The International Monetary Fund has also listed insolvency law discrepancy as one of the three main obstacles to increasing cross-border investment in the EU1.
Accordingly, in recent years, the EU has taken a number of actions to reduce the misalignment between EU member states in relation to insolvency law.
The first of these was Regulation (EC) 1346/2000 on insolvency proceedings , which clarified the competent jurisdiction and applicable law for insolvency proceedings and required automatic recognition of insolvency proceedings started in one EU member state in all other EU member states (other than Denmark). The purpose of the Regulation was to create a framework for coordination between national authorities, with the ultimate goal of strengthening cooperation and ensuring a more consistent approach across the EU to the handling of cross-border insolvency proceedings. This Regulation was amended by Regulation (EU) 2015/848 (the “Recast Insolvency Regulation”) which made certain changes to the original Regulation and added certain new elements including a framework for co-operation between officeholders and insolvency courts and a new process called a group co-ordination proceeding which allowed for the co-ordination of insolvencies of companies within the same corporate group.
Second came Directive (EU) 2019/1023 (or the “Restructuring and Insolvency Directive”, enacted within the framework of the so-called “Capital Markets Union”) which was intended (amongst other things) to standardise provisions relating to restructuring and pre-insolvency rescue procedures. Although the aim of this Directive was to standardise provisions relating to rescue plans across the EU, the Directive itself afforded EU member states a number of options to implement this concept into domestic law. Accordingly, when the Directive was implemented by EU member states, there were subtle differences in implementation in each state and as a result, the Directive’s objective of harmonisation was not fully achieved.
The most recent EU proposal on the subject matter, published on 7 December 20222 (the “Proposal”) is still awaiting consideration by the European Parliament and the Council of the European Union. It is worth noting that the European Council has previously signalled willingness to enact harmonisation measures in the insolvency and restructuring domain.3
What sets this latest Proposal apart from previous EU legislative actions is the fact that, for the first time, certain substantive law issues will be subject of harmonisation. Procedural rules will no longer be the sole element to be harmonised. The main areas proposed to be harmonised under the Proposal are:
- claw-back actions;4
- directors’ and officers’ duties to file for insolvency promptly, if certain conditions are met;5
- so-called “pre-pack” procedures;6
- creditors’ committees.7
- liquidation regimes for companies below certain size thresholds (aimed at simplifying the process for micro enterprises);8 and
- information rights (aimed at bridging information asymmetries among EU member states).9
The proposed changes will be examined in detail below.
The underlying principles of the Proposal
The Proposal aims, as stated in its first Recital, to “remove obstacles to the exercise of fundamental freedoms, such as the free movement of capital and freedom of establishment, which result from differences between national laws and procedures in the area of insolvency”.10 Due to such differences, insolvency proceedings can take anywhere from a few months to several years to complete and the associated costs may vary enormously depending on the country where the insolvency proceedings are opened.
In implementing this harmonisation, the European Commission also intends to ensure that:
creditors are able to extract the maximum value from the insolvent company’s liquidation;
available insolvency procedures are efficient; and
the recovered value is distributed in a more equitable and predictable manner.
In addition, the Proposal aims to make insolvency proceedings more accessible to so-called ‘micro-enterprises’ (see further below), which are often worse off in insolvency because they lack the necessary resources to pay the associated legal costs.11 The introduction of simplified procedures for these types of enterprises is intended to ensure that they can benefit from the discharge of debts regardless of size or significant cash availability. Secondly, it is hoped that more coherent management of the residual assets of micro-enterprises and the resultant increased recoveries for creditors will reduce the perceived risk of investing in these types of enterprises.12
Ultimately, the European Commission’s aims are that the reformed rules would encourage investors to offer more favourable credit terms to debtors13 as creditors would benefit from better recovery rates on the debtor’s insolvency. Further, under the Proposal, in the event of a debtor’s insolvency, creditors would benefit from the new provisions relating to creditors’ committees which would enable creditors to coordinate decisions more effectively. The proposed information rights in the Proposal would further enhance creditor confidence in lending to debtors in EU member states.14
The Proposal is a draft EU Directive. EU Directives are not directly applicable in EU member states (unlike EU Regulations, which do have direct applicability) but instead prescribe a set of minimum standards that must be transposed by EU member states into national law. EU member states have freedom to decide how to transpose the requirements of a Directive into their national law. In some cases, EU member states may go beyond the minimum standards set out in the Directive or may already have national laws which go beyond the Directive (which may in effect mean that rules across EU member states are not identical, though they will each meet the same baseline).
A summary of the key measures that EU member states will be required to introduce into their national law if the Proposal is voted through is set out below:
Directors’ duty to file for insolvency promptly – Under Articles 36 and 37 of the Proposal, EU member states would be required to introduce measures that: (i) oblige directors15 to file for insolvency no later than 3 months after they become aware (or can reasonably be expected to have become aware) that a company is insolvent; (ii) ensure that directors are liable to creditors for any damages arising as a result of directors’ failure to comply with the obligation set out in (i). The Proposal does not, however, set out a definition of when a debtor should be considered to be ‘insolvent’. Accordingly, it is possible that the time at which this obligation arises for directors may vary across EU member states if a harmonised definition of ‘insolvency’ is not ultimately included in the directive adopted by the EU.
