Insolvency special The following four articles explore the various facets of insolvency law, starting with a comparison of international jurisdictions prefaced by Mathew Ditchburn. Illustrations by Simon Pemberton
The recession might be global but international insolvency laws have a distinctly local feel, particularly when it comes to rescuing businesses. Most countries have seen a rash of corporate failures but, inevitably, each has its own set of insolvency rules for dealing with them.
The
Following the Enterprise Act 2003, introduced after the dot.com crash to rescue distressed businesses, an administrator can be appointed by a company or its directors or the holder of a qualifying charge without a court order. This makes the process cheaper, quicker and easier.
The primary purpose of administration is to maintain the company as a going concern. More often, the profitable parts are sold to a new company and the liabilities left behind. In “pre-pack” administrations (see p83), a buyer is identified and terms agreed before the administrator is appointed. Buyers are often connected to the failed business, which may make them uniquely placed to achieve the rescue. Detractors argue that this risks abuse because it rules out an open market sale to the highest bidder.
Administrators have broad powers. Unlike liquidators or companies in US Chapter 11 proceedings, they cannot disclaim onerous contracts. A statutory moratorium protects the company from legal proceedings.
Company voluntary arrangements (CVAs) have made a comeback. These are hypothetical contracts between a company and its creditors, whereby a proportion of the debts are paid off, enabling the company to continue trading. The contract will bind all creditors, regardless of whether or how they voted, if it receives the approval of 75% by value of creditors. Some see this as a way of restructuring a company’s leasehold liabilities. Stylo Barratt, for example, tried unsuccessfully to use a CVA to convert rent to a percentage of turnover, while JJB Sports changed its leases from quarterly to monthly payments (see p83).
As property prices begin to recover, the
How we compare
CVAs are probably the nearest equivalent to Chapter 11 proceedings. The business remains in the control of the company, rather than a court appointee. The CVA proposal is similar to the reorganisation plan and disclosure statement voted on by creditors in Chapter 11 proceedings.
One key difference is the absence in the
French amicable settlement proceedings are a hybrid. Management remains in the hands of the company but a court-appointed mediator or conciliator facilitates negotiations with creditors. The aim of avoiding a cessation of payments is a step towards a rescue culture. Safeguard proceedings take their inspiration from Chapter 11 but involve a judicial process.
The Spanish system has been streamlined and it now has a single, court-based but flexible process. The existing management retains control of the company provided that the directors make the application.
In some jurisdictions, it is more difficult to avoid insolvency proceedings. In the
Wish you were here
This disparity between insolvency laws and the possibility of rescuing a company under its existing management has led to “insolvency tourism”, particularly by German companies migrating to the
During the recession, insolvency laws in all jurisdictions will be tested and there may be calls for reform. Whether this means that the rescue culture will be pulled back or pushed further remains to be seen. Since governments are unlikely to make major changes until the economic dust settles, companies and creditors will have to make the most of the existing rules.
Mathew Ditchburn is an of counsel in the real estate disputes team at Lovells LLP
US
In the
On filing for Chapter 11, an automatic stay of all legal actions gives the company time to propose an orderly restructuring. Except in cases of fraud or gross mismanagement, the business remains in the control of the company, termed a debtor in possession (DIP). The DIP runs day-to-day operations while negotiating a reorganisation plan with creditors and the bankruptcy court.
Creditors are generally barred from cancelling contracts because of the automatic stay. Subject to court approval, the company can reject onerous contracts, including leases, but retain those crucial to the business. The court supervises the sale of company assets and approves major transactions or expenditure in a transparent process. Official committees of creditors or shareholders and informal committees of banks, bondholders and others may be heard in the case.
Chapter 11 is flexible and allows almost any type of lawful restructuring. Creditors and shareholders can vote on the proposed plan, which is filed with a disclosure statement. If it is approved and confirmed by the court, the company will continue to operate and pay its debts under its terms. In the absence of agreement, the court will protect the legal priorities of creditors and can approve a reorganisation plan proposed by the company using a procedure called “cramdown”. It binds all creditors, even if they do not agree.
Chapter 11 is criticised for leaving the company’s management in place as a DIP, since its actions led to insolvency. Proponents argue that the existing management knows the company and its customers best and will be subject to the strict oversight of the court.
The time and expense involved are also criticised. Some cases involve armies of lawyers and restructuring professionals, whose costs are borne by the company – a significant factor in the level of recovery by creditors. Successful Chapter 11 proceedings, however, generally return significantly more value than would liquidation.
Robin Keller is a partner and Hugh Hill is a lawyer in the business restructuring and insolvency team at Lovells LLP, New York
A director or management board member must file for insolvency within three weeks of the company becoming insolvent. Creditors can file for insolvency if their claims are not settled. Preliminary insolvency proceedings are initiated, during which the court verifies whether assets can cover the costs of proceedings.
