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Directive on preventive restructuring procedure

In view of ongoing restrained economic development in a large number of Member States, the European Commission tabled the proposal for a Directive on redesigning of remedial corporate insolvency on 22 November 2016. After an intense political discussion the proposal has passed its first reading in the European Parliament in September 2018.

The aim here is to enable early structural adaptations and thus avoid insolvency and the associated retrenchment of employees. In addition, the Directive should help to rehabilitate bankrupt entrepreneurs faster and despite everything retain their collective corporate experience for the national economy. Specifically, this should occur through discharging residual debt within a period of at most three years. At the same time, it should offer an incentive on the level of liable management to react to crises early on and disclose and approach these by way of restructuring measures. This incentive is also clearly reflected in the intention that the control of the company should fully or at least in part remain with the debtor who is willing to restructure.

Second chance for ailing companies

The European Commission sees the need for reform against the backdrop of creating a capital market union and the Single Market Strategy; currently there are still great obstacles for a broad development of the capital markets within the EU. From the Commission’s point of view, too many viable companies that have encountered financial difficulties are still being liquidated. Too few companies are given a second chance by way of early restructuring.

At first glance, the European framework conditions for the future preventive restructuring plan resemble the German insolvency plan model: For instance, the formation of creditor groups (classes of creditors) was adopted in order to make effective coordination of a restructuring plan possible. The contributions to restructuring made by creditors should primarily be in the form of waiving (partial) claims against the company that finds itself in a crisis.

However, when conducting a more detailed analysis clear differences emerge: For instance, the Directive proposal envisages that legal remedies against the plan and its confirmation do not have a suspensive effect and thus no influence on the effectiveness of the regulations laid down in the plan. In contrast to the insolvency plan within insolvency proceedings, the preventive restructuring plan actually should only create a binding effect on the creditors that participated in the actual voting procedure around the restructuring plan.

Directive holds disadvantages for affected creditors

In order to afford the ailing company the necessary time in which to investigate the planned restructuring options, it is envisaged within the framework of the preventive restructuring procedure to allow it a stay of execution, which for example can also only be ordered with regard to individual creditors. Here there is talk about a period of 4 to at most 12 months. Such a breathing space for the debtor significantly increases its suppliers’ default risk and in this context would also involve the danger that an already strained liquidity situation could ultimately deteriorate. This is all the more concerning since it is envisaged that during the phase of this stay of execution delivery conditions agreed by the parties could also be frozen.  From the start of the suspension phase, it should no longer be possible to convert supplies to delivery against prepaid invoices, end current contracts that have not yet been fully executed unilaterally or deviate in any other way from relevant conditions to the debtor’s detriment. Avoiding these regulations with contractual clauses and provisos in the event of the preventive restructuring procedures is excluded according to the draft. Thus implementing the Directive in its current form would, aside from the intended advantages from a macroeconomic view, unfortunately also entail significant interferences in the private autonomy and the property rights of the debtors concerned.

Also somewhat concerning: According to the draft, during the suspension phase the duty of the person in the company responsible for filing an application for insolvency is to be suspended as well as protection from insolvency applications by creditors granted. Even in the event that suspension ends without agreement on a restructuring plan, the debtor should not necessarily be forced to file an application for insolvency unless in this event there are other reasons for filing.

Better placement of venture capitalists

Aside from breathing space, it is of considerable importance to a company in financial difficulties to procure liquid funds. In order to facilitate and especially support this, financial assistance and remedial loans should be privileged in such a way that these debts are granted a legal priority over all other unsecured debts. In addition, in the event of possible subsequent insolvency, it should not be possible to contest such restructuring aids or challenge them on any other basis. The same should also apply to reasonable consultants’ fees in the context of generating, negotiating and implementing the restructuring plan and wages.

Restructuring administrator as an objective third party

Instead of the liquidator or custodian [Sachverwalter] it is envisaged that possibly a so-called restructuring administrator accompanies the restructuring efforts. This is welcomed because a neutral third party is required in order to protect creditors, and will conduct the negotiations with the creditors using the necessary objectivity. A restructuring administrator should be involved if the suspension of enforcement measures of individual or all creditors should be granted or creditors’ rights could be interfered with to their detriment. Also the participation of a higher authority or a court should only be necessary if possible rights of the debtor or of the participating creditors are interfered with.

No independent review of claims

Noticeable in this context is that so far an objective review of all asserted claims, which define the basis of each creditor position and thus the associated right to vote, is not intended. This is even more problematic because the intended vote within creditor classes contains enormous potential for conflict as it is: In principle, the intention is that agreement with the plan will require a majority in each of the voting creditor classes. However, legal confirmation of the plan should already be possible if it was approved by at least one class of creditors which does not consist of shareholders or another class of creditors that would not have received any payments in the context of regular liquidation. Alone the agreement of one group of creditors (not subject to an objective claims review) would thus open the possibility to have the restructuring plan, which generally is connected with deep cuts into the creditors’ rights, legally confirmed.

Overall evaluation

How then should the proposals be evaluated overall? The topic was intensely discussed in several meetings. The present text of the proposal represents a compromise of the different views on the topic and was endorsed by the plenary meeting of the European Parliament in September 2018.

After a sober evaluation, however, the businesses to be restructured may, aside from getting rid of the stigma of insolvency, see a particular advantage in the fact that they would still continue to be completely in control of their companies according to the current plans in the preventive restructuring procedure. However, today already cases of misuse of the stay of execution to the creditors’ disadvantage are stacking up in insolvency plan procedures that are conducted under self-administration.

During the further discussion of the draft it is extremely important to consider that the creditors’ rights are not completely crushed. This is already demanded in Section 14 of our constitution. Aside from the overly long periods for which a stay of execution should be granted, the abovementioned shortcomings of the objective control of the asserted claims and the decision on planned measures of the debtor company are especially mentioned here. Majority decisions should also be made by a real majority of the creditors and not only by the affected groups.

Within the framework of the reform to further facilitate the restructuring of companies (ESUG) in 2012, whose concrete effects have been evaluated in 2017, the introduction of pre-insolvency proceedings were already discussed and a decision to reject this was taken because of the misuse potential of a preventive restructuring procedure. Instead the regulations on self-administration and protective shield proceedings were agreed under the attendant control of custodians and insolvency court.

Experiences with the ESUG show that this decision was correct. Therefore Germany would be well advised, to take the evaluation findings from the assessment of the ESUG into account and try to make sure that the Member States´ legislation remains in power when it comes to define rules on the mandatory appointment of an insolvency practitioner to ensure that the interest of all parties are taken into account.