For the last decade, the European Union has been reconceptualizing its corporate restructuring framework with the hope of bolstering capital markets and improving cross-border lending. Unfortunately, the system remains plagued by two intractable problems: divergent substantive law at the Member State level and jurists unaccustomed to guiding reorganization cases. The result is a system beset by uncertainty and disparate treatment. The EU is intent on addressing these problems, but progress has been elusive. The EU must work through recommendations and directives to encourage Member States to align substantive restructuring law with policy design. But Member States have been unresponsive to the EU’s recent efforts. The prospect of addressing these intractable problems in the foreseeable future is grim. Therefore, this Article breaks with current scholarship and urges the EU to adopt a radical alternative. The EU should consider making legal and structural changes that will facilitate bankruptcy tourism. I argue that affording corporations increased discretion as to the location of restructuring cases will aid in creating judicial hubs of optimal law and experienced jurists. The EU has the power to adopt my recommendations by simply modifying its own law and procedure, which should accelerate implementation timelines.
Ultimately, economists foresee an impending financial correction. The EU’s restructuring framework is unprepared to offer predictable and comprehensive reorganization outcomes for the next wave of distressed corporations. This Article proposes a novel vantage point from which to assess policy alignment.
By Himani Singh (New York University School of Law)
Corporate rescue is used as a pre-cursor to bankruptcy filing to provide the creditor classes of a stressed debtor with necessary means to formulate a plan of reorganization to recover their dues and make the business of the debtor sustainable again. A prepackaged bankruptcy commonly referred to as “Pre-packs”, is a form of corporate rescue which may involve any element or combination of restructuring methods to be undertaken in respect of a debtor.
Pre-packaged bankruptcy finds its roots in United States and United Kingdom; but is yet to be formally integrated in the Indian bankruptcy regime. While the latest Insolvency and Bankruptcy Code, 2016 has been helpful in improving the stressed asset statistics, the statute is still undergoing teething troubles and has scope for bringing in many improvements such as introducing Pre-packs. The concept of Pre-packs however is niche in India and its viability has been extensively debated. There have been apprehensions that the Indian market is not developed enough to allow out of court of restructuring, but some of the recent decisions by the National Company Law Tribunals have indicated a different trend.
In this backdrop, this term paper discusses the basic features of Indian insolvency structure and how Pre-packs will fare in the market given the current regulatory regime. The paper analyses the corporate insolvency resolution process in India, highlights specific challenges to introduction of Pre-packs and presents a holistic overview of the benefits as well as disadvantages that Pre-packs would bring along with them.
On January 12, 2019, a new ‘Code of enterprise crisis and of insolvency’ was adopted in Italy.
The qualifying aspect of the new law is its emphasis on early intervention. The early warning system is based on enhanced internal monitoring and a ‘duty to scream’ imposed on public creditors, if the company is delinquent on VAT or social security contributions. All business entities must set up adequate ‘organisational, management and accounting’ systems that allow early detection of a crisis and timely dealing with it. The law also creates a public office that should help debtors to find an agreement with creditors or induce them to file for a proper reorganisation procedure.
There are incentives for debtors and directors who tackle the crisis early (and for auditors who take the appropriate steps). On the other hand, undue delay is addressed in various ways. Among them, a new presumption regarding the quantification of damages in case of directors’ trading after the moment when the company is deemed dissolved, that will make it easier for trustees to hold directors liable.
The reform also brings in updates on international jurisdiction, now entirely based on centre of main interest (COMI) (however, there is no general cooperation obligation with regard to cross-border insolvency), and a comprehensive set of rules on group crisis (seemingly compliant with the UNCITRAL principles).
Finally, the law makes relevant changes regarding two of the three available restructuring instruments, while there is nothing new with regard to the very peculiar reading of the absolute priority rule (APR) according to Italian insolvency law.
The law broadens the scope of the cramming down on dissenting creditors (subject to a 75% supermajority in the relevant class) in out-of-court, but court-confirmed debt restructuring agreements: once restricted to financial creditors only, they are now available with respect to all creditors. The confirmation of the plan, which envisages only intra-class cram down, is possible irrespective of compliance with any priority rule (absolute or relative), with the only backstop of a ‘best-interest test’, now based on a comparison with a liquidation scenario. This makes the Italian ‘scheme of arrangement’ a very flexible and effective tool (confirmation rates are also very high, in practice).
Regarding judicial composition with creditors (concordato preventivo), the law confirms the controversial requirement (introduced in 2015) that a minimum 20% payment of unsecured creditors is ensured when a liquidation plan is proposed, and adds the requirement of some form of ‘external’ financial input. By contrast, there is no such a threshold when the business is due to continue under the plan: however, ‘business continuation’ is now defined more narrowly than in the past – it is such only if creditors are paid mainly out of proceeds of the ongoing business, rather than from asset sales, or, under a statutory definition, if the continued business employs at least one-half of the previous workforce. This requirement may exceedingly restrict access to reorganisation or transfer wealth from creditors to employees.
