Preferences

One of the cardinal principles governing the liquidation of insolvent estates is the equal treatment of creditors—the classical par condicio creditorum. Debtors on the eve of bankruptcy, either of their own volition or under pressure, may accord preferential treatment—by way of payment or security—to certain creditors. The bankruptcy laws of most, if not all, countries therefore contain rules aiming at the reintegration of the bankrupt estate through avoidance of preferences given after insolvency or cessation of payments or even earlier. These provisions are included in, in lieu of, or cumulative with a general relation back of the effects of the adjudication. Again, the laws of the different countries vary greatly with respect to the elements that must be present to make a transfer voidable as a preference, especially those of a subjective character such as intent on the part of the debtor or knowledge of the debtor’s financial status on the part of the creditor.

In the United States, except in the case of insiders, the preference period is 90 days before the date of the petition; transfers to existing creditors made within that period that have a preferential effect are voidable, unless the debtor was neither insolvent at the time of the preferential transfer nor rendered insolvent thereby or unless the payment was made in the regular course of business. In England a preference given by an insolvent, or an individual rendered insolvent thereby, to a creditor other than an associate of the debtor is voidable if it was made within six months prior to the filing of the bankruptcy petition and was motivated by the desire to give a preference. In Canada, in cases other than preferences to creditors related to the debtor, the preference period is three months prior to the receiving order (i.e., the order initiating the proceedings). The transfer must have been made or suffered by an insolvent with a view to giving the creditor a preference; but this element is presumed to exist if the transfer in fact had a preferential effect. In Australia the preference period commences six months prior to the petition. A transfer within such preference period by the bankrupt to a creditor that gives the creditor a preference is voidable if the debtor was insolvent at that time, unless the creditor had no reason to suspect that the debtor was insolvent at that time and that the transfer would give him a preference. The New Zealand law differentiates between preferences made by an insolvent with the view of giving a preference and preferences made without such purpose. In the first alternative the preference period is two years prior to the date of adjudication, in the second it is one month.

The French law of 1985, preserving vestiges of the traditional relation-back theory, invalidates payments of debts made after their due date and the date of the cessation of payments if the recipient had knowledge of the cessation of payments. In addition, anticipatory payment of unmatured debts, payment of debts made by other than ordinary means of payment, or the grant of security interests for preexistent debts are invalid if made after the cessation of payments, regardless of the creditor’s knowledge. Rules of the latter type also govern in Latin American countries (e.g., Argentina, Brazil, Chile, and Mexico). In Argentina the payment of matured debts with ordinary means may be voidable if the creditors knew of the cessation of payments. The laws of these countries vary as to the outer limits of the suspect period, ranging from two years in Argentina and Chile to 60 days in Brazil.

In the civil-law countries that do not adhere to a general relation-back doctrine, such as Germany, Italy, or Portugal, preferential transfers to creditors prior to an adjudication may be voidable, but the governing laws vary materially as to the relevant time frames and types of preferences. In Germany transfers by the debtor granting a security interest or satisfaction to which the creditor at that time was not entitled are voidable if made within 10 days prior to or after a cessation of payments or filing of a bankruptcy petition, unless the creditor shows that at that time he knew neither of the cessation of payments or petition nor of a preferential intent on the part of the debtor. The voidable act may not precede the adjudication by more than six months. In addition, security interests or satisfaction obtained by the creditor after a cessation of payments or filing of a petition are voidable if the trustee shows that the creditor knew of the cessation of payments or petition. In that case the date of the adjudication is irrelevant. Similar rules governing preferences apply in Austria. Voidability is provided if the preference was obtained within 60 days prior to or after the petition or within one year prior to the adjudication after insolvency. Moreover, in the case of transfers to the creditor in conformity with an obligation, the trustee must prove the preferential intent of the debtor and knowledge thereof by the creditor, whereas, in the case of payments made or security interests granted not in conformity with an existing obligation, the only defense is lack of preferential effect. In Italy anticipatory payments of debts that fall due only on the day of or after the adjudication are ipso jure (by the law itself) invalid if made within two years prior to the adjudication. Payments, effected by normal means, of debts that were payable at the time of such payment are voidable as preferences provided that the payment was made within one year prior to the adjudication, while the debtor was insolvent, and the trustee demonstrates that the creditor knew of the debtor’s state of insolvency. Payment of matured debts made by other than normal means and security interests granted for preexisting unmatured debts are voidable if made within two years prior to the adjudication unless the creditor shows that he was ignorant of the debtor’s state of insolvency. In Switzerland voidable preferences consist in the grant, without prior obligation to that effect, of security interests for existing debts; satisfaction of debts by other than usual means of payment; or premature payment of debts, if the respective acts were committed within six months prior to the adjudication, while the debtor was insolvent. The creditor can defeat the avoidance by showing lack of knowledge of the debtor’s financial condition. In addition, all acts committed with the intent to prefer a creditor are voidable for five years after their execution, if the intent was recognizable by the creditor.

