Viability Assessment in Corporate Debt Restructuring: Optimizing the Filtration Effect of the European Directive on Restructuring and Insolvency
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, International and Comparative | 0

By Lydia Tsioli (King’s College London)

Lydia Tsioli

Despite being pivotal in corporate debt restructuring, viability, an intricate notion with double meaning and double role, has not been systematically examined in Europe. Against this background, and especially given that the new European directive on restructuring and insolvency (the “Directive”) is currently under transposition and restructuring law is making its first steps as a harmonized field across Europe, my recent paper, published in Norton Journal of Bankruptcy Law and Practice, undertakes a doctrinal, comparative [USA, UK] and economic analysis of law examination of viability with the aim of putting forward suggestions that will make viability the linchpin of the Directive, thus optimizing its filtration effect as defined below. 

In doing so, the paper first analyses and distinguishes the two different meanings of viability, namely financial viability and economic viability, and clarifies what the precise role of law is within the viability-related discourse. Such role consists in providing indicators of viability and incorporating appropriate “filtering mechanisms”, a term of art introduced by the paper, which refers to mechanisms filtering non-viable debtors out of the restructuring procedure, hence contributing towards satisfaction of restructuring’s overall goal of saving viable debtors only. 

The way in which such filtering mechanisms are triggered depends on who plays the role of the “ultimate viability assessor” within a restructuring framework, for example an Insolvency Practitioner (“IP”) or a court. Depending on this, the paper distinguishes between IP-centered and Non-IP – centered models of viability assessment and identifies the Directive as standing closer to the Non-IP – centered one. 

What the paper suggests though, is that, what ultimately matters is the appropriateness of filtering mechanisms in any chosen model of viability assessment. Such mechanisms can be most characteristically found under Chapter 11, Title 11 of US Bankruptcy Code and are the conversion/dismissal of a Chapter 11 case and stay relief under section 362. The paper examines them extensively and demonstrates how the existence or inexistence of viability in its double meaning, constitutes the “litmus test” for the triggering of Chapter 11’s filtering mechanisms. 

In light of these comparative findings, the paper finally turns to the European directive and identifies its filtering mechanisms. The paper subsequently, and most importantly, makes suggestions on how the filtration effect of the Directive’s existing mechanisms can be optimized through appropriate interpretation, transposition, judicial practice or future reform. Through these suggestions, it is aspired that first, the Directive will properly reflect the notion of viability and consequently achieve an effective filtering of viable debtors from non-viable ones, and second, viability will ultimately become the primary point of focus and linchpin of European corporate debt restructuring overall.

The paper, entitled “Viability Assessment in Corporate Debt Restructuring: Optimizing the Filtration Effect of the European Directive on Restructuring and Insolvency” is available here.

Reprinted from Norton Journal of Bankruptcy Law and Practice, Vol. 30 No. 5 (October 2021), with permission of Thomson Reuters. Copyright © 2021. Further use without the permission of Thomson Reuters is prohibited. For further information about this publication, please visit https://legal.thomsonreuters.com/en/products/law-books or call 800.328.9352.

The paper has been awarded the 2021 Silver Medal in the International Insolvency Institute’s “Prize in International Insolvency Studies”.

Rethinking Priority: The Dawn of the Relative Priority Rule and a New ‘Best Interest of Creditors’ Test in the European Union
by | posted in: Bankruptcy Roundtable Updates, Cramdown and Priority, International and Comparative, Priority | 0

By Axel Krohn (Martin-Luther-University Halle-Wittenberg, Germany)

Axel Krohn

The European Directive on restructuring and insolvency (“Directive”), which came into force in July 2019, has triggered a series of interesting debates. The possibility for EU Member States to subject the cram-down from Article 11 to a “relative priority rule” (“EU RPR”) when implementing the Directive into national law has proven to be particularly controversial.

Despite a confusing conceptual overlap with approaches presented in the U.S., the European interpretation of “relative priority” breaks new ground. The rule stipulates that, under a restructuring plan, dissenting voting classes have to be treated merely more favorably than any junior class. Although the Directive allows national lawmakers to refrain from the EU RPR and introduce a familiar “absolute priority rule” (“APR”)—that is, that a dissenting class of creditors must be paid in full before junior parties may receive any distributions—the EU RPR has already found supporters in various jurisdictions and should therefore be thoroughly examined.

This article identifies one aspect of the cram-down that has received little attention to date. In addition to the EU RPR, the European legislature has introduced a new “best interest of creditors” test (“EU BIT”), which does not—as in 11 U.S.C. § 1129(a)(7)(ii)—use the value that a party could expect in a hypothetical liquidation as a comparator, but refers to the “next-best-alternative scenario.” Although the concept of combining the EU RPR and the EU BIT is coherent in theory and may even eliminate some misconceptions about the EU RPR, the interaction of the two cram-down elements is likely to raise problems in practice.

