Kristin van Zwieten
University of Oxford and ECGI
Related Party Transactions in Insolvency
Transaction avoidance rules are widely considered to be an important tool for the regulation of related party transactions in insolvency. Existing ‘best practice’ guidance on the design of insolvency laws assumes that such avoidance rules are best operationalised within collective insolvency procedures. But in many jurisdictions the commencement of collective insolvency proceedings is value destructive; so much so that creditors may prefer to see firms fail outside such proceedings, even if this means foregoing opportunities to use the avoidance tools available within them. This suggests that avoidance tools may be most powerful when available outside insolvency proceedings as well as within them.
Many jurisdictions do have some such form of avoidance action, often described as the ‘actio Pauliana outside bankruptcy’, on their statute books. But these forms of action have been neglected in the literature on the control of related party transactions in insolvency, and, perhaps as a consequence, have not benefited from international initiatives to improve the operation of domestic insolvency rules in cross-border cases in the same way that transaction avoidance actions brought in connection with collective insolvency proceedings have benefited. The chapter begins by evaluating the case for approaching transaction avoidance within insolvency proceedings, before turning to consider aspects of the design of the ‘actio Pauliana outside bankruptcy’, including measures to improve its efficacy in cross-border cases.
The managers of a failing firm may prefer to gift corporate assets to related parties than to await execution against the assets by creditors. They may also wish to prefer related party creditors to creditors with whom the firm has negotiated at arm’s length. The latter kind of transaction causes no direct loss to the firm, assuming the transfer discharges a genuine debt, but is nevertheless (assuming the firm is, or in all probability will be, balance-sheet insolvent) obviously harmful to non-preferred creditors, who are left to look to a diminished pool of assets for satisfaction. The absence of constraints (soft or hard) on either form of behaviour might be expected to adversely impact on the cost and/or availability of unsecured credit ex ante. Secured credit may substitute, but will not always be available – the debtor may not have any assets that can be validly pledged – and in any case has its own costs.