Germany’s insolvency law has only in very few cases – around 1% of filings – been used for a Chapter 11-style going concern restructuring of a debtor company. Initiatives to introduce processes like the scheme of arrangement, an English procedure that was also commonly used to restructure non-English companies and is capable of Chapter 15 recognition in the U.S., were not successful, even though recoveries for unsecured creditors in Germany are remarkably low compared to other jurisdictions.
A paradigm shift occurred when the EU in June 2019 passed its directive 2019/1023 on preventive restructuring frameworks, which requires all EU member states to introduce a restructuring process for companies in financial difficulties, but before an actual insolvency. On September 18, 2020, a draft law was presented to introduce a scheme-like procedure in Germany, which provides for a restructuring of selected liabilities with 75% majority by amount in class, a cross-class cram-down subject to tests similar as in a U.S. Chapter 11 proceeding, a court-approved stay on enforcement and collateral realization, and even a rejection of onerous contracts by the court.
The draft law has been welcomed as a big step towards a restructuring culture in Germany by many advisors and practitioners, and as a potential blueprint for the implementation of the EU directive in other European jurisdictions.
Reprinted with permission from the October 06, 2020 edition of the Law.com International 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or email@example.com.
By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)
Argentina’s new government under President Alberto Fernández recently completed a bond exchange which was approved overwhelmingly by its foreign bondholders. The final restructuring deal that Argentina reached with its foreign bondholders in early August was the product of a fraught and tortuous negotiating process that lasted several months and came after Argentina had defaulted on its sovereign debt in late May for the ninth time in its history.
A recent four-part article published in Global Restructuring Review examines the negotiating dynamics in the restructuring negotiations between Argentina and its foreign bondholders. The article focuses in particular on what I call the “three P’s”—namely, the pandemic, the professoriate, and the Pope—that I argue underpinned Argentina’s strategy in those negotiations.
Argentina sought to use each of the “three P’s” to its advantage. First, the pandemic likely made Argentina’s foreign creditors more accommodating in their stance vis-à-vis Argentina in light of the strains the pandemic placed on Argentina’s sovereign balance sheet. Second, Argentina benefited from the support of prominent professors from around the world who expressed their strong support for Argentina’s negotiating position. The professors weighed in on various matters such as whether Argentina’s debt sustainability would or would not be restored by debt restructuring proposals then under consideration and what type of collective action clauses (CACs) for binding dissenting creditors through a supermajority vote should be used in the new bonds issued pursuant to the restructuring. Third, Argentina sought to benefit from the Pope’s moral authority as reflected in a meeting the Pope held in late January with President Fernández as well as in the Pope’s participation a few days later in a Vatican conference on issues of debt and development.
In its final section, the article discusses the economic prospects for Argentina post-restructuring in view of the major economic challenges that Argentina will continue to face notwithstanding the outcome of the recently concluded sovereign debt restructuring. The article also provides an overview of certain factors that may be relevant to Argentina’s upcoming discussions with the International Monetary Fund (IMF) concerning the IMF’s outstanding loan of $44 billion to Argentina.
The full article can be found here. This four-part article was first published in Global Restructuring Review (GRR) and is reposted with the permission of the GRR.
By Sanjay Kumar Yadav, Syamantak Sen, and Vivek Badkur (National Law Institute University, Bhopal, India)
Under Indian Insolvency Law, any person may be designated as a resolution professional (“RP”), provided he is enrolled with an insolvency professional agency and registered with the Insolvency and Bankruptcy Board of India. The role of an RP, under Indian Insolvency Law, is similar to that of a private trustee under Chapter 11 of the US Bankruptcy Code.
Any person is eligible to be appointed as an RP, provided he is independent of the corporate debtor and no further eligibility criterions have been prescribed, under Indian Insolvency Law. However in a surprising turn of events, the National Company Law Appellate Tribunal in State Bank of India v. Metenere Ltd. (May 22, 2020), directed substitution of an Interim RP, based on him being a former employee of the financial creditor.
