Bankruptcy - Law - Notes, Study notes of Law

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Bankruptcy Law

Developed By:

1. Mitiku Mada
2. Alemayehu Tilahun

Sponsored by the Justice and Legal System Research Institute

2009

• General Introduction ………………………………………………………………. Table of Contents
• Chapter One: Introduction to Bankruptcy ……………………………………….
• Introduction ………………………………………………………………………….
• Objectives ……………………………………………………………………………
• 1.1. Bankruptcy: Defined…………………………………………………………
• 1.2. Evolution of the Law of Bankruptcy………………………………………….
• 1.3. The Scope of Law of Bankruptcy in Ethiopian Legal System……………….
• 1.4. Principles of Bankruptcy……………………………………………………..
  • 1.4.1. Cardinal Principles…………………………………………………..
  • 1.4.2. Subsidiary Principles………………………………………………..
• 1.5. Bankruptcy compared to Winding Up………………………………………..
• 1.6. Conditions of Bankruptcy……………………………………………………
• Chapter Summary ……………………………………………………………………
• Review Questions …………………………………………………………………….
• Chapter Two: Judgment of Bankruptcy and its Effects …………………………..
• Introduction …………………………………………………………………………..
• Objectives ……………………………………………………………………………...
• 2.1. The Judgment of Bankruptcy……………………………………………………..
• 2.2. Effects of Judgment……………………………………………………………….
  • 2.2.1. Effects as regards the Debtor…………………………………………..
  • 2.2.2. Effects as regards the Creditor…………………………………………
• 2.3. Administration of Properties of the Debtor……………………………………….
• 2.4. Enforcement of Judgment…………………………………………………………
• Summary ………………………………………………………………………………
• Review Questions ………………………………………………………………………
• Chapter Three: Persons Responsible for Conducting Bankruptcy Proceedings ….. ii
• Introduction ……………………………………………………………………………..
• Objectives ………………………………………………………………………………..
• 3.1. The Court……………………………………………………………………………
  • 3.1.1. Hearing of Appeals from the Orders of the Commissioner……………….
    • Powers of the Commissioner…………………………………………….. 3.1.2. Making Orders on Matters which are Outside the
  • 3.1.3. Supervision of the Overall Bankruptcy Proceedings…………………….
• 3.2. The Commissioner………………………………………………………………….
  • 3.2.1. To authorize the Trustee to enter Appearance in Legal Proceedings…….
  • 3.2.2. To authorize the Trustee to appoint Assistant……………………………
  • 3.2.3. To call the Creditors’ Committee…………………………………………
    • all steps necessary to preserve the assets………………………………… 3.2.4. To take or to cause to be taken by the competent authorities
    • Jurisdiction of the Court…………………………………………………. 3.2.5. To refer to the Court Claims which fall within the
    • Concerning the Bankrupt Estate…………………………………………. 3.2.6. To Supervise and deal with all Matters
• 3.3. Trustees……………………………………………………………………………...
  • 3.3.1. Powers and Duties of the Trustees………………………………………..
  • 3.3.2. Discharge of Duties with All Care………………………………………..
  • 3.3.3. Deposit Funds…………………………………………………………….
  • 3.3.4. Do Functions in Person……………………………………………………
  • 3.3.5. Represent the Universality of Creditors…………………………………..
  • 3.3.6. Administer the Bankrupt Estate…………………………………………...
  • 3.3.7. Remuneration of Trustees………………………………………………….
  • 3.3.8. Controlling the Activities of Trustees………………………………………
• 3.4. The Creditors’ Committee……………………………………………………………
  • 3.4.1. The Functions of the Creditors’ Committee……………………………….
• Summary …………………………………………………………………………………. iii
• Review Questions …………………………………………………………………………
• Chapter Four: Measures in Relation to the Assets of the Debtor …………………….
• Introduction ……………………………………………………………………………….
• Objectives …………………………………………………………………………………
• 4.1. Conservatory Measures……………………………………………………………….
• 4.2. Provisional Measures…………………………………………………………………
• Chapter Summary ……………………………………………………………………….
• Review Questions …………………………………………………………………………
• Chapter Five: Proof of Debts ……………………………………………………………
• Introduction ………………………………………………………………………………
• Objectives …………………………………………………………………………………
• 5.1. Procedures of Proof…………………………………………………………………..
• 5.2. Parties jointly Liable with the Bankrupt Person………………………………………
• 5.3. Rights of Creditors……………………………………………………………………
  • 5.3.1. Rights of Creditors Secured by Movables………………………………….
  • 5.3.2. Rights of Creditors Secured by Immovable………………………………...
