On 2 July 2021, the Eastern High Court ruled in the matter of BS-48509/2020-OLR, deciding on avoidance of prepayments to a lawyer who had assisted the company with examining the possibilities of restructuring.
In the case, a creditor had filed a bankruptcy petition against the company on 6 November 2018, and the company then contacted a lawyer requesting assistance to examine the company’s restructuring possibilities.
The assisting lawyer received two prepayments: DKK 30,000 on 13 November 2018 and DKK 20,000 on 22 November 2018.
On 27 November 2018, the lawyer sent an invoice to the company stating that the work included, among other things, participation in an initial meeting on 12 November 2018, review of the company’s accounting records, various correspondence and participation in meetings concerning various restructuring models. On payment of the invoice of DKK 39,375, it was partially set off against an amount of DKK 31,250, equalling the lawyer’s share of the two prepayments.
Bankruptcy estate demanded repayment of prepaid legal fees
On the same day, bankruptcy proceedings were commenced against the company. When the bankruptcy order was issued, the company had assets for only approx. DKK 90,000, while claims had been filed for more than DKK 2 million. Subsequently, the bankruptcy estate brought legal action against the lawyer claiming repayment of the amount of DKK 31,250 under sections 72 and 74 of the Bankruptcy Act.
Section 72 of the Bankruptcy Act concerns payments of debt and other transactions made after the reference date, which in this case is the date when the bankruptcy petition was filed: 6 November 2018.
Payment could not be avoided as restructuring was not possible
The City Court found that the payments were voidable as the lawyer had not been in contact or dialogue with the creditor who had filed the bankruptcy petition, and as it ought to have been clear to the lawyer that restructuring was not an option, and that the work performed was therefore futile. The lawyer brought the decision before the Eastern High Court.
The High Court did not find that the payments were payment of work already performed (payment of debt). The High Court therefore denied that the payments could be avoided under section 72(1) of the Bankruptcy Act.
However, the High Court found that the payments were prepayments. It was thus the High Court’s opinion that the payments could be avoided under section 72(2) of the Bankruptcy Act.
The High Court took into account the information about the described work, compared with the information about the company’s limited assets and the size of the company’s liabilities. The High Court found that it had not been proved that the prepayments had been necessary - neither in the interest of maintaining the company nor in the interest of safeguarding the creditors’ common interests to a reasonable extent, which are conditions for preventing avoidance under Section 72(2) of the Bankruptcy Act.
On that basis, the High Court affirmed the City Court’s judgment, and the lawyer had to repay the fees received.
Judgment should not deter companies in distress from seeking legal advice
In Horten’s opinion, the decision can hardly be construed to the effect that a company in distress is not able to seek legal advice on a potential restructuring when a bankruptcy petition has been filed against the company. This should be seen in connection with section 94(1), no. 1 of the Bankruptcy Act where reasonable costs incidental to attempting to procure a total solution in respect of the debtor’s financial affairs by means of e.g. restructuring are claims preferential to those of other creditors in the order of priority of creditors.
By contrast, the High Court’s judgment can be seen as an indication that an adviser cannot secure payment of unnecessary work irrespective of prepayments in the cases where it is apparent beforehand or after very simple examinations that any attempts of restructuring are futile. This applies especially in cases where the lawyer’s work was commenced only by agreement with the company's management and without including the company’s principal creditors.