A bankruptcy proceeding commences upon filing a bankruptcy petition. The bankruptcy petition may be filed by the debtor itself or a creditor.
When the bankruptcy petition has been filed, the court will decide whether or not to commence the proceeding. At this point, attention should be paid to differences in verification of the bankruptcy petition of the debtor and the bankruptcy petition of the creditor in the court. While in respect of the bankruptcy petition of the debtor the court only performs a formal verification as described above, the verification of the bankruptcy petition of the creditor is more comprehensive. In respect of the bankruptcy petition of the creditor, the court additionally analyses whether, pursuant to the law, there are any additional conditions that prohibit the creditor to commence the bankruptcy proceeding of the debtor on the basis of the bankruptcy petition. For instance, the court cannot commence the bankruptcy proceeding of the debtor on the basis of the bankruptcy petition of the creditor if the debtor objects to the claim on a reasoned basis and the court finds that the dispute over the claim must be adjudicated outside bankruptcy proceedings. This basically means that the claim of the creditor is not clear. The court will also not commence the bankruptcy proceeding of the debtor if the claim of the creditor does not meet the minimum amount as stipulated by the law. For example, the amount of a claim of the creditor against a public limited company must be at least EKr200,000 ($16,000) in order to commence the bankruptcy proceeding of the latter. The abovementioned court's ability not to commence bankruptcy proceedings upon the existence of certain conditions should help to avoid hearings of unfounded bankruptcy proceedings.
A court will decide on the commencement of bankruptcy proceedings within 10 days after the filing of the bankruptcy petition and make a ruling on the decision. If commencement of bankruptcy proceedings must be decided in a preliminary hearing (there will be no need for a preliminary hearing if the debtor itself has filed the bankruptcy petition), the court will decide, within 10 days, on the time of the hearing and will deliver the summonses. The preliminary hearing is necessary, above all, for the debtor to have an opportunity to protect itself against the bankruptcy petition. It must be noted that, pursuant to Estonian law, commencement of bankruptcy proceeding does not constitute a declaration of bankruptcy this means that bankruptcy will not be declared upon commencement of the bankruptcy proceeding. Also, at this stage there is no possibility of talking about the establishment of the insolvency of the debtor. Basically, in Estonian national law an approach has been adopted whereby a certain period of time remains between the commencement of the bankruptcy proceeding and the issuing of a bankruptcy order. This period of time is necessary for ascertaining the economic situation of the debtor and for ensuring preservation of assets of the debtor to the highest possible extent. The court can appoint an interim trustee for the performance of these two tasks.
Making a bankruptcy order
The main issue, which the court verifies when hearing the bankruptcy petition, is insolvency. When the court has heard the bankruptcy petition, it basically has three choices. The court dismisses the petition if the debtor is solvent and the bankruptcy proceeding will be terminated. Second, the court can terminate the bankruptcy proceeding by abatement. If the court terminates the bankruptcy proceedings by abatement by a ruling without declaring bankruptcy, this means that the debtor is insolvent, but its situation is so bad that its assets are insufficient even for covering the costs of the bankruptcy proceedings, and it is impossible to recover or reclaim the assets. As a third possibility, if the court establishes that the debtor is insolvent and there exist no grounds for the abatement of bankruptcy proceedings, the court will declare bankruptcy by its judgement.
As can be seen from the above, the commencement of bankruptcy proceedings does not coincide with declaration of bankruptcy.
Such regulation causes problems in practice because if the bankruptcy proceeding has already been commenced it may look as if the bankruptcy of the debtor has already been declared, and this may significantly damage the interests of the debtor. It is very difficult to change the impression of the public, the debtor's business partners and its potential business partners, as well as to explain that the commencement of bankruptcy proceeding does not yet mean the insolvency and bankruptcy of the debtor.
