insolvency

Ideas for an insolvency framework for innovative companies in a 28th Regime

StephanMadaus

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.

Principles for a special cross-border restructuring law

StephanMadaus

This week UNCITRAL Working Group V has started considering the thorny issue of applicable law in insolvency proceedings in its latest project. The deliberations use the recommendations 30–34 and accompanying commentary of the UNCITRAL Legislative Guide on Insolvency Law (the “Guide”) as the starting point and intend to focus first on lex fori concursus and exceptions thereto in the context of a simple scenario– an insolvency proceeding with respect to a single debtor – taking up any other issues of applicable law in insolvency proceedings. The baseline scenario already encompasses the question whether applicable law rules may raise distinct issues in the context of reorganization as opposed to liquidation. In my view, the answer to this question is YES based on the assessment published in my new Working Paper (download here).

The paper explains the phenomenon of a restructuring (or reorganization in US bankruptcy law terminology) and the mechanisms for cross-border effects. It analyses the role of the lex causae and continues to portray why this role has been sidelined in insolvency proceedings by the lex fori concursus. The analysis demonstrates that the asset-oriented rules and principles of cross-border insolvency law are not well aligned with the needs in debt-oriented restructuring procedures. The paper concludes by identifying principles for the development of a special cross-border restructuring framework based on the principles of Private International Law.

The key insights of the paper are summarizes as follows:

(1) The debtor’s COMI is not a solid criteria both for allocating debt-oriented restructuring proceedings and their recognition abroad.

(2) Debt-restructuring proceedings in the country closest connected to the law governing the restructured debt under PIL rules shall pincipally both be available there (in terms of international jurisdiction even without COMI) and recognised abroad.

(3) Debt-restructuring proceedings in a country with (only) a sufficient connection to the law governing the restructured debt under PIL rules may pincipally be made available there (policy choice in terms of international jurisdiction with or without COMI and extending the lex fori to substantive modification) but only recognised in countries with closer connections under a substantive protection test.

(4) Debt-restructuring proceedings in the country not connected to the law governing the restructured debt under PIL rules shall pincipally not be made available (in terms of international jurisdiction without COMI) and cannot expect to be effective abroad.

These insights may provide orientation in a world where modern legislation shows the tendency to extend the tools available in restructuring and insolvency proceedings to affect substantive rights. Plans and discharges may discharge or amend creditor rights against third parties in or even without a group context. Executive contracts may be terminated not only in case of the administration of a bankruptcy estate but also if petitioned by the debtor in some (Dutch) restructuring proceedings.

European Model Protocols – Abschluss des EU-Forschungsprojekts

StephanMadaus

Am 17. Juni 2021 hat ein Forschungsprojekt seinen formalen Abschluss gefunden, dass im Jahr 2017 in Rom begann: die Entwicklung eines European Model Protokolls auf Basis der seit ca. 30 Jahren etablierten Praxis in grenzüberschreitenden Insolvenzen. Auf der finalen Konferenz, die leider nur online stattfinden konnte, erläuterte das Projektteam seine Forschungswege und -ergebnisse. Das Projekt wurde durch die EU finanziert (JUST-AG-2017/JUST-JCOO-AG-2017).

Kooperationspflichten für Verwalter und Gerichte in der EuInsVO

Das im Projekt erarbeitete European Model Protocol übernimmt nun nicht schlicht die in 30 Jahren erarbeiteten Inhalte von Kooperationsvereinbarungen zwischen Insolvenzverwaltern aus mehreren Nationen. Es nimmt seinen Ausgangspunkt vielmehr in den besonderen Vorgaben der Europäischen Insolvenzordnung, die seit 2017 sowohl für Haupt- und Sekundärinsolvenzverfahren als auch für Insolvenzverfahren über transnationale Unternehmensgruppen allgemeine Kooperationspflichten vorsehen. Diese Pflichten treffen dabei nicht nur die beteiligten Verwalter, sondern auch die Gerichte.

