Fraudulent transfer claim against a third party: A basic instrument for protecting creditors against debtors’ insolvency | In Principle

The deepening crisis of debtor honesty means that today, more than ever, creditors face the risk that debtors will not only fail to pay their debts voluntarily, but will hinder enforcement by transferring assets to third parties. In such situations, a fraudulent transfer claim against the third party (sometimes called a “Pauline action”), known and applied in legal systems of many countries around the world, comes to the creditor’s rescue.

Fraudulent transfer claim against a third party: how it works

Through a fraudulent transfer claim, a creditor affected by the debtor’s disloyal or dishonest behaviour may recover its claim from the assets of a third party with whom the debtor has conducted a transaction injuring the creditor. The fraudulent transfer claim allows the creditor to challenge in court the effectiveness of a transaction between the debtor and a third party which injured the creditor (including a future creditor)—in other words, to set aside the transaction or render it ineffective against the creditor.

This way, the creditor can bring about a situation where it can satisfy its claim against property or intangibles which have left the debtor’s assets or did not enter the debtor’s assets as a result of the challenged transaction. The creditor will be able to carry out enforcement against property or intangibles currently held by a third party which once belonged, or should have belonged, to the debtor.

Therefore, the fraudulent transfer claim against a third party protects the creditor, who without it would remain defenceless in a situation where the debtor, through disloyal (or dishonest) behaviour, with the involvement of a third party, made payment of the claim impossible, by rendering itself insolvent, or insolvent to a greater degree.

The existence of a security interest (mortgage, pledge) against an asset that is the subject of a transaction to the detriment of creditors does not stand in the way of successfully bringing a fraudulent transfer claim against a third party.

Fraudulent transfer claim in the Polish legal system: main principles

In Polish law, the institution of fraudulent transfer claim against a third party is regulated primarily by Art. 527–534 of the Civil Code. These provisions are intended to protect the creditor from the effects of the debtor’s insolvency.

In the literature on the subject (e.g. P. Machnikowski in Civil Code: Commentary, ed. E. Gniewek (Warsaw 2011, p. 966)), it is rightly argued that the Polish regulations on fraudulent transfer claims against a third party allow the creditor to limit the risk arising from a situation where:

• After incurring an obligation, the debtor may continue to freely administer its assets (including disposing of assets).
• The debtor is liable for performance only with its assets existing at the time of initiation of enforcement or acquired later.
• A creditor whose claim arose earlier generally has no priority in enforcement proceedings before creditors whose claims arose later.
• The risk of the debtor’s insolvency affects the creditor regardless of whether the insolvency occurred before the claim arose, at the time of its occurrence, or only afterwards.

In Poland, a fraudulent transfer claim against a third party can only be used to protect a monetary claim (Civil Code Art. 527 §2). The institution for the protection of non-monetary claims (e.g. for specific performance of a contract obliging a party to enter into another contract) is regulated separately, in Civil Code Art. 59.

A fraudulent transfer claim may be used to challenge only an actual and valid transaction. If the transaction was illusory, the creditor should seek to invalidate the transaction and not challenge it with a fraudulent transfer claim (as the sanction of absolute invalidity precedes and subsumes the sanction of relative ineffectiveness under a fraudulent transfer claim against a third party).

In the Polish system, the subject of the fraudulent transfer claim may be transactions of the following types:

• Dispositive, or both creating an obligation and dispositive (e.g. gift, sale, lease, rental, establishing a contractual mortgage or pledge, easement agreement etc)
• Consisting in relinquishment of a future right or claim (expectative)
• Related to a court settlement
• Procedural, which constituted the basis for issuance of a court decision (e.g. a joint application by the debtor and other participants in the proceedings for division of joint property, distribution of a decedent’s estate, or elimination of joint ownership, if, as a result of granting the application, the assets subject to division were acquired by the participants in the proceedings other than the debtor).

It is prudent to assume that a fraudulent transfer claim against a third party cannot be directed against a debtor’s passive conduct (e.g. an omission or failure to act).

The subject of the fraudulent transfer claim against a third party cannot be a court decision itself (but the debtor’s procedural actions preceding that decision can be).

As mentioned, a fraudulent transfer claim may allow the creditor to carry out enforcement of the claim against property or intangibles currently held by a third party, which once belonged or should have belonged to the debtor.

A third party may defend against liability to a creditor under a fraudulent transfer claim by satisfying the creditor itself or indicating assets of the debtor sufficient to satisfy the creditor (Civil Code Art. 533).

