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Introduction to bankruptcy

The Norwegian Advisory Council on Bankruptcy will below provide a brief
introduction in the legal aspects of bankruptcy. This introduction is prepared for people without any previous
knowledge of the matter.



1. How are bankruptcy proceedings initiated?

1.1 Introduction
1.2 The debtor must be insolvent
1.3 Petition to institute bankruptcy proceedings
1.4 Bankruptcy decree

2. What happens in a bankruptcy?

2.1 An estate in bankruptcy is established
2.2 An attorney at law is appointed trustee in bankruptcy
2.3 Board of trustees and general meeting of creditors
2.4 Distribution of assets
2.5 Suspension and penalty

3. Arrangements other than bankruptcy

3.1 The Debt Settlement Act
3.2 Other types of debt reorganization

TEXT: HALVARD LEIRVIK

1) HOW ARE BANKRUPTCY PROCEEDINGS INITIATED?

1.1 Introduction

Both individuals and companies can go bankrupt. During a bankruptcy, an investigation of the debtor’s financial situation is carried out. The bankruptcy shall determine the debtor’s assets and liabilities.

Bankruptcy is not a criminal offence.  On the other hand, bankruptcy may uncover illegal actions such as inadequate keeping of accounts.

During bankruptcy, all the debtor’s assets are realized.  Some assets are exempt from this rule – such as clothes, furniture and other personal belongings. The purpose of the sale is to obtain money to pay those who have a claim against the debtor. A complete settlement does not occur very often. In most cases only a small portion of the required money is obtained. Bankruptcy will therefore result in a loss of money for both the debtor and those who hold a claim against the debtor. The last mentioned are called creditors. A significant objective of the bankruptcy is that the money shall be distributed fairly among the creditors.


Debt relief is not granted after bankruptcy. The debt that is not settled must be covered by the debtor’s future income. However, if a limited company (Ltd.) goes bankrupt, the company will cease to exist. This means that the debt will never be settled. 

In 1998, 3 320 bankruptcies were registered at the Bankruptcy Register in Brønnøysund.

The number of the bankruptcies will vary according to the economic situation. The number of bankruptcies in Norway since 1920 shows the following:

Year

Instituted bankruptcies

1926

1 317

1950

221

1980

765

1985

1 340

1990

3 814

1992

5 749

1998

3 320

The number of bankruptcies per annum was less than 1 000 during the whole period from 1928 to 1983. At the beginning of the 1990s the number multiplied considerably.

1.2 The debtor must be insolvent

In order to go bankrupt, the person or the company must be insolvent. The opposite of being insolvent is being solvent. These words are used as labels for the financial situation of a person or a company.

If one is insolvent, one does not have enough money to pay bills and other liabilities within the due dates. You are, however, not insolvent if you may have to defer payment for some of your bills, such as the rent. The word insolvent is used only when the lack of cash will last for an uncertain period of time. The law does not stipulate exactly how long this period must be.

Even if a debtor lacks cash, he is not insolvent as long as his total assets are of greater value than the debt he is responsible for. An example may more readily explain: A pensioner living off a small pension has a very low income. It can be difficult to pay all the bills with the pension. But if the pensioner owns a beautiful, old house that he can sell, he is not insolvent. An exception to this would be if the sale of the house did not result in enough to pay the total debt.

1.3 Petition for instituting bankruptcy

Insolvency is a condition for bankruptcy. However, bankruptcy is the result only if someone wants it to be; a creditor or the debtor himself.

According to the law, the debtor is sometimes obligated to petition for bankruptcy. This is due to the fact that otherwise the creditors will lose unnecessary amounts of money. If the creditors request the debtor to become bankrupt, it is because they suspect the debtor of having poor finances. If the debtor goes bankrupt, the creditors at least have the hope of receiving some money.

When someone has decided to go bankrupt, he or she sends a petition for instituting bankruptcy to the local court. In the cities this court is called the city court, otherwise throughout the country it is called the district court. But when a city court or a district court works with cases concerning bankruptcy, they are called a bankruptcy court. In Oslo the arrangement is different; here there is a permanent court called Oslo Bankruptcy Court that deals with bankruptcies.

The person who petitions for bankruptcy risks having to pay a portion of the bankruptcy proceedings expenses. At the time the petition is submitted, a certain sum must be paid to cover these expenses. This sum is currently NOK 20 000. If it should prove that the debtor has enough money to cover the expenses, the sum will be reimbursed.

