Challenging of the debtors transactions in bankruptcy proceedings

Ganeva Ekaterina Olegovna PhD in Law Associate Professor of the Department of Civil Law of the Irkutsk State University Law Institute; Coordinator of the Youth Research Center of the Research Institute of Legal Protection of Lake Baikal ISU 664082, Russia, Irkutskaya oblast', g. Irkutsk, ul. Ulan-Batorskaya, 10 kareva10@mail.ru Other publications by this author

The current Russian legislation provides creditors with a fairly wide range of tools to protect their rights and legitimate interests in bankruptcy cases, which, in particular, can include contesting transactions. The category of disputes on challenging transactions in bankruptcy is one of the most difficult categories, along with disputes on bringing to subsidiary liability and recovery of losses from persons controlling the debtor. Contesting the debtor's transactions aimed at achieving the maximum possible fair satisfaction of creditors' claims is aimed at "returning to the bankruptcy estate the value that came out of the debtor's property in the presence of the conditions specified in the law" ^{[1, p. 271]}. Being an effective way to return to the bankruptcy estate that property that can be sold to satisfy creditors' claims, contesting transactions is aimed at protecting their interests ^{[2, p. 416]}.

Despite the undeniable importance of this institution, which makes it possible to return the debtor's assets, replenish the bankruptcy estate, and eliminate problems associated with violation of the principle of proportionality and proportionality of satisfaction of creditors' claims, there is still a fragmentation of legal material, which gives rise to topical theoretical and practical issues of challenging the debtor's transactions.

Certain aspects of challenging the debtor's transactions became the subject of research in the works of A. N. Levushkin, R. K. Lotfullin, R. T. Miftakhutdinov, E. D. Suvorov, A.I. Shaidullin, I. M. Shevchenko, etc. However, the topic of challenging transactions in bankruptcy is multidimensional and requires further study, taking into account the current state of legislation, constantly changing approaches in the practice of its application, and existing problems in the field under consideration.

The relevance of the topic under consideration is also evidenced by the increase in the number of applications for recognition of debtor's transactions as invalid in recent years. According to the Unified Federal Register of Bankruptcy Information (hereinafter referred to as the EFRS) ^[3], in 2021, arbitration courts considered 14,143 applications for invalidation of debtor's transactions, of which the share of satisfied applications was 45%; in 2022, arbitration courts considered 16,747 applications for invalidation of debtor's transactions, of which 47% were satisfied; during the period January-June 2023, 8,273 applications were considered, of which the share of satisfied was 43%. Statistical data indicate that the number of cases related to challenging transactions in the framework of bankruptcy proceedings is growing. At the same time, there is also an increase in the number of satisfied applications for recognition of the debtor's transactions as invalid (for the period 2019-2022, the share of satisfied applications from among those considered by the courts increased by 5%), which indicates the importance of this institution in bankruptcy ^[4].

According to G. F. Shershenevich, "the question of the force of legal actions, alienations and transactions committed by an insolvent debtor before the opening of the bankruptcy process was a "sore spot" of Russian pre-revolutionary legislation" ^{[1, p. 287]}. G. F. Shershenevich, describing the unsatisfactory situation in which the legislation was at that moment, noted that "there may be such phenomena that have long been provided for by foreign legislation and which are capable of undermining good faith in civil, especially in trade, turnover. ... the legislation does not prevent the donation of property on the eve of declaring insolvency. ... practice has managed to take advantage of this gap – a rare competitive case in our everyday life is devoid of a criminal connotation" ^{[1, p. 287]}.

Currently, the possibility of challenging the debtor's transactions in bankruptcy cases is provided for in Article 61.1 of Federal Law No. 127-FZ "On Insolvency (Bankruptcy)" (hereinafter - the Bankruptcy Law).

Transactions made by the debtor or other persons at the expense of the debtor may be declared invalid:

- on special grounds provided for by the Bankruptcy Law (Articles 61.2, 61.3 and other grounds contained in the Bankruptcy Law);

- on general grounds provided for by civil law (the Civil Code of the Russian Federation or legislation on legal entities) (Paragraph 17 of the Resolution of the Plenum of the Supreme Arbitration Court No. 63 "On certain issues related to the application of Chapter III.1 of the Federal Law "On Insolvency (Bankruptcy)" (hereinafter referred to as Paragraph 63 of the Supreme Arbitration Court)).