This raises concerns as it is prevalent in India for retired bankers to be appointed RPs and may therefore alter such practice, besides potentially disqualifying all former employees from acting as RPs, where the employer is involved. In this article, we discuss whether such substitution is founded in law and its consequent impact on the Indian insolvency jurisprudence, with respect to appointment of RPs.
By Ilya Kokorin, Leiden Law School (The Netherlands)
The current economic downturn triggered by the spread of COVID-19 demonstrates that the role of insolvency law should not be restricted to resolving conflicts between private parties (i.e. creditors and debtors). Nevertheless, the very framework of insolvency law remains primarily: (i) microprudential – single entity focused and designed to protect individual debtors and their creditors, (ii) contractarian – implementing the idea of creditors’ bargain and solving coordination problems between creditors of a single entity, and (iii) reactive – centred around post-crisis liquidation of assets and allocation of proceeds among creditors. It may therefore be ill-fitted to serve the public interest in mitigating the negative externalities of large-scale (systemic) corporate debacles (e.g. Chrysler, GM, British Steel, Carillion) or handling the economy-wide instability experienced nowadays.
In contrast to corporate insolvency, in the aftermath of the global financial crisis of 2008 (GFC), bank resolution in the European Union (EU) and the USA went through fundamental changes that seek to preserve financial stability and ensure continuity of critical functions. Bank resolution has increasingly embraced the macroprudential vision, recognizing the need for an advanced preparation and a speedy intervention to ensure continuity of critical functions, preservation of financial stability and avoidance of bailouts. This vision has resulted in the specific proactive and reactive recovery and resolution strategies. In the recent paper Insolvency of Significant Non-Financial Enterprises: Lessons from Bank Failures and Bank Resolution, I explore whether the modern approaches to bank crises can be extended to non-financial enterprises. I discuss how insolvency law might help minimize social harm stemming from wide-ranging shocks and grand-scale business failures and suggest what we can learn from bank failures and bank resolution.
The failure of Carillion, once the UK’s second-largest construction company, has shown that the reactive approach to crisis resolution, centred around post-crisis intervention, posed significant risks not only for creditors but also for other stakeholders and communities at large. Carillion had around 43,000 workers, of whom 19,000 were based in the UK. It owed around GBP 2 billion to the extensive network of 30,000 suppliers, sub-contractors and other creditors and left the pension liability exceeding GBP 2.5 billion. Even though the signs of financial distress appeared long before Carillion filed for liquidation in January 2018, these warning signals were largely ignored. The failure of Carillion had substantial implications for the provision of public services, raising environmental, health and safety concerns. It ultimately led to a state intervention backed by taxpayers’ money. However, the actual economic and social cost of Carillion’s insolvency are hard to quantify. Financial distress of such a significant enterprise (significant non-financial enterprise or SNFE) required timely state intervention. Nevertheless, its multiple profit warnings came as a surprise to the Cabinet Office.
Insolvency of Carillion was characterized by the absence of timely reaction to prevent crisis escalation, a genuine threat of public disruption and a vast complexity determined by both the debtor’s organizational structure, consisting of more than 320 group members, and the nature of its activities. Many of the same features were observed in the failure of banks and banking groups during the GFC. As a response, both the EU (BRRD) and the USA (Title II of the Dodd-Frank Act) have embraced a proactive and precautionary approach focused on preparation and early response. In my paper, I use the case of Carillion to inquire whether selected bank recovery and resolution tools could have been adopted to prevent the collapse of Carillion, or to mitigate its negative consequences.
In particular, I analyse three such tools, namely: (i) intervention powers granted to state authorities for early (preventive) reaction to the escalation of financial problems before the actual insolvency, (ii) entity and group recovery and resolution planning, and (iii) administrative-led insolvency process. I conclude that while the first two mechanisms may prove beneficial, the last one is rather controversial. While an administrative-led process has certain advantages and prevails in bank resolution, it may be difficult and unnecessary to replicate or transpose to non-financial enterprises. Instead, a transparent court-supervised process with active involvement of creditors and debtors, as well as a limited and targeted engagement of public authorities on matters of public interest should be encouraged.
