Most people and businesses are from time to time affected by a bankruptcy. They may be employed by a company going into bankruptcy, contracting party to a business that goes bankrupt, or owner or board member of a company being declared bankrupt. The person or company taken under bankruptcy proceedings are subject to extensive and complex regulations and in this article we will try to give an overview and introduction to these regulations.
Bankruptcy is a joint debt collection proceeding. In a bankruptcy the debtor’s assets are seized by the estate, the assets are realized and the funds are distributed to creditors. “Creditors” can be both financial creditors (banks and other financial institutions) and others who have claims against the debtor – such as employees, public authorities, suppliers and other contracting parties. The Norwegian bankruptcy system is based on a liquidation of the debtor’s assets. Although there are possibilities of making an arrangement with the creditors (see section 3.4 and 5 below), the Norwegian bankruptcy system does not aim at restructuring the insolvent company or group.
The objectives for the bankruptcy system are that it shall seek settlement of the outstanding claims; ensure equal treatment of creditors of an insolvent debtor; it shall allow for an efficient liquidation of the debtor’s business; and from a social viewpoint, a bankruptcy shall be an orderly liquidation of the business.
The procedural aspects of a bankruptcy is largely regulated by the Norwegian Bankruptcy Act (Act 1984/58), while the comprehensive rules regarding creditors and the estate’s rights and obligations are mainly stated by the Norwegian Recovery Act (Act 1984/59). It is in principle the same rules that apply for private individuals and companies.
Limited liability companies may in certain cases be forcibly dissolved by judicial decree. This usually occurs if the annual accounts are not submitted within certain deadlines or if the company lacks the necessary board members or auditor (if required). An enforced liquidation will in general follow the same rules as liquidation under the bankruptcy legislation.
1. The Bankruptcy Process
With the bankruptcy process is meant the statutory procedure where all assets of the insolvent debtor are seized by the bankruptcy estate in order to distribute the values to the creditors. Below, we discuss this process, the players being involved and actions on the various stages.
1.1. Initiating of bankruptcy proceedings: Filing by the debtor / filing by a creditor
Only an insolvent debtor can be declared bankrupt. In order to be insolvent according to Norwegian law, it is required that the debtor is both insufficient and illiquid. Insufficient means that debts exceed assets (negative equity). Illiquidity means that the debtor is unable to pay his debt as this falls due.
Basis for initiating bankruptcy proceedings is either a bankruptcy petition by the debtor himself, or a bankruptcy petition from a creditor. For an insolvent debtor it may be a criminal offense not to file for bankruptcy in time. A creditor requesting bankruptcy proceedings to be initiated will have to pay a fee as security for the estate’s costs (at present NOK 43.000). If the debtor himself or an employee files for bankruptcy there is in general no such requirement.
According to the Norwegian Bankruptcy Act, bankruptcy proceedings shall also be initiated if debt negotiations according to the Norwegian Bankruptcy Act have failed.
The bankruptcy court decides if bankruptcy proceedings shall be initiated. A hearing is normally held unless it is the debtor himself that files for bankruptcy. The bankruptcy estate is established when the court’ decision is made. The estate thereafter represents the interests of the joint creditors and takes possession of the debtor’s assets.
The Norwegian Bankruptcy Act contains detailed regulations of how the estate shall proceed, both in relation to the debtor, its creditors and other parties affected by the bankruptcy.
1.2. The estate and its administration
The estate is managed by a trustee appointed by the court. The trustee is usually a lawyer. Each district court has its list of lawyers who they appoint on a regular basis and suggestions to appoint others are usually not taken into consideration.
In larger estates or complex estates, it is usually appointed a creditors’ committee. The trustee and the creditors committee form the administrators of the bankruptcy estate. The members of the creditors’ committee are appointed by the court from and among representatives of the creditors. It is common that major creditors are represented in the creditors’ committee.
According to the Norwegian Bankruptcy Act an auditor for the estate shall be appointed, however in most cases the estate’s financial situation does not allow appointment of an auditor. If an auditor is appointed, it will review the accounts and management of the debtor’s business, and submit a report to the court.
The meeting of creditors is held in court where the creditors are entitled to participate. Decisions from the meeting of creditors are binding on the trustee and the creditor’s committee, unless they are set aside by the court.
The court is as such not a part of the administration of the estate, but it has authority to instruct and control the estate.
1.3. The estate’s duties
The trustee’s main task is to safeguard creditors’ common interest against the individual claimant and towards third parties.
