Guidelines and tips to follow in an insolvency proceeding in Spain

This article explains some of the most relevant aspects of insolvency and debt collection proceedings. From a practical point of view, these concepts must be valued considering the possibility that an economic actor may have to participate in an insolvency proceeding when such economic actor is demanded to participate by a creditor, or when an economic actor voluntarily participates in such a proceeding as a debtor. The necessity of the economic actor to choose between the liquidation or approval of an agreement with the creditors, and the difficulties of the insolvency process should be kept in mind. In particular, the type of creditor involved may contribute to the difficulty of the economic actor’s decision to choose between liquidation, or approval of an agreement with the creditors. This article also adds a brief reflection about the poor use of the insolvency proceeding for cases of debt affecting families.

Insolvency and its accreditation in a voluntary insolvency proceeding

Differing from the regulation on insolvency presented in the Commercial Code, the application for initiating an insolvency proceeding does not, in its current regulation within the Insolvency Law, require a judge to assume that the debtor is in an insolvent situation. The new regulation found in Article 2 of the Insolvency Law states that the debtor must justify its actual or imminent state of debt and insolvency. With this new insolvency regulation, it is not enough for the debtor to simply state that it is insolvent before a judge during an insolvency proceeding. Instead, the debtor must properly justify its insolvent situation to avoid the risk that a judge might reject the proceeding. So that the debtor can comply with this requirement to be declared insolvent, the Insolvency Law does not limit the debtor´s means of justification. The documentation, however, that Article 6 requires the debtor to present has special relevance so that the proceeding can continue successfully.

The debtor must properly justify its insolvency

In effect, amongst other documents, the instrument that the Insolvency Law considers suitable for justification of insolvency must be the annual report. The annual report is a document that expresses the economic and judicial history of the debtor. It is especially useful for determining the causes of the debtor´s insolvent state, as well as any valuations and measures about the viability of the debtor’s property. The annual report, accompanied by other relevant documents, must contain a clear and reasoned explanation of the current situation of the company. It must be kept in mind that the annual report is not only important to convince a judge presiding over a commercial matter of the convenience of having the insolvency proceeding, but also because the use of the annual report will have consequences in the case that in the insolvency proceeding there is a corresponding classification phase. It must be remembered that Article 164.2II of the Insolvency Law says that an insolvency proceeding will end with a result of guilty when the debtor has committed a serious inaccuracy in any of the documents accompanying the application for the declaration of an insolvency proceeding, or in any of the documents the debtor presents during an insolvency proceeding, or when the debtor has presented any false documents. This Article refers in general to those special documents used by the debtor when applying to obtain a declaration of an insolvency proceeding.

The existence of an asset

The initiation of an insolvency proceeding to liquidate a company is a frequent occurrence in Insolvency Law practice. Such types of proceedings may not involve practically any class of assets as the object of the liquidation. There exist conflicting positions among the judges of insolvency proceedings about how they treat such a proceeding. One option is that the proceeding will be conducted considering all of the actions of reintegration. In a broad sense, the actions of reintegration under this view are those that could be established against acts of the insolvent actor from the start, if a classification phase applies as it frequently does in these cases, with a declaration of the insolvency proceeding administrators´ responsibility in fact or law that the insolvent company has had in the last two years. A second view that insolvency judges follow is to issue a report in which the insufficiency of a company´s assets are explained. Such report must comply with Article 176 of the Insolvency Law, declaring the conclusion and record of the insolvency proceeding in any of the phases of the procedure. This view applies when it is proven that in any phase of the insolvency proceeding there exist no assets or rights of the insolvent actor before the court, or rights of third parties to satisfy the debts of the creditors.

The objective of the insolvency proceeding

Insolvency Law procedure only allows two forms of termination: (1) by agreement with creditors or (2) by liquidation. The debtor should assess which option for termination it prefers before presenting the application to initiate the insolvency proceeding in which the debtor wants to be declared insolvent. The debtor has the option to direct, from an initial standpoint, the procedure for the form of termination that it desires. As indicated above, these two forms of termination could be an agreement with creditors or the pure and simple liquidation of the company when the debtor has dedicated itself to a professional or business activity.

