Procedural costs in bankruptcy proceedings

Bankruptcy is a collective proceedings by which creditors are able recover their debts from debtors, and its primary purpose is to maximise the value of debtors’ assets to maximise recovery.

As such, an assessment is required of how procedural costs affect the achievement of the primary purpose (or principle) of bankruptcy proceedings. One additional key goal ought also to be borne in mind here: that collective recovery should be achieved as quickly as practicable and at as low a cost as possible.

Bankruptcies tend to be extremely expensive, with costs incurred for commencing the proceedings, engaging litigation to claw back assets for the bankruptcy estate, discovering and securing assets, liquidating assets and distributing the estate, and, finally, remunerating the bankruptcy administrator. All of these are a huge drain on the bankruptcy estate and greatly limit creditors’ ability to recover what they are owed.

This paper will focus on the advance for procedural costs, one specific type of expense that always appears in bankruptcy proceedings and is in effect a precondition for filing a bankruptcy petition.

I. The problem

Article 59 of the Serbian Bankruptcy Law (Official Gazette of the Republic of Serbia, Nos. 104/2009, 99/2011 – Other Law, 71/2012 – Constitutional Court Ruling, 83/2014, 113/2017, 44/2018, and 95/2018) governs advancing procedural costs and the consequences of failing to make this advance.

As such, for the court to even test bankruptcy commencement criteria, the petitioner will have to make an advance payment that serves to initially cover any costs of commencing the proceedings and discovering the debtor’s assets. The amount of the advance is set by the bankruptcy judge.

Article 59 sets out the costs deemed to be covered by the advance: these are the expenses of publishing an advertisement of bankruptcy and notifying the creditors, retaining a bankruptcy administrator, securing assets, and registering the bankruptcy with the Serbian Business Registers Agency.

To prevent judges from assessing the advance arbitrarily, the Bankruptcy Law sets out ceilings for each category of company, which range from 50,000 dinars (some 425 euros) for micro-enterprises to 200,000 dinars (about 1,700 euros), 600,000 dinars (approximately 5,100 euros) for small firms, to 1 million dinars (some 8,500 euros) for large bankrupt businesses.

As such, the judge is required to take into account the size of the debtor and the circumstances of the case in question when assessing the amount of the advance to cover the costs listed above. The amount must be reasonable and justified, and obviously must not exceed the statutory ceilings. The bankruptcy petition will be dismissed if the petitioner fails to pay the amount assessed by the court within the statutory time limit of five days of being so ordered.

In other words, advancing procedural costs is a necessary precondition that must be met before bankruptcy proceedings can commence. The Bankruptcy Law stipulates this as a mandatory step in preliminary bankruptcy proceedings, the part of the bankruptcy process in which commencement criteria are tested. As such, the initial advance is completely predictable, and any petitioner is able to take it into account before deciding to file a petition.

One less foreseeable aspect of bankruptcy proceedings, however, which the Bankruptcy Law treats as an optional feature rather than a formal requirement, is the ability of the bankruptcy judge to order the petitioner to advance additional funds to cover procedural costs.

This option is made available in Article 13[4] of the Bankruptcy Law in cases where the debtor holds assets of negligible value, or where its debts exceed its assets, or where no assets held by the debtor have been found prior to a creditor or the debtor filing a bankruptcy petition. In these situations, the bankruptcy judge is to instruct the petitioner – generally a creditor – to make an additional advance and so allow the proceedings to continue.

In this situation the bankruptcy judge may set as high an amount as they believe is justified. The Bankruptcy Law provides no additional requirements for either the judge or the bankruptcy administrator to justify or substantiate the amount of the advance.

The absence of any statutory constraints on the bankruptcy judge creates much room for arbitrary decision-making, which is likely to influence the behaviour of the party seeking continuation of the bankruptcy proceedings.

In practice, bankruptcy judges consult bankruptcy administrators when assessing these amounts, and the assessment is quite frequently based on nothing more than the bankruptcy administrator’s broad assessment of the costs involved which is then taken by the bankruptcy judge at face value. Still, as there is no requirement in the current Bankruptcy Law for the decision to be specifically substantiated or economically justified, the payment often poses a major financial strain on the creditor/petitioner.

The absence of any statutory constraints on the bankruptcy judge creates much room for arbitrary decision-making, which is likely to influence the behaviour of the party seeking continuation of the bankruptcy proceedings.

