The effects of making a donation on the eve of bankruptcy – case studies

In Polish civil law, a donation is one of the forms of transferring property, which consists in the gratuitous transfer of goods or rights to the donee. However, making a donation, especially in the context of the threat of bankruptcy, may give rise to serious legal consequences. In a situation where the debtor is in a difficult financial situation and his bankruptcy is inevitable, making donations may be considered an action aimed at preventing the satisfaction of creditors. The aim of this article is to analyze the legal effects of donations made in the foreground of declaring bankruptcy based on the provisions of civil law and bankruptcy law. Examples illustrating these issues will also be presented.

Contents:

The concept of donation and its significance in the context of bankruptcy

A donation is a unilateral, gratuitous benefit in which the donor transfers certain property to the donee without expecting any reciprocal benefit. In principle, donations are acts that do not impose a financial burden on the donee, but they can create serious problems in the context of bankruptcy of the debtor. Particular attention should be paid to situations in which a donation is made just before the debtor's bankruptcy is declared, which may lead to so-called fraudulent activities.

Fraudulent activities are deliberate actions taken by the debtor aimed at creating or deepening insolvency, which consequently lead to ineffective satisfaction of the creditor. Such actions may be considered unlawful, and the donation itself may be treated as ineffective within the framework of bankruptcy proceedings or on the basis of the Civil Code. Recognizing the unfair action of the debtor as ineffective comes down to enabling creditors to enforce against the asset that the debtor has disposed of from his estate.

Actions of a dishonest debtor – principles of bankruptcy law.

Within the framework of bankruptcy proceedings, the court and the trustee have the right to examine all legal acts performed by the debtor before the declaration of bankruptcy, especially those that could limit the satisfaction of creditors. Based on the provisions of the Bankruptcy Law, the bankruptcy court may decide to invalidate legal acts performed by the debtor during the period in which the debtor should have foreseen that his financial situation was serious enough to require the declaration of bankruptcy. In particular, the following acts are subject to assessment:

1. They were made shortly before the declaration of bankruptcy (e.g. donations, sale of property at a reduced price).

2. They are highly unfavourable to creditors (e.g. gift of property that could be used to satisfy claims).

3. They were made without remuneration or for remuneration significantly lower than the market value (e.g. donation of real estate).

If it is found that the debtor made a donation in a way that was intended to harm creditors, it may be ruled ineffective. The purpose of such a provision is to ensure that the debtor's property, which can be used to satisfy creditors' claims, is not removed or transferred to third parties.

Consequences of making a donation in the context of civil and bankruptcy law.

In the context of civil law, a donation is a fully legal act, however, if the debtor is at risk of insolvency, it may be considered an act aimed at fraud or concealing assets from creditors. According to Article 527 of the Civil Code, a legal act performed to harm creditors may be considered ineffective, which also includes donations. In the literature on the subject, based on Article 527 of the Civil Code and subsequent articles, it is indicated that in order for a creditor to request that a debtor's legal act be recognized as ineffective, the following conditions must be met:

a) performance of a valid legal act by the debtor;

b) harm to creditors;

c) a third party gaining financial benefits;

d) the debtor was aware of the harm to the creditors at the time of performing the act;

e) the awareness of a third party about the harm to the creditors or the acquisition of such awareness by the debtor while exercising due diligence (see M. Załucki (ed.), Civil Code. Commentary, Warsaw 2019, commentary to art. 527, Legalis 2019).

Similarly, bankruptcy law provides for the possibility of invalidating such actions that lead to the removal of the debtor's assets, preventing the satisfaction of creditors' claims. Such actions are treated as so-called "fraudulent actions" that are intended to circumvent bankruptcy law. Within the framework of the discussed legal act, the content of Article 127 section 1 of the Bankruptcy Law is of key importance, which directly refers to gratuitous legal actions. According to the cited provision: "Legal acts performed by the bankrupt are ineffective towards the bankruptcy estate. during the year before the date of filing the bankruptcy petition, which assets he disposed of, if any free of charge or for a fee, but the value of the benefit of the bankrupt grossly exceeds the value of the benefit received by the bankrupt or reserved for the bankrupt or for a third party”.

Based on the regulations governing the manner of conducting bankruptcy proceedings, the trustee has the authority to file a claim within the scope of the so-called Pauliana actio, as well as to take the place of the plaintiff in a case initiated by a creditor before the declaration of bankruptcy, who challenged the legal acts of the bankrupt. Importantly, in such cases, the legal acts of the bankrupt made in the period up to 5 years back are examined.

Case Studies: Case 1: Donation of Cash for Purchase of Real Estate.

