Sham encumbrance of assets to convince third parties of non-existent legal consequences may constitute a crime. Incurring fictitious obligations is an example.
Poland’s Penal Code offers protection to creditors when a debtor frustrates or reduces the satisfaction of a creditor by removing, concealing, selling, donating, destroying, actually or apparently encumbering, or damages its assets which are seized or at risk of seizure, or removing indications of seizure. If the purpose of such action is to frustrate enforcement of a ruling of a court of other state authority, it is subject to imprisonment from 3 months to 5 years under Penal Code Art. 300 §2.
Difficulties may arise in defining the types of rulings by courts or other state authorities for which frustration of enforcement is punishable under the Penal Code. Generally, this clearly applies to any judicial ruling imposing on the debtor a direct obligation to pay money—but not only. Such a ruling could also include a court order declaring the debtor bankrupt. With respect to such rulings, it should be determined whether the debtor’s act was made for the purpose of sham encumbrance of assets that have been seized or are only under threat of seizure. In the case of execution proceedings, the Civil Procedure Code precisely defines the moment at which seizure occurs. This is not so clear in the case of bankruptcy proceedings, particularly if the debtor made the sham encumbrances of assets after the declaration of bankruptcy but before the bankruptcy trustee took any action.
This was the type of case faced by the Wrocław Court of Appeal, which attempted in its judgment of 24 August 2012 (Case No. II AKa 189/12) to define when in the case of a bankruptcy proceeding the debtor makes a sham encumbrance of its assets seized during the course of the proceeding, and when the assets are only threatened with seizure. In the court’s opinion, the mere declaration of the debtor’s bankruptcy does not yet cause its assets to be seized. Seizure requires manifestation, as in the case of execution against real estate (Civil Procedure Code Art. 847 §1). Thus it is only inclusion of a specific asset of the debtor’s in the inventory by the bankruptcy trustee that causes seizure of that asset. Until that point the debtor’s assets are only threatened with seizure.
The ruling was issued under the following facts. In 2004, the court declared the bankruptcy of a debtor operating as a sole trader. During the bankruptcy proceeding, the attorney for a creditor filed a proof of claim for a promissory note obligation in the amount of PLN 800,000, allegedly secured by a cooperation agreement between the creditor and the debtor from 2002. During the proceeding, the court found that the encumbrance on the debtor’s assets was a sham, and the promissory note was issued by the debtor only to create the appearance that his assets were encumbered. Thus, in the court’s view, the debtor’s action was clearly intended to frustrate the enforcement of a court order by fictitiously encumbering his assets.
In the justification for the judgment, the court of appeal stated that the offence defined in Penal Code Art. 300 §2 is an individual offence of which only the debtor can be the perpetrator. The sham encumbrance of assets as referred to in the code should be interpreted, according to the court, to mean any behaviour consisting of creating circumstances to convince third parties that the legal effects in question were achieved, when in reality they did not occur at all. Sham encumbrance of assets in this respect could take various forms, including more specifically incurring fictitious obligations.
This judgment counsels great caution when approaching any acts by the debtor in the face of even a threat of seizure of its assets. From a literal wording of the law, only actions consisting of sham encumbrance of assets are threatened with criminal liability, which could suggest that this has to do only with actions involving establishment of liens against property. But the court of appeal interpreted this provision more broadly, also treating incurring fictitious obligations as a form of sham encumbrance of assets. Unfortunately, the court did not explain what it meant by a “fictitious obligation,” but it may be inferred from the facts of the case that this has to do not only with backdating agreements, but also incurring obligations which the parties from the start never intend to perform, e.g. by entering into an agreement in which the debtor will provide cash consideration but will not demand that the other party provide its non-cash consideration.
Under such a broad conception of actions qualifying as offences under Penal Code Art. 300 §2, creditors clearly obtain an additional mechanism for protection of their rights against dishonest debtors. It should be pointed out that under Civil Code Art. 58, transactions that are contrary to law are invalid. The state of being contrary to law may also involve violation of mandatorily applicable provisions of public law, including criminal regulations (Supreme Court of Poland judgment of 28 October 2005, Case No. II CK 174/05, published at OSNC 2006 No. 9 item 149). Thus if a creditor seeks to set aside a sham transaction by the debtor, it may achieve the same purpose by demonstrating that the transaction was a sham under Civil Code Art. 83 §1 or by demonstrating the transaction was used to achieve criminal purposes and thus is invalid under Civil Code Art. 58 §1.
Natalia Kobyłka, Difficult Receivables Recovery Practice, Wardyński & Partners