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Myth or Reality: The class of "mega-debtors"


Legal Insight

January 2020

George Psarakis LL.M. (mult.), PgCert

Republished from Euro2Day

Summary: The question is simple: Are there "mega-debtors" who actually default on their debts, bankrupting their businesses but at the same time remaining highly wealthy themselves? What are the tactics of these individuals, how are they treated by their creditors and what is the truth? 

The question is simple: Are there "mega-debtors" who are indeed defaulting on their debts, bankrupting their businesses but at the same time they themselves remain extremely wealthy? What are the tactics of these individuals, how are they treated by their creditors and what is the truth? 

1. Is the phenomenon of rich shareholders but poor companies against the law?

The very economic rationale behind the construction of the joint-stock company and other corporations is to limit risk. Shareholders invest certain funds and only those they wish to put at risk to achieve their purpose. Otherwise they would simply not risk their assets, thus limiting investment in a country. So, in principle, the phenomenon of seeing companies go bankrupt but their shareholders remaining active and wealthy is not only moral but also a consequence of the law itself. We enter the grey zone when the dominant shareholder of the company proceeds to remove significant corporate assets or fraudulently financially wipe out the company. 

2. The most common ways of salvaging the company's "jewels" (or "how the captain is not the last to leave the ship").

The legislator is not always so cunning; most of the time he deals with problems in an ideal way. Other times the legislation does have gaps, especially when it comes to new provisions that have not yet had time to be tested in practice. Most of the time, however, while the appropriate legislative tools are in place, the lenders do not show the necessary zeal in pursuit. Here are some of the most well-known cases of fraudulent debt avoidance, as they have emerged through court decisions:

a) First of all, one of the most important factors in the minds of entrepreneurs who want to salvage their assets is time. Time is needed to organise and carry out the various fraudulent actions, especially when news of the impossibility of repayment is leaked to the market. This is where bankruptcy law, and in particular the law on reorganisation, comes in handy. Through the old conciliation petition, and now the reorganisation petition, dozens of companies have gained time to enable their operators to remove corporate assets by various methods. This was acknowledged by the legislature itself when it attempted to change the relevant legislation in 2016: 'In particular, through successive postponements and cancellations of the opening petition discussion, while maintaining preventive measures, many debtors held their creditors hostage and the business itself stagnant. During this period, these debtors were able to engage in abusive practices' (from the explanatory memorandum to the law in question). 

b) The second stage is the removal of the company's valuable assets or at least those that can be transferred ("crown jewels"). The transfer usually takes place in newly created companies whose boards of directors are composed of persons trusted by the entrepreneur and whose shareholders are foreign companies where the beneficial owner is not easy to identify. As this transfer will have to be justified in some way, the payment of the sale price is made, for example, by offsetting debts allegedly owed by the old company to the new one, or in other cases at a price well below the market value. 

c) In other cases, where there are no fixed assets of particular value but the business relies mainly on know-how, customers and suppliers, the solution adopted by entrepreneurs is to set up a new company (sometimes with family members or controlled partners as shareholders). In many cases, this new company will also have the same registered office as the old company.

d) It is common to use the company's funds to pay the personal debts of the shareholders/board members. i.e. when the main shareholder of the company pays his personal expenses from the company's funds, he in fact removes assets with which the company's creditors could be satisfied. The same is also the case when corporate liquidity is distributed as directors' fees or directed to the entrepreneur through informal loans (cash facilities). Other methods of draining corporate funds are overcharging in contracts for the use of intangible assets (e.g. the lease of a trademark or a fee for a study) where the companies receiving the fees are again located in foreign jurisdictions and are in the interests of the entrepreneur, or the creation of dummy debts to affiliated companies which are preferentially repaid.

e) Moreover, the main owner of the company (shareholder, partner, etc.) has usually guaranteed the receipt of bank financing and is therefore liable with his personal property. For this reason, he ensures that he has concealed his own assets in advance. He usually does this by transferring his main assets before the storm to new companies, foreign or otherwise, which he sets up for this purpose only (and not to relatives, where it is easy to break the contract through fraud).

f) However, since the company, if it becomes insolvent, will start to be pursued criminally and civilly by the State and the insurance funds, for the debts to which the members of the management are usually personally liable, the following happens: there are cases where the entrepreneur places elderly persons who are not related to him and have no assets as representatives of the company, where neither seizure against them nor imprisonment of them is possible (over 70 years old with exceptions).

