This article appeared in the 2012 edition of The International Comparative Legal Guide to: Corporate Recovery & Insolvency; published by Global Legal Group Ltd, London.
1 ISSUES ARISING WHEN A COMPANY IS IN FINANCIAL DIFFICULTIES
1.1 How does a creditor take security over assets in Bulgaria?
Under Bulgarian law, security interests over assets can be created by way of a pledge (залог) of chattels and receivables or a mortgage (ипотека) over real property.
Registration of a mortgage agreement with the Real Estate Agency (Агенция поВписванията) is a requirement for the validity of a mortgage (Section 166 para.2 of the Obligations and Contracts Act, [OCA], Закон заЗадълженията иДоговорите). This register is now accessible online at WWW.icadastre.bg. However, the database for most of the country's territory is still not complete. Therefore, at present, ownership and a mortgagee's priority over real estate located in Bulgaria must be checked on the spot with the respective regional office of the Real Estate Agency.
A pledge over moveable assets requires, in principle, the pledgor to hand over and surrender the possession of such assets (Section 156 para.1 OCA). A pledge over receivables requires a notification to the debtor to take effect towards any third person. A possessory pledge, however, is rarely used in commercial transactions.
In 1997, the Bulgarian Special Pledges Act (Закон заОсобените Залози, SPA) introduced a special non-possessory pledge (особен залог). Existing and future receivables, dematerialised shares, shares in a limited liability company, chattels, future crop, intellectual property and even an entire enterprise can be pledged as collateral as an aggregate of floating assets and liabilities, including real property. To ensure that the security interest is enforceable against third parties (pledge perfection), a formal consent of the pledgor has to be filed with the public Central Special Pledges Register, and/or other public registers (depending on the nature of the collateral). The pledgor remains in possession of the collateral and may continue to use it; however, upon occurrence of default and notification thereof to the pledgor, the latter is obliged to hand over the collateral to the secured creditor. The creditor is entitled to sell the pledged assets at its own discretion against the (fair market) price achievable at the time of the sale. The SPA contains a provision clearly stipulating that the commencement of insolvency proceedings does not affect the already commenced enforcement of a special pledge over the assets of the insolvent debtor (Section 43 para.1 SPA). Some courts, however, have adopted the view that it is at the discretion of the court to stay the out-of-court sale of assets. Other courts maintain that the staying of ongoing enforcement of a special pledge would contravene the statutory law. The case law is still unsettled on this matter.
1.2 In what circumstances might transactions entered into whilst the company is in financial difficulties be vulnerable to attack?
Transactions made by insolvent or over-indebted debtors that are null and void by operation of law or that may be challenged are explicitly set forth in Articles 646 and 647 of the Bulgarian Commerce Act (Търговски закон, [CA]).
Transactions that are invalid by operation of law include:
- the following actions and transactions executed after the commencement of insolvency proceedings, provided that the applicable insolvency law rules have not been observed (e.g. when the consent of the administrator was a precondition): (i) performance of any obligation that has become due prior to the commencement of insolvency proceedings; (ii) disposal of any asset of the insolvency estate; and (iii) creation of a security interest over any asset of the insolvency estate; and
- the following actions and transactions executed after the date on which the debtor became insolvent or over-indebted (this date is determined by the court): (i) performance of a monetary obligation that has become due prior to the date of insolvency or over-indebtedness; (ii) disposal of any asset of the insolvent party's estate without consideration in return; (iii) creation of a security interest over any asset of the insolvent's estate; and (iv) any other disposal of assets of the insolvent party's estate for a considerably inadequate consideration (Section 646 para.1 CA).
The transactions that may be challenged in insolvency proceedings and set aside with respect to the insolvency creditors are: (i) any free-of-charge transaction for the benefit of any of the debtor's affiliates (as defined in the CA) executed within 3 years prior to the commencement of insolvency proceedings; (ii) any free-of-charge transaction for the benefit of any third person (other than a debtor's affiliate) executed within two years prior to the commencement of insolvency proceedings; (iii) any transaction executed within two years prior to the commencement of insolvency proceedings, where the considerations owed by the debtor and the counterparty were considerably inadequate to the detriment of the debtor; (iv) any transfer of ownership made in lieu of a performance of due payment, provided that such transaction has been executed within three months prior to the occurrence of insolvency or over-indebtedness and recovery of ownership would increase the value of the insolvency estate; (v) creation of a security interest within one year prior to the commencement of insolvency proceedings, provided that the claim was existing and unsecured before the security interest was created; (vi) creation of a security interest to secure an existing claim of any shareholder of the debtor, provided that such security interest is created within two years prior to the commencement of insolvency proceedings and the shareholder's claim was unsecured before the security interest was created; and (vii) any other transaction between the debtor and any of its affiliates (as defined in the CA), provided that such transaction was executed within two years prior to the commencement of the insolvency proceedings and has a detrimental effect on the creditors' interests.
