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Bankruptcy

Going through bankruptcy affects the life of the person concerned, and it is therefore important to know what becoming bankrupt entails.

It is often possible to solve debt problems without declaring bankruptcy. The Office of the Debtors’ Ombudsman can provide information and advice on measures that could help individuals to resolve their financial difficulties.

What is bankruptcy?

Bankruptcy entails using the proceeds from the bankrupt person’s assets to pay their debts. If the person has no assets, bankruptcy proceedings may conclude without yielding any funds that can be used towards payment of debts. Either the debtor or the debtor’s creditors can petition for bankruptcy proceedings.

Petition for bankruptcy proceedings

The debtor may request that their estate be subjected to bankruptcy proceedings if they cannot pay their creditors when the claims fall due and it is deemed unlikely that the debtor’s financial difficulties will subside within a short time.

The petition for bankruptcy proceedings must be made in writing and directed to the District Court where the debtor has their legal address or domicile, if the domicile is different from the legal address.

The petition shall include the following:

  1. A statement that the debtor requests that their estate be subjected to bankruptcy proceedings and that the petition is based on Article 64 of the Act on Bankruptcy, etc., no. 21/1991.
  2. The debtor’s full name and national ID number.
  3. The debtor’s legal address and domicile, if the domicile is different from the legal address.
  4. Is the debtor engaged in commercial activities? If yes, the following must be included:
    1. A short description of the commercial activities.
    2. The location of the commercial activities.
    3. Whether the activities take place in a separate firm with its own name and national ID number.
  5. A clear description of the circumstances of the case and the debtor’s arguments; i.e., how the debtor’s finances came to be in a position where the debtor considers it appropriate to petition for bankruptcy.
  6. Itemised information on the debtor’s assets and liabilities. This must specify what proportion of the debts are due and payable/in default.
  7. Monthly income and expenses, and how much money is left each month to allocate towards payment of debts.
  8. The petition for bankruptcy proceedings must be accompanied by documents showing that the debtor cannot pay their creditors’ claims when they fall due. The documents that must be included are, for example, the debtor’s last income tax return, together with a summary of pay-as-you-earn taxes or pay slips for the months not included in the tax return; remittance slips; and (if applicable) transcripts from the Commissioner’s records, stating that the debtor has been subjected to unsuccessful distraint.
  9. The petition and accompanying documents shall be filed in two copies.

Cost of bankruptcy proceedings

  • The District Court Judge may demand that the petitioner pay ISK 250,000 as security for the bankruptcy expense if it is not clear that the debtor’s assets will be sufficient to cover payment of the expense.
  • When a petition for bankruptcy is filed, a fee of ISK 19,000 must be paid to the Treasury.
  • A debtor who petitions for bankruptcy proceedings may apply to the Office of the Debtors’ Ombudsman for financial assistance with bankruptcy expenses. The application form can be found here. Certain legal requirements must be met in order for the application to be approved.
  • When a creditor petitions to have a debtor’s estate subjected to bankruptcy proceedings, the creditor must pay the security fee for the bankruptcy expenses if requested to do so. It should be noted that information on bankruptcy proceedings can be found on the Iceland Customs and Revenue website

Proceedings before the District Court

When the debtor is the petitioner, the judge will review the debtor’s claims and accompanying documents. The judge may request that the debtor submit further documents if the information available does not clarify the case sufficiently. If the judge considers the conditions for bankruptcy to be fulfilled, the debtor is summoned to a hearing at which the judge will enter a bankruptcy ruling. The debtor must either appear at the hearing in person or be represented at the hearing by a lawyer. It should be noted that other individuals, such as family members, may not appear on the debtor’s behalf. If the debtor or their lawyer does not attend the hearing, the petition is deemed to have been withdrawn.

Execution of bankruptcy proceedings

After the ruling has been entered

  • When the debtor has been declared bankrupt, a separate legal entity is established – the bankruptcy estate – which takes over the debtor’s financial entitlements and obligations. When the ruling is entered, all claims against the bankruptcy estate fall due.
  • All of the debtor’s assets and liabilities therefore belong to the estate during the bankruptcy process.
  • After the bankruptcy ruling is entered, the District Court Judge appoints a trustee in bankruptcy, who oversees the estate. The division of the estate generally takes several months. If the division of the estate takes an unusually long time, the trustee should be contacted.

The trustee’s actions:

  • The trustee in bankruptcy issues a call for claims, inviting the debtor’s creditors to declare claims against the estate.
  • The trustee determines whether any cancellable measures were taken during the prelude to bankruptcy; for example, concealment of assets.
  • The trustee also takes decisions on how the assets and entitlements of the estate shall be disposed of, including how and to whom they shall be sold, and at what price. Finally, the proceeds from the assets, if any, are used to pay the estate’s debts.
  • The trustee actually works as the agent of the creditors and is required to protect their interests while settling the estate.

What happens to the debtor’s income during the division of the estate?