Hypothetically, after the creditor has filed a bankruptcy petition, they are required to advance the procedural costs as ordered by the bankruptcy judge. This payment is first followed by a hearing in preliminary bankruptcy proceedings and then by the commencement of bankruptcy proceedings proper. Thereafter, between the adoption of the decision to commence bankruptcy proceedings and the initial creditors’ hearing, the bankruptcy administrator will search for the debtor’s assets and use their findings to produce the report on the economic and financial position of the debtor. But should the bankruptcy administrator fail to take control of the debtor’s books (for instance due to failure of the previous management to co-operate), and so be unable to discover the debtor’s assets or their value, the practitioner is likely to come to the potentially erroneous conclusion that the debtor actually holds no assets.

Since, in this particular case, the bankruptcy administrator may find seeking for the debtor’s assets and taking possession of its documents somewhat more complicated than usual, they could decide it may not be in their best interest continue the process, as their fee award will almost certainly be disproportionately low in comparison with the effort invested. Simple maths reveal it does not pay to take the trouble with such bankruptcies (which require much work without the certainty of there being realisable assets), and the most convenient option for the bankruptcy administrator would be to seek the proceedings to be closed. Put differently, unless there are assets whose existence and value are known in advance, the bankruptcy administrator will quite frequently have no interest in taking up the case.

As noted above, bankruptcy judges consult bankruptcy administrators when assessing additional advances and often base their decisions on practitioners’ opinions, and this reveals the extent to which bankruptcy administrators are able to exert influence on rulings that affect creditors. For instance, a bankruptcy administrator may make a sweeping, excessively high estimate of the additional expenditure required. Doing so could, in effect, force the creditor’s hand into making a move that will ultimately not benefit them.

In this case the creditor is in an exceptionally awkward situation. Their ability to recover their debt depends on the outcome of the bankruptcy and on the bankruptcy administrator’s ability to discover assets. Yet at the same time, for this asset discovery process to continue, the creditor is forced to again advance the procedural costs, this time in an amount that may be inordinately high, reaching as much as ten times the ceiling of the initial advance. Given that the bankruptcy administrator proved unable to discover any assets on their first try, the outcome is highly uncertain.

The creditor, therefore, faces the onerous task of choosing between not incurring any additional cost but giving up on their debt, on the one hand, and taking the chance of advancing a large sum in exchange for no certainty of recovery, on the other.

II. The solution

This issue can decisively impact the economic position of the creditor and their ability to recover debts in bankruptcy proceedings, and therefore ought to be regulated by law to minimise uncertainty.

There are a variety of ways to address this problem by introducing requirements for bankruptcy judges or bankruptcy administrators.

One very effective solution that would eliminate issues with decision-making by judges would be to legislate ceilings for additional advance payments. These could be based on the size of the debtor, similarly to how the initial advance is regulated.

In this approach, the additional advance required to continue the bankruptcy proceedings would be determined by the category of the debtor (i.e., whether it is a micro-enterprise or a small, medium-sized, or large business). The ceilings would not necessarily have to be identical to those for initial advances. That being said, care ought to be taken to find a satisfactory solution that would reduce the potential gap between the high amounts of bankruptcy advances and their economic justification for creditors.

One option here would be to limit the additional advance to, for instance, no more than three times the ceiling for the initial advance payment. For example, a judge could seek an advance of no more than 150,000 dinars (about 1,275 euros) for a bankrupt micro-enterprise. The relevant consideration here is understanding whether it is justified to assess additional advances in amounts several times higher than initial ones. If 50,000 dinars is sufficient to cover the costs of advertising, notifications, retaining a bankruptcy administrator, and securing assets, one may well ask what further steps in a bankruptcy proceedings warrant the additional expenditure of, say, 400,000 or 500,000 dinars (roughly between 3,000 and 4,000 euros), especially as the bankruptcy administrator has already taken nearly all the actions they felt necessary.

The Bankruptcy Law could also be amended to introduce requirements for bankruptcy administrators that could improve the position of creditors.

Here, as judges often consult bankruptcy administrators and frequently rely on their estimates when assessing advances, the Law could mandate that bankruptcy administrators submit a duly justified report, containing an exhaustive list of further actions to be taken in the bankruptcy proceedings with a breakdown of costs, which would then inform the judge’s decision.

This arrangement would prevent bankruptcy administrators from making broad-based estimates of future costs, and preclude bankruptcy judges’ rulings from relying on such approximations. At the same time, as any additional costs would be substantiated, creditors would benefit from more certainty and transparency in decision-making as to any additional advances required to continue bankruptcy proceedings. In sum, the current Bankruptcy Law can be amended to address emerging issues identified in practice. What is required is identifying these situations, which often arise in actual cases, and proposing potential solutions that could help the legislator regulate these matters more clearly.

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