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Assumption of debt as an inoperative transaction for the purposes of insolvency proceedings

It is common practice in the Czech Republic for buyers to settle a part of the purchase price by assuming the seller’s debt toward third parties. However, these arrangements are not entirely risk-free for the seller.

The parties to a purchase agreement may agree to settle the purchase price (or a part thereof) such that the buyer, with the consent of the third-party creditor, enters the seller’s role of obligor towards said creditor, i.e., such that the buyer assumes a debt of the seller towards a third party. However, if an insolvency procedure against the seller’s assets is subsequently being initiated, then the agreed method for discharging the purchase price may cause the purchase agreement to be declared an inoperative transaction. In such a case, the buyer would have to surrender the purchased item to the estate (or else pay the cash equivalent of the purchased item’s value to the estate).

At the beginning of this year, the Supreme Court handed down a judgment which dealt with this very situation. The parties to a purchase agreement had agreed that the purchase price for a piece of real estate would be paid for the most part by way of the assumption of debt owed by the seller to a third party. Following the execution of the purchase agreement, an insolvency proceeding was brought against the seller, and the seller was subsequently declared bankrupt.

In the ratio decidendi of its decision, the Supreme Court explained that because of the contractual arrangement for payment of the purchase price in the above-described manner, the purchase agreement in question must be considered, for the purposes of the proceeding, a legal transaction without adequate counterperformance within the meaning of Sec. 240 of the Insolvency Act. In the view of the Supreme Court, the seller had in actual fact not received any counterperformance which could have been used in the insolvency proceeding to satisfy other creditors of the seller.

By contrast, the creditor whose claim was accepted by the buyer as the new obligor has nothing to fear. The fact that it now has a claim toward a "new" obligor who may in fact be in a better financial position to honor the debt, supposedly does not qualify as preferential treatment of that creditor over the seller’s other creditors within the meaning of the Insolvency Act. In this respect, the Supreme Court noted the following: "Preferential treatment is to be assessed in terms of what assets have been removed from the property of the debtor. The debt which is no longer a part of the debtor’s estate following the agreement on the assumption of debt could not have been used to satisfy the other creditors of the debtor."

In the light of the above, we recommend that buyers who enter into a purchase agreement with a view to "paying" the purchase price by assuming debt give special attention to the financial health of their contractual partner.

Source:
Act No. 182/2006 Coll., on insolvency and the methods for resolving it
Czech Supreme Court judgment 29 ICdo 4/2018 of 26 February 2020

 

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