COVID-19 Crisis Requires Legislators to Adapt Insolvency Legislation

The COVID-19 (corona) virus has reached pandemic status. It currently spreads over the world and is expected to infect a majority of all people within the next month(s), according to health experts. The medical urgency justifies the current extraordinary measures taken by many governments globally—measures that, at the same time, also have devastating effects on businesses and entrepreneurs as sectors slow down or are effectively closed down.

Weathering the storm

Strong appeals have been made to prevent bankruptcies caused by the COVID-19 crisis. The exogenous economic shock hits both financially reasonably healthy companies, which depend on a smooth inflow of liquidity, and companies with fundamentally solid business models. Many companies with a viable business model just a few weeks ago would now be forced to file and possibly suffer a piecemeal liquidation in the resulting insolvency proceedings. In the current, distressed market conditions there is a significant risk of sales at an under value.

Not surprisingly, many governments and institutions have announced economic measures to prevent an outbreak of businesses entering into liquidation proceedings. The European Commission published two communications dealing with the economic consequences of the COVID-19 crisis. In the first Communication on a coordinated economic approach the Commission announced several liquidity measures which complementing EU Member States may take that fall outside the scope of EU state aid rules. In the second Communication, the Commission announced a Temporary Framework for State Aid setting out and broadening the scope of state aid measures that fall within current EU state aid rules. Institutions such as the World Bank, IMF and ECB have also announced financial measures to strengthen economies.

Prevent unnecessary bankruptcies

The extraordinary economic situation raised by the COVID-19 outbreak requires legislators to undertake extraordinary measures. This extends also to insolvency legislation in order to prevent unnecessary bankruptcies. Insolvency legislation which is effective under normal market conditions may prove insufficient or ineffective in the current situation. Measures in these times should be effective without too many formalities, especially when courts and public authorities may not be fully available due to lockdown measures.

The Executive of the Conference on European Restructuring and Insolvency Law (CERIL)—an independent non-profit organisation of European lawyers and other restructuring and insolvency practitioners, law professors and (insolvency) judges—also considers that existing insolvency legislation may not provide adequate responses to the situation in which many businesses currently find themselves. In a statement, the Executive calls upon EU and European national legislators to take immediate action to adapt insolvency legislation to prevent unnecessary bankruptcies.

Adapting insolvency legislation

CERIL suggests that two steps should be taken immediately by European national legislators. First, the duty to file for insolvency proceedings based on over-indebtedness should be suspended. Such duties exist in several EU Member States, for instance Austria, Germany, Greece, Italy, Latvia, Poland and Spain. The current economic uncertainty hampers the effectiveness of this duty which is aimed at selecting non-viable businesses. In recent days, some countries have suspended (Germany) or extended (Austria) this duty. Second, in response to a (partial) shutdown of businesses for a number of weeks or months, urgent measures are required addressing the illiquidity of businesses.

In addition, the CERIL statement recommends that EU and national legislators consider further measures. In urgently adapting insolvency legislation, they should include measures to make available interim (crisis) finance, suspend the duty to file based on inability to pay, provide for ‘hibernation’ (going into winter sleep) of (small) businesses by means of a general moratorium or deferral of payments, and provide support for the livelihood of entrepreneurs and their employees.

The CERIL Executive Statement on COVID-19 and insolvency legislation is available here.

Gert-Jan Boon is Researcher and Lecturer in insolvency law at Leiden University.