The trustee’s tasks are (ref the Norwegian Bankruptcy Act section 85) to
- identify the assets of the estate, and for that purpose examine and if necessary contest any demands to hand over assets held by the estate;
- collect the accounts receivable held by the estate;
- ensure the safekeeping and if possible an increase of the assets held by the estate, and selling them on the best possible terms;
- ascertain whether submitted claims shall be entitled to dividends;
- decide – with the exception of his own, the auditor and creditors committee members’ remuneration – which claims are to be accepted as preferential claims;
- cancel the bankruptcy seizure (abandonment) or transfer to the mortgagee of specified assets;
- provide specified information to the prosecution authorities and the Financial Supervisory Authority;
- notify the county governor as early as possible if the business is expected to involve to illegal pollution;
- give notice as early as possible to the local employment office about which workers who have claims against the estate, if there are workers in the debtor’s business.
The estate is supposed to deliver reports to court. In the reports there will be given information about the debtor’s business management, accounting, information on the estate’s assets, information about potentially voidable or criminal offenses, and whether there are reasons for a temporary disqualification for persons involved in the business.
1.4. The closing of the estate
Bankruptcy proceedings may have three kind of main results:
(i) The estate may have funds to be distributed to creditors, and before the estate is closed there will be a dividend payment to the creditors.
(ii) The estate shall be closed if there are no funds to be paid to creditors or to fund the estate’s administration.
(iii) The estate can also be handed back to the debtor if the bankruptcy proceedings show that there are sufficient funds to cover all the creditors, or the creditors agree to hand back the estate or the debtor through the bankruptcy succeeds in negotiating a settlement with the creditors.
In situation (i) the assets are realized, the values are distributed to creditors according to specific distribution rules (see section 2.3 below). The court shall approve the final distribution from the estate.
2. The Creditor’s rights in the estate
A creditor will usually have a number of rights against the estate, rights the estate is obliged to respect. Below we discuss some of these rights.
2.1. Mortgage right/pledge
A creditor with a valid and legally protected mortgage/pledge securing its claim has a preferential right to cover its claim by realization of the collateral. If there is no additional value for the estate after covering the secured claims, the estate will usually cancel the seizure of the relevant assets. But the estate can also decide to make a collective sale of all or part of the debtor’s business and include the collateral in such a sale. The mortgagee/pledgee shall then receive payment from the funds received by the estate when selling the collateral.
The estate can also realize the pledged assets if there is an additional value accruing to the estate. Assets with no economic value for the estate may usually not be sold by the estate with the effect of extinction of unpaid encumbrances. There is however an exception if the collateral is sold together with other assets of the estate and a sale is expected to create greater dividends for the estate than if the assets are sold individually. Exemptions also apply to the transfer of all or parts of the business with the aim of continued operation after the bankruptcy.
2.2. Collateral according to the Financial Collateral Act
The Financial Collateral Act (Act 2004/17) contains a special regulation of certain collateral rights. The law applies only between legal persons, and it is required that one of the parties is a financial institution, investment firm or a similar “professional party.” Furthermore, the act only applies to pledging of securities, cash deposits and undrawn credit commitments. The collateral can further only secure the settlement of a monetary claim or delivery of securities. Other kinds of collateral or other forms of pledges/mortgages do not fall within the range of the act.
The act allows for a more extensive right of use for the creditor of the collateral than what is permitted under the Mortgages and Pledges Act. The act also allows disposal of the collateral according to terms to be agreed upon, without following the requirements according to the Enforcement Act. Collateral governed by financial collateral agreements has in addition a stronger protection against avoidance based on preferential treatment of creditors. The created security rights can further be realized without the legal mortgage right held by the estate (see section 3.3. below), and the estate’s right to refuse realization by the pledgee within the first six months after the date of filling does not apply for collateral according to the act.
2.3. Dividend right
Creditors pretending to have claims against the debtor originating from before the bankruptcy proceedings were opened must notify the estate about the claim. Both conditional and unconditional claims as well as damage claims caused by the debtor’s bankruptcy can be notified to the estate.
A notified claim needs to be documented. The estate thereafter decides if the claim is approved as dividend claim or not. The final approval of dividend claims takes place in the creditors’ meeting.
If a claim is secured by collateral over the debtor’s assets, only the part of the claim that is not covered by collateral is entitled to dividends.
The dividend payments are funded by sale of the debtor’s assets. The claims are divided in different types of claims which have different priority and are covered in line with this priority order:
- Expenses of the bankruptcy: The expenses related to the bankruptcy proceedings shall always be covered first. These costs are not true dividend claims, but claims arising in connection with the bankruptcy.
- Preferential claims of the first degree: To the extent that there are sufficient funds to cover expenses of the bankruptcy, preferential claims of the first degree shall be covered. This category includes on further conditions such as unpaid salary or other remuneration to bankruptcy debtor’s employees, claims for holiday pay/holiday remuneration, claims for pension payments and claims for maintenance for spouse or children.
