Concept and conditions for the sale of a bankruptcy debtor as a legal entity
The institute of sale of a bankruptcy debtor as a legal entity, as one of the modalities of sale in bankruptcy proceedings, is regulated by the Law on Bankruptcy (“Official Gazette of RS”, No. 104/2009, 99/2011 – other law, 71/2012 – CC decision, 83/2014, 113/2017, 44/2018 and 95/2018 (hereinafter: “Law”).
According to the Law, bankruptcy proceedings can move in two directions, in the direction of bankruptcy or in the direction of reorganization.
The bankruptcy judge will make a decision on bankruptcy if at the first creditor hearing the appropriate number of creditors votes for it, representing at least 50% of the total unsecured claims against the bankruptcy debtor, if the reorganization plan has not been submitted, i.e. if the reorganization plan has not been adopted at the reorganization plan review hearing.
When bankruptcy proceedings are initiated towards bankruptcy, the rule is that they will be conducted either by selling the entire property, property units or individual assets of the bankruptcy debtor, or by selling the bankruptcy debtor as a legal entity, which, in principle, was an exception until recently.
In order for the bankruptcy debtor to be sold as a legal entity, it is necessary to meet several conditions prescribed by the Law:
- A decision on bankruptcy must be made;
- The sale of the bankruptcy debtor as a legal entity must be purposeful in relation to the sale of the assets of the bankruptcy debtor;
- Separate and pledge creditors must be informed about the intention to sell, the sales plan, the expediency of the sale and other relevant data on the planned sale (no later than 30 or 15 days before the sale, depending on the method of sale of the bankruptcy debtor); and
- There must be the consent of the board of creditors.
The basic argument in favor of this method of sale in the bankruptcy procedure is the more favorable settlement of creditors because in many situations it can be shown that the bankruptcy debtor as a legal entity is worth more than its property, and that the costs of selling the assets of the bankruptcy debtor are sometimes much higher than the case when selling the bankruptcy debtor as a legal entity, which is why this sales modality is becoming increasingly popular in bankruptcy proceedings.
The latest amendments to the Law introduced the fact that in case of a sale by direct agreement, separate and pledge creditors have the right of the first refusal which can be used within 5 days from the date of receiving the notice of intention to sell, sales plan, expediency of sales and other relevant data on the planned sales. What is interesting in connection with the use of the right of pre-emption of separate and pledge creditors, is the fact that they can use this right indirectly, in a way that this right can be exercised through related parties, of course after submitting the proof that it is indeed a related party.
In addition to the above, the question arises whether foreign persons can participate as potential buyers in the sale of the bankruptcy debtor as a legal entity.
According to the Serbian legislation, unlike the purchase of real estate of a bankruptcy debtor, there are no obstacles for a foreign person to buy a bankruptcy debtor as a legal entity.
Namely, a foreign person will not always be allowed to buy the real estate of the bankruptcy debtor. This is due to the fact that when selling the real estate of the bankruptcy debtor, the application of substantive law must be taken into account, and in that sense there are restrictions prescribed by the Law on Fundamentals of Property Relations in the part concerning the rights of foreign persons to perform activities on the territory of the Republic of Serbia and whether the real estate that is the subject of sale is necessary for a foreign person to perform activities.
Consequences of the sale of a bankruptcy debtor as a legal entity
The rule that bankruptcy is conducted in order to terminate the legal personality of the bankruptcy debtor does not apply in the case of sale of the bankruptcy debtor as a legal entity, because the bankruptcy debtor does not cease to exist, but in some way “emerges” from bankruptcy while maintaining legal personality and continuing business.
The sale of the bankruptcy debtor as a legal entity has two procedural legal consequences that are correlated, as follows:
- Suspension of bankruptcy proceedings in relation to the bankruptcy debtor, and
- Continuation of the bankruptcy proceedings in relation to the bankruptcy estate, which consists of money obtained from the sale of the bankruptcy debtor, assets of the bankruptcy debtor that were not subject to assessment, but also the subsequently found assets of the bankruptcy debtor.
