Source: https://mail.abyssinialaw.com/online-resources/study-on-line/item/391-principles-of-bankruptcy
Timestamp: 2020-07-13 08:48:04
Document Index: 259490845

Matched Legal Cases: ['Art. 1995', 'Art. 1996', 'Art. 969', 'Art. 973', 'Art. 972', 'Art. 970']

<?xml encoding="UTF-8">Principles of Bankruptcy
Art. 1995- Debtor’s fraud
Art. 1996- Fraudulent acts
There may be different properties under the possession of the debtor on the date of declaration of bankruptcy. Some of them may belong to the debtor himself and others belong to another person. The debtor might have received the properties belonging to other persons either on hire, bailment or other reasons. As a result of declaration of bankruptcy, the properties of the debtor are to be attached and realized for the benefit of the creditors. Assets are available for distribution among creditors only to the extent that the debtor has or acquires a beneficial interest in them. Property in the possession of the debtor, but belonging to another is returnable to its owner, subject to any right which the debtor may have to keep in his possession (e.g. under a lease). This is not an asset available for distribution to creditors. Even if they are under possession of the debtor on the day of declaration of bankruptcy, the properties which belong to other persons should not be the subject of attachment and realization. In other words, it is only the properties over which the debtor has interest that have to be attached. For example, assume that W/ro Tsehay is a debtor who could not pay her debts towards her creditors and as a result declared bankrupt. On the date of declaration of bankruptcy, W/ro Tsehay possessed a refrigerator which belongs to Ato Zegeye. The refrigerator was possessed because of contract of pledge between Zegeye and Tsehay. In this case, the refrigerator shall not be considered as the property of W/ro Tsehay and be the subject of attachment. Rather it has to be given to Ato Zegeye, subject to the rights to which W/ro Tsehay is entitled against Zegeye.
What type of interest of the debtor do you think is to be considered? Did you answer “rights of ownership?” If your answer is so, that is correct. As we have seen earlier, the debtor may become possessor of properties belonging to other persons because of different reasons. He may become possessor because of pledge, mortgage, usufruct, bailment, etc. Where the possession is as a result of relationships other than those entitling to ownership, the rights of the real owner shall not be affected by the fact that the debtor is declared bankrupt. But where the debtor has acquired possession of the property as a result of a legal relationship that confers him the right of ownership, such property would be the subject of attachment and be realized for the benefit of the creditors.
A) The assets available to the general body of creditors may be swelled by the amount of payments or transfers made by the debtor before declaration of bankruptcy under a transaction which is void or voidable at the instance of the liquidation. Where the debtor has already made payments to persons entitled before the debt of declaration of his bankruptcy, that payment affects the assets available to the creditors. Where the debtor has already transferred certain properties belonging to him before the date of his declaration, still this affects the assets available for the general body of creditors. The trustee, representing the estate, takes what is available at the beginning of the bankruptcy proceedings. This is with the deduction of those payments or transfers made before the date of declaration of his bankruptcy.
B) In a compulsory bankruptcy, all dispositions of the debtor’s property made after the presentation of the bankruptcy petition are void unless authorized or ratified by the court. The fact that a petition to the bankruptcy of the debtor could not prevent the debtor from entering into different transactions. The debtor may dispose his properties though an application to his declaration of bankruptcy is already presented. Such disposition of the properties of the debtor would be valid only where there is court authorization. In the absence of court authorization or ratification of the disposal already made to the properties of the debtor, the transaction would be void. But where the court has ratified the disposition or has authorized for such disposition, the trustees take what remains after such disposition.
Principle III: Personal Rights would be converted into rights of proof
In order for the creditor to get payment, he shall enter the procedure of proving his claim just like the other creditors. Had the debtor not been declared bankrupt, the creditor would have got payment without going into the procedure of proving debts. It would have been possible for the creditor to personally approach the debtor and satisfy his claim. On the part of the debtor, it is also possible to admit that he is indebted to the creditor and pay the whole or part of the debt he owes to the creditor. Generally, it is a cardinal principle of bankruptcy that purely personal rights against the debtor, whether to money, property or the performance of services, ceases to be exercisable by action and become converted into rights to prove in competition with other unsecured creditors. This characteristic marks off real rights from personal rights. The former are in principle unaffected by the bankruptcy process, for the trustee takes subject to them; by contrast, bankruptcy puts an end to a creditor’s ability to enforce purely personal rights of an individual unsecured creditor to a share in realization of assets.
