Avoidance actions in Serbia and in Montenegro: An overview

In response to the EU Commission's proposal for a directive to harmonse specific elements of insolvency law on 7 December 2022, this article explores avoidance actions, one of the Directive Proposal’s key aspects, and the way avoidance actions are regulated in Serbia and Montenegro as EU candidate countries.

In the context of insolvency proceedings, avoidance actions involve the annulment of transactions undertaken by the insolvent debtor before the initiation of insolvency proceedings.

Avoidance actions in Serbia

Avoidance actions in insolvency proceedings in Serbia are prescribed by the Law on Bankruptcy ("Official Gazette of RS", no. 104/2009, 99/2011, 71/2012, 83/2014, 113/2017, 44/2018 and 95/2018).

Serbian Law on Bankruptcy recognises two primary kinds of debtor legal action, which can be annulled: (1) legal actions that discriminate between creditors; and (2) legal actions aimed at causing harm to the creditors. Avoidance actions regarding discrimination among creditors are aimed at ensuring the equal treatment of creditors and are focused on relations between the creditors. When it comes to avoidance actions regarding harm caused to the creditors, however, the focus is on creditors-debtor relations.

The Law on Bankruptcy prescribes the following:

• General and special conditions for avoidance actions;
• The procedure for avoidance actions;
• The consequences of avoidance actions.

General conditions for avoidance actions

The general rule of the Law on Bankruptcy is that avoidance actions can be taken against a legal action made prior to the opening of the insolvency proceedings, which disrupt attempts by bankruptcy creditors to achieve an even settlement or cause harm to creditors. Avoidance actions can also be taken against legal actions that put individual creditors in a more favorable position.

The general conditions for avoidance actions are:

1. Legal action

The avoidance action is always directed at a legal action but only an action with proprietary effect (i.e. one that affects the debtor’s property).

Failure to take legal action is equated with legal action.

2. Time when legal action is taken and deadlines for avoidance actions

An avoidance action can be taken only against legal actions taken prior to the opening of insolvency proceedings.

The Law on Bankruptcy prescribes different relevant times for the undertaking of legal action for the times to be susceptible to avoidance action. These relevant times (i.e. deadlines) are prescribed based on the type of legal action. The deadlines vary and range from six months to five years.

3. Harm to creditors

Avoidance action can be taken only against legal action with a proprietary effect. In addition to this prerequisite, this effect needs to impact the debtor’s property in a way that may cause harm to his creditors.

The term “harm to creditors” is an umbrella term and applies to the following two legal actions: (1) legal acts that discriminate between creditor; and (2) legal acts aimed at causing harm to the creditors. Harm to creditors exists in every instance where the bankruptcy estate is harmed (i.e. reduced).

4. Positive outcome for creditors

The final condition for taking avoidance action is that such action will have a positive outcome for creditors. An avoidance action needs to provide better chances for creditors to settle their claims.

Special conditions for avoidance actions

Other than the general conditions for undertaking avoidance actions, the Law on Bankruptcy prescribes special conditions that must be met in certain situations:

1. Legal actions of usual settlement

Legal actions of usual settlement are legal actions undertaken in the last six months before the submission of a proposal for the initiation of bankruptcy proceedings, which provide a creditor with security or provide settlement in a manner and at a time that is in line with his rights.

Avoidance action may be taken against an action of usual settlement if at the time the bankruptcy debtor was unable to pay and the creditor knew or should have known about this inability to pay.

An action of usual settlement can be contested even when it was undertaken after the filing of a proposal for initiation of bankruptcy proceedings if the creditor knew or should have known that the bankrupt debtor was unable to pay or knew that a proposal for initiation of bankruptcy proceedings had been submitted.

2. Legal actions of unusual settlement

Actions of unusual settlement are legal actions, which provide a creditor with security or a settlement that he did not have the right to request or that he had the right to request but not in the manner and at the time when it was taken.

Action of unusual settlement can be contested if it was taken within the last twelve months before the filing proposal for initiation of bankruptcy proceedings.

3. Legal actions with direct damage to creditors

Legal actions with direct damage to creditors are ones causing direct damage to creditors at the time of their undertaking, unlike indirect damage expressed in damage to the bankruptcy estate.

Avoidance action may be taken against legal actions with direct damage to creditors if the legal actions were:

1. undertaken during the last six months before the submission of the proposal for initiation of bankruptcy proceedings, and at the time of conclusion of the transaction, the bankrupt debtor was unable to pay and if the co-contractor of the bankrupt debtor knew about his inability to pay;
2. concluded after the submission of a proposal to initiate bankruptcy proceedings and the co-contractor of the bankrupt debtor knew or should have known that the bankrupt debtor was unable to pay or that a proposal to initiate bankruptcy proceedings had been made;
3. not taken by the bankrupt debtor resulting in the loss of any of his rights or the ability to exercise a right, and the action was taken or omitted during the last six months before the submission of the proposal for initiation of bankruptcy proceedings.

4. Legal actions with intentional damage to creditors

A legal transaction or a legal action concluded or undertaken during the last five years before the filing of a proposal to initiate bankruptcy proceedings or after with the intention of damaging one or more creditors can be contested if the co-contractor of the bankrupt debtor knew about the bankruptcy debtor's intention.

The procedure for undertaking avoidance actions

Avoidance action can be taken via:

• Lawsuit, but only if submitted no later than the beginning of the main division;
• Counterclaim or objection in case of ongoing proceedings.
• The avoidance action can be taken by the following persons:
• Creditor;
• Bankruptcy administrator (acting in the name of the insolvency debtor and on his behalf).
• The avoidance action can be taken against the following persons:
• The person with whom the debtor has concluded the relevant transaction or towards whom the relevant legal action was taken;
• Insolvency debtor (if the avoidance action has not been taken by the bankruptcy administrator in his name and on his behalf).

The consequences of avoidance actions

If the court allows the avoidance action, the legal action taken by the debtor produces no effect on the bankruptcy estate and the person against whom the action was taken must return all that he received into the bankruptcy estate.

Avoidance actions in Montenegro

Avoidance actions in insolvency proceedings in Montenegro are prescribed by the Law on Bankruptcy ("Official Gazette of Montenegro", no. 1/2011, 53/2016, 32/2018, 62/2018 and 1/2022.).

The regulation of avoidance actions in Montenegro closely mirrors their regulation in Serbia and the key characteristics outlined above also apply to avoidance actions under Montenegrin bankruptcy law.

Harmonising Serbia and Montenegro’s insolvency avoidance rights regulation with the Directive Proposal

The current legal framework of Serbia and of Montenegro is in line with Article 4 of the Directive Proposal which provides for a basic standard of creditor protection and differs only slightly in Article 6 point 3 regarding legal acts that cannot be declared void.

Article 5 provides that the provisions on avoidance actions are minimum harmonisation rules and that EU member states can maintain or adopt provisions providing for a greater level of creditor protection, which is also the case for avoidance of action regulation in Serbian and Montenegrin insolvency legislation.

Consequently, avoidance actions regulation envisioned by the Directive Proposal already exists in Serbian and Montenegrin insolvency legislation, which should not need significant amendments to comply with the Directive Proposal.

For more information on the Directive Proposal and avoidance actions rule in Serbia and Montenegro, contact your CMS client partner or these CMS experts.