Barriers to the successful recovery and return of stolen assets are numerous. They can include a lack of political will to investigate and charge corrupt politicians, lack of trust between countries, deficient resources to pursue cases, a lack of effective coordination, differences in legal traditions, and the existence of a global financial system that offers easy opportunities for corrupt officials to move and conceal illicit funds.1
Most commonly, governments use criminal prosecution and confiscation to go after assets of corrupt officials, while the use of civil forfeiture tools is gaining more traction, where available. But the magnitude of the challenges to cross-border asset recovery requires practitioners to employ existing legal tools creatively.
The use of an insolvency framework in the context of asset recovery can offer another civil avenue to gain control of stolen assets held by or on behalf of debtors. Under certain circumstances, insolvency measures can complement criminal law or confer significant advantages over criminal law, such as a lower burden of proof (compared to the criminal process), more control over the process, and an expanded set of potential targets.
While choosing the right recovery approach always depends on the facts of the case and the specifics of the available legal tools in a given jurisdiction, the scenario that is most likely to be well suited for this type of civil remedy is one where a company or other legal person was used as an instrument of corruption or money laundering. For example, in cases in which a company’s only activity was to issue fictitious invoices to justify the transfer of bribes to company directors or cases where a company was used as a pass-through entity to launder proceeds of corruption, it can be targeted through insolvency proceedings.
In most jurisdictions, there are two standard tests for commencement of insolvency proceedings: (i) illiquidity, or the inability to pay existing obligations as they become due in the ordinary course of business and (ii) the balance sheet test, a situation where liabilities exceed assets.
A third method of commencing insolvency proceedings, just and equitable grounds, has evolved through case law in a number of common law jurisdictions, such as the United Kingdom, British Virgin Islands, Cayman Islands. It deserves specific consideration in cases of corruption, embezzlement, or any type of fraudulent activity, because this test can be applied to wind up companies that were created for the purpose of furthering a corrupt or fraudulent scheme, even if they are not technically bankrupt or insolvent.2
Though the process varies by jurisdiction, the first step in insolvency proceedings is usually the appointment of an insolvency representative to take control of the debtor entity and its assets and ensure that the value of the entity is maximized for the benefit of its creditors. Under most insolvency laws, an insolvency representative is appointed by either: (i) the court; (ii) the court with creditor input or at the direction of the creditors; or (iii) independent appointing authorities.3 4
Once the insolvency process begins, there is generally an automatic or court-imposed moratorium against any action, execution, or other legal process against the insolvent person or entity.5 If an entity has assets within the jurisdiction in which it was declared bankrupt, insolvency procedures will generally prevent any further diversion of assets out of the insolvent entity.
The effect of such a moratorium internationally is often complex, but the existence of international regimes such as the Council of the European Union’s Regulation on insolvency proceedings6 and the United Nations Commission on International Trade Law (“UNCITRAL”) Model Law will often give this stay on proceedings extra-territorial effect.7
Insolvency representatives are primarily charged with protecting the rights and interests of creditors and injured parties. But there are two types of cases where the powers and tools available to them can be used to identify and retrieve illegally obtained proceeds stolen by corrupt officials – often to great effect: 1) The insolvency representative acts on behalf of an insolvent person or entity that was deprived of assets following corrupt activities conducted by one of its directors or managers (i.e. the insolvent entity is the victim of corruption or fraud). 2) The insolvency representative acts on behalf of a person or entity that perpetrated or assisted in the corruption.
Insolvency representatives generally have the benefit of broad powers to access information and to demand testimony from individuals such as company directors or managers. Powers of the insolvency representative often include the ability to compel the production of books and records, including from the entity’s lawyers and banks. That way, the insolvency representative who is put in charge of the insolvent entity may be able to gain access to privileged materials previously shared with the corrupt entity’s lawyers – and this alone can sometimes change the entire outlook of a case.
The insolvency representative will often conduct or order a comprehensive audit of financial statements and suspicious transactions to find information that can lead to a recoverable asset. Typically, they have a duty to report (to criminal agencies and supporting institutions) any illegal or irregular conduct uncovered in the administration of an entity and thus help in the detection and identification of illicit assets. (In cases of embezzlement of public funds, the main creditor of an entity is the government.)
One of the primary functions of an insolvency representative is to maximise the value of a debtor’s entity for the benefit of its creditors. Aside from selling off tangible company assets, maximising value of an insolvent entity also entails the monetization of intangibles, including potential claims for annulment of preference or transactions at undervalue, fraudulent transactions, wrongful trading, breach of duties and damages against persons who have diminished or enabled harm against the debtor’s estate.