Clawback / avoidance actions – Under Articles 4 to 12 of the Proposal, EU member states would be required to introduce legal measures which are capable of rendering void the following types of pre-insolvency transactions:
- Preferences: actions which benefit a creditor or group of creditors and
which are perfected: (a) up to three months prior to the submission of a request for the opening of insolvency proceedings (on the baiss that the debtor is unable to pay its debts); or (b) after the submission of a request for the opening of insolvency proceedings; and
which are not in satisfaction of an existing claim (unless the creditor knew (or should have known) that the debtor was unable to pay its debts or that a request for the opening of insolvency proceedings has been submitted. This knowledge is presumed in case of a related party); and
which are not actions taken for fair consideration and for the benefit of the entire insolvency estate;
- Actions for no or inadequate consideration which are perfected up to one year prior to the submission of a request for the opening of insolvency proceedings;
- Actions intentionally detrimental to the general body of creditors:
where such actions are perfected: (a) up to four years prior to the submission of a request for the opening of insolvency proceedings; or (b) after the submission of a request for the opening of insolvency proceedings; and
- where the counterparty knew or should have known of the debtor’s intent to cause detriment to the general body of creditors (this knowledge is presumed in the case of a related party).
Limitation periods: EU member states would be required to ensure that the limitation period for all claims relating to the above avoidance actions is at least three years from the date of the opening of insolvency proceedings in respect of the debtor.
Consequences: EU member states would be required to implement measures which ensure that the party which benefitted from the void transaction compensates the insolvency estate in full for the detriment caused to creditors by that void transaction.
‘Pre-pack’ sales – Under Articles 19 to 35 of the Proposal, EU member states have the option of adopting either of the following procedures to ensure that pre-pack sales (ie the sale of the assets of a business negotiated before and completed immediately or shortly after entering into an insolvency process) are conducted to the highest of standards:
- a two-stage process, being a “preparation phase” (a debtor-in-possession process) where a monitor (an insolvency practitioner) is appointed to run a fair, transparent and competitive process to find an appropriate buyer for the whole or a part of the debtor’s business, followed by a “liquidation phase” in which the sale is approved by the court;
- alternatively, through a public auction process where the auction is conducted by the court in the “liquidation phase” within a strict timeline (no more than four weeks in total from the start of the “liquidation phase”).
Moratorium: EU member states would be required to ensure that debtors can benefit from a stay of enforcement action during the preparation phase (i.e. the competitive bidding / public auction phase) if they are insolvent or on the brink of insolvency.
Bids from related parties / secured creditors: EU member states would be required to ensure that: (a) related parties are able to participate in the bidding process, provided the existence of the relationship is properly disclosed; (b) secured creditors are able to participate in the bidding process and are able to offer their secured claims as part of the consideration in their bid (provided the secured claims are significanlty below the market value of the business).
Asset tracing – Further to Articles 13 to 17 of the Proposal, EU member states would be required to ensure that insolvency practitioners appointed in ongoing insolvency proceedings can (either directly or through designated courts), access bank account and beneficial ownership information held in public and non-public registries set up pursuant to the EU’s anti-money laundering framework, for the purposes of identifying and tracing assets belonging to the insolvency estate. Further to Article 18 of the Proposal, EU member states would also be required to ensure that insolvency practitioners (including those in other EU member states) have access to certain national asset registers.
Creditors’ committees – Further to Articles 58 to 67 of the Proposal, EU member states would be required to enact measures to faciliate the appointment of a creditors’ committee where the general meeting of creditors decides that one is necessary or where one is ordered to be established by a court. The members of the committee should reflect the different interests of the creditors or creditor groups and should act independently of the insolvency practitioner appointed in respect of the estate. The committee’s role is to ensure that creditors’ interests are protected and to supervise the insolvency practitioner. EU member states should ensure that the committees have a minimum set of rights in this regard, including the right to request information and to be consulted on certain matters, including the sale of assets outside the ordinary course of business;
‘Simplified’ insolvency procedure for ‘micro-enterprises’ – Articles 38 to 45 of the Proposal require EU member states to ensure that microenterprises have access to simplified winding-up procedures when they are insolvent. One of the key aspects of this simplified procedure is that EU member states would need to ensure that an insolvency practitioner would only be appointed in respect of such enterprises where the debtor or a creditor or group of creditors requests such an appointment and there are sufficient funds in the insolvency estate to fund such an appointment or the party requesting the appointment is able to cover the costs of it.
First European reactions to the Proposal and comparisons with the UK and US frameworks.
As the Proposal is relatively recent, only limited commentary is available as to how various EU member states will implement it: however, some preliminary comparisons can be made with the legal systems of the main EU member states, as well as with relevant provisions in the United Kingdom and in the United States.
Firstly, the provisions on claw-back actions in the Proposal appear to be partly inspired by §§ 130, 131 and 133 of the German insolvency act Insolvenzordnung, particularly, the concepts of transactions for inadequate consideration and transactions intended to cause harm to creditors.16
The creditors’ committee is of US and British derivation17 and can be found in many other legal systems.
The concept of the ‘pre-pack plan’, on the other hand, is clearly influenced by US legislation. In the US, ‘pre-pack plans’ followed by a competitive sale of the company are very common in the context of Chapter 11 proceedings18. Such measures also exist in other jurisdictions, such as England and Wales, Scotland,19 and Canada20, as well as in Spain21 and in France (where a similar instrument has existed since 2014).22
On the other hand, the simplified liquidation procedure for ‘micro-enterprises’ departs considerably from the UK and US approach. Subchapter V, Chapter 11, US Bankruptcy Code was recently introduced in the US: among other things, this Chapter modelled a ‘simplified’ liquidation or restructuring procedure for small businesses23 on the basis of the existing Chapter 11 restructuring procedure.24
The US approach
As mentioned above, many aspects of the Proposal are based on the US’s reorganization regime set forth in Chapter 11 of the United States Bankruptcy Code. Key aspects of the Chapter 11 approach are detailed below:
Claw-back actions – One of the important powers given to debtors (who typically remain in control and possession of their assets in the U.S system) or trustees overseeing a Chapter 11 case is the ability to avoid, or claw-back, pre-bankruptcy transfers of the debtor’s property through preference and fraudulent transfer actions. Successful avoidance actions result in the return of the transferred property or its value to the estate for redistribution to creditors.