By Aurelio Gurrea-Martínez (Singapore Management University)
Corporate insolvency law can serve as a powerful mechanism to promote economic growth. Ex ante, a well-functioning insolvency framework can facilitate entrepreneurship, innovation and access to finance. Ex post, corporate insolvency law can perform several functions, including the reorganization of viable companies in financial distress, the liquidation of non-viable businesses in a fair and efficient manner, and the maximization of the returns to creditors. Therefore, if having an efficient corporate insolvency framework is essential for any country, it becomes even more important for emerging economies due to their potential for growth and their greater financial needs.
Unfortunately, the academic literature has generally paid more attention to the regulation of corporate insolvency in developed countries. Thus, it has largely omitted the debate about the optimal design of insolvency law in jurisdictions that, in addition to requiring a more active policy debate, amount to 85% of the world’s population and 59% of the global GDP, since they include some of the world’s largest economies such as China, India, Brazil, Russia and Indonesia.
In my new article, ‘Insolvency Law in Emerging Markets’, I seek to fill this gap in the academic literature by analyzing the problems and features of insolvency law in emerging economies and suggesting a new framework for financially distressed companies in these countries. My paper argues that, even though, in an ideal scenario, any improvement of the insolvency framework in these countries should start by enhancing the judicial system and the sophistication of the insolvency profession, these reforms usually take time, resources and political will. In fact, due to a variety of factors, including corruption, lack of awareness about the importance of the insolvency system for the real economy, or lack of political incentives to engage in such complex reforms whose benefits will only be shown in the long run, they might never occur. For this reason, my paper suggests an insolvency framework for emerging economies taking into account the current market and institutional features of these countries. If these conditions change over time, or they do not exist in some particular emerging economies, my proposal would need to be adjusted accordingly.
My proposed corporate insolvency framework for emerging markets is based on three fundamental pillars. First, pre-insolvency proceedings and out-of-court restructuring should be promoted as a way to avoid an insolvency system that is usually value-destroying for both debtors and creditors. Second, insolvency proceedings should be reformed to respond more effectively to the problems and features existing in emerging markets, which generally include the prevalence of small companies and large controlled firms, as well as the existence of inefficient courts and unsophisticated insolvency practitioners. Finally, emerging economies should adopt a more contractual approach to deal with a situation of cross-border insolvency. Thus, by facilitating the choice of insolvency forum, debtors, creditors and society as a whole will be able to enjoy the benefits associated with having access to more sophisticated insolvency frameworks. Besides, since many debtors and creditors would be using foreign insolvency proceedings, this value-creating forum shopping may incentivize many Governments in emerging economies to invest the resources needed to improve the market and institutional environment existing in these countries, hopefully making the insolvency framework suggested in this article no longer needed.
By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)
As part of the overall global economic slowdown in the wake of the COVID-19 pandemic, many emerging market economies around the globe have suffered sharp economic downturns, particularly in light of the lockdowns of economies that were imposed in many of these countries. With the economic fallout from the COVID-19 pandemic in emerging economies, a number of these economies have been faced with a veritable perfect storm.
Specifically, many of these economies have been adversely affected by, among other things, a sharp drop in prices for commodities such as oil and various metals, the drying up of foreign tourism revenues in view of the disruption of international air travel and the closing of national borders, and the major decrease in remittances due to layoffs of overseas foreign workers. In addition, many major emerging market currencies have experienced significant depreciation vis-à-vis hard currencies such as the US dollar.
Moreover, emerging economies as a whole have also faced what economists term a “sudden stop”—i.e., a sudden outflow of foreign investment capital that had previously been flowing into these economies. Furthermore, the public finances of governments in the emerging markets have become strained as such governments have been forced to make expenditures on economic recovery programs as well as public health responses to the pandemic.
