The European Commission published a draft Directive in November 2016, with the aim of ensuring that all Member States have in place an effective mechanism for dealing with viable, but financially distressed, businesses. Articles 16 and 17 of the draft Directive are aimed at encouraging interim financing, designed to ‘keep the lights on’ for a brief period while the debtor negotiates with its creditors for a resolution to its financial distress, and ‘new’ financing, aimed at funding the implementation of a restructuring plan.
Creating such a financing regime is a complex and difficult issue, as the law’s intervention in this area often involves constraints on the rights of existing creditors, requiring a careful balance to be maintained between existing creditors’ rights and the rights of the interim financier. In a recent paper, we examine the underlying policy rationale and benefits of having new and interim financing available to financially distressed debtor companies, discuss the risks involved, and comment on the European Commission’s proposals. We put forward recommendations regarding how these proposals can be improved.
We examine the Commission’s proposals in light of the experience of jurisdictions that have already tackled these issues, notably the US and Canada, or have developed a market-based solution to this problem, such as the UK. As the European Union considers these changes, it needs to ‘trip the light fantastic’, an expression used to signify dancing and moving nimbly around and through a situation. Building consensus around an approach to insolvency financing will not be easy, given different preferences by Member States for more or less rigidity regarding priority of claims. While the Commission’s wish to include such measures in its restructuring proposals is laudable, the measures as drafted raise concerns.
The European Commission proposes, broadly, two measures. First, the provisions aim to protect new and interim financing from being rendered ‘void, voidable or unenforceable’ in the subsequent insolvency of the debtor company (Art 16(1), extended to protection for ‘other restructuring related transactions’ by Art 17), and to protect the grantors of such financing from ‘civil, administrative and criminal liability’ in that subsequent insolvency (Art 16(3)), subject to fraud or bad faith being involved in either case. Whilst it is important to encourage new and interim financing by protecting it from such ex post claims, these measures are unlikely to make much difference in practice. While many Member States seek to invalidate improper transactions on insolvency (eg, where security is provided to a creditor for no new value), Member States tend to have provisions in their insolvency laws that protect new and interim finance where there is a quid pro quo for the benefit that the creditor receives. At best, these provisions are likely to be relevant to only a small minority of Member States.
Second, while Article 16(2) tackles the issue of priority for new and interim finance over the claims of existing lenders, it does not introduce anything akin to the super-priority that is attributed to facilitating corporate rescue in the US and Canada. Article 16(2) merely states that Member States ‘may’ afford priority to the providers of new and interim financing, and that if they do so such financing shall rank ‘at least senior to the claims of ordinary secured creditors’, but is otherwise silent as to how such priority should operate. This cautious approach is understandable; however, by putting this issue on the table, but failing to say more, the Commission raises the possibility that Member States may introduce measures that fail to account of the risks associated with such financing, an issue we examine in our paper. We suggest that there are four fundamental aspects of such financing on which the Directive could give guidance to Member States, all of which are aimed at maintaining the integrity of the insolvency process: (i) effective notice to pre-filing creditors and the ability of those creditors to object; (ii) thresholds for the debtor to qualify for such financing, for example a requirement that the debtor demonstrate that it cannot adequately finance itself without the priority being granted; (iii) a menu of relevant criteria to balance benefit and prejudice, such as considering whether any creditors will be materially prejudiced and whether the financing enhances the prospects of a viable business in the future; and (iv) a role for the court in resolving disputes, ensuring fairness to stakeholders, and serving as an accountability check on interim financing arrangements. While this last point is at odds with the approach of the draft Directive, which seeks to minimise intervention by courts and judicial authorities, experience in the US and Canada suggests that the court is of central importance in balancing the various competing interests.
Janis Sarra is Presidential Distinguished Professor and Professor of Law at the Peter A. Allard School of Law, University of British Columbia, Canada and Jennifer Payne is Professor of Corporate Finance Law at the University of Oxford.