- Preferential Transfer - A preference is a transfer of a debtor's interest in property by an insolvent debtor to, or for the benefit of, a creditor on account of a pre-existing debt made within 90 days (or if the creditor is an insider, within one year) before the date the bankruptcy petition was filed, and that allows the recipient of the transfer to receive more than it would have otherwise received in a liquidation of the debtor’s assets in a Chapter 7 bankruptcy proceeding.25
- Fraudulent Transfer - A fraudulent transfer is a transfer of a debtor's interest in property, or an obligation incurred by the debtor, made within two years before the petition date (or other time limit set by US state law, typically up to 4 to 6 years) for which the debtor received less than reasonably equivalent value at a time when the debtor was (or was rendered) insolvent.26
D&O's Duties – In the US, the duties and obligations that directors and officers owe to a business entity, shareholders, or creditors are governed by state law.
Directors and officers owe two core fiduciary duties to a solvent corporation for the benefit of its shareholders: (1) duty of care and (2) duty of loyalty. Upon insolvency, directors' fiduciary duties to the company require consider of the creditors, because the interests of shareholders are subordinate to those of creditors once insolvent. However, directors and officers are usually protected by the so-called ‘business judgment rule’, which presumes the board of directors acted on an informed basis, in good faith, and in the honest belief that they took actions or made decisions that were in the best interests of the corporation. It usually is difficult to overcome this business judgment presumption in litigation against directors for violating their fiduciary duties absent a showing of fraud, self-dealing or other disinterestedness.
‘Pre-pack’ procedures – In the US, ‘pre-packs’ utilize the bankruptcy process to implement an out-of-court restructuring agreement between a debtor and its major creditors. Generally, ‘pre-packs’ are more appropriate for restructuring the financial debt on a debtor's balance sheet, with non-financial claims typically being paid in full and otherwise legally unaffected by the bankruptcy. A successful ‘pre-pack’ is faster and more efficient than a traditional Chapter 11 case (indeed, there are examples of ‘pre-pack’ cases getting in and out of court within days). Like a traditional Chapter 11 plan, it can bind non-consenting creditors and must still comply with the same plan confirmation requirements.
Creditors’ committee role – The creditors’ committee represents the interests of unsecured creditors with the goal of maximizing its constituents’ recovery under a plan of reorganization. The committee usually comprises 5 to 7 unsecured creditors from the top 30 of the debtor’s creditors who are willing to serve. The committee is then permitted to retain legal and financial advisors, the fees of which are paid by the debtor. Creditors’ committees protect and promote the interests of the collective unsecured creditor group, rather than the individual interests of their members. This collective action aims to provide a check against the power of the debtor and secured lenders in the case, and the committee is often entitled to a significant amount of information from the debtor that allows it to gain leverage in the bankruptcy process.
‘Simplified’ procedure for ‘micro-enterprises’: small business bankruptcies under Subchapter V of the Bankruptcy Code – The reorganization process under Chapter 11 can be costly and burdensome for small businesses. Recognizing these issues, US Congress passed the Small Business Reorganization Act (SBRA), which adds a new Subchapter V to Chapter 11 of the Bankruptcy Code. Subchapter V provides small businesses with aggregate liabilities of up to USD 7,500,000 (through 21 June 2024) with an opportunity to reorganize in a streamlined and cost-effective bankruptcy proceeding.
Key features of Subchapter V that differ from a typical Chapter 11 proceeding include: (1) a Subchapter V Trustee is appointed in all cases; (2) no official creditors’ committee is appointed (unless by court order); (3) the Subchapter V debtor does not have to file certain pleadings that are necessary in a Chapter 11 case; (4) the debtor must file a proposed plan of reorganization within 90 days; and (5) certain burdensome plan approval requirements that exist in typical Chapter 11 cases do not exist in Subchapter V cases. These reduced requirements and expeditious process are designed to allow small businesses to move in and out of bankruptcy court more swiftly and successfully than in a typical Chapter 11 reorganization.
The UK approach
Directors’ duty to file for insolvency – In England and Wales, there is no obligation on directors and officers to file for insolvency within a specified time period. However, the insolvency framework has a number of safeguards in place to ensure that directors file for insolvency promptly when they know (or should know) that a company is insolvent. For instance, where directors know that there is no reasonable prospect of avoiding insolvent administration or liquidation, but nevertheless continue trading, they may face personal liability for any losses which arise as a result of their decision to keep trading, whether in the form of an action for wrongful trading, breach of duty or misfeasance. If such actions are successful, it could also result in the director being the subject of a disqualification order, which would prohibit the director from holding a directorial post or participating in the management of another company for up to 15 years.
Following the recent decision of the UK Supreme Court in BTI v Sequana & Ors27, it is also now clearer that directors who fail to give sufficient weight to creditors’ interests where an insolvency process is a probable outcome, can be found personally liable for breach of fiduciary duty. The overall effect is therefore that directors need to carefully monitor the company’s position when it is deteriorating, and work closely with advisors, in considering whether or when they should place a company into an insolvency process.
