Creditors are often faced with the long-term default of a counterparty. One of the options offered by the legislator is to open insolvency proceedings against the debtor, with the help of which the fullest possible fulfillment of obligations can be achieved. Insolvency proceedings of a legal entity are a set of measures, of a legal nature, within the framework of which the claims of creditors are covered by the debtor’s assets in order to facilitate the fulfillment of the debtor’s obligations. Of course, the use of insolvency proceedings itself does not guarantee the creditor’s claims will be fully satisfied, but from the creditor’s point of view there is a possibility insolvency proceedings may lead to a more favorable outcome for the creditor than in the case of simple debt recovery. In all fairness, it should be noted most insolvency proceedings in Latvia unfortunately end without a positive outcome for unsecured creditors.
In Latvia, the insolvency proceedings of a legal person are often considered to be the debtor’s bankruptcy proceedings, within the scope of which the creditors’ claims are covered by the sale of the assets belonging to the debtor, and the legal person ceases to exist. If the debtor’s insolvency proceedings have been initiated, the transition to legal protection proceedings aimed at restoring the debtor’s ability to meet his obligations is possible in exceptionally rare cases. Insolvency proceedings of a legal person apply not only to “classic” legal entities – limited liability companies and joint stock companies (with the exception of the inheritance mass and credit institutions), but also to partnerships and natural persons – individual merchants.
In the cases specified in the Insolvency Law, both the debtor itself and the debtor’s unsecured creditors may request the initiation of insolvency proceedings of a legal person. Currently, it is also necessary to take into account the provisions of the Law on the Suppression of Consequences of the Spread of Covid-19 Infection, according to which the legislator prohibits creditors from submitting an application for insolvency proceedings for a certain period of time and has provided an exemption of the debtor from the obligation to submit an insolvency application in certain cases (currently creditors are prohibited from submitting an application for insolvency proceedings until 1 September 2021, while the debtor is not obliged to submit an insolvency until 31 December 2021, except in certain cases).
The debtor is obliged to immediately apply for insolvency proceedings of a legal entity if the debtor has not settled debts whose due date has expired for more than two months, as well as in other cases. If the management board fails to comply with this obligation, the members of the management board may be personally liable to creditors.
The creditor, in turn, has the right to apply to a court for insolvency proceedings of a legal person if:
An application for insolvency proceedings of a legal person may not be submitted by a secured creditor. If the claim is not fully secured, the secured creditor may file an application for insolvency proceedings of the legal person only in the amount of the unsecured part of the claim. An unsecured creditor is also not entitled to apply for insolvency proceedings if legal proceedings against the debtor have been initiated or are pending.
When submitting an application for insolvency proceedings to a court, the applicant is obliged to pay both the state fee and the legal entity insolvency deposit in the amount of two minimum monthly salaries (EUR 20,000 in 2021), which ensures the financing of the insolvency proceedings of the legal entity if during the process it turns out that the debtor itself has no property or the property is less than the amount of the deposit, and no one applies to finance these proceedings.
The declaration of insolvency proceedings by a court judgment has significant consequences for the debtor. Among other things, operations of the debtor’s governing bodies, such as the capital company’s, shareholders’ meetings and shareholders, as well as the board of directors’ (if any), will be suspended and replaced by a court-appointed insolvency administrator.
A representative of the debtor who is obliged to cooperate with the administrator in the insolvency proceedings, providing him with information and documents about the debtor, is appointed. Information on the commencement of insolvency proceedings will be entered in the public – insolvency – register, which is available on the website of the Company Register of the Republic of Latvia. After the entry in the insolvency register, the period for filing creditors’ claims begins to run. Claims shall be submitted to the administrator within one month from the date of entry in the insolvency register regarding the declaration of the debtor’s insolvency proceedings. If a creditor misses the deadline for submission of such claims, it may submit its claim against the debtor within a period not exceeding six months from the date of the entry of the debtor’s insolvency proceedings, but not later than until the day when a plan for satisfaction of creditors’ claims has been drawn up in accordance with the procedures specified in law. It is important to emphasize that the statute of limitations expires, and thus the creditor loses the status of a creditor and his right of claim against the debtor. The creditor must take into account that during the insolvency proceedings of a legal entity, the debtor’s claims can be set off against the creditor’s claims if they have arisen at least six months before the date of the declaration of insolvency proceedings of the legal entity. On the other hand, the administrator may challenge the set-off as any other transaction concluded by the debtor in court if the transaction has been concluded within three years prior to the date of declaration of the legal person’s insolvency proceedings and if he can prove it has caused damage to the debtor.
