Czech Supreme court ruling places limits on how much banks can collect from insolvent debtors

It is not an uncommon practice that borrowers in financial difficulties wish to pay their debts to their banks before other creditors. This may be particularly the case in in times of crisis like the present. This can be bad news for low-priority creditors during difficult times, but a recent Supreme Court ruling reduces the risks to these rank-and-file creditors by limiting the ability of an insolvent debtor to pay a bank ahead of anyone else. In fact, a bank may be paid less than other non-financial creditors. How?

Supreme Court decision 29 ICdo 149/2017 explored whether a bank must pay back money if the repayment was made by a borrower who was insolvent, but no insolvency proceedings were in place. In other words, the court ruled on whether a borrower's insolvency trustee can successfully challenge a loan repayment before insolvency proceedings have started.

In its decision, the court set conditions for banks and other professional credit providers that are stricter and less beneficial than those applicable to other non-financial creditors.

The legal basis for this 'claw-back of repayment' decision is a rule in insolvency law that renders transactions in favour of one creditor to the detriment of other creditors ineffective. Under this law, a debtor's preferential transactions can be challenged if the debtor was insolvent or the transaction led to the debtor’s insolvency. In addition to repaying a loan prior to its maturity, the waiver of debtor‘s rights or providing collateral for an existing debt, the courts also see the repayment of an overdue loan as preferential if this repayment curtailed the satisfaction of other creditors.

Czech creditors, including banks and other professional credit providers, have traditionally relied on a statutory exemption that set conditions under which a transaction such as a loan repayment could not be challenged even if the transaction was preferential. The exemption's main condition is that the creditor, after employing "due care", could not have known that the debtor had been insolvent when repaying the loan, interest or other payment.

The Supreme Court placed limitations on this exemption by creating a more rigorous definition of "due care" for financial institutions, such as banks. According to the court, to demonstrate "due care", banks and other professional credit providers must exercise professional expertise, experience and knowledge when assessing whether or not a debtor is insolvent. If in the course of its dealings with a borrower, the bank learns that the borrower meets the conditions of insolvency, all bank payments made by the borrower can be challenged unless the bank is able to demonstrate that the borrower was in fact not insolvent. According to the court, a bank is better than anyone else able to identify insolvency if it exercises its legal right to receive the borrower's financial reports, either on a regular basis or on demand. If these reports suggest that the borrower's financial health is deteriorating, banks must use their contractual rights to request additional data.

The court's rigorous definition of "due care" appears to have been a game-changer. A bank or credit provider can not avoid the implications of the Supreme Court decision since a creditor's right to receive information on a borrower's financial status is an essential right and duty of any diligent financial institution.

Therefore, we recommend that banks regularly conduct a financial assessment of borrowers from the insolvency perspective since failing to identify a borrower's deteriorating financial health could lead to the bank's obligation to return any and all payments received from the borrower for the period when the borrower was actually insolvent.
Importantly, this obligation may be theoretically greater than the entire loan amount if a borrower used a current account credit or revolving loan when insolvent (i.e. the borrower repeatedly utilised this credit).

This ruling clearly carries serious financial implications for lenders. As earlier case law has shown, the fact that the lender also provided new loans to an insolvent borrower is not an effective defence since the lender could still be required to pay back all the amounts to the insolvency trustee for the benefit of all the other creditors.

This does not mean that banks and credit providers are without any defence or lack strategies to mitigate risks. The situation can differ from loan to loan, but a proper structuring of collateral, adequate information duties and introducing internal measures to identify and address any insolvency as soon as possible can significantly reduce risks.

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