As mentioned, the APR conundrum – the matter is domain of case law – is not solved by the new law. While the discussion regarding APR among creditors is confined mainly to what constitutes ‘new value’ (thus evading the APR waterfall), APR still seems not to apply to equity holders, in case of business continuation.
Finally, the new law introduces very minor tweaks to ‘plain’ insolvent liquidation proceedings, solving some interpretive issues but without an innovative approach, and makes the ‘certified reorganisation plan’, an out-of-court restructuring framework, somewhat more stable in case things don’t work out and the debtor ends up insolvent.
Certain new measures are already in force, but the whole new Code will come into force on 15 August 2020. It should be noted that the new law fully applies – as the law it supersedes – only to enterprises with less than 200 employees. Enterprises exceeding that threshold are deemed ‘large’ and, while being able to access ordinary restructuring tools, if insolvent they are subject to ‘extraordinary administration’, a special going-concern liquidation regime that provides for broad discretion for governmental authorities and the pursuit of business continuity even at the expenses of creditors’ rights.
The paper offers a comprehensive review of the main features of the new law, setting it in the context of the current Italian insolvency law framework.
Coupled with continued efforts in financial deleveraging and industrial reorganization, China delivered a number of changes to its bankruptcy law in 2019 in an effort to further accommodate smooth market exits for non-profitable businesses and to provide greater opportunities for viable businesses that experience temporary liquidity issues to be restructured as going concerns.
Currently, a lack of detailed rules and practical solutions to issues arising out of bankruptcies often deters parties from initiating such proceedings in China. The new rules will provide further clarification on extensively litigated/disputed issues and enhance transparency and consistency in the bankruptcy courts’ handling of cases. The developments encourage more usage of restructuring and compromise proceedings to find market solutions to address insolvency of Chinese companies.
“China’s bankruptcy laws and practices will be more and more market-driven,” said Xu Shengfeng, a Shenzhen-based bankruptcy and restructuring partner of Zhong Lun Law Firm, notwithstanding perceptions among foreign investors that “China’s bankruptcy regime is rather bureaucratic and administrative, with a certain level of involvement by local governments.”
“The goal is to build an institution in which the government’s role can be minimized, until its complete exit,” Xu said. “It cannot be done within a year or two, but this is certainly where things are headed.”
Market players, in particular financial institutions and asset management companies, are becoming more active and playing a greater role in leading restructuring and compromise proceedings. “Right now, many of the restructuring cases need capital injection from outside investors, and it is a great time for asset management companies,” Xu said. The recent U.S.-China Trade Deal promises to open doors for U.S. firms to obtain asset management licenses to acquire Chinese NPLs – see Article 4.5 of the US-China Economic and Trade Agreement.
Key changes to China’s restructuring regime in 2019 included:
establishment of specialized bankruptcy courts in Beijing, Shanghai, Shenzhen, Tianjin, Guangzhou, Wenzhou and Hangzhou;
Supreme People’s Court’s Judicial Interpretation III on the Enterprise Bankruptcy Law (EBL);
joint announcement of the Plan for Accelerating Improvement of the System for Market Entity Exits by 13 major state departments;
further establishment of regional bankruptcy administrator associations, including those in Beijing and Shanghai;
comment solicitation and final issuance of the Minutes of Conference on National Courts’ Civil and Commercial Trial Work, which devoted a section specifically for amendment of bankruptcy rules and restructuring regimes; and
“It was definitely a year of highlights,” said Xu. “The professionalism of bankruptcy trial teams, the establishment of online bankruptcy information disclosure platform, the promotion of pre-packaged restructurings and so on. The Supreme People’s Court is also making headways in the areas of personal bankruptcy and cross-border bankruptcy.”