  • Earned income that the debtor acquires during the bankruptcy process is retained by the debtor and does not revert to the estate. The same applies to inheritance, bequests, gifts causa mortis (deathbed gifts), and gifts inter vivos (living gifts) if the donor has decided on such an exemption in a lawful manner.
  • Any money that the debtor earns using the above income is also retained by the debtor. Other financial entitlements that would generally have reverted to the debtor shall instead revert to the estate during the division process.

How are the debtor’s assets handled during the bankruptcy process?

  • The general rule is that the estate takes over all financial entitlements (assets) that the debtor owned or enjoyed at the time the bankruptcy ruling was entered. Immediately upon being appointed, the trustee shall take steps to deprive the debtor of control over the assets.
  • In spite of the bankruptcy process, the debtor retains those assets that are not subjected to distraint.

The following assets are exempted:

  • Prepayments of living expenses, provided that the funds are held separately in the debtor’s custody and are intended for future expenses.
  • One-time payments of benefits for permanent disability or for the loss of a provider, provided that the funds are held separately in the debtor’s custody and are intended for a period in the future.
  • Monetary assets that are necessary to defray the short-term living expenses of the debtor and those for whom the debtor is financially responsible.
  • Liquid assets that are necessary for the debtor to maintain a modest household in the typical manner.
  • Items of considerable sentimental value, unless such an exemption is considered unfair vis-à-vis the petitioner.
  • Liquid assets that are necessary due to disability or infirmity.
  • Educational materials.
  • Items used for work. However, the value may not exceed ISK 50,000, adjusted for changes in the price level.

The trustee is authorised to permit the debtor to rent real estate from the estate for up to twelve months.

Communications between debtor and trustee

  • During the division of the estate, the debtor is required to attend meetings called by the trustee and to provide information and documents requested by the trustee in connection with the process. The debtor is required to surrender to the trustee any assets that belong to the estate, together with necessary documents, such as bookkeeping data.
  • The debtor shall also be available during the bankruptcy process in case their presence is needed for a determination of the estate’s resources or an examination of the debtor’s actions prior to the bankruptcy ruling.

How are bank accounts handled while the estate is being divided?

  • Immediately after the bankruptcy ruling is entered, the trustee will request that all of the debtor’s accounts and payment cards be closed.
  • All else being equal, the debtor can then open a new deposit account without overdraft privileges or receive a prepaid credit card; however, this is usually subject to the trustee’s approval while the estate is being divided.

Various measures available to the trustee

  • The trustee can request that the debtor be removed from the Iceland Revenue and Customs employer register and that the debtor’s value-added tax number be closed.
  • The estate may terminate leases or any other long-term legal relationships in the conventional manner, or with fair advance notice if the contract is non-cancellable or specifies a longer termination period, unless the contract has been registered or entered to the public record in a similar manner.
  • The trustee takes over the debtor’s holdings in companies and attempts to divest them.

How are bankruptcy proceedings concluded?

  • The bankruptcy process can conclude with the distribution of funds to creditors if there are any assets in the estate. It can also conclude without distribution if there are no assets in the estate.

The debtor’s position after the estate has been divided

  • Debts that are not paid during the bankruptcy process expire (are cancelled) two years after the division of the estate is complete unless the limitation period was interrupted.
  • It should be noted that according to Article 26 of the Act on the Icelandic Student Loan Fund, no. 60/2020, claims from the Icelandic Student Loan fund are excluded from the provisions of the Act on Bankruptcy, Etc. on the length of the limitation period; i.e., the special rules in the Bankruptcy Act on interruption of limitation periods do not apply to student loans.
  • For two years, the debtor remains liable for payment of those debts that were unpaid during the bankruptcy proceedings. The debtor may interrupt the limitation period by making payment.
  • It should be noted that the Collections Centre for Fines and Court Costs may decide that an alternate punishment of a fine will be applied during the two-year limitation period if collections measures are deemed pointless or have been tried to the fullest extent possible.

Interruption of limitation period?

  • A creditor can only interrupt the limitation period (also called the statute of limitations) by obtaining a court judgment acknowledging the interruption. By law, when the limitation period is interrupted, a new limitation period begins.
  • In order to obtain such a judgment, the creditor must demonstrate that it has particular interests at stake in interrupting the limitation period and that it can be deemed likely that the claim will be satisfied during a new limitation period.
  • If the limitation period is not interrupted by court judgment, all debts that were not paid during the bankruptcy proceedings expire two years after the division of the estate is complete. This does not apply, however, if the debtor has interrupted the limitation period with a payment or an acknowledgement of debt (discussed further below).
  • It should be noted that according to Article 26 of the Act on the Icelandic Student Loan Fund, no. 60/2020, claims from the Icelandic Student Loan fund are excluded from the provisions of the Act on Bankruptcy, Etc. on the length of the limitation period; i.e., the special rules in the Bankruptcy Act on interruption of limitation periods do not apply to student loans.

