Negligence and Dishonesty in Insolvency Proceedings, or When a Debtor Risks Revocation of Arrangement

Insolvency proceedings are often seen as a last resort for debtors to deal with an untenable financial situation and get a fresh start. Insolvency, also known as personal bankruptcy, is one of the key ways to achieve this fresh start. However, debt relief has clear rules. The debtor must act honestly and comply with legal obligations throughout the proceedings. Otherwise, the insolvency court may annul the debtor's arrangement and, under certain conditions, decide at the same time how to resolve the debtor's bankruptcy. This article focuses on situations where a debtor's negligent or reckless approach in insolvency proceedings may lead to losing the possibility of resolving his or her bankruptcy by means of insolvency, in view of the Supreme Court's assessment of the issue in its recent decision of 28 June 2024, Case No. 29 NSCR 28/2023.

Insolvency as a boon

Insolvency is a fundamental pillar of insolvency proceedings. It provides the debtor with the opportunity to repay his debts in a reduced amount and to be relieved of the payment of the rest of his debts after a certain period of time. However, this "boon" is not for everyone. According to the Insolvency Act, only a debtor who is a natural person or a legal person that is not considered an entrepreneur and does not have debts from business can propose a solution to bankruptcy or threatened bankruptcy by means of insolvency. The law further requires that the debtor meet certain conditions, one of the most important of which is the debtor's honesty and responsible attitude to the performance of its obligations. Any negligent, reckless or even dishonest action may result not only in the rejection of the petition for insolvency but also in its subsequent annulment if these facts are discovered during the insolvency proceedings.

Obligation to provide complete and truthful information

One of the main obligations of the debtor in insolvency proceedings is, for example, the obligation of the debtor to provide the insolvency court with true and complete information on its liabilities, assets and financial situation, in particular in the form of lists. These lists must contain all relevant information, including information which the debtor may subjectively consider to be of minor or no value.

In practice, it is often the case that the debtor omits certain information, either negligently (recklessness on the part of the debtor) or intentionally (dishonest intent on the part of the debtor). However, this carelessness or dishonest intent on the part of the debtor can have significant consequences. Failure to list a creditor or assets may be perceived as recklessness which may lead to the rejection of the application for authorisation of the arrangement or the annulment of the arrangement (however, the failure to list a creditor only if the debtor has been requested to do so by the insolvency court in the course of its supervisory activities or has submitted it with the application for arrangement, cf. below).

Recklessness in drawing up lists

A careless approach to drawing up a list of liabilities (if the debtor submits it when filing for insolvency and declares that it is a correct and complete list) or assets is one of the most common reasons why courts reject an application for insolvency. In the aforementioned Supreme Court decision, it was stated that if the debtor fails to submit a complete list of his liabilities, his conduct may be considered at least reckless or negligent. This conclusion also applies to cases where the debtor fails to submit a list of liabilities despite being ordered to do so by the insolvency court.

Negligence in disclosing assets

Another common problem in insolvency is the submission of an incomplete or misrepresented asset list. The debtor is obliged to list all his assets, including assets he considers worthless or insignificant. If the debtor fails to disclose such assets, the insolvency court may conclude that the debtor has breached its obligations and, if it is proven that the debtor intentionally failed to disclose the assets, the insolvency may be revoked due to the debtor's dishonest intent.

The debtor's obligation to disclose all of his assets was confirmed by the Supreme Court in the aforementioned decision (Case No. 29 NSCR 28/2023), where it stated that the debtor cannot decide on his own whether or not certain assets are of value for the insolvency proceedings. If the property exists, the debtor is obliged to disclose it, even if, in his opinion, it has no market value.

Incomplete list of creditors

A typical example of a debtor's reckless and negligent behaviour is the failure to include certain creditors in the list of creditors at the insolvency court's request during its supervisory activity (if the debtor did not voluntarily include them in the application for authorisation to repay, as this is not the debtor's obligation in the course of the insolvency proceedings, cf. § 104(1)(b) in conjunction with § 104(4), last sentence of the Insolvency Act).

An example is a case from the decision-making practice of the Supreme Court (e.g. Case No. 29 NSCR 45/2010), where the debtor did not mention his foreign creditors in his proposal for insolvency, which he subsequently claimed were not relevant for the insolvency proceedings. However, the insolvency court found the existence of liabilities between the foreign creditors and the debtor, as well as the fact that the debtor was aware of these liabilities, from which the debtor's dishonest intention can be inferred.

The main reason for this is to protect the rights of creditors. Insolvency proceedings are collective proceedings in which the aim is also to satisfy creditors' claims as far as possible. Any omission or misrepresentation in the list of liabilities undermines that objective and increases the risk that some creditors will not be adequately satisfied. It is therefore important that the debtor carefully draws up the list of liabilities (if he is obliged to do so or has drawn it up in accordance with the above-mentioned provisions of the Insolvency Act) and consults his legal counsel in case of any ambiguity, for example.

Seeking maximum satisfaction of creditors

In addition to the obligation to provide complete and truthful lists of assets and liabilities, the debtor in insolvency proceedings is obliged to seek the maximum satisfaction of its creditors. This means that he must use all his income to meet the conditions of the insolvency.

In practice, it often happens that the debtor is, for example, employed by a friend and his salary is artificially set at the minimum required for the insolvency so that the debtor can keep the funds for personal purposes after the insolvency instalments have been paid. If, however, the insolvency court finds that assets are being "diverted" out of the insolvency in this way, this situation is very often the reason for the annulment of the insolvency arrangement, since the debtor does not, among other things, demonstrate that he has made every effort to satisfy his creditors to the maximum extent possible.

Incomplete information as a manifestation of dishonest intent

The Supreme Court has repeatedly emphasised in its decision that deliberate concealment of assets, creditors or income may also be considered as dishonest intent, even if the amounts involved are relatively small. The debtor must approach the insolvency process with the utmost responsibility and transparency, otherwise the debtor risks that the insolvency court will reject the debtor's application for insolvency or decide to annul the insolvency.

Conclusion

Insolvency proceedings are a process that offers debtors a unique chance for a fresh start. However, this chance comes with clear rules that must be followed. The debtor must act honestly, transparently and responsibly throughout the proceedings. Any reckless or negligent, or even dishonest, approach can lead to the insolvency court rejecting the application for a debt relief or cancelling the debt relief. Therefore, it is essential that the debtor fulfils all his obligations diligently, provides complete and truthful information and makes every effort to satisfy creditors.

If you have any questions regarding this topic or related issues, please do not hesitate to contact us. We will be happy to learn more about your case and provide you with appropriate legal assistance.