The outbreak of COVID-19 and the subsequent drastic governmental measures to curb the contagion have affected many businesses, small and large. It may be too early to fully grasp its consequences and determine the long-term effects (if any) on the foundations of insolvency law. What is clear, however, is that the pandemic has severely affected international trade, bringing the world economy to a standstill and intensifying ‘territorialist’ sentiments. This particularly hits multinational enterprise groups, dependent on global supply chains and uninterrupted liquidity flows (eg airlines). As a result, we may expect an increase in the number of group insolvencies, spanning across various jurisdictions and affecting networks of many small businesses. Does insolvency law offer a solution?
Group insolvency and coordinated responses
Until recently the problem of insolvency of corporate groups has not been widely recognized or addressed. However, modern insolvency law acknowledges the specificity of enterprise group insolvencies, premised on the existence of close operational and financial links and interdependencies between group members. It is accepted that maximisation of insolvency estate value and procedural efficiency depend on the coordination of insolvency proceedings opened with respect to group entities. Such group coordination is prescribed in the European Insolvency Regulation (EIR 2015), the UNCITRAL Model Law on Enterprise Group Insolvency 2019 and, at a national level, the recently reformed German insolvency law.
These instruments promote the adoption of a ‘group solution’ to preserve group synergies and maintain the enterprise going concern value. The key tools to facilitate cooperation and coordination of insolvency proceedings include: (i) communication and cooperation between courts and insolvency practitioners (IPs), inter alia, by way of cross‐border insolvency protocols; (ii) coordination of parallel insolvency/restructuring proceedings through the opening of special proceedings (ie group coordination and planning proceedings); and (iii) appointment of the same IP in separate insolvency proceedings of group members.
Conflicts of interest in group insolvencies
Despite the growing body of mechanisms and channels to exchange information and coordinate parallel insolvency proceedings, important limitations remain. One of the major limitations relates to the avoidance of conflicts of interest. The EIR 2015, the draft Guide to Enactment of the Model Law 2019, many national laws and soft law instruments mention this limitation.
Conflicts may arise in a situation of a dispute between group members concerning enforcement of intra-group claims, transaction avoidance actions and the allocation or transfer of assets within a group. The main idea behind restricting communication and cooperation in a situation of a conflict of interest is to dodge or minimize the potential harm that can be caused by such communication to the interests of individual group members (and their creditors), which preserve their separate legal identity. In other words, cross-border communication and cooperation are constrained in situations where one or more entities have competing interests and serving one’s interest may be to the detriment of the others.
In a recent article ‘Conflicts of interest, intra‐group financing and procedural coordination of group insolvencies’, I explore how the risks arising from conflicts of interest in group insolvencies can be controlled and mitigated, while ensuring efficient cross‐border cooperation and communication. I conclude that the likelihood and gravity of conflicts of interest depend on the coordination tool utilized (ie conclusion of insolvency protocols, opening of special proceedings, appointment of a single IP). In general, the risk of conflicts of interest correlates with the degree of procedural coordination.
When resorting to procedural coordination and consolidation strategies or applying conflict mitigation tools (eg additional IPs, court/creditor approvals, appointment of an independent coordinator or a group representative), it is important to keep in mind that communication and cooperation to the maximum extent possible is the rule, while restrictions based on the risk of conflicts of interest is an exception. This is why conflict‐of‐interest limitations should be strictly and narrowly interpreted, well justified and rarely and cautiously used.
Coordination in cross-border bank resolution
The global financial crisis has shown that cooperation and procedural coordination are key to effective and efficient resolution of cross-border banking groups. In 2011, the Financial Stability Board (FSB) issued the Key Attributes of Effective Resolution Regimes, which recognize that an effective resolution regime should include rules on (and encourage) close cooperation, information exchange and coordination between resolution authorities before and during the resolution process. At the EU level such rules have now been implemented in the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR), which, among other things, prescribe adoption of group recovery and resolution plans, cooperation within resolution colleges and crisis management groups and centralized bank resolution decision-making by the Single Resolution Board (SRB).
Nevertheless, the separateness of entities in the banking group is preserved. For example, resolution powers and resolution tools, as well as the ‘no-creditor-worse-off’ principle, only apply on an entity level. Somewhat surprisingly, unlike the instruments of general corporate insolvency law mentioned above, neither the BRRD nor the SRMR contain the explicit language restricting cross-border bank cooperation because of a potential or an actual conflict of interest. In the article titled ‘Co-ordination in bank resolution and the issue of conflicts of interest’ (J.I.B.L.R. 2020, 35(3), 107-115), I conclude that this outcome can be explained by two main reasons. The first reason rests on the specific order of values embraced in bank resolution, particularly evident in the prevalence of public interest considerations (ie protection of financial stability and critical functions) and the administrative nature of resolution process. The second reason highlights the special regulatory framework that includes ex ante mechanisms, such as group recovery and resolution plans and group financial support agreements, which may reduce the risks of conflicting or damaging behaviour in times of crisis, making conflicts of interests more manageable.
We have not yet seen a widespread application of group coordination tools in practice (maybe with the exception of cross-border insolvency protocols, but even then, primarily in common law jurisdictions). The pandemic therefore will test to what extent modern insolvency law is fit to deal with insolvencies of complex multinational enterprise groups.
Ilya Kokorin is a Meijers PhD candidate at the Department of Financial Law, Leiden University.