By Sara L. Chenetz and Tina N. Moss (Perkins Coie)
Reward Science and Technology Industry Group Co., Ltd. (“Reward”) joins a growing list of Chinese companies that have chosen to file a case in U.S. Bankruptcy Court in connection with their restructuring efforts under the People’s Republic of China’s Enterprise Bankruptcy Law (“EBL”). These U.S. cases are known as “Chapter 15” cases, in which the foreign representative of the debtor files a petition in a U.S. bankruptcy court seeking “recognition” of a foreign proceeding. Relief granted to Reward in its Chapter 15 proceedings included a stay of all efforts by Reward’s U.S. creditors to continue litigation and to commence any new lawsuits or other efforts to collect on claims in the United States. Additionally, the Reward foreign representative was granted the power to administer Reward’s U.S.-based assets for the benefit of its creditors and to gather evidence within the United States concerning Reward’s liabilities, assets, business affairs, and operations, including through examining witnesses under oath and issuing subpoenas to obtain documents. Reward’s Chapter 15 case demonstrates that companies that are the subject of EBL cases or are considering whether they could benefit from filing an EBL case may also be able to obtain protections from creditor action in the United States by commencing a Chapter 15 case. As part of a Chapter 15 case, U.S. bankruptcy courts may halt litigation and other collection efforts against the Chinese business (temporarily or permanently), limit the enforceability of certain contract provisions, and simultaneously facilitate the Chinese’s business’ efforts to reorganize or liquidate.
By Jonathan Seymour, Steven L. Schwarcz (Duke University School of Law)
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 Dubai International Financial Centre (the “DIFC”), one of the leading international financial hubs in the Middle East, Africa and South Asia (the “MEASA”) region, has recently announced the enactment of the new DIFC Insolvency Law, Law No. 1 of 2019 (the “New DIFC Insolvency Law”), which became effective in June 2019. Importantly, the New DIFC Insolvency Law which will repeal and replace the Insolvency Law of 2009 and was the subject of substantial research and global benchmarking introduces a completely new rehabilitation provision for distressed companies in the DIFC in addition to the previously existing procedures such as company voluntary arrangements, receiverships and liquidations. With the goal of promoting the rehabilitation of viable businesses that are part of the DIFC while addressing the continuing needs of the various stakeholders involved, the DIFC made several key changes as part of its enactment of the New DIFC Insolvency Law including: (1) the introduction of a debtor in possession procedure known as rehabilitation; (2) the introduction of a procedure that allows the management of a company to be replaced by a court-appointed administrator when there has been mismanagement of or misconduct by the company or management; (3) enhancing and modernizing existing rules and procedures; and (4) the incorporation of the UNCITRAL Model Law on Cross-Border Insolvency.
On July 25, 2019, the Judicial Insolvency Network announced its adoption of the Modalities of Court-to-Court Communication (the “Modalities”), which “apply to direct communications (written or oral) between courts in specific cases of cross-border proceedings relating to insolvency or adjustment of debt opened in more than one jurisdiction.” The Modalities are intended to facilitate implementation of the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters, which since 2017 have been adopted by courts in several countries, including the Supreme Court of Singapore, the U.S. Bankruptcy Courts for the District of Delaware, the Southern District of New York and the Southern District of Florida, and courts in the United Kingdom, Australia, The Netherlands, South Korea, Canada, Bermuda, and the Eastern Caribbean. The U.S. Bankruptcy Court for the District of Delaware adopted the Modalities on an interim basis on July 25, 2019. It is anticipated that other courts will do so as well in the near term.
Mark G. Douglas (Jones Day) summarized key features of the Modalities and other developments since the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters as developed and implemented by JIN (the judicial Insolvency Network) here.
In In re PT Bakrie Telecom Tbk, 601 B.R. 707 (Bankr. S.D.N.Y. 2019), the U.S. Bankruptcy Court for the Southern District of New York provided a primer on several important issues that a court may have to consider in ruling on a petition for recognition of a foreign bankruptcy proceeding under chapter 15 of the Bankruptcy Code. These include the requirement that a foreign debtor have property in the United States before being eligible for chapter 15, the rules regarding the appointment of a “foreign representative” for the debtor, what qualifies as a “collective proceeding” for the purpose of chapter 15 recognition, and the “public policy” exception to recognition. One notable conclusion by the court is that merely because a foreign proceeding has concluded does not prevent the later appointment of a foreign representative.
An examination of all of the issues highlighted by PT Bakrie entails a detailed factual analysis and careful application of the provisions of chapter 15 consistent with its underlying principles and purpose in providing assistance to foreign tribunals overseeing cross-border bankruptcy cases. Dan T. Moss and Mark G. Douglas (Jones Day) provided such a close examination and detailed analysis of the case here.
Vasile Rotaru (Droit & Croissance / The Rules for Growth Institute)
From a functional law and economics perspective, the recent European restructuring directive (the ‘Directive’) brings both welcome innovations and multiple pitfalls. Its final text bears the traces of the divergent objectives and inspirations of its drafters. In a recent paper, I attempt to provide a thorough analysis of the different hidden ‘models’ and important measures of the Directive, as well as its unfortunate oversights.
The first part of the paper lays the theoretical foundations of the subsequent analysis. It has long been argued that insolvency law should pursue two objectives: (i) facilitating debtor’s ex ante access to finance; and (ii) ensuring an efficient ex post distribution of resources in the economy, by restructuring economically viable companies with bad capital structures and swiftly liquidating companies with an unsustainable business. Together, the two should result in wealth maximization, the default (but by no means only) criterion for assessing business law’s merits.
