The last week of March 2019 will be of unparalleled suspense for the European (cross-border) insolvency community. Only one day before the originally planned Brexit date, the European Parliament will vote on the proposed directive on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures (Restructuring Directive). This directive will reshape the European restructuring landscape.
In 2011, the European Parliament adopted a resolution requesting that the European Commission submit proposals for the harmonisation of certain areas of insolvency law. This resolution was driven by the finding that the disparities between national insolvency laws create competitive advantages or disadvantages which promote forum shopping. The European Parliament thought it necessary to undertake steps to prevent this phenomenon spreading. The first proposal for the harmonisation of substantive insolvency law has become part of the European Capital Markets Union plan. The Restructuring Directive aims to reduce the most significant barriers to the free flow of capital stemming from differences in the member states’ restructuring and insolvency frameworks. According to the European legislator, a higher degree of harmonisation in insolvency law is essential for a well-functioning internal market and a true Capital Markets Union. Increased convergence of insolvency and restructuring proceedings is thought to facilitate legal certainty for cross-border investors and make it easier for investors to assess credit risks.
Amongst other things, the Restructuring Directive seeks to introduce into the laws of the member states—to the extent not yet present—preventive restructuring frameworks that should enable debtors to restructure at an early stage, thereby avoiding insolvency. The proposal follows the European Commission’s 2014 Recommendation ‘on a new approach to business failure and insolvency’. The European Commission published its proposal for a Directive in November 2016 after concluding that the Recommendation did not have the desired impact. This proposal was discussed by Horst Eidenmüller here and described extensively by Michael Veder and me in chapter 25 of Capital Markets for Europe.
In essence, the procedure as envisaged in the Restructuring Directive is a mixture of the UK Scheme of Arrangement and the American Chapter 11 plan procedure. Where there is a ‘likelihood of insolvency’, the debtor may offer a plan to (some of) its creditors and/or shareholders. During the negotiations, the debtor stays in control of the company’s business. The negotiations may be supported by a stay of individual enforcement actions. After the affected parties have voted on the plan in classes, the court will scrutinize the plan process and the fairness of the plan proposal before confirming it. As a minimum safeguard, creditors should be no worse off under the restructuring plan than in liquidation or any other ‘next best alternative’ scenario if the restructuring plan were not to be confirmed. The Restructuring Directive obliges member states to introduce a US-style cross-class cram down mechanism, allowing the court to bind a dissenting class to the plan. Such a far-reaching element is not yet present in most existing European pre-insolvency plan procedures. Although the proposed procedure may be used to ‘prevent insolvency’, taking into account the availability of a stay and a cross-class cram down, it is in essence an insolvency procedure safeguarding the maximisation of value.
The final text of the Directive is in many ways a compromise, leaving member states ample room for implementation. Member states may, for example, choose to include a viability-test; decide to allow extensions of the stay of individual enforcement actions; or add a headcount-test in their national voting thresholds in addition to the majority in value-test that is prescribed by EU law. Furthermore, member states are free to define ‘likelihood of insolvency’ and the criteria for class composition.
Member states will not only have considerable freedom in shaping the procedure. The same is true for the substantive safeguards against unfair plans. The Restructuring Directive provides national legislators with a questionable choice between two standards when drafting the most fundamental safeguard to protect affected creditors and shareholders, namely, the standard that determines under which circumstances a plan may be forced upon a dissenting class of creditors or shareholders. The 2016 proposal contained an ‘absolute priority rule’ (APR), which is similar to its US counterpart. This rule essentially requires that a dissenting class of creditors is paid in full before any value can be distributed to a lower ranking class. The APR ensures that priority is respected. The European legislator seems to have taken into account the criticism voiced against the American APR, being that this standard is too rigid. The final text of the Restructuring Directive contains an APR with somewhat softer edges, allowing for derogations from the priority rules when (i) necessary to achieve the aims of the restructuring plan and (ii) such derogations do not unfairly prejudice the rights or interests of any affected parties. The UK Government plans to introduce an APR along the same lines in the ‘restructuring plan procedure’, which Jennifer Payne discusses here.
However, in a fairly late stage of the legislative process, in addition to the APR a ‘relative priority rule’ (RPR) was introduced. This standard was advocated by the Codire research group in their final report dated July 2018, which is criticised by Rolef de Weijs, Aart Jonkers and Maryam Malakotipour in a recently published paper. The final text of the Restructuring Directive includes a RPR as an alternative standard for a cross-class cram down. As a result of this addition, member states are free to opt for the APR or the RPR. The RPR, as formulated in the Directive, entails that a dissenting class can be bound to a plan, as long as this class is treated ‘more favourably’ than any lower ranking class. Such a rule does not respect priority but compromises it. The standard allows plans that distribute value to shareholders without paying trade creditors in full, or plans that contain pay-outs for unsecured creditors at the expense of preferential creditors. The RPR enables the redistribution of value, allowing for the reshuffling and curtailing of pre-existing rights in a manner that is unpredictable. This is incompatible with the desire to create legal certainty for investors. This uncertainty will hamper the free flow of capital, thereby undermining the Commission’s pursuit of a true capital markets union.
After member states have implemented the Restructuring Directive, considerable differences between preventive restructuring frameworks will continue to exist. It is expected that these disparities will continue to incentivise forum shopping. The availability of foreign restructuring schemes obviously depends on the applicable private international law framework. Assuming that many of the 27 frameworks resulting from implementing legislation will be added to Annex A of the European Insolvency Regulation (recast), the debtor’s Centre of Main Interests (COMI) will determine jurisdiction. In particular, the applicable cornerstone safeguard in case of a cross-class cram down, the APR or the RPR, will be a crucial factor to take into account when preparing a restructuring process. Senior creditors will push for a jurisdiction in which their absolute priority rights will be respected, whereas shareholders of financially distressed companies will press for a jurisdiction in which the chances of keeping their interests in the company are higher: jurisdictions that opt for the RPR. This is contrary to the policy of the European Parliament to avoid incentives for parties to move their COMI from one member state to another, seeking a more favourable legal position.
By giving member states the latitude to choose between a rule that respects priority and one that modifies it, the Restructuring Directive is, unfortunately, at serious risk of failing in its original ambitions of creating legal certainty for investors and reducing incentives for forum shopping. Upon adoption, this risk should be minimised by persuading national legislators to implement the APR.
Anne Mennens is a PhD candidate and lecturer at the Business & Law Research Centre at Radboud University, Nijmegen, the Netherlands. In Hilary 2018, she was a Junior Academic Visitor at the Commercial Law Centre at Harris Manchester College, Oxford.