The main amendment that is planned at the moment is that, before declaring the bankruptcy, it should not be referred to as a bankruptcy proceeding. Therefore, it would not be possible to talk about the bankruptcy proceedings in respect of the debtor, whose insolvency has not been established and whose bankruptcy has not yet been declared. Hence, the proposal to amend the Bankruptcy Act is in the principle that the bankruptcy proceeding will commence with declaration of bankruptcy.
Claims in a bankruptcy proceeding
Claims accepted for filing
According to the Bankruptcy Act, claims existing at the time of the declaration of bankruptcy are accepted for filing in a bankruptcy proceeding. Upon the declaration of bankruptcy, all claims against the debtor become collectable. Therefore, it is inconsequential for the bankruptcy proceeding whether the creditor's claim has actually become collectable before the declaration of bankruptcy the existence of the claim is sufficient. Furthermore, claims arising after the declaration of bankruptcy can also be filed in a bankruptcy proceeding. Such claims are known as consolidated claims. Generally, consolidated claims comprise claims due to a debtor's (who is legal person) continued business operation or obligations due to agreements that the debtor has failed to carry out. Consolidated claims also comprise obligations to compensate damage caused by unlawful action of the debtor during the bankruptcy proceeding.
Filing and defence of claims
Creditors are obliged to notify the trustee of all of their claims against the debtor, arising before the declaration of bankruptcy, at the latest within two months of the date when the bankruptcy notice was published in the Ametlikud Teadaanded (Official Notices), irrespective of the basis of the claim and the due date of its satisfaction. The trustee will be notified of the claim by the submitting of a written petition (proof of claim) to the trustee.
When the claims have been submitted to the trustee, the next step is the defence of the claims. The defence of the claims is performed at the meeting for defence of claims. The trustee will inform the creditors of the meeting and the opportunity to examine the filed claims.
At the meeting for defence of claims, claims will be examined in the order of their filing. A claim, its priority and the right of security to guarantee the claim are regarded as approved if neither the trustee nor any creditor contests it at the meeting for defence of claims, or if a creditor or trustee who has filed an objection waives the objection at the meeting for defence of claims. It is worth noting that the trustee is obliged to contest a claim at the meeting for defence of claims if there is a basis for it. A creditor can also file a written objection before the meeting for defence of claims. According to the Bankruptcy Act, claims settled by a court judgment entered into force, as well as registered rights of security, are regarded as approved without defence. A list of approved claims is consequently devised. The list will include information about to what extent the claim has been approved, the priority assigned to it and whether the claim is guaranteed by right of security. Should a creditor's claim not be approved, the creditor is entitled to file an action for approval of the claim to a court.
Disputes concerning the approval of a claim
If a claim, its priority or the right of security guaranteeing the claim were not approved at the meeting for defence of claims, the approval of the claim or the right of security will be settled in a court on the basis of an action filed by the creditor. If the trustee has contested the claim or the right of security, the debtor represented by the trustee will act as the defendant. If a creditor has contested the claim or the right of security, the creditor who has contested the claim, its priority or the right of security will act as the defendant. The action can be filed within one month from the date when the meeting refused to approve the claim of the right of security. A claim is considered defended when it has not been contested.
The Estonian Bankruptcy Act allows set-off of claims in bankruptcy proceedings. If a claim of a creditor could be set off against a claim of the debtor before the declaration of bankruptcy, the creditor's defended claim can also be set off after the declaration of bankruptcy. If the claim was related to a suspensive condition at the time of the declaration of bankruptcy, or if the claim was not yet collectable at the time of the declaration of bankruptcy, or if the claim is not designated for performance of obligations of the same category, the claim cannot be set off before the suspensive condition has realised, the claim has become collectable or the obligations can be regarded as of the same category. Set-off is not allowed when the suspensive condition of the debtor's claim is realised or the claim becomes collectable before the creditor obtains the opportunity to set off the claim. Set-off of a claim acquired through assignment is also allowed. It is important to note that a claim acquired through assignment can be set off in a bankruptcy proceeding only if the assignment of the claim and written notification of the debtor thereof have not taken place later than three months before the declaration of bankruptcy. A claim acquired through assignment cannot be set off if the claim against the debtor was assigned within the last three years before the initiation of the bankruptcy proceeding, the debtor was insolvent at that time and the person who acquired the claim knew or should have known thereof at the time of the assignment.
