The Supreme Court Confirmed the Possibility of Litigating without the Risk of Being Liable for the Opposing Party’s Legal Costs

The Supreme Court established in its landmark judgment KKO 2024:56 that when a bankrupt company continues litigation after the bankruptcy estate has declined to do so, and the company's representative exercises the company's right to plead, the representative cannot be held personally liable for the opposing party's legal costs. The ruling potentially raises the threshold for litigating against financially distressed entities and calls for companies to carefully consider their dispute resolution strategies to avoid unrecoverable legal expenses.

The main issue in the case primarily pertained to the interpretation of a construction contract between Companies A and B. In our view, however, the most notable precedent in the case concerned the treatment of legal costs. After Company A, a limited liability company (osakeyhtiö), declared bankruptcy, its bankruptcy estate withdrew from the litigation. Consequently, Company A, which was represented by its CEO, i.e. Person C, continued the litigation in accordance with Chapter 3 Sections 3 and 4 of the Finnish Bankruptcy Act (120/2004).

This raised the question of whether Person C could be held personally liable for the legal costs incurred by Company B, as the question is not regulated under the Bankruptcy Act. Company B sought to hold Person C personally liable for its legal costs incurred after Company A's bankruptcy, as Company B could not have recovered the legal costs from the bankrupt Company A.

The Supreme Court mainly examined whether Person C could be held personally responsible for Company B’s legal costs under the Bankruptcy Act or the Finnish Code of Judicial Procedure (4/1734), or by piercing the corporate veil.

First, the Supreme Court held that Person C could not be held liable for the legal costs under Chapter 4 Section 12 of the Bankruptcy Act. The court noted that the provisions of the said Section define the obligations and responsibilities of the debtor, such as the cooperation and information duties, but they do not define the representative of the bankrupt company as the debtor within the meaning of Chapter 3 Sections 3 and 4 of the Bankruptcy Act. Therefore, Person C's personal liability for the legal costs could not be based on the debtor status under the Bankruptcy Act.

Second, the Supreme Court held that Person C could not be liable for Company B’s legal costs under the Code of Judicial Procedure. As Person C was only exercising Company A’s right to plead, Person C did not become a party to the litigation. Therefore, Person C could not be held liable for Company B’s legal costs as a party to the litigation.

Last, the Supreme Court assessed whether Person C could be held liable through piercing the corporate veil, as Person C was the representative of Company A. The court stated that piercing the corporate veil could be done in cases where a representative has misused the corporate structure (i.e. the limited liability), noting however that this is an exception that requires explicit misuse of the corporate structure, as established in its decision KKO 2018:20.

The Supreme Court found no evidence of misuse of the corporate structure in this case, given the timing and basis of the litigation between Companies A and B. Therefore, Person C could not be held personally liable for Company B's legal costs.

In its judgment, the Supreme Court recognised that the arrangement was asymmetrical, as Company A could have recovered its legal costs from Company B, but Company B could not recover its legal costs from Company A due to the bankruptcy of Company A, nor could it recover its legal costs from Person C. However, the court stated that the asymmetry in itself does not justify personal liability for the debtor company's owner or representative. Instead, the assessment must be done considering the claims made, the grounds for the claims, and the overall circumstances leading to the litigation.

This Supreme Court ruling highlights a significant gap in the current Bankruptcy Act that allows an insolvent debtor company to continue litigation without an actual risk of being liable for the opposing party's legal costs.  

The Supreme Court acknowledged that the legislation does not address the issue at hand, which underscores the need for legislative amendments to address this asymmetry and to ensure fairness in terms of the liability for legal costs.

Moreover, this ruling may increase the threshold to litigate or continue to litigate against a company that is on the verge of insolvency or already declared bankrupt. Companies should be mindful when assessing their dispute resolution strategy, as pursuing litigation against a financially distressed entity could result in significant legal costs without the prospect of recovery, even if the case is won.

If you have any questions about the ruling, please contact the undersigned or your regular Borenius contact.