Clawback / avoidance actions – The insolvency framework in England and Wales specifies various bases for challenging transactions entered into by a company within specified periods before the company enters an insolvency process. Each of the avoidance actions set out in the Proposal, being: preferences, transactions for inadequate consideration and transactions to the detriment of creditors, have parallels in English law. However, the “lookback periods” are considerably longer under English law: the relevant periods are six months prior to the onset of insolvency and two years prior to the onset of insolvency in respect of preferences and transactions at an undervalue respectively, and these may be longer still where transactions with related parties are concerned
Under English law “transactions defrauding creditors” can be challenged – this is similar to the “transactions to the detriment of creditors” avoidance action set out in the Proposal. However, under English law, such transactions may be challenged even where the company has not entered into insolvency. They may be challenged up to 6 years or up to 12 years after the relevant transaction, depending on whether they are claims for a sum of money or are “specialty” claims (e.g. those arising under a deed28).
In addition, floating charges entered into by a debtor in the 12 months prior to the onset of insolvency (this period is extended to 2 years where related parties are concerned) and extortionate credit transactions entered into in the 3 year period prior to the onset of insolvency, are also open to challenge under English law.
Generally, if a challenge under any of these bases is successful, the court will make an appropriate order to undo the effect of the transaction in question (for example, by ordering the return of assets to the insolvent debtor).
‘Pre-pack’ sales – While there is no specific legislative framework for ‘pre-pack’ sales in the insolvency framework in England and Wales, they are commonplace in the UK and are carried out pursuant to an insolvency practitioner’s general power to sell the company’s assets. ‘Pre-packs’ have been criticised in some quarters for being non-transparent processes and as a consequence, there has been growing scrutiny of these processes in recent years. In 2021, new regulations were introduced to govern ‘pre-pack’ sales involving all or a substantial part of the company’s assets and which are made by an administrator to connected parties within 8 weeks of a company being placed into administration. The regulations now require either (a) the purchaser to obtain and disclose to the administrator a report from an evaluator which confirms that the grounds and consideration for the sale are reasonable; or (b) the administrator to obtain creditor approval in respect of the sale. Although ‘pre-packs’ in England and Wales frequently do involve creditors offering up their claims as part of the consideration offered for the purchase of the business, this mechanism is not enshrined in English law.
Asset tracing – Under English law, insolvency officeholders have a number of investigatory powers available to identify and trace assets belonging to the insolvent debtor. These include:
- the power to obtain from any party (including a third party) any property, books, papers or records which are (or appear to be) the property of the insolvent debtor;
- the power to obtain from any party (including a third party, such as a bank) information concerning the promotion, formation, business, dealings, affairs or property of the insolvent debtor. While there are conflicting judicial decisions on the issue, in certain cases, English courts have held that this power can be used extraterritorially;
Foreign insolvency officeholders are also able to obtain the assistance of the English courts in gathering evidence and information about the assets of the insolvency estate, through one of the following methods: (a) judicial letters of request (mainly available to courts in Commonwealth countries, but also in certain other designated countries such as Ireland and South Africa); (b) the assistance provisions set out in the UK legislation implementing the UNCITRAL model law on cross-border insolvency (although the foreign insolvency would first need to be recognised by the English court for the officeholders to avail themselves of such assistance).
Creditors’ committees – Similar to the Proposal, the establishment of creditors’ committees in England and Wales is not mandatory. Typically these are established in more contentious insolvencies. Creditors’ committees are usually comprised of a small group of representative creditors. Their function is to supervise the insolvency officeholder and provide guidance on controversial matters. This guidance is not, however, a substitute for consulting the general body of creditors where this is required by the insolvency rules. The creditors’ committee has the power to require information from the officeholder about the progress of the insolvency. The creditors’ committee owe fiduciary duties to other creditors of the insolvent debtor.
‘Simplified’ insolvency procedure for ‘micro-enterprises’ – The insolvency procedures in England and Wales apply equally to ‘micro-enterprises’ and to large enterprises. There is no specialised or simplified procedure for ‘micro-enterprises’.
Initial reactions in Germany and potential impacts on the existing legal framework
In Germany, the initial reactions to the Proposal have been mainly positive. The fact that the European Commission is taking a further step towards harmonization of insolvency laws in Europe and thereby contributing to reduce uncertainties for investors in cross-border insolvencies has been welcomed.29
If the Proposal were adopted, the need for amendments to German insolvency law would be reasonably limited. Many parts of the Proposal are already anchored in the German Insolvency Code (Insolvenzordnung, “InsO”), but other parts of the Proposal would require some adjustments to the InsO. A few areas that would require clarification when transposing the Proposal into national law have already been identified by scholars.30 Some of the issues which have received attention are set out below:
Claw-back actions, D&Os duties and liabilities, creditors’ committees – The Proposal’s regulations on the topic31 are not new to the InsO.32 If the Proposal were implemented in its current version, no adjustments of German insolvency law would likely be required in this respect. The same applies to the Proposal’s regulations on the duties and liabilities of directors33 and minimum standards for creditors' committees.34 To some extent German insolvency law even provides stricter rules than those envisaged in the Proposal.
Asset tracing – The proposed regulations on asset tracing35 aim to facilitate asset tracing in other EU member states. By providing better access for insolvency administrators to bank information (Art. 14) and national asset registers (Art. 18), the Proposal aims to strengthen creditors’ protection. If the Proposal were implemented, additional provisions would need to be implemented to indicate which courts would be competent to handle such requests.36
‘Pre-pack’ procedures – The Proposal for the implementation of uniform regulations on ‘pre-pack’ proceedings37 has received the greatest attention in Germany so far. German law already provides for the possibility of selling an insolvent company in preliminary insolvency proceedings (namely through an asset deal or alternatively by way of a so-called ‘insolvency plan’ proceeding which can be either an asset deal or a share deal). In Germany, it is already common practice for the preliminary insolvency administrator (in preliminary insolvency proceedings) or the preliminary custodian (in self-administration proceedings) to carry out the sale of the company through an auction process and then execute the purchase agreement shortly after the opening of the insolvency proceedings, subject to the approval of the majority of creditors.
