The Italian Government, similarly to others, has enacted several measures aimed at curbing the potentially devastating economic effects of the COVID19 pandemic. The lockdown designed to limit contagion has paralyzed entire industries, abruptly caused losses and liquidity shortages of an unprecedented magnitude, and is threatening millions of jobs. Insolvencies loom and a chain-reaction might overhaul the very fabric of the economy.
In order to tackle these issues, a decree of April 8 (Decree-Law No. 23 of April 8, 2020; hereinafter the ‘Decree’) puts forward a panoply of tools, from measures to support the liquidity of companies (by granting a State guarantee in relation to new finance) to stronger golden powers of the State to control acquisitions in strategic sectors; from tax relief to a suspension of litigation (including debt enforcement actions); from a simplification of shareholders’ meetings to emergency provisions in support of employment. We want to focus here on some important new rules concerning insolvency law.
The idea behind these measures is to 'sterilise', at least temporarily, the economic effects of the pandemic. We posit, however, that these measures create a kind of legal limbo that might generate dangerous uncertainties, especially if these measures were interpreted and applied as special rules that may derogate from the general criteria of correct business management.
A first measure, the more general one, concerns the postponement of the entry into force of the new Code of Crisis and Insolvency (CCI), initially scheduled for 15 August 2020 and now postponed to 1 September 2021. One of the alleged goals of this piece of legislation is to facilitate the turnaround of companies through alert procedures designed to intercept at an early stage the symptoms of a crisis. It might therefore seem contradictory to delay the entry into force of a statute pursuing these goals. Obviously enough, however, the new rules were not envisioned to operate in a massive depression due to exogenous causes. In the current scenario, its application would result in countless procedures to avoid insolvency, or in significant risks for entrepreneurs or directors that do not activate them. In addition, there is a serious question concerning the adequacy of the judicial and extra-judicial resources that would be required to face a massive number of procedures, further complicated by the very novelty of the law. It is therefore preferable to remain with our feet on the ground and continue to use the current regulatory framework, imperfect as it might be, but with the potential advantage of not triggering forays in a new and uncharted territory.
Other, more specific, measures amending Italian insolvency law are set forth under Articles 9 and 10 of the Decree.
Article 9 concern proceedings based on agreements with creditors. The amendments operate differently depending on the stage that proceedings were at on 23 February 2020. The measures may consist of a moratorium on the fulfilment of the reorganisation plan; or they may take the form of the granting of a time limit to amend the plan.
The second provision (Article 10) freezes applications for the declaration of bankruptcy filed between 9 March to 30 June 2020 , declaring them inadmissible.
There are also two provisions of company law that indirectly concern insolvency law.
Article 6 of the Decree concerns the legal treatment of balance-sheet losses. The ‘recapitalize or liquidate’ rule, which required to either recapitalize a corporation or to liquidate it in case of substantial losses that reduce the capital, is suspended for losses incurred until 31 December 2020.
Article 8 governs shareholders’ and intra-group loans that may be disbursed in the period following the entry into force of the decree and on 31 December 2020, sterilising the rule of subordination of shareholders’ claims and the obligation on the lender to repay the loan reimbursed in the year before the opening of insolvency proceedings.
The Government's choice was therefore to intervene in support of enterprises in crisis, either current or prospective, from two different angles. On the one hand, extending their credit capacity through the issuance of State guarantees, thus allowing them access to financing channels that would certainly have been impracticable without public intervention. On the other hand, it creates a time buffer to be used to overcome the distress situation through the recovery of the normal economic cycle, or through reorganization proceedings.
Expanding the credit capacity of a company in crisis does not mean, obviously, taking on the losses suffered by it; just as moving forward the deadline for the fulfilment of tax and social security obligations, does not mean to forgive them. In other words, the measures contained in Decree No. 23 of 2020 do not allow companies to ‘write off’ liabilities; on the contrary, these measures, especially if misinterpreted and applied, risk amplifying (or even determining) the crisis in the medium term. There has not been any collectivization (id est, suffered by taxpayers) of the economic effects of the healthcare pandemic.
Similarly, making a bankruptcy petition unforeseeable does not mean that the state of insolvency will no longer exist; just as granting a moratorium to finalize an agreement with creditors (or enforce it) in the context of a pre-insolvency procedure does not mean removing the state of distress.
The consequence of this is that companies, even if allowed to do so by virtue of the guarantee given by the State, should only have recourse to the new financing channels if they reasonably consider, on the basis of a careful examination of possible future scenarios, that they can repay the borrowed capital. In other words, there is no derogation from the criteria of correct business administration, and, above all, there are no exceptions to the duty of protection towards creditors imposed on the debtor. The deterioration of the economic condition of the company, as a result of conduct not inspired by the criteria of correct business administration, inevitably exposes the director to liability.
The ability to benefit from the public guarantee could trigger a phenomenon of moral hazard that pushes directors to gamble ‘all or nothing’, even when it would be reasonable not to increase the leverage ratio, thus making concrete the risk of asset depletion to the detriment of (a) taxpayers, within the limits of the losses associated with the enforcement of the guarantee against the State; (b) previous creditors, because of the potentially diluting effect of fresh money; and (c) subsequent creditors, who could be induced to extend credit to the distressed company, by virtue of the appearance of solvency generated by the guaranteed financing.
The domino effect is just around the corner.
Rationality, prudence, expertise, diligence, good faith and fairness: today more than ever it is necessary to refer to ‘general principles’ to conform the behaviour of economic agents. Otherwise, markets already weakened might implode, crushed by the economic pandemic.
Daniele Vattermoli is Full Professor of Commercial and Insolvency Law at La Sapienza, University of Rome.