The EU’s proposed pre-insolvency restructuring procedure offers opportunities for creditors and investors. However, it is not without risk, as is demonstrated by a comparison of the proposed procedure with both British and Singapore schemes of arrangement, as well as the chapter 11 proceeding in the US.
The EU draft directive of November 22, 2016 seeks to implement a so-called preventive restructuring framework for European member states. Negotiations are well along, and the directive is envisaged to be finalized and adopted before the European Parliament election of 2019.
The preventive restructuring framework aims to help companies which are experiencing financial difficulties to implement a restructuring at an early stage, thereby avoiding insolvency and maximizing returns for creditors. The UK and Singapore scheme of arrangement procedure and the US Bankruptcy Code’s chapter 11 proceedings serve as a benchmark.
While it is expected that the member states will be granted considerable flexibility in implementing the directive in national law, the starting position under the draft directive is that debtors and creditors conduct out-of-court negotiations in order to formulate a restructuring plan. The preventive restructuring framework seeks to create opportunities to achieve a quasi-consensual restructuring which will bind dissenting creditors and shareholders. Three measures (discussed in further detail below) are proposed to facilitate the process and the successful implementation of the plan: (i) a moratorium to suspend enforcement action; (ii) the ability to use cram-down, or cross-class cram-down mechanisms so that the plan is universally binding on all creditors; and (iii) granting privileged status to new financing and other restructuring measures (restructuring privilege and super senior financing).
The draft directive makes it easier for active creditors and (distressed) investors to plan a restructuring, in conjunction with new financing, in advance, and to implement the restructuring quickly in circumstances where the debtor is in agreement with the proposals. However, in such a scenario there is always a risk of prejudice to other creditors. There is also a danger that creditors will be left with no option but to agree to, or rather not oppose, the plan; particularly where there is a risk that the debtor company could otherwise become insolvent. Therefore, in order to protect their interests, creditors will need to keep themselves informed and actively participate in restructuring discussions from the outset.
Each of the three measures proposed to facilitate the pre-insolvency restructuring procedure and successful implementation of the plan (mentioned above) will now be briefly examined.
In order to facilitate negotiations, the debtor can avail itself of a full moratorium (suspending all enforcement actions against it), or one which is limited to a particular class of creditor actions, for a period of up to four months (which can be extended for up to 12 months in certain circumstances).
The moratorium suspends any obligation on the part of the debtor to file for insolvency and the right of creditors to place the debtor into insolvency. In addition, creditors are prevented from reneging on their outstanding obligations, and terminating existing contracts, and cannot declare amounts due prior to their maturity, or otherwise vary obligations to the detriment of the debtor, on the basis of outstanding liabilities or corresponding contractual rescission clauses (ipso facto clauses).
The introduction of a special three-month moratorium, which would precede any form of restructuring to allow a debtor time to consider options for rescue, is currently being discussed by the UK government. In contrast, the laws relating to chapter 11 proceedings and a Singapore scheme of arrangement already provide for an automatic moratorium. However, in contrast to a Singapore scheme, the EU’s draft directive on the proposed pre-insolvency restructuring procedure does not, for instance, explicitly extend to affiliated companies of the debtor, such as in circumstances where collateral is provided by subsidiaries.
The creditors’ ability to influence the restructuring is therefore impeded by the existence of the moratorium. They run the risk that a debtor’s existing assets will be further depleted in the future. A creditor’s only real option for relief is to prove that the moratorium “unreasonably prejudices” them. Creditors can form a blocking minority with other creditors, but there does not seem to be a remedy to prevent a moratorium generally.
The draft directive does not expressly stipulate who has locus standi to initiate the formulation of a restructuring plan. However, there are strong grounds to suggest that (at least in respect of the initial proposal) it is the debtor, because the preventive restructuring framework and cross-class cram-down mechanism are only available with the express consent of the debtor. However, amendments to the draft directive discussed by the European Parliament’s Committee on Legal Affairs envisage that creditors will also be able to submit an alternative plan.As is the case for the German insolvency plan procedure, a majority of creditors in all creditor classes must vote in favor of the plan in order for it to bind dissenting creditors (cram-down). The draft directive leaves it open to member states to determine majority voting requirements (but a majority of no more than 75 percent is required). Singapore and UK schemes require a 75 percent majority in value and a simple majority in number. Chapter 11 proceedings require a two-thirds majority in value and also a simple majority in number.
Even if not all creditor classes vote in favor of the plan, it can still bind dissenting creditors (cross-class cram-down) if certain conditions are met. For example, the requirement that the dissenting classes are paid prior to a subordinate class receiving anything under the plan (rule of absolute priority). Chapter 11 proceedings and the Singapore scheme of arrangement also allow for cross-class cram-down, but the UK scheme does not. The proposed cross-class cram-down mechanism is currently being considered at Council level.
Accordingly, class formation is a matter of great importance. Whilst the draft directive provides for a court to review class formation, there is no early right of appeal for creditors, as is the case for the UK scheme of arrangement.
Privileged status of financing
According to the draft directive, new (interim) financing and other transactions related to the restructuring are not open to challenge in subsequent insolvency proceedings and are exempt from civil, administrative and criminal liability. There are exceptions to this rule for fraudulent or mala fide transactions. In addition, member states may elect to give priority to new (interim) financing in subsequent insolvency proceedings over unsecured creditors or superior classes of creditors (super senior financing). This concept also exists in chapter 11 proceedings and in Singapore schemes. Contractual arrangements can be put in place to achieve a comparable position in a UK scheme.
The world of restructuring continues to progress towards finding alignment across jurisdictions with respect to processes and to bring best practice to the EU’s proposed pre-insolvency restructuring procedure. The development of the scheme in Singapore will continue to provide opportunities for practitioners to no longer only consider the US for chapter 11 or the UK scheme of arrangement (pursuant to the Companies Act) in restructuring. Nevertheless, there are still many questions to be answered, and it is the hope of the authors that such questions will be addressed in the near term to develop a fully functioning framework.
An earlier version of this article appeared in German in the March/April 2018 issue of FINANCE magazine, co-authored by Bob Rajan, Managing Director and co-head of Alvarez & Marsal Germany.
Compliments of DLA PIPER, a member of the EACCNY