However, various questions have arisen on the envisaged rules on ‘pre-pack’ proceedings. From a German perspective, the main issue is that according to the Proposal ‘pre-pack’ proceedings formally consist of two phases: in a first preparation phase, a buyer is to be sought; a subsequent liquidation phase serves to carry out the pre-negotiated sale and to distribute the realization proceeds to the creditors. This would be a new concept for German insolvency law. Whether these requirements could be integrated into the existing legal provisions in the InsO by minor changes or whether the German legislation would need to be changed substantially is currently the subject of discussion among scholars.38
Another subject of discussion is Art. 24(2) of the Proposal. The presumption of this provision is that, in ‘pre-pack’ proceedings, even a single binding offer corresponds to the market price of the insolvent company. This may be a problem if there is only one single offer submitted by a related party. In this respect, the Proposal provides for an obligation of the insolvency administrator or custodian to always take into account the creditors’ interests.39 However, it is debatable whether this, in the German legal system, would be sufficient to prevent deals where the insolvent company is acquired by a related party for a purchase price much below market value, leaving behind unsecured creditor liabilities (so called ‘phoenixing’).40
‘Simplified’ liquidation proceedings for ‘micro-enterprises’ – Insolvency proceedings without the involvement of an insolvency administrator for small and ‘micro-enterprises’,41 which the Proposal aims to implement, do not exist in German insolvency law. In this respect, German law would have to be amended substantially. It is expected that such proceedings could significantly reduce the number of ‘ordinary’ insolvency proceedings in Germany: this is because ‘micro-enterprises’ within the meaning set out in the Proposal, are companies with less than 10 employees and an annual turnover or an annual balance sheet total not exceeding EUR 2 million.42 In 2020, this threshold would have caught the vast majority of German companies, i.e. roughly 2.1 million companies of around 2.5 million companies in total.43
Initial reactions in France and potential impacts on the existing legal framework
French public authorities are yet to comment on the Proposal and there is little indication of how they intend to proceed. It is likely that the implementation of the Proposal will require a few amendments to French insolvency law, even if most of these provisions are already well settled in the French Commercial Code (FCC) Code de commerce, which contains the vast majority of rules applicable to insolvency proceedings.
Claw-back actions – Regarding avoidance actions, the Proposal provides for a minimum harmonisation which does not require EU member states to enact provisions that are more protective of creditors' interests.44 Articles L. 632-1 to L. 632-4 of the FCC already provide comprehensive and demanding provisions which allow avoidance actions to be brought against certain acts and transactions carried out during the look-back period. In addition, the French Civil Code entitles creditors to sue under the ‘action paulienne’ to have a specific transaction declared unenforceable against them, if they can show that it was concluded by fraud / in violation of their rights.
A few adjustments would need to be made however, for example in relation to intentionally fraudulent actions, i.e. ‘legal acts’ defrauding creditors,45 where the French legislator would have to extend the length of the look-back period to 4 years prior to opening of the insolvency.
‘Pre-pack’ procedures – Article 19 of the Proposal requires EU member states to include in their insolvency regime a ‘pre-pack’ proceeding composed of two subsequent phases, a ‘preparation phase’ and a ‘liquidation phase’. This provision would not fundamentally affect French law, nor the current practice of the ‘pre-pack’ in conciliation proceedings (procedure de conciliation). French insolvency law is broadly in line with the Proposal:46 Article L. 611-7 of the FCC provides for a ‘pre-pack’ assignment mechanism and, generally, the main provisions in the Proposal appear to be in place under French law, such as:
- the existence of two phases where only the second one is an insolvency proceeding within the meaning of Regulation (EU) 2015/848;47
- the lack of divestiture of the debtor in the ‘preparation phase’;
- the transparency of the offer;48
- the appointment of an insolvency practitioner during the ‘liquidation phase’ who may incur civil liability in the event of misconduct;
- the transfer of contracts necessary for the continuation of the business;49 and
- the principle of exclusion of the debtor's debts from the assignment.
‘Simplified’ liquidation proceedings for ‘micro-enterprises’ – The FCC already provides for a simplified procedure consistent with that provided for in the Proposal.50 However, the French legislator may have to make certain adjustments, in particular regarding the position given to the insolvency practitioner and the privileged use of electronic auctions. For instance, for ‘micro-enterprises’, the appointment of an administrator is mandatory under French law. Under the Proposal, such appointment could be avoided when it entails excessive costs for the State.51
The Proposal also encourages the extension of the scope of the French simplified judicial liquidation to a greater number of debtors that meet the European definition of ‘micro-enterprise’. It is possible that the French legislator may include of the simplified judicial liquidation in Annex A of Regulation (EU) n° 2015/848, with a view to increasing the visibility of this procedure at the European level.
D&O's duties to promptly file for insolvency if certain conditions are met – Under the Proposal, the directors of an "insolvent legal entity" should apply for opening of insolvency proceedings no later than 3 months after becoming aware (or 3 months after they can reasonably be expected to have become aware) of insolvency.52 Under French law, debtors have to declare the cessation of payments within forty-five days53 and debtors who fail to meet this requirement are guilty of mismanagement, which may give rise to liability for insufficiency of assets.54
As with the Proposal, French Law recognises a broad concept of directors, which covers not only de jure but also de facto managers. To this extent, French Law already complies with the Proposal. It even appears to be more stringent with regard to the time limit for declaring insolvency; 45 days from the cessation of payments, instead of 3 months after becoming aware of insolvency.