Zwei unterschiedliche Adressaten derselben Pflicht

Auf der Basis einer detaillierte dogmatischen Analyse der sich hieraus ergebenden zwingenden rechtlichen Vorgaben haben wir entschieden, zwei separate Modellregelungen zu schaffen.

Das Verwalter-Protocol

Der erste Teil des European Model Protocol richtet sich an Verwalter, die den Inhalt, die Formen und die Grenzen ihrer Kooperation konkretisieren und so planbar gestalten wollen. Hier bietet wir in 24 Modellklauseln Lösungen für die verschiedenen Themenkreise der Kooperation an: von der Informationsgewährung über die Behandlung streitiger Themen bis hin zur gemeinsamen Planentwicklung. Diese Protocols würde in der bekannten Form zwischen den Verwaltern verhandelt, angepasst und vereinbart.

Die Gerichts-Guidelines

Der zweite Teil des European Model Protocol betrifft die beteiligten Gerichte. Die von uns im Rahmen des Projekts gewonnenen empirischen Erkenntnisse legen hier nahe, dass Richterinnen und Richter in EU-Mitgliedstaaten starke Bedenken gegen eine persönliche Unterzeichnung von Vereinbarungen mit ausländischen Gerichten tragen, sodass aus unserer Sicht eine Kooperationsförderung nicht im Wege klassischer „Gerichts-Protocols“ erfolgen kann, sondern über die gesetzlichen Verfahrensordnungen bzw. – wo möglich – über Verfahrensgrundsätze oder Guidelines der betreffenden Gerichte erfolgen sollte, die aus Anlass eines Insolvenzverfahrens etabliert werden können, dann aber über den einzelnen Insolvenzfall hinaus wirken dürfen. Hierfür haben wir 20 Modellregeln entworfen, in denen Gerichte die Formen und Grenzen gerichtlicher Kooperation bestimmen und so rechtssicher planbar machen können.

Ziel: Die Etablierung einer EU-Protocol-Kooperations-Kultur

Das zweiteilige European Model Protocol bietet kooperationspflichtigen Beteiligten in einem grenzüberschreitenden Insolvenzverfahren einen Orientierungspunkt und eine Verhandlungsgrundlage für die konkrete Erfüllung dieser Pflicht. Für die Gerichte sind die Gerichtsverwaltungen und auch der Gesetzgeber, vielleicht sogar der EU-Gesetzgeber, aufgefordert, diese Grundlagen zu implementieren. Verwalter dürfen das EMP gern als Verhandlungsbasis nutzen. Die Musterregeln erlauben dabei nicht nur eine rechtssichere Handhabung der neuen Kooperationspflichten der EuInsVO. Sie dienen auch dazu, die bislang eher im Common Law zu findende Kooperationskultur in den EU-Mitgliedstaaten praktikabel und damit positiv erfahrbar zu machen. Vielleicht entsteht so mit der Zeit auch bei den Verfahrensbeteiligten in EU-Insolvenzverfahren eine Kultur protocol-gestützter Kooperation.

 

Weitere Einzelheiten zum Projekt, insbesondere zu den beteiligten Universitäten, finden sich hier.

 

Das European Model Protocol kann hier in englischer, deutscher, französischer, italienischer und spanischer Sprache heruntergeladen werden.

 

Der Forschungsbericht ist hier als Buch erhältlich, kann aber auch als e-Book hier heruntergeladen werden.

A Simple Guide to the Relative Priority Rule

StephanMadaus

The final version of the Directive (EU) 2019/1023 on Restructuring and Insolvency provides for a new rule to assess the fairness of the distribution of value under a plan if an affected class of creditors voted against the plan: the Relative Priority Rule (RPR). It is provided in art. 11 (1) (c) stating that one of the conditions to confirm a plan over the veto of a class is that the plan

‘ensures that dissenting voting classes of affected creditors are treated at least as favourably as any other class of the same rank and more favourably than any junior class’.