• 5.4. Recovery………………………………………………………………………………
• Chapter Summary ………………………………………………………………………..
• Review Questions …………………………………………………………………………
• Chapter Six: Settling the Bankruptcy …………………………………………………..
• Introduction ………………………………………………………………………………
• Objectives …………………………………………………………………………………
• 6.1. Composition…………………………………………………………………………..
  • 6.1.1. Institutions and Officers involved in Compositions………………………..
    • 6.1.1.1. Court…………………………………………………………………
    • 6.1.1.2. Commissioner………………………………………………………...
    • 6.1.1.3. Trustees……………………………………………………………….
    • 6.1.1.4. Creditors’ Committee………………………………………………… iv
  • 6.1.2. Definition of Compositions…………………………………………………
  • 6.1.3. The Juridical Nature of Compositions………………………………………
    • 6.1.3.1. The Object of Composition………………………………………….
    • 6.1.3.2. Is a Composition a Contract or Sentence……………………………
  • 6.1.4. The Initiation for Composition……………………………………………..
  • 6.1.5. Time of Proposal……………………………………………………………
  • 6.1.6. The Contain of Composition Proposal………………………………………
  • 6.1.7. Presenting the Proposal to the Creditor Committee………………………...
  • 6.1.8. Voting……………………………………………………………………….
  • 6.1.9. Secured Creditors……………………………………………………………
  • 6.1.10. Relatives of the Bankrupt Person…………………………………………..
  • 6.1.11. Rights acquired after Adjudication of Bankruptcy…………………………
  • 6.1.12. Approval of the Proposals of Composition by the Creditors………………
  • 6.1.13. Approval of the Composition………………………………………………
  • 6.1.14. Set Aside Confirmed Composition…………………………………………
  • 6.1.15. Grounds to Reject the Confirmation……………………………………….
  • 6.1.16. Confirmation of Composition……………………………………………...
  • 6.1.17. Follow-Up after Confirmation……………………………………………..
  • 6.1.18. Provisions for the Execution of the Composition………………………….
  • 6.1.19. The Effects of Composition……………………………………………….. - 6.1.19.1. Effects of Confirmation on Bankruptcy Proceedings…………… - 6.1.19.2. Exception to the Suspension…………………………………….. - Person…………………………………………………………… 6.1.19.3. Effects of Confirmation on Persons jointly Liable with the Bankrupt - 6.1.19.4. Effects of Confirmation on Mortgage…………………………..
• 6.2. Compulsary Winding Up…………………………………………………………….
  • 6.2.1. Sale of the Debtor’s Properties…………………………………………….
  • 6.2.2. The Fate of Debtor Entitled to Assistant from the Bankrupt Estate……….
  • 6.2.3. Involving in Business Transactions………………………………………..
  • 6.2.4. Distribution of the Proceeds……………………………………………….
  • 6.2.5. Setting Aside of Share corresponding to the Contested Debt…………….. v
• 6.3. Closure of Bankruptcy Proceedings…………………………………………………..
  • 6.3.1. Absence of any Claim against the Estate……………………………………
  • 6.3.2. Final Distribution of the Product of Winding Up……………………………
  • 6.3.3. Insufficiency of Assets……………………………………………………….
    • 6.3.3.1. The Effects of Closure of the Bankruptcy…………………………
    • 6.3.3.2. Set Aside the Judgment of the Closure of Bankruptcy……………
• Chapter Summary ………………………………………………………………………..
• Review Questions …………………………………………………………………………
• Chapter Seven: Scheme of Arrangement ……………………………………………….
• Introduction ……………………………………………………………………………….
• Objectives ………………………………………………………………………………….
• 7.1. Institutions and Officers……………………………………………………………….
• 7.2. Definition……………………………………………………………………………...
• 7.3. The Application………………………………………………………………………..
• 7.4. Contents of the Proposal……………………………………………………………….
• 7.5. Consideration of Application…………………………………………………………..
• 7.6. The Effects of Refusal of Application……………………………………………….
• 7.7. Opening of Proceedings under Scheme of Arrangement…………………………….
• 7.8. Effects of Admission of Application…………………………………………………
  • 7.8.1. Effects as regards the Debtor and his Properties……………………………
  • 7.8.2. Effects as regards the creditors………………………………………………
• 7.9. Approval of the Scheme of Arrangement…………………………………………….
• 7.10. Approval and Confirmation of the Scheme of Arrangement………………………..
• 7.11. Effects on Debtor……………………………………………………………………
• 7.12. Effects on Creditors…………………………………………………………………
• 7.13. Conclusion…………………………………………………………………………..
• Review Questions ………………………………………………………………………….
• References ………………………………………………………………………………….

