Dear clients and cooperation partners,
Welcome to the New Year 2011! The last months of the previous year gave a glimpse of the new Insolvency Law from various aspects – whether and how it would influence creditors' tax payments and how the law can affect acquisition of distressed companies. These and other topics are available below in this new SORAINEN Restructuring & Insolvency Team newsflash. Unfortunately, hopes that the new law would ensure a more rapid and efficient solution to insolvency cases have not proven true. Courts and administrators are unable to meet the time limits specified in the law and cases do not start as soon as planned. Hopefully these are only initial difficulties so that gradual improvements will also be seen in this field.
Regional Head of the Restructuring & Insolvency Team
- NEW INSOLVENCY LAW – NEW INVESTMENT POSSIBILITIES?
- SUPPORT OFFERED BY THE STATE IF COOPERATION PARTNERS CANNOT PAY
- ISSUES OF DEBT LIABILITY IN THE CONTEXT OF PUBLIC SERVICES
- SORAINEN SUCCESFULLY PROTECTS CLIENT AGAINST INSOLVENT COMPANY
1. NEW INSOLVENCY LAW – NEW INVESTMENT POSSIBILITIES?
A situation involving insolvency or financial distress is usually considered uninviting for attracting investment, but indeed it can mean new investment opportunities. A company in financial distress or with insolvency already set in or looming can be an attractive target from the perspective of potential investors. To illustrate: this could lead to acquiring company assets or the whole business below actual value, expanding one’s market share, or investing in a profitable business idea with only interim financial difficulties. There is reason to believe that the new Insolvency Law could encourage this kind of investment activity.
Under the new Insolvency Law, insolvency procedure is what we used to call bankruptcy under the old law, during which the debtor’s entire property is sold and all income is used for settling with creditors. However, unlike the previous regulation the new law explicitly stipulates that the debtor’s property does not have to be sold as individual assets but can also be sold as a going concern. Moreover, in contrast to the Commercial Law under which business transfers always involve the joint and several liability of both seller and buyer for all business related liabilities until the transfer, a buyer acquiring a business as part of the insolvency procedure can be sure of being free from pre-insolvency business related liabilities as these will not transfer.
The legal protection process in the new Insolvency Law might be even more attractive for potential investments. This was not the case with the old law, where restructuring methods applicable during the legal protection process were restricted to those explicitly recognised in the law. In contrast, the new law permits use of any methods which have the effect of restoring the debtor’s ability to settle its obligations. This would include, for example, increasing the debtor’s share capital or sale of its shares in order to attract additional investments from strategic or financial investors, reorganising the debtor’s corporate structure, selling off the debtor’s assets or of businesses not related to its principal activities, rearranging the debtor’s payment liabilities, using the debtor’s assets for further security. Moreover, investors who invest in implementation of a legal protection plan may insist that the plan should include special privileges These would survive even if the legal protection process fails, while the funds invested in implementing a failed legal protection plan would acquire priority ranking.
At this stage it is still difficult to estimate if and to what extent the new insolvency law might increase interest among investors in insolvent or financially distressed companies. Yet there appear to be good reasons why such investment opportunities should at least be given a thought.
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2. SUPPORT OFFERED BY THE STATE IF COOPERATION PARTNERS CANNOT PAY
At present due to the economic situation in the country, one of most often encountered reasons for company insolvency is liquidity problems due to cooperation partners’ inability to timely settle accounts for goods and services received. To give companies the option to “survive” and avoid insolvency, the Saeima (Latvian Parliament) has amended the Law On Corporate Income Tax.
Under these amendments, under certain conditions creditor companies will be able to suspend payment of corporate income tax (CIT) for three years if no payment is received for goods and services supplied. This would free up further funds for business activity. But for debtor companies that fail to pay for goods and services received within six months after the payment deadline, income subject to CIT will be increased if the creditor notifies the amount as a reserve for doubtful debts. If the reserve accrued within three years is not decreased by inclusion in taxable income or by writing off the debt in costs, then the creditor company will have to increase the taxable income by the sum of the doubtful debt for which the special reserve was formed.
It is important to note that businesses will be allowed to apply the special rules from 2011 to 2013. To do so, creditor companies must inform receivers of goods or services (debtors) in writing no later than 31 December of the taxation year that they are forming a reserve for doubtful debts for the amount of the debt. Otherwise the general procedure is applicable to calculating income subject to CIT. This means that a creditor company’s income increases and the debtor company’s income decreases even though payment is not made.
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3. ISSUES OF DEBT LIABILITY IN THE CONTEXT OF PUBLIC SERVICES
Debt collection and sale of secured property can often cause administrative procedural issues. These include situations when the new owner of an immovable property is forced to accept debt liabilities for public utilities such as heating energy, electricity or gas supply incurred by the previous owner or user. If immovable property is bought at a compulsory auction, then regulations on cancellation of debt liability upon approving the auction statement do not apply to debt liabilities for public utilities. Most often in these cases, suppliers of public utilities require the new owner to undertake responsibility for the previous owner’s or user’s debts as a precondition for reconnecting the supply. Situations also arise where the previous owner has undertaken liabilities arising from construction of infrastructure, for example to use or buy a certain amount of gas for a period. Based on this agreement, utilities providers require new owners either to meet the consumption volume or to pay a contractual penalty. In practice, these liabilities are not undertaken voluntarily.
The essence of the problem is lack of efficient regulation regarding mutual liability relations of utilities providers and recipients in the case of change of ownership of immovable property. Thus, for example, the Civil Procedure Law (Section 613, Paragraph three, Point 2) is clear that approving the auction statement cancels debt liabilities registered in the Land Book for immovable property. The situation could be partially resolved by proposed amendments to the Civil Procedure Law (Section 628) at present before the Cabinet of Ministers for approval. Under the amendments, money received from sale of immovable property encumbered by a mortgage should be used first to cover the costs of executing the judgment and employees’ claims and then to cover debts incurred for utilities supplied such as heating energy, cold water, natural gas, electricity, and other services. However, covering debts for public utilities cannot exceed 10% of the total value of the mortgage over the immovable property on the day of auction.
In cases when debt or consumption volume liability exists, the provider of public utilities will most likely insist that the new owner should undertake responsibility for these liabilities. A possible solution should be assessed within the scope of the particular case. Options to consider include addressing the issue to Public Utilities Commission or other state institution as well as filing a court claim. However, it is important to identify liability issues related to debt and consumption volume towards providers of public utilities early in the course of concluding a transaction. For example, before deciding to take part at an auction, it would be essential to find out public utility-related liabilities on the immovable property concerned. Addressing these issues early in transactions is more likely to lead to an optimal solution in relation to purchase of immovable property.
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4. SORAINEN SUCCESFULLY PROTECTS CLIENT AGAINST INSOLVENT COMPANY
SORAINEN Latvia successfully assisted RIGABURGER, a company forming part of the Hesburger chain, in a dispute with an insolvent Latvian company. The administrator of the insolvent company asked the court to annul several contracts between RIGABURGER and the insolvent company. The insolvency was initiated after conclusion of the contracts but the company was declared insolvent retrospectively. As a result of the litigation, the court of first instance upheld the validity of the contracts as these caused no losses to the insolvent company. The client was advised by partner Agris Repšs and senior associate Raivo Raudzeps.