There are a few exceptions to the rule of pre-payment when submitting a petition for bankruptcy. The debtor himself does not have to pay, and the same applies to employees who have not received their salaries, and who therefore want to petition for the bankruptcy of their employer. The bankruptcy court may also make other exceptions to the rule for pre-payment if the court is of the opinion that it is vital that bankruptcy proceedings be instituted.

This arrangement involving that a person can become responsible for the bankruptcy expenses, results in many creditors  becoming wary about submitting petitions for bankruptcy. It is therefore becoming common that although companies are insolvent, bankruptcy petitions are not being submitted.

1.4 Bankruptcy decree

After the bankruptcy court has received the petition to institute bankruptcy proceedings, the bank immediately summons a meeting.  The debtor and the creditor, who has petitioned the bankruptcy, attend this meeting. If the bankruptcy court finds that the debtor is insolvent, and that the other conditions of bankruptcy are fulfilled, a decree will be passed to institute bankruptcy proceedings. Decree is the name of a specific type of legal decision. This decree can be appealed in the court of appeal. If no one appeals the decree, bankruptcy is a fact.

2) WHAT HAPPENS IN A BANKRUPTCY?

2.1 An estate in bankruptcy is established

The biggest change that takes place after instituting bankruptcy is that an estate in bankruptcy is established. This involves establishing a differentiation between the debtor as a person and his financial situation.  Mostly, the debtor loses his right to control his own money and property.  There are of course some exceptions; clothes and other personal items of use are not included in the estate of bankruptcy. These things will not be effected by the bankruptcy.

It is important to remember that an estate in bankruptcy only includes those things owned by the debtor. Things that are owned by the family are not included in the estate. Determining which items belong to the debtor can often be difficult. This applies, for example, when a married person goes bankrupt. In this situation it has to be determined which spouse owns what.

The debtor must assist during the bankruptcy proceedings. It is his duty to provide information regarding his financial situation and property.

All the belongings of the debtor must be registered. This task is the responsibility of the trustee (The trustee is usually an attorney at law.  Further information about the trustee is found in the next section). During this period the debtor is not allowed to use his property. If a factory goes bankrupt, management must lock all the gates and give the keys to the trustee. The trustee will ensure that property does not in any way disappear, such as by theft. The trustee shall also ensure that the property is insured.

Although a bankrupt factory must leave everything to the trustee, it may be of interest to continue operations. Operations will then take place under the management of the estate.  This solution is especially used when it is profitable for the factory to complete a project, such as finishing the building of a ship.

2.2 An attorney at law is appointed trustee

When a bankruptcy decree is passed, a trustee is appointed. He is assigned to carry out the tasks that occur during the bankruptcy. The trustee is very often an attorney at law. His main task is to contribute to carrying out the bankruptcy in a generally accepted manner. The trustee shall investigate whether the estate can file compensation claims against anyone in order to obtain more money for the creditors. If the debtor has paid any debts during the last few months prior to the bankruptcy, these payments can in some cases beset aside.

If the trustee finds that the bankrupt company owns items that may lead to pollution, he is responsible for notifying the public authorities.


Information concerning bankruptcy is publicized through advertisements in Norsk Lysningsblad and newspapers (local newspapers). In these advertisements, the creditors are requested to submit their claims. 

2.3 Board of trustees and general meeting of creditors

The trustee and the bankruptcy court are not the only ones involved in a bankruptcy estate.

If the estate includes large assets or requires difficult evaluations, a creditors committee may be appointed. Appointments are made either by the bankruptcy court or by a general meeting of creditors.  (Further information about a general meeting of creditors is found in the next section.) The creditors committee consists of 1-3 representatives from the creditors. Together with the trustee, these people represent the board of trustees. If a company has gone bankrupt, the employees may also be represented on the board of trustees. The main task of the board of trustees is to ensure that the trustee carries out his job in a generally accepted manner.

During the bankruptcy all the creditors are summoned to pass decisions.  This meeting is called the general meeting of creditors.  The general meeting of creditors is the highest body of authority in a bankruptcy. This is reasonable as the estate consists of money that  is owed to the creditors.

Should a disagreement arise at the general meeting of creditors, the creditors must make their decision by voting. However, each creditor does not just have one vote each.  The creditors vote according to the size of the claim they have against the debtor. The larger the claim, the greater power the creditor has. The general meeting of creditors is directed by a judge from the bankruptcy court. In most cases, very few creditors attend the general meeting of creditors.