On special grounds, the following may be invalidated: a) suspicious transactions with unequal counter-provision (clause 1 of Article 61.2 of the Bankruptcy Law); b) suspicious transactions committed with the aim of harming the property rights of creditors (clause 2 of Article 61.2 of the Bankruptcy Law); c) transactions with preference (Article 61.3 of the Bankruptcy Law); d) transactions made in bankruptcy proceedings in violation of bankruptcy legislation (paragraph 2, paragraph 1, Article 66, paragraph 5, Article 82, paragraph 7, paragraph 4, Article 83 of the Bankruptcy Law) ^{[5, p. 27]}.

What transactions can be challenged in insolvency (bankruptcy) cases?The Bankruptcy Law broadly interprets the concept of "transaction" in comparison with the Civil Code of the Russian Federation (hereinafter – the Civil Code of the Russian Federation), fixing the possibility to challenge any actions of persons who caused or could have caused a decrease in the debtor's estate, or an increase in any obligations on the debtor's side. "Within the meaning of Article 61.1 of the Bankruptcy Law, the list of legal actions that can be challenged in a bankruptcy case is not limited solely to the concept of "transactions" provided for in Article 153 of the Civil Code of the Russian Federation" (paragraph 11, paragraph 19 of the Review of Judicial Practice of the Supreme Court of the Russian Federation No. 3 (2021)). At the same time, when challenging transactions on special grounds, the industry affiliation of such transactions does not matter, since the Bankruptcy Law "extends the application of its postulates to challenge actions aimed at fulfilling obligations arising in almost all branches of law, including civil, labor, family, as well as tax, customs and others" ^[6].

Thus, according to the rules of Chapter III.1 of the Bankruptcy Law, disputes may be:

- actions aimed at fulfilling the contract (cash or non-cash payment by the debtor of a monetary debt to the creditor, transfer by the debtor of other property to the creditor's property), as well as actions to terminate the obligation (set-off, novation agreement, provision of compensation, etc.);

- banking operations (debiting by the bank of funds from the client's bank account to repay the client's debt to the bank or other persons (both without acceptance and on the basis of the client's order));

- actions in other industry legislation (payment of wages, prenuptial agreement, agreement on the division of common property of spouses, payment of taxes, fees and customs duties, transfer of funds to the recoverer in enforcement proceedings);

- actions committed by other persons (statement of set-off made by the creditor);

- actions for the execution of a judicial act (determination on the approval of a settlement agreement).

According to E.D. Suvorov, "all types of acts and actions that can be challenged: 1) if it is a question of challenging fraudatory or unequal transactions, they entail a decrease in the bankruptcy estate; 2) if it is a question of challenging preferential satisfaction, they entail individual satisfaction" ^{[7, p. 43]}.

Thus, in order to protect creditors from unfair behavior of the debtor and some of its counterparties, as well as in order to comply with the principles of priority and proportionality of satisfaction of the claims of all creditors, any legal facts that negatively affect the debtor's estate can potentially be challenged (Definition of the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation dated December 18, 2017 No. 305-ES17-12763(1,2) in case no. A40-698/2014).

It is important to note here that the possibility of challenging actions provided for by the Bankruptcy Law should not apply to legal relations that are not complicated by bankruptcy.

Thus, disagreeing with the position of the district Court on the admissibility of resolving a corporate dispute by challenging payments, motivated by reference to the provisions of the Bankruptcy Law, the Judicial Board for Economic Disputes of the Supreme Court noted that "challenging payments made in non-cash form as independent transactions is allowed by bankruptcy law (paragraph 3 of Article 61.1 of the Bankruptcy Law) in connection with special grounds for challenging such transactions" (Ruling of the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation dated September 5, 2023 No. 309-ES23-8899 in case No. A60-23945/2021).

Within the framework of special bankruptcy grounds, it is possible to challenge such actions as the rejection of a claim and the conclusion of a settlement agreement, since such actions are likely to negatively affect the bankruptcy estate and, as a result, the property rights of creditors. It is obvious that the rejection of the claim objectively affects the state of the debtor's bankruptcy estate to the detriment of the interests of its creditors, therefore such an action can be challenged under bankruptcy rules in compliance with the procedural form. The challenge of the refusal of the claim must be carried out through an appeal against the judicial act by which the refusal of the claim was accepted. At the same time, the courts, when evaluating this judicial act, are obliged to check the rejection of the claim for its compliance with special norms of the Bankruptcy Law, and not be limited only to a formal check of the rejection of the claim for compliance with the requirements of procedural legislation (The ruling of the Judicial Board for Economic Disputes of the Supreme Court issued Definition No. 305-ES21-1766(1,2) in case No. A40-193248/2018). In terms of challenging the settlement agreement, the position is similar, the settlement agreement can be challenged only by challenging the judicial act that approved the settlement agreement, and operations for the execution of the settlement agreement can be challenged independently by challenging the transaction in the framework of a bankruptcy case.