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GENERAL INTRODUCTION

Persons could not be always financially self-sufficient. Sometimes it happens that persons enter into different transactions either on cash basis or on credit basis. It is common that persons enter into transactions as a result of which one becomes a creditor and the other a debtor. Where there is such a relationship, the relationship has to be settled by a legal device when one of them fails to discharge his her obligation.

Because of certain reasons, the debtor may refuse or fail to pay the debt he owes from the creditor. If creditor is left without any remedy in case where the debtor defaults to pay the debt, it would have a repercussion on the relationship among the members of the society. In the old times, there were certain measures to be taken by the creditor against the debtor. It was common that in earlier times the debtor is mutilated, arrested, etc where he defaults to pay the debt to the creditor. These measures were fond to be appropriate in those times given the then level of development of the society. These and other measures later proved to be outdated as the society continued to develop from time to time.

Instead of the traditional measures, developed and up-to-date mechanisms were devised. One of the important mechanisms is the one that regulated the relationship by a legal device such as the law of bankruptcy. The law of bankruptcy is a legal mechanism to settle the relationship between the creditor and the debtor as opposed to the above- mentioned traditional systems. This course is about a legal device of settling commercial relationship between the debtor and creditor.

The course is divided into seven chapters including the introductory part. After the introductory chapter, is the judgment of bankruptcy and its effects. Will be discussed by high lighting particularly the procedures and requirements for the debtor to be adjudged bankrupt and the effects to follow the adjudication of bankruptcy of the debtor. The effects could be as regards the debtor himself, the creditors or third parties. The third chapter will deal with the persons responsible to carry out the bankruptcy proceeding. In

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CHAPTER ONE

INTRODUCTION TO BANKRUPTCY

Introduction

The concept of bankruptcy is one of the difficult issues for it is not common in the practice of courts in our country. It is only recently that the course started to be offered to students in universities and colleges. Currently, only few of the higher educational institutions included the course in their curriculum. Before one goes into the details of bankruptcy, it is important to get acquainted with the historical background as well as the meaning of bankruptcy. In this Unit therefore, we are going to discuss the historical background, meaning, and basic principles of bankruptcy.

The Unit is divided into six sections. The first section is on the historical background of bankruptcy. In this section, we will mainly discuss the historical background in the world and in Ethiopia particularly. The second section will deal with the meaning of bankruptcy. In this section we will discuss the different possible meanings of bankruptcy and the definition of the concept under the Ethiopian Commercial Code. The third section is on the scope of the law of bankruptcy. In this section the focus will be on the subjects of the law of bankruptcy and the jurisdiction of courts. The provisions of other laws than the bankruptcy law will also be discussed under this section. The fourth section will deal with the cardinal principles of bankruptcy. In this section we will discuss the important and general principles governing the law of bankruptcy in various countries of the world. The fifth section is on comparison between bankruptcy and winding up. In this section we will focus on the points of similarity and difference between bankruptcy and winding up. The sixth and last section is on the conditions of bankruptcy. In this section the focus will be on the conditions that must exist for the existence of bankruptcy.