Therefore, the Law stipulates that the agreement on the sale of a bankruptcy debtor as a legal entity must contain a provision that the assets that were not subject to assessment during the sale of the bankruptcy debtor as a legal entity will enter the bankruptcy estate in order to prevent the misuse of the bankruptcy debtor’s property.
In order to achieve the final realization of the sale of the bankruptcy debtor as a legal entity, it is necessary for the court to issue a decision stating that the sale has been made and ordering the deletion of the burden incurred before the sale, provided that the property in respect of which the removal of the encumbrance is requested has been the subject of assessment, and that the court decision shall become final. Until the court decision becomes final, the buyer will not be able to exercise the rights regarding the sale of the bankruptcy debtor as a legal entity.
After the sale, the bankruptcy estate will be registered in the bankruptcy estate registry maintained by the Business Registry Agency and represented by the bankruptcy trustee. In court practice, it is indisputable that the registered bankruptcy estate is the holder of rights and obligations, and that it has legal capacity, so it regularly appears in court proceedings as a passively legitimized party in the proceedings. This position was confirmed by the Decision of the Commercial Court of Appeal Pž 7335/2016 dated 17 November 2016.
In practice, the question is whether the bankruptcy estate, which undoubtedly has legal capacity, can appear in the role of an actively legitimized person in court proceedings. In essence, this depends on whether the assets and rights have entered the assessment of the bankruptcy debtor as a legal entity, i.e. whether they are the subject of a sale. If certain rights and assets have not been included in the assessment, or are not the subject of sale, in that case the bankruptcy estate appears in the role of an actively legitimized person in court proceedings. Therefore, during the potential sale of the bankruptcy debtor as a legal entity it is very important to read and understand the sales documentation, because if certain assets or rights are not listed in the sales documentation, in that case, the legal entity will not claim the right to that property or rights after “emerging” from bankruptcy.
The obligatory legal consequence of the sale of the bankruptcy debtor as a legal entity is reflected in the fact that neither the bankruptcy debtor nor its buyer are liable for claims against the bankruptcy debtor that arose prior to the suspension of the bankruptcy proceedings and legal entities that provided services of general interest to the bankruptcy debtor cannot suspend the performance of these services on the basis of unpaid bills that arose before the opening of the bankruptcy procedure.
Acquisition of shares/stocks and deleting all encumbrances incurred prior to the sale of a bankruptcy debtor as a legal entity
After the sale of a bankruptcy debtor as a legal entity the buyer pays the price and the court makes a decision on the sale and it becomes final, there will be a change of the founder, i.e. owner of the company, because the buyer of the bankruptcy debtor becomes its only member or shareholder and acquires management and ownership rights.
In other words, the individual assets of the bankruptcy debtor are not transferred to the ownership of the buyer, rather the buyer acquires shares/stocks in the legal entity and becomes a member of the company.
If the buyer of the bankruptcy debtor is a legal entity, the relationship between the controlling and dependent company is established between the buyer and the sold bankruptcy debtor.
Simultaneously with the registration of the buyer as a member of the company, all encumbrances must be deleted both on the shares and on the assets of the bankruptcy debtor that have entered the assessment of the bankruptcy debtor as a legal entity.
Therefore, the bankruptcy judge is obliged, after the sale of the bankruptcy debtor as a legal entity, if it is determined that within the sold bankruptcy debtor there is property on which a lien (encumbrance) is constituted, to make a decision ordering the deletion of all encumbrances incurred before the sale of the bankruptcy debtor, i.e. registration of other rights acquired through sale.
This was confirmed by the Decision of the Commercial Court of Appeal, Pvž 563/2019 dated 5 December 2019, as well as by the Decision of the Commercial Court of Appeal, Pvž 196/2018 dated 24 April 2018.
