The debtor paid and then went into bankruptcy: when the creditor must return the payment

After a demand from a lawyer, the customer finally pays invoices six months overdue. A few months later it is in bankruptcy and the creditor receives a letter from the trustee: the payment is ineffective against the creditors and must be returned to the estate. The trustee is not harassing the creditor: bankruptcy is meant to ensure that creditors are satisfied rateably, and a payment by which a debtor already insolvent preferred one of them frustrates that aim. Slovak and Czech law therefore both give the trustee a tool to claw such a payment back. For the creditor, it matters to know when that risk is real and how to respond.

Slovakia: a preferential legal act

Act No. 7/2005 Coll. on Bankruptcy and Restructuring defines a preferential act broadly:

A preferential legal act for the purposes of this Act is a legal act by which the debtor wholly or partly satisfied a monetary claim otherwise falling due only on the declaration of bankruptcy, secured its obligation later than the obligation arose, agreed a modification or replacement of its obligation to its own detriment or otherwise unjustifiably preferred its creditor over its other creditors.

— Section 59(1) of Act No. 7/2005 Coll. (unofficial English translation)

The first limb of the definition targets satisfaction of a debt that was not yet due. Payment of an overdue invoice is attacked by the trustee through the last, general limb of the definition, that is as unjustified preference of one creditor over the others; whether the payment crossed that line is assessed by the court on the circumstances, in particular whether the debtor was at that time failing to pay other creditors.

Preference alone is not enough, however. An act may be avoided only if it caused the debtor’s insolvency or was made during insolvency, and with a person connected to the debtor insolvency at that time is presumed (Section 59(3)). In time, only acts from the period of one year before the commencement of the bankruptcy proceedings may be avoided, or three years for connected persons (Section 59(4)). What matters is the commencement of the bankruptcy proceedings, not the declaration of bankruptcy; where bankruptcy was declared during restructuring proceedings, time runs from the commencement of the restructuring (Section 57(5)). Acts from which the claims have already been satisfied may also be avoided (Section 57(3)), so a paid invoice is not a closed matter.

Avoidance may be sought by the trustee and, if the trustee does not act on a creditor’s suggestion, by a creditor with a registered claim. The right lapses if it is not asserted against the obliged person or in court within one year of the declaration of bankruptcy; against the obliged person it is regarded as asserted only if that person acknowledged it in writing (Section 57(1) and (2)). Hence a practical piece of advice: do not sign the trustee’s demand or acknowledge it in writing before you have had it assessed whether the conditions for avoidance are met.

What happens if the payment does not stand

Where an ineffective legal act is one by which the debtor satisfied its monetary obligation, the creditor is obliged to return the debtor’s performance to the estate concerned. If the creditor returns the performance, the claim extinguished by that performance is restored to its original extent. The right to satisfaction of the restored claim may be asserted in the bankruptcy as a claim against the estate concerned, but only to the extent to which the restored claim would have been satisfied had it been asserted by registration.

— Section 63(2) of Act No. 7/2005 Coll. (unofficial English translation)

The creditor therefore does not lose the claim but is put back in the position it would have been in without the payment: it receives only what it would have received as a registered creditor. The right of avoidance may also be exercised by the trustee denying a registered claim that arose from an avoidable act (Section 62(6)); we describe how to respond to a denial in the question the trustee denied our registered claim.

Czechia: similar logic, a different process

The Czech Insolvency Act (Act No. 182/2006 Coll.) treats as preferential an act as a result of which one creditor receives, at the expense of the others, greater satisfaction than would fall to it in bankruptcy. It must be an act made at a time of insolvency or an act that led to insolvency; for close persons and persons within a group, insolvency is presumed. Acts from the last three years before the commencement of the insolvency proceedings may be avoided where a close person or a group was involved, otherwise from the period of one year (Section 241). An act made on terms usual in commercial dealings for which the debtor received reasonable consideration is not a preferential act, provided that no close person or group is involved and that the creditor could not, even with due care, have known that the debtor was insolvent (Section 241(5)(b)). Whether payment of an old invoice after a reminder can also rely on that exception depends on the circumstances of the particular payment.

In Czech proceedings only the insolvency administrator may seek avoidance, by an avoidance action brought within one year of the effects of the decision on insolvency; otherwise the right lapses (Section 239(1) and (3)). A claim for surrender of performance from an ineffective act cannot be met by set-off (Section 238), so you cannot settle the return of a payment with your own claim; we discuss the conditions for set-off in Czech insolvency in the question can we set our claims off.

Instalment schedules and security from a debtor in crisis

Instalments paid under an instalment schedule are performance by the debtor like any other and, if the debtor was insolvent at the time, they carry the same risk. Additional security is more sensitive. A security right over the debtor’s assets created for a debt that already exists falls expressly within preferential acts: in Slovakia as securing an obligation later than it arose (Section 59(1)), in Czechia as providing assets to secure an obligation that already exists (Section 241(3)(d)). The rules on avoidance in bankruptcy concern legal acts relating to the debtor’s assets (Section 57(1)). A guarantee by a managing director or accession to the debt by a third party binds someone else’s assets, so those rules will generally not reach it in the debtor’s bankruptcy. With an instalment agreement with a debtor already in difficulty, prefer security from a third party; we show how to draw such an agreement up in the question debt acknowledgement and an instalment schedule between businesses.

How to proceed

If the trustee has attacked your payment, check when the proceedings commenced, whether the payment falls within the statutory period, whether the debtor was insolvent at the time and whether you are connected with it. With a Czech debtor, check also whether you can rely on the exception for acts on terms usual in commercial dealings. We conduct the defence against the trustee and the registration of the restored claim through our registering a claim in bankruptcy in Slovakia and registration in insolvency proceedings in Czechia services. We prepare an instalment agreement that will hold up even in a later bankruptcy through our debt acknowledgement and instalment schedule service.