Creditors’ committees – The Proposal introduces a ‘creditors' committee’ to strengthen the position of creditors in insolvency proceedings, which aims to ensure a fair and predictable distribution of the value recovered from the insolvent debtor.55 The latter should not be confused with the creditors' committees that existed until 2021 under French law,56 nor with the classes of creditors introduced following the implementation of the Directive (EU) 2019/1023. Those French classes have the sole purpose of bringing together creditors to consider the nature of their claims and interests so that they can decide on a draft restructuring plan. Therefore, introducing ‘creditor committees’ into French law could represent the main difficulty in implementing the Proposal in France57 as it would imply a significant redefinition of the role of French collective proceedings organs. It would potentially give rise to confusion in roles or even a redundancy of the existing French provisions.
Initial reactions in Spain and potential impacts on the existing legal framework
In Spain, there has been limited reaction to the Proposal. There have been no statements by the legislator on how the implementation of the Proposal might affect existing insolvency regulations (namely the insolvency law reform act Ley 16/2022, de 5 de septiembre, de reforma del texto refundido de la Ley Concursal, “TRLC”), nor commentaries by scholars on the topic.
The implementation of the Proposal could arguably be easier than in other EU countries58 since the TRLC was recently approved (in December 2022), and included some of the aspects of the Proposal (although they were not developed in great detail). Notwithstanding this, the implementation of the Proposal will require further amendments of the TRLC, especially with regard to the regime of claw-back actions, the creation of creditor’s committees or the exoneration of the guaranteeing partner from the payment of debts in the liquidation of micro-enterprises.
A preliminary analysis of the potential impact of the implementation of the Proposal in the Spanish legal framework is set forth below.
Claw-back actions – The Proposal establishes different kinds of ‘legal acts’ that can be subject to claw-back: i) ‘legal acts’ benefiting only a creditor or a group of creditors (“Legal Acts Type I”); ii) ‘legal acts’ without consideration or with a manifestly inadequate consideration (“Legal Acts Type II”); and iii) ‘legal acts’ intentionally detrimental to creditors (“Legal Acts Type III”).
While the Proposal defines which ‘legal acts’ are subject to claw-back (Legal Actions Type I, II and III), the TRLC establishes that "acts detrimental to the estate” (in general) are subject to claw back. Apart from such general statement, Spanish insolvency law establishes some presumptions to determine which ‘legal acts’ must/can be considered ‘detrimental to the estate’ (and therefore, subject to claw-back):
- Presumptions iuris et de iure (i.e. legal presumptions where no evidence can be provided to the contrary): acts of disposition with no consideration and payment of credits due and payable after the declaration of insolvency (excepted if secured).
- Presumptions iuris tantum (i.e. presumptions where evidence to the contrary can be provided): acts of disposal in favour of parties closely related to the debtor, granting of security over pre-existing debts, payment of secured credits that were due and payable after the declaration of insolvency.
Under the TRLC59, Legal Acts Type I, II, and III are subject to claw-back if they have been carried out within 2 years60 prior to the insolvency submission or after the submission and prior to declaration of insolvency. Conversely, under the Proposal, Legal Acts Type I, II, and III are subject to claw-back if they have been carried out i) within 3 months prior to the insolvency submission for Legal Acts Type I; ii) within 1 year prior to the insolvency submission for Legal Acts Type II; and iii) within 4 years prior to the insolvency submission for Legal Acts Type III61.
D&O's duties to promptly file for insolvency if certain conditions are met – Articles 36-37 of the Proposal are intended to prevent D&Os from delaying the opening of insolvency proceedings when there is evidence of an entity’s distress. According to the Proposal, ever since the directors become aware - or could reasonably be expected to have been aware - that the entity is insolvent, they are obliged to submit the request for insolvency within 3 months. As the TRLC62 establishes a 2-month period instead of 3, no amendments may be needed to the law. Article 37 of the Proposal aims to prevent the deterioration of the entity’s value, declaring D&Os civilly liable for the damages that the delay of the request may entail. This consequence is already encompassed in the TRLC.63
‘Pre-pack’ procedures – The so-called ‘pre-pack’ procedures set out in the Proposal are already encompassed in the TRLC64 but the Proposal includes a more regulated regime. As to the possible amendments to the TRLC, amendments may be required so that parties closely related to the debtor are able to acquire the debtor’s business or part thereof, under certain conditions.
Creditors’ committees – The Proposal proposes measures which require the establishment of a creditors' committee if the creditors elect to do so, in order to protect the interests of all creditors. These committees, consisting of 3-7 members have various functions, including the duty to supervise the insolvency trustee and the duty to ensure that the liquidation is conducted as fairly as possible. There is no similar provision in the TRLC: thus, unless the Spanish legislator chooses to exclude the creation of creditors’ committees (e.g. when the overall costs thereof are not justified in view of the limited economic relevance of the insolvency estate, of the low number of creditors or the circumstance that the debtor is a microenterprise), the TRLC would need be amended to implement these aspects of the Proposal.
‘Simplified’ liquidation proceedings for ‘micro-enterprises’ – In Spain, as of 1 January 2023, there are special proceedings for the liquidation of ‘micro-enterprises’,65 so the provisions of the Proposal related to the winding-up of insolvent micro-enterprises (articles 38-57) would not require major amendments to the TRLC. The most important amendment that the TRLC may be subject to is likely to be the introduction of a rule allowing - only in simplified liquidation procedures for micro-enterprises - partners, owners or founders with unlimited liability (personally liable for debts) to be fully discharged from debts once the liquidation is completed.