3. But what are the solutions that the legislature and our courts have come up with for all these cases?

a) A quite effective method of dealing with these morbid phenomena is based on the construction of "removal of the autonomy of the legal person". In simple words, the creditor of the now insolvent company claims his money not only from the latter but also from the owner of the company (its main shareholder, etc.), i.e. from the one who has carried out all the above-mentioned fraudulent actions. This is irrespective of whether or not the owner has guaranteed it with his personal property. In such cases, it is considered that the main shareholder's invocation of 'irresponsible' is abusive. In fact, the creditor can also use the same legal construction against the companies that the entrepreneur used to "hide" his assets, e.g. against a third newly established company to which he transferred his residence and which has no other commercial activity ("contrary removal of self-sufficiency"). Of course, our case law is strict on the conditions that must be met in order to accept the above. 

b) Then, possibly in the above cases the crime of infidelity may have been committed. The company's management, instead of protecting its assets, 'stripped it of its jewellery' at the critical time in order to avoid selling it to satisfy creditors. Even if in these cases there was the agreement of all the shareholders of the company (resolution of the general meeting, etc.), if the company was on the verge of bankruptcy, it must be accepted that it is not sufficient to avoid criminal conviction of the members of the board of directors. Recently, e.g, a verdict was published by the Athens Municipal Court which referred a representative of a company to a criminal hearing, following a complaint by creditors, for allegedly committing the offence of dishonesty by paying his personal expenses out of the money of the company of which he was the CEO. Similarly, a company representative was recently prosecuted for allegedly transferring at much lower than market values real estate to affiliated companies, thereby depriving creditors of corporate property. 

c) Where the company is on the verge of bankruptcy or has gone bankrupt, its representative may be personally liable for the offence of causing bankruptcy (Article 98 of the Bankruptcy Code). This is a new provision which is of particular importance in that, inter alia, it focuses the attention of the board members not only on the interests of the company's shareholders but also on those of its creditors, particularly when the company is on the verge of becoming financially unable to service its debts.

d) In addition, if the company becomes bankrupt, it is possible to revoke loss-making transfers that have taken place up to 5 years after the date of the declaration of bankruptcy. This of course presupposes the bankruptcy of the company and entails the obligation to re-transfer the asset to the bankruptcy estate. 

e) In all cases where the representative of a company is liable, liability can also be established, both in criminal and civil law, for the real director who hides behind any straw men he has appointed to take his place in the management and who is actually in charge (de facto director - shadow director). 

f) An equally interesting provision is that which establishes the liability of the new owner of the company in the event of a transfer. That is, in the previous example where a new company is set up to operate from the same registered office as the old one (usually by the children of the entrepreneur), using the same intangible or intangible assets of the old company (e.g. clientele, goods, distinctive signs, etc.), the creditors of the old company can take action against the new company, claiming that the individual assets of the business - or the main assets - have been transferred to the new company (Article 479 of the Civil Code). Even the use of the same telephone number has been used as evidence in favour of the liability of the new company. Indeed, in the recent decision of the Athens Court of Appeal No 93/2020, it was accepted that even the transfer of only customers from one company to another can constitute a transfer of an undertaking.

4. All of the above can be easily deduced if one studies our case law (court decisions) of the last 15 years. Through the court decisions real stories of businessmen emerge and finally all their methods of avoiding payments and removing assets are analysed. However, what ultimately emerges as a conclusion is that whether or not similar morbid phenomena can be dealt with depends on the persistence and ability of the lender to finance the legal battle. There is no state mechanism that will automatically take action, and even the state and the relevant insurance funds are not involved and do not investigate such particularly complex cases (involving foreign companies, etc.). Not even the credit institutions do not want to get involved in court battles in not so clear-cut cases, contenting themselves with asserting their obvious and 'clean' claims (through guarantees, mortgages, securities, etc.). The small creditor will be the weakest link, since he will have neither the money nor the motivation to engage in litigation (unless, of course, many small creditors organise themselves and collective actions emerge, a rare phenomenon). Therefore, if there is no major creditor who can finance the legal dispute that will be opened, the entrepreneur who has used all the above methods is likely to be 'discharged' from his debts without any bloodshed, which of course constitutes a 'moral hazard' for all other entrepreneurs operating in the market. 

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