The unsecured creditors get pari pasu distribution
What do you understand by pari pasu distribution? Did you answer saying, “it refers to proportionate distribution”? If your answer is so, that is great. It is distribution of the proceeds of sale of the properties of the debtor based upon the claim of each creditor. For instance, Ato Menbere is a debtor who is declared bankrupt for he failed to pay his debts towards the creditors. After all expenses are deducted, the proceeds from the sale of the properties of the debtor was 100,000 Birr. There were three creditors who proved their debts and claimed from Ato Menbere. One of the creditors, Ato Tesfu, claimed 30,000; the second creditor, W/ro Tizita, claimed 50,000 Birr; and the third creditor, Ato Geleta, claimed 100,000 Birr. In this case the claim of the creditors and the proceeds of sale of the properties of the debtor are not compatible. Therefore, what is available after sale has to be distributed proportionately among the three creditors in proportion to the claim of each creditor.
The principle of pari pasu distribution, which has been the feature of bankruptcy law, is often diminished because of certain reasons. First and foremost by the extensive range of security rights and analogous devices that have evolved over the years. As a result of development, creditors usually get a certain kind of security to guarantee the debtor’s discharge of his duties. The existence of such securities enables the creditors to satisfy their claims from the securities in their hands. As a result, no competition would be with the other creditors for the proceeds of sale of properties of the debtor. Second, by the massive expansion of the range of debts made preferential by laws. Different laws recognize certain debts to be preferential and therefore the creditor would have preferential right against the debtor. In such cases, it is the other creditors, who are neither secured nor preferred, that compete for proportionate distribution of the proceeds of sale of properties of the debtor.
Do you agree that creditors who acquire a right after declaration of the debtor’s bankruptcy are also entitled to pari pasu distribution? Did you answer “No?” If so, you are correct. The principle of proportionate distribution applies only in relation to unsecured creditors who acquired a right before the declaration of bankruptcy. As we have discussed earlier, it is pre-liquidation rights that are to be respected. Those creditors who become creditors as the result of contract entered into by the trustee/liquidator are entitled to have their claims treated as expenses of the bankruptcy process and paid out of the assets in priority even to the claims of preferential creditors. For example, assume that Ato Tadesse is the debtor who is declared bankrupt on June 1, 2005. Before his declaration of bankruptcy there were four creditors to whom he is indebted. On declaration of his bankruptcy, W/ro Yodit was appointed as trustee to carry out the bankruptcy proceeding. With the view of carrying out the bankruptcy process, W/ro Yodit entered into a contract for the hire of a warehouse belonging to Ato Kebede. In the contract, it was agreed that Ato Kebede was entitled to the payment of 40,000 for the service he renders and the money would be paid after a month. In this case, even if he acquired the right after the declaration of bankruptcy of Tadesse, Kebede’s claim would be paid in priority to the other creditors. The four unsecured creditors would get proportionate distribution of the proceeds from the sale of properties of the debtor. In other words, the proportionate distribution does not apply as regards the claims of Ato Kebede.
The rationale behind such a priority is that to enable the trustee/liquidator or the commissioners obtain goods or services during the bankruptcy process. Where there is no such a distinct right the bankruptcy proceeding would not be carried out properly and speedily. No one would be willing to enter into transactions with a person or the representative of a person who is already declared bankrupt. But where one knows that he will be entitled to priority right in the distribution and not to compete for proportionate but full payment of his claims, then he would be encouraged to enter into transactions that can facilitate the bankruptcy process. In the above given example, had Kebede known that he would compete with the other unsecured creditors for pari pasu distribution, he would not have entered in such a transaction. As a result of the pari pasu distribution he would have got less than what he claimed (less than 40,000), while the priority right entitles him for the full amount he claims.
Do you accept that there could be instances where the pre-liquidation creditors can get priority right? If you answered “Yes”, that is correct. Even pre-liquidation creditors will be able to jump the queue where the trustee is dependent on their continuing to supply goods or services and they make it a condition that existing debts must first be paid. In such a case, the liquidator is entitled to pay the pre-liquidation claims in question as being expenses of the liquidation necessary to preserve the debtor’s business or its other assets. For example, assume that Ato Debalke is the debtor who is declared bankrupt for he could not pay his debts to the creditors. Before his declaration of bankruptcy, he concluded a contract for the supply of a raw material with W/ro Yemisrach. The latter used to supply the agreed quantity of raw material to the factory of Ato Debalke. After the declaration of bankruptcy of Ato Debalke, the court ordered for the continuity of the business for justifiable reasons. For the business to continue, it is necessary that the raw material continues to be supplied. As a result, the trustee is to continue the relationship with W/ro Yemisrach. In case Yemisrach demands prior payment of the debts due and not yet paid before the declaration of bankruptcy, the trustee can pay in priority to other unsecured creditors. It is necessary to facilitate the bankruptcy process and therefore, W/ro Yemisrach is entitled to get payment in priority.
