the obligations of a debtor which has subsequently been declared insolvent, the declaration of insolvency of the debtor does not affect the validity of the security. Any claw-back provisions applicable in the debtor s insolvency process do not extend to the security granted by third parties to secure the debtor s obligations. Where a third party grantor of security has been declared insolvent, such security may become subject to claw-back under the general grounds (i.e., where the transaction has resulted in loss to the company) or if the pledge or the mortgage has been established after a record has been made in the insolvency register on declaration of the company s insolvency. For the time being, the case law is ambiguous in relation to whether or not the grant of security in support of the obligations of a third party can be said to result in a loss to the company. While it has been held that the grant of security does not, in itself, result in a loss, in some cases the court has concluded that the grant of security in support of the acquisition of the company s own shares is subject to claw-back in the company s insolvency. 2.7 What is the claw-back regime for security which has been agreed (i.e. the relevant security agreement has been executed) but not yet perfected at the time of the adjudication in bankruptcy of the debtor/grantor? As mentioned in 1.4 above, a pledge or a mortgage agreement is subject to claw-back if the pledge or the mortgage has been established after a record has been made in the insolvency register on declaration of the company s insolvency. Accordingly, no pledges or mortgages may be perfected after such record has been made in the insolvency register. Martins Aljens Senior Associate Tel. +371 6724 0689 Mobile. +371 2659 8324 martins.aljens@rln.lv RAIDLA LEJINS & NORCOUS Valdemara 20, LV-1010, Riga, Latvia Tel. +371 6724 0689 Fax +371 6782 1524 www.rln.lv 8