2.4 Distribution of assets

The creditors that have ensured lien in specific properties will achieve the best result of the bankruptcy. A bank, for example, will ensure a mortgage in the house when granting a loan to purchase a house. If the house is sold during the bankruptcy, the bank will have priority to the income. Often, much of the debtor’s property is mortgaged, leaving very little left for the creditors who do not have security.

The debtor’s property shall be sold in a way that will provide the largest income. In earlier times it was common to sell the items of the estate at an auction. Auctions are still used, but not quite as often. The trustee can hire an assistant, for example a real estate agent, to take care of the sale of the estate.

The bankruptcy is usually concluded before reaching the stage of distributing assets between the creditors. This is usual in cases where the estate contains few items that are not mortgaged. If the estate does not have enough assets to cover the expenses of the bankruptcy itself, all handling of the estate shall be discontinued immediately. In 1997, 77 % (!) of all the estates were discontinued in this manner (2 440 of in all 3 161 estates).

One example of an expense that occurs during the handling of a bankruptcy is the trustee’s salary.

Creditors submit their claims to the trustee. He will investigate whether the claims are valid. In addition the trustee shall state which priority the claim shall have when distributing the assets.  In less complicated estates, the trustee may also decide whether a claim shall be approved or not. If a creditors committee has been appointed, this authority belongs with the board of trustees.  In special cases, it may also be decided that the decision shall be made at a general meeting of creditors.

Best priority is given to mass claims. These are expenses that occur during the bankruptcy proceedings themselves. 

After all these expenses are covered, it is time to pay the first class prioritized claims. This group includes salary claims from people who have been employed by the debtor. There are, however, several limitations as to which salary claims can be approved. In connection with salary claims it is important to be aware of the fact that the state has established a salary guarantee arrangement for bankruptcies. This arrangement entails that an employee may, in accordance with more detailed rules, receive his/her salary from the state. When a salary is paid in accordance with the guarantee, the state takes over the employee’s claim against the estate. 

Further information in regards to salaries in connection with bankruptcy is found in the article «Handling of salary claims in a bankruptcy».

The next group of prioritized claims is the second class claims. This group includes, among other things, tax claims from the state and municipality.

Finally, the ordinary claims and late prioritized claims are paid.There is seldom any money left for these groups.

Bankruptcy proceedings are concluded when the means have been distributed or the bankruptcy proceedings are discontinued because there are no means for distribution. 

2.5 Suspension and penalty

It is not illegal to go bankrupt. However, during bankruptcy proceedings one may discover that the debtor has breached the law, or that he in some other way has conducted his affairs reprehensibly. In such cases the debtor should be allowed to suffer for a while so that he will not be tempted to repeat his actions. There are therefore certain decisions regarding penalty and suspension.

The debtor can be suspended for a period of time from involvement in the foundation of and management of most types of businesses. He can be suspended from establishing new companies, from being the administrating director or a member of the board.  Suspension is imposed by the bankruptcy court and applies for a period of up to two years.  The bankruptcy court’s decision for suspension can be appealed to the court of appeal.

The trustee will evaluate whether there are grounds for suspension.  If there is, he must first of all notify the bankruptcy court.  It is possible to impose suspension if there is suspicion of illegal acts. Suspension can also be imposed on the basis of irresponsible business methods. Suspicion of illegal actions is thus not a condition for using this arrangement.

The purpose of a suspension is to stop people who are constantly involved in bankruptcies. Suspension can be used for both personal bankruptcies and when companies go bankrupt. Should bankruptcy apply to a company, suspension can be used against all the company board members and the director.

Further information concerning suspension can be found in the article «Suspension of Directors».

The Criminal Code also includes regulations concerning bankruptcy.  Among other things, it can be a criminal offence to withhold means from the creditors during bankruptcy. Unfair treatment of creditors can also be a criminal offence. Any breach of these regulations is punishable with fines and imprisonment. The police are responsible for investigating breaches of the regulations in the Criminal Code. According to the Debt Reorganization and Bankruptcy Act, the trustee shall investigate whether any serious criminal offences have been committed in connection with the bankruptcy. If so, the police must be notified as soon as possible.

Further information on this topic can be found in the article «Treatment of criminal offences in connection with bankruptcy».

