paragraph issue Companies in bankruptcy

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1 Our lawyers Oscar Battegay, lic. iur., Notar Andreas Bättig, lic. iur., LL.M. Mark-Oliver Baumgarten, Dr. iur., LL.M. Marc Bernheim, Dr. iur., LL.M. Irène Biber, lic. iur. Yara Brusa, MLaw Andreas Dürr, lic. iur., Notar Dominik Elmiger, M.A. HSG David W. Frei, lic. iur. Christoph Gasser, Dr. iur., LL.M. Gaudenz Geiger, lic. iur., LL.M. Markus Gottstein, lic. iur. Eva Gut, lic. iur. Michael Hamm, Dr. iur., TEP Damian Hess, lic. iur., LL.M. Andrin Hofstetter, lic. iur. Philipp Känzig, lic. iur. Martin Kern, M.A. HSG Sarah Khan, lic. iur. Stefan Knobloch, PD Dr. iur. *Not admitted to the bar. Staiger, Schwald Partner Ltd. Genferstrasse 24 P.O. Box 2012 CH-8002 Zurich Telephone Telefax Thunstrasse 7 P.O. Box 281 CH-3000 Berne 6 Telephone Telefax Heuberg 7 P.O. Box 2032 CH-4001 Basel Telephone Telefax ssplaw@ssplaw.ch ssplaw.ch Urs Leu, Dr. iur. Peter Lutz, Dr. iur., LL.M. Marc Metzger, Fürspr., LL.M. Natalie Peter, Dr. iur., LL.M., TEP Pascal Sauser, MLaw Daniel Sauter, Dr. iur. Thomas M. Schmid, lic. iur., LL.M. Florian Schneider, lic. iur. Hans-Peter Schwald, lic. iur. HSG Hans-Rudolf Staiger, Dr. iur., TEP Thiemo Sturny, Dr. iur., LL.M. Cyrill Süess, lic. iur. HSG Gian Andri Töndury, lic. iur., LL.M., TEP Yasemin Varel, lic. iur. Severine Vogel, MLaw, certified Tax Expert Johannes Vontobel, lic. iur. Désirée Wiesendanger, lic. iur., LL.M. Stefan Wigger, MLaw, certified Tax Expert * Sarah Witschi, MLaw paragraph July Companies in bankruptcy 06 Voluntary dissolution and liquidation of a stock corporation 09 Bankruptcy of a spouse Companies in bankruptcy The bankruptcy of a company has considerable effects on its customers, suppliers, and affiliates. If the company is threatened by bankruptcy, in addition, risks and obligations arise for its corporate bodies, where noncompliance can lead to personal liability for its individual members and possibly even to criminal liability. issue GENERAL INFORMATION ON BANKRUPTCY Bankruptcy primarily occurs when a company is over-indebted, that is, when the value of its assets no longer covers the total of its debts. Bankruptcy leads to complete liquidation of all attachable assets belonging to the bankrupt company, whose proceeds are used to the extent possible to pay the debts of the company. After conclusion of bankruptcy proceedings, the bankrupt company is deleted from the Commercial Register and thus ceases to exist. Opening bankruptcy proceedings causes all debt obligations of the bankrupt company to become due, with the exception of those that are secured by real estate through mortgages. Once bankruptcy proceedings are commenced, the responsible bankruptcy office issues a notice to the creditors that calls on them to register their receivables or claims with the bankruptcy office within one month from the date of the announcement, providing proof of the claim. Delayed registration of claims is permitted but coupled with disadvantages (in particular additional costs). Also, each creditor known to the bankruptcy administrator is sent a copy of the notice. In addition to the principle claim, creditors can claim interest up to the date bankruptcy procee-

2 03 An entrepreneur bears the risk of being personally liable to third parties for damage incurred in case of bankruptcy of his company. In case of a threatened over-indebtedness situation, the executive bodies are subject to special rules of behaviour; strict compliance with them is necessary in order to avoid director's liability suits. Marc Bernheim, Attorney-at-Law, Dr. iur., LL.M. dings were commenced, along with debt collection costs. Upon expiry of the submission period, the bankruptcy administration reviews the submitted claims and decrees a rank order (Kollokationsplan, schedule of claims). Rejected claims are noted in the schedule of claims, specifying the reason for rejection. Creditors who wish to contest the schedule of claims because their claim has been rejected in whole or in part or not permitted to the claimed extent must file suit against the estate with the court at the place of bankruptcy within 20 days after publication of the schedule of claims (Kollokationsklage, action to contest the schedule of claims). If a creditor wishes to contest the admission of a claim by another creditor, its rank, or its amount, he must file suit against this creditor (also known as a rejection suit, Wegweisungsklage). Creditors of a bankcrupt company must register their claims, otherwise they will not be taken into account in the distribution of the bankruptcy proceeds. BANKRUPTCY OF CUSTOMERS If a contract of sale exists with the bankrupt entity, a seller who transferred the sold good to the bankrupt entity prior to commencement of bankruptcy proceedings is no longer able to withdraw from the contract and reclaim the transferred good (as the sale of goods law would provide in case of default by the buyer), even if the seller has expressly retained this right. The seller thus has no other possibility than to register his sale price claim with the bankruptcy office. The situation is different when the sold good was transferred with a valid reservation of title. In this case, the ownership of the sold good remains with the seller, who can withdraw from the contract and demand the sold object to be segregated from the bankruptcy estate. BANKRUPTCY OF SUPPLIER If a supplier enters into bankruptcy and still has outstanding receivables, they will be collected by the bankruptcy administration. If a creditor also has a monetary claim against the bankrupt supplier, the mutual claims can be offset against