As an alternative to the RPR, art. 11 (2) allows Member States to implement an Absolute Priority Rule (APR) stating that the plan must ensure

‘the claims of affected creditors in a dissenting voting class are satisfied in full by the same or equivalent means where a more junior class is to receive any payment or keep any interest under the restructuring plan.’

As a result, all Member States are faced with the choice of either implementing the RPR or the APR when implementing the Directive into their local restructuring laws.

While the APR represents a concept that has been a part of US law for 80 years and German law for 20 years, the idea of an RPR is not just new. It has also not yet been explained extensively by scholars. If Member States consider implementing such a concept, they would probably like to know how it works and what it needs to work best.

The following quick guide aims at providing this assistance:

A simple guide to RPR (download here).

(An updated version correcting three typos was posted on Jan. 20 at 14:55 CET.)

ELI Report on business rescue finalized and approved

ELI Report on business rescue finalized and approved

StephanMadaus

Nach dem Eingang aller Berichte der National Correspondents im Jahr 2016 (siehe Beitrag) haben Prof. Bob Wessels und ich im Sommer 2017 unseren rechtsvergleichenden Bericht fertiggestellt. Er wurde auf der Jahrestagung des European Law Institute im September 2017 in Wien ohne Gegenstimme angenommen und ist nun als Instrument des ELI hier abrufbar. Eine Veröffentlichung des Berichts in Buchform ist für das erste Quartal 2018 bei Oxford University Press geplant. Dort sollen zeitgleich auch die Länderberichte (insgesamt ca. 1.100 Seiten) erscheinen.

Bob and I (left and center on the photo, with project assistant Gert-Jan Boon) are pleased to report that last week, during the General Assembly and Annual Conference of the European Law Institute (ELI) in Vienna, our report ‘Rescue of Business in Insolvency Law’ was approved as an official ELI Instrument.

The Report consists of 115 recommendations explained on more than 375 pages. Its ten chapters contain recommendations on a variety of themes affected by the rescue of financially distressed businesses: (1) Actors and procedural design, (2) Financing a rescue, (3) Executory contracts, (4) Ranking of creditor claims; governance role of creditors, (5) Labour, benefit and pension issues, (6) Avoidance transactions in out-of-court workouts and pre-insolvency procedures and possible safe harbours, (7) Sales on a going-concern basis, (8) Rescue plan issues: procedure and structure; distributional issues, (9) Corporate group issues, and (10) Special arrangements for small and medium-sized enterprises (SMEs) including natural persons (but not consumers). The Report also includes a glossary of terms and expressions commonly used in restructuring and insolvency matters.

We as Reporters feel that the Report is timely and may have a significant and positive impact on the harmonisation efforts of the European Commission as laid down in the November 2016 Proposal for a Directive on preventive restructuring frameworks. The topics addressed in the Report are intended to present a tool for better regulation in the EU, developed in the spirit of providing a coherent, dynamic, flexible and responsive European legislative framework for business rescue. Mindful of the European Commission’s commitment to better legal drafting, the Report’s proposals are formulated as comprehensibly, clearly, and as consistently as possible. Still, the recommendations are not designed to be overly prescriptive of specific outcomes, given the need for commercial flexibility and in recognition of the fact that parties will bargain in the ‘shadow of insolvency law’. The Report is addressed to the European Union, Member States of the EU, insolvency practitioners and judges, as well as scholars. The targeted group many times flows explicitly from the text of a recommendation or the context in which such a recommendation is developed and presented.

We cherish the belief that the report will assist in taking a next, decisive step in the evolutionary process of the European side of business rescue and insolvency law.

The suggested citation is either:

Wessels, Bob and Madaus, Stephan, Business Rescue in Insolvency Law – an Instrument of the European Law Institute (September 6, 2017). Available at SSRN: https://ssrn.com/abstract=3032309,

or alternatively

Wessels, Bob and Madaus, Stephan, Business Rescue in Insolvency Law – an Instrument of the European Law Institute (September 2017). Available at http://www.europeanlawinstitute.eu/fileadmin/user_upload/p_eli/Publications/Instrument_INSOLVENCY.pdf.