What appears to be a problem in practice is when there are unresolved claims in the real estate register on real estate that was the subject of liquidation of the bankruptcy debtor’s property, and which is sealed. This is a situation when there is a request on the real estate that is under appeal, and in accordance with the positive regulations of the Republic of Serbia, until this request is finally resolved, no change in the real estate register is allowed. This especially because the Law on the Procedure for Registration in the Cadastre of Real Estate and Lines explicitly stipulates that the order of decision-making cannot be violated by a special law, which absolutely applies to the Law as well.
Therefore, when deciding on the sale of a bankruptcy debtor as a legal entity, it is important to thoroughly check all the requests registered on the real estate, so that there would be no problems later. This especially if the potential buyer bases its business strategy on buying the bankruptcy debtor as a legal entity, to later encumber its property with mortgages as a means of securing a loan, which would absolutely not be possible until the suffix in the name of the company that reads “in bankruptcy” is deleted from the cadastre.
Tax treatment of the sale of a bankruptcy debtor as a legal entity
i. Tax on the Transfer of Absolute Rights
According to the Article 24 paragraph 1 item 4 of the Law on Property Taxes, the sale of a bankruptcy debtor as a legal entity is considered the subject of taxation – if the buyer has not assumed the obligations of the legal entity it bought or has taken over only part of those obligations.
Therefore, in that case, the buyer of the bankruptcy debtor, as a taxpayer, would be obliged to file a tax return and pay tax on the transfer of absolute rights, on the basis that in this situation would be the agreed price of the bankruptcy debtor, or the market price if the agreed price is below the market price.
However, this provision of the Law on Property Taxes is contradictory to the provisions of the Law which stipulates that for claims against the bankruptcy debtor that arose before the suspension of bankruptcy proceedings, neither the bankruptcy debtor nor its buyer are liable to creditors, and is also contrary to the Administrative Court (see: Judgment 9. U.5924/2011 dated 15 January 2014) because it is contrary to the nature of the institute of sale of a bankruptcy debtor as a legal entity.
Namely, in the case of the sale of a bankruptcy debtor as a legal entity, there is no transfer of the entire property of the legal entity for a fee that is subject to taxation, there is only a transfer of shares, and the transfer of shares was deleted as a subject of taxation by a legal amendment back in 2009. The buyer of the bankruptcy debtor becomes the owner of the share, i.e. shares of the bankruptcy debtor as a legal entity, so the legal entity retains in its assets all obligatory, real and other rights, which existed both at the time of opening the bankruptcy and after the sale of the bankruptcy debtor, and therefore cannot be subject to taxation at the rate of tax on the transfer of absolute rights.
Regardless of the above, various solutions can be found in the practice of the Tax Administration. In certain situations, the buyer of the bankruptcy debtor is exempt from paying taxes on the transfer of absolute rights, while in some situations the taxes are cut. What the Tax Administration primarily looks at is whether the bankruptcy debtor as a legal entity was sold with the property and rights that are subject to taxation or not. If the answer is affirmative, the Tax Administration will usually (depending on the branch) take the value of taxable property as the basis and will levy a tax on that.
All in all, the potential buyer of the bankruptcy debtor as a legal entity must be ready to pay this tax, regardless of the decision of the Constitutional Court and regardless of the contradiction of such taxation with the nature of the institution of selling the bankruptcy debtor as a legal entity.
ii. Property Tax
When it comes to the property tax, the sale of a bankruptcy debtor as a legal entity should not have an impact on this type of tax, because the buyer of the bankruptcy debtor does not acquire ownership over the bankruptcy debtor, but only a share in the bankruptcy debtor’s capital. Therefore, the buyer does not become the owner of real estate or other assets of the bankruptcy debtor, and therefore is not liable for this tax.
iii. Value Added Tax – VAT
If we start from the above-mentioned position that the sale of the bankruptcy debtor as a legal entity changes the owner of the bankruptcy debtor’s capital and having in mind the provision of the Law on Value Added Tax which stipulates that share transactions are exempt from VAT, the conclusion would be that in the described situation VAT is not paid.
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