each other. BANKRUPTCY OF AN AFFILIATE If a subsidiary or an affiliated company enters into bankruptcy and the bankrupt entity has been granted a loan by its parent or another affilitate shortly before bankruptcy proceedings were commenced, such loan may be qualified as equity pursuant to the theory of an equity replacing loan. Due to its treatment as equity capital in the bankruptcy, the lender would no longer be able to claim the repayment of the loan in this case. An equity replacing loan may be at issue if the loan has been granted at a time when the affiliate was already over-indebted and no independent third party (particularly no bank) would have been willing to grant the company a loan ( third-party test ). Denying repayment of the loan (or rejecting any such loan claim in the procedure of contesting the schedule of claims) is based on the consideration that granting such additional funds solely makes it possible for the over-indebted company to continue its business, but not effecting a sustainable and structural reorganization. It should be noted that this reclassification of debt into equity capital is controversial and court practice has not yet found a conclusive answer on this issue. An alternative with the same effect, would be the treatment of corresponding claims as loans with implied subordination. Here as well, no precedents are available. DUTIES AND RISKS FOR THE EXECUTIVE BODY OF AN OVER-INDEBTED OR A COMPANY IMMEDIATELY THREATENED WITH BANKRUPTCY Notice of over-indebtedness If there is substantiated concern that a corporation, e.g., a stock corporation (Aktiengesellschaft) or limited-liability company (Gesellschaft mit beschränkter Haftung), is overindebted, then an interim balance sheet must be drawn up. If the interim balance sheet shows that the claims of the company s creditors are not covered either at going-concern value or at liquidation value, the executive body of the company (that is, the Board of Directors of a stock corporation or the managing directors of a limited-liability company) are required to notify the judge, who opens bankruptcy proceedings on the company. If there is substantiated concern about over-indebtedness of a corporation, an interim balance sheet must be drawn up and the judge notified if necessary. A comparable regulation also applies to foundations. For banks and insurances, the specific regulations of banking respectively insurance law govern such cases. The notice of

3 04 05 Transactions with companies in financial difficulties involve legal and financial risks for lending banks and suppliers with regard to a possible bankruptcy. Clarifying the legal issues in advance may be rewarding in such situations. Damian Hess, Attorney-at-Law, lic. iur., LL.M. over-indebtedness (Überschuldungsanzeige or Bilanzdeponierung) must be differentiated from the notice of insolvency (Insolvenzerklärung), which presumes the inability of the debtor to pay and does not necessarily imply over-indebtedness. Despite over-indebtedness, the judge needs not to be notified if valid subordination declarations from creditors exist to the extent of the under-coverage. This is the case when creditors make a binding declaration in favour of all other creditors, indicating that in case of bankruptcy, composition moratorium, or liquidation of the company they only wish to be satisfied for their claims once the debts owed to all other creditors have been satisfied in full. The purpose of the subordinations is to enable the over-indebted company to continue its business operations in order to ultimately remedy the over-indebtedness. If in a situation of over-indebtedness the executive body of the company fails to notify the judge in due time, it cannot be excluded that the members of that body will be liable in subsequent bankruptcy proceedings for the damage arising from this omission. This liability would cover the damage of the creditors that occured to them between the time when the judge would have had to be informed and the time when the judge was actually notified. With regard to the subordinations, the executive body of the company must ensure that they satisfy the numerous requirements (such as irrevocability, unconditionality, or the creditor s waiver of offsetting). In practice, the model from the Swiss Institute of Certified Accountants and Tax Consultants (Treuhand- Kammer) is often used in uncomplicated cases. In more complex situations it is recommended to arrange the subordinations by taking into account the specific circumstances. Challenging payments and creditor preference If a bankrupt company has made payments to its creditors within a certain period prior to commencement of bankruptcy proceedings, risks for the executive body exist, but also for the creditors who received such payments. Such payments may be challenged by the bankruptcy administration (paulianische Anfechtungsklage, avoidance action or Paulian Action ) and must be refunded to the bankruptcy estate as the case may be. The avoidance action is successful if the bankrupt company has made gifts or voluntary conveyances within one year prior to commencement of bankruptcy proceedings (action to avoid a gift), or if in case of existing over-indebtedness unusual actions were taken within one year prior to commencement of bankruptcy proceedings, such as payment of a debt that was not due, repayment of a debt in another manner than customary means of payment, or retroactive provision of collateral for already existing liabilities (voidability due to over-indebtedness). If the company pays a debt shortly before commencement of bankruptcy proceedings, the creditor may possibly