US and English Courts welcome most- but not all- foreign debtors

JCRCoverTMA’s Journal for Corporate Renewal July/August 2016 published an article written by Nava Hazan, Mark Salzberg and Susan Kelly, which discusses how the US Bankruptcy Courts have been open to foreign debtors, as well as the limits to such availability, which was the subject of the recent Baha Mar decision in Delaware.

The article further describes how it is increasingly common for foreign companies to use the English scheme of arrangement in cross-border restructuring matters. Several recent cases show the English judiciary, much like its counterpart in the US, has welcomed this type of cross-border restructuring, even where the nexus of the foreign debtor to the UK is minimal.

English Court decides who can be a foreign representatives under Cross-Border Insolvency Regulations 2006

Allied FlagsThe English Court has recently considered who can be  recognised as  “foreign representatives” under the Cross-Border Insolvency Regulations 2006 (CBIR) in the case of Re 19 Entertainment Limited, about a US company in Chapter 11. The Re 19 Entertainment judgment appears to be the first English case where directors of a company in Chapter 11 proceedings were recognised as “foreign representatives.”

Under the CBIR, an English court can give effect, in its jurisdiction, to a foreign law/court order or the legal status of a foreign representative. If a person is deemed a “foreign representative,” they are entitled to commence and participate in proceedings under the insolvency laws of the enacting state.  This means the proceedings will be supervised and controlled by the foreign court.

Chapter 11 proceedings involve reorganisation of companies or liquidation (only if the rescue of the company cannot be achieved) under US bankruptcy law. Once these proceedings have begun, the debtor is given an exclusive 120 day period in which to provide the court with a reorganisation plan. The system under US law is broadly similar to that of administration in England but in the US, Chapter 11 proceedings tend to be ‘debtor in possession’ which means the company’s directors retain control over the management of the company.

The applicants in this case were directors of 19 Entertainment Limited which is part of a group of companies who specialise in owning, producing and developing entertainment content. The applicants applied for recognition of the Chapter 11 proceedings by the English court and for discretionary relief in the UK.

The judge first considered the location of the COMI. The address of the company’s registered office was in London which gave rise to a rebuttable presumption that the COMI was in London. In considering the presumption, the judge considered a number of factors including the fact that the London office had been shut down, all business activities took place in the US, the directors are US citizens and creditors gave evidence that they believed the COMI to be in Los Angeles.  The presumption was rebutted and the COMI was instead held to be in the US.

The main issue in the case was the granting of relief and the form that this relief would take.  In order to grant relief, the Chapter 11 proceedings had to amount to ‘foreign main proceedings’.  These are proceedings in a foreign state pursuant to a law relating to insolvency which are controlled or supervised by a foreign court for the purpose of reorganisation or liquidation. The outcome of the case was that the application was granted to recognise the Chapter 11 proceedings.

The court also had to decide whether the applicants (i.e. the directors of the company) were ‘foreign representatives.’ A foreign representative is deemed to be a person authorised in foreign proceedings to administer the reorganisation/liquidation of the company or to act as a representative of the foreign proceedings.  In US proceedings, the continuation of a debtor in possession to operate and manage the business during the bankruptcy proceeding under Chapter 11 is the norm. Therefore the court accepted the directors were indeed foreign representatives.

Art 21(g) CBIR enables the court to grant any additional relief which may be available to an English insolvency office-holder under English law. In this case, relief was granted in the form of a moratorium similar to that provided in para 43 of sch. B1 of the Insolvency Act 1986. The moratorium prevents a winding up petition or other creditor action whilst steps are taken to put the company into administration.

When an Asset is not an Asset

Empty office showing business failure

The Court of Appeal has recently considered the status of contingent assets within the balance sheet test for insolvency in the context of a company’s inability to pay its debts. Under Section 123 Insolvency Act 1986, a company is deemed unable to pay its debts if its assets are less than its liabilities including contingent liabilities but nothing is said about the status of contingent assets.