According to the law, the court-appointed administrator decides either on the continuation of the debtor’s economic activity to the full extent or to a limited extent, if the continuation of such activity is economically justified, or on its termination, and immediately begins a full inventory of the debtor’s documents and property and prepares the debtor’s balance sheet, accepts, registers and verifies the creditor’s claims, and immediately takes possession of all the debtor’s property, as well as the property of third parties in the debtor’s possession or which the debtor is holding. The administrator also provides creditors and the Insolvency Control Service with a report on its activities, recovers receivables and takes legal actions to recover other property of the debtor, applies to the Insolvency Control Service for satisfaction of employees’ claims from the resources of the employee claims guarantee fund, sells the debtor’s property and conducts other activities, as well as file claims against the members of the Management Board and the Council.
From the creditors’ interests point of view, the statutory obligation of the administrator to assess and bring actions against members of the legal person’s management bodies and members of the capital company (shareholders) for damages, as well as to assess the debtor’s transactions and bring an action for annulment of such transactions if they have resulted in damages to the debtors.
In practice, directly challenging the debtor’s officers and dealing with transactions detrimental to the debtor often proves to be the only way to maintain the expectation of at least partial settlement with the debtor’s creditors. On the one hand, the administrator is not bound by the instructions of the creditors or their representative institutions – the creditors’ meeting. On the other hand, the “autonomy” of such an administrator is not absolute, since the administrator, as a person equivalent to a public official, performs a public duty and is endowed with public powers, thus the legislator has entrusted most of the administrator’s supervisory powers to the Insolvency Control Service. However, it should be taken into account that the administrator may be removed by the court on its own initiative, at the request of the Insolvency Control Service or the administrator, or at the initiative the administrator, or on the initiative of the creditors’ meeting, if any of the grounds specified in the Insolvency Law is established.
According to the Insolvency Law, the insolvency administrator only has the obligation to inform the creditors, who have the right to object to the administrator’s intended actions. In Latvia, unfortunately, the legislator has determined a relatively limited competence of the creditors’ meeting, providing only the right to decide on the determination of the administrator’s remuneration, the initiation of the administrator’s dismissal, the recognition of the expenses of the insolvency proceedings as justified, the type of sale of the debtor’s property or the extension of the sale term, as well as further handling of the property excluded from the property sale plan. The creditors’ meeting adopts its decisions basically by a simple majority of votes. The number of votes in the creditors’ meeting is determined according to the value of the creditor’s principal claim, with one vote for each full euro. The votes in the creditors’ meeting shall be allocated to the unsecured creditor, as well as to the secured creditor in the unsecured part of the claim, if a vote is taken to initiate the dismissal of the administrator.
An important issue for creditors is the amount of the expenses of the insolvency proceedings. The most important item of these costs is the administrator’s fee, which is mainly covered by the debtor’s property. The procedure for its calculation is specified in the Insolvency Law, and it consists of the following items: 1) remuneration equal to two minimum monthly salaries set by the state; 2) equal to 10% of the recovered property of the debtor, specifically the sale of the property and debt collection; 3) remuneration for the sale of the pledged property, the amount of which according to the calculation formula included in the law depends on the amount payable to the creditors (for example, if the amount payable to the creditor is between EUR 142,287 and EUR 711,435, then according to law the remuneration of the administrator is EUR 8,039,15 plus 3% of the amount payable to the creditor above EUR 142,287). The law includes the principle that the administrator’s remuneration depends directly on the financial situation of the insolvent entity – the more assets it owns, the more money the administrator will recover to satisfy creditors’ claims, and the administrator’s remuneration will be higher.
The administrator may also receive additional remuneration if the debtor to be administered is considered to be a large enterprise in terms of the number of employees (based on the annual turnover and the number of employees), as well as if the debtor continues to perform its economic activity. At the same time, the Insolvency Law provides for the administrator’s right to agree with the creditors’ meeting on a different amount of remuneration or the procedure for covering it, e.g., the creditors’ meeting may decide that the administrator must be paid a monthly remuneration. In practice, such a remuneration model is often applied when the insolvent entity is a large company or if it continues its economic activity.
Finally, it is important for creditors to know the order in which creditors’ claims are covered by the Insolvency Law. First of all, the costs of the insolvency proceedings are fully covered by the debtor’s property and other sources of financing. In the next round, the claim of the Insolvency Control Service is fully covered if the claims of the debtor’s employees are satisfied from the resources of the Employee Claims Guarantee Fund in accordance with the Law “On Protection of Employees in the Event of Employer Insolvency”. After full satisfaction of the above-mentioned claims, the claims of certain types of employees, as well as the claims of the tax administration, shall be covered next. After full satisfaction of all the above-mentioned claims of the creditors, the remaining funds of the debtor shall be distributed to satisfy the claims of other creditors in the amount of the principal debt, and in case of insufficient funds, the respective claims shall be satisfied proportionally to the amount due to each creditor. From the debtor’s funds remaining after the satisfaction of the claims of the unsecured creditors in the amount of the principal debt, the ancillary claims of the unsecured creditors are satisfied (in proportion to the amount due to each creditor). Finally, in the case of cash, the costs are paid to each participant or shareholder proportionally to the amount of his investment.
March 26, 2021 by Gints Vilgerts, Managing Partner
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