The article discusses the implications of the global economic slowdown associated with COVID-19 for restructuring activity in the emerging markets around the globe. In particular, the article examines how the economic slowdown may give rise to several different types of emerging market restructurings, namely, sovereign debt restructurings, corporate debt restructurings, and infrastructure project restructurings. It also examines how the economic slowdown in the emerging markets might affect restructuring-related matters involving state-owned enterprises (SOEs) and non-performing loans (NPLs) in national banking systems.
The article also considers special issues associated with China’s newly prominent role as the largest official creditor to the emerging markets and developing countries and China’s sponsorship of Belt and Road Initiative (BRI) projects around the world. Further, the article discusses other legal and policy issues that have become more salient in recent years in the context of emerging market restructurings, such as the role of holdouts in sovereign debt restructurings as well as the relevance in corporate debt restructurings in these jurisdictions of any potential gap that may exist between insolvency/restructuring law and practice.
By Tomas Richter (Clifford Chance) and Adrian Thery (Garrigues)
Under EU Directive 2019/1023 promulgated in June 2019, the 27 Member States of the European Union must enact rules supporting preventive restructurings of businesses threatened by insolvency. The restructuring frameworks to be enacted are in a large part modelled after the U.S. Chapter 11 yet they are not carbon copies of it. Also, the 27 Member States have widely differing insolvency laws against whose background the preventive restructuring frameworks must operate, and significantly diverging institutions by which they will have to be applied. The implementation tasks will be both varied and formidable.
However, certain threshold questions are very similar across jurisdictions when it comes to particular topics relevant to corporate restructurings. In the context of agreeing to and adopting a restructuring plan, some of the key questions arise in relation to classification of investors’ claims and interests, grouping these claims and interests into classes, voting in the classes, and obtaining an official approval of the restructuring plan after investors have expressed their opinions on it via the voting mechanism.
The purpose of this first guidance note, published by INSOL Europe, is to flag some of the key issues that national legislators will want to consider in this particular context when implementing the restructuring frameworks prescribed by Title II of the Directive, and, at least at times, also to respectfully suggest which approaches, in the authors’ humble opinions, might perhaps be explored more productively than others.
By Axel Krohn (Martin-Luther-University Halle-Wittenberg, Germany)
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.
By Xiahong Chen (China University of Political Science and Law)
The modification of Enterprise Bankruptcy Law of the People’s Republic of China in 2006 had been announced to be in legislative organ’s amendment procedure for years. As there is no further progress in 2020, the slow process must not catch the urgent needs of economic community for corporate rescue after breakout of coronavirus epidemic. Consequently, the Supreme People’s Court of P.R.China was playing an active role in policy-making from judicial perspective concerning civil disputes resolution. From April to June 2020, the Supreme People’s Court of P.R.China had issued 3 judicial guidance in series to direct judicial hearing of civil case in all level of courts during and after the epidemic, with purpose to guide judicial hearing of civil cases relating to disputes caused by coronavirus. Among them, the second one, published on 19 May 2020, contains 7 important guidelines for judicial hearing of bankruptcy cases relating to COVID-19, aiming to improve possibility of corporate rescue and enhance viability of those financial-distressed companies further.
Changes of bankruptcy policy in above-mentioned guidance include: (1) Court-supervised negotiation between the insolvent debtor and those creditors before the opening of bankruptcy proceeding; (2) Distinguishing real causes of insolvency when examining bankruptcy criteria; (3) Further promoting the link between civil execution proceedings and bankruptcy proceedings; (4) Extending the reorganization period from maximum of 9 months according to EBL 2006 by another 6 months; (5 ) Highlights of effective protection of creditors’ substantive rights and procedural rights in bankruptcy proceedings;(6) Maximizing the debtor’s ability to continue operations and the value of property disposal; (7) Promoting the efficient hearing of bankruptcy cases.
In this short note, the author Xiahong Chen, fellow of Bankruptcy Law and Enterprise Restructuring Research Center of CUPL, was invited by the INSOL Europe, introduces the main points of adjustments of bankruptcy policies relating to epidemic in detail. According to his observation, like the global legal and policy changing trends in bankruptcy area all over the world recently, the changes concerning judicial hearing of bankruptcy cases in China is expected to be helpful for survival of those financial struggling companies.
