The challenges of harmonising insolvencies and restructurings

The challenges of harmonising insolvencies and restructurings

What harmonisation provisions have the European Commission recommended and what is their legal status?

Original news
Press Release: European Commission recommends new approach to rescue businesses and give honest entrepreneurs a second chance, LNB News 12/03/2014 100

The European Commission has set out a series of common principles for national insolvency procedures for businesses in financial difficulties. The objective is to shift the focus away from liquidation towards encouraging viable businesses to restructure at an early stage to prevent insolvency. With around 200,000 businesses across the EU facing insolvency and 1.7 million people losing their jobs each year as a result, the Commission wants to give viable enterprises the opportunity to restructure and stay in business. The Recommendation follows a public consultation last year on a European approach to insolvency (IP/13/655), and a proposal to revise existing EU rules on cross-border insolvencies, which recently received the approval of the European Parliament (MEMO/14/88).

What has the European Commission proposed?

On 12 March 2014, the European Commission issued a recommendation containing detailed provisions seeking to harmonise insolvencies and restructurings throughout the EU (the Recommendation) (for the full text, see Commission Recommendation on a new approach to business failure and insolvency).

General harmonisation is also supported by the European Parliament and the Organisation of Economic Cooperation and Development (OECD). The Recommendation takes into account the findings of INSOL Europe's Study on a new approach to business failure and insolvency—Comparative legal analysis of the member states' relevant provisions and practices.

The Recommendation asks member states to:

• facilitate the restructuring of businesses in financial difficulties at an early stage, before starting formal insolvency proceedings, and without lengthy or costly procedures to help limit recourse to liquidation
• allow debtors to restructure their business without needing to formally open court proceedings
• give businesses in financial difficulties the possibility to request a temporary stay of up to four months (renewable up to a maximum of 12 months) to adopt a restructuring plan before creditors can launch enforcement proceedings against them (Recital 18)
• facilitate the process for adopting a restructuring plan, keeping in mind the interests of both debtors and creditors, with a view to increasing the chances of rescuing viable businesses
• reduce the negative effects of a bankruptcy on entrepreneurs’ future chances of launching a business, discharging their debts within a maximum of three years

The Recommendation runs in parallel with the Commission's other proposals to reform the EC Regulation on Insolvency, which only deals with issues of jurisdiction, recognition and enforcement, applicable law and cooperation (see News Analysis: European Parliament proposes significant changes to reform the EC Regulation on Insolvency and Practice Note: Reforms to EC Regulation on Insolvency 1346/2000 proposed by the European Commission).

The following types of debtors are specifically carved out from the Recommendation on the basis that most are subject to their own special recovery and resolution frameworks:

• insurance undertakings
• credit institutions
• investment firms and collective investment undertakings
• central counter parties
• central securities depositories
• other financial institutions
• consumers

What are the objectives of the Recommendation?

The divergence between member states' laws has an impact on:

• the recovery rates of creditors in different jurisdictions
• investment decisions, and
• the restructuring of groups of companies

A more coherent approach at EU level would not only improve returns to creditors and the flow of cross-border investment, but would also have a positive impact on entrepreneurship, employment and innovation. The World Bank has produced substantial reports to show improved insolvency laws promote greater investment in that country (see Practice Note: Table of advantages/disadvantages), and the Recommendation notes that discrepancies between national frameworks lead to increased costs and uncertainties in assessing the risks of investing in another member state (see Recitals 4, 8, 11, 12 and Recommendation 2).

Currently, early intervention (ie before formal insolvency proceedings have started) is not possible in several countries (eg Bulgaria, Hungary, Czech Republic, Lithuania, Slovakia, Denmark). Where it is an option, procedures can be inefficient or costly.

In some countries, it can take many years before honest entrepreneurs (ie individuals) who have gone bankrupt can be discharged of their old debts and try another business idea (eg Austria, Belgium, Estonia, Greece, Italy Latvia, Lithuania, Luxembourg, Malta, Croatia, Poland, Portugal, Romania). A shortened discharge period would make sure bankruptcy does not end up as a life-sentence.

Evidence suggests that failed entrepreneurs often learn from their mistakes and are generally more successful the second time around (eg Henry Ford's first automobile company failed within two years, but he later went on to create a successful business).

What is the legal status of a Recommendation?

Recommendations from the Commission do not have any legal force (unlike regulations, directives and decisions) and are not binding on member states. However, they do have a political weight. The aim of a Recommendation is to encourage member states to prepare legislation to address the issues identified.

When must action be taken?

The Recommendation asks member states to enact appropriate measures within one year. The Commission will assess the situation 18-months after adoption of the Recommendation, based on yearly reports from member states, to evaluate whether further measures are needed to strengthen the harmonisation.

What are the detailed provisions?