have to repay the funds received. The avoidance action will also be successful if it can be shown that payments were made to creditors within five years prior to commencement of bankruptcy proceedings with the intent of damaging other creditors (voidability for intent). Voidability for intent is particularly of importance for lending banks, for instance in the context of the amortisation of loan debts by a company that is in financial difficulties. When making such payments, the executive body of a company facing bankruptcy must additionally take into account to possibly be subject to criminal charges due to preference of creditors (Art. 167 of the Swiss Criminal Code, Strafgesetzbuch). The threat of punishment is imprisonment up to three years or a fine. The question of whether creditor damage caused by void payments also triggers liability claims against the members of the executive body under corporation law is controversial and has not yet been unequivocally resolved by case law. However, it appears that the Swiss Federal Supreme Court recognizes a duty of equal treatment of creditors under company law. Therefore, corresponding liability claims cannot be excluded. Quite the contrary, in larger bankruptcy proceedings, the possibility of asserting liability claims is regularly considered and such claims are indeed quite often raised. Marc Bernheim, Damian Hess

4 06 07 The voluntary dissolution and liquidation of a stock corporation can be an alternative to a liquidation by the Bankruptcy Office. However, if there is a risk that creditors will suffer damage, then legal assistance should be obtained as early as possible. Stefan Knobloch, Attorney-at-Law, PD Dr. iur. Voluntary dissolution and liquidation of a stock corporation The shareholders of a stock corporation may adopt a resolution to dissolve their company by adopting a corresponding resolution and order the liquidation. Shareholders generally use a voluntary dissolution with liquidation either to obtain access to blocked capital of an inactive company or to prevent the commencement of bankruptcy proceedings to avoid damage to their reputation. RESOLUTION TO DISSOLVE WITH LIQUIDATION Shareholders may adopt a resolution to dissolve the company and order liquidation. A specific reason is not necessary. Adopting such resolution requires a majority of at least two-thirds of the votes represented at the general meeting and an absolute majority of the par values of the shares represented. The Board of Directors must report the dissolution to the Commercial Register immediately. Thereafter, the company's business name is supplemented with the words in liquidation. EFFECT OF THE DISSOLUTION RESOLUTION When liquidation commences, the powers of the company s bodies are limited to actions which are necessary to carry out the liquidation and which, however, cannot be carried out by liquidators. For instance, the general meeting is prohibited from declaring dividends or at least according to prevailing scholarly opinion adopting capital increases. The powers of the Board of Directors are largely replaced by the powers of the liquidators; in particular, the Board of Directors is no longer empowered to dispose of the assets of the company. In particular, the Board of Directors is no longer empowered to dispose of the assets of the company. Otherwise, the company continues to retain its legal personality and legal capacity to act, although according to the traditional view, the company s purpose is limited to liquidation. When liquidation commences, transferability restrictions set forth in the articles of association cease to apply, i.e., even registered shares with restricted transferability may principally be freely transferred. THE LIQUIDATORS By law, the liquidation is handled by the Board of Directors. However, the articles of association or the general meeting may assign the liquidation to individual members of the Board of Directors or to other persons. At least one liquidator must be domiciled in Switzerland and authorized to represent the company. The Board of Directors must report the liquidators to the Commercial Register for entry immediately. The general meeting may recall the liquidators at any time. Moreover, if good cause exists, a judge may recall the liquidators upon request of a shareholder and appoint new liquidators. CANCELLATION OF THE DISSOLUTION WITH LIQUIDATION According to current case law from the Swiss Federal Supreme Court, the shareholders may cancel the adopted dissolution with liquidation. However, such a cancellation is only possible as long as the distribution of the company s assets to the shareholders had not yet begun. COURSE OF LIQUIDATION The liquidation procedure may be summarized as follows (in simplified terms): - Preparation of a balance sheet as of the effective date of the dissolution. It is unclear whether this balance sheet must be audited by the auditor and approved by the general meeting. Depending on the circumstances, however, it may be advisable particularly for the liquidator to have this balance sheet audited by the auditor and approved by the general meeting. - Creditors known to the company are to be notified by letter of the dissolution and requested to register their claims. Any other creditors must be informed by public annoncement in the Swiss Official Gazette of Commerce as well as in the form envisaged in the articles of association. - Receivables are to be collected and other assets liquidated. - Calling in outstanding share capital. If the company s assets are insufficient to perfom its obligation, then the outstanding share capital must be called in from the shareholders.

