Privilege in bankruptcy

The Supreme Court in Finland made an interesting decision in 2011 concerning the border line between the powers and rights of insolvency administration, and legal privilege. This judgment, which overrules decisions made by lower instances, was also based on European legislation not so often referred to in the reasoning of Finnish courts.

Before examining the judgment, it is important to understand some of the main principles of Finnish insolvency practice, in particular issues relating to the sale of distressed debtor's assets and difficulties creditors seem to face in the Finnish legal system.

Insolvency legislation in Finland provides two alternative procedures: bankruptcy or corporate restructuring. Finnish law makes technically a clear distinction between liquidation and corporate restructuring, as these procedures are regulated by different legislation and have completely separate proceedings.

In Finland, Bankruptcy is regulated by Bankruptcy Law (20.2.2004/120). Bankruptcy proceedings are intended to liquidate the debtor's assets. A debtor's property is used in its entirety to repay debts. The debtor ceases to exist as an operational entity as all management powers and assets have been transferred to the bankruptcy estate. Equity usually loses all its value.

The corporate restructuring programme does not affect equity as such, in particular if the company is able successfully to complete the repayment programme. Corporate restructuring does not signify the restoration of solvency but usually means haircut of loan capital.

A private individual, a corporation, a foundation or another legal person may be declared bankrupt. Either the debtor or a creditor may file a petition for bankruptcy. A debtor company may petition for bankruptcy by a decision of the board. A creditor may file for bankruptcy if his claim against the debtor is so clear that its validity cannot justifiably be disputed.

Bankruptcy begins when the court makes an order of bankruptcy of the debtor. The court will appoint an estate administrator (trustee) at the beginning of the bankruptcy.

At the start of the bankruptcy, the debtor loses the authority over its assets of the bankruptcy estate. The authority is passed to the estate where powers to decide are thus used by the creditors. After the beginning of the bankruptcy, transactions realised, payments made and contracts concluded by the debtor will primarily not be binding on the estate.

The bankruptcy does not terminate the debtor's contractual relationships nor does it as such serve as a justification for terminating a contract. If, at the beginning of the bankruptcy, the debtor has not performed a contract to which it is a party, the other contracting party can request a declaration of whether the bankruptcy estate commits to the contract.

After the liquidation of assets, the bankruptcy proceedings are concluded by the disbursements to the creditors. The debtor is not released from liability for those debts that are not repaid in full in the bankruptcy.

Restructuring proceedings may be undertaken in order to rehabilitate a distressed debtor's viable business, to ensure its continued viability and to achieve debt arrangements.

Restructuring proceedings include a number of phases: applying for restructuring proceedings; commencement of the proceedings; preparing a report of the debtor's assets, liabilities and other undertakings; investigating the grounds for restructuring and drafting a restructuring programme; creditors voting on the programme; and approval of the restructuring programme by the court. These phases, in other words the restructuring proceedings, take approximately six to 12 months.

Realising the restructuring programme can then take between six to 12 years.

An application for restructuring proceedings may be filed by the debtor, a creditor or several creditors together (not, however, by a creditor with an unclear or contested claim) or a probable creditor, for example a guarantor. A district court may decide on commencing the restructuring proceedings if at least one of the prerequisites stated in the Restructuring of Enterprises Act (47/1993) is fulfilled: the application is a joint application by the debtor and creditors or expressly supported by creditors, the debtor faces imminent insolvency or the debtor is insolvent but the insolvency can be remedied.

The restructuring proceedings cannot be commenced if, for instance, the debtor is insolvent and it is probable that the proceedings will not remedy the insolvency or that the debtor's assets are not sufficient to cover the costs of the restructuring proceedings.

The court appoints an administrator who will undertake the necessary activities in order to realise the purpose of the proceedings and to protect the interests of the creditors. The administrator drafts the proposal for restructuring programme. The administrator co-operates with the creditors, which may be represented by an advisory committee of creditors.

Once the restructuring has begun, the debtor must not repay restructuring debts or provide security for such debts. A payment made in violation of the interdiction will be returned. Notwithstanding the interdiction, a secured creditor is entitled to receive and enforce interest payments that have become due after filing the application. In debt arrangements, unlike in the case of unsecured debt, the amount of a secured debt may not be cut. However, a secured creditor is not allowed to realise the pledge. This is a significant difference to bankruptcy proceedings where security may be realised.

Primarily, the commencement of restructuring proceedings will have no other effect on the existing undertakings by the debtor. The restructuring proceedings as such do not justify terminating contractual relationships or demanding changes in their contents. The debtor is responsible for its contractual duties and new debts that must be complied with and repaid when they become due.

For the owners of the debtor company, restructuring is a more beneficial procedure than bankruptcy proceedings. Successful restructuring allows future income from the company. Regardless of the restructuring proceedings, the managing bodies of the company continue their activities, even though they have partially restricted authority.