Mrs. Anna was aware of her financial problems, but she and her husband took out another loan. In less than a year, Mrs. Anna filed for bankruptcy. During the bankruptcy proceedings, the trustee, as part of the analysis of the claims, determined that the loan reported by the creditor burdened the bankrupt and her husband, and the purpose of taking it out was to purchase real estate. In the described factual situation, Mrs. Anna acted as a co-borrower of the housing loan, but Mr. Anna was entered as the owner of the real estate. only the debtor's husband. In this state of affairs, the situation should be interpreted as a gift from the debtor to her husband. In the face of the regime resulting from the content of Article 127 of the Bankruptcy Law, the trustee took steps to increase the funds of the bankruptcy estate as a result of reversing the effects of the ineffective legal act of the bankrupt towards the bankruptcy estate, resulting from the conclusion of a loan agreement and transferring the funds obtained in this way as a free gift to the spouse for the purpose of purchasing real estate. Based on the interpretation of the regulations and the nature of the credit obligation, the trustee took the position that the value of the legal act performed by the bankrupt corresponded to half the value of the loan granted (Article 379, paragraph 1 of the Code of Civil Procedure).

The amount restored to the bankruptcy estate allowed for the satisfaction of over PLN 30% creditors' claims participating in bankruptcy proceedings.

Case Studies: Case 2: Car Donation Before Bankruptcy.

Mr. Marek, being aware of the upcoming bankruptcy, decided to transfer the share in the passenger car, of which he was a co-owner, to his father (the second co-owner) by way of a gift. The car was the only asset of Mr. Marek. At the time of the gift, the debtor already knew about the inability to settle obligations to creditors.

The trustee, examining the debtor's actions, found that the legal act was performed with the intention of removing an asset that could be used to satisfy the creditors' claims. The period between the performance of the act and the filing of the bankruptcy petition for the debtor was in line with the standard resulting from the content of Article 127 of the Bankruptcy Law, and therefore the debtor performed the gratuitous legal act within a year before filing the bankruptcy petition. In this state of affairs, this act was deemed by law to be ineffective against the bankruptcy estate, which consequently led to the necessity of calling on the donee to return the said asset to the bankruptcy estate. Due to the fact that giving away ½ of the share in the car is becoming physically difficult, the donee was offered to pay the equivalent in cash. The actions taken by the trustee contributed to increasing the bankruptcy estate with cash, and thus to increasing the degree of satisfaction of the creditors.

Case studies: Case 3: Donation of a residential premises.

During the bankruptcy proceedings, the trustee received information that the bankrupt and his wife had made a donation of a residential premises (part of their marital property community) to their child. Less than a month after making the donation, the spouses entered into an agreement to establish the separation of property. Thus, this agreement did not cover the residential premises that had been removed from the marital property community. At the time of making the donation, the debtor was burdened with due and undue financial obligations. By making the donation, the Debtor became insolvent, as he had no other assets apart from the aforementioned apartment, and did not earn sufficient income to satisfy his creditors. After nearly 2 years of insolvency, the debtor was declared bankrupt. During the bankruptcy proceedings, the trustee, analyzing the content of the land and mortgage register of the premises in question, received information that after the declaration of bankruptcy, the son of the bankrupts made a donation of the apartment in question to his mother (the bankrupt's wife).

Thus, in the first agreement, there was an increment from the debtor's and his wife's assets to their son, and in the second, the son made an increment to his mother (the bankrupt's wife). In the described case, the provisions authorizing the trustee to file an action under Article 527 of the Civil Code were applied. The court proceedings conducted led to the recognition of the donation made by the bankrupt as ineffective with respect to the bankruptcy estate, and consequently led to the restoration of the asset to the bankruptcy estate, allowing for full satisfaction of the creditors participating in the bankruptcy proceedings.

Summary.

Making a donation before the declaration of bankruptcy can lead to serious legal consequences for both the debtor and the donee. If the donation was made in order to hide assets from creditors, it may be considered an invalid act with respect to the bankruptcy estate, which leads to the restitution of this asset to the bankruptcy estate. Importantly, there is no retransfer of ownership of the subject of the donation to the bankrupt, but only authorizes the trustee to dispose of the subject asset during the bankruptcy proceedings. When considering such cases, the court takes into account the purpose of making the donation, the time of its making and the value of the transferred assets. Any intentional actions of the debtor aimed at causing insolvency or significantly increasing its degree will affect the possibility of obtaining debt relief or the scope of the established creditor repayment plan, causing, for example, its extension to even 84 months. 

Magdalena Żabińska

See Full Bio