As the first EU text regulating substantive insolvency law, the European Directive on Preventive Restructuring and Insolvency is a remarkable achievement towards the modernization of insolvency and restructuring regimes in the EU. However, its harmonization effect is likely to be limited, given the many options for implementation: 143 different options, in fact.
These many options reflect friction points between member states and different policy approaches to the regulation of restructuring and insolvency. A recent IMF Working Paper analyses the breadth of these choices, their trade-offs and consequences, and the likely result of divergent restructuring models in Europe.
Implementation of the Directive can bring about much-needed improvements to national systems, especially in the current crisis, which may require wide-scale restructuring of enterprises. The Directive aims to address issues in insolvency systems revealed by the European Financial Crisis, where overwhelmed courts in many countries struggled to process the increased case load. It does so by introducing ‘preventive restructuring procedures’ or ‘pre-insolvency procedures’ (ie, ‘hybrid’ restructuring procedures that combine out-of-court and in-court elements) which aim to facilitate informal negotiations between the debtor and its creditors and minimize the role of the court and insolvency administrators.
Some features of the Directive are particularly crucial: The debtor-in-possession regime and the stay of creditor actions are strong incentives for entrepreneurs to commence restructuring before their financial situation is beyond repair; cross-class cram-down introduces flexibility and improves the possibilities for approval of restructuring plans.
Beyond these key features, the Directive offers a wide range of options, some of which are as fundamental as the modality of implementation. For example, some countries may choose to implement the Directive in a single stand-alone restructuring procedure or in two or more restructuring procedures, eg, one procedure only for financial claims, based on confidentiality and assisted by a limited stay, and another more general and public restructuring mechanism. Some may decide to sprinkle individual rules throughout several already existing procedures. Alternatively, since the hybrid restructuring procedure contemplated in the Directive incorporates many elements of a formal reorganization procedure, some countries may be tempted to replace reorganization with the new restructuring procedure, thereby eliminating reorganization entirely.
Apart from the design of a single or multiple restructuring procedures, implementation presents member states with a multiplicity of other decisions to make, which may be looked at through the lens of two fundamental trade-offs: (i) creditor versus debtor protection; and (ii) flexibility and cost savings versus increased legal safeguards. Policy makers will need to weigh these trade-offs when deciding on specific options and in considering the cumulative effect of their choices, which may result in an unbalanced system.
Some options could have particularly negative consequences: a long stay of creditor actions, combined with easy access to the procedure, could result in debtor abuse and in the frustration of creditor rights. Avoiding the splitting of claims in secured and unsecured portions, dispensing with the requirement of creating creditor classes and, especially, using “relative priority” as a safeguard for the approval of restructuring plans, could create distributional tensions and damage some categories of claimants (such as unsecured creditors) at the expense of secured creditors and shareholders. Introducing a regime for new finance that does not provide any priority will not contribute to the success of enterprise restructurings.
Given the complexity and scope of the Directive—which also includes other important areas, such as early warning systems, insolvency institutions, a second chance for entrepreneurs, and data collection—most European countries are still in the process of implementation.
In conclusion, harmonization of insolvency laws is a complex challenge, only achievable in the long term. In the short term, differences in European restructuring and insolvency regimes will likely persist, but the implications of this are unclear. Diverging implementation of the Directive can result in competition among member states, but it remains to be seen whether such competition will be positive (a ‘race to the top’) or negative (a ‘race to the bottom’). In any event, member states should take this opportunity to strengthen their restructuring regimes to prepare for the impact of the Covid-19 crisis.
The views expressed in this blogpost are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Jose Garrido is Senior Counsel in the International Monetary Fund’s Legal Department.
Chanda DeLong is a Senior Counsel at the International Monetary Fund.
Amira Rasekh is a Senior Counsel at the International Monetary Fund.
Anjum Rosha is a Senior Counsel at the International Monetary Fund.