WSNP and the executive order

On November 26, 2012, the Minister of Security and Justice announced a number of measures aimed at combating bankruptcy fraud more effectively.[1] One of these measures concerns the introduction of the Civil Administration Prohibition Act ("the bill"). This bill[2] makes it possible to impose a management ban under civil law on directors of legal entities engaged in bankruptcy fraud. However, the bill contains no provisions for partnerships[3] or sole proprietorships. This article discusses whether the Wsnp administrator under the management ban should be given the same task as that assigned to the trustee in bankruptcy.

The bill

The bill makes it possible to impose a management ban on the director of a legal entity. This management prohibition will take the form of an addition to the Bankruptcy Act, in Articles 106a through 106d. Such a management prohibition entails a ban on managing a legal entity, for a maximum period of five years. This concerns "a director [...] who has manifestly performed his duties improperly during or in the three years preceding the bankruptcy," according to the first paragraph of the proposed Section 106a Fw. Imposition of an administrative ban can be requested from the court by the public prosecutor or by the trustee appointed in the bankruptcy in question. In the event a request for the imposition of the management ban is granted, the director can no longer manage legal entities. In addition, while the ban is in effect, this director cannot be reappointed as a director (or supervisory director).

The bill complements already existing civil law powers, such as the inquiry procedure (Article 2:344 BW et seq.), the possibility of holding a director personally liable in the event of manifestly improper management (Article 2:138 BW and 2:248 BW) and the bankruptcy pauliana (Article 42 and 47 Fw). These are measures that revolve around recovery or retrospective supervision. The management ban provides for preventive measures to combat bankruptcy fraud.[4] It follows from the Explanatory Memorandum that the purpose of the management ban is to prevent (future) damage, because a director cannot continue his (fraudulent) activities as a director through all kinds of detours and with new or with other legal entities. Indeed, the director can then no longer use the limited liability offered by a legal entity.

Section 106a(6) of the proposal provides that a management ban can also be imposed on a person who runs a business in the form of a sole proprietorship or general partnership. That person can then no longer become a director of a legal entity.

As mentioned, the management ban focuses on the management of a legal entity. It does not prohibit doing business through the figure of the partnership or the sole proprietorship. Nor does it include a prohibition on share ownership. It follows from the Explanatory Memorandum that the reason is that the prohibition should not go beyond the goal to be achieved. That goal is to take away the possibility of limited liability through a legal entity.

Paragraph 2 of Section 106a of the FW gives five situations in which, barring exculpation, manifestly improper management is assumed. In the first place, this is the case when the conditions for directors' liability, as referred to in Sections 2:138 (1) or 2:248 (1) of the DCC, are met (paragraph 2 under a). In addition, manifestly improper management is assumed in the event that legal acts performed by the director are nullified on the basis of the involuntary liquidation clause and one or more creditors are substantially prejudiced as a result (paragraph 2 sub b) or if a director seriously neglects his obligation to inform and cooperate with the trustee (paragraph 2 sub c). The fourth ground on which manifestly improper management is taken as a given is if the bankrupt (or the director himself) has been involved twice within three years in a previous bankruptcy (paragraph 2 sub d). The last ground is mentioned in Article 106a paragraph 2 sub e, namely when an administrative fine has been imposed on the director or legal entity for a number of offenses as referred to in the Algemene Wet inzake Rijksbelastingen.

The bill offers a number of positive handles with regard to combating fraud. For example, the cases in which an administrative ban can be claimed have been broadened in that it is no longer specifically required that, if the director has manifestly performed his duties improperly, improper management was a major cause of the bankruptcy. As a result, an administration ban can also be sought in cases where the bankruptcy is due to other causes, according to Insolad.[5] In addition, the administration ban creates the possibility not only to seize upon conduct prior to the bankruptcy as grounds for seeking an administration ban, but what is new is that conduct during the bankruptcy can also be grounds for seeking an administration ban. The regulations contained in the bill are further elaborated in Sections 106b through 106d of the Fw; however, it would take us too far to go into those sections in more detail in this contribution.

Role for the administrator?

Since the proposal stipulates in Section 106a(6) that the regulation applies mutatis mutandis to natural persons acting in the course of a profession or business, one may wonder whether this regulation could possibly become relevant to debt restructuring practice as well. The Public Prosecutor's Office and the trustee are granted the power to request an administration ban in the first paragraph. The administrator is not mentioned there. The question is whether this was a deliberate choice of the legislator, or whether the legislator did not consider that the Wsnp administrator might also have a role to play here. It seems that the latter is the case. The Explanatory Memorandum to the bill states that in practice it appears that business owners also commits bankruptcy fraud through sole proprietorships. Research has shown that in some 11% of the cases wrongful or paulian bankruptcies are committed by natural persons acting in the exercise of their profession or business. Although such persons are personally liable for the debts incurred, it is nonetheless - according to the Explanatory Memorandum - undesirable if such business owner could in future, when continuing its business activities after bankruptcy, still benefit from the limited liability offered by a legal person. It is therefore observed that natural persons acting in the exercise of a profession or business also commit bankruptcy fraud. Wsnp administrators also face such business owners, but nowhere in the Explanatory Memorandum is the Wsnp administrator mentioned in that context.

