Sweden: New Swedish Legislation on Right of Priority in Bankruptcies

Last Updated: 9 February 2004
Article by Dag Di Meo

The current Swedish right of priority legislation, which is set forth in the Right of Priority Act (SFS 1970:979) was amended on 1 January 2004. The new legislation has been preceded by considerable disunion in the Swedish Parliament with several controversial questions being raised. So what are the reasons for changing the legislation? The overall aims of the new rules are 1) to facilitate business reorganisations without bankruptcy through earlier reorganisations, 2) to strengthen the employees wage protection and through a reduction of special interests in composition negotiations, 3) to abolish the possibility of competition on unequal terms due to the fact that an estate in bankruptcy can continue to conduct the business as a result of the fact that wages are compensated from the wage guarantee, and to 4) focus decisions with respect to loans more on the borrower’s repayment than on security interests.

Current rules

Under Swedish law, creditors possessing security interests in personal or real property are prioritised creditors in the bankruptcy. They possess a preferential right to payment from the security interests. Property subject to security interests cannot be encumbered with expenses of the bankruptcy, other than such as relates to the custody or sale of the property. Creditors with possessory liens, e.g. as a result of a contract for repair, are equated with security interest holders.

Before the other creditors can obtain dividends, the bankruptcy estate’s expenses and liabilities must be paid from those assets in the bankruptcy, which are not encumbered with security interests. Thereafter, the following applies, subject to certain simplifications. Firstly, the assets are applied to the payment of the creditors’ cost for placing the debtor in bankruptcy and the payments of loans, which have been granted during an attempt at business reorganisation prior to the bankruptcy.

Thereafter, certain assets are applied to the payment of not more than three months rent on real property, and after that to claims secured by floating charges. Rights of priority for rent and for floating charges applies to all property presently except, among other things bank balances and cash, negotiable promissory notes, shares and bonds as well as property which can be pledged through registration, such as real estate and ships.

Next, creditors having rights of priority in property on which execution has been levied will receive dividends, if the execution cannot be avoided as a preferred transaction on the grounds that it was carried out less than three months prior to the bankruptcy.

Thereafter, claims for wages which became due and payable not more than three months prior to the granting of the bankruptcy petition or which relate to wages following notice of dismissal pursuant to the Employment Protection Act and claims for holiday compensation for the current and preceding year become payable. Wage claims, which have a right of priority in a bankruptcy, are guaranteed by the State up to a total amount of SEK 100 000 per employee, and where the state has paid compensation pursuant to the wage guarantee, the State is subrogated to the employees’ rights in the bankruptcy.

Finally, the remaining assets are divided among what are commonly referred to as creditors without any right of priority, in proportion to their claims.

New legislation

The right of priority for rental claims is being abolished. This is of course a considerable deterioration for the landlords, since the landlords according to the old rules in most bankruptcies had the best right of priority. To compensate for this, a new provision is introduced in the Right of Priority Act. If a landlord requests that the estate places the premises at the landlord’s disposal, the estate must do so within one month, or else the estate is responsible for the rent until the premises is left. The intention with this rule is to accelerate the process of placing the premises at the landlord’s disposal.

The priority right for floating charges is being converted into a right of priority in 55 per cent of all property. With this alteration, it will not matter whether the accounts receivable of the business are converted into liquid funds immediately prior to a bankruptcy.

The right of priority for tax claims is being abolished. Such proposal has been presented many times, the first time in 1970. However, the Government has constantly opposed such abolition. The main reasons cited have been that the State cannot refrain from giving credit and cannot freely choose its debtors, that the State finances would be detrimentally affected, that the debt collection would become tougher and that tax morals would be affected. The proposal has now been realized, but the State will be compensated as a consequence of the other legislative changes, primarily the conversion of floating charges.

The right of priority for wage claims is restricted to wages which accrued during a period of three months prior to the filing of the bankruptcy petition until one month after granting the petition, subject to a ceiling of ten times the statutory base amount (currently approximately SEK 39 000, i.e. 390 000). These claims and claims for wages following notice of dismissal, which correspond to what is paid pursuant to the Employment Protection Act, i.e. for a period not exceeding eight months, are protected through a State wage guarantee with a ceiling of four times the statutory base amount. The rights of priority for the wage claims dealt with above seldom have significance for the employee. In most cases, all assets are used up for creditors with superior rights of priority and, therefore, the wage guarantee is of central importance. If an employee whose employment has been terminated works for the estate after one month after the granting of the bankruptcy petition, the wages will be paid from the estate without the possibility of utilising the wage guarantee.

The purposes with the new legislation

As stated in the preamble, the primary reasons for the new legislation in this area is to facilitate for certain companies, that have a solid business concept to carry through composition negotiations and avoid bankruptcy. The underlying thought is that the State will have revenues instead of costs by keeping the company alive and the employees as tax payers’. The owners and employees will also profit from this.

Another thought is to strengthen the employee’s wage protection in the bankruptcy by increasing the ceiling for right of priority for wage claims to ten times the statutory base amount together with increasing the ceiling for State wage guarantee to four times the statutory base amount.

The new legislation will also equalize competition between companies that are run by the estate in bankruptcy and other companies. Such competition is unsound, since bankruptcy estates, if they have the possibility to run the company without having to pay wages to the dismissed employees who are compensated from the wage guarantee during their period of notice, could drive ordinary companies out of competition.

Another expectation with the new legislation is that it will contribute to that decisions with respect to loans are focused more on the borrower’s repayment abilities than on security. Bankruptcies and business compositions involve costs for owners, employees, suppliers and the State, which should be avoided through investigation into credit rating based on the ability of reimbursement and on better credit follow-up.

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.

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