Conflict of Special Regulations: Annulment of a Spin Off within the Insolvency Procedure

The case in question will probably trigger controversies between the promoters of the various relevant areas of practice in trying to find the most appropriate alternative for interpreting and combining "special and even more special " legal provisions so that the intended purpose of the legislator at the moment of issuing the two incident acts be reached.

Spin off under Law no. 31/1990

Briefly, the factual situation analyzed here as an example is this:

At the end of 2015, a limited liability company whose main activity consists in the exploitation and production of mineral aggregates ("the company subject to spin off") underwent a partial spin off by setting up a new limited liability company (the "newly established company"), in accordance with the provisions of art. 238 et seq. of the Company Law no. 31/1990, republished and amended.

According to the spin off Project, “the fundamental reasons underlying the envisaged spin off are:

• Separating the core business activities and operations, namely the transport activities from the exploitation and production of mineral aggregates. This will give the two companies more flexibility in setting out the strategies and policies specific to each activity, and managing their resources more appropriately, quickly and in a more targeted manner, which will make it possible to use equity more efficiently.
• The creation of smaller companies (independent structures capable of performing separate economic activities) will allow for a more efficient and tailored management of the needs specific to each of the two core activities, but also for faster responses to market reactions and changes, as well as the much easier identification of non-profitable activities and operations or which are subject to multiple risks specific to each core activity.
• Partial spin off is aimed, by separating the core, secondary and auxiliary businesses, corresponding to specific fields, at the streamlining specific expenses, as well as the profitability of activities which are subject to the spin off”.

Invoking an exception from the publication into the Official Gazette of Romania, the director of the company undergoing spin off published the spin off draft on the company’s own website. 

Even if according to the provisions of Law 31/1990, the company that has opted to advertise the draft on the web site must (i) ensure the technical conditions for the continuous and uninterrupted display of documents provided by law for a continuous period of at least one month before the extraordinary general meeting to decide on the spin off, and, moreover, (ii) has the task of proving the continuity of advertising and ensuring the security of its own web page and the authenticity of the displayed document; these facts are not verified carefully by the court on confirmation of spin off.

Following the publication in the Official Gazette of the General Meeting of Shareholders Decision, whereby the partial spin off was approved, which is, in practice, the moment when the spin off was actually and effectively opposable to third parties, a creditor filed a challenge, but it was dismissed as late, given that the objection had as its object elements of legality of the spin off draft and not of the GMS decision, and the Companies Law provides that the challenge must be lodged within 30 days of the publication of the spin off draft, even if the same law provides that the term runs from the publication in the Official Gazette, a publication which in this case has not been achieved.

Against this background, in the beginning of 2016 the spin off became effective, and a month later, the company subject to spin off filed an application for opening the insolvency proceedings, citing the lack of liquidity for the payment of the due debts.

Opening the insolvency procedure. Applicability on spin off

Upon the analysis of the financial situation of the company subject to spin off within the insolvency procedure, the official receiver court found the following:

• The partial spin off of the debtor company by setting up a new company to take over the exploitation and production of mineral aggregates had a negative impact on the activity of the debtor company, its financial performance at the end of June 2016 dropping considerably compared to before the spin off;
• The spin off implied the transfer of the quasi-total amount of non-current assets (real estate and plant and equipment) to the newly established company together with the subsidy for investments from EU funds and the credits contracted from the banking institutions for the EU co-financing, the debtor company being left with the losses accumulated with all claims to be recovered from clients, receivables that are most likely to have a low degree of recovery;
• Whereas the reasons and the purpose of the spin off were based on efficient management and profitability of the activity, the opening of the insolvency proceedings at the request of the debtor shortly after the spin off unlawfully denied the legal justification of the envisaged spin off from the draft and raises suspicions on the real reasons and the legitimacy of the purpose of the spin off, as it was implemented.

Applicability of provisions on canceling fraudulent transfers from the Insolvency Law

Starting from the factual and legal situation before and after the spin off, the question arises whether a spin off process can be analyzed from the perspective of the incidence of art. 117 of Insolvency Law no. 85/2014, which provides the possibility for the official receiver to bring actions for the annulment of fraudulent acts or fraudulent operations of the debtor.