Next, let's consider the question of how the court should act if, within the framework of a bankruptcy case, a requirement is made to invalidate the contract as a whole, and during the review it will be established that it is not the contract as a whole that is invalid, but its individual parts, actions to execute this contract? The answer to this question is contained in the Ruling of the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation dated 12/24/2021 No. 305-ES21-18487 in case No. A40-259314/2019, which notes that if the court finds that there are no grounds for invalidating the contract as a whole, then the court must proceed to checking specific actions on the execution of this agreement. Thus, the bankruptcy trustee filed an application for invalidation of the contract as a whole. The courts refused to satisfy the stated requirements, noting that, in general, the contract does not have signs of invalidity. However, the Judicial Board for Economic Disputes of the Supreme Court, correcting errors made by the courts of lower instances, indicated that individual actions to execute the contract had signs of invalidity, when considering the case it was necessary to identify these actions and, accordingly, invalidate not the entire contract, but actions to execute it according to Art. 61.2 or Art. 61.3 The Bankruptcy Law. Thus, the court may invalidate specific actions if it is established that there are grounds for this.

It is also interesting to consider the issue of the specifics of challenging the chain of transactions in the framework of a bankruptcy case. Challenging the chain of transactions in the framework of bankruptcy proceedings is an important mechanism for protecting the interests of creditors and combating unfair actions of the debtor. In the chain of transactions, not all transactions are disputed as independent elements of the chain, but a single transaction is determined, covered by a chain of sequentially completed transactions, and is subject to dispute. Judicial practice, naming the signs of a chain of transactions, indicates that such transactions should be united by a single purpose, intent on withdrawing liquid assets of the debtor; should be aimed at harming the property rights of creditors; should deprive creditors of the opportunity to repay claims at the expense of disputed property. In addition, affiliation and interest between the debtor and the ultimate acquirer must be established (Definition The Judicial Board for Economic Disputes The Supreme Court of the Russian Federation dated July 31, 2017 No. 305-ES15-11230 in case No. A40-125977/2013). The chain of transactions includes a sequence of several interrelated transactions that can lead to deterioration of the debtor's financial condition and concealment of his assets. Thus, a debtor can transfer his assets to a third party through a series of transactions that, at first glance, may seem legitimate. However, "in such chains of transactions, the goal will violate the legal principle of making transactions, namely the principle of non-use of law provided for in Article 10 of the Civil Code of the Russian Federation" ^[8].

The following situation can be an illustrative example. The debtor transfers liquid property to another legal entity that is formally unaffiliated and unrelated to the debtor. In the future, this legal entity implements the transferred property to the beneficiary, who is actually interested in receiving it. Such sequential execution of several transactions is carried out in order that, in the event of a dispute over a transaction made by the debtor, the original transaction is disputed. And as a rule, a legal entity that acquires property under the initial transaction does not have any other property. Therefore, even if this transaction is declared invalid, it will be impossible to receive anything from this legal entity in the future, while the beneficiary remains with the property. In this case, it is necessary to qualify the combination of two transactions as a single transaction. Thus, challenging the chain of transactions makes it possible to immediately involve the final acquirer as a defendant in the bankruptcy case ^[9]. It seems that in this case we are talking about a double qualification, namely: first, a chain of transactions is determined, this chain should be qualified as a fake transaction that covers a single transaction for the withdrawal of assets, and then the provisions of Articles 61.2, 61.3 of the Bankruptcy Law apply to the covered transaction. The consequences of invalidity apply to the covered transaction, that is, to the transaction that was actually aimed at withdrawing assets.

The Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation in its Ruling No. 306-ES17-11031(6) dated August 27, 2020 in case No. A65-27171/2015 indicated that "the courts did not investigate the question of whether the transactions were fake, possibly covering up in fact one really completed transaction - the withdrawal of the debtor's asset in favor of the beneficiary as the ultimate owner, the actual beneficiary and the direct participant in the considered interconnected chain of transactions." The courts did not investigate whether these transactions were fake and possibly covering up one single transaction. That is, in this case, the courts applied the consequences of invalidity for the initial transactions by collecting funds from counterparties, rather than establishing that this is a single transaction that covers the transaction for the withdrawal of property. Thus, the consequences of invalidity should be applied to the covered transaction and the property should be returned to the bankruptcy estate, rather than collecting money from counterparties.

It should be noted that, challenging a particular action on the performance of a contract, one cannot limit oneself only to evaluating this particular performance without covering the entire legal relationship between the parties.

The legal position of the Supreme Court of the Russian Federation boils down to the fact that "in a situation where one expenditure operation led to the company's preferred receipt of the balance on its account, a subsequent operation, on the basis of which a sum of money from external sources was received into the same account, replenishing the bank's correspondent account, and therefore the bankruptcy estate, eliminates this preference for the amount received" (Ruling of the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation dated April 27, 2023 No. 305-ES22-3388 (7) in case No. A40-234427/2020). Thus, the bank was declared insolvent (bankrupt), and during the examination of the insolvency application it was established that funds were transferred from the account in this bank belonging to the organization a few days before the introduction of the temporary administration and the revocation of the bank's license. The bankruptcy trustee challenged only this transfer, pointing out that it has the characteristics of a transaction made in preference to a specific creditor, since it was carried out a few days before the date of the introduction of the interim administration. The courts declared this transaction invalid. However, the Supreme Court of the Russian Federation, having expanded the study of this relationship, found that after the transfer transaction was made from the account, the same organization subsequently replenished its correspondent account with cash and, accordingly, it replenished this expenditure transaction. The courts needed to assess the overall relationship of the parties to these transactions.

The Presidium of the Supreme Court of the Russian Federation in the Review of judicial practice in resolving disputes on insolvency (bankruptcy) for 2022, he gives another example. Funds were transferred from the organization's currency account to the accounts of the same organization in other credit institutions. The bank was declared bankrupt, and this transaction was disputed as a transaction made with preference. However, the Supreme Court of the Russian Federation pointed out that "the courts did not take into account the receipt of funds from external sources, including other credit institutions, to the company's ruble settlement account used to purchase currency during the disputed period."

Also, the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation in its Ruling dated May 4, 2023 No. 305-ES19-18803 (9, 16) in case No. A40-168513/2018, where the bankruptcy trustee disputed payments in favor of the gas station from the debtor, indicated that "contrary to the conclusions of the courts, the real nature of the debtor's relationship with customers, which served the basis for making payments, indicates that there is no harm to the property rights of creditors." The courts of the first three instances established that the transaction was made in the absence of a counter-provision. The gas station issued invoices, and according to these accounts, funds were transferred by the bankrupt. The courts declared the transactions invalid. The Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation, considering this case, found that in this case the relationship was very complex. The company (bankrupt) issued fuel cards. For these fuel cards, it attracted money from counterparties. Points were credited to fuel cards, and contractors refueled at the gas station using fuel cards. For the fuel provided, the gas station billed the organization, which had to be paid. If we evaluate it as a whole, then it is impossible to say that there was no counter-provision, since the counter-provision was just the transfer of funds for them by counterparties purchasing fuel cards. Thus, in this case, when determining the sign of harm, it was necessary to assess the cumulative economic effect for the debtor from entering into several legal relations united by a common goal.

In conclusion, let us consider one of the controversial issues in the field of challenging debtor's transactions in bankruptcy cases, namely the question of the ratio of special grounds provided for by the Bankruptcy Law and the general norms of the Civil Code of the Russian Federation on recognizing transactions that can be qualified as committed with abuse of law ^[10] as invalid (Articles 10 and 168 of the Civil Code Russian Federation).

I.M. Shevchenko suggests the following method of resolving the dispute on the basis of Articles 10, 168 of the Civil Code of the Russian Federation and Articles 61.2, 61.3 of the Bankruptcy Law: "a claim based on Articles 10 and 168 of the Civil Code of the Russian Federation can be used only in situations where there is no specific norm that allows restoring violated rights of a person, however the defendant's behavior contradicts the principle of good faith (clause 3 of Article 1 of the Civil Code of the Russian Federation). If there is such a norm, as in our case (these are Articles 61.2 and 61.3 of the Bankruptcy Law), then the claim based on Articles 10, 168 of the Civil Code of the Russian Federation is not subject to application" ^{[11, p. 154]}.