In the case of Evans v Jones, the liquidator of Rococo Developments Limited (“Rococo”) was seeking to recover directors’ loans repayments of circa £450,000.   The directors defended the action by stating that at the time the payments were made the value of Rococo’s assets was greater than the amount of its liabilities taking into account its contingent assets and as it was solvent, the preference action should fail.

The contingent asset in question was an unlawful dividend of £75,000 made by Rococo to its directors (who were also its shareholders and so the beneficiaries of the dividend) at or around the time the preferential payments were made.   The question the Court of Appeal had to determine was whether the unlawful dividend could or should be treated as an asset of Rococo on the assumption that it was recoverable.   If it was in fact an asset, then Rococo would not have been deemed unable to pay its debts at the time the preferential payments were made and those payments would not be recoverable as they would not have been made at a “relevant time” as required by Section 240 Insolvency Act 1986.

The Court of Appeal concluded that the claim against the directors with regard to the unlawful dividend payment was itself contingent on Rococo’s subsequent insolvency.   This is because it was contingent on firstly, being discovered and secondly, being pursued – neither of which was likely to happen so long as the directors  remained in control of Rococo.   The court described the claim against the directors for unlawful dividend payments as an “unknown unknown” at the time the preferential payments were made and therefore so remote a contingency as past capable of properly being taken it into account when assessing Rococo’s commensurate balance sheet.

The court followed the approach taken in  BNY v Eurosail [2007] that the “… assets to be valued are present assets of the company.   There is no question of taking into account any contingent or prospective assets …”  The court also relied on the fact that Section 123(2) explicitly refers to contingent and prospective liabilities but not to contingent or prospective assets.

This case builds on the English jurisdiction’s critical analysis of balance sheet solvency with the benefit of 20/20 vision and further highlights the view that a “liberal” approach to the use of hindsight is permissible when reviewing payments made by a company suffering financial distress.   However, it is not permissible, nor indeed sensible, to “re-write history.”

The Second Circuit’s General Motors Decision Defines Limits To “Free And Clear” Sales

Detroit, Michigan, USA - March 30, 2010: The towers of the Detroit Renaissance Center, the world headquarters of the General Motors Corporation.

Last week, the Second Circuit Court of Appeals reversed a bankruptcy court order barring tort claims for product defects against the purchaser of General Motors’ (“Old GM”) assets.  The purchaser (“New GM”) had purchased Old GM’s assets “free and clear” in Old GM’s 2009 bankruptcy case under section 363 of the Bankruptcy Code.  The Second Circuit’s ruling is certainly a victory for the plaintiffs who are seeking damages for personal injuries arising out of product defects and redress for lost economic value for defective vehicles.  However, the court’s ruling also underscores the broad scope of “free and clear” sales under normal circumstances.

According to the plaintiffs, beginning in 2002, Old GM began installing ignition switches in numerous vehicle models that the company knew to be defective.  The switches were prone to turn the vehicle off from minimal torque as light as a swinging key ring – even while moving.  This caused the power-steering, power-brakes, and airbags all to turn off during operation.  While Old GM employees knew of the defect, no notice was ever provided to customers.  Rather, Old GM actively concealed the defect from customers and continued to install the defective switches in vehicles until it secretly changed the design in 2006.  Old GM filed bankruptcy in 2009, never disclosing the faulty switch or corresponding potential liability to its customers, and consummated a sale of substantially all of its assets to New GM free and clear of all encumbrances four months later.  New GM did not issue a recall for the defective switch until February 2014, and a multitude of plaintiffs immediately filed suit against New GM.

New GM sought to have the ignition switch cases dismissed, arguing that it could not be liable because it purchased Old GM’s assets free and clear of all claims, including the plaintiffs’ claims, under section 363.  The bankruptcy court agreed.  The court found that Old GM knew about the defect and its contingent liability to the plaintiffs at the time of the bankruptcy, and due process therefore required the plaintiffs to have been given proper notice and an opportunity to participate in the sale process.  Nevertheless, the bankruptcy court held that the plaintiffs’ claims were barred because the court would have approved the sale free and clear of the plaintiffs’ claims even if the plaintiffs had objected, and therefore the plaintiffs could not demonstrate that they had been prejudiced by the lack of notice.