Initial reactions in The Netherlands and potential impacts on the existing legal framework
In the Netherlands, the Working Group on Assessment of New Commission Proposals (Werkgroep Beoordeling Nieuwe Commissie Voorstellen; the "BNC") has conducted an assessment of the Proposal. Broadly speaking, the BNC agrees with the legal framework of the Proposal. The Dutch government considers a well-functioning system of insolvency law of great importance to society: however, it seeks to prevent any interference of the Proposal on the Dutch insolvency practice that would affect its efficiency.
The Proposal contains several potential differences in comparison with the current insolvency legislation in the Netherlands, mainly codified in the Dutch Bankruptcy Act (Faillissementswet; "DBA"). Three of these differences could significantly impact the existing Dutch legal framework:
- the expansion of the possibilities for the liquidators to successfully initiate claw-back actions;
- the possibility of using the ‘pre-pack’ method, currently not allowed in the Netherlands; and
- the obligation for directors to file for bankruptcy and the directors' liability that follows from late filing for bankruptcy.
Should the Proposal be accepted and enter into force in the current form, it could have the following impact on the Dutch legal framework:
Claw-back actions – The DBA already provides for a legal framework entitling a bankruptcy trustee to undo legal acts of a bankrupt debtor that have been harmful to creditors and to reverse the transaction, e.g. a payment (art. 42 ff. DBA). Therefore the bankruptcy trustee is entitled to nullify congruent and incongruent legal acts if certain requirements are met. These requirements are similar to the requirements proposed in the Proposal. However, in relation to the avoidance of incongruent legal acts, the Proposal would seem to imply that it is sufficient to prove that the debtor was unable to fulfil its payable debts (taking into account a three months period). This seems to be an objective test and that there would appear to be no requirement to prove the subjective requirement of the debtor's awareness of its inability to fulfill its payable debts. This is a significant differentiation from the current DBA since the DBA requires that proof that the debtor was (or should have been) aware of own inability to fulfil its payable debts for the nullification of incongruent legal acts.
Furthermore, omissions are currently excluded from being the subject of claw-back actions under the DBA. Therefore the Proposal will broaden the scope of the Dutch legal framework, as it includes omissions in the definition of ‘legal acts’ subject to claw-back.
‘Pre-packs’ – The ‘pre-pack’ method has been regularly adopted in the Dutch legal system since 2017. On two occasions, in 2017 and 2022, the European Court of Justice (ECJ) addressed preliminary queries from Dutch courts regarding the ‘pre-pack’ method.66 The ECJ concluded that ‘pre-pack’ was only allowed if it is codified into national law. As ‘pre-pack’ had not yet been codified in the Netherlands, its application was precluded. Currently, the Dutch legislator is considering two legislative proposals which would codify ‘pre-packs’, namely the Continuity of Enterprises Act (Wet Continuïteit Ondernemingen I) and the Transfer of Undertaking in Bankruptcy Bill (Wetsvoorstel Wet Overgang Van Ondernemingen in Faillissement). In anticipation of ECJ case law on the subject matter, both legislative proposals have been put on hold. With the introduction of the Proposal and the ECJ ruling, the legislative proposals are likely to stay on hold until the Proposal has been finalised.
D&O's duties to promptly file for insolvency if certain conditions are met – The D&O’s duty to file for bankruptcy and the D&O's liability for late filing for bankruptcy will be a new addition to the Dutch legal system. Currently, article 2:246 of the Dutch Civil Code (Burgerlijk Wetboek; “DCC”) prohibits a company’s D&Os from filing for bankruptcy without first seeking permission from the shareholders. The reasoning behind these new obligations in the Proposal is that D&Os are deemed to be the first to become aware of the company’s distress.
‘Simplified’ liquidation proceedings for ‘micro-enterprises’ – The Dutch legal system already contemplates two procedures for the simplified liquidation of companies, namely the so-called ‘turbo-liquidation’ and the ‘accelerated liquidation in bankruptcy’ (art. 2:19(1) and/or 2:19(4) DCC; and art. 16 DBA). These procedures are not limited to ‘micro-enterprises’, and are thus broader in scope compared to the 'simplified' liquidation set out in the Proposal. As these are procedural differences only, it is unclear whether any amendments to the DBA will be required for the Dutch legal framework to be in line with the current wording of the Proposal.
Creditors’ committees – The Dutch legal framework is broadly in line with the creditors' committee prescriptions in the Proposal. However, pursuant to the DBA, the establishment of a creditors' committee requires approval by a supervisory judge (rechter-commissaris), whilst no such approval is required under the Proposal. Thus, if the current wording of the Proposal is approved, the provision for supervisory judge approval may have to be amended in the DBA.
Initial reactions in Italy and potential impacts on the existing legal framework
In Italy only limited comments on the content of the Proposal are available to date, especially in relation to its transposition into Italian law. So far, it has been pointed out that if the current wording of the Proposal were to be adopted, the Proposal would largely be in line with the inspiring principles of the rules currently in force in Italy – albeit with some necessary adaptations, given that to a certain extent the Proposal appears to be inspired to German law principles.67
Obvious differences from the current legal framework set out in Italy’s Business Restructuring and Insolvency Code (Legislative Decree No. 14 of 12 January 2019, “BRIC”) are:
(i) the notion of transactions subject to claw-back, which under the Proposal extend to any conduct having legal effects, including the distressed party’s omissions;68
(ii) the extension of the look-back period may lead to a general tightening of the rules currently in force, especially with reference to claw-back actions for transactions with manifestly inadequate consideration;
(iii) procedural rules for liability actions against D&Os.69
We discuss below the Proposal’s potential impact on Italy’s existing legal framework:
Claw-back actions – The BRIC’s current rules on transactions detrimental to creditors70 do not differ substantially from those previously provided for by the old Italian Bankruptcy Law.71 The European Commission - in contrast with the BRIC’s rules72 - has opted for a “broad” concept of ‘transaction’ which includes any conduct having legal effects73, including debtor’s omissions that have the effect of causing harm to creditors. In addition, the Proposal includes not only the debtor’s transactions, but also those performed by the debtor’s contractual counterparties or even by third parties. In this respect, the current notion of ‘transaction’ found in the Italian BRIC may necessarily have to be broadened. Specifically:
- On preferential transactions favouring a creditor over the others,74 the Proposal does not significantly diverge from current Italian rules. Under article 166(2) BRIC, transactions performed by the debtor 6 months prior to the opening of the judicial liquidation or any time thereafter, are avoidable if the liquidator proves that the favoured creditor was aware of the debtor’s insolvency.