 

3) OTHER ARRANGEMENTS THAN BANKRUPTCY

Bankruptcy is not the only solution when insolvency problems become too great. There are other arrangements that may help the debtor, and that ensure equality for the creditors.

3.1 The Debt Settlement Act

Many people experienced a debt crisis during the 1980s. On July 17, 1992, the Storting therefore approved an Act concerning voluntary and compulsory debt settlement for individuals. As the name suggests, this Act only applies to individual persons – not companies. The purpose of the Act is to give people that have large debts the opportunity of starting anew.  Debtors are given a chance to regain control of their financial situation.

The arrangement involves setting up a plan for the debtor’s expenses and income for the next five years. If he lives simply and follows the determined plan, much of his debt will be settled by the end of the five-year period. Bankruptcy does not give debt relief. Debt settlement will therefore often be a better solution for the debtor.


The debtor is responsible for requesting a debt settlement arrangement. Specific application forms must be obtained and submitted to the Enforcement Officer. In rural districts, the sheriff has the responsibilities of the Enforcement Officer. The cities usually have an Enforcement Officer. People who are contemplating a debt settlement application will receive assistance from the Enforcement Officer.

A person can only request a debt settlement arrangement once in his/her life.

People who have contracted a personal debt in connection with business cannot apply for a debt settlement arrangement unless he has stopped doing business.  The law contains the condition that a debt settlement arrangement cannot be «supportive». It may be difficult to understand what this condition actually means. The idea is to avoid debt settlement arrangements that seem unfair or unreasonable. If the debt was contracted on the basis of squandering money, a debt settlement arrangement may seem «supportive» to other people who can just barely meet their expenses.

After the Enforcement Officer has received the debt settlement application, it is usually forwarded to the court of enforcement for further handling.  In some cases the Enforcement Officer himself will deny the application, but he can never approve an application on his own.

If the court of enforcement feels that the basic conditions for debt settlement are fulfilled, the court will issue a decree for instituting debt reorganization.

Debt reorganization means that the creditors and the debtor shall discuss whether it is possible to come to some kind of agreement in regards to these payment problems. Institution of debt reorganization is publicized in the newspapers and Norsk Lysningsblad.

During debt reorganization, the debtor must prepare a proposal for debt settlement. As a rule, the proposal will include debt relief for part of the debt. Deferred payment is usually suggested for the part of the debt that is to be paid.  If the debtor’s house is larger than what is required, he must sell the house to obtain ready cash.  Other property, with the exception of personal belongings, must also be sold.

During the time right after debt reorganization has commenced, creditors are not to accept any payments from the debtor. The debtor will be granted payment deferment for three months, but eventually interest will start to accrue.  This allows the debtor a period of time to work with arranging a debt settlement.

Debt settlements can be voluntary if all the creditors accept it. It can also be compulsory if the arrangement is accepted against the protests of the creditors. In 1997, 1 070 voluntary and 1 142 compulsory debt settlements were registered in Norway.

The court of enforcement must stipulate a compulsory debt settlement in order for it to be valid. The court of enforcement shall ensure that the arrangement is in accordance with current regulations.


3.2 Other types of debt reorganization

The expression debt reorganization is also used in other cases than those where the rules of the Debt Settlement Act apply. Bankruptcy can be avoided for a certain period of time by debt reorganization. This applies to all types of debtors, also for businesses.

The debtor’s objective is to achieve an agreement with all the creditors. These agreements usually include deferred payment of the debt as well as partial debt relief from the creditors. The agreement can be voluntary, and is then called a voluntary debt settlement.  The agreement can also be entered into against the protests of some of the creditors. The agreement is then called a compulsory composition.

The debtor has to take the initiative for debt reorganization. A written request must be submitted to the bankruptcy court. If the bankruptcy court finds that the conditions for debt settlement are fulfilled, a decree will be passed.

This type of debt reorganization will normally be publicized. The bankruptcy court can, however, decide not to publicize the matter. A reason for this could be that it would damage the debtor if everyone was made aware of the debtor’s insolvency.

If the creditors cannot come to an agreement regarding a voluntary arrangement, a majority can accept a compulsory composition. How large a majority is required, will depend on the compulsory composition. The law demands that with this type of agreement, the debtor must pay a minimum of 25 % of the debts to all the creditors.

Compulsory composition negotiations are public. A compulsory composition must be approved by the bankruptcy court. Stipulation shall ensure that a compulsory composition is not accepted if it conflicts with the law.


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