In the face of bankruptcy, paying one creditor and not another: is this allowed?

In the face of bankruptcy, an indirect director pays his affiliated group company, but not its financier. Rabobank believes that this director should have understood that, as a result, the company would not be able to pay off Rabobank and would also have no recourse for the resulting loss. It claimed compensation for its damages in the case in which the North Holland District Court ruled on June 27, 2018,[1] based on wrongful conduct.

General rule for selective payment

The court considered that the basic principle is that a director is free to determine which creditors (there first) are paid (selective payment). There is no general rule that says a debtor must pay his creditors proportionally. This also applies when it comes to payments to affiliated companies.

This becomes different when bankruptcy is imminent

However, this becomes different if it is clear that bankruptcy is inevitable, at least if the director must take seriously into account that not all debts can be paid. In that case, the legal ranking of creditors must be respected. But when must a director seriously take into account that not all debts can be paid? This depends on all the facts and circumstances of the case.

When is selective payment no longer allowed

A warning from the bank that the obligations were not being met was insufficient in this case to assume that it was reasonably clear that the debtor would go bankrupt, because at the same time there was an ever-growing turnover. Two subsequent warnings were also not enough because there was talk of a possible acquisition or merger. The court ruled in this case, that at the time Rabobank (for the second time) terminated the financing, it became clear that bankruptcy was becoming inevitable. The director should have understood then that paying an affiliate alone would result in Rabobank no longer being able to be paid, nor would there be any recourse for damages. The payments that were subsequently made exclusively to the affiliate were therefore unlawful. However, the court did rule that only half of the subsequently paid net amounts were due to Rabobank. The other half was for the affiliated company because that was the only other creditor. Both creditors should (the thinking goes) have been paid proportionally.

Special circumstances

There may be special circumstances that make selective payment to an affiliated company (preferential treatment) still justified. However, the defense that the affiliated company also had a large claim, but no collateral like Rabobank, is not a special circumstance, according to the court.

Selective payments to an affiliate

In this case, selective payments were allowed to be made to an affiliated company before an "impending" bankruptcy because the affiliated company had made payments to the later bankrupt during that period. This was, in the court's view, also in Rabobank's interest because it allowed business operations to continue for some time. Another factor was that Rabobank had not yet terminated the financing at that time and it was not obvious that the director was suspending payments to others in order to reserve funds for the benefit of Rabobank.

If you as business owner are not getting your bill(s) paid or do not know if you can (partially) pay some creditors and others, please contact us. We will be happy to help you.

[1] District Court of North Holland, June 27, 2018, ECLI:NL:RBNHO:2018:5244 inc. Rabobank/Maro Beheer B.V.