Draft EU Directive proposed harmonising restructuring and insolvency

We look at the new proposed EU Directive and how it will harmonise restructuring, insolvency and discharge procedures across all Member States, including its potential effect on the UK.

Original news

The European Commission is to introduce rules on business insolvency designed to increase opportunities for companies in financial difficulties to restructure early to prevent bankruptcy and avoid dismissing staff. They are further designed to ensure entrepreneurs have the opportunity to do business post-bankruptcy.

When must Member States comply with the new EU Directive?

On 22 November 2016, the European Commissioner proposed a Directive on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU (COM)(2016) 723 (the draft Harmonisation Directive).

The draft Harmonisation Directive is just at the proposal stage and must go through the European Commission's co-decision procedure, meaning further discussions and possible amendments from the European Council (comprised of Member States) and the European Parliament.

Once finalised, it will enter into force 20 days after publishing in the Official Journal (OJ) and Member States must implement provisions to comply with most provisions within two years from when it enters force (the requirements of Title IV of the draft Harmonisation Directive: training of judges and IPs, supervision and remuneration of practitioners and electronic communications, must be complied with within three years).

Does Brexit mean that the UK is exempt?

This will depend on when the draft Harmonisation Directive is finalised and published in the OJ and also on the timing of the UK's exit following a triggering of art 50 TEU.

Theresa May has stated that she intends to trigger art 50 TEU by 31 March 2017. Assuming art 50 TEU is triggered then, exit will occur at the earlier of either an exit agreement entering into force or two years after notice is given (unless all other EU Member States unanimously vote to extend). This means exit would occur by 31 March 2019 at the latest.

On this basis, the draft Harmonisation Directive would need to be finalised and effective before 31 March 2017 (then requiring Member States to comply within two years) in order for the UK to be required to comply whilst it is still part of the EU.

In any event, the UK government has already launched its own consultation on modifying corporate insolvency, with many of the proposals echoing the principles behind the draft Harmonisation Directive and the implementation of any such changes may well proceed regardless of whether or when the Harmonisation Directive enters force for the UK.

Why is harmonisation a good idea?

A well functioning insolvency framework is an essential part of a good business environment as it supports trade and investment, helps create and preserve jobs and helps economies absorb more easily the economic shocks that cause high levels of non-performing loans and unemployment. These are all stated key priorities of the European Commission.

Increasingly companies will have a cross-border dimension when you consider their client base, supply chain, scope of activities investor and capital base and very few companies are purely national. Inefficient and divergent insolvency laws make it harder for investors to assess credit risk, particularly when making cross-border investments. The EC believes that more cross-border risk sharing, stronger and more liquid capital markets and diversified sources of funding for EU businesses will deepen financial integration, lower costs of obtaining credit and increase the EU's competitiveness.

The main objective is to reduce difference between national laws and enhance the rescue culture. The EU also provides some compelling evidence in its Fact Sheet and Explanatory Memorandum, including:

  •  currently in Europe half of businesses survive less than five years
  • in the EU, approximately 200,000 firms go bankrupt each year, resulting in 1.7 million direct job losses every year. One in four of those is a cross border insolvency (ie involving creditors and debtors in more than one Member State)
  • the EU average ranking in the World Bank's Doing Business report is 11.6 which is 5% below the OECD average for high income countries (see Practice Notes: Harmonising insolvencies and restructurings across Europe and Table of advantages and disadvantages of restructuring in various jurisdictions worldwide)
  • the World Bank report shows recovery rates vary between 30% (Croatia and Romania) and 90% (Belgium and Finland) within the EU
  • currently, four Member States have no restructuring provisions
  • discharge periods in Member States vary from one to ten years

The aim of the draft Harmonisation Directive is to provide legal certainty to cross border investors and companies operating across the EU. The current differences in legal frameworks amongst the Member States leads to uncertainty and additional costs for investors in assessing their risks, less developed capital markets and persisting barriers to the efficient restructuring of viable companies in the EU.

The proposal's objective is to remove these obstacles to the exercise of fundamental freedoms, such as free movement of capital and freedom of establishment. The EC decided to use a Directive to set up the framework giving Member States flexibility on how they actually implement its requirements.

What are the main provisions of the draft Harmonisation Directive?