Whether the legislator did not consider this, or whether the legislator made a conscious choice, the question arises for us whether it is (after all) desirable that the Wsnp administrator can also claim an administration ban. To answer this question, it is necessary to examine whether the grounds in Section 106a(2), whereby manifestly improper management is assumed and on the basis of which the trustee can claim an administration ban, also apply mutatis mutandis in the case of a debt restructuring arrangement.

In the context of admission to the debt rescheduling arrangement, good faith with respect to the arising and unpaid debts cannot be said to exist, among other things, if the debtor "has conducted his own business (sole proprietorship) and has kept and is available (virtually) no accounting records." This is evident from Annex 5.4 of the Rules of Procedure for the Application of Insolvency Proceedings of the District Courts.[6] Running a business without proper financial records, from which the rights and obligations of the business can be known, can lead to the conclusion that there has been improper management. Thus, while the ground mentioned in Section 106a(2)(a) may also apply mutatis mutandis in the debt restructuring scheme, the application of the debt restructuring scheme, however, will not be possible in such a case.

The administrator, like the trustee, may also have to deal with the situation in which legal acts have been annulled on the basis of the bankruptcy pauliana. After all, Articles 42 through 47 Fw are by the linking provision of Article 313 Fw applicable by analogy in the debt restructuring scheme. Thus, the ground of paragraph 2 under b also applies by analogy. And why should an administrative ban be claimed in respect of a (former) business owner who seriously neglects his duty to inform and cooperate with the trustee in the bankruptcy (subsection 2 (c)), and not in the case of debt restructuring?

The last ground discussed here is that of paragraph 2(d). During a debt restructuring arrangement, the debtor can be declared bankrupt in respect of claims that do not fall within the scope of the debt restructuring arrangement. This follows from article 312 Fw. As a result of the bankruptcy declaration, the debt restructuring arrangement ends by operation of law. It may also happen that the debt rescheduling arrangement is terminated prematurely and that there are assets available to satisfy the claims in whole or in part therefrom (article 350 paragraph 5 Fw). In that case, the debtor also becomes bankrupt, but by operation of law. In debt restructuring practice, therefore, a debtor may find himself in a state of bankruptcy twice in three years, namely when an earlier bankruptcy has been converted into a debt restructuring arrangement, which arrangement then again ends in bankruptcy. So even then - by the successor trustee, admittedly - an administrative ban can be claimed.

It follows from the Explanatory Memorandum that the board prohibition provides an important tool to effectively combat fraud. According to the Minister of Security and Justice, the trustee and the Public Prosecutor are the appropriate parties to request the management ban. The Public Prosecutor in case the public interest is at stake, the trustee because in practice he is often the first to encounter signs of fraud in a bankruptcy. Once a debt restructuring arrangement has been declared, the administrator may also come across signs of fraud. If that is the case, in our opinion one of the following options should be available to the Wsnp administrator:

1. The administrator is granted the same powers as the trustee. The administrator seeks an administration ban, after which interim termination is also requested; after all, fraud is not compatible with the purpose and spirit of the debt restructuring scheme.

2a. The administrator is not granted the power to seek an administration ban. The administrator requests an interim termination and also informs the successor trustee - who is appointed because the interim termination ends in bankruptcy - that perhaps an administration ban should be requested. In addition, the administrator should have the opportunity to report to the Public Prosecutor's Office what he or she has observed, so that the Public Prosecutor's Office can request an administrative ban. This is in view of the (public) interest served by this.

2b. In the absence of any income for distribution, the interim termination referred to under 2a does not result in bankruptcy. Even then, the administrator should be able to report to the Public Prosecutor's Office what has been found.

It follows from the above that the grounds, on which the public prosecutor and the trustee can request the imposition of an administrative ban, in theory largely apply mutatis mutandis to the Wsnp. How has the bill now been received in (bankruptcy) practice?

Critical sounds

Research shows that criticism of the bill as it is currently presented has come from various quarters. This criticism mainly focuses on the so-called "empty estate problem" and also struggles with balancing interests.[7] By "empty estate problem" is meant that a trustee can do little in a possible case of bankruptcy fraud, if he finds no or insufficient financial means in the bankruptcy estate to be able to investigate fraudulent acts. However, the bill does not address the empty estate issue, the criticism goes,[8] since it does not address the cases where there are insufficient financial resources to seek such an injunction, and in those cases, it is likely that a trustee will indeed fail to do so.

As Wessels also argued in his lecture given in Utrecht on December 19, 2013 on the occasion of the 10th anniversary of the Beroepsvereniging Bewindvoerders Wsnp (BBW)[9], the question is whether such a request fits within the legal task of a receiver. After all, according to Insolad, a management ban is claimed in the public interest, while the trustee only represents the interests of creditors.