The Office wishes to point out that if a creditor initiates such an acknowledgement case in order to interrupt the limitation period, the debtor must mount a defence in the case so that the Court will not automatically find in favour of the creditor.

In this context, it is worth noting the decision in Supreme Court Case no. 119/2016. The judgment in that case discusses the statutory amendment of 2010, when the limitation period for claims in bankruptcy cases was shortened to two years. Reference is made to the fact that the amendment restricted creditors’ unilateral right to interrupt the limitation period without considering the debtor’s wishes.

The judgment states as follows:

“With this, however, there was no change made in the manner in which debtors could interrupt the limitation period on a claim against them …”

In the Supreme Court’s opinion, the bankrupt person interrupted the limitation period on the claim by making an unexpected payment on a student loan after the estate had been divided, thereby triggering a new limitation period. According to this judgment, a debtor can interrupt the limitation period on a claim after bankruptcy by acknowledging the debt or making a payment on it. Creditors may conduct surveys of the debtor’s assets for two years after the bankruptcy proceedings, and if the debtor acquires objects or entitlements with financial value, creditors can subject the items to distraint. If, during this two-year period, a debtor acquires an asset and a creditor subjects it to distraint, the portion of the creditor’s claim that is paid from the proceeds of the asset does not expire. However, the portion of the claim that is not paid from the proceeds of the asset does expire at the end of the two-year period.

 

Garnishment of wages following bankruptcy

Treasury debt collectors – i.e., Iceland Revenue and Customs and local Commissioners – are authorised, during the two-year limitation period, to garnish up to 75% of the debtor’s wages from their employer in order to pay public levies owed by the debtor. Public levies include income tax, local tax, the Construction Fund for the Elderly, special income tax, investment tax, domestic injury insurance, overpaid child benefits, and overpaid mortgage interest allowances.

Treasury debt collectors are also authorised to collect funds from a debtor’s spouse under a special liability rule that applies to the payment of public levies. According to this rule, married couples or jointly taxed cohabiting couples are personally liable for the payment of public levies. This liability applies to obligations created during the years in which the parties are taxed jointly.

The Child Support Collection Centre is authorised, during the two-year limitation period, to garnish up to 50% of a debtor’s wages from their employer in order to pay child support owed by the debtor.

Payments made by netting of debt and garnishment of wages do not interrupt the limitation period.

It should be noted that if the debtor negotiates a payment agreement that lowers the amount of wages garnished, such an agreement and payments made in accordance with it could interrupt the limitation period during the two-year period unless an explicit written proviso is made, stating that the debtor does not acknowledge the debt and requests that payments be specifically allocated (if possible) to payments accruing after the bankruptcy. It is advisable to obtain written confirmation that payments do not interrupt the limitation period.

If a payment agreement was made with the Child Support Collection Centre before bankruptcy proceedings were sought, it is possible to request that payments made under the agreement not be used after the bankruptcy to pay previously existing debt, but to make child support payments accruing afterwards, so that the limitation period is not interrupted.

Further information can be obtained from the Child Support Collection Centre and Treasury debt collectors.

The impact of bankruptcy

A bankruptcy ruling is entered to the CreditInfo default register and affects the credit score issued by the company for a specified period of time.

  • The debtor’s commercial bank may note the bankruptcy in the debtor’s business history. This will have a negative effect on the debtor’s credit score at the bank. If the debtor requests a loan or other facility again after the bankruptcy, an individual assessment is carried out and various factors examined, such as the debtor’s debt service capacity according to the bank’s assessment, collateral, the scope of the bankruptcy, the length of time since the bankruptcy occurred, etc.
  • Creditors may conduct surveys of assets to determine whether it is possible to use distraint measures to defray part of the debt.
  • Even though creditors cannot interrupt the limitation period without Court acknowledgement, they may continue collection measures during the two-year limitation period. Creditors/Collections entities determine whether they will collect debts abroad from debtors after bankruptcy and during the limitation period. In certain countries, the regulatory framework allows the garnishment of wages for Icelandic claims being collected in the country concerned.
  • Guarantees are activated following bankruptcy. Creditors can therefore begin collecting payment from guarantors and generally do so before the two-year limitation period is over. It is clear, however, according to the judgment in Supreme Court Case no. 507/2016, that the two-year limitation rule can apply to a guarantor. According to the decision in that case, it was not possible to begin collections procedures against the guarantor when the claim was cancelled vis-à-vis the principal debtor before the end of the limitation period. In this context, it is necessary to discover when the guarantee was provided in order to determine whether the rules laid down in the Act on Limitation Periods for Claims, no. 150/2007, apply.
  • It should be noted that if a debtor does not want the Icelandic Student Loan Fund to begin collecting their student loan payments from the loan guarantor, the debtor may negotiate with the Fund to withdraw the acceleration of the loan and begin paying it in the conventional manner. As soon as the debtor makes a payment on the student loan, the limitation period is interrupted.

 

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