Recent European legislation is giving reputable bankrupt entrepreneurs a second chance and makes it easier for viable enterprises in financial difficulties to access preventive restructuring frameworks at an early stage to prevent insolvency.
The new Directive of the European Parliament and of the Council on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt (the Business Insolvency Directive) amends Directive (EU) 2017/1132 (Directive on restructuring and insolvency) and seeks to reduce barriers to the free movement of capital and establishment, created by differences in the law of Member States with regards to their national rules for insolvency and restructure. The Business Insolvency Directive complements the 2015 Insolvency Regulation and Member States have two years to implement its provisions or, if this is duly justified, an additional year.
The aim of the Business Insolvency Directive
Essentially, the Business Insolvency Directive ensures that honest debtors in each Member State are assisted in identifying situations that could lead to insolvency, early access to a preventive restructuring framework to prevent it, or, at the very least, a “second chance” if insolvency does occur. The introduction of a harmonised framework will enable the internal market to function efficiently, without undue delays, cost and uncertainty. Such uncertainty can make it unnecessarily difficult for honest and viable businesses to stabilise after facing financial hardship and can mean additional costs for investors who could provide assistance to such distressed enterprises, making them less likely to invest in an uncertain situation.
In addition to the above, the Business Insolvency Directive hopes to reduce the amount of non-performing loans on bank’s balance sheets and prevent the creation of similar debt by ensuring that action is taken prior to the enterprise defaulting on their loans. It has been suggested that small and medium-sized enterprises are particularly to gain from this framework, as they may have otherwise lacked the resources required to discharge themselves from debt in an efficient and timely way.
Key elements of the new rules
The Business Insolvency Directive creates a procedure that is similar to the UK’s Scheme of Arrangement and the American Chapter 11 plan procedure. Where there is a ‘likelihood of insolvency,’ the debtor can suggest a plan to some of its creditors, aimed at facilitating negotiations between the parties prior to any eventual insolvency, to try and prevent the insolvency from happening. If necessary, the negotiations can be supported by a stay of enforcement actions. According to the Business Insolvency Directive, the creditors and/or shareholders will vote on the plan in “classes” and then the court will examine the fairness of the plan to decide whether or not it shall be approved. The decision of the court will bind even dissenting creditors, which is very similar to the US’ cross-class cram down mechanism.
The European Parliament has allowed some flexibility with regards to the implementation of the Business Insolvency Directive. Notably, each state is free to define “likelihood of insolvency” as well as the criteria for each class. One could argue that allowing such great flexibility could prove to be counter-productive to the whole aim of the Directive, as it will naturally lead to discrepancies in national law, although of course this remains to be seen.
Each State will also have considerable flexibility with regards to the safeguarding of dissenting creditors and/or shareholder’s interests against unfair plans. Member States are essentially given a choice with regards to deciding when they can impose a restructuring plan upon a dissenting class of creditors and/or shareholders. The legislators have adapted an ‘absolute priority rule’ (APR) which is currently used in the US, but at the same time allowing for a more lenient approach than that used in the US. Essentially, the Business Insolvency Directive suggests that a dissenting class of creditors would need to be paid in full before anything can be distributed to a lower ranking class while ensuring that, if it is necessary to achieve the aim of the plan and as long as there is no unfair prejudice on the rights or interests of any affected parties, enterprises can deviate from the APR.