Optionality and EU Harmonization of Restructuring and Insolvency Law: The case of the Preventive Restructuring Directive and Priority Rules

Introduction

The EU has, over the last ten years or so, sought to adopt directives harmonizing the contents of national restructuring and insolvency laws. The achievement of sufficient political consensus around such directives has often necessitated the inclusion of options for Member States, thereby reducing the resulting level of uniformity. In an article forthcoming in the European Business Organization Law Review, I analyze whether such optionality is compatible with the goals of harmonization in this area.

Background

The Preventive Restructuring Directive of 2019 requires Member States to have in place restructuring frameworks satisfying several requirements. The 2022 proposal for a Directive harmonising certain aspects of insolvency law—which currently is undergoing the EU legislative procedure—would, if adopted, establish EU law requirements for transaction avoidance, pre-pack mechanisms, and the duties of directors of insolvent companies.

Two rationales underpin the efforts to harmonize the contents of national restructuring and insolvency laws. The first is that differences between legal regimes generate additional transaction costs in cross-border transactions, as prospective investors must either obtain advice on local laws or invest in ignorance of their implications. The second argument is that variations between national insolvency regimes may cause competitive distortions between companies situated in different Member States, as the quality of national frameworks may impact their access to financing.

While the objectives seem clear, achieving political agreement on a single set of rules has proved challenging. During their respective legislative processes, both the Preventive Restructuring Directive and the pending Directive on certain aspects of insolvency law were watered down as regards the level of prescriptiveness. For instance, the Preventive Restructuring Directive includes numerous provisions that either allow national laws to define key concepts or permit Member States to choose between two or more rules. Uniform rules across EU’s Member States are therefore far from assured.

Is optionality compatible with the goals of harmonization?

The difficulty in reaching consensus on a single set of uniform rules raises the question of whether harmonizing national restructuring and insolvency laws is worthwhile: is a directive that, on certain issues, leaves it up to Member States to choose between two or more rules (optionality) better than no harmonization at all? Or should the Commission abstain from putting forward the proposal when it anticipates difficulties in getting through a proposal for uniform rules?

In the article, I analyze this question. I propose two cases where a directive with optionality is better than no harmonization at all when evaluated from the perspective of reducing legal costs associated with cross-border transactions.

The first is where the options are clearly defined and of a limited number. In this scenario, a person acquainted with the Directive’s options will more easily learn the rule chosen in other Member States, thus reducing the amount of assistance required from local counsel compared to the baseline without harmonization.

The second case is where the Directive’s transposition phase, during which Member States must at least verify whether existing rules comply with the Directive’s requirements, serves as a catalyst for discussions on reform beyond what is strictly required to ensure compliance. If the transposition phase has this effect, and rules chosen by Member States converge towards the same standard, this could sow the seeds of further harmonization and true uniformity.

I go on to discuss the two proposed mechanisms against the Preventive Restructuring Directive’s requirements for so-called ‘priority rules’ and the options left for the Member States in this regard, as well as the priority rules in place in five EU Member States following the Directive’s transposition.

I show that the design of the Preventive Restructuring Directive violates the condition of permissible rules being limited in number and clearly defined. The directive’s requirements are formulated in a manner that allows many configurations. Unsurprisingly, no two of the five Member States share identical priority rules. Evaluated from the perspective of reducing legal costs associated with learning about the contents of another member state’s restructuring laws, the Directive’s provisions arguably do no better than not dealing with the priority issue at all.

As regards the second mechanism, I show that there is some convergence towards a ‘relaxed’ absolute priority rule. Accounts of the Preventive Restructuring Directive’s transposition in other member states also provide examples of this trend. While the sample size is very small, it is nonetheless interesting to note that there is some correlation between (i) the degree of change between pre- and post-transposition priority rules and (ii) whether a Member State has recently reformed its restructuring regime. Everything else being equal, it seems plausible that a jurisdiction that has not reformed a field of law in a long time is more susceptible to reform than one where recent efforts have been made both by lawmakers and private actors adjusting to the new rules.

The full paper can be accessed here.

Sjur Swensen Ellingsæter is an Associate Professor at the Department of Law and Governance, BI Norwegian Business School.