EU reforms aim to help businesses avoid likely insolvencies

The legislation represents a serious attempt by EU law makers to set a Europe-wide standard and legal framework for the establishment of pre-insolvency restructuring opportunities.

The new directive

The new EU directive 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 has been in the making for nearly three years. It represents the final product of discussions between EU law makers which commenced when the European Commission presented proposals for reform in 2016.

The directive was formally adopted by MEPs in March this year and then by the Council of Ministers in June. It was published in the Official Journal of the EU on 26 June and takes effect on 16 July. Each EU member state must implement the reforms into national law before 17 July 2021.

In many EU countries, the new laws that will be implemented will be the first of their kind.

The purpose of the legislation is to provide businesses threatened by insolvency with a legislative framework for preventive restructuring proceedings.

The reforms seek to remove obstacles struggling businesses may face when trying to attract capital and to reduce the accumulation of non-performing loans.

Early warning tools

A central component of the new directive is the requirement that each EU member state provide debtors with access to at least one 'early warning tool' that helps to detect circumstances that can lead to a likelihood of insolvency and which flags the need for debtors to act without delay.

The directive sets out a non-exhaustive list of examples for such tools, including alerts that notify debtors when they have failed to make payments, the provision of incentives to accountants, tax and social security authorities or other third parties to highlight a "negative development" to the debtor, and access to advisory services.

Access to a preventive restructuring framework

In line with the requirements of the directive, each EU member state will also be responsible for ensuring that businesses which are likely to fall into insolvency can access a preventive restructuring framework that "enables them to restructure, with a view to preventing insolvency and ensuring their viability, without prejudice to other solutions for avoiding insolvency, thereby protecting jobs and maintaining business activity".

Entrepreneurs can file an application for access to the preventive restructuring framework in the event of a likelihood of insolvency. Member states have the option to extend the right to apply to creditors or employees' representatives too, or to restrict it to legal persons only.

Preventive restructuring frameworks established under the new directive are likely to vary across the EU, as the implementation of the directive falls under the jurisdiction of each member state. It is clear, though, that the directive envisages a central role for insolvency practitioners in assisting with preventive restructurings. Care should be taken to ensure that the practitioner is qualified in the relevant procedure.

Restructuring plans

One aspect of the preventive restructuring framework is the so-called restructuring plan. The directive envisages that debtors and creditors will work together to agree restructuring plans, allowing courts to confirm a plan in the event the parties have not reached an agreement.

The possibility of participation, coordination and joint implementation of the plan is an important aspect of this procedure and of the directive as a whole. The plan, if approved, is binding only for the parties that agree to it.

The restructuring plan must contain, among other things, information on the debtor's current economic situation and the position of its employees, the measures it proposes to take to restructure and the consequences, where they arise, of such action on employment at the company. The plan should also set out a statement explaining why it has a reasonable prospect of preventing the debtor's insolvency.

The directive gives member states the option of excluding shareholders from this