The Second Circuit upheld the bankruptcy court’s holding that due process required that proper notice be given to the plaintiffs, but it reversed the bankruptcy court’s ruling that the plaintiffs had failed to show that they had been prejudiced by the due process violation.  Initially, the appellate court noted a split of authority as to whether a plaintiff must even show prejudice resulting from a due process violation.  However, the court ultimately did not have to reach this issue because it found that the plaintiffs had in fact sufficiently demonstrated that they had been prejudiced.  The court pointed out that the 2009 sale to New GM was a negotiated deal with input from multiple stakeholders resulting in New GM voluntarily assuming certain liabilities it was not legally required to assume.  The court found that it was far from certain that there would not have been material differences in the terms of sale had the plaintiffs been at the bargaining table, especially considering the significance of their aggregated claims.  Therefore, the court found that it could not “say with any confidence that no accommodation would have been made for [the plaintiffs] in the Sale Order” if they had been given an opportunity to participate in the sale and negotiation process.

The practical takeaway for parties and bankruptcy practitioners is to reinforce the need for debtors to fully disclose all potential liabilities in their bankruptcy proceedings, so that no creditors are left unbound by the process.  Moreover, although it may be the debtor, as seller, who is responsible for notifying interested parties in the context of an asset sale under section 363, it is also crucial for a purchaser to ensure that proper notice is provided in order to avoid later being saddled with liabilities it thought were left behind.  Notwithstanding these potential pitfalls, the Second Circuit’s decision underscores just how “free and clear” a sale under section 363 can be, provided that proper notice is given to all interested parties.

The “3 Rs” of Education: Reading, Writing and… Restructuring?

College Costs - PoundSignificant changes have taken effect and are expected to continue within the education sector, the result of which may lead to an increase in restructuring activity and additional pressure on funding streams.

In the Further Education (“FE”) sector, the Government has introduced “Area Reviews”, whereby FE institutions within a particular geographical area are encouraged to merge with one another in order to consolidate the number of FE providers in that area. The stated aim is to create “fewer, larger and more financially resilient organisations” (1). It is estimated that as many as 1/3 of current FE institutions may disappear as a result of the anticipated consolidations.

These mergers will lead to increased pressure on the management teams of FE providers who will have to deal with all the usual issues that combinations bring, such as integration of management teams, service provision and the cultures of the various entities. If those management teams have not undertaken a merger before, it will present them with obvious challenges and may result in reliance upon professional advisors, which will be an additional cost for the institutions to bear.

The Government has announced that it will make available a “restructuring facility”, whereby Government funding can be made available to meet those costs. However, that facility is only designed for FE providers to use in the event that alternative funding is not available, meaning that the institutions are likely to look to incur additional debt in the first instance, if their balance sheets can support it. The Government has also stated that, once the Area Reviews are completed, no Exceptional Finance Support will be available for those FE institutions that have been through an Area Review.

Separately, Higher Education (“HE”) providers are facing problems caused by increased competition. With the burden of the cost of HE shifting further from the Government to the student, students understandably expect the best “bang for their buck”.  Greater scrutiny is being given to the “measurable” aspects of HE, including student satisfaction surveys, employment prospects and staff/student ratios. With approximately 70% of HE providers’ funding estimated to come from tuition fees, a decrease in student numbers for those institutions who can’t compete as well as others within the sector will lead to funding strains.

In addition, the research income provided by corporate and charitable bodies is increasingly focused upon the highest performing HE providers, given increased scrutiny by corporates and charities on their return on investment and research output. This is seeing a flight of funding from the lowest performing institutions, which may make them unviable, especially if the third party funding cuts are met with decreased student numbers.

