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Pre-insolvency restructuring proceedings: The implementation of the EU Restructuring Directive into national law
Against the background of the still subdued economic development in a large number of member states, the European Commission presented a proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on preventive restructuring frameworks, second chances and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU on 22 November 2016. After a lengthy discussion on the subject and a compromise reached between the Council, Commission, and Parliament in December 2018, the Directive entered into force in July 2019.
The primary aim of the initiative is to enable structural adjustments to be made at an early stage and thus avoid insolvencies and the associated redundancies. In addition, the Directive is intended to help to rehabilitate failed entrepreneurs more quickly and to preserve for the national economy the entrepreneurial experience they have gained. In concrete terms, this is to be achieved, for example, through the discharge of residual debt within a maximum of three years. At the same time, this is also intended to provide an incentive at the level of management to react to crises at an early stage and to disclose and address them through restructuring efforts. This intended incentive is also clearly expressed in the fact that control of the company is to remain entirely or at least partially with the debtor willing to restructure. Finally, the Directive also contains provisions designed to adapt the procedures in insolvency proceedings to the requirements of the present day, such as the introduction of digital communication between the parties involved, which has still not been realized in many Member States – including Germany.
A second chance for ailing companies
According to the initiators of the Directive, too many viable companies in financial difficulties are still being wound up. According to the Commission, too few have so far been given a second chance through early restructuring.
Large part of the European framework conditions for pre-insolvency restructuring are reminiscent of the German model for an insolvency plan. For example, the formation of creditor groups (class formation) when voting on a restructuring plan. Furthermore, the creditors’ contributions to the reorganisation primarily take the form of waiving (partial) claims against the company in crisis.
However, a more detailed analysis also reveals significant differences. For example, the Directive stipulates that appeals against the plan and its confirmation do not have a suspensive effect and thus do not influence the effectiveness of the arrangements made in the plan. In contrast to the insolvency plan within insolvency proceedings however, the out-of-court reorganisation plan is only intended to have a binding effect on creditors who participated in the specific voting procedure on the reorganisation plan.
In order to provide the ailing company with the necessary time in which to investigate the planned restructuring options, the restructuring proceedings grant protection against enforcement measures being taken by creditors, which in special cases can also be ordered only in respect of individual creditors. The moratorium normally extends for 4 to a maximum of 12 months.
Mandatory certificate of continued viability should be introduced by national legislators
However, such a breather for the debtor significantly increases the default risk of its suppliers and bears the risk that an already tight liquidity situation will deteriorate further anyway. For this reason alone, national legislators must be required to introduce a mandatory viability check, using the power granted to it for this purpose under Article 4 (3) of the Directive, in order to prevent abuse of the procedure by companies for which there is, in any case, no serious prospect of successful restructuring. The procedure for this could be modeled on the procedure for obtaining a certificate under section 270b of the German Insolvency Act (InsO) in the previous protective shielding procedure. The procedure should also include a statement that the company to be reorganised is not already insolvent according to the standards of the InsO. Furthermore, it would be appropriate to require the representatives of the company to be restructured to notify any subsequent occurrence of insolvency immediately to the creditors.
Moratorium entails considerable disadvantages for creditors
It is also particularly problematic for affected creditors that, according to Article 7 (4) of the Directive, during the moratorium, the terms of delivery previously agreed by the parties can also be frozen in the case of essential contracts. From the beginning of the “suspension phase”, it is then no longer possible to: suspend an “essential” delivery already contractually agreed upon regarding previously missed payments, to make delivery dependent on advance payment in deviation from a previously agreed payment term, to unilaterally terminate current contracts that have not yet been fully executed or to deviate in any other way from conditions of contracts already concluded to the detriment of the debtor. Circumvention of these regulations by contractual clauses and reservations is expressly forbidden. In addition, national legislators are authorised to extend the application of these provisions to “non-essential” contracts.
Due to this content of the Directive, it will be essential to ensure that the interests of suppliers are not completely undermined when the Directive is being implemented by national legislators. National legislators should, therefore, work towards a clear definition of the concept of “essential” contracts, without making use of the power to extend the scope to include non-essential contracts. It should also be urged that legislators make use of the right to create safeguards to avoid undue hardship on those affected. Particularly with regard to the interests involved in continuing obligations, it must be clarified that affected creditors retain the rights arising from the plea of uncertainty under § 321 of the German civil code (BGB). Creditors who lose their rights to the retention of title to sold goods or other security interests as a result of the moratorium should be granted substitute rights of separation and segregation in accordance with section 21 (2) no. 5 InsO in the event of subsequent insolvency of the company to be restructured.