In the punctual analysis of cases provided by the Insolvency Law, several situations were identified where spin off can be the object of an action for annulment, which we submit to you for debate:

• deeds of free transfer, made in the two years prior to opening the insolvency (let. a) art. 117 par. 2) – even if the spin off does not circumvent a free transfer within the strict meaning of the law, we appreciate that the process of spin off applied to the debtor can be qualified as a "civil legal deed in which only one party has a patrimonial advantage", namely the newly founded company, its shareholders and the creditors assigned to it through the Spin off Draft. Thus, from the assets of the company subject to spin off, the profitable component and the assets attached to it were spun off, the debtor remaining with the accumulated losses, together with all receivables from clients, receivables with a low degree of recoverability.
• operations where the debtor’s performance is obviously greater than the other party’s, made in the 6 months prior to opening the procedure (let. b) art. 117 par. 2) – if spin off cannot be regarded as a free transfer, then clearly the company subject to spin off’s contribution clearly exceeds the “benefit” in the spin off process, since the benefit received is in fact the reduction of the liability and the quality of the assets remaining.

In a legal process of spin off, the principle of proportionality refers to both the liabilities and the transferred or remaining assets, but under two aspects: quantitative and qualitative. From the half-yearly financial reporting results that after the spin off, the debtor remained with very few fixed assets, a decrease of 80-90%, although the spin off was to be carried out "proportionally and symmetrically".

• deeds concluded during the two years prior to the opening of the procedure with the intent of all the parties involved in them to evade goods from the pursuit of the creditors or to damage in any other way their rights in the procedure (let. c) art. 117 par. 2) - considering that by spin off, significant assets have been transferred to the newly formed company, and the decision to spin off belonged to the shareholders of both companies, it can be considered that this criterion has also been met;
• The transfer or the assumption of obligations by the debtor within a period of 2 years prior to the opening of the procedure with the intention to hide / delay the state of insolvency or to defraud a creditor of the procedure (let. g) art. 117 par. 2) – the way in which the spin off was implemented can be assimilated to an operation carried out to defraud the interests of certain remaining creditors of the debtor company, all the more so since the configuration of the remaining liability was set in such a way as to ensure a majority of the affiliated companies owned by the shareholders of the company subject to spin off, who also decided on the spin off process.

The applicability of the above-mentioned provisions may also be nuanced in the context of par. (3) of art. 117, which excluded application of par. (2) to certain acts concluded "in good faith in the performance of an agreement with creditors concluded as a result of extrajudicial negotiations for the debtor's debt restructuring, provided that the agreement was reasonably conducive to the financial recovery of the and not to be aimed at harming and/or discriminating against creditors." Or, in the case of the company subject to spin off, the creditors did not know that they intended to spin off, nor were they consulted on the way in which to accomplish spin off.

Regarding the subjective part of the transfer achieved through the spin off, one can apply the provisions of art. 117 par. (4) let. (a) with a shareholder holding at least 20% of the capital of the company or, as the case may be, of the voting rights in the general meeting of the shareholders, where the debtor is a limited liability company; and (d) with a director or a member of the supervisory bodies of the debtor, limited liability company; given that the spin off was decided by the two shareholders of the debtor, one of which also holds the position of director and the structure of the newly constituted company is the same.

Annulment of the spin off under the Companies Act

If, from the perspective of Insolvency Law, spin off could be subject to a legality and legitimacy control by the bankruptcy judge in the insolvency proceedings of the company subject to spin off, from the perspective of the Companies Act, the nullity of the spin off can be declared only if it has not been subject to judicial review before the judge delegated to the Trade Registry or if the decision of one of the general assemblies that voted the draft spin off is null or void. However, the proceedings for the annulment and declaration of nullity of the spin off cannot be initiated after the expiration of a period of six months from the date on which the spin off became effective, according to the Companies Act, while the Insolvency Law provides for a 16-month period from the opening date of the insolvency proceedings of the company subject to spin off.

Therefore, in the context in which we might consider that the Insolvency Law is the special law in relation to the Companies Act and that the above-mentioned provisions may be applied, we submit to your analysis a last aspect, namely the existence of res judicata where the legality of the spin off had already been determined by a ruling issued under the Companies Act, emphasizing the processual nature of this institution, since the material nature of irrefutable legal presumption of judicial truth in the sense of final judgment is no longer dealt with in the new civil code.

The answer to this question is found in the recent judicial practice whereby if the delegated judge, according to the special competency norms, issued judgment in a non-litigation proceeding, and formally analyses whether all stages of spin off had been fulfilled, the decision issued in such proceeding does not represent res judicata.

We thus conclude that it is necessary to acknowledge the prevalence of legislation on insolvency and it is mandatory that business people, company directors and their consultants not lose sight of the fact that a deed or an operation must have a legitimate cause (purpose, objective), both from the perspective of the business and from the perspective of the company’s creditors, and not just pursue the exaggerated formalism provided by Romanian law, sometimes to the detriment of the core of the issue.

By Alice Ene, Senior Associate, Voicu & Filipescu