The problems for the HE sector outlined above were in existence prior to the Brexit vote on June 23rd. Brexit may well bring additional pressures, given the number of EU citizens that choose to study in the UK, with a consequential increase in funding for those HE providers. In terms of staffing, many lecturers choose to base themselves in the UK for research and teaching purposes. It is unclear whether the UK will continue to be as attractive from an academic perspective post-Brexit. If that leads to a perceived decline in the quality of the academics that HE providers employ, then, again, this could mean that research funding follows those academics to wherever they choose to base themselves.

 

(1) (March 2016 BIS report: “Reviewing post-16 education and training institutions”)

Jevic Holding: The Case That Keeps On Giving

us-supreme-courtThe Jevic Holding Corp. bankruptcy case is proving to be precedent setting.  In a prior post, we examined how the court had greatly increased the evidentiary burden on a party seeking to hold one company liable for the debts of another company under a “single employer” theory.  That ruling was seen as a boon for private equity firms who were oftentimes the target of Chapter 11 creditor committee claims seeking to make them liable for the debts of their portfolio companies.

Now, the U.S. Supreme Court is poised to rule on yet another issue arising from the Jevic case.  On June 28, 2016, the Supreme Court granted a petition for certiorari to decide whether a bankruptcy court may “dismiss a case through an agreement that gives payment to lower-ranking creditors ahead of more senior-ranked creditors.”  This technique is sometimes referred to as a “structured dismissal.”

In Jevic, the bankruptcy court approved a settlement among the debtor, the creditors’ committee, the private equity firm and the lead pre-petition lender.  The settlement provided for cash payments and other concessions from secured creditors in return for dismissal of various avoidance actions brought by the unsecured creditors committee.

The settlement was opposed by a group of drivers who had successfully sued the debtor for violation of the WARN Act and an analogous New Jersey statute by failing to provide them with the required 60-day notice before a plant closing or mass layoff.  Under the proposed settlement, the drivers would receive no distribution, although the settlement would provide payments to tax and general unsecured creditors.  The drivers contended that this settlement, which was to be followed by a dismissal of the bankruptcy case, was contrary to the priority rules in section 507 of the Bankruptcy Code since most of the drivers’ $12.4 million claim was entitled to priority status given to employee wage claims.  The U.S. Trustee also objected to the settlement.

The bankruptcy court approved the settlement, in essence finding that the settlement was a better result than any likely alternative where unsecured creditors, including the drivers, would receive nothing. The district court affirmed on appeal, and the drivers and the U.S. Trustee appealed to the Third Circuit Court of Appeals, arguing that structured dismissals were either banned by the Bankruptcy Code or at least had to comply with the Bankruptcy Code’s priority distribution scheme.

The Third Circuit affirmed the lower courts’ rulings, holding that a bankruptcy court has discretion to approve structured dismissals unless there is a showing “that the structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process.”   Further, the Court, following the Second Circuit’s decision in In re Iridium Operating LLC, held that settlements that deviated from the Bankruptcy Code’s priority scheme could be approved if they have “specific and credible grounds to justify the deviation.”  This was contrary to the Fifth Circuit’s decision in Matter of AWECO, Inc.

In granting certiorari, the Supreme Court will attempt to resolve this circuit split and decide how much flexibility is given to debtors and other parties to craft structured dismissals that deviate from the Bankruptcy Code’s priority scheme.  The Court’s decision will likely have a tremendous impact upon bankruptcy cases, since parties will now know the outside limits of their ability to resolve their competing claims through negotiation.  We will keep our readers informed of the Supreme Court’s decision when issued sometime in 2017.

Tata Steel and proposed changes to pensions legislation- a watching brief for the insolvency world

steelOver the past few months, we have commented on the steel industry crisis and some of the employment law issues arising from it in the context of insolvency. The article written by our Pensions team here discusses the Government’s proposals to assist the British Steel Pension Scheme and its struggling principal employer Tata Steel, one of its primary aims being to avoid entry into the PPF by reducing increases to members’ benefits to the statutory minimum (but which would ultimately see those members better off). Such changes would usually require member consents, which logistically and/or conceptually can present real difficulties.