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Objectives

At the end of this chapter you should be able to:  discuss the historical background of bankruptcy;  define the concept of bankruptcy;  distinguish the scope of bankruptcy under Ethiopian Law;  enumerate the cardinal principles of bankruptcy;  apply the different principles to different practical cases;  compare and contrast bankruptcy and winding up, and  identify the conditions of bankruptcy.

1.1. Bankruptcy: Defined

It is proper to define the term bankruptcy before delving into the discussion on the concept. Some literatures reveal that the term bankruptcy is used only for individual debtor's insolvency whereas the term liquidation is used for insolvency of business organization. However, many jurisdictions use the term bankruptcy interchangeably with insolvency and some times use bankruptcy as general term applied for natural as well as for legal persons.

Let us see the dictionary definition. A Dictionary of Modern Legal Usage traces the origin of the term and then defines it. It begins with shading light from where the term was coined and hence Bankruptcy in French or Latin bancus "table” plus ruptus "broken". This is literally to mean „broken table‟, and then extended the three definitions as follows:  the fact of being financially unable to pursue one's business and meet one's engagements;  the fact of having declared bankrupt under a bankruptcy statute;  the field of law dealing with those who are unable or unwilling to pay their debts.

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bankrupt by a court of law. Bankruptcy is a situation whereby a person by his acts and conducts affords evidence of his inability to pay or his intention to avoid payment of his debts.

Little to say about the working definitions; in the first case it shows that the adjudication of a debtor as bankrupt in the competent court of law which has power to do so when the legal requirements are satisfied. The adjudication can be initiated by the interested parties as the laws of various jurisdictions may provide. The second definition reveals the conduct or acts of the debtor must show his unwillingness to pay his debts due. To exemplify this, the creditor may provide to the debtor execution order which he obtained from the court of law and he may fail to get payment from the debtor. In addition, criminal charge may be filed against the debtor for his fraudulent conduct as per criminal code for his tendency to defraud and this can also be a condition to evidence his conduct. The intention of the debtor could also be disclosed when he absconds and his whereabouts is not known.

It has been said that the terms insolvency and bankruptcy are interchangeably used in many literatures. However, one could be misled by the terms. To make distinction between the terms is of no importance for practical purpose. But for better understanding and academic purpose it is possible to draw distinction. Hence, with some reservation one can say, insolvency presupposes bankruptcy or bankruptcy is an outcome of insolvency. It is also possible to draw another distinction and one can also say that all insolvencies may not lead to bankruptcy and all bankruptcies are not an outcome of insolvency. This is because the course of business does not depend on solvency. If there is sufficient liquidity, a debtor can discharge his debts running his business on credit basis. A business may be prevented from paying creditors and still have more assets than liabilities. However, if it lacks liquidity then it is deemed to be in a state of bankruptcy. Liquidity is the status or condition of a person or a business in terms of his or its ability to convert assets into cash. It is the degree to which an asset can be acquired or disposed of without danger of intervening loss in nominal value.

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Definition of Bankruptcy under the Ethiopian Commercial Code

Book V of the Commercial Code under Article 969 and 970 defines, as to what bankruptcy is, in two different ways. As a principle, under Article 970 (1) the Code states that bankruptcy shall not result from mere suspension of payments, unless a judgment in bankruptcy is given or factual conditions are fulfilled in the way the law requires. The two situations provided to define bankruptcy are stated as follows: First , “Any trader who has suspended payments and has been declared bankrupt shall be deemed to be bankrupt.” Second , a sentence passed by a criminal court in respect of bankruptcy or any offence connected with bankruptcy not withstanding that suspension of payments has not been established by a judgment in bankruptcy shall be deemed to be bankruptcy of fact (emphasis added Article 970 (2) of the Commercial Code).

