Fraudulent Transactions: When a Contract Becomes a Tool for Asset Dissipation

One of the most common practical challenges in bankruptcy proceedings arises when, by the time insolvency proceedings are formally commenced, the debtor remains the legal owner of the business while a substantial portion of its assets has already been transferred to related parties, encumbered by security interests, disposed of at an obviously undervalued price, or moved through a chain of transactions which, although appearing entirely lawful when viewed individually, ultimately produce a single economic outcome — the reduction of the debtor's estate from which creditors' claims could otherwise be satisfied.

To address such situations, Article 42 of the Bankruptcy Code of Ukraine establishes a special mechanism allowing the commercial court to invalidate the debtor's transactions or challenge its asset-related actions performed either after the commencement of bankruptcy proceedings or within the three-year period preceding the opening of the case. At the same time, this provision should not be interpreted as creating automatic invalidity for every transaction concluded during the so-called "suspect period."

Not Every Suspicious Transaction Is Fraudulent

The key issue in these disputes is not whether the transaction was concluded within the three-year suspect period, but rather what actual economic effect it produced for both the debtor and its creditors. If a company sells an asset at market value, receives the purchase price, and uses those funds in its business operations, the subsequent commencement of bankruptcy proceedings cannot, by itself, transform such a transaction into a fraudulent one. The situation is fundamentally different where assets are transferred without adequate consideration, disposed of significantly below market value, transferred to related parties, or where the debtor, while already experiencing financial distress, creates unjustified preferences in favour of a particular creditor.

In practice, the transactions most frequently challenged under Article 42 of the Bankruptcy Procedures Code include:

• transfers of assets below market value;
• gratuitous transfers of property or waivers of proprietary claims;
• transactions concluded with related or affiliated parties;
• early repayment of obligations owed to selected creditors;
• granting security for pre-existing obligations;
• assuming liabilities without receiving any corresponding economic benefit.

This list should not be viewed as an exhaustive catalogue of prohibited transactions but rather as a framework for assessing the debtor's conduct. The commercial court must determine not only whether the transaction formally occurred, but also whether it had a legitimate business purpose, whether the debtor received genuine consideration, whether the transaction diminished the bankruptcy estate, and whether it adversely affected the rights of other creditors.

Particular attention should be paid to transactions involving related parties, as affiliated companies, family members and controlled entities frequently become vehicles for asset dissipation. Nevertheless, the existence of a corporate or family relationship should never substitute for proper legal analysis. Where a transaction is concluded on market terms, or even on terms more favourable to the debtor, where the purchase price reflects fair market value and is actually paid, the mere affiliation of the parties should not, in itself, justify the conclusion that the transaction was fraudulent.

The Supreme Court Focuses on Economic Substance Rather Than Legal Form

Recent case law of the Supreme Court demonstrates an increasingly consistent tendency to evaluate transactions not merely through the prism of their formal legal validity but by reference to their actual economic substance. What matters is not only whether the parties properly documented their agreement, but whether the transaction was effectively used as a mechanism for removing assets from the debtor's estate, granting preferential treatment to selected creditors, or artificially reducing the assets available for distribution.

Such an approach is broadly consistent with the objectives of insolvency law. Formal compliance with civil law requirements does not necessarily imply good faith. A sale and purchase agreement may satisfy every statutory requirement, contain all mandatory contractual terms and comply with the applicable formalities, yet if it was concluded with a related party shortly before bankruptcy, at a price substantially below market value and without any genuine transfer of consideration, its economic substance differs significantly from the legal form chosen by the parties.

At the same time, this approach requires careful application. Judicial scrutiny of a transaction's economic substance should not evolve into retrospective criticism of every unsuccessful business decision. Businesses inevitably face commercial risks, may dispose of assets during periods of financial pressure, accept less favourable commercial terms or undertake urgent transactions in an effort to preserve liquidity. Such decisions are not inherently fraudulent. The dividing line is crossed where legitimate commercial risk gives way to conduct deliberately aimed at preventing creditors from obtaining satisfaction of their claims.

For that reason, courts should assess the overall factual context rather than relying on any single criterion. The timing of the transaction, the debtor's financial condition, the relationship between the parties, the adequacy of consideration, the reality of payments, the subsequent movement of the asset and the overall impact on the creditors collectively determine whether the transaction constitutes an ordinary commercial arrangement or forms part of a deliberate asset dissipation scheme.

Asset Recovery and the Choice of Legal Remedy

Where a transaction is declared invalid under Article 42 of the Bankruptcy Procedures Code, the primary consequence is the restoration of the transferred asset to the bankruptcy estate or, where restitution in kind is impossible, compensation based on the market value of the asset at the time the transaction was concluded. From the creditors' perspective, the objective extends beyond obtaining a judicial declaration of invalidity; the ultimate purpose is the effective restoration of assets available for distribution.

Equally important is Part 5 of Article 42, which provides for subsidiary liability of persons who initiated, approved or facilitated fraudulent transactions or asset transfers. This mechanism significantly changes the risk profile for controlling shareholders, directors and other decision-makers, as the prospect of personal liability substantially reduces the effectiveness of schemes in which the legal entity serves merely as a formal vehicle for asset dissipation.

Ultimately, fraudulent transactions in bankruptcy extend far beyond the validity of an individual contract.