1.3 What are the liabilities of directors (in particular civil, criminal or disqualification) for continuing to trade whilst a company is in financial difficulties in Bulgaria?
If a company becomes insolvent or over-indebted, each director is obliged to file an insolvency application to the court within 30 days as of the day when the status of insolvency or over-indebtedness was established (Section 626 para.1 CA). Should the directors fail to notify the court within the said term, they can be held liable (joint and several liability) for the damages suffered by creditors as a result of the delay (Section 627 CA).
There are several criminal offences specified in the Bulgarian Criminal Code (Section 227b et seq.) that deal with the director's criminal liability in connection with insolvency. Among others, directors are criminally liable for failure to file an insolvency application with the court within 30 days of the day the company suspended performance of any due payment; however, the imprisonment penalty may be replaced by an administrative sanction (Section 78a Criminal Code) that may take the form of a fine of up to approximately EUR 2,600 only.
2 FORMAL PROCEDURES
2.1 What are the main types of formal procedures available for companies in financial difficulties in Bulgaria?
Should a debtor become insolvent or over-indebted, formal insolvency proceedings must be initiated as required pursuant to the CA. This is the only procedure for a debtor in financial difficulties available under Bulgarian law. Once insolvency or over-indebtedness is established (by the court) there is an option for (i) creditors to adopt a reorganisation plan aiming at the survival of the distressed company, (ii) a composition agreement between the debtor and all creditors to be reached, or (iii) if neither (i) nor (ii) occur, the court must declare the debtor's bankruptcy and the administrator will proceed to liquidation.
There is no legal means for the debtor to unilaterally apply for protection and obtain a moratorium when insolvency or over-indebtedness is imminent but has not yet occurred.
2.2 What are the tests for insolvency in Bulgaria?
Bulgarian insolvency law applies the standard that contains both the cessation of payments and balance sheet (and market value) tests. It recognises both insolvency (неплатежоспособност) and over-indebtedness (свръхзадлъжнялост) as grounds for commencing insolvency proceedings (Section 607a CA). Notwithstanding the occurrence of insolvency or over-indebtedness, the court shall not open insolvency proceedings should it find that the debtor's distress is of a temporary nature or where the debtor's property is enough to cover all of its liabilities (Section 631 CA).
2.3 On what grounds can the company be placed into insolvency procedure?
Insolvency proceedings must commence whenever the competent court has established that a merchant is insolvent. In addition, for a limited liability company (дружество сограничена отговорност), a joint-stock company (акционерно дружество), and a partnership limited by shares (командитно дружество сакции), insolvency proceedings must be launched in cases of over-indebtedness.
A merchant is qualified as insolvent if it is unable to pay a monetary obligation that is due and payable, and is arising out of its business affairs. There is a legal presumption for a state of insolvency if the debtor has ceased to perform due payments. Should the claim for payment put forward as a ground for insolvency be disputed, the court that entertains the insolvency application is competent to establish whether the alleged monetary obligation has fallen due and payable.
A company incorporated in the form of a limited liability company, a joint-stock company or a partnership limited by shares qualifies as over-indebted when its monetary liabilities exceed the value of its assets. There are no further legal provisions on how the value of liabilities and assets has to be estimated for the purpose of the over-indebtedness test. In practice, the court appoints expert witnesses that evaluate certain liquidity indexes on which basis the court determines whether over-indebtedness is in place.
2.4 Please describe briefly how the company is placed into insolvency procedure.
An application for commencement of insolvency proceedings may be filed with the competent court (at the seat of the company in question) either by the debtor itself (via its liquidator when it is undergoing a voluntary winding-up procedure), or by a creditor, or by the National Revenue Agency (Национална агенция поприходите), or – in the case of over-indebtedness only – by any member of the managing bodies of the debtor.
Should the applicant be the debtor, it must provide the court with, among other things, a balance sheet evidencing its assets and liabilities and a list of all known creditors. Both creditors and the debtor must have notified the National Revenue Agency of the contemplated filing for commencement of insolvency proceedings in advance.