- Preferential claims of the second degree: To the extent that there are sufficient funds to cover both expenses of the bankruptcy and preferential claims of the first degree, preferential claims of the second degree shall be covered. This category includes on further conditions tax claims, VAT claims, claims for social security contribution, and certain refund claims related to tax and social security contributions, etc.
- General Bankruptcy Claims: The general bankruptcy claims will only receive dividend if the preferential claims are covered.
- Claims ranking last: This category of claims is covered last, and payment is subject to that all the higher ranked claims are covered. The category includes claims for the period after initiating of the bankruptcy proceedings, subordinated claims, and claims based on a donative promise in an insolvent estate of a deceased person.
Claims that are not covered: The Bankruptcy debtor is in principle still liable for debts that are not covered. Limited liability companies and foundations are however dissolved after bankruptcy proceedings. The liability for debts that are not covered is therefore most important where the debtor is an individual person.
2.4. Set off
The creditor is often in a position where it can set off his claim against the bankruptcy debtor towards a claim held by the bankruptcy debtor/the estate. To the extent that the claims overlap, they are settled through set off. Set off is permitted in bankruptcy, but specific rules apply and these both expand and restrict the set off possibilities compared to the general set off rules.
3. The estate’s rights against the creditor
The estate also has rights against creditors that the creditors are obliged to respect. Below, and in the following we discuss some of these.
3.1. The debtor’s assets
The bankruptcy estate “steps into the shoes” of the bankruptcy debtor and seize all the debtor’s assets and claims. If the estate has claims towards a third party, it will collect the money or other assets. This means that the estate may collect the debtor’s bank deposits, the debtor’s receivables and other claims held by the debtor. The estate will have to respect rightful objections, e.g. notification of defects. Some assets are excluded from the seizure by the estate, such as some of the bankruptcy debtor’s personal belongings.
3.2. Avoidance of transactions
The bankruptcy estate can set aside a creditor’s fraudulent payments or transactions, e.g if a creditor has received substantial values from the bankruptcy debtor in the period before bankruptcy is initiated. If the transaction is set aside, the assets or values shall be reversed back to the estate. The rules regarding avoidance of transactions have the aim to ensure equal treatment of creditors. The rules regarding avoidance of transactions are categorized according to what types of transactions they can attack, and the most common are:
- Gifts: Gifts that are given from the debtor in the last year before the filing date in bankruptcy may be set aside. In certain cases also gifts granted up to five years before the deadline can be set aside. The term “gift” includes both fully and partially gratuitous dispositions. There are also special rules on invalidation of unreasonably high remuneration.
- Extraordinary payments: Extraordinary payments can be set aside if the payments are made with amounts that significantly have deteriorated the debtor’s ability to pay, if they are made with extraordinary means of payment or before the normal payment date. Such payments can be set aside if they are made up to three months before the filing date, and in some cases up to two years before the filing date.
- New collateral for older debt: Collateral for older debt can be set aside in two situations. Firstly, it can be set aside if the collateral was agreed upon at a later stage than the debt. Secondly, the security can be set aside if it has not been given legal protection without undue delay. Collateral established up to three months before the filing date can be set aside by the estate according to these rules. In certain cases, this is extended to two years before the deadline
- Involuntary charges or liens established up to three months before the filing date, and in some cases up to two years before the filing date, may also be set aside.
In addition to these rules the estate may set aside transactions where the other party has not acted in good faith. According to these rules the estate may set aside transactions carried out up to ten years before the filing date. It is however required that the transaction is regarded as unfair preference towards other creditors. It is also required that the debtor’s economy was weak or was seriously weakened by the transaction. In addition, it is required that the beneficiary knew or ought to have known about the debtor’s financial situation and the circumstances that made the transaction unfair.
There are also rules regarding avoidance of transactions in separate acts such as the Marriage Act (Act 1991/47) sections 51-53 and the Insurance Contracts Act (Act 1989/69) section 16-2.
3.3. Legal mortgage in favor of the bankruptcy estate – Mortgage and Pledges Act section 6-4
The Mortgage and Pledges Act (Act 1980/2) includes a legal mortgage right in favor of the estate. The legal mortgage applies to all of the debtor’s assets on which it rests a pledge or a mortgage, and that may be subject to execution or bankruptcy seizure. It will also apply to assets that a third party has furnished as security for the debtor’s debt. Legal mortgage is limited to five percent of the asset’s estimated value or the revenue from a sale of such asset, but limited to a maximum of 700 times the court fee in each asset registered in an asset register (at present NOK 602.000). The lien has best priority in such property.
