The European Commission is pursuing its „EU Startup and Scaleup Strategy“ vigorously. A cornerstone of this strategy forms a regulatory initiative that would establish a specific legal framework governing various aspects of ‚innovative‘ businesses from ‚birth to death‘. Since qualifying EU businesses would need to opt into such a scheme, the framework will create a separate legal regime at the EU level besides Member States‘ laws – a ’28th Regime‘.
A 28th insolvency regime?
Since the ’28th Regime‘ encompasses the ‚death‘ of a business, it seems obvious that it must comprise a 28th insolvency framework. The latest briefing of the European Parliament indicates that this is indeed intended, yet not universally supported by stakeholders in Brussels.
There are (at least) two challenges if the project was to include a separate 28th insolvency law framework. First, the EU legislator (which includes the Member States in the Council) would need to agree on the content of these rules. This task alone has proven notoriously difficult to pursue ever since the European idea included the ambition of creating a harmonised legal framework. The modest achievements in recent attempts to ‚further harmonise‘ Member States‘ insolvency laws illustrate the size of this challenge.
Second, any 28th insolvency regime would only make sense if accompanied by a separate cross-border insolvency framework. The simple application of the European Insolvency Regulation would be harmful because it would allow for the commencement of local (secondary) insolvency proceedings in all the Member States, in which the debtor has an establishment. As a consequence, local insolvency law would supersede the 28th regime (see Art. 3 (2), 35 Eur Insolv Reg.) in all Member States, where the business has relevant assets and personel, in particular in the State of the main establishment. Even more, the COMI-based jurisdiction rule (Art. 3 (1) Eur Insolv Reg.) would not be able to cater for a 28th regime that is not necessarily connected to any state where the business has its centre of main interest (COMI).
Ideas for a new approach
Faced with such fundamental challanges, it seems appropriate to consider a special framework that is designed from a blank page starting with the special needs of businesses in a 28th regime: innovative companies in the shape of startups or scaleups. The regime would not be available for other types of businesses (from ‚mum-and-pop shops‘ to corporate groups). Provided that the EU initiative remains focussed on such ‚innovative‘ companies, the design of a special insolvency framework could be developed by the typical financial structure and stakeholder incentives present in such companies.
In addition, it must be remembered that the insolvency framework would be relevant only if an innovative company cannot be liquidated solvently, which is an exercise governed by company law. If funding cannot be secured for the next funding cycle, the remaining value in the company (IP rights, hardware, goodwill) must be preserved while the company is orderly wound up.
A simplified insolvency framework would provide a clear and predictable set of rules for this task that could be developed around these guiding principles:
- No distribution on behalf of risk capital lending (both equity and debt lending) because the investment risk materialised;
- Sponsors retain the right to realize IP rights and hardware (as agreed in the financial documents) without the risk of avoidance actions or fraudulent transfer claims (safe harbour);
- Directors are immediately discharged from any obligation related to the business including late filing liability (with the exception of fraud);
- In return, sponsors fund full payments on behalf of other unpaid creditor claims (including tax claims).
This set of rules would provide stakeholders, who funded the exploration of innovative ideas, the exclusive right to retain the product of their investments and protect them from potential insolvency law risks (sage harbour) in exchange for a last round of (limited) exit funding. The sponsors and directors of innovative companies would be able to move on from failing endeavours with predictability and certainty if they ensure that other creditors are paid as promised.
Stakeholder incentives
Such an insolvency framework is designed to give Member States comfort. Governments would not need to insist on the commencement of secondary proceedings because all local creditors (who are not risk capital providers) are paid.
Further, the distinct nature of the new set of rules should ensure that the initiative is not threatend by Member States‘ vetos driven by concerns of establishing a model provisions for a future EU-wide uniform insolvency law for all types of businesses.
The proposed framework provides for a fundamental set of rules triggered by the opt-in of the company. Stakeholders remain able to rely on the general set of insolvency law as applicable if preferred and if accepted by the company. Even in an opt-in case, the distinct set of rules defines a default scenario that serves as an alternative scenario if stakeholders prefer a restructuring as a solution. Finally, the special framework is capable of supporting a pre-pack sale if this instrument was included.
Cross-border rules safeguarding this approach
Any implementation of a 28th insolvency regime requires adjustments to the EU cross-border insolvency framework. The 28th regime is not the lex fori concursus as identified in Art. 7, 35 Eur Insolv Reg. by reference to the Member State with jurisdiction to open main or secondary proceedings. It is a standalone set of rules, preferably under EU law, e.g. included in a new chapter in the revised European Insolvency Regulation. Jurisdiction to open such proceedings could be centralised with one special court in Europe (potentially followig ideas on the overall design of the legislative project). Recognition of its legal effects could be secured by adding a sentence in Art. 32 (1) Eur Insolv Reg.
Any recognition outside of Europe would depend on the respective cross-border insolvency framework in the target jurisdiction. Relevant jurisdictions like the United States or the United Kingdom have implemented the UNCITRAL Model Law on Cross-border Insolvency and allow for the recognition and support of decisions issued in main and non-main proceedings. The ability to rely on these frameworks should guide the further development of a special cross-border regime for the 28th insolvency regime.