The article questions whether measures intended to help this pension scheme and certain others facing similar financial difficulties could in fact result in bad law and inconsistencies, however good the intentions are.

Insolvency practitioners should be aware of this potentially changing landscape. If measures putting more control into the hands of pension trustees are implemented and schemes have a better chance of avoiding being wound up then it may assist a few companies to trade through financial difficulties.

For those insolvency practitioners advising on a company’s financial position before a formal insolvency and appraising any restructuring options or improvements to the financial covenant, there may be value in considering if trustees of the pension scheme can implement measures which are not only in the best interests of members but might also help the company as well.

However, as matters stand the Government is only considering implementing special dispensation for large (100,000 member plus) schemes whilst leaving other (equally deserving) schemes without the same tools to manage underfunding issues.

The article suggests now is the time to consider a statutory override across the board to allow trustees to implement measures which can help members get a better overall deal; an override which in our view may also add another dimension to the restructuring landscape.

 

Turmoil in the North Sea – An IP’s Practice Guide

Silhouette of ocean oil rig at sunset.Until recently the oil and gas sector has not been on the restructuring communities radar. However, last year global oil prices hit an all-time low, which led to a record number of insolvencies in the industry. Consequently in conjunction with Lexis Nexis we have produced the Guide to insolvency in the UK oil and gas industry.

Historically, the oil and gas market has been a significant contributor to the UK economy. It has generated over £300 billion and supports a workforce of more than 375,000. However, in 2015-16 UK oil and gas production generated negative receipts to the UK Government of -£24m, compared with +£2.15bn the year before. The North Sea is an increasingly mature basin and consequently it is one of the more expensive places in the world to produce oil. To put this in context it costs US$40 to produce a barrel of oil in the UK compared to less than US$5 in Kuwait. Record low oil prices have therefore significantly impacted the North Sea, leading to a 56% rise in oil and gas insolvencies in 2015. Oil and Gas UK released figures earlier this month showing that employment in the industry has fallen by 8,000 with a further 120,000 jobs being lost in the wider economy.

The economic significance of the sector and the financial difficulties it is facing makes it an complex sector for an insolvency practitioner (“IP”). However, the sector is highly regulated and consequently there are a number of nuances which IP’s should be aware of in a restructuring or insolvency scenario, the key ones being: 

1. E&P Licences

A key feature of the UK industry, especially compared to the US market, is that a Government body, the Oil & Gas Authority (“OGA”), will need to be consulted and its co-operation and consent obtained to any restructuring or insolvency process. This is because in the UK, the Crown owns all the oil and gas in the ground, and grants an exploration and production company (“E&P Company”) the right to extract that oil and gas. This licence is an E&P Company’s most valuable asset and can be revoked on the occurrence of a number of events including insolvency, change of control and failure to pay the licence fee. The OGA’s consent is also required to charge the licence.

2. Joint Operating Agreements (“JOA”)

Another feature in the sector is that most E&P Companies enter into joint ventures to spread their expertise, cost and risk. Their relationship is governed by a JOA which is usually based on an industry standard. On any restructuring, the terms of the JOA will need to be carefully considered as it is standard that if one party defaults under the JOA, the other parties can be required to make up that shortfall, and the defaulting party will forfeit their interest in the joint venture and loose the right to receive information and vote. The enforceability of these clauses has yet to be tested.

3. Decommissioning Costs

The UK has very strict decommissioning laws, and decommissioning costs are one of the most significant and unpredictable expense in this sector. Given the maturity of the UK’s basin, the amount spent on decommissioning is predicted to increase from £1 billion in 2013 to £8 billion in 2018, with approximately £60 billion being expected to be spent on decommissioning over the next 30 years. On any restructuring or insolvency, a purchaser will need to provide security for its share of the decommissioning costs. Additionally on any formal insolvency, an IP is likely to want to satisfy himself that he will not run the risk of acquiring personal liability for any environmental breaches before accepting the appointment.  The unprecedented levels of decommissioning activity in the North Sea is beginning to lead to a number of disputes and Ben Holland and Michael Davar of Squire Patton Boggs, London have just published a new book on decommissioning: Oil and Gas Decommissioning: Law, Policy and Comparative Practice (Global Law & Business, ed. 2, 2016).

