Restriction of set-offs in liquidation form of insolvency solution
We would like to draw your attention to an interesting decision which was rendered in the publicized case of LESS holding insolvency proceedings which deals with the issue of conditions for offsetting receivables within insolvency proceedings.
The High Court of Prague on June 18, 2014 in its decision file no. 1 VSPH 1002/2014-B-581 (KSPH 37 INS 23802/2012) changed the decision of a first-instance court and denied a motion for preliminary injunction which prevented offsetting of mutual receivables of the debtor (LESS & FOREST, s.r.o.) and its registered creditors until the time of liquidation of all assets from the insolvency estate.
In the aforementioned decision which was successfully appealed, the first-instance court has transformed the reorganization of LESS & FOREST, s.r.o. to a bankruptcy and at the same time banned all set-offs of debtor’s and creditors’ receivables, based on a motion of the debtor. The debtor argued that certain creditors could seek reduction of their receivables through set-offs in the extent greater than what they could receive from proceeds of liquidation of assets which would lead to restriction of funds necessary to run the debtor’s business operations. The first-instance court granted the motion and reasoned that if set-offs were to be allowed, the size of insolvency estate would diminish extensively whereas 300 employees needed to have their severance packages paid from the estate and the receivables of 2 creditors (who were able to carry out the set-offs) amounted to approx. one fifth of all estimated proceeds, i.e. formed a material part of the insolvency estate.
Several creditors appealed the injunction and claimed that (i) the funds deposited on the accounts of the debtor are sufficient to pay the severance packages of employees, (ii) the decision of first-instance court is unreviewable since the court failed to establish why one fifth of the estate constitutes inadmissible curtailment of creditors, and (iii) the Insolvency Act does not stipulate reasons of special importance (which may give grounds for preliminary injunction) with respect to the determination how large is the amount which shall be (as a result of the set-off) deducted from the insolvency estate.
Section 82 (3) of the Insolvency Act stipulates that due to reasons of special importance the insolvency court may prohibit (via a preliminary injunction) set-offs of mutual receivables of the debtor and creditors in specific cases or for a specific period, if such injunction is not contrary to the common interest of creditors. Under Section 140 (2) of the Insolvency Act the set-offs or receivables are allowed ever after the declaration of insolvency if the statutory conditions are met.
Under the decision of the appellate court this provision must be interpreted as follows: in case the insolvency of a debtor is resolved through bankruptcy, the set-offs are permitted as a general rule; the restriction of sett-offs should aim to prevent the loss of funds necessary to retain the business operations of the debtor within a non-liquidation scenario of insolvency resolution. The set-off as a legal instrument by itself does not contravene the common interests of creditors, no matter the size of the insolvency estate or the extent of potential set-offs. In the opinion of the court the reasons of special importance cannot be found in the simple conclusion that set-offs lead to a reduction of the insolvency estate since such is the result of any set-off, yet the Insolvency Act does not forbid the set-offs. On the contrary, the prohibition of set-offs could cause damage to certain creditors who would be obligated to fulfill their obligation for the benefit of the estate despite gaining only proportionate consideration on their receivables towards debtor.