If costs are covered, the insolvency proceedings can begin and a liquidator is appointed. The powers of the existing management terminate. The liquidator can end legal relations and agreements and contest payments made by the company during the three months before it filed for insolvency, and may demand repayment without consideration. This period may be longer up to 10 years for shareholders’ loans, agreements with family members and wilfully adverse transactions.
Once insolvency proceedings have begun, creditors must register their claims in order to be taken into account. The four types of creditor are: Aussonderungsberechtigte and Absonderungsberechtigte – secured creditors who, for example, own land charges and mortgages on property belonging to the company and liens on machines or accounts Massegläubiger – those who deal directly with the liquidator or with whom the liquidator has decided to continue business and Insolvenzgläubiger – all other creditors.
Insolvency proceedings take at least a further three months most last several years. Dividends average at 3% of the claim.
If a liquidator does not continue the business, he can sell the assets, particularly real property. A buyer can then terminate any tenancy agreement, even a long-term one, with immediate effect. By contrast, tenants will not have a termination right. If the insolvent company is a tenant, the liquidator can terminate the tenancy agreement on three months’ notice. The landlord cannot terminate, but the liquidator must pay the rent if he decides to carry on business from the property.
German insolvency law is complex and offers all parties various options. Those taking unlawful advantage of its flexibility, including creditors, may face criminal prosecution and be liable for imprisonment of up to 10 years or a fine on conviction.
Sabine Reimann is a real estate partner at Lovells LLP, Düsseldorf
Amicable settlement proceedings include the mandat ad hoc here, a solvent company petitions the court for the appointment of a mediator to help formulate a voluntary arrangement with its creditors. The arrangement is contractual only and cannot be imposed on dissenting creditors. If a company faces more serious difficulties, or is insolvent for less than 45 days, it may apply for conciliation proceedings, whereby a court-appointed conciliator will help it to reach an arrangement with its creditors that can be formalised by the court. The court may defer debts arising under claims filed during the proceedings and stay enforcement proceedings. Creditors that advance new financing under the arrangement will have priority in any subsequent judicial insolvency proceedings.
Judicial proceedings apply to debtors that are unable to meet their debts out of available assets: known as “cessation of payments”. They include: reorganisation proceedings, where the company has a good chance of recovery and liquidation proceedings, where a reorganisation is not possible. Reforms in 2005 implemented safeguard proceedings inspired by Chapter 11, which were made more attractive to debtors following changes to the rules in 2008. Whereas judicial proceedings were previously available only to debtors that faced insuperable difficulties likely to lead to cessation of payments, safeguard proceedings are initiated by debtors facing difficulties “they are unable to overcome” and aimed at dealing with financial difficulties and saving the business.
The main features of judicial proceedings include: the suspension of legal actions against the debtor a prohibition on paying debts that arose prior to the proceedings and the continuation of existing agreements, even if they provide for automatic termination in the event of insolvency. The court-appointed administrator decides whether to continue or terminate ongoing contracts. Debts arising under contracts continued by the administrator normally have priority. Any creditor that fails to file claims for pre-insolvency debts within two months will lose the right to any distribution.
Safeguard and reorganisation proceedings can give rise to a plan for the recovery or continuation of the business or the sale of all or a portion of the business to a third party. Liquidation proceedings can end in a sale of all or part of the business as a going concern or the realisation of a company’s assets.
Virginie Adam is a disputes lawyer and Sophie Lok is a banking lawyer at Lovells LLP, Paris
The Insolvency Act (introduced in 2004) sets out a single process for all potential situations: the directors file an application, in which case the judge checks only that formal requirements have been met, or a creditor applies to court. The advantage of the former is that the directors will not normally be removed from office except in cases of wilful misconduct or gross negligence.
Directors must file for insolvency within two months of the date on which they are, or should be, aware of the situation. If they breach this obligation, they may be liable for the company’s remaining debts once its assets have been sold. The courts have been flexible where late filing has not negatively affected the company’s financial position.
There are three possible outcomes to proceedings. The first, the implementation of a convenio anticipado or pre-packaged plan, consists of an agreement between the company and at least 20% of its creditors it is included in the documentation provided at the time of filing. There are no limitations on the contents of the agreement, which may deal, among other things, with the continuation of the business with partial debt cancellation, a debt for equity swap and asset disposals. Second, an “ordinary” insolvency agreement (or convenio ordinario) is subject to certain legal restrictions. Finally, the company can be wound up.
Reforms in 2008 led to a two-year suspension of the statutory obligation for directors to call a shareholders’ meeting and to propose a capital reduction if the company’s losses reduce net asset value (NAV) to below two-thirds of equity (or to wind up the company if NAV falls below 50% of the share capital) .
More recent changes aim to secure refinancing implemented by real estate companies in the “precautionary” period, the two years prior to insolvency proceedings where all transactions may be reviewed by the administrator. If the refinancing meets certain requirements, it is protected and may not be revoked. Existing schemes may be adapted to meet these requirements and benefit from the new regulation.
Emilio Gomez is a real estate partner at Lovells LLP, Madrid