A more in depth analysis of the issues facing IP’s in the sector is contained in the attached article. Readers may also be interested in our earlier blogs:

Coming down the pipeline: risk and opportunity for the oil and gas sector in the era of low oil prices” and “2016: Friend or Foe in the Face of the Global Oil Pricing Crisis?

Brexit: Keep Calm and Carry On

exit from the eurozoneAs the country recovers from the shock outcome of last Thursday’s Referendum, the question which Restructuring professionals must now consider is “what does Brexit mean for me?”. The truth is that nobody really knows. The Referendum decision is not legally binding on the UK Government and the process of the UK leaving the EU will only start once the UK has served formal notice on the EU pursuant to Article 50 of the Treaty on the European Union. This will start a two year negotiation period to effect Brexit. In the meantime, the UK remains a member of the EU and EU law continues to apply.

So, in some respects it is very much business as usual for now, but on the basis that David Cameron’s successor will give notice to leave the EU, we recommend that clients start considering the consequences of Brexit now. Preparation for those consequences may include looking at the following:

Contract Reviews – Many contracts refer to an array of EU laws, regulators and territories which should be reviewed to determine how Brexit may/will impact. Can the contract be varied to mitigate the impact of Brexit? What is the potential impact on the contract price being linked to Sterling, the Euro or the Dollar? Does the governing law clause need amending? Will Brexit result in a breach of contract? Whilst unlikely, can force majeure or material adverse effect clauses be relied upon? How can the contract be future-proofed?

Financing and security reviews – Brexit caused turmoil in the markets initially and led to a reduction in the UK’s credit score rating and a significant devaluing of sterling. Before the Referendum, warnings of a post Brexit recession were rife. Is your business/customer at risk of breaching its financial covenants as a consequence of Brexit? Do those facilities and security need to be reviewed and changes made to protect the position?

Vulnerability to Brexit – Brexit is going to impact some more than others. How much do you or your clients/customers trade with other EU countries? How will your supply chain be affected? Do you currently benefit from EU funding? Is the tax efficiency of your business based on EU law? Does your business benefit from EU emission allowances? Will you need a licence or other authorisation to trade in the EU?

Public Policy – The UK will have to review where domestic legislation may need to be amended to take account of Brexit. It will be important to businesses to understand what changes are likely to be coming down the line. Many of the legal changes will be driven by policy decisions made in London and/or Brussels in particular. Keeping on top of these Policy decisions may allow businesses to position themselves to benefit from or at least mitigate the effects of legislative change. Do you need to engage with public policy professionals to assist in lobbying for changes which will have a positive impact on your business?

International Trade Arrangements – To what extent does your business involve the supply of goods between the UK and other EU member states? How will your business be impacted by the potential imposition of tariffs and other trade barriers restricting the free movement of goods post-Brexit?

Immigration and employment– What nationality are your employees? How will your ability to recruit/second employees be affected and will any parts of your business have to be downsized?

Communication – To what extent do you need to make any public statements or disclosures in relation to the impact of Brexit on your business. What is your strategy for communicating the impact of Brexit with your staff?

Other issues will arise as the full impact of Brexit unravels over the coming weeks and months. Squire Patton Boggs are ideally placed to help, given our global footprint (including 15 offices across the EU), our Public Policy practice in Brussels and the expertise we have in many areas of your business and those you will be advising which may be affected. We look forward to partnering with you in order to facilitate the inevitable changes Brexit will bring.

