The Future of Restructuring Law in Europe: Greater Harmonisation, but at What Cost?
The European Commission has published its “Proposal for a Directive ... on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures ...”. If enacted, the Directive would be the first serious step towards the harmonisation of the domestic insolvency laws of EU Member States. The most significant existing EU law in the insolvency field – the European Insolvency Regulation – leaves most aspects of the design of insolvency procedures to Member States to determine, and instead focuses on enhancing the effectiveness of these procedures in cross-border cases.
The European Commission now proposes harmonisation of two areas of substantive Member State law: the rules governing the restructuring of financially distressed business debtors (Title II of the proposed Directive), and aspects of the rules governing the treatment of bankrupt entrepreneurs, particularly the time to discharge after commencement of bankruptcy proceedings (Title III). Additionally, the Commission proposes a series of measures to enhance the efficiency of insolvency rules and procedures more generally (Title IV), and new measures to improve the collection and publication of data on national insolvency procedures (Title V).
Those who have been following the work of the European Commission in insolvency law in recent years will not be surprised by the choice of topics for substantive harmonisation: in 2014, the Commission issued a non-binding Recommendation that invited Member States to (i) “... put in place a framework that enables the efficient restructuring of viable enterprises in financial difficulty ...”, the Commission setting out six “minimum standards” for the design of such frameworks, and (ii) ensure a “second chance” for entrepreneurs by limiting the time to discharge in personal bankruptcy proceedings to a maximum of 3 years. Almost all of the Recommendation was dedicated to the first set of proposals (restructuring). The Commission’s focus on restructuring was driven primarily by reports that good businesses were being destroyed in liquidation procedures because of the absence of restructuring alternatives, with attendant losses to creditors ex post and to debtors ex ante (given expected increases in the cost of capital wherever reduced recoveries in insolvency were anticipated).
In a recent paper we considered the restructuring aspects of the Commission’s Recommendation in some detail. We accepted the case for harmonisation of the restructuring laws of Member States in principle, given the evidence that divergence in the design and operation of insolvency laws across Member States meant that some financially distressed debtors were significantly better positioned than others to achieve value-preserving restructurings, and the significant negative impact of these divergences in cross-border cases in particular (cross-border activity being an essential feature of the internal market).
We took issue, however, with some of the restructuring standards the Commission set out in its Recommendation, expressing particular concern at the Commission’s emphasis on minimising court involvement in the operation of state-supplied restructuring procedures, and querying whether the framework suggested by the Commission contained adequate controls against abuse. More generally, we queried the Commission’s apparent focus on restructuring as the only available alternative to a piecemeal sale in liquidation, suggesting that another obvious option, namely an insolvency procedure under which a viable business could be sold quickly and on a going concern basis to a new owner, and the proceeds distributed to creditors in accordance with the priority scheme prescribed by law, could be expected to be value maximising for creditors in many cases.
In its proposal for a Directive, the Commission sets out rules aimed at ensuring “... that viable enterprises in financial difficulties have access to effective national preventative restructuring frameworks which enable them to continue operating ...” (Recital 1). As in the Recommendation, the basic idea is a DIP reorganisation procedure in which the debtor negotiates a plan with creditors or select classes of creditors and (where national law so provides, shareholders) that – if voted on by the prescribed majority (as set out in national law) and approved by designated national administrative and/or judicial authorities – becomes binding, even on dissenting parties to the plan. To facilitate negotiations, the debtor would be able to apply for a stay on enforcement action by creditors, and the commencement of insolvency proceedings. A majority of affected creditors would only be able to bind a minority where their rights were “sufficiently similar”; as such, creditors would need to be divided into classes (at minimum, the Commission suggests, secured creditors would need to be treated as a separate class) (Art. 9(2)). Additionally, the plan could not be sanctioned (so as to become binding on dissenters) where it would reduce the rights of affected creditors below that which they would reasonably be expected to obtain in a going concern or piecemeal sale (Arts. 10, 2(9) – the “best interest of creditors test”). The Proposal provides that the imposition of the stay and the sanctioning of the plan would be the tasks of the “judicial or administrative authority” designated in national law – not necessarily, then, a court.
