EU Directive harmonising restructuring and insolvency finalised

We look at the new Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures (the Restructuring and Second Chance Directive) and how it will harmonise restructuring, insolvency and discharge procedures across all Member States, including its potential effect on the UK.

 Original news

LNB News 06/06/2019 70

The European Commission is introducing 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 6 June 2019, the European Council adopted 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) 72 (the Restructuring and Second Chance Directive).

The Restructuring and Second Chance Directive will enter into force 20 days after being published in the Official Journal (OJ) and Member States must implement provisions to comply with most provisions within two years from when it enters force (ie depending on OJ publication date—June/July 2021—see art 34, Restructuring and Second Chance Directive)(although the requirements of Title IV of the Restructuring and Second Chance 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 the timing of the UK's exit following a triggering of art 50 TEU. Note that under the terms of the last draft withdrawal agreement (Nov 2018), the transitional period would end on 31 December 2020, or such other date as extended under art 132. Accordingly, if the withdrawal agreement is approved in this format without any extension to the transition period, the UK would not need to comply with this Restructuring and Second Chance Directive.

However, the UK government had already launched its own consultation on modifying corporate insolvency, with many of the proposals echoing the principles behind the Restructuring and Second Chance Directive and the implementation of any such changes may well proceed regardless to ensure that the UK remains competitive.

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 competitivenes.

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

  • in Europe, half of businesses survive less than five years
  • in the EU, approximately 200,000 firms go bankrupt each year, resulting in 1.7m 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 World Bank report shows recovery rates vary between 30% (Croatia and Romania) and 90% (Belgium and Finland) within the EU
  • several Member States have no restructuring provisions
  • discharge periods in Member States vary from one to ten years

The aim of the Restructuring and Second Chance Directive is to provide legal certainty to cross border investors and companies operating across the EU. The current differences in legal frameworks among 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 after the earlier EU Recommendation in 2014 failed to gain sufficient traction. 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.

What are the main provisions of the Restructuring and Second Chance Directive?

The Restructuring and Second Chance Directive is a key deliverable under the European Commission's wider Capital Markets Union Action Plan and the Single Market Strategy. The Restructuring and Second Chance Directive states that it is intended to complement 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 Restructuring and Second Chance 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 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 Restructuring and Second Chance 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 (Restructuring and Second Chance 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 (Restructuring and Second Chance Directive, recital 18) meaning the debtor should be left in possession
  • 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 (Restructuring and Second Chance 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 (Restructuring and Second Chance 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 Explanatory Memorandum, 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 Restructuring and Second Chance 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 (Restructuring and Second Chance 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 what the outcome on Brexit is.

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 Restructuring and Second Chance Directive will bind all remaining Member States meaning that we should see greater harmonisation and consistency in this area. The Restructuring and Second Chance Directive also comments that it should reduce forum shopping from individual debtors moving to jurisdictions where the discharge period is shorter (see Restructuring and Second Chance 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.

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