5 08 09 In cases of financial difficulties or bankruptcy of one spouse, it is not uncommon for transfers under property law to occur between the spouses. Such transfers may protect marital assets and thus be a sensible option, but they should be well prepared and carefully considered. Markus Gottstein, Attorney-at-Law, lic. iur. - Performance of obligations. Insofar as no over-indebtedness is to be expected, the obligations must generally be performed. In exceptional cases, placing a corresponding amount in escrow with a court, or providing collateral may be necessary instead of performing the obligations. Distribution of the assets to the shareholders is only permitted once all debts have been repaid or secured. - Preparation of final accounts and distribution of the assets to the shareholders. The final accounts constitute the basis for distributing the assets. Here, it is unclear whether these final accounts must be audited by the auditor and approved by the shareholders. Distribution of the assets to the shareholders is only permitted once all debts have been repaid or secured, but no sooner than one year after the third notice to creditors. However, if a licensed audit expert confirms that the debts have been repaid and the interests of third parties are not at risk, then the distribution may occur already three months after the third notice to creditors. - Deletion of the company from the Commercial Register. After completion of the liquidation procedure, the liquidators must report the termination of the company to the Commercial Register. The liquidation procedure is completed once the company has performed all its obligations and the assets have been distributed. If the deletion of the company occurs too early or if assets and/or liabilities are discovered after the deletion, then the company can be re-entered in the Commercial Register, subject to certain conditions. The actions listed above must be carried out by the liquidators. If the liquidators determine that the company s assets will not be sufficient to cover the company s liabilities, i.e., that the company is over-indebted, then the liquidators must notify the judge to open bankruptcy proceedings. Should the liquidators fail to notify the judge, the auditors are obliged to do so. As opposed to this, according to current case law (obiter dictum), the Board of Directors is not subject to this obligation in the liquidation process. If the company is over-indebted, it is possible to avoid involving the judge, if the over-indebtedness is resolved by contribution of funds (generally by shareholders) or waivers of claims, or if creditors subordinate their claims in the amount of the over-indebtedness. Stefan Knobloch Bankruptcy of a spouse: Consequences of liability and possible precautionary measures If a married person becomes bankrupt, various issues arise for that person's spouse: How are his or her own assets affected? What is the destiny of his or her claims against the bankrupt spouse? How can the spouses protect the assets of the other spouse from possible negative effects of a bankruptcy? ASSETS SUBJECT TO LIABILITY IN CASE OF BANKRUPTCY OF A SPOUSE Basically, each spouse is liable for his or her debts to third parties to the extent of his or her total assets (Article 202 of the Swiss Civil Code, Zivilgesetzbuch, CC). The assets of each spouse consist of the property acquired during marriage (Errungenschaft) and the spouse's individual property (Eigengut) (known as the statutory marital property regime of participation in acquired property pursuant to Article 181 CC) unless a different regime was agreed upon by marriage contract, or separation of property has occurred. Claims of the bankrupt spouse against the other spouse belong to the bankruptcy estate. Thus, creditors may have, in principal, access to such claims. Basically, the assets of the other spouse are not liable for the debts of the bankrupt spouse. The provisions and rules of the Code of Obligations determine which spouse is the debtor of a respective claim. It is irrelevant whether the spouse assumed an obligation before or during the marriage. In principle, the property acquired during marriage and the individual property of the other spouse cannot be held liable for the debts of the bankrupt spouse, unless contractual provisions with a creditor lead to a joint liability of the spouses. The other spouse may possibly be liable as a joint and several debtor for the ongoing needs of the family (Article 166 CC). The bankruptcy of one spouse has no influence on the marital property regime, as long as the spouses live under the marital property regime of participation in acquired property. However, the other spouse is entitled to demand a court order imposing separation of property (Article 185 CC). If on the other hand the spouses agreed upon community of property (Gütergemeinschaft), a separation of property takes place by law (Article 188 CC) in case bankruptcy proceedings have been opened against one spouse.