By Gert-Jan Boon, Leiden University (The Netherlands)
The COVID-19 (corona) virus has reached pandemic status. It currently spreads over the world and is expected to infect a majority of all people within the next month(s), according to health experts. The medical urgency justifies the current extraordinary measures taken by many governments globally, measures that, at the same time, also have devastating effects on businesses and entrepreneurs as sectors slow down or are effectively closed down.
Weathering the storm: a European perspective
In Europe and beyond, strong appeals have been made to prevent bankruptcies caused by the COVID-19 crisis. The exogenous economic shock hits both financially reasonably healthy companies, which depend on a smooth inflow of liquidity, and companies with fundamentally solid business models. Many companies with a viable business model at start of 2020 would now be forced to file and possibly suffer a piecemeal liquidation in the resulting insolvency proceedings. Under the current, distressed market conditions there is a significant risk of sales at an under value.
Not surprisingly, many governments and institutions have announced economic measures to prevent an outbreak of businesses entering into liquidation proceedings. This includes the US Government with the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Similarly, measures to strengthen economies have been taken by many European countries and institutions such as the World Bank, IMF and ECB.
At a European Union level, the European Commission published several communications dealing with the economic consequences of the COVID-19 crisis. In the first Communication on a coordinated economic approach the Commission announced several liquidity measures and described which complementing measures EU Member States may take that fall outside the scope of EU state aid rules. In the second Communication, the Commission announced a Temporary Framework for State Aid setting out and broadening the scope of state aid measures that fall within current EU state aid rules. Also, the Commission expressed its commitment for ‘using every available euro in every way possible to protect lives and livelihoods’. Furthermore, a bank package has been adopted to facilitate bank lending to businesses.
Prevent unnecessary bankruptcies
The extraordinary economic situation raised by the COVID-19 outbreak requires legislators to undertake extraordinary measures. This extends also to insolvency legislation in order to prevent unnecessary bankruptcies. Insolvency legislation which is effective under normal market conditions may prove insufficient or ineffective in the current situation. Measures in these times should be effective without too many formalities, especially when courts and public authorities may not be fully available due to lockdown measures.
The Executive of the Conference on European Restructuring and Insolvency Law (CERIL) — an independent non-profit organisation of European lawyers and other restructuring and insolvency practitioners, law professors and (insolvency) judges — also considers that existing insolvency legislation in Europe may not provide adequate responses to the situation in which many businesses currently find themselves. In a statement published in March 2020, the Executive calls upon EU and European national legislators to take immediate action to adapt insolvency legislation to prevent unnecessary corona bankruptcies. Although prepared for the European context, these recommendations may also be an inspiration for legislators in other parts of the world.
Adapting insolvency legislation
CERIL suggests that two steps should be taken immediately by European national legislators. First, the duty to file for insolvency proceedings based on over-indebtedness should be suspended. Such duties exist in several EU Member States, for instance Austria, Germany, Greece, Italy, Latvia, Poland and Spain. The current economic uncertainty hampers the effectiveness of this duty which is aimed at selecting non-viable businesses. In recent days, some countries have suspended (Germany) or extended (Austria) this duty. Second, in response to a (partial) shutdown of businesses for a number of weeks or months, urgent measures are required addressing the illiquidity of businesses.
In addition, the CERIL statement recommends that EU and national legislators consider further measures. In urgently adapting insolvency legislation, they should include measures to make available interim (crisis) finance, suspend the duty to file based on inability to pay, provide for ‘hibernation’ (going into winter sleep) of (small) businesses by means of a general moratorium or deferral of payments, and provide support for the livelihood of entrepreneurs and their employees.
The CERIL Executive Statement on COVID-19 and insolvency legislation is available here.
This is an amended version of the blog that appeared before on the Oxford Business Law Blog.
* Gert-Jan Boon is Researcher and Lecturer in insolvency law at Leiden University.