A Comprehensive Economic and Legal Analysis of the Effects of Europe’s Fragmented Insolvency Laws

This post comes to us from Andrew Wilkinson and Paul Bagon of Weil, Gotshal & Manges.

Together with AFME and Frontier Economics, we have produced a new report into European insolvency law reform entitled “The potential economic gains from reforming insolvency law in Europe”. The report was submitted to the European Commission on 22 February 2016. The research shows that European insolvency law reform could boost GDP output and create jobs across Europe.

Currently, national insolvency frameworks in Europe vary in many respects. These differences can have a range of negative effects on financial markets and the real economy, including:

• discouraging cross-border investment (particularly with respect to multinational companies or those with complicated financing structures), thereby reducing the efficiency of EU capital markets in general;
• discouraging the timely restructuring of viable companies in financial difficulty, often resulting in a distressed company entering liquidation rather than restructuring as a going concern;
• increasing uncertainty among issuers, investors and other stakeholders with respect to creditor recovery rates;
• putting SMEs at a competitive disadvantage, as they generally do not possess the financial resources required to take advantage of more efficient restructuring procedures available in other Member States; and
• making it harder to address the high levels of non-performing loans (NPLs), which absorb bank capital, reduce the efficiency of capital allocation, and represent a challenge to banking system stability.

In March 2014, the European Commission published its “Recommendation on a new approach to business failure and insolvency” (the Recommendation). The primary objective of the Recommendation is to establish minimum restructuring and insolvency standards across the EU but is non-binding and has not been widely adopted by Member States. Due to the low level of voluntary compliance with the Recommendation, the European Commission is considering introducing binding legislative reform in this area.

The proposed reforms do not seek to fundamentally alter local insolvency laws. Instead the European Commission proposes that Member States should be required to reform their existing insolvency laws to ensure that they are compliant with prescribed minimum insolvency standards to help reduce barriers to cross-border investment and enable earlier and more efficient restructuring. The harmonisation of insolvency laws in the EU is considered by the European Commission to be an important policy initiative facilitating improved market functions throughout the EU and providing an enhanced framework in which European banks can de-lever NPLs.

The key conclusion of the report is that by observing the impact of variations in the quality of national insolvency frameworks on the pricing of credit using corporate bond yields as a proxy there are significant economic benefits attributable to investing in insolvency reform and convergence to best practice. These payoffs are distinct and robust relative to the payoffs from other categories of institutional reform. The report recommends the adoption of minimum standards for insolvency laws across Europe, including:

• the introduction of a statutory stay to enable quick and effective restructurings;
• the creation of a consistent framework for fast judicial resolution of valuation disputes;
• granting super-priority status to new financing to provide working capital to a distressed company;
• giving creditors stronger rights to propose viable restructuring plans whilst preventing cram downs under which creditors or shareholders with no economic interest in the enterprise can veto the commencement of formal insolvency proceedings or delay otherwise viable restructuring. restructurings; and
• requiring national insolvency agencies to publicly report on outcomes.

In particular, the report finds that a significant negative correlation exists between corporate bond yields and expected recovery rate, suggesting that countries with strong insolvency regimes have lower borrowing costs. Using this bond modelling, alongside available data, the report is able to show the macroeconomic impact of insolvency reform at an EU level demonstrating that if all EU Member States were to reach a recovery rate of 85% a permanent increase in GDP of €41bn to €78bn is implied (amounting to between 0.3% and 0.55% of EU28 GDP). An increase in employment in the EU28 is also shown at between 600,000 and 1.2 million jobs. The distribution of macroeconomic effects suggests that absolute gains from insolvency reform could flow to Italy, Spain and France, as well as some central European Member States such as Poland, Hungary and Romania.

The report also contains an overview of current national insolvency regimes in France, Germany, Italy, Spain, the UK, the Netherlands and Luxembourg, as well as case studies relating to recent cross-border insolvency procedures and recent reforms at national level.

A full copy of the report can be found at the Weil European Restructuring Watch website here.