One important limitation is that the legal mortgage can only be used to cover “necessary estate administration costs.” For instance will handling of cases under the Wage Guarantee Scheme, costs relating to the accession to the debtor’s contracts or liability the estate incurs fall outside of this term. The estate administration costs must also be “necessary” which implies a discretionary limit to what extent these funds can be used.
Any mortgagee has the right to redeem the estate’s legal mortgage by paying the value of the mortgage. Whoever pays the estate, steps into the estate’s right in such assets. If there are several mortgagees who want to step into the estate’s right, the one with the best priority will be allowed to step into the estate’s right. If the amount paid to the estate turns out not to be required, the estate shall return the amount.
The bankruptcy debtor can ask for a compulsory composition with its creditors. A compulsory composition largely follows the same principles as compulsory composition under debt settlement proceedings according to the Norwegian Bankruptcy Act. A compulsory composition may be adopted if a necessary majority approves the composition, and entail delay of payment, percentual reduction of debt, liquidation composition or a combination of these solutions. We rarely experience compulsory composition under a bankruptcy, but it may be appropriate for private debtors who would otherwise be liable for the remaining debt after the completion of an ordinary bankruptcy proceedings.
4. International bankruptcies
According to Norwegian law a Norwegian bankruptcy estate seize the debtor’s assets regardless of whether they are located in Norway or abroad. Similarly, foreign creditors notify their claims to the Norwegian bankruptcy estate. For a foreign bankruptcy estate the situation is similar. It takes in principle seizure of the debtor’s assets in Norway and a Norwegian creditor must notify its claims to the foreign bankruptcy estate. This may understandably cause difficulties and disputes between domestic and international creditors.
It is also quite common that foreign companies which have their principal place of business in Norway (Norwegian branch of a foreign entity) are declared bankrupt in Norway pursuant to the Norwegian Bankruptcy Act. A Norwegian company may in certain cases also be declared bankrupt according to foreign jurisdictions, such as the Chapter 11 process in the US.
However, there are not uniform international regulations governing where a bankruptcy is to be opened if the bankruptcy debtor has activity in or connection to more than one jurisdiction. Nor is the legal position for a bankruptcy estate in other jurisdictions clear. There are international conventions that have attempted to regulate the international bankruptcies-situation such as the EU Bankruptcy Regulation (Council regulation (EC) 1346/2000) and the Nordic Bankruptcy Convention from 1933. However, most questions need to be solved in each case depending on the legal issue in question and the jurisdictions involved. The unclear legal situation is as an example reflected in a recent Supreme Court ruling where a creditor was allowed to obtain execution lien according to Norwegian law even if the debtor was subject to Spanish bankruptcy proceedings.
5. Restructuring through bankruptcy
In many cases, all or part of a business that has been through a bankruptcy may form the basis for a viable business after the bankruptcy. To salvage a viable business it is necessary to have or establish an entity that can acquire all or part of the business from the bankruptcy estate and possibly from the mortgagees/pledgees. The main advantage with acquiring business from a bankruptcy estate is that it gives a possibility to continue with the profitable parts of the business. One can hire the parts of the previous workforce that one needs, contracts can be renegotiated and one can establish the appropriate size of the operations. On the other hand the estate is likely to provide no or limited warranties regarding the acquired assets, and the debtor’s employees and contracting parties are not obliged to enter into new agreements with the acquiring entity.
6. Guarantors and co-debtors
If the principal debtor is declared bankrupt, the creditor can usually request payment from guarantors or other co-debtors. The due-date and scope of liability must be determined by a review of the guarantee documents and the corresponding documentation. For financial institutions the Norwegian Financial Agreement Act contains specific rules concerning the maturity and scope of guarantee liability. The act also contains requirements for notification and consent requirements from the guarantor, and proper handling in relation to these rules may be essential for maintaining a legitimate claim. The creditor must also make sure to interrupt the limitation period in relation to guarantors so the claim is not time-barred.
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Our practice is one of the largest in Norway when it comes to handling bankruptcies. We assist clients with all kind of bankruptcy law questions, either on behalf of creditors, contracting parties, bankruptcy debtors, directors or other parties affected. If you have questions to the article or would like advice on Norwegian bankruptcy law matters, please contact the author.
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About the author
Harald Sætermo is a Norwegian attorney-at-law and a partner in the law firm Rime. Harald has more than 15 years experience as a business lawyer in Norway. His work includes representing some of the largest financial institutions in Norway and the Nordic countries, listed companies, other commercial enterprises and private individuals. He has previously been an in-house lawyer at Nordea, Senior Lawyer at the Law firm Schjødt in Oslo, and teacher/external examiner at the Faculty of Law, University of Oslo.
Tel +47 906 50 410