Taking counsel

  • 2005-11-23
  • By Arnis Esenvalds [ LOZE, GRUNTE & CERS ]
Interpretation of the Insolvency Act 's

a threat to Latvian commercial banks?

Bank loans, as well as their collateralization and the fulfilment of obligations in the manner provided by the agreement, are quite commonplace. If a client has not followed the provisions of the agreement, the banks are entitled to terminate the agreement unilaterally and require an early repayment of the loan and accrued interest.

However, as absurd as it may sound, it turns out that through a peculiar interpretation of the Act On Insolvency of Enterprises and Companies (hereafter, the Insolvency Act), a bank client in Latvia may both sell the commercial pledge and fully recover the loan amount paid to the bank.

A real court case has proven that without making amendments to the laws, it is possible that Latvian commercial banks' usual loan policy might be threatened. In the given case, a company breached its contractual obligations, as a result of which the bank, in compliance with its rights as agreed on in the loan agreement, terminated the agreement and legally claimed repayment of the loan and its interest. So that the client could repay the loan, the bank allowed it to sell the commercial pledge. Approximately a month after the sale of the pledge and repayment of the loan, the client filed an insolvency petition in court, and it was satisfied.

At that moment events were initiated that might turn not only into an unpleasant fact for one certain bank but into a system that threatens the entire loan policy of all Latvian commercial banks.

Pursuant to Article 72.1 of the Insolvency Act, the insolvency administrator asked the court to recover from the bank the money transferred by the debtor. The administrator in the claim stated that the company had settled its debt obligations with the bank earlier than determined by the previously signed loan agreement. But the Insolvency Act provides that "amounts that the debtor has paid for the settlement of debts within the last six months prior to the day when the insolvency came into effect, shall be repaid pursuant to a court judgment if [...] the payment was made before the time period for fulfilment of the obligations expired."

The court satisfied the administrator's claim both in the first and the second instance courts.

Taking into account the conditions described above, I believe that there is no legal basis for considering that the payment was made before the time period for fulfilment of obligations expired. This payment was made within the term stated in the agreement executed by the parties, as both parties had entered into a loan agreement that, without violating the procedure prescribed by laws and regulations, allows the rights of the parties to agree on the mutual payment procedure.

The situation is aggravated by the fact that by applying Part 1 of Article 72 of the Insolvency Act, the court did not consider it necessary to apply Part 3 of the same Article, which, if the circumstances specified in Part 1 of this Article are established, prescribes that the previous status existing between the parties be renewed 's namely, renewing the parties' obligations that were valid before the debt was returned.

In this particular situation, it means that if the court established the circumstances stated in Part 1 of Article 72 of the Insolvency Act, then the provisions of Part 3 of the same Article must be ensured, which would provide the bank's right to the commercial pledge that is the very basis for every bank's loan policy, and the status of a secured creditor in the course of insolvency procedure.

As a result of applying the wrong legal provision, the bank lost both the money paid by the debtor and the commercial pledge that had been the security for the loan.

The Association of Latvian Commercial Banks has informed mass media that it is developing proposals for the new draft insolvency act to avoid malicious usage of bank loan policy; however, companies should take into account that the current situation may cause commercial bank services to become more expensive as a hedge against such future risks.