Bankruptcy estate and recovery of property
The concept of bankruptcy estate
Bankruptcy estate is the property that the debtor owns at the time of the declaration of bankruptcy. Bankruptcy estate also includes the property that is successfully reclaimed or recovered in the course of the bankruptcy proceeding. Furthermore, the debtor may also acquire property during the bankruptcy proceeding by, for example, continuing the business operation such property is also included in the bankruptcy estate. The debtor's existing property is included in the bankruptcy estate automatically, on the basis of the bankruptcy ruling. Bankruptcy estate is regarded as designated property to be used in order to satisfy the claims of the creditors and to carry out the bankruptcy proceeding.
According to the Bankruptcy Act, bankruptcy estate does not include property that cannot be claimed. For instance, bankruptcy estate cannot include the debtor's (who is a natural person) personal items that are essential for his/her personal needs.
Recovery of property
The Bankruptcy Act differentiates between general and specific bases of recovery. Applying the general bases, the court will declare all transactions executed from the initiation of the bankruptcy proceeding up to the declaration of bankruptcy null and void, as well as transactions executed before the initiation of the bankruptcy proceeding: (i) within one year, provided that the other party of the transaction knew or should have known that the transaction would damage the creditors' interests; (ii) within three years, provided that the debtor knowingly damaged the creditors' interests and the other party of the transaction knew or should have known that the debtor thereby damaged the creditors' interests; or (iii) within five years, provided that the debtor knowingly damaged the creditors' interests with the transaction and the other party of the transaction was connected with the debtor, who knew or should have known thereof.
The purpose of specific bases of recovery is to provide compositions that are explicit and easier to apply for more typical cases when the recovery is justified. Unlike the general bases, the specific bases are largely based on proving objective circumstances, not as much on the existence and proving of subjective bad faith of the parties of the transaction. Furthermore, in the case of specific bases, the terms limiting the period of contesting the transactions made after the initiation of the bankruptcy proceeding are, in general, significantly shorter.
The application of specific bases is justified under the following circumstances:
- the debtor has granted property or sold it so cheaply that the transaction has the character of a gift;
- the debtor has performed financial obligations, preferring certain creditors to others;
- the debtor has placed certain creditors in a more favourable situation than others, providing securities at a later point; and
- the debtor has distributed common property in a way that damages the creditors' interests.
A precondition for recovery (both on general and specific bases) is that damage to the creditors' interests will be identified. A transaction executed under conditions regarded as normal in the practice cannot generally damage the creditors' interests.
If the court declares a transaction null and void in the case of recovery, the other party will return the resources acquired through the transaction to the bankruptcy estate, together with its fruits and other obtained profit. If the other party knew or should have known about the circumstances underlying the recovery and the recovery is performed, the party will also compensate the profit lost due to the party's fault that could have been acquired following the accepted rules of operation. However, the recovery of a transaction does not mean that the other party of the transaction (the person who will return the resources acquired through a recovered transaction to the bankruptcy estate) will be bereft of the resources delivered due to the recovery. The law provides that if the other party has transferred something to the debtor through a recovered transaction, the transferred property will be returned to the party. Should that prove impossible, the value of the transferred property will be compensated for. But if the other party knew or should have known at the time of the transaction that the transaction will damage the other creditors' interests, the party is only permitted to claim a compensation for property transferred to the debtor, acting as a bankruptcy creditor with the lowest priority.
Satisfaction of claims
Before the satisfaction of the creditors' claims, payments related to the bankruptcy proceeding are made from the bankruptcy estate. The law provides a conclusive regulation for the order of payments related to the bankruptcy proceeding:
- claims arising from the consequences of exclusion and recovery of property;
- support to be paid to the debtor and his/her dependants;
- consolidated obligations; and
- bankruptcy proceeding expenses.
