A debtor on the verge of insolvency may be tempted to favour related or influential parties (such as company insiders or important financiers) before his divestment in favour of a liquidator. That is why insolvency law typically allows the liquidator to avoid transactions which the debtor has concluded in the twilight zone prior to insolvency and which are detrimental to the creditors. In a recent preliminary ruling (Vinyls Italia, C-54/16), the ECJ offers the debtor an interesting escape route: he can simply contract around an avoidance provision by submitting an otherwise voidable transaction to a law under which the transaction is not avoidable.

1 Background

The facts of the case can be briefly summarized as follows. Two Italian companies, Vinyls Italia and Mediterranea, enter into a charter agreement subject to English law. Further to this agreement, Vinyls makes several payments to Mediterranea. Two of those payments are made less than six months before insolvency proceedings are opened against Vinyls in Italy. The liquidator subsequently challenges those payments on the basis of an Italian avoidance provision. According to that provision, any transaction concluded by the debtor within six months prior to his bankruptcy is avoidable in case the debtor’s counterpart was aware of the debtor’s insolvency.

However, Mediterranea alleges that the payments are not voidable, on the basis of article 13 of the Insolvency Regulation. That provision states that the rules relating to the voidness, voidability or unenforceability of legal acts detrimental to all the creditors are not governed by the law of the State of the opening of proceedings (the lex concursus) where the person who benefited from such act proves that:

• the said act is subject to the law of a Member State (the lex causae) other than the lex concursus, and
• that law does not allow any means of challenging that act in the relevant case.

Indeed, Mediterranea argues, the contested payments are subject to English law, which does not contain an avoidance provision similar to the Italian provision invoked by the liquidator. Hence, those payments are not voidable.

2 The ECJ’s ruling

In its preliminary ruling, the ECJ endorses that view:

1. In answer to the second preliminary question,[1] the Court finds that the requirement that the lex causae “does not allow any means of challenging that act in the relevant case” should be interpreted as meaning that, when the lex causae contains an avoidance provision which establishes other requirements than that of the lex concursus, the defendant should prove that the requirements of that provision are not fulfilled in the relevant case.
2. The Court then turns to the remaining preliminary questions, and delivers the final blow to the liquidator’s position. It holds that article 13 may be validly invoked even if contract parties have their registered office in one and the same Member State, on the territory of which all other relevant elements are situated as well.
3. According to the court, the only condition is that the parties have not acted fraudulently or abusively.  A finding of an abusive practice however requires a combination of objective and subjective elements. First, it must be apparent from a combination of objective circumstances that, despite formal observance of article 13, the purpose of that provision has not been achieved (objective element). Second, it must be apparent from a number of objective factors that the essential aim of the transaction concerned was to obtain an undue advantage (subjective element). In other words, only manifestly fraudulent transactions are excluded from the scope of article 13.

3 First thoughts

All this puts the beneficiary of an act by an insolvent debtor which is detrimental to his creditors in a very comfortable position:

• such a transaction is voidable only if both the lex concursus and the lex causae contain a similar avoidance provision which is applicable to it; even if
• parties have selected a lex causae which has no link whatsoever with the transaction and all factual elements of the transaction are located in the State of the opening of proceedings; unless
• the choice of law is manifestly fraudulent; however, virtually all Member States have adopted avoidance provisions against manifestly fraudulent transactions prior to insolvency; thus, article 13 is arguably not relevant in such cases anyway.

In a previous post, we have underlined the importance of insolvency law for the protection of creditors against the harmful effects of acts by their debtor. Indeed, provisions of insolvency law, such as avoidance rules, are linked to a connecting factor which is not (entirely) freely selectable, namely the centre of the insolvent debtor’s main interests. This connecting factor acts as an anti-abuse mechanism which limits the parties freedom to select applicable law, similar to the real seat mechanism in company law. As a consequence, if mandatory creditor protection mechanisms are designed as rules of insolvency law, a debtor cannot simply contract around them by means of a choice of law.  Now, the ECJ seems to  undermine even that. The preliminary ruling in Vinyls Italia makes it possible for a debtor who is or will soon become insolvent to elude the avoidance provisions of the lex concursus, simply by selecting a legal system under which the particular transaction he wishes to enter into is not voidable.

Whereas article 13 is meant to serve as shield to protect bona fide third parties, it could become a weapon to harm creditors with impunity.

Gillis Lindemans

[1] In answer to the first preliminary question, the Court considers that subject to the principles of equivalence and effectiveness, it is for the national rules of procedure to determine in which time limit and in which form a an objection based on article 13 should be raised, and whether or not the national court may do so of its own motion.