An application filed by the debtor (or liquidator) must be considered immediately by the court in an ex parte hearing. In case of a creditor's application, the debtor and the creditor must be summoned and an open hearing must take place within 14 days of the application receipt. The court must decide on the insolvency application within three months of the day when the application was filed. In practice, the statutory terms are rarely met.
2.5 What notifications, meetings and publications are required after the company has been placed into insolvency procedure?
The filing of debtor's application for commencement of insolvency proceedings shall be made public in the Trade Register (Търговски регистър; available online at http://www.brra.bg). Where the application for insolvency proceedings is requested by any eligible person other than the debtor the application is not made public. Should the insolvency application be granted, the court must, among other things, announce the commencement of the insolvency proceedings, and set the date for the first creditors' meeting. Except in case where the debtor applies for insolvency, the first public notice about the insolvency proceedings is the court decision on commencement of insolvency proceedings. It is made public at the Trade Register. Some other court rulings, such as the announcement of bankruptcy and commencement of liquidation, the adoption of a reorganisation plan or composition agreement, staying, termination and resumption of proceedings, also have to be made public at the Trade Register. The actions of the debtor, the creditors, the creditors' meeting, the administrator and the court have to be entered in a special book which is made publicly available at the office of the court. The book is maintained in both paper and electronic form, but is not available online.
With respect to EU Member States, Art. 40 of Council Regulation (EC) No. 1346/2000 on insolvency proceedings (EC Regulation) is directly applicable in Bulgaria. It stipulates that the commencement of insolvency proceedings must be notified in other Member States. There is no obligation on the part of the debtor or administrator to notify the known creditors in a country that is not an EU Member State.
3.1 Are unsecured creditors free to enforce their rights in insolvency procedure?
Once insolvency proceedings commence, unsecured creditors can no longer obtain an executive writ and enforce a judgment; pending litigations against the debtor are suspended except for pending foreclosure proceedings for collection of public debts owed to the State or municipalities (Art. 193 Tax and Social Procedure Code, Данъчно -осигурителен процесуален кодекс). All pending and new claims must be lodged with the administrator. If a pending claim is disputed by the administrator, the respective proceedings will continue.
3.2 Can secured creditors enforce their security in insolvency procedure?
The general rule on automatic the stay of enforcement proceedings applies equally to secured creditors, except in cases of disputes where secured creditors have security over a third persons' property. Section 638 para.3 CA gives the court the power to lift the stay on enforcement proceedings that were initiated by secured creditors before the insolvency proceedings commenced, where the interest of these creditors is adversely affected. No provision is available to lift the stay where secured creditors (other than creditors having security over a third persons' property) had not initiated proceedings by the time of the commencement of insolvency proceedings.
Notwithstanding the creation of security interests, any person in possession of collateral is obliged to hand it over to the administrator. The only exception to this rule, pursuant to Section 43 para.1 and para.2 SPA, is that the commencement of insolvency proceedings does not affect the already commenced enforcement of a special pledge over the assets of the insolvent debtor (i.e. an outof- court sale of collateral). Due to the controversial case law, however, at present, this rule may not be fully relied upon (see question 1.1 above).
3.3 Can creditors set off sums owed by them to the company against amounts owed by the company to them in insolvency procedure?
Creditors are entitled to set-off their claims against the counter-obligations of the debtor, provided that such claims and counter-obligations are of the same nature (e.g. monetary claims and obligations) and became due before the date of the commencement of insolvency proceedings. The creditor only needs to notify the administrator about the set-off.
The court may declare a set-off invalid with respect to the insolvency creditors should the administrator prove that the claim of the creditor or the counterclaim that its set-off came into existence at a time when the creditor (A) already knew about the insolvency or over-indebtedness of the debtor or (B) knew that the application for the commencement of insolvency proceedings had been lodged.
4 CONTINUING THE BUSINESS
4.1 Who controls the company in insolvency procedure? In particular, please describe briefly the effect of the procedures on directors and shareholders.
The effect of the commencement of insolvency proceedings on directors has to be determined by the court. As a general rule, upon the commencement of insolvency proceedings the directors may continue to conduct debtor's business; however, a new transaction may only be entered into with the administrator's prior consent. The court may fully divest the directors from their powers and entitle solely the (interim) administrator appointed by the court to manage the debtor's business and dispose of its assets. Once the debtor has been declared bankrupt, only the administrator is entitled to act on behalf of the insolvency estate.
The shareholders do not have any say in the liquidation or the restructuring of the debtor. Should the creditors adopt a reorganisation plan envisaging the conversion of a debt (claim) into equity, the court's decision to approve such a plan has the effect of a decision to increase the company's capital adopted by the general meeting of shareholders.