When the payments related to the bankruptcy proceeding have been made, the creditors' claims are satisfied according to the following priorities:
- approved claims secured by pledge and submitted within the specified term;
- other approved claims submitted within the specified term; and
- approved claims not submitted within the specified term.
The claims of the next priority are satisfied after the claims of the preceding priority have been fully satisfied. Should the bankruptcy estate prove insufficient for satisfying all claims of one priority, the claims of the same priority are satisfied in proportion with the amounts of the claims.
In principle, bankruptcy proceedings include the possibility that an amount of money remains in the bankruptcy estate after the creditors' claims have been fully satisfied. Should the bankruptcy estate include a remainder of property after the payments have been made and the creditors' claims are fully satisfied, the remainder of property will be returned to the debtor.
Rehabilitation and compromise
Rehabilitation and compromise in the Bankruptcy Act
The Bankruptcy Act defines the rehabilitation of a company as taking measures that allow satisfying the creditors' claims through the continued business operation of the debtor. The Bankruptcy Act deals with the rehabilitation of a company, which is justified as a legal person that may own more than one company (its business entities).
When a company is included in the bankruptcy estate, the Bankruptcy Act obligates the trustee in bankruptcy to initiate an active analysis of whether the company's operation should be liquidated or rehabilitated. If the trustee deems that rehabilitation of the company is reasonable, he/she will devise a plan for the company's continued operation (rehabilitation plan). It is important to note that the trustee will specify in the rehabilitation plan whether a rehabilitation with or without compromise would be more functional. When compromise is applied, the creditors will usually reduce their claims, thereby giving the debtor's company presumably better opportunities to satisfy the reduced claims by way of continuing the operation. If the rehabilitation is performed without a compromise, the bankruptcy proceeding will be continued and the claims remain unchanged.
Irrespective of whether the trustee devises a rehabilitation plan or submits a proposal for liquidation, he/she will notify the creditors of the decision at the first general meeting of creditors. The general meeting of creditors has the option to either approve the rehabilitation plan presented by the trustee or to decide for the liquidation of the company. The general meeting may also submit a proposal to the trustee to present a new rehabilitation plan. Furthermore, the general meeting may submit a proposal to the trustee to approve a rehabilitation plan in a situation where the trustee has proposed liquidation to the general meeting.
The new Rehabilitation Act
At the end of 2008, an entirely new Rehabilitation Act entered into force in Estonia. The rehabilitation proceeding provided in the Rehabilitation Act is based on the presumption that it would be possible in many cases to ultimately satisfy the creditors' claims to a greater extent, also preserving a number of jobs, among other things, if the company continues its operation instead of liquidation and the satisfaction of claims is spread over a longer period of time.
The Rehabilitation Act defines the rehabilitation of a company as taking a set of measures in order to overcome the company's financial difficulties, to restore its liquidity, to improve its profitability and to ensure sustainable economy.
Rehabilitation presupposes the proprietor's active participation as long as only the proprietor of the company has the right to initiate a rehabilitation proceeding. The proprietor submitting a rehabilitation petition will substantiate the likelihood of future insolvency, the company's need for rehabilitation and the potential of sustainable operation of the company in the future. When the proprietor has reliably indicated the compliance to the abovementioned conditions in the petition, the court will initiate a rehabilitation proceeding, issuing a corresponding ruling. The ruling will specify, among other instructions, the deadline for accepting a rehabilitation plan and a deadline for submitting it to the court for approval. Besides the deadline for submitting the plan, the court will also appoint a rehabilitation consultant, whose main function is to advise the proprietor on the devising of the rehabilitation plan.
After the initiation of the rehabilitation proceeding, claims of creditors are identified. The intention of the Act is that the debtor will be motivated to include the claims filed against it in the rehabilitation plan. It must be added that the law also prescribes an important function for the rehabilitation consultant: to analyse all claims to be rearranged in the rehabilitation plan and, if necessary, require the creditors to submit additional proof.