The draft Harmonisation Directive is a key deliverable under the European Commission's wider Capital Markets Union Action Plan and the Single Market Strategy and follows on from the EU's earlier Recommendation in 2014 (see Practice Note: Harmonising insolvencies and restructurings across Europe). The problem with the EU Recommendation was that because it was not legally binding, few Member States took any action. The EC recognised that while it prompted some reforms, it didn't have the desired impact of consistent changes across all Member States and even those which implemented the Recommendation did so in a selective manner. The draft Harmonisation Directive states that it is intended to complement the EC Regulation on Insolvency 1346/2000 and the Recast Regulation on Insolvency 848/2015 by requiring Member States to ensure their national restructuring procedures comply with certain minimum principles of effectiveness.

Essentially the draft Harmonisation Directive requires Member States to ensure their restructuring procedures comply with various minimum principles. The three key elements are:

  • common principles on the use of early restructuring frameworks
  • rules to allow entrepreneurs to benefit from a second chance (specifically, individual debtors will be fully discharge from their debt after three years without further conditions, with safeguards to prevent abuse and deal with dishonesty or fraud)
  • targeted measures for Member States to increase the efficiency of insolvency, restructuring and discharge procedures—it is intended this will reduce the excessive length and costs of procedures in many Member States

The draft rules observe the following key principles:

  • debtors will have access to early warning tools (eg accounting and monitoring duties for the debtor or their management as well as reporting duties under loan agreements - see draft Harmonisation Directive, recital 16) which can detect a failing business and encourage restructuring at an early stage, meaning viable enterprises in financial difficulties will have access to early restructuring wherever they are located in the EU
  • the debtor will benefit from a breathing space of four months (extendable up to 12 months) to facilitate negotiations and a successful restructuring (Harmonisation Directive, recital 19). During this period, directors will be relieved from any duties to file for insolvency proceedings. Also contracts must be honoured and ipso facto clauses cannot be relied upon
  • the length of proceedings will be shortened with court involvement limited to specific cases where necessary to protect the interests of stakeholders. The appointment of IPs is not mandatory but should be made on a case by case basis (Harmonisation Directive, recital 18) meaning the debtor should be left in possession (as under the chapter 11 model)
  • holdouts (dissenting minority creditors) can be crammed down by the court, provided that their legitimate interests are safeguarded. Note that the absolute priority rule should be respected by the restructuring plan (ie dissenting creditors to be paid in full before more junior classes can receive any distribution or keep any interest under the restructuring plan (Harmonisation Directive, recital 28)). Creditors should be divided into classes and as a minimum, secured creditors should form a separate class to unsecured creditors. Additionally shareholders are not permitted to obstruct a restructuring
  • new financing will be protected (ie not attackable as an antecedent transaction) and will benefit from security at least higher than existing unsecured creditors (Harmonisation Directive, recital 31)(note US DIP finance is still significantly better offering super seniority over existing secured creditors)
  • employees (workers) will enjoy full labour law protection in accordance with the existing EU legislation (the draft Explanatory Memorandum, p11 notes Member States may decide to place workers in a separate class to vote on a restructuring)
  • increased use of specialised practitioners, judges and courts (specialist judges and IPs can take quick decisions) as well as increased use of technology (eg online claims filing and notifications to creditors) to improve efficiency and reduce the costs and length of insolvency procedures

Importantly the draft Harmonisation Directive doesn't seek to harmonise core aspects of insolvency such as rules for opening insolvency proceedings, defining insolvency or the ranking of claims as it is recognised that the current diversity across Member States was too large to bridge. Various practical assistance is contemplated, included a requirement that Member States shall make model restructuring plans available online (draft Harmonisation Directive, art 8(2)).

What are the practical implications for R&I lawyers and practitioners?

For now, it is a question of waiting and seeing whether the draft Harmonisation Directive is finalised, published in the OJ and effective (ie 20 days after publication in the OJ) before 31 March 2017.

If the timing means that it is applicable to the UK for a period before exit from the EU, the UK must decide whether and if so how to implement its requirements.

Regardless of the impact on the UK, the Harmonisation Directive will bind all remaining Member States meaning that we should see greater harmonisation and consistency in this area. The draft Harmonisation Directive also comments that it should reduce forum shopping from individual debtors moving to jurisdictions where the discharge period is shorter (see draft Harmonisation Directive, recital 8). It remains to be seen whether it will in fact reduce forum shopping entirely as there are often other factors at play.

Further Reading

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Brexit—general issues and future relationship between the UK and EU

Harmonising insolvencies and restructurings across Europe

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First published on LexisPSL Restructuring and Insolvency

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