The first definitional provision indicates declaration of bankruptcy through judgment by competent court after investigation. To declare someone as bankrupt the main test is suspension of payments. This can be called judicial bankruptcy or legal bankruptcy. The second definition envisages the factual bankruptcy. In this case criminal court may pass sentence on the debtor even though suspension of payment is not proved by court as alleged by interested party. The offence under which the debtor is sentenced shall be connected with bankruptcy or in respect of bankruptcy.

What kind of offences are connected with bankruptcy or, in respect of bankruptcy, would be point of discussion to make the second definition more understandable? In this regard it is proper to refer to the Penal Code of Ethiopian. The 1957 Penal Code of Ethiopia provides ten provisions under Book VI Title II Chapter II. of The heading of this chapter reads "Offences Relating to Proceedings of Debt, Execution and Bankruptcy". For instance, if we see Article 683 within the same chapter; "a debtor subject to proceedings by way of execution against whom a declaration of default has been delivered, and who with intent to prejudice his creditors has reduced his assets, whether materially or fictitiously, is punishable with a simple imprisonment or in grave cases, with rigorous imprisonment not exceeding five years.” Also as provided under Article 684, if a debtor

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The medieval Italian cities enacted statues dealing with the collection and distribution of the assets of a debtor, especially merchants, who absconded or fraudulently caused insolvency. Life for the medieval debtor was likely to be nasty, brutish and short. Just as the charging of usury by money lenders was regarded as contrary to the laws of God, and was punishable according to both the church and the power temporal so also was falling into debt considered moral sin. In addition, medieval Spanish law restored the judicial cession bnorum, which is an ancient Roman law by which privilege given to debtors to alleviate his hardship by relinquishing voluntarily his assets to his creditors by petitioning a magistrate. The Site Partides , a codification published by authority of Don Alfonso X the wise king of Castile and Leona, during the second half of the 13th^ century, contained detailed provisions relating to insolvent debtors, applicable to merchants and non- merchants. The Site Partides is a Spanish Law which is the most important monumental code that was influenced by Roman and Canon law and by the customs of Castile.

Laws dealing with the property of absconding and fraudulent debtor, modeled after the statute of medieval Italian cities spread through out Western Europe. Provisions of this type were adopted in the commercial centers of France, Brabant, and Flanders during the 15 th^ and 16th^ centuries. Emperor Charles V, as count of Flanders, inserted stringent provisions for the repression of bankruptcies in his Decree for the administration of justice and good order in 1531. But these were measures designed for the protection of the individual creditors; more than 250 years were to elapse before the notion took hold of official collection and realization of a debtor's estate for the purpose of distribution among his creditors generally. This was introduced in the State of Hennery VIII (1542), which is the first bankruptcy statute to be enacted in England. As literature reveals, this statute was not a measure designed for the relief of debtors but was inspired by the Northern European models and entirely pro-creditors.

In France, national rules on insolvency and bankruptcy were inserted into the Ordinance du Commerce of 1673. The rules regulated both voluntary assignments for the benefit of creditors made by indebted merchants and the proceedings, and effects following from

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bankruptcy. It was interpreted to restrict bankruptcy proceedings to merchants only, and laws of many other countries followed the French lead. Thus, in Spain the limitation of bankruptcy to merchants was adopted by the ordinance of Bilbao, which were sanctioned in 1737 and subsequently applied in Latin American countries, especially in Argentina.

As has been said earlier, ancient legislations were entirely restricted to persons engaged in commerce. The restriction of bankruptcy legislations to persons engaged in commerce created a need for liquidation proceedings applicable to other debtors. On that basis, a Spanish jurist of the 17th^ C, Salgado de Somoza, elaborated detailed rules for the initiation and conduct of voluntary liquidation proceeding which were "concourse of creditors" or a suit or remedy to enable creditors to enforce their claims against an insolvent or failing debtor. His tract, entitled Labyrinthus Creditorum , influenced the course of Spanish law and also had great impact on the common law of the German States. As a result, Spanish law developed two classes of liquidation proceedings, one for merchants and the other for non-merchants. Spanish law in that respect was the model for the legislation in Portugal, Argentina, Brazil and other Latin American countries. Other nations, including Australia, Germany, England, the United States and nations influenced by English law brought the case of both merchants and non-merchants under their bankruptcy laws.