Several aspects of the Commission’s Proposal curtail creditor and other stakeholder rights more significantly than the Commission’s earlier recommendations. For example, while the Recommendation said little about the treatment of contracts that were executory at the time of the initiation of restructuring proceedings, the Proposal now sets out rules designed to constrain the ability of counterparties to “... withhold performance, terminate, accelerate or in any other way modify executory contracts during the stay period ...” (Recital 21) provided obligations incurred after the commencement of proceedings are met (Art. 7(4)-(6)). Where the Recommendation left it to Member States to decide whether a plan could be sanctioned in circumstances where a majority of affected classes had agreed but a majority within each class had not (so as to bind dissenting classes), the Proposal now provides for cross-class cram down (Art. 11 – provided the “absolute priority rule” is observed). Where the Recommendation provided limited protection (from transaction avoidance and personal liability rules, except in cases of fraud) for new finance agreed as part of a restructuring plan, the Proposal extends this protection to interim finance (Art. 16(1)-(2) giving Member States the option to provide such financiers with priority in the event of a subsequent liquidation, at least vis-à-vis “ordinary unsecured creditors”), and offers significant new protection for “... transactions carried out to further the negotiation of a restructuring plan confirmed by a judicial or administrative authority or closely connected with such negotiations ...” from transaction avoidance, again excepting fraud (Art. 17).
Hence, the Proposal very much resembles a full-blown insolvency (corporate restructuring) proceeding such as Chapter 11 in the US (best interest of creditors test, absolute priority rule, cross-class cram-down, etc). At the same time, the Commission has retained its emphasis on minimised state involvement: Article 4(3). Under the Proposal, the designated judicial or administrative authority would be involved only in (a) disposing of applications for the imposition or lifting of the stay, and (b) sanctioning a plan already approved by the prescribed majority of affected creditors/shareholders, by which point in time significant costs will have been sunk into the restructuring negotiations. There is no provision mandating the appointment of a supervisor: this is left to Member States to determine (Arts. 5, 2(15)). Hence, the Proposal aims at swift (and confidential, if possible) procedures with minimal court involvement.
The overall result appears to be a “have your cake and eat it” approach to reorganisation: have a full-blown restructuring process with significant curtailments of creditor rights on the one hand and extremely limited court control on the other; have significant privileges for debtors (and, interestingly, for workers, who are offered various forms of enhanced protection under the Proposal relative to the Recommendation), with limited safeguards for creditors. If the overall idea is to improve access to finance for business debtors, this seems highly problematic. The Commission might have been better advised to mandate auctions of distressed businesses, which require little court involvement/oversight:
We are concerned by the continued focus in the Proposal on restructuring – renegotiating with creditors – as the solution in circumstances where debtors are over-leveraged but have a viable business. Nothing in the Proposal encourages Member States to put in place mechanisms that facilitate going concern sales as an alternative to negotiating a plan with creditors and shareholders. The Proposal provides that a stay should be made available where “... necessary to support the negotiations of a restructuring plan ...” (Article 6(1)), without addressing whether such a plan would be in the best interests of creditors. Consideration of whether creditors would be better off in a going concern sale is left to the final stage – the sanction of the plan – after significant costs have been incurred in the renegotiation process.
On a more positive note, we think the provisions of Title IV (new measures to improve the general efficiency of Member State insolvency procedures) and Title V (new measures to ensure better data relating to Member State insolvency procedures) are interesting and potentially of significant value. We think there is much to gain from focusing on improving the quality of the institutional framework for the delivery of insolvency laws – courts, and insolvency practitioners. An essential first step in doing so is improving the quality of data available on the performance of these institutions.
Horst Eidenmüller is the Freshfields Professor of Commercial Law at the University of Oxford.
Kristin van Zwieten is the Clifford Chance Associate Professor of Law and Finance at the University of Oxford.
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