“Pay up or dispute it!” Some thoughts on liquidation proceedings

“Pay up or dispute it!”
Some thoughts on liquidation proceedings

Act XLIX of 1991 on Bankruptcy and Liquidation Proceedings (which originally also regulated voluntary liquidation proceedings), i.e. the Liquidation Act, has been in force since 1 January 1992, yet to this day we encounter cases where clients (or indeed opposing parties) are completely unaware of the essence of liquidation proceedings and the risks that such proceedings pose to them.

As liquidation proceedings can have extremely serious legal consequences (including the winding up of the company), it is worth reiterating a few key points.

The fundamental essence of liquidation proceedings is that based on a final court ruling the creditors (or the liquidator) take control in place of the owners and the former management of the company deemed insolvent in accordance with the criteria set out in law (the ‘debtor’), with the primary aim of satisfying known creditor claims from the debtor’s assets, whilst winding up the debtor without a legal successor.

Liquidation proceedings may be initiated against a company for a number of reasons. We will not be discussing here those trivial cases where liquidation proceedings are preceded by a final court judgment, enforcement, bankruptcy proceedings, or possibly voluntary liquidation proceedings. Our article aims to address the scenario where liquidation proceedings are initiated or would be initiated by one market participant against another. Specifically, Section 27 (2) (a) of the Liquidation Act, which provides that the court declares the debtor insolvent if the debtor has failed to settle or contest an undisputed or acknowledged contractual debt within 20 days of the due date, and has not complied with the creditor’s subsequent written demand for payment.

In other words: any outstanding invoice or payment demand arising from a contract (if the amount of the claim, calculated without interest and surcharges, exceeds 1 million Hungarian forints (approximately 2,850 EUR), or 200,000 Hungarian forints (approximately 570 EUR) after 31 December 2026) may provide grounds for initiating liquidation proceedings if the debtor has previously acknowledged the claim or has not contested it within the prescribed deadline. The ordering of liquidation proceedings is purely formal; even claims that are otherwise unfounded or disputable may provide grounds for such an order if the above conditions are met. If an application is filed for the commencement of liquidation proceedings against a company, the court will not examine whether the claim is well-founded, but rather whether there has been an acknowledgement or a dispute.

To this day, a common mistake made by companies is failing to properly contest the claim (or making a statement that could be interpreted as an acceptance, even though that was not the intention). In addition to the requirement that the dispute must be raised within the time limit, the debtor has to dispute the legal basis, existence, due date, extent or amount of the payment obligation in substance in order to dispute the claim effectively. The debtor’s dispute must be made in writing no later than the day before receipt of the creditor’s demand for payment. In many cases, what happens is not simply that someone forgets about an invoice, but rather that the invoice is not considered legitimate for some reason and they do not wish to pay it; however, this is not communicated to the other party in the appropriate form (e.g. the dispute is raised verbally or by telephone rather than in writing) or in the correct manner (e.g. although the statement intended as a dispute is made in writing, it cannot be interpreted as a substantive dispute based on the above) or at the appropriate time (i.e. too late), thereby opening the possibility of liquidation proceedings being initiated.

Failure to dispute is also risky because the creditor may wish to enforce the claim years later (the general limitation period is five years), by which time it is no longer certain that the debtor possesses all the information necessary to mount a defence. It may also be the case that the claim is to be recovered not by the original creditor, but by a factoring company that has purchased the claim.

Another common mistake is that a company may feel secure, given that its financial position is stable and in order, and assumes that liquidation proceedings - which are associated with an actual inability to pay - cannot be brought against it. However, as we have seen above, the ordering of liquidation proceedings and the legal definition of insolvency do not depend on the company’s actual financial position; a single undisputed creditor’s claim may be sufficient for the court to order such proceedings.

An interesting fact from legal history is that Decree-Law No. 11 of 1986, which regulated liquidation proceedings prior to 1992, did indeed define the concept of insolvency based on the circumstances relating to the debtor’s actual financial position; however, this gave rise to numerous practical problems of legal interpretation and application, which led the legislature to opt for a paradigm shift; instead of a complex examination of the debtor’s actual financial position, it introduced a simple legal presumption that if the debtor has failed to pay a claim without justification, it is likely to be actually insolvent. It should be noted that this legal presumption is not entirely unfounded, as in the vast majority of cases, liquidation proceedings are initiated against debtors who are genuinely unable to settle their debts.

Clearly it does not help with orientation that although the basic concept has remained unchanged since 1992 - namely, that liquidation proceedings may be ordered at the request of even a single creditor, based on the acknowledgement of a claim or in the absence of a dispute of the claim, regardless of the debtor’s actual financial position - the legislation has changed on numerous occasions, as the time limits, and the details of the conditions, etc.

Although the court calls upon the debtor to make a statement prior to ordering liquidation proceedings, there is no longer any opportunity to dispute the merits of the claim at this stage; at most, it is possible to demonstrate that the application to initiate liquidation proceedings is unfounded because it is based on an unacknowledged, disputed claim.

If a creditor files an application for ordering the liquidation proceeding against a debtor and the dispute is late, there is still a possibility of mitigating the damage, i.e. of avoiding the order of liquidation proceeding; that the debtor pays the creditor’s claim. If the debtor otherwise considers the claim to be unfounded but the debtor’s dispute is late, the debtor’s payment of the debt does not constitute an acknowledgement of debt, and the payment can be reclaimed in civil court proceedings.

Of course, the optimal situation for everyone is to avoid finding themselves in a position where they are exposed to the risk of liquidation proceedings in the first place, and where they can only avoid a liquidation order by paying an unfounded claim (if there are sufficient funds to cover it), particularly given that seeking the return of the paid amount through a court proceeding may take a long time and involve further costs. Our advice in this regard is that if anyone receives an invoice or claim based on a contract which they consider to be unfounded, they should contact a lawyer immediately so that the claim can be disputed professionally and lawfully. Disputing the claim is necessary even if you only wish to dispute a part of it, because in the absence of a dispute, even a partially settled invoice may serve as grounds for ordering liquidation proceedings; indeed, in certain cases, partial payment may even be interpreted as an acknowledgement of debt. As for claims that are otherwise well-founded, it is obviously advisable to settle them by the due date. In short: pay up or dispute it!