During the last years, the financial crisis has increased the amount of insolvency work, in particular restructuring arrangements. Creditors have favoured voluntary arrangements for certain reasons. Recent experience has indicated that Finnish law does not provide the most efficient tools for a takeover by creditors and simultaneous sale of the debtor's business as a going concern entity. For example, under English law there are pre-packaged sales in administrations, and schemes of arrangement. Finnish law does not contain such procedures even if it might be possible to achieve similar reorganisation with creative legal and financial engineering.

Under both procedures (bankruptcy and corporate restructuring) it is possible to sell the business of the debtor but it has proven to be complicated if parties are not in agreement.

In practice, the distinction between these two procedures is not complete since after a bankruptcy application by a creditor the debtor or another creditor may apply for corporate restructuring of that same entity. The court will then first decide whether there are grounds to begin the restructuring proceedings which aim to the acceptance of the restructuring programme by creditors' vote and final confirmation of the court. Therefore, an immediate takeover by the creditors with bankruptcy is not necessarily possible.

Since the court first decides on the potential for corporate restructuring, filing for bankruptcy by creditors might actually bring only uncertainty. The examination of the application for restructuring which takes some time since the matter might be financially and legally complicated. If creditors are not united, they have difficulties to get such application rejected. This is problematic since keeping the distressed debtor's business as a going concern as far as possible is often crucial for maximising the price in the sale of the business.

In corporate restructuring, the equity is protected and also at least in short term management keeps its position. This limits the takeover by creditors if parties disagree. In restructuring, the sale is only possible with the consent of the owners of the debtor.

In bankruptcy, the trustee is able to manage the business of the debtor for the benefit of creditors. The estate can sell any business of the debtor if the majority of creditors so decides. Law does not provide pre-pack rules, however. In fact the trustee should be independent when nominated.

The estate administrator is personally responsible for the conscientious and proper administration of the estate. His duties include taking possession of the assets of the estate, managing and maintaining those assets, taking any necessary measures for the collection of the debtor's receivables and securing the claims belonging to the estate, the cancellation of contracts that are not needed or are not profitable, examining the extent of the estate and taking any measures needed to reverse transactions and recover assets to the estate, drawing up the estate inventory and the debtor description, setting a lodgement date and examining the claims that can be taken into consideration in the disbursement list, seeing to the sale of assets belonging to the estate, disbursing the funds to the creditors in accordance with the disbursement list and drawing up the final settlement of accounts for the bankruptcy.

Thus, an estate administrator has been granted extensive statutory rights to inquire after information pertaining to the assets and debts of the estate. As the trustee of the creditors, the statutory rights of the administrator are derived from the debtor's rights and are thus largely equivalent to the rights of the debtor. The administrator has for this reason the right to receive any information the debtor could receive, including but not limited to the debtor's bank accounts, payments, financing arrangements and commitments, assets and taxation.

Basically any information pertaining to the debtor's business falls under the statutory rights of an estate administrator. However, the administrator does not have the right to receive private or sensitive material concerning the debtor when it does not directly concern the estate, for example information concerning the health of the debtor.

The estate administrator's right to receive information is reciprocally supplemented by the debtor's statutory duty to provide any relevant information and cooperation necessary for the discharge of the estate administrator's duties.

According to a preliminary ruling of the Finnish Supreme Court, the provisions concerning the legal privilege and the right to information of an estate administrator should, due to the requirements of the European Convention on Human Rights (ECHR), be interpreted such that the statutory right to information of the estate administrator does not set aside the secrecy obligation of an advocate.

In the preliminary ruling (KKO 2011:19), the Supreme Court assessed the estate administrator's right to obtain information regarding payments between the debtor in bankruptcy, a private individual, and the law firm that handled her affairs. The debtor had very substantial court cases. The bankruptcy estate argued in its claim that her place of residence was unknown and therefore it had not been possible to obtain all information needed for the management of the bankruptcy estate. The bankruptcy estate thus demanded that the law firm, which had access to documents containing information that was relevant for the investigation of her bankruptcy estate, should provide the information to the estate administrator.

The question in this case was whether the law firm was, in spite of legal privilege, obliged to disclose information to the estate administrator.

According to Chapter 8 Section 9 of the Finnish Bankruptcy Act, notwithstanding any provisions on secrecy, the estate administrator must have the same access as the debtor to information concerning the debtor's bank accounts, payments, financing arrangements and commitments, assets, taxation and other circumstances of the debtor's financial situation or economic activity, as is necessary for the scrutiny and administration of the estate. On the other hand, according to Section 5c of the Advocate Act, an advocate must not without due permission disclose the secrets of an individual or family or business, or professional secrets which have come to his knowledge in the course of his professional activity.