4.2 How does the company finance the insolvency proceedings?
The costs of the insolvency proceedings must be paid out of the debtor's estate. If the property of the debtor available for distribution is not enough to cover the initial expenses, the court may determine the amount that will have to be prepaid within a time limit set by the court. If such costs are not prepaid on time, the court will declare the debtor's bankruptcy, cease the creditor's business, impose attachment security measures on the insolvency estate and stay the proceedings for one year. Upon the expiration of this term, the court will terminate the proceedings and order the winding up of the debtor, unless in the meantime the initial costs have been procured. The court will act likewise if, in the course the insolvency proceedings, it determines that the insolvency estate assets are not sufficient to cover the expenses.
Should the business continue, further costs (e.g. wages, rent) must be covered by the operative revenues of the debtor.
4.3 What is the effect of each procedure on employees?
The commencement of insolvency proceedings itself does not affect existing employment contracts. The administrator may terminate employment contracts only if the debtor's business is shut down in full or in part by the administrator or is suspended for more than 15 business days. Employees have a legitimate ground to resign from an employment contract without prior notice only in the event their remuneration is not paid.
The administrator is obliged to acknowledge all receivables arising out of employment contracts without any specific request. In addition, 20% of the employees are entitled to propose a reorganisation plan for the survival of the company.
4.4 What effect does the commencement of insolvency procedure have on contracts with the company and can the company terminate contracts during each procedure?
In general, agreements in force are not affected by the commencement of insolvency proceedings. Contractual provisions granting the counterparty an unconditional right, for example, of termination or acceleration of the contract in the event of the commencement of insolvency proceedings, are not explicitly declared unenforceable per se.
Upon commencement, the administrator has a statutory right to terminate a contract with 15 days' prior notice. In the absence of any statement by the administrator, the counterparty of the debtor may require the administrator to declare whether the contract is terminated or remains binding. Failure to respond within the 15 days as of the request triggers an irrefutable presumption that the contract is terminated. Should a contract be terminated, the counterparty is entitled to claim damages ensuing from such early termination within the insolvency proceedings (non-privileged claim).
5.1 Broadly, how do creditors claim amounts owed to them in insolvency proceedings?
Creditors have to submit their claims within one month as of the date on which the court decision for commencement of insolvency proceedings is made public with the Bulgarian Trade Register. Creditor's claims can be lodged within a period of two months following the expiration of the one-month term; however, creditors lodging their claims within the two-month term have no right to challenge the claims lodged within the preceding one-month term.
Claims that arose (i.e. became due, irrespective of whether payable or not) before the date when the decision for commencement of the insolvency proceedings was made public, but have not been lodged within the said terms of (in total) three months, are timed-barred from recognition in the insolvency proceedings.
A creditor whose claim is rejected by the court is entitled to bring and assert its claim in general civil proceedings, outside the insolvency, in order to preserve its right to receive a quota of the insolvency estate. The respective quota must be provisioned by the administrator (if meanwhile a distribution of proceedings is made or a reorganisation plan is proposed) until the claim is finally settled.
5.2 What is the ranking of claims in insolvency proceedings? In particular, do any specific types of claim have preferential status?
The following categories of creditor's claims are satisfied in the following order of priority (Section 722 CA):
- claims of secured creditors;
- costs of insolvency proceedings;
- employees' claims;
- public (State and municipal) claims;
- claims that became due after the commencement of insolvency proceedings;
- (ordinary) unsecured claims that became due prior to the commencement of insolvency proceedings; and
- other non-preferential claims (certain claims for interest, claims of shareholders, etc.).
Claims within a class rank pari passu among each other. All claims in a particular class should be paid in full before the next rank is paid.
5.3 Are tax liabilities incurred during insolvency proceedings?
The commencement of formal procedures does not have any bearing on the general applicable tax regime. Insolvent or over-indebted companies therefore continue to be taxable entities.
6 ENDING THE FORMAL PROCEDURE
6.1 Is there a process for "cramming down" creditors who do not approve proposals put forward in these procedures?
For the purpose of adopting a reorganisation plan for the business of the debtor, the creditors are divided into five classes according to their priority rights. The required majority for the approval of a reorganisation plan within a class is 50% of the total amount of the claims attributed to such class. At least one class of creditors whose claims will not be paid in full according to the plan must have accepted the plan. The main requirement for the plan to be approved is that creditors holding 50% of all the acknowledged claims vote favourably, notwithstanding their allocation to particular classes. This approach will enable the support of some of the creditors to make the plan binding on others.