6 10 11 A bankruptcy certainly does have considerable consequences for the entrepreneurs, their employees, and their creditors, that is, lenders and suppliers, but also customers. However, a bankruptcy does not necessarily have to mean the end of an entrepreneurial career. Staiger, Schwald & Partner has many years of experience in the field of debt collection and bankruptcy law and can assist in a bankruptcy both as consultant and as counsel in court proceedings. Upon a change in property regime, the previous property regime will be dissolved and a separation of property will be carried out. In case of dissolving the participation in acquired property, each spouse is at first entitled to his or her individual property. In addition, the balance of the property acquired during marriage must be determined for each spouse separately. In case of a positive balance, a financial benefit, in case of a negative balance, a financial setback results. Each spouse may claim half of the financial benefit of the other spouse respectively a share according to a possible particular agreement (Article 215 (1) CC). A spouse who suffers a financial setback must bear it alone (Article 210 (2) CC). It is necessary to critically assess whether a change in the marital property regime will actually place the other spouse in a better position. However, as long as no liquidation of the marital property regime takes place, the share in the property acquired during marriage of the other spouse does not form part of the assets subject to liability; instead, it is considered as mere expectancy. Therefore, the creditors cannot access it. For this reason, the financial consequences of a liquidation of the marital property regime may not always be advantageous to the spouses. If the financial benefit of the bankrupt spouse turns out to be smaller than that of the other spouse, a change of the marital property regime is not advisable. POSITION OF THE SPOUSE VIS-À-VIS OTHER CREDITORS In principle, compared to the other creditors, the other spouse is not privileged in his or her position as a creditor of the bankrupt spouse. The claims of the other spouse are ordinary third-class claims (Article 219 of the Debt Enforcement and Banking Act, Bundesgesetz über Schuldbetreibung und Konkurs, DEBA), which include claims arising from liquidation of the marital property regime. Maintenance and support claims according to family law for the last six months prior to commencement of bankruptcy proceedings are the sole exception - these are so-called first-class claims (Article 219 DEBA). They become due upon the opening of the bankruptcy proceedings (Article 208 DEBA), and the spouse must report them to the bankruptcy office after the first bankruptcy proceedings have been commenced (Article 232 DEBA). In principle, spouses are not treated as privileged compared to other creditors in bankruptcy proceedings. Claims between the spouses under marital property rights arise (only) upon the liquidation of the marital property regime. Consequently, the liquidation of the marital property regime must take place before such claim can be submitted for bankruptcy purposes. The claim must be submitted no later than the conclusion of the bankruptcy proceedings (possibly with additional costs, Article 251 DEBA). POSSIBLE PRECAUTIONARY MEASURES Creditors of the bankrupt spouse are principally not entitled to cover their claims with assets of the other spouse. Nevertheless, the statutory marital property regime may lead to uncertainties in connection with the scope of the assets subject to liability. It is not always clear which assets and liabilities of a spouse belong to which property class (property acquired during marriage or individual property). Such uncertainty could be remedied by a prior agreement of separation of property, leading to a clear separation of assets and liabilities. The spouses may agree upon a different marital property regime at any time in a marriage contract (Article 187 CC). In addition, the estate of one spouse may be designated by contract with the creditor as the sole liability substrate. Finally, we should like to mention the transfer of assets of the bankrupt spouse to the other spouse with the intention to protect such property from the access of creditors. In this case, it should be noted that assets of the other spouse may, as an exception, be subject to liability for the creditors of the bankrupt spouse. Regardless, if such assets currently are part of the assets of the other spouse due to a liquidation of the marital property regime or due to a change in the marital status, if they have belonged to the assets subject to liability of the bankrupt spouse before, creditors will still have access to those assets (Article 193 CC). Furthermore, if a transfer of assets from the bankrupt spouse to the other spouse occurs within certain deadlines before the opening of bankruptcy proceedings, the provisions of the avoidance action ( Paulian Action, Article 285 et seq. DEBA) have to be observed: transfers of assets subject to liability taking place shortly before bankruptcy can be challenged by the creditors of the bankrupt spouse under certain circumstances and within certain deadlines. Markus Gottstein, Bianca Steiner