The law provides that the proprietor of a company under rehabilitation will devise a rehabilitation plan concerning its future operation, indicating the desired objective and specifying the means of achieving that objective. On the basis of the rehabilitation plan, the creditors will deem whether they believe in the company's continuity and future outlook or not. In the latter case, they will vote against the approval of the rehabilitation plan. As a rule, the rehabilitation proceeding must be terminated after that. Should the creditors accept the plan, the court will subsequently approve it, whereupon the rehabilitation plan acquires legal force. After the approval of the rehabilitation plan, the plan becomes valid and mandatory for both the proprietor and the creditors, whose claims will be rearranged by the rehabilitation plan. The rehabilitation plan is not applicable to the claims that are not included in the rehabilitation plan.
It is important to note that a company under rehabilitation cannot be declared bankrupt while the plan is valid. Should the rehabilitation fail, the rehabilitation plan must first be annulled. When a rehabilitation plan is annulled, the consequences of the initiation of the rehabilitation proceeding will become void (also retroactively). A creditor whose claim had been rearranged by the rehabilitation plan will retrieve the claim against the proprietor in its initial amount.
Paul Varul Attorneys-at-Law
Paul Varul graduated (cum laude) from the Faculty of Law of Tartu University in 1975 and obtained his PhD from St Petersburg University in 1985. Paul has been a member of the Estonian Bar Association since 1994. His primary practice areas include contract law, commercial law and bankruptcy law. Paul was the chairman of the main committee of the Estonian Civil Code between 1992 and 1999 and headed the expert committee of the Commercial Code from 1999 to 2002. He was Minister of Justice of the Republic of Estonia from 1995 to 1999.
Paul has been a full professor at the Faculty of Law of the University of Tartu since 1992. He is the co-author of numerous draft Acts (Law of Property Act, Law of Obligations Act, Bankruptcy Act and the Commercial Code, among others) and the co-author of the Law of Obligations Act, commented editions (Volume I from 2006 and Volume II from 2007).
Paul has published more than 80 academic publications: he is the editor-in-chief of Juridica and Juridica International, journals of the Law Faculty of the Tartu University, and he frequently lectures on insolvency, both in Estonia and abroad.
Paul has served as an arbitrator at the Arbitration Institute of the Stockholm Chamber of Commerce and has been working as the member of the Study Group on a European Civil Code since 2003. In 2007 he was chosen as a member of the International Insolvency Institute, as an internationally-renowned expert in insolvency law.
Paul Varul Attorneys-at-Law
Helmut Pikmets graduated from the Faculty of Law of Tartu University in 1994 and joined Paul Varul Attorneys-at-Law the same year. Helmut studied commercial law at the Stockholm School of Economics in 1992. He has published numerous articles and given lectures on insolvency and tax-related topics.
Helmut was admitted into the Estonian Bar Association in 1996 and his practice in insolvency-related cases spans back to that time. He was the liquidator of Tartu Kommerspank, the first commercial bank established in the Soviet Union, which can be considered the beginning of his career in insolvency practice. Helmut has since been the chief adviser and representative in some of the most substantial and complicated bankruptcy cases in Estonian court practice: for instance, the bankruptcy proceedings of AS Eesti Maapank, AS Ühinenud Meiereid and AS Satwo (Estonian distributor for the Ford Motor Company). The AS Eesti Maapank proceeding is the most complicated case in Estonian legal practice so far, comprising more than 4,000 different execution, bankruptcy, liquidation and criminal proceedings.
Helmut has also taken part in reorganising numerous insolvent companies, enabling the owners to overcome economic difficulties and to continue their activities without the company being liquidated. One of the most substantial examples was the reorganising of AS Dvigatel, a large heavy industry corporation. Helmut, assisted by colleagues from Paul Varul Attorneys-at-Law, advised the company in restructuring, refinancing its debts and making its shares public (on the OMX Nordic Exchange).