Thus, there may be a clash between the public interest (preventing bankruptcy fraud) and the interest of creditors (receiving the highest possible proceeds from the bankruptcy).[10] For example, a trustee may have to weigh interests if he has found a director liable and can enter into a settlement with that director, on the condition that the trustee refrains from seeking an administration ban. On the one hand, the creditors in the bankruptcy may benefit from such a settlement, and it could be argued that entering into such a settlement is within reason (with the administration ban action serving as "chump change" in negotiating the amount of the settlement, according to Insolad). On the other hand, claiming an executive order may be of social importance. The creditors then have no (direct) interest in it. However, they will pay for the costs if the trustee would not enter into the settlement and would subsequently claim, at the expense of the estate, an administration ban."[11]

The above also applies to a certain extent to the Wsnp administrator. After all, as follows from Section 316 of the FW, he is charged with the supervision of the debtor's compliance with his obligations under the debt restructuring scheme as well as the management and liquidation of the estate. The latter task is performed by the Wsnp administrator in the interest of the creditors. According to Insolad, additional tasks assigned to the administrator may not interfere with the performance of the primary tasks. In our opinion, this should also apply to the Wsnp administrator. In addition, the amount of the remuneration of the Wsnp administrator is already fixed in advance, while the trustee may declare the extra activities at the expense of the estate. Understandably, Insolad believes that it is undesirable that on the one hand the administrator is assigned tasks whose results do not benefit the creditors, but which subsequently have to be paid by the estate. For the Wsnp administrator, on the other hand, the question is whether the remuneration he or she receives is in proportion to the extra work that may be assigned; work that also serves a public interest. This is expected to create a storm of criticism in advance. Insolad correctly notes that it is desirable that funding from other sources should take place for the performance of such duties.

Conclusion

The foregoing has shown that there is common ground between trustee and administrator in terms of identifying fraud. We also believe that the grounds of the proposed second paragraph of Section 106a Fw are partly applicable by analogy in the case of debt restructuring. We also believe that the criticism of the bill, as regards the role of the trustee, can be applied one-to-one to the role of the administrator. The question is therefore whether it is desirable that the Wsnp administrator can also claim the administration ban.

Of the previously described options, which in our opinion should be available to the administrator in the event that fraud is detected, we do not believe that the first-mentioned option is preferable. After all, if the Wsnp administrator himself claims a management ban, the previously discussed points of criticism remain at issue: who finances the extra work and how does the interest of the creditors relate to the public interest? In our opinion, therefore, the second option - namely to request interim termination in the event that fraud is detected - is the most obvious one. If interim termination then leads to bankruptcy by operation of law, the administrator can then inform the successor trustee that perhaps an administration ban should be requested. In particular, however, in the case where interim termination does not result in bankruptcy, the administrator should have the option of reporting what he or she has found to the Public Prosecutor's Office so that the Public Prosecutor's Office can request an administration ban. We concur with the criticism discussed earlier and believe that, in view of the interest it serves, seeking an administration ban belongs pre-eminently to the Public Prosecutor's Office. However, this does not alter the fact that good cooperation is required with regard to combating fraud. Administrators, and perhaps also Wsnp administrators, should be involved in this fight since they will be among the first to identify such fraud.

In conclusion, we believe that the positive aspects offered by the bill in its current form with respect to combating fraud do not outweigh the (possible) negative consequences. For the time being, we consider the current safeguards offered by the statutory regulation of Title III of the Bankruptcy Act to be adequate. Therefore, granting the administrator the power to claim an administrative ban is not, in our opinion, of (sufficient) added value.

[1] Parliamentary Papers II 2012-13, 29 911, no. 74

[2] Bill available for download at http://www.rijksoverheid.nl/documenten-en-publicaties/kamerstukken/2013/03/29/wetsvoorstel-civielrechtelijk-bestuursverbod.html.

[3] Partnership, general partnership and limited partnership.

[4] Explanatory Memorandum under section 2.

[5] The Insolvency Law Association attorneys, which studied the preliminary draft and highlighted a number of comments on the bill in its letter dated November 19, 2013. This letter is available for download at http://static.basenet.nl/cms/105928/website/reactie-insolad-op-voorontwerp-bestuursverbod.pdf.

[6] Available at https://zoek.officielebekendmakingen.nl/stcrt-2012-26606.html.

[7] TvI 2014/16, Fraud and abuse in bankruptcies: investing in an approach that does work, Drs. J. Brouwer RA, p.1. + FIP, June 2013, Legislative proposal Civil Administrative Prohibition Act, mr. R.J. Philips, p. 114.

[8] TvI 2014/16, p.1.

[9] The text of that lecture was published in abridged form in Wsnp Periodical 2014/01; the full text is available for download at http://bobwessels.nl/wp/wp-content/uploads/2013/12/2013-12-19-10-jaar-BBW.pdf.

[10] FIP, June 2013, p. 114.

[11] FIP, June 2013, p. 118.