Increased risks of facing an “avoidance of transactions” for creditors supporting the restructuring efforts
In this context, it is of enormous importance to ensure that payments to suppliers who have made the restructuring procedure possible by continuing to supply the struggling company are not contested in the event of subsequent insolvency. Although the Directive contains corresponding provisions in Articles 17 and 18, it makes them subject to “additional grounds laid down in national law”. This passage in the text takes on particular significance against the background of the German Federal Courts’ (BGH) case law on the avoidance of “fraudulent transactions” that creates significant risks for creditors.
Not only against the background of the limitation of the risk of rescission but also to prevent creditors who support the restructuring plan from being subjected to further undue hardship in the event of the failure of the restructuring attempt, liabilities based on services rendered after the announcement of the intended implementation of restructuring proceedings should, in the event of subsequent insolvency proceedings, be regarded as debt of the insolvency assets in the meaning of section 55 (2) InsO.
Restructuring administrator as an objective third party
Unfortunately, the demand of some member states for a restructuring administrator to be appointed to accompany the restructuring efforts did not make it into the Directive. However, the compromise reached with the Directive at least provides for the appointment of a “restructuring officer” to be mandatory when creditors’ interests are being affected, for example, when ordering the suspension of enforcement measures or voting by creditors on the restructuring plan, where individual groups of creditors can be outvoted (cross-class-cram-down).
Article 5 (2) of the Directive allows member states a certain degree of freedom to provide for the mandatory appointment of an administrator in further cases. Here, too, German legislators should be called upon to make use of this leeway in the interest of safeguarding creditors’ interests. It should also not be forgotten here to expressly regulate the liability of the administrator/agent as well as that of the organs of the company to be restructured. In this context, a reference to the tried and tested regulations in §§ 60 and 61 InsO could be made.
In principle, it is also in the interest of the creditors of economically ailing companies if they are provided with a real chance of restructuring. In addition to relieving them of the “stigma” of insolvency, the new pre-insolvency reorganisation procedure to be created under the Directive offers the debtor company the advantage of retaining almost complete control of the reins during the restructuring proceedings.
Even now, however, cases of abuse of enforcement protection to the detriment of creditors are accumulating in insolvency plan proceedings conducted under the company’s management. When transposing the Directive into national law, it is, therefore, essential to ensure that creditors’ rights are not overly neglected. This is already required under Article 14 of Germany’s Constitution.
In addition to the introduction of a viability review, clear rules must be created during implementation to avoid undue hardship for creditors affected by the moratorium and the obligation to continue deliveries, and their protection against the further risk of avoidance of transaction must be ensured. When creating national regulations for the mandatory appointment of a restructuring administrator (representative), experience with the recent German insolvency reform “ESUG” should be taken into account.
To avoid duplication and abuse through a series of “restructuring attempts”, the introduction of pre-insolvency restructuring proceedings should ultimately be accompanied by the simultaneous abolition of insolvency plan proceedings under the German Insolvency Act.
Current status – outlook
The Directive entered into force on 16 July 2019. A tight timetable has been set for its implementation; the majority of the regulations are to be implemented within two years, which is why the responsible Federal Ministry of Justice and Consumer Protection (BMJV) is currently working on drafting the national regulations. Current developments concerning the Coronavirus are likely to make the issue even more urgent.
PASCHEN had represented the interests of the Federal Credit Management Association (BvCM) at the first hearing of the associations in this context, whose demands were subsequently set out in a first position paper. In order to provide the Ministry with more concrete suggestions as to how the procedure should be structured to meet legitimate creditor interests, PASCHEN had also initiated a joint statement by BGA, DIHK, BDI, BDEW, and ZDH. This contains – irrespective of industry-specific peculiarities – joint proposals and demands, which all companies represented by the author’s support.
In the meantime, the department responsible at the BMJV had made it known that there were plans to implement the directive in three phases. As the Minister of Justice then announced in a press release issued by the BMJV on 7 November 2019, the initial plan was to initiate the shortening of the residual debt discharge in the first stage at the turn of the year 2019/2020.
With a slight delay, the Ministry then presented a corresponding draft bill in February 2020. This is based on the construction of a “phasing in”, already presented in the press release from November, to gradually shorten the current deadline by one month per month, starting from the date of entry into force of the Directive on 16 July 2019. This is intended to prevent debtors from postponing an application that was already due in anticipation of a more favourable legal situation in the future.
The draft envisages that both entrepreneurs and consumers should benefit from the shortening, but points out in its explanation that the Directive would also allow a restriction to persons previously engaged in business activities. We do not, however, assume that this restriction will occur in the law.
Activities regarding the implementation of the regulations on pre-insolvency restructuring proceedings have also already accelerated. A further round of hearings for those affected by the changes in the BMJV was planned for 19 March 2020 but had to be cancelled due to the crisis. We assume that a catch-up will take place soon, as the pre-insolvency restructuring process will most likely become even more important against the background of the economic effects of the Corona crisis.
In any case, the implementation of the other regulations on the modernisation of insolvency proceedings, such as their complete digitalisation, is not expected until later.
We will keep you informed about any further developments.