- On gratuitous transactions or transactions for inadequate consideration, the Proposal differs significantly from Art. 166(1) BRIC, by excluding the transaction from these rules if the creditor proves being unaware of the debtor’s insolvency. Also, under the BRIC, consideration is ‘inadequate’ if the obligations assumed by the distressed party exceed the given or promised consideration by 25%.
- On transactions intentionally performed to the detriment of creditors, the Proposal provides for a set of rules comparable to the ordinary avoidance action75 in Italy which is set out in Articles 2901 of the Civil Code and 165 BRIC.76
‘Pre-packs’ – The BRIC provides for the accelerated sale of the company which are partly akin to the ‘Pre-pack’ plan concept in the United States. Many other provisions which permit a ‘pre-pack’ sale in a restructuring context can be found throughout the new Italian BRIC code.77 For instance, the newly-established Negotiated Settlement procedure under the BRIC allows a court-sanctioned transfer of the distressed business (or business branch) with discharge of previously incurred debt. In general, the BRIC rules on creditor arrangement procedures, such as Composition with Creditors (Concordato Preventivo) and Debt Restructuring Agreements (Accordi di Ristrutturazione dei Debiti), contemplate the sale of the assets of a distressed business negotiated before and completed immediately or shortly after entering into the arrangement scheme.
D&O's duties to promptly file for insolvency if certain conditions are met – Under Article 36 of the Proposal, EU member states will have to ensure that in the event of corporate insolvency, the directors are to submit a request for the opening of insolvency proceedings within 3 months after having become aware (or from when they can reasonably be expected to have become aware) of distress. In the preparatory documents published with the Proposal, the European Commission specified that the notion of ‘director’ shall be interpreted broadly, in line with the suggestion of the UNCITRAL Legislative Guide on Insolvency Law78 according to which “As a general guide, however, a person might be regarded as a director when they are charged with making or do in fact make key decisions with respect to the management of a company”.79
The wording of Articles 36-37 of the Proposal do not clarify whether “submit[ting] [...] a request for the opening of insolvency proceedings”80 could include a request by the directors to access a restructuring alternative to liquidation, such as negotiated settlement81 or a debt restructuring agreement82 which are some of the restructuring tools available in Italy. A literal interpretation of the rule would suggest not, but this may be at odds with current Italian insolvency law where several restructuring tools are also accessible by the distressed party.83 Such an interpretation would also be at odds with the principles expressed in EU Directive 2019/102384 tending to favour the distressed party’s recourse to preventive restructuring tools as much as possible, instead of insolvency. On this aspect, clarifications would be welcome when the Proposal is being considered in more detail by the EU institutions.
‘Simplified’ liquidation proceedings for micro-enterprises – Articles 268 ff. of the BRIC envisage resorting to a controlled liquidation procedure for smaller commercial enterprises,85 agricultural enterprises, professionals and generally for all non-entrepreneurs not specifically excluded. The requirements to access this tool differ slightly from those set forth in the Proposal, which refers to the criteria in the definition of ‘micro-enterprise’ in Annex A of Commission Recommendation (EC) 2003/361:86 a ‘micro-enterprise’ is “an enterprise which employs fewer than 10 persons and whose annual turnover or annual balance sheet total does not exceed EUR 2 million”. There is some overlap in the criteria set out in the BRIC (which refer to categories of small debtors who are not subject to other arrangement schemes, and exclude liquidation if debts do not exceed €50,000) and this suggests an organic transposition in Italy of the Proposal’s provisions on simplified liquidation of micro-enterprises.
Creditors’ committees – In Italy the role of the creditors’ committee – which is contemplated in insolvency liquidation proceedings – has not been substantially affected as a result of the enactment of the BRIC,87 whereby the major innovation envisaged by the European Commission is enshrined in Article 58(3) of the Proposal, allowing each EU member state to exclude the possibility of setting up a creditors’ committee if the overall costs to be incurred are not justified or sustainable in light of the available assets of the proceedings, the number of creditors or the debtor being a micro-enterprise.
The extent to which the approval process of the Proposal will affect its substance is yet to be seen, as is the timing and ways in which the final directive will be transposed into domestic law by EU member states. In this respect, while the Proposal is awaiting its first-reading in the European Parliament, it would be helpful if the EU Council were to discuss and adopt a general guideline on how to approach the Proposal, in order to help speed up the enactment process and to facilitate an agreement between the institutions involved in the complex legislative mechanisms of the European Union.88
Authored by Hessel Roeleveld, Manon Cordewener, John Beck, Kaitlyn Hittelman, Srishti Kalro, Oliver Humphrey, Rebecca Newell, Ardil Salem, Kim Lars Mehrbrey, Marine de Montecler, Jon Aurrekoetxea, Eugenio Vázquez, Filippo Chiaves, Federico Pappalettera, and Pietro Orlandi.