Basically, the right of unsecured creditors is a right in personem, and it is not a right in rem. In other words, the unsecured creditors have a right against the debtor, but not against the properties of the debtor. As their right is a right against the debtor and not against the assets, they cannot claim to take the properties of the debtor in distribution. Nor can they claim to participate in the realization of the properties of the debtor. What normally they are entitled to is to get distribution of the proceeds of sale of the properties of the debtor. To this effect, the properties of the debtor have to be identified and realized by a neutral body of persons, usually the commissioner and the trustees. Where the assets are not sufficient to cover the claims of creditors not secured, they are to get proportional distribution of the proceeds of sale. But as regards secured creditors, since they hold either movable or immovable properties belonging to the debtor, they have a right and interest in specie in those properties or the realization of such properties.
Bankruptcy Compared to Winding up
Do you think that winding up is the same to bankruptcy? If you answered “Yes”, that is not correct. As we have seen earlier, bankruptcy is the judicial process by which the debtor is found not able to meet his commitments towards his creditor. On the other hand, the Black’s Law Dictionary defines winding up as:
“process of settling the accounts and liquidating the assets of a partnership or corporation, for the purpose of making distribution of net assets to shareholders or partners and dissolving the concern.” What one can infer from this definition is that winding up presupposes a company or another business organization where there are shareholders or partners.
Winding up on the ground of insolvency may start by resolution of members of the company or the business organization. In this case, it is commonly known as members’ voluntary winding up since it is their voluntary resolution that is the cause for the winding up. Similarly, bankruptcy may be adjudicated based on the petition of the debtor himself. We will have a separate discussion on petition as one of the grounds for adjudication of bankruptcy later in this material. The fact that a company is in voluntary winding up does not debar a petition for it to be wound up by the court. Petition could be presented and the court orders the winding up of the company or corporation. There might be instances where the winding up process resulting from the resolution of the members stacks due to different reasons. In such cases, the court orders winding up and such order is to be effected.
Winding up may also start by a winding up order on a petition by a creditor or other party having a locus standi to present a petition. In this case, it is known as compulsory winding up for it is not the members who wanted the winding up but the creditors or other persons having legal right against the company or the business organization. Regarding bankruptcy, one or more of the creditors can present petition to the effect that the debtor be declared bankrupt. Not only the creditors, but also the court and the public prosecutor can present petition for the declaration of bankruptcy of the debtor.
Winding up does not divest the company of title to its assets but makes it in effect a statutory trustee of the assets for its creditors. As a consequence of the winding up process, the company would not totally lose the right of ownership over its assets. Normally, if the company or corporation loses the right of ownership, no one remains the owner until the property is sold. On sale, the buyer becomes the owner. But in the time between the beginning and end of the winding up process, the company or corporation remains the owner. Though it is the owner, there is no right to dispose or enjoy the fruits or even to make use of the properties. The company or corporation simply remains the trustee who keeps the asset properly. The same is true in the case of bankruptcy. The debtor remains the owner of his assets till the trustees transfer to other persons on sale.
Control of the company passes to the liquidator (either the official receiver or an outsider or by the creditors). As a consequence of start of the winding up process, the company falls under control of the liquidator to be appointed to carry out the winding up process. In the case of bankruptcy also control of the assets and the business of the debtor falls into the hands of the commissioner and the trustees to be appointed for the purpose of carrying out the bankruptcy process.
The liquidator is usually assisted by a liquidation committee and certain of his powers may be exercised only with the sanction of that committee or of the court. In the case of bankruptcy, however, the commissioner is to be assisted by the trustees and the creditors’ committee. The court of jurisdiction is also to overlook and supervise the whole bankruptcy proceeding.
The liquidator is responsible for getting in and realizing the assets, ascertaining the debts and distributing dividends. The trustees, in the case of bankruptcy, are responsible to collect and preserve the rights of the debtor, to realize the available assets and to distribute the proceeds among the entitled creditors.
When all the assets have been got in, the liabilities established and the distribution completed, the winding up process is at an end. The final process is dissolution of the company, which terminates its legal existence. In the case of bankruptcy also, the process comes to an end on the final distribution of the proceeds of sale of the assets.