The paper takes a ‘functional’ approach, which is fueled by a deep skepticism towards any extensive cost-benefit analysis. It suggests that the ex ante focus should be on ensuring that a suitable epistemic framework is in place when the decision as to the redistribution of resources has to be taken. This implies incentivizing decision-makers to reliably reveal their preferences and bear the costs of their actions while diminishing coordination failures and potential conflicts of interests. Starting with this intuition, I attempt to reformulate the classical creditors’ bargain theory, underlining that so called ‘preventive’ proceedings are no exception.
In the second part of the paper, I rely on this theoretical framework to provide a critical analysis of the main measures of the Directive. I show that the apparent complexity of its final text (the contemplated proceedings could potentially take more than 70 forms) is owed to its drafters pursuing divergent objectives: economic efficiency or short-term preservation of businesses and jobs at all costs, with an unfortunate bias in favor of the latter (especially concerning SMEs).
Moreover, two coherent formal ‘models’ of proceedings are offered. The first is a unitary, public proceeding, with a potential general moratorium for up to four months. The second is a two-step proceeding—partially inspired by the current French model—that would start with an amicable phase devoid of wide publicity and would be accompanied by individual moratoria granted on a casuistic basis where they seem justified. The second, short and public ‘closing’ phase would be triggered in the specific circumstances where the restructuring plan has to be forced upon dissenting stakeholders. Once a decision has been made as to the objectives and formal model, most of the subsequent transposition options follow.
The Directive implies a devolution of decision-making powers to classes of affected stakeholders, although the court preserves a far too important role. Indeed, stakeholders are in the best position to identify and exploit any restructuring gain. It remains to be seen which criteria will be used to ensure that the interests of members of a class are aligned and no abusive behavior takes place. Where a plan is not approved by all classes of stakeholders, the Directive provides for a cross-class cram-down, where a majority of classes or at least one class of stakeholders who are ‘in the money’ must approve the plan. The latter option could potentially lead to abuses and uncertainties, given the meagre experience of European practitioners with valuations as a going concern. The cram-down can involve a debt-equity swap imposed both on shareholders, who should be treated as any other class of stakeholders and dissenting creditors. This possibility is not trivial, as it forces creditors to continue financing the business, and should be duly justified.
Unfortunately, the contemplated protections of stakeholders’ interests are somewhat underwhelming. For instance, instead of ensuring that all stakeholders share the restructuring gain in accordance with their respective ranks in the capital structure, the Directive provides for a confusing and dangerous ‘relative’ priority rule, which will likely render the negotiations unpredictable, or, alternatively, for an incomplete ‘absolute’ priority rule. Moreover, no protection is provided against debtor’s potentially abusive behavior before the opening of proceedings.
Finally, the paper offers some insights into the expected impact of its transposition into French law. In particular, its last part suggests that any transposition needs to aim at increasing the transparency and predictability of restructuring proceedings in order to foster secondary debt markets, and therefore to ensure that impatient creditors can easily be replaced by those interested in the restructuring gain.
By Emma Cervantes, Victoria Dodev, Shane Ellement, Isabelle Sawhney (Duke University, School of Law)
Italy has €2.4 trillion of debt – an unsustainable level in pressing need of a restructuring. However, traditional avenues for sovereign restructurings cannot be utilized because Italy’s situation is complicated by several factors. First, the massive outstanding bond stock and diversity of bondholders makes a traditional consensual restructuring impractical. Additionally, about 68% of outstanding bonds are held by Italian parties, making any restructuring harmful to the domestic economy. To further add to this complicated situation, the ESM Treaty purports to impose additional restraints on Italy’s ability to restructure through the addition of CACs to approximately 60% of Italy’s bond stock.
Fortunately, there is a loophole in Italy’s bonds that can resolve these problems: Italy can unilaterally extend its maturities without bondholder consent. This power stems from the fact that Italy’s domestic government securities are issued as decrees under the relatively unknown 2003 Consolidated Act, which explicitly grants Italy the power to unilaterally extend bond maturities. Accordingly, 98% of its outstanding bond stock, about €2 trillion, can be restructured without bondholder consent. This strategy could result in the largest sovereign debt restructuring in history being done unilaterally.
This proposal demonstrates that the inclusion of CACs in some of its bonds does not foreclose the use of Italy’s Article 3 power. The proposal also describes the mechanics by which Italy would exercise its right to extend maturities. Unilaterally extending maturities does not require any retroactive utilization of the local law advantage. Nor does it expose Italy to significant legal risks in its domestic courts or under European treaties and conventions.