COVID-19: Insolvency Reform Package adopted by the Spanish Government: Duty to File for Bankruptcy and Duty to Promote the Winding-up or Recapitalization of the Company

On April 28, the Spanish Government approved Royal Decree-Law 16/2020 (‘RDL 16/2020’), passing a series of insolvency, refinancing, corporate and procedural measures. The purpose of the legislation, expressly set out in its preamble, is to seek ‘an expeditious solution to the backlog of proceedings that were suspended when the state of emergency (estado de alarma) was declared, once the suspension is lifted’ and ‘to respond to the inevitable increase in litigation that will result (…) from the health crisis itself’. In particular, the new law relieves many companies that met the criteria for insolvency because of the lockdown that has been imposed across the whole country since 14 March, from the obligation of filing for voluntary insolvency or commencing the liquidation phase if they cannot comply with their creditors’ composition or refinancing agreements. Thus the measure gives them time to resolve their economic and financial difficulties that have increased as a result of the national lockdown, currently still in force, and establishes measures to help them to do so.

This post about the Spanish insolvency law reform considers the suspension of two directors’ duties: the duty to file for insolvency if the company is insolvent (Sections 5 and 165.1.1 of the Spanish Insolvency Act), and the duty to promote the winding-up or restructuring of the company or to file for insolvency when its losses reduce its net assets to less than 50% of the share capital (Sections 363.1 e) and 367 of the Spanish Companies Act). 

Under RDL 16/2020 (article 11.1), the duty to file for insolvency, is deferred until 31 December 2020 to give companies enough time to overcome temporary financial problems arising from the national lockdown and, thereby,  to avoid them filing for insolvency without their directors incurring liability for failing to file within two months after the state of emergency is lifted.  This measure at least serves to flatten the curve of insolvency proceedings in an attempt to avoid the collapse of Spanish insolvency courts. As a consequence, insolvency judges will not consider applications for insolvency filed by a creditor between the declaration of the state of emergency and 31 December 2020 (RDL 16/2020, article 11.2).

This rule was absolutely necessary since the previous suspension of the duty to file for insolvency under Royal Decree-Law 8/2020 of 28 March (article 43) was only to be effective during the state of emergency, but now it seems too broad for various reasons. Firstly, the suspension does not distinguish between cases where insolvency has occurred after 14 March because of the lockdown, and those where companies that were already insolvent on that date or that had previously filed a petition for insolvency or the so-called ‘pre-insolvency’ notice, ie a three-month moratorium for restructuring or filing for insolvency (Section 5 bis of the Spanish Insolvency Act). These latter firms, in my opinion, should not benefit from this automatic extension of the period for filing for insolvency. Secondly, the suspension stipulated in Royal Decree-Law 16/2020 is too long (more than 8 months) to apply automatically. I think a shorter period (for example, until September 30) would have been more prudent, with the possibility of extending it, if necessary, for one or two additional three-month periods (as in Germany), depending on the circumstances and the evolution of the crisis. Thirdly, the measure is not consistent with the two-year period for exercising clawback actions, the so-called ‘suspect period’ (‘período sospechoso’), and should have been extended for the same period so as not to be prejudicial to the insolvent company’s creditors (as is the case in the Czech Republic or in Singapore, for example).

With regard to the second duty of directors, to promote the winding-up or restructuring of the company or to file for insolvency when its losses reduce its net assets to less than 50% of the share capital, although it may also seem necessary to suspend this legal obligation at the moment (as many experts have highlighted), this rule, established in article 18 of RDL 16/2020, is a clear example of poor legislative technique. It would have been simpler (and technically more appropriate) to temporarily suspend the application of section 363.1 e) of the Spanish Companies Act, including the grounds for dissolving a company due to severe losses, for a reasonable period of time (for example, one year).  An alternative measure would have been to temporarily suspend the period for calling a shareholders’ general meeting to ask to wind up or recapitalise the company, as already established a month earlier by article 40.11 of Royal Decree-Law 8/2020. Instead, the rule established under RDL 16/2020 is really complicated. On the one hand, it establishes indefinitely that losses occurring in 2020 will not be taken into account for the purpose of the aforementioned section 363.1 e) of the Spanish Companies Act, and, on the other hand, that, if the said legal ground for dissolution applies based on the company’s results for 2021 (ie the results reported in the annual accounts that would be prepared in the first 6 months of 2022), a general meeting must be called within two months from the end of the financial year passing a resolution to dissolve or to recapitalise the company. At the same time, the requirement to promote dissolution, recapitalisation or insolvency within two months from the moment an increase in losses causes the company’s net assets to fall below 50% of the share capital remains fully in force.

This raises a number of questions.  Firstly, the rule does not suspend the legal duty in absolute terms, since, if the ground for dissolution occurs this year as a consequence of the losses reflected in the 2019 annual accounts, which all Spanish companies are currently in the process of preparing and approving, the proposal to dissolve the company must be made in the two months following the lifting of the state of emergency. Moreover, shareholders will be able to file for judicial dissolution, which helps neither to secure a sufficient period during which the company’s financial difficulties can be resolved by extrajudicial means nor to flatten the curve of judicial proceedings (in fact, it has quite the opposite effect).

Secondly, it makes no sense for losses incurred in 2020 not to be computed indefinitely (‘sine die’) for this purpose, since they continue to be reflected in the company accounts and produce the other corresponding legal effects (for example, legal capital reduction for losses, limiting distribution of dividends, etc).  If the purpose of the rule is to enable directors and managers to resolve the company’s financial and economic problems, especially those arising because of the national lockdown, without assuming legal risks (the directors’ personal liability vis-a-vis new company creditors), it makes no sense for this provision not to apply on a temporary basis only, as is the case for all other provisions in the RDL 16/2020.

Thirdly, the reference to the company’s results of 2021 is equally difficult to understand since it is not clear whether or not losses incurred in 2020 have to be taken into account for assessing whether the assets have fallen below the threshold set in section 363.1 e) of the Spanish Companies Act for the purpose of the 2021 annual accounts.

Finally, it makes no sense to establish the duty to dissolve or recapitalise the company within the first two months after the end of the financial year and thus before the mandatory deadline by which directors must have prepared the 2021 annual accounts and, even more so, before the annual accounts’ approval by the shareholders’ general meeting.  Consequently, this cannot be used as a basis for verifying whether this ground for dissolution even exists or for adopting the appropriate measures to eliminate it (for example, a legal capital reduction, remission of credits by shareholders or parent companies, etc).

José Carlos González Vázquez is a full professor of commercial law at the Complutense University of Madrid and a founding partner of MA Abogados.