Around the 19th^ C, as time went on, the trend against debtor who fails to pay his debt was changed. Another assumption came into play, which was that the debtor could be honest but unfortunate. And hence, bankruptcy laws should widen their umbrellas not only to creditors but also should direct the focus of their concern to relieving the honest debtor from the burden of oppressive indebtedness and permitting him a fresh start. This is in effect freeing him from obligations and responsibilities consequent up on business misfortune which he can not satisfy by his own efforts. Thus, the already existing legalistic approach was abandoned in favour of the economic approach aiming at debtor‟s rehabilitation and corporate reorganizations. In recent times, however, a great effort has been made to remove the disgrace attached to bankruptcy. Even the terms „bankrupt‟ and „bankruptcy‟ (or their equivalents in other languages) are less used and less frequent in

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The second half of the 19th^ C. in Africa as a whole and in Ethiopia particularly had unforgettable history with marked change in the laws. It was during this time that the existing laws including the Commercial Code came to existence. With regard to its source the 1960 Commercial Code is somewhat eclectic. The then drafters noted that:

all traders buy in order to resell, all enter into contract whether of sale, agency, or carriage, and all use forms of banking credits. Bill of exchange, share companies, private limited companies, bankruptcy and other collective procedures of liquidating the goods of a trader are all institutions known almost every where. Thus, to use comparative law as an element of legislative policy is less dangerous in commercial matters than in the domain of pure civil law

However, there are indefinable differences in the continental law approach and common law approach in areas like persons subject to bankruptcy, number and nature of procedure, effect of bankruptcy on debtor, judges‟ role in the proceeding, freedom left to creditors, intervention of administrative authority and defining circumstance under which a person could be declared bankrupt.

J. Escara also noted in his avante project and in the discussions before the sub- commission, that some of the differences are negligible. To exemplify, whether the circumstance under which a person can be declared bankrupt are defined in generic terms or enumerative list which does not create difference. This is because the general definition itself incorporates the limitative enumerative list. He conducted delicate selection of principles from different sources. Hence, in practice the Latin and Germanic institutions are the sources of the continental principles of the Ethiopian Commercial Code. But the existence of Anglo-American commercial practice and on the other hand, the excellent solutions furnished on more than one point by the written commercial law of England and the United States has also contributed to the Ethiopian law. Hence, the source and development of Ethiopian bankruptcy law has similar history with many other

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countries and it cannot be traced to a single country as a source or limited legal family as the only source.

1.3. The Scope of law of Bankruptcy in Ethiopian Legal System

An important question to be answered here is as to whom does the bankruptcy proceeding apply. In other words, who are the subjects of bankruptcy proceeding? Have you tried to answer the question? If so, that is great.

As we have discussed earlier in the part dealing with the historical background of bankruptcy, in the earlier times bankruptcy applies to persons who involved in commercial activities. That is to say, it is only persons who involved in commerce that can be the subjects of bankruptcy. But later, because of the influence of Spanish law, persons who did not engage in non-commercial activities were made the subjects of bankruptcy proceedings.

Do you agree that the bankruptcy proceeding applies to all citizens of the country who failed to pay debts to their creditors? I hope your answer would be “No”. If you answered so, that is great. Assume that one of the distance learners of the Alpha University College (Ato Messay) borrowed 50,000 Birr from you. He has never carried out commercial activity. After you made repeated requests to get the loan paid, he refused because of different reasons. In this case, do you think that you can apply to the court demanding the student to be declared bankrupt? Did you answer “No”? If so you are correct. As far as the scope of application of bankruptcy proceeding in our country is concerned, Ato Messay would not be declared bankrupt. Then, the question remains as to who is the subject of the bankruptcy law.

Assume that in the above given hypothetical case, Ato Messay is a businessman who carries on one or more of the activities enumerated under Article 5 of the Commercial Code. Do you agree that Messay should be declared bankrupt in case he is not in a position to pay the debt he owes to you? I am sure that your answer will be “Yes”. If you