Liquidation assumes the termination of business activity and the disappearance of the debtor’s assets. Liquidation involves a directed procedure to end the legal relations of the insolvent actor. In the most common case of companies, there exists as a consequence of liquidation the loss of control over the commercial entity by its administrators, and the assumption of control over the entity by insolvency proceeding administrators. The insolvency proceeding administrators convert the assets into money and pay the creditors, and the partners of the company if there is a sum remaining. The liquidation process ends by cancelling the inscription of the company in the Commercial Registry with the resulting disappearance of the company.

The agreement presents other, less drastic consequences. Reaching an agreement with creditors only involves the possibility of arriving at an agreement with creditors through the simple form of negotiation. The agreement cannot pertain to only one creditor, but rather it must be adopted by a majority of them according to Article 124 in the Insolvency Law. Article 124 refers to the majorities needed for the accepting of proposals in the agreement, and requires a favourable vote of, at least, half of the creditors involved in the insolvency proceeding who have no special privilege, but whose creditors are not subordinate (normal creditors). When the proposal consists of the whole payment of those ordinary credits in a time period of no greater than 3 years, or in the immediate payment of those expired ordinary credits with a partial remission less than 20%, it will be sufficient that the vote in favour is a portion of the creditors more than the vote against. For those anticipated proposals of the agreement it will be necessary, in every case, the adhesion of creditors who are the holders of the credits to be paid, at least, half of the normal creditors at the insolvency proceeding. For the effects of the calculation of the majorities in every vote, those privileged creditors will be considered included in the group of normal creditors able to vote in the insolvency proceeding that vote in favour of the proposal.

For the approval of the agreement it must be observed that the creditors are those that truly have the right to vote.

Without a doubt, to reach an agreement it is oftentimes not only enough that the insolvency proceeding results in approval of an agreement, but also it is convenient to know the opinion of the most significant creditors so that the approval has at least a minimum of possibilities for success. For such success to be had it should be kept in mind that not all creditors have the right to vote. Those holders of subordinate credit and those who have acquired credit for acts entre vivos after having declared the insolvency proceeding are not entitled to vote, except in the case that the acquisition has taken place through a universal holder or, as a consequence, of a forced execution (Article 122 of the Insolvency Law). At the same time, other creditors, because of their privileged position, may attend the meeting and intervene in the deliberations. Their presence, however, will not affect the calculation of the quorum of the constitution, nor will they have to submit to the effects of the resulting approved agreement unless they have voted in favour of the agreement (Article 123.2 of the Insolvency Law). It can be concluded that when the approval of an agreement with creditors is sought, it is not enough to simply present an agreement; the support that creditors can lend must also be considered.

The insolvency proceeding involving families and their debts

In relation to physical or natural persons that can be affected by an insolvent situation, it is difficult to affirm that an insolvency proceeding could be a solution. This is especially difficult to affirm when the situation involves families and not those entities dedicated to business or professional activities. The overindebtedness of families, present in many Spanish families, presents a difficult fit with Insolvency Law. This is because the Insolvency Law is considered to apply to judicial persons in insolvent situations, and especially for those who dedicate themselves to a business or professional activity. This application is different from what occurs in other countries. For example, professor Cuena Casas recently indicated that in Germany during 2004, there were 84,000 insolvency proceedings involving physical or natural persons. In Spain, however, during the first semester of 2008 (while in full economic crisis), there were only 26 insolvency proceedings declared involving physical or natural persons.

It is difficult to affirm that the insolvency proceeding could be a solution for the insolvency of families and not those entities that are dedicated to business or professional activities.

The most important obstacles to overcome so that an insolvency proceeding can be a true utility for insolvent situations involving families appears to be when the issue of mortgages is involved. Payment of mortgages, which usually taxes the family life, is usually sought by creditors. Thus, the case of the insolvency proceeding initiated by a debtor will probably not involve a mortgage unless the proceeding involves an affected asset of a business or professional activity. The familial character of accommodations for living is irrelevant despite the fact that it is usually the principal or most important and protected familial asset.