The Supreme Court noted that the relationship between the client and the advocate is based on trust and secrecy of confidential information. The secrecy obligation of an advocate ensures that the client's defence can be constructed in the best possible way. The secrecy obligation of an advocate also promotes a fair trial in general. The European Court of Human Rights has given several decisions concerning Article 6(3)(c) of the ECHR, which states that every person who is charged with a crime has the right to defend himself by a counsel of his own choice. These facts together promote the interpretation that the secrecy obligation of an advocate can be breached only because of cogent reasons.

Legal privilege is thus not without exceptions. For example, the law concerning the prevention and investigation of terrorism and money laundering includes a compulsory notification obligation which also concerns advocates. The statutory obligation has though been limited to concern only certain business transactions of the client. Section 4(4) of the law states that it does not apply to matters concerning counsel in court proceedings. Also Chapter 3 Section 66 of the Enforcement Code includes a statute concerning a third party's obligation to disclose information. According to the provision, an advocate is required to inform the bailiff of any assets or receivables of the debtor he has in his possession or is otherwise in charge of.

Chapter 17 Section 23(1) of the Code of Judicial Procedure contains the prohibitive provision stating that an attorney or counsel may not testify in respect of what the client has entrusted to him for the pursuit of the case, unless the client consents to such testimony. The scope of application of this provision is, however, narrower than the advocate's general obligation of secrecy as described in Chapter 15 Section 17 of the Code of Judicial Procedure.

The Supreme Court states in its conclusions that the billing information between an advocate and a client is not a matter of the core area of an advocate's obligation of secrecy. The information concerning such facts as from which account and by which means a client has paid her bills has usually no relevance to the defence of the client and thus revelation of such information would not be a breach of the confidentiality between a client and an advocate. As previously stated, this would also be in unison with the interpretation that an advocate's obligation of secrecy is not without exceptions.

The Court continued that an essential purpose of the secrecy obligation of an advocate is to ensure a fair trial. An advocate cannot defend his client properly if there is a risk that the confidential information of the client might be leaked to outsiders.

The bankruptcy estate has announced in its reply that the information sought after in the claim is necessary to the estate administrator in determining the debtor's money transactions and possibly in determining if the debtor has hidden her assets. The billing information might provide information as to from which bank and from whose account the bills have been paid or if the debtor has used cash to pay the bills.

The advocates of the law firm in question have counselled the debtor at least in a criminal case in which the debtor has been found guilty of an embezzlement offence. According to Article 6(3)(c) of the ECHR, a debtor has the right to defend himself through legal assistance of his own choice. To receive counselling, the debtor has to pay the lawyer's fees, which in practice is done through bankers. The information regarding such money transfers might contribute to the revelation of property of the debtor. The Court explained that if law firms were forced to disclose information about their client's bankers, the fear of revelation of property in such cases would make it difficult for the debtor to resort to legal assistance. Consequently, a party in her position would not be free to choose her counsel, which is a requirement of a fair trial.

Due to the requirements regarding a fair trial in the ECHR and the provisions concerning the estate administrator's right to inquire information, the Supreme Court established that the collision of the provisions concerning the secrecy obligation of an advocate and the estate administrator's right to inquire information should in the present case be interpreted such that the right to information for the estate administrator does not set aside the legal privilege. Thus, the Supreme Court concluded that the secrecy obligation of an advocate prevents the information required in the claim to be submitted to the bankruptcy estate. The bankruptcy estate's claim was dismissed and judgments of lower Courts overruled.

Mika Salonen
		Mika Salonen advises on M&A, insolvency and commercial contract-related questions, and is the head of the Borenius’ insolvency practice. He has acted as an adviser and administrator in large corporate restructurings and has also handled transactions related to capital markets and financing. He has served as a member of a board of directors and as an administrator for companies in the field of entertainment. Salonen has been a partner since 1998. He headed Baltic operations from 2003 to 2008 and is now head of the firm’s Russian desk. He completed his law degree from the University of Turku with an LLM from the University of Amsterdam in 1992. Borenius Attorneys at law Yrjönkatu 13 A,  FI-00120 Helsinki, Finland T: +358 9 615 333 • F: +358 9 6153 3499 E:  mika.solonen@borenius.com • Web: www.borenius.com

Kaisa Voutilainen
		Kaisa Voutilainen advises on dispute resolution and insolvency-related questions. She also represents clients in large litigations related to damages and contractual issues as well as securities markets. In addition, she has experience in advising on significant construction disputes as well as on issues regarding bankruptcy estates and related actions for recovery. Before joining Borenius, Voutilainen worked several years for other Helsinki-based law firms. She has also worked as a trainee at the District Court of Tuusula. She is an accredited mediator of the Finnish Bar Association and lectures regularly on issues related to construction law and real estate law. She is a member of the board of directors of the Helsinki Bar Association and a member of the Delegation of the Finnish Bar Association. Borenius Attorneys at law Yrjönkatu 13 A,  FI-00120 Helsinki, Finland T: +358 9 615 333 • F: +358 9 6153 3499 E:  kaisa.voutilainen@borenius.com • Web: www.borenius.com