How to deal with bankruptcy during legal proceedings

What is the purpose of bankruptcy?

In short, the purpose of bankruptcy is for the insolvency administrator to wind up the estate in an orderly manner by realising and distributing the assets amongst the creditors in accordance with a statutory order of priority. The company that goes into bankruptcy (the bankrupt company) immediately loses control of its assets upon the bankruptcy order, and the bankrupt company may no longer enter into commitments that can be enforced in the bankruptcy proceedings.

What happens to the dispute upon the bankruptcy order?

If the dispute in the ongoing legal proceedings concerns property (e.g. claims or other assets) that may form part of the bankruptcy estate, the bankruptcy estate has a right, but not an obligation, to take over the bankrupt company's case. In other words, the liquidator must decide whether the bankruptcy estate should intervene in the proceedings. The estate then steps in as a party in place of the bankrupt company. The decision is based on the insolvency practitioner's assessment of whether taking over the case is in the estate's best interests or not, with the likely outcome of the proceedings being a key factor in that assessment.

If the bankruptcy estate chooses not to step into the proceedings, it is deemed to have waived its right to the property covered by the dispute. The proceedings do not automatically conclude if the bankruptcy estate does not take over the bankrupt company's claim. The bankrupt company remains a party to the proceedings, and the case proceeds unless one of the parties withdraws their claim. This constitutes an exposed position for the party bringing the action against the bankrupt company; see more below.

What is the risk if the opposing party is declared bankrupt during ongoing proceedings?

If the opposing party is declared bankrupt and the bankruptcy estate has chosen to intervene in the proceedings, this does not entail any particular risks beyond those inherent in any legal proceedings. If the bankruptcy estate is successful in its claim, the proceeds will accrue to the bankruptcy estate. If, however, the bankruptcy estate is unsuccessful, it is jointly and severally liable with the bankrupt company for all costs incurred prior to the assumption of the claim and solely liable for costs relating to the period after the assumption of the claim. The claim constitutes a preferential claim against the bankruptcy estate, which means that it takes precedence over most other debts in the bankruptcy. If the bankruptcy estate joins the proceedings as a defendant, the bankruptcy estate is liable for all legal costs, regardless of whether they relate to the period before or after the takeover.

If the opposing party is declared bankrupt whilst proceedings are ongoing and the bankruptcy estate has not taken over the bankrupt company's case, there is a risk that payment of the legal costs will likely not be made by that party. The bankruptcy estate is therefore not liable for any legal costs.

Personal liability

If, as a counterparty to a bankrupt company, you are unable to recover the principal sum or legal costs awarded to you, it may be possible to seek payment from someone other than the company under the rules on personal liability or piercing the corporate veil.

The main principle is that the representatives of a limited company are not personally liable for the company's debts. There are, however, some exceptions. A typical example is where the directors of a bankrupt company have failed to comply with the provisions of company law regarding the preparation of a balance sheet showing the company's financial position when the company's equity falls below half of the registered share capital.

Piercing the corporate veil means that shareholders or others with a controlling influence may, under special circumstances, be held liable for the company's obligations in the form of personal liability. However, this is an exceptional situation.

What happens if the opposing party strips the company of its assets during ongoing legal proceedings?

It is not uncommon for companies on the brink of bankruptcy to dispose of assets in order to strip the company prior to or during legal proceedings. This may be done with the aim of making it more difficult for the opposing party to recover the awarded capital sum and legal costs. The assets disposed of by the company may, under certain circumstances, be recovered and returned to the bankruptcy estate. Disposal of assets may also, under certain conditions, constitute a criminal offence and be punishable as fraudulent conduct against creditors.

Key points

• The bankruptcy estate has a right, but not an obligation, to take over the bankrupt company's case in ongoing legal proceedings.

• If the bankruptcy estate does not intervene in the proceedings and the bankrupt company does not withdraw its claim, the opposing party risks not being paid the legal costs awarded to them.

• In exceptional cases, claims may be directed against the company's representatives or owners through personal liability or piercing the corporate veil.