Viability Assessment in Corporate Debt Restructuring: Optimizing the Filtration Effect of the European Directive on Restructuring and Insolvency

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 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”.

Corporate Restructuring under Relative and Absolute Priority Default Rules: A Comparative Assessment

By Jonathan Seymour, Steven L. Schwarcz (Duke University School of Law)

Jonathan Seymour
Prof. Jonathan Seymour
Steven L. Schwarcz
Prof. Steven L. Schwarcz

The European Union recently adopted a Restructuring Directive intended to facilitate the reorganization of insolvent and other financially troubled firms. Although the central goal of the Directive parallels that of Chapter 11 of U.S. bankruptcy law—to protect and maximize the value of financially distressed but economically viable enterprises by consensually reorganizing their capital structure—the Directive introduces an innovative but controversial option: that EU Member States can decree that reorganization negotiations should be subject to a relative priority default rule, as opposed to the type of absolute priority default rule used by Chapter 11.

The purpose of the default rule—whether relative or absolute priority—is to provide a mechanism whereby a plan of reorganization may be approved notwithstanding failure of the parties to reach a consensus. Such a “cram down” plan reflects that one or more classes of impaired creditors or shareholders dissents. In that case, the EU’s relative priority default rule would allow confirmation of the cram down plan so long as senior classes are treated more favorably than junior classes. In contrast, Chapter 11’s absolute priority default rule would require senior classes to be paid in full before junior classes receive any distribution under the cram down plan.

EU officials argue that relative priority would provide a fairer and more pragmatic default rule than absolute priority. We disagree. As explained below, we believe that a relative priority default rule would, perversely, make consensual reorganization plans less likely. We also illustrate why a relative priority default rule could produce unfair and economically undesirable outcomes.

A relative priority default rule would make consensual reorganization plans less likely because, unlike an absolute priority default rule, it would not function as a penalty default. Absolute priority functions as a penalty default because it would require a costly and contentious going-concern valuation of the debtor, in order to determine what share of the equity in the reorganized debtor is necessary to pay the claims of senior classes in full before any remaining value may be paid to junior classes. To avoid that cost and contention, the parties are motivated to negotiate a consensual plan, even if they would have to give up some value.

Relative priority, in contrast, would not operate effectively as a penalty default rule. A debtor could gain approval of a nonconsensual (i.e., cram down) plan without any valuation of the reorganized business. Even if a valuation is required, a simple and relatively inexpensive floor or ceiling valuation should suffice, rather than the precise valuation required under absolute priority. Parties therefore would have little incentive to compromise.

A relative priority default rule also would permit unfair outcomes. Our article shows how such a default rule would permit shareholders to retain much of the value in a reorganized business, while forcing creditors to accept significantly less than full payment. That could make debt investments less attractive in EU Member States that adopt a relative priority default rule. At the same time, relative priority would create incentives, as was the case in the early years of the U.S. bankruptcy laws, for senior and junior classes to collude to “squeeze” intermediate classes. Additionally, by reducing the risk of insolvency for shareholders and management, relative priority could operate as a subsidy for overleveraged businesses and encourage risky behavior.

For all of these reasons, we believe that EU Members States should avoid adopting a relative priority default rule. Our article also responds to potential defenses of that option. We demonstrate that relative priority is unnecessary to deter holdout creditors from obstructing the plan negotiation process. We additionally explain why relative priority is not needed to promote successful reorganizations of small and medium sized businesses. To the extent that traditional Chapter 11-style reorganization has not worked well for small businesses in the US, we suggest that the recent Small Business Reorganization Act provides a better restructuring model by permitting such businesses to reorganize on a “best efforts” basis.

The full article is available here.