The key provisions include recommendations that:

• restructuring be available at an early stage, when there's a likelihood of insolvency (Recommendation 6(a))
• the debtor keeps control over the day-to day operation of its business—ie the debtor should remain in possession and not be replaced by an insolvency practitioner (Recommendation 6(b))
• a temporary stay of up to four months (extendable up to 12 months) be available against individual creditor enforcement actions including secured and preferential creditors—in countries where stays are subject to certain conditions, a stay should be granted if creditors representing a significant amount of the claims likely to be affected by the restructuring plan support it (Recommendations 6 (c),10–14). Directors' duties to file for insolvency within a set time period are suspended during the stay (see Practice Note: Table comparing European directors' duties)
• new financing (eg DIP financing, new loans, selling certain assets and debt for equity swaps) is not automatically void, voidable or unenforceable (Recommendations 6(e) and 27–29) but need court confirmation (Recommendation 21)—unfortunately it doesn't go on to give this financing super priority
• court involvement be limited to where it is necessary and proportionate (Recommendation 7), restructurings should be opened without formal court proceedings (Recommendation 8) and the appointment of a court mediator/supervisor shouldn't be compulsory (Recommendation 9)—member states should specify the conditions when a plan may be confirmed, including at least:
◦ the plan ensures the protection of the legitimate interests of creditors
◦ the plan has been notified to all creditors likely to be affected
◦ the plan does not reduce the rights of dissenting creditors below what they would reasonably be expected to receive in the absence of the restructuring, if the debtor's business was liquidated or sold as a going concern
◦ any new financing is necessary to implement the plan and does not unfairly prejudice the interests of dissenting creditors (Recommendation 22)—courts should be able to reject plans which clearly don't have any prospect of preventing the debtor's insolvency and ensuring the viability of the business (Recommendation 23)
• member states should lay down specific provisions on the content of restructuring plans requiring:
◦ clear and complete identification of the creditors affected
◦ the effects of the proposed restructuring on individual debts or categories of debts
◦ the position taken by affected creditors
◦ where applicable, the conditions for new financing
◦ the potential of the plan to prevent the insolvency of the debtor and ensure the viability of the business (Recommendation 15)
• classes—creditors with different interests should be treated in separate classes which reflect those interests (as a minimum, secured and unsecured creditors should form separate classes) (Recommendation 17)
• cram down by court (the requisite majority should be prescribed by national law)—however, where there are more than two classes of creditors, member states should be able to empower courts to confirm restructuring plans which are supported by a majority of those classes of creditors, taking into account in particular the weight of the claims of the respective classes of creditors (this is similar to provisions under Italian law) (Recommendations 18 and 21)
• creditors be allowed to vote on the plan by registered letter or secure electronic techniques (Recommendation 19)
• bankrupt individuals/entrepreneurs who have not acted dishonestly or in bad faith be automatically discharged from their debts (excluding those arising from tort) within three years at most, without any need to re-apply to court (Recommendations 30–33)
• member states to ensure that tax revenues are collected and recovered, especially in cases of fraud, evasion or abuse (Recital 14 and Recommendation 4)

What are the practical implications for restructuring and insolvency professionals in the UK?

Fortunately the UK already adheres to many of the provisions. Some major benefits are the recommendations that member states:

• allow debtors in out of court restructurings to apply to court for a temporary stay of up to four months—in practice, restructurings have relied on standstill agreements to give debtors a breathing space (see Practice Note: Key elements of a standstill agreement), but this should help cases where standstills can’t be agreed
• should empower courts to confirm restructuring plans which are supported by a majority of those classes of creditors, taking into account in particular the weight of the claims of the respective classes of creditors—this is potentially a very strong and useful mechanism to force through plans against dissenting classes of creditors and holdouts

However, the Recommendation is limited as regards:

• DIP loans—not granted super priority status but are simply not automatically void
• groups—although the Recommendation recognises the problems facing groups (no restructuring plan involving the continuation of the business of groups of companies has ever been accepted in three or more jurisdictions) and aims to help the restructuring of groups (the impact assessment refers to designing a restructuring plan which could work for all its subsidiaries, instead of designing one plan for each subsidiary—see Impact Assessment), there is little detail on exactly how this will be accomplished

If you are a LexisPSL Subscriber, click the links below for further information:

European Parliament proposes significant changes to to reform EC legislation on Insolvency  (Subscriber access only)

Reforms to EC Regulation on Insolvency 1346/2000 proposed by the European Commission (Subscriber access only)

Table of advantages/disadvantages of various jurisdictions worldwide (Subscriber access only)

Table comparing European directors' duties (Subscriber access only)

Key elements of a standstill agreement (Subscriber access only)

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About the author:
Kathy specialises in restructuring and cross-border insolvency. She qualified as a solicitor in 1995 and has since worked for Weil Gotshal & Manges and Freshfields. Kathy has worked on some of the largest restructuring cases in the last decade, including Worldcom, Parmalat, Enron and Eurotunnel.