Conditions of Bankruptcy
As we have discussed earlier, the Commercial Code did not define the concept of bankruptcy. It simply dealt with the conditions of bankruptcy. As per the Code, there are two important conditions that need to be fulfilled for the existence of bankruptcy. The two conditions are suspension of payments and declaration of bankruptcy. In the absence of any of these two conditions there is no bankruptcy. In other words, the two conditions are cumulative rather than alternative. You can read the following provision as regards the conditions of bankruptcy:
Art. 969- Conditions of bankruptcy
What do you think amounts to suspension of payments? In other words, when can one say that there is suspension of payments? Reading of the provisions of Article 971 of the Commercial Code will enable you answer these questions.
Suspension of payments shall result from any fact, act, or document showing that the debtor is no longer able to meet the commitments related to his commercial activities.
As you read in the above-given provisions the situation of suspension of payments arises from any fact, act, or document showing that the debtor is not able to meet his commitments. There are important issues to be raised in that relation. The first one is as to what facts can show that the debtor is no longer able to meet his commitments. Can you guess what facts could be considered? I hope that you have tried to list down certain facts that may show that the debtor is no longer able to meet his commitments. One fact could be that the debtor’s business has continuously fallen from time to time for a long period of time. In other words, where the fact that the business has been falling down instead of growing up is clear, it can be inferred that the debtor has suspended payment.
The second issue is as to what act could indicate that the debtor is no longer able to meet his commitments. Can you guess possible acts that can show that the debtor is no longer able to meet his commitments? If you do so that is great. Here, note that the act that can show that the debtor is no longer able to meet his commitments is the act of the debtor himself and not that of other persons. Accordingly, if the debtor has absconded without leaving or representing an agent to carry out the business, it could be a good example of an act to show that the debtor is no longer able to meet his commitments. Another example of an act could be where the debtor misappropriates or misuses his properties. Where it is corroborated with other circumstances, the unusual act of the debtor to misappropriate or misuse the properties could be a ground to infer the situation of suspension of payments. For example, assume that Ato Mesfin is the debtor of ten creditors. He has been performing commercial activities for the last seven years. During those times he has never misappropriated his assets and has properly managed them. But his conduct changed since the last two weeks in that he unusually misuses the assets. He drives the cars carelessly and even sells certain properties for a value much lesser than the market price. In this case, the act of Ato Mesfin can indicate that he is no longer able to meet his commercial commitments.
The third important issue is about documents. What documents are you going to consider saying that there is a situation of suspension of payments? You might have mentioned books of account, if any. If that is so, you are correct. In order to establish that the debtor is no longer able to meet his commitments, books of account, balance sheet and other similar documents can be good indicators. You can have a look at of the provisions of Article 973 of the Commercial Code, regarding the important documents to indicate suspension of payments.
Art. 973- Documents to be annexed to the notice
(1) The following documents, dated and signed, shall be annexed to the notice given under Art. 972:
a) the balance sheet of the firm;
b) the profit and loss of account;
c) a list of commercial credits and debts, with the names and address of the creditors and debtors.
(2) Reasons shall be given in the notice where any of the documents required under sub-art. (1) cannot be provided or is incomplete.
Even though the documents are expected to be presented along with a notice of suspension of payment by the debtor himself, the law considers such documents to assist the court to decide that a person should be declared bankrupt because he suspended payments.
Do you agree that the fact that one has suspended payments is sufficient for the bankruptcy of a person? Did you answer “No?” If your answer is so, you are right. Your answer is well supported by the provisions of Article 970 of the Commercial Code.
Art. 970- Bankruptcy of fact
(1) Where no judgment in bankruptcy is given, bankruptcy shall not result from mere suspension of payments.
(2) A sentence may be passed by a criminal court in respect of bankruptcy or any offence connected with bankruptcy notwithstanding that suspension of payments has not been established by a judgment in bankruptcy.
As you can read from the provisions of sub-article (1) of the above given Article, the mere fact that one has suspended payments could not suffice to his bankruptcy. Though the fact that he has suspended payments could be proved from different facts, acts, or documents, this by itself does not suffice bankruptcy. There should be judgment of bankruptcy of the same person along with the suspension of payments. In other words, the suspension of payments has to get court recognition as a result of which there has to be judgment of bankruptcy.
Another important point to be considered from the above mentioned Article is in relation to criminal matters. As we have seen earlier, for the existence of bankruptcy, the conditions of suspension of payments and declaration of bankruptcy are necessary. Even though these conditions are not fulfilled, a court should not be prevented from deciding on criminal matters related to bankruptcy. In other words, the conditions of bankruptcy should not be a pre-condition for the court to entertain criminal cases related to bankruptcy. Where suspension of payments is proved, even though it is not established by court declaration, a criminal court can pass judgment on matters of crime related to bankruptcy.
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