Spanish banks must refund homebuyers’ deposits on unfinished developments

Incomplete building projectA ruling by the Supreme Court in Spain says Spanish banks that held deposits for property that was never built are to be held to account. Around 100,000 people in the UK are thought to have paid big sums towards such properties in Spain but these were lost when several developers went bust in the wake of 2008’s financial crisis. Estimates for how much British buyers could claim are around £4bn.

Prior to the economic crisis that hit Europe, many people in Spain purchased properties off-plan where the developments were not yet built and handed the developer advanced payments on the purchase price, which were paid into accounts set up in banks. When the property bubble burst, many of these projects never materialised and millions of euros have been trapped in the accounts since, in order to minimise the cost of the developments, it was common practice for banks to grant loans without requiring guarantees or insurance.

Traditionally, it was considered that only the insolvent developers that had failed to complete the developments were liable to refund the deposits to the homebuyers with no liability for the bank in which the deposits advances were paid. Spanish law applicable at the time forced banks to supervise the funds advanced by homebuyers to the developers, it being their responsibility to ensure that the deposits were paid into special accounts at the bank in question, and separated from the developer’s other accounts.

The rulings concern the joint and several responsibility of banks, as co-respondents along with the developers, which, due to their scant diligence and lack of caution when granting loans, must respond to homebuyers in the event of the insolvency of the developer unable to repay these amounts.

After examining the special protection obligations granted to homebuyers by Spanish legislation, the Supreme Court has resolved that the bank must also be liable in those cases in which the necessary protection measures have not been implemented, such as the need for the amounts advanced by homebuyers to be deposited in special accounts set up by the developers, even though it was the latter’s obligation to set up such accounts.

Consequently, the Supreme Court held: “In home sale-purchase transactions governed by Law 57/1968, credit institutions accepting homebuyers’ deposits into a developer’s account without requiring that a special account be opened and the relevant guarantee produced, shall be liable to homebuyers for the entire amount advanced by the homebuyers and deposited in the account or accounts the developer has opened at said institution”.

This means that, in the event that the developer becomes insolvent, buyers who have paid deposits may claim back the amounts deposited in the bank, rather than wait until the end of the insolvency process, when in any case they rarely recoup the advances paid to the developers. The banks are also liable to repay legally accrued interests since the first deposit was paid.

The Supreme Court is unequivocal in both of its rulings, highlighting that banks cannot overlook their duty of special protection and allege that they were unaware of the nature of these advances, since in both cases it was patently clear that the amounts deposited were advances to the developer on the sale price of the home; hence, although these amounts did not feature in special accounts separated from the developer’s other accounts, the banks did know what the deposits were and what their purpose was.

Accordingly, the Supreme Court ruled that the banks cannot be considered to be third parties unconnected with the relationship between buyer and seller, but rather they have a duty to supervise the developer to whom they granted the loan; in other words, they have the duty to ensure that the developer has contracted a guarantee or insurance. Consequently, the Supreme Court denied that the banks were unconnected third parties, as they alleged, but held that, precisely because the bank knew or should have known that the buyers were paying advances into an account, it was legally bound to open a special, separate, properly insured account, and by not doing so it incurred in the specific liability indicated above.

To quote the Supreme Court, the bank “knew or should have known that the second of the deposits corresponded to an advance payment on the sale price, since this was noted in the guarantee of reimbursement of the first of the amounts deposited at the bank”, and, as a result, it was legally bound to uphold the duty of supervision and require the developer to implement measures to protect the buyer, which in these cases was the obligation to open a special, separate, duly insured account at the bank.

Although Law 57/1968, of 27 July, concerning the receipt of advance payments in the construction and sale of homes, applicable at that time in Spain granted forceful and imperative protection to homebuyers, holding banks jointly and severally with developers for the amounts advanced by homebuyers, the law that currently governs those situations, namely Law 20/2015 of 14 July, concerning the regulation, supervision and solvency of insurers and reinsurers, limits the liability of banks so that they are only liable in respect of developments with permits and reduces the period for wronged homebuyers to claim back the amounts advanced.

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