First, this article discusses the concepts of the two priority rules and traces the motives of the European legislature for introducing the EU RPR.

Three aspects in particular appear to have motivated the legislature in drawing up the rule. For one, the legislature wished to create more flexibility in plan negotiations and thus respond in particular to special needs in the restructuring of smaller businesses. The rule may bring advantages, especially when it is reasonable to enable existing shareholders to participate in the continued business by means of an equity interest. Second, with regard to some Member States, the desire has arisen to create an instrument to overcome structural blocking positions of certain preferential (priority) creditors, in particular tax authorities. Finally, there is a trend in Europe which sees in the Directive a procedure that enables a structured contractual renegotiation of debts and detaches itself from the “traditional laws of insolvency law,” including the APR.

This article then deals with the new EU BIT and examines its interaction with the EU RPR.

It is worth noting that the EU BIT plays a much more important role in an EU RPR cram-down than under an APR. By moving away from the traditional liquidation benchmark and instead linking to the “next-best-alternative scenario,” the test protects precisely the value that can be achieved from the perspective of a creditor outside insolvency without cooperating with other parties. The then remaining reorganization surplus, which is subject to the EU RPR, is that fraction of the going concern surplus which can only be achieved through the combined efforts of all parties involved, but which creditors cannot claim in an individual case of enforcement.

Despite this harmonious interaction in theory, doubts may be expressed as to whether the combination of the EU RPR and the EU BIT would work in practice. The new focus on the hypothetical next-best-alternative scenario value will likely lead to an additional stress point in plan negotiations. The EU RPR, which does not itself contain a clear guideline for the distribution of the remaining surplus, is then to be applied between two unclear values, namely the hypothetical next-best-alternative value and the presumed reorganization value. It is reasonable to assume that the resulting distributional uncertainty will cause new hold-up potential and render it difficult to realize consensual plans, especially in larger restructuring cases. Also, it seems likely that unsophisticated junior creditors will face difficulties in defending their rights adequately in view of the potentially unclear next-best-alternative scenario value, and that others will try to use this to their advantage in complex negotiations.

The full article is available here.

The Rise and Fall of Regulatory Competition in Corporate Insolvency Law in the European Union
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, International and Comparative | 0

By Horst Eidenmüller (University of Oxford; European Corporate Governance Institute – ECGI)

In a recent paper, I discuss the rise and fall of regulatory competition in corporate insolvency law in the European Union. The rise is closely associated with the European Insolvency Regulation (EIR, 2002), and it is well-documented. The United Kingdom (UK) has emerged as the ‘market leader’, especially for corporate restructurings. The fall is about to happen, triggered by a combination of factors: the recasting of the EIR (2017), the European Restructuring Directive (ERD, 2019) and, most importantly, Brexit (2019). The UK will lose its dominant market position. I present evidence to support this hypothesis.

Regulatory competition in European corporate insolvency law happened by accident: it was the unwelcome consequence of the entering into force of the EIR in 2002. The EIR was designed to eliminate forum shopping and to harmonize Member States’ jurisdiction and conflicts rules for international insolvencies. However, in practice, it did not achieve this end. The Regulation’s test for main insolvency proceedings, a company’s ‘Centre of Main Interests’, can be manipulated. Forum shopping became almost a signature feature of the EIR, and the UK emerged as the ‘market leader’ for corporate restructurings in the European Union (EU). The available data clearly confirms this assessment. The popularity of the UK as a restructuring venue also stems from the attractiveness of the Scheme of Arrangement—a procedure that is not within the scope of the EIR. Under the applicable European rules, restructuring decisions taken by courts in one Member State must be automatically recognized in all other Member States.

The regulatory landscape for corporate insolvency law in the EU is changing. The EIR was recast in 2017, the EU passed the ERD in 2019, seeking to harmonize Member States’ pre-insolvency restructuring regimes so that local businesses get local access to restructuring processes, and the UK will probably leave the EU in 2019.

I argue that the recast EIR will not significantly affect forum shopping and regulatory competition in corporate restructurings. However, the ERD will have such an effect, i.e. it will significantly reduce forum shopping and regulatory competition in corporate restructurings. This is because the ERD mandates that Member States implement certain key features of pre-insolvency restructuring regimes by 2021, effectively ruling out radical legal innovations departing from the new European standard. Unfortunately, the ERD is a ‘defective product’: it mandates inefficient procedures and should be repealed.

Most importantly, Brexit will eliminate the dominant competitor in the European restructuring market, i.e. the UK. This is because Member States will no longer be forced to automatically recognize decisions taken in UK restructuring proceedings. It appears that the restructuring market already anticipates this effect: one can observe a decline of the popularity of the Scheme of Arrangement in cross-border cases from 2016 onwards. I present evidence in the form of hand-collected data on cross-border Schemes of Arrangement to support this hypothesis.

The full article is available here.