Compensation, liquidation of contracts, bankruptcy and biterality

Did you know that two obligations can be extinguished through compensation, but it is not always that simple? We explain all the details in this article.

Set-off is one of how two obligations can be extinguished. Compensation is regulated in art. 1,196 of the Civil Code, and for its application, it is required:

• That two different people are mutually obligated
• That these obligations are homogeneous
• The respective obligations that each party may demand from the other have expired and are liquid and enforceable.

The compensation system is simple and usually operates in traffic between people and between companies. However, things get complicated when one of the two parties to the relationship to be compensated declared insolvent.

Contest layouts

The problem with bankruptcy is that from the moment it is declared, all its creditors have to be treated on equal terms.

Suppose, for example, that Pepe has some bills to collect from Juan, who is declared bankrupt. And suppose that Juan also has a bill to collect from Pepe.

In principle, these “crossed” invoices could be compensated and extinguished. Still, Juan’s contest prevents it, because if the compensation were applied, Pepe would be receiving more favourable treatment than Juan’s other creditors.

What corresponds, in these cases, is that Pepe pays Juan what he owes him, and Juan distributes among all his creditors (including Pepe) what he has received, proportionally to all of them.

This solution may be unfair for Pepe because, usually, he will end up paying more money than Juan owes him. For this reason, there are some rules in the bankruptcy regulations to correct this situation.

The current Consolidated text of the Bankruptcy Law regulates art. 153 compensation in these terms:

Article 153. Compensation

1. The compensation whose requirements would have existed before the declaration of insolvency will produce full effects, even if it is alleged after that declaration or even if the judicial resolution or the administrative act that declares it has been issued after it. The fact that the creditor has notified the insolvency administrator of the existence of the credit will not prevent the declaration of compensation.
2. Once the bankruptcy has been declared, the compensation of the credits and debts of the bankrupt will not proceed, except for those that come from the same legal relationship. What is established in the norms of private international law remains excepted.
3. The controversy over the amount of the credits and debts to be compensated and the concurrence of the compensation budgets will be resolved by the insolvency judge through the channels of the insolvency incident.

The current art. 153 introduces two nuances with respect to art. 58 of the bankruptcy law of 2003, stating:

• that the “fact that the creditor has notified the insolvency administrator of the existence of the credit will not prevent the declaration of compensation“, and
• Once the bankruptcy has been declared, the credits and debts of the bankrupt will not be compensated, except for those that come from the same legal relationship.

First nuance

The first nuance does not pose greater complexity and is a reflection of art. 1,202 of the Civil Code prescribes that the compensation effect takes place “although the creditors and debtors are not aware of it”.

In this way, the compensation is configured in the bankruptcy text in the same way as the Civil Code, inspired by French law, in which it operates by right, by the simple coexistence of two reciprocal obligations between the same creditor and the same debtor, with respect to fungible and homogeneous objects, expired, liquid and payable.

And in this sense, all the criticisms that have been levelled at civil law regarding the automatic configuration of compensation can be extrapolated to bankruptcy law, where it is not difficult to imagine situations in which such automation could be counterproductive (think of our example, what would happen if Pepe wants to vote for an agreement for Juan, but is left without credit due to the automatism of the compensation, and cannot vote to facilitate Juan’s continuity).

Second nuance

The second nuance establishes the contractual settlement mechanism to compensate reciprocal benefits in the opposite direction, as numerous judicial resolutions had already recognized.

One of the differences between the “common” compensation regime is when one of the parties to the relationship is in bankruptcy -is regulated in the first paragraph of the art. 153 TRLC-, and the extinction of obligations by contractual settlement introduced in the second paragraph of the same article, lies in the fact that in the first case the conditions for compensation (maturity, liquidity, enforceability…) had to be met at the time of the declaration of the insolvency, while for cases of contractual liquidation, this temporary barrier does not necessarily operate.

Numerous judicial decisions of Courts and Tribunals had already applied the concept of contractual liquidation to extinguish reciprocal obligations, upon detecting the existence of the same obligational relationship, as the Supreme Court had done in its judgments 405/2013, June 21, 2013; 188/2014, of April 15, 2014; 428/2014, of July 24, 2014, or -in a negative way- when detecting the non-existence of that reciprocity, as in the case of judgment 129/2019, of March 5, 2019.

Approaches

The jurisprudential criterion now reflects art. 153.2 tells us that to extinguish obligations in the opposite direction, we must determine whether or not there is a reciprocal relationship.

The concept of what should be understood by reciprocal relationships is very casuistic, of course. Still, just as it was done in its day with the credits generated by financial derivative contracts, it may be helpful to attend to the concurrence of the bilaterality, as explicitly indicated in the section 28th of the Provincial Court of Madrid in its Judgment of June 7, 2016 (sixth legal basis).

It seems that it may be justified to extinguish a credit right with another in the opposite direction when there is a direct correlation in the genesis of one and the other, even though they have accrued at different times. Between one and the other, there has been a declaration of bankruptcy of the parts.