The legal position is fixed in Paragraph 63 of the Supreme Arbitration Court, according to which the presence in the Bankruptcy Law of special grounds for challenging transactions in itself does not prevent the court from classifying a transaction in which an abuse of law was committed as null and void, including when considering the creditor's claims. Thus, the Supreme Arbitration Court of the Russian Federation allowed the possibility of a general qualification of an invalid transaction both under Articles 10, 168 of the Civil Code of the Russian Federation and under special provisions of the Bankruptcy Law.

Currently, the Supreme Court of the Russian Federation departs from this position and indicates that it is impossible to mix the provisions of Articles 10, 168 of the Civil Code of the Russian Federation with special rules on contesting transactions and apply them together.

Thus, in the Ruling of the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation dated March 6, 2019 No. 305-ES18-22069 in case No. A40-17431/2016, it was noted that the presence of similar elements of the offense does not mean that the totality of the same circumstances can be qualified as under paragraph 2 of Article 61.2 The Bankruptcy Law, as well as Articles 10, 168 of the Civil Code of the Russian Federation. The qualification of a transaction as invalid under Articles 10, 168 of the Civil Code of the Russian Federation is possible only if the circumstances of its commission go beyond the signs of a suspicious transaction. Thus, the court distinguishes that if a transaction has signs of invalidity on special grounds (bankrupt), in particular according to paragraph 2 of Article 61.2 of the Bankruptcy Law, then its qualification under Articles 10, 168 of the Civil Code of the Russian Federation is unacceptable. Thus, Articles 10, 168 of the Civil Code of the Russian Federation are applied only if the bankrupt grounds for challenging fixed in Chapter III are inapplicable.1 of the Bankruptcy Law ^[12].

This is due to the special nature of the norms of the Bankruptcy Law, which should take precedence over the general norms of the Civil Code of the Russian Federation. Otherwise, the special structures for challenging transactions enshrined in the Bankruptcy Law will not make sense, since any transaction can be challenged on the general grounds provided for by the Civil Code of the Russian Federation. At the same time, the Bankruptcy Law contains a number of restrictions on challenging a transaction on special grounds (art. 61.2), in particular, it must be committed during a period of suspicion.

Meanwhile, judicial practice allows double qualification of transactions disputed in bankruptcy on special bankruptcy grounds and the provisions of Article 170 of the Civil Code of the Russian Federation on the invalidity of imaginary and fake transactions, in particular, when challenging a chain of covered fake transactions (Review of judicial practice of the Supreme Court of the Russian Federation No. 1 (2021)).

In conclusion, the following conclusions can be drawn.

Due to the objectives of bankruptcy legislation, the opportunity to challenge any legal facts that negatively affect the debtor's estate provides creditors with a mechanism for replenishing the bankruptcy estate at the expense of property illegally alienated by the debtor. It is noteworthy that in the framework of a bankruptcy case, certain actions on the execution of the contract may also be invalidated. At the same time, it is important that when challenging an action to execute a contract, one cannot limit oneself only to evaluating this particular performance without covering the entire legal relationship between the parties. Such an expansive interpretation of the concept of a transaction when resolving the issue of the admissibility of its challenge seems justified, but such an approach should not be applied in cases not related to bankruptcy.

In the framework of an insolvency (bankruptcy) case, when challenging a transaction that has signs of invalidity on special bankruptcy grounds and under Articles 10, 168 of the Civil Code of the Russian Federation, double qualification is not allowed. However, when challenging a chain of transactions, double qualification is permissible if special rules provided for by the Bankruptcy Law and the provisions of Article 170 of the Civil Code of the Russian Federation are applied. First, the chain of transactions should be qualified as a fake transaction covering a single transaction for the withdrawal of assets, after which the provisions of Articles 61.2, 61.3 of the Bankruptcy Law should apply to the covered transaction aimed at the withdrawal of the debtor's assets. In this case, the consequences of invalidity should be applied to the covered transaction.

It is obvious that the legal regulation of challenging the debtor's transactions in the framework of insolvency (bankruptcy) cases requires further work on a doctrinal understanding of the rules on challenging the debtor's transactions, taking into account the achievements of judicial practice in order to balance the interests of creditors and ensure the stability of civil turnover.