A second impediment to solve cases of overindebtedness of families through an insolvency proceeding is the lack of a liberating effect of the existing debt that could remain after the insolvency proceeding ends. Other laws like the German Insolvency Law allow the exoneration of debt after an insolvency proceeding, while Spanish legislation allows the debtor to continue responding to debts not yet satisfied in whole or in part after an insolvency proceeding. Without an agreement, an insolvency proceeding will not have as a consequence a true satisfaction of the debt of insolvent families.

The classification of an insolvency proceeding

The consequences of a possible guilty outcome at an insolvency proceeding must be especially valued

The Insolvency Law does not always contemplate the possibility that section six applies during an insolvency proceeding relating to the classification of an insolvency proceeding, but rather that section six applies only with the judicial approval of an agreement (Article 163 of the Insolvency Law). Such an agreement must establish for all creditors, or for those of one or various classes, a partial remission of the debt owed that is more than one-third of the credit owed, or a postponement of payment for more than three years; this is common in the beginning of all cases in the liquidation phase. This regulation presents the question of, in the case of presenting an offer to reach an agreement, if the proposed partial remission or postponement of payment must exceed the limits that the Law considers deciding for the insolvency proceeding to undergo a classification given the consequences of the classification that may result in some cases. An analogous consideration must be formulated when a company directly seeks to liquidate in an insolvency proceeding. An insolvency proceeding classified as guilty has important consequences for the insolvent actor. In some cases, it also has important consequences for others because a judicial sentence of a classification of an insolvency proceeding as guilty must determine the other persons affected by such a classification. Consequences of a guilty classification of an insolvency proceeding could include: that other parties may be declared guilty; that other affected persons may be disqualified by the classification of guilty to administer assets during a period of two to 15 years, for example, such persons may be disqualified to represent or administer for any person during the same time period; that the declared guilty participants or those persons affected by a classification of guilty at an insolvency proceeding may lose any right they had as creditors in the insolvency proceeding or to the amount owed, and be forced to return the assets or give up the rights that such creditors had obtained illegally to the debtor´s property, or those assets or rights that such creditors had received to the amount owed to indemnify any damages.

It is also important, however, to emphasize that another especially serious consequence can be added to those mentioned above that affects the insolvency proceeding administrators. Article 172.3 of the Insolvency Law states: If the classification section has been formed or reopened as a consequence of the opening of the liquidation phase, the judicial decision will be able to sentence those insolvency proceeding administrators or liquidators, in law or in fact, of the judicial person whose insolvency proceeding is classified as guilty, and to sentence those who have met this condition within the last two years from the date of the declaration of the insolvency proceeding, to pay to those creditors involved in the insolvency proceeding, completely or in part, the amount that those creditors do not receive in the liquidation of the amount due. There is a novelty in our Spanish Insolvency Law that has precedents in French Law, and also in Anglo-Saxon Law. Compared with those precedents found in such laws of other countries, this novelty has some different shades. The Law, however, contemplates the possibility of obligating those responsible for the social administration of the payment of the deficit that results after the liquidation phase in an insolvency proceeding. This responsibility of payment of the deficit may be for the total deficit or part of it. Payment of this deficit corresponds not only to those administrators of the insolvency proceeding with current obligations based on the declaration of the insolvency proceeding, but this responsibility corresponds also to those who have been administrators of the insolvency proceeding in the past two years.

With a classification of the insolvency proceeding as guilty, there exists the possibility to obligate those responsible for the social administration of the payment of the deficit that results after the liquidation phase in an insolvency proceeding.

At issue is a responsibility whose nature is controversial. There do not exist coinciding judicial pronouncements about whether this responsibility is one of sanction or guilt. In any case, the responsibility that may be demanded may be quantitatively important, affecting the property of those declared responsible for a long time.

The conclusion cannot be more obvious. A debtor that seeks the possibility to declare itself insolvent in an insolvency proceeding in Spain must prove that it does not fit into a category of guilt to avoid those pernicious consequences that may result from an insolvency proceeding with a classification of guilty against the debtor.

This article is not considered as legal advice

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