Creditors entitled to share in the distribution of the estate. One of the principal objectives of bankruptcy is the distribution of the proceeds of the estate among the creditors. The designation of the categories of claims entitled to share in such distribution, the order of distribution, and the regulation of the procedures for their establishment form an important ingredient of modern bankruptcy legislation. At the outset a distinction must be made between secured and unsecured creditors. The recognition and assertion of security interests is subject to rules that aim at the separate satisfaction of the secured party from the proceeds of the collateral. To the extent that a secured creditor holds a claim that exceeds the value of the collateral—a so-called undersecured creditor—the creditor must comply with the rules governing unsecured debts. Many laws also require timely claim of security interests to permit orderly distribution of the estate. Moreover, the separate enforcement of security interests may be barred by the institution of bankruptcy proceedings. Security interests may be voidable as fraudulent or preferential transfers or because of inconsistency with overriding policies of the bankruptcy legislation. Except for these limitations, a security interest will remain unimpaired by bankruptcy and provide priority over creditors who do not possess a right of satisfaction from the specific property. The French law of 1985, however, subordinates all types of security interests to the rights of creditors originating during the period between the order instituting the procedure for economic rehabilitation or liquidation and the order of liquidation, and there is a general complaint against the consumption of the assets by secured creditors.

Generally speaking, “bankruptcy debts” or “provable claims” are based on transactions or occurrences prior to the date of bankruptcy. Creditors whose claims result from acts in, or expenditures for, the administration of the bankrupt estate are not creditors of the bankrupt and are paid before the latter. Post-bankruptcy debts incurred by the debtor are not payable from the estate. The line that divides provable post-bankruptcy claims from non-provable post-bankruptcy claims varies. In England, Australia, and Canada debts provable in bankruptcy (bankruptcy debts) include any debt or liability to which the bankrupt is subject at the date of the bankruptcy or to which he may become subject before his discharge by reason of an obligation incurred before the date of bankruptcy. In England liabilities accruing after the debtor’s discharge on an obligation incurred before bankruptcy are also provable. The date of bankruptcy within the meaning of these laws is that of the adjudication or making of the sequestration or receiving order, respectively. In the United States the date of the petition controls the determination of provable debts, but “gap creditors” are included if the adjudication follows an involuntary petition. In continental European and Latin American countries and countries influenced by their laws, such as Austria, France, Germany, Italy, Portugal, Spain, Argentina, Brazil, Chile, and Japan, creditors entitled to share in the estate are likewise those whose claims originated prior to the adjudication, while subsequent creditors are relegated to assets not entering into the estate.

Under most modern bankruptcy laws, provable debts include all types of pre-bankruptcy obligations, whether matured or unmatured, liquidated or unliquidated, unconditional or contingent. A provable unliquidated liability may be based on contract or tort, including personal injury as well as damages to property. This also holds true for most common-law countries, in particular England, the United States, Canada, and New Zealand. In Australia, however, demands for unliquidated damages arising other than by reason of contract or breach of trust are not provable. In Brazil creditors with unliquidated claims are entitled to the setting aside of a reserve. If at the time of proof the amount of the liability is still undetermined, many laws provide that it may be estimated.

In principle, bankruptcy laws aim at equality among creditors. Nevertheless, for social or fiscal reasons bankruptcy laws recognize or grant preferential rights to certain categories of claims. These rights are not security interests in particular assets but priorities in the distribution of the proceeds from their sale. These priorities may attach either to the proceeds from the entire estate or only to those from certain classes of assets. Some bankruptcy laws establish complex hierarchies of priority. The most common general priorities relate to tax claims and claims of or for the benefit of the labour force. In some countries labour claims not only have priority over all other provable claims but outrank even the rights of secured creditors. Examples of the latter approach are the laws of Brazil and France.