This means that an insolvency representative is generally entitled to bring claims against a company’s former directors and managers for their wrongdoing in involving the company in a corruption scheme. And while many other legal tools focus on the bribe payers, insolvency mechanisms can be used against an expanded set of targets including bribe takers and third parties. For example, claims for restitution or damages can be made against intermediaries and facilitators that assisted in the embezzlement or payment of bribes. In large public corruption cases, the value recovered from damages claims directed against third party facilitators with deep pockets, who enabled the criminal acts, can be substantial. If defendants or assets are located in a foreign jurisdiction, the powers of an insolvency representative may be easier to enforce abroad than those of a creditor.
The pursuit of assets across borders requires careful planning and strategic thinking, especially where applicable laws diverge. As a general rule, the location of assets will determine the applicable law. In certain circumstances, assets located in one jurisdiction may be ring-fenced under local insolvency law for creditors within that jurisdiction in a first priority ranking.
For standard insolvency processes, as well as for the recovery of assets through these processes, jurisdiction matters significantly—in law and in practice. For example, if the matter is a corporate insolvency case filed against a company incorporated in an offshore jurisdiction, then the offshore law and jurisdiction would most likely apply. However, if the bribe-taking company is incorporated in a country in the developing world, that country’s law and jurisdiction would most likely apply.
Global insolvency systems are at varying stages of development. In many developing countries, outdated insolvency laws remain on the books, and occasionally there is limited or no local experience in conducting insolvency cases.
Common law systems offer the clearest path toward pursuit of asset recovery through insolvency proceedings. The United States, the United Kingdom, and common law offshore jurisdictions that are popular as a repository of value or used frequently in offshore structuring such as the BVI, Cayman Islands, and Jersey often feature the world’s most developed institutional insolvency systems, including highly skilled judges and insolvency practitioners.8
Many developing jurisdictions, especially those with civil law heritages, do not have the concept of just and equitable grounds to begin insolvency proceedings, which can present challenges for cross-border asset recovery if the debtor company is solvent. But using an insolvency framework can be a clever strategic move for governments seeking to recover proceeds of corruption in cases where prosecutors can show that the entity is liable for unpaid taxes, or when the insolvency legislation allows prosecutors to request courts to open a bankruptcy case, which is permissible in some civil law countries.9
[1] For a full discussion of the types of problems encountered in international asset recovery, see the StAR publication: Barriers to Asset Recovery, (Washington DC, World Bank) World Bank, 2011.
[2] Just and equitable grounds is mainly a common law concept and, while the concept is not clearly defined in many legislative frameworks which provide for it, it has evolved through case law. The qualification of whether there exist just and equitable grounds for winding up an entity is largely at the discretion of the court. For example, in the United Kingdom, winding up orders have been made where a company was formed for fraudulent purposes. For example: Anglo-Greek Steam Co (1866) LR 2 Eq 1; Re West Surrey Tanning Co (1866) LR 2 Eq 737; Re London and County Coal Co (1867) LR 3 Eq 355. Source: https://southsquare.com/articles/just-and-equitable-winding-up/
[3] Assessment of Insolvency Office Holders, Review of the profession in the EBRD region, European Bank for Reconstruction and Development, 55, 2014.
[4] Different jurisdictions have differing approaches to selecting and appointing insolvency representatives, and these may vary depending on the type of insolvency proceedings. In developed jurisdictions, it is common that a professional from an international accounting firms is appointed as insolvency representative. In the public model (more common in developing countries), an employee of the state is appointed as the Insolvency Representative. Some states also allow legal professionals to serve as Insolvency Representatives. Also see: WBG Principles, C.17; The UNCITRAL Legislative Guide on Insolvency Law, United Nations Commission on International Trade Law, 176, 2004; Assessment of Insolvency Office Holders, Review of the profession in the EBRD region, European Bank for Reconstruction and Development, 55, 2014.
[5] A moratorium can sometimes be initiated as early as the presentation of the originating insolvency process.
[6] Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (Recast Insolvency Regulation).
[7] 44 States have adopted the Model Law on Cross Border Insolvency. The new UNCITRAL Model Law on Recognition and Enforcement of Insolvency-Related Judgments was adopted by UNCITRAL at its session in July 2018.
[8] The court system of the BVI in particular has established robust protections for those who have been the victims of fraud and corruption. Similarly, the courts in Jersey also offer protection where financial services have been misused and persons have been the victims of fraud.
[9] In France or Belgium, prosecutors can directly go to court and ask to open a bankruptcy process. In the U.S. or UK, only the creditor may ask for the case opening.
This is an edited excerpt of a forthcoming StAR publication “Going For Broke – Insolvency Tools to Support Cross-Border Asset Recovery”, written by a team coordinated by StAR, in collaboration with the subcommittee on asset recovery at the International Bar Association (IBA).