Unfortunately, in Poland a fraudulent transfer claim against a third party is a rather complicated institution, not always effective, and its application requires caution. Therefore, we must point out that this general overview (with its references to analyses of particular issues connected with fraudulent transfer claims) can by its nature reveal only a fragmentary picture of what should be kept in mind when a creditor is considering pursuing a fraudulent transfer claim against a third party in a particular factual situation. Thus, in every case, and consistently, we advise in matters of this type to rely on professionals specialising in protecting creditors against the effects of debtors’ insolvency.

Grounds for bringing an action for a fraudulent transfer claim against a third party

Civil Code Art. 527 §1 (the main provision governing the fraudulent transfer claim against a third party) states: “If, as a result of a transaction performed by a debtor to the detriment of creditors, a third party gains a financial benefit, any of the creditors may demand that the transaction be declared ineffective with respect to the creditor, if the debtor acted knowingly to the creditor’s detriment, and the third party knew of the detriment or, exercising due care, could have learned of it.”

For a creditor to successfully pursue a fraudulent transfer claim against a third party, the following grounds must all be met:

• The claim protected by a fraudulent transfer claim against a third party exists; in other words, the creditor has the right to obtain a monetary benefit from the debtor.
• The debtor has performed a transaction with a third party whereby the third party gains a financial benefit, and the transaction injures the creditor (including a future creditor).
• The debtor acts with knowledge of injuring the creditor (including a future creditor).
• The third party knows that the debtor acted with the knowledge of injuring the creditor or could have learned this by exercising due care. (But note that if the transaction was performed to the detriment of future creditors, in the fraudulent transfer claim against a third party, it must be proved that the third party knew of the injury.)

In principle, a creditor bringing a fraudulent transfer claim has to prove the existence of these grounds (but there are legal presumptions that, in certain situations, make the creditor’s task easier—more on this below). The existence of a protected claim does not need to be established by a prior court decision, but may be proved by other means. However, holding a court ruling from which a claim already arises obviously makes it easier for the creditor to pursue a fraudulent transfer claim against a third party.

Creditor’s position in proceedings for a fraudulent transfer claim against a third party

• What the creditor should prove, and certain helpful presumptions

First of all, the creditor must bear in mind that the grounds for bringing a fraudulent transfer claim against a third party are understood and applied very differently in practice.

For example, what does “insolvency” mean as referred to in Civil Code Art. 527 §2? (“A transaction by the debtor is performed to the creditor’s detriment if, as a result of the transaction, the debtor is insolvent or becomes insolvent to a greater degree than before performing the transaction.”) As a general rule, “insolvency” is taken to mean the debtor’s current inability to meet its financial obligations. Sometimes, it is argued that this does not amount to a declaration of bankruptcy or existence of grounds for bankruptcy. Quite often, it is assumed that insolvency occurs when the enforcement conducted in accordance with the Civil Procedure Code does not lead to satisfaction of the creditor’s claim. However, sometimes the view is adopted that it is sufficient to demonstrate that if enforcement were commenced against the debtor, it would not satisfy the claim.

The awareness of a creditor’s injury, i.e. “bad faith,” must be proved on the part of both the debtor and the third party. In practice, it is most often assumed that to prove knowledge of injury, it is sufficient to prove that the debtor and the third party at least failed to exercise due care to determine whether a transaction would injure the creditor’s rights. However, we are familiar with cases where a creditor has been required to demonstrate affirmative knowledge (“intention”) by the parties to the transaction injuring the creditor, especially by the third party.

In this respect, the creditor may be assisted by presumptions (evidentiary tools) provided for in Civil Code Art. 527 §§3–4 and 529.

The first presumption (from Art. 527 §3) relates to a situation where a person who gains a financial benefit as a result of the debtor’s fraudulent act is “a person in a close relationship with the debtor.” Such a person is presumed to have known that the debtor acted with the intention to injure creditors.

Example: A debtor transfers his assets to a third party who is the debtor’s spouse or cohabitant. The spouse or cohabitant will be considered to be in a “close relationship” with the debtor. The transferee will have to prove that, even if in the exercise of due care, they could not have known that they were injuring the creditor’s interests by performing the transaction with the debtor.      

The second presumption (from Art. 527 §4) relates to a situation where, as a result of the debtor’s acts, a financial benefit is gained by a “business entity maintaining ongoing economic relations with the debtor.” Then it is presumed that the transferee knew that the debtor intended to injure the creditor.