6.2 What happens at the end of each procedure?
When either a reorganisation plan is approved or a composition is reached (this requires the agreement of the debtor and all creditors), the court shall terminate the insolvency proceedings. A supervisory body elected by the creditors may monitor the fulfilment of a reorganisation plan. With respect to a composition agreement, the general contract law is applicable.
If the debtor does not comply with the provisions of the reorganisation plan or is in breach of the terms of the composition, the supervisory body and/or the creditors together holding claims of at least 15% of the aggregate amount of the debt are entitled to call the court. If the implementation of the plan is set aside or the composition is terminated by the court, the effect will be the same as though no plan were proposed or approved, or no composition reached: the liquidation proceedings must commence without any recourse to a new rehabilitation procedure. The court will declare the debtor's bankruptcy, order the termination of the debtor's business operation, and entitle the administrator to proceed with liquidation. The insolvency estate must be realised by the administrator under the supervision of the court in compliance with the decision of the creditors. The administrator shall convert the debtor's assets into cash and allocate the proceeds amongst the creditors according to their quota.
7 ALTERNATIVE FORMS OF RESTRUCTURING
7.1 Is it common to achieve a restructuring outside a formal procedure in Bulgaria? In what circumstances might this be possible?
A restructuring outside formal proceedings is not possible in Bulgaria. Although the company in financial difficulties may negotiate an out-of-court reorganisation, there is no legal provision discharging the directors' civil and criminal liability for failure to timely file for the commencement of insolvency proceedings. Therefore, in any case of insolvency or over-indebtedness, directors have to file an application for the commencement of insolvency proceedings with the court. Then it is up to the court to decide whether the company is insolvent and/or over-indebted or whether any restructuring may be carried out.
7.2 Is it possible to reorganise a debtor rather than realise its assets and business?
A reorganisation plan may be proposed alongside the application for commencement of insolvency proceedings by the applicant, the debtor or the creditor. Thereafter, other participants in insolvency proceedings that meet certain requirements (such as the administrator, secured and unsecured creditors and employees) may propose a reorganisation plan as well. The deadline for proposing a plan is one month from the date of the publication of the list of accepted creditors' claims admitted by the court. No extension of this term is possible.
Upon the commencement of formal insolvency proceedings, at any stage of the proceedings, the debtor may enter into an extrajudicial composition with all creditors whose claims have been approved by the court. The composition must be in writing and must settle all the claims brought by the creditors. The parties are free to agree on the extrajudicial composition's provisions, including the adoption of the corporate or business reorganisation of the debtor. When entering into such a composition, the debtor acts at its sole discretion, without any involvement on the part of the administrator.
7.3 Is it possible to achieve an expedited restructuring of the debtor by means of a pre-packaged sale? How is such a sale effected?
No, debtors in distress have no recourse to expedited court approval of any pre-packaged plan that may shorten and simplify the insolvency proceedings.
Only the two restructuring procedures addressed in the foregoing question 7.2 are available. Both of them require the court's approval and may be launched only after formal insolvency proceedings have been commenced. There is no legal means for the debtor to unilaterally apply for protection and obtain a moratorium when insolvency or over-indebtedness is imminent but has not yet occurred.
8.1 What would be the approach in Bulgaria to recognising a procedure started in another jurisdiction?
The EC Regulation is directly applicable in Bulgaria. It requires the recognition of all proceedings opened in an EU Member State without a formal recognition procedure. Thus, a judgment obtained in another EU jurisdiction shall produce the same effects in Bulgaria as under the law of the Member State of the commencement of insolvency proceedings. Principally, the administrator appointed by a court of another EU Member State which has jurisdiction over the debtor may exercise all the powers conferred on him by the law of such jurisdiction, including removing the debtor's assets from the territory of Bulgaria.
The effects of insolvency proceedings opened in another (non-EU) state are recognised in Bulgaria on conditions of reciprocity if the debtor's registered main office is located in the state of the court that handed down the respective judgments. Bulgarian law recognises the foreign administrator's rights as conferred by the law of the jurisdiction where the insolvency proceedings have been commenced, provided that they are incompliance with Bulgarian public policy rules. Notwithstanding any foreign insolvency proceedings, secondary insolvency proceedings may be opened and conducted in Bulgaria upon the administrator's or debtor's request if a significant part of the insolvent party's estate is located in Bulgaria. Foreign creditors are treated in the same way as local creditors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.