Example: A creditor does not have to prove that the debtor’s regular business partner knew about the relationship between the creditor and the debtor and that the creditor acted with the intention to injure the creditor. By virtue of Civil Code Art. 527 §4, it is presumed that this was the case. If the debtor’s regular business partner wants to refute this, he will have to provide compelling evidence of his excusable ignorance that he was participating in injuring the creditor.

The third presumption (from Art. 529) is that the debtor has knowledge of the creditor’s injury when the debtor performs a transaction without consideration to the benefit of a third party, causing or aggravating the debtor’s insolvency.

Art. 528 also strengthens the creditor’s procedural position. It applies to transactions without consideration (e.g. gifts) between a debtor and a third party. Then, it is irrelevant whether the third party who gained a financial benefit knew or could have known that the debtor was acting with the intention of injuring the creditor—the creditor does not have to prove this. The creditor may demand that an act be declared ineffective even if the third party did not know, and by exercising due care could not have known, that the debtor was acting intentionally to injure the creditor.

• Problems related to formulating a fraudulent transfer claim against a third party

Holding a transaction by the debtor performed to the detriment of creditors to be ineffective takes place through a court action or a defence against a third party who gained a financial benefit from the transaction (Civil Code Art. 531).

To initiate the legal proceedings based on the fraudulent transfer claim against a third party, the creditor brings an action seeking the relevant relief to the competent court against the third party who gained a financial benefit from the transaction.

On the other hand, when the third party has further disposed of the benefit (in favour of a “fourth party,” “fifth party” etc), the creditor may proceed directly against the person to whom the disposal was made, if that person knew of the circumstances justifying recognition of the debtor’s action as ineffective, or if the disposal was made without consideration.

It is vital to formulate the fraudulent transfer claim against a third party in a detailed and precise manner. In terms of the persons involved and the subject matter, the fraudulent transfer claim against a third party (Art. 527 and following) must be strictly specified in the prayer for relief (petitum). It cannot be assumed that the court examining the case will seek out the necessary elements of the claim.

The debtor’s insolvency (or an increase in the degree of insolvency) caused by the challenged action must exist both at the time the fraudulent transfer claim against a third party is filed and at the time when the court rules on the creditor’s claim to recognise the transaction as ineffective against the creditor. Therefore, the courts also take into account transactions performed by the debtor after execution of the challenged action and the status of the debtor’s assets at the time the hearing closes. The courts examine whether there is a causal link between the established state of insolvency or a higher degree of insolvency, and the debtor’s transaction challenged by the fraudulent transfer claim. In other words, the courts look at whether the creditor would actually have been satisfied if the transaction had not been performed. This must also be reflected in the statement of claim (or subsequent pleadings by the claimant). And it should be pointed out that not every transaction reducing the debtor’s assets may be regarded as injuring a particular creditor. In such situations, it may turn out that instead of a fraudulent transfer claim against a third party, some other instrument of creditor protection should be pursued.

The claimant must specify the amount in dispute, which in the case of a fraudulent transfer claim against a third party often poses some difficulty. Is it the value of the claim owed to the claimant by the debtor, or the value of the benefit gained by the third party, or perhaps the value of an asset that left, or did not enter, the debtor’s assets? In this regard, the case law is not clear. However, generally, the determination of the amount in dispute in a fraudulent transfer claim against a third party should begin with an exact determination of the value of the claim against the debtor and the value of the property or intangibles that were removed from the debtor’s assets (or did not enter the debtor’s assets) to the detriment of the creditor. In most cases, the lower of these values will be recognised as the amount in dispute.

• Interim relief in a fraudulent transfer claim against a third party

The creditor may apply for interim relief to secure its claims before, or simultaneously with, bringing an action in a fraudulent transfer claim against a third party. This is important, as bringing a fraudulent transfer claim does not in itself deprive the third party of the right to transfer the benefit on to subsequent parties (this is a basic principle of civil law, as pointed out above).

Therefore, we advise a creditor intending to file a fraudulent transfer claim against a third party to immediately take steps to disclose the claim to a broad group of participants in legal transactions (even before the third party sells the property or intangibles to a fourth party or encumbers the assets with a lien or contractual rights). Due to the non-monetary nature of a fraudulent transfer claim against a third party, this relief can be granted for example through a court injunction banning the third party from disposing of the property or intangible (i.e. by prohibiting sale or encumbrance of the assets). Here there is an open-ended catalogue of methods to secure claims, including methods to secure monetary claims, listed in Civil Procedure Code Art. 747. However, the creditor must keep in mind that the requested method of security should be aligned with the subsequent execution of the judgment if the claim is successful.

Obtaining interim relief, for example an injunction against the debtor’s disposal of real estate, will ensure that the creditor’s protection is more complete. In short, in a fraudulent transfer claim, the creditor must be vigilant and proactive in obtaining interim relief for their claim, as there is a risk that even if they obtain a favourable ruling on their claim (rendering ineffective the debtor’s transaction that caused them injury), they will not be able to satisfy their claims if they are outraced in satisfaction of their claims by a mortgagee of a third party, fourth party etc.

From our experience, we can state that obtaining interim relief in a fraudulent transfer claim against a third party provides an excellent forecast of the final ruling in the case. When granting such relief, the courts are often guided by the assumption that if the creditor has made a showing that a fraudulent act by the debtor and a third party has injured the creditor, it is also likely that the debtor and the third party may take further such actions. At the stage of formulating the application for interim relief in a fraudulent transfer claim, it is worth taking all available steps to prove the fraudulent nature of the challenged action (e.g. using business intelligence or private investigators).

• Court fee and duration of the trial

Currently, if the amount in dispute does not exceed PLN 20,000, the court filing fee for a fraudulent transfer claim against a third party must be paid pursuant to Art. 13(1) of the Act on Court Fees in Civil Cases, which indicates the specific amount of the fee depending on the amount in dispute (e.g. if the amount in dispute is between PLN 15,000 and PLN 20,000, the fee for the claim is a flat PLN 1,000).

However, if the amount in dispute exceeds PLN 20,000, the fee will be 5% of the amount in dispute, but not more than PLN 200,000 (pursuant to Art. 13(2) of the act).

A bill to amend the Act on Court Fees in Civil Cases is pending which would reduce the court fee for a fraudulent transfer claim in cases where the amount in dispute exceeds PLN 20,000 and the creditor already holds a legally final ruling against the debtor. But it is not yet clear if this wording will ultimately be adopted.

Based on our experience, it takes from two to five years (depending on the court and the complexity of the case) for a fraudulent transfer claim against a third party to be heard by a Polish court.

• Period for bringing a fraudulent transfer claim against a third party

The creditor must also keep in mind the time limit for filing a fraudulent transfer claim. Civil Code Art. 534 provides that the creditor has five years to file a fraudulent transfer claim against a third party. This time limit begins to run on the date when the transaction resulting in the creditor’s injury was performed. Failure to meet the deadline renders the right to bring the fraudulent transfer claim time-barred.

However, in practice, determining when the five-year time limit for filing a claim begins to run may pose some difficulties (the law expressly refers to the “date of the transaction,” meaning the date when the transaction was performed, not the date of its material effect).

If a creditor wants to file a fraudulent transfer claim against a fourth, fifth, etc party (pursuant to Art. 534), the beginning of running of the five-year period is therefore calculated from the date of performance of the transaction between the third party and the subsequent party, but only if the court has previously declared the debtor’s transaction with the third party ineffective. In other words, when the court recognises that a transaction by the debtor with a third party is ineffective due to the creditor’s injury, the time limit for claiming ineffectiveness of the transaction transferring the benefit from the third party to a fourth party (and each subsequent party) is calculated from the date of performing of each subsequent transaction.

Consequences of obtaining a judgment in a fraudulent transfer case against a third party

A judgment rendered in a fraudulent transfer case against a third party is not a judgment against the debtor (although one of the grounds for issuing the judgment is precise determination of the claim owed by the debtor to the creditor), but is a judgment against the third party who gained a financial benefit from the debtor to the detriment of the creditor.

As a result of the judgment, the third party will be subjected to enforcement by the creditor against specific assets of the third party, up to the value of the claim against the debtor specified by the creditor. In other words, on the basis of the judgment, the creditor gains the right to seek satisfaction from property belonging to a third party, with whom the creditor has had no previous legal relationship.

In principle, a creditor against whom the debtor’s transaction has been declared ineffective will have priority of satisfaction (except for the aforementioned exception concerning establishment of a mortgage lien).

This means that with priority before the creditors of the third party, the creditor may seek satisfaction from assets that, as a result of the transaction declared ineffective, have left the debtor’s assets or did not enter the debtor’s assets (however, exceptions to this rule exist which are disadvantageous to the creditor).

Jan Ciećwierz, adwokat, Adam Studziński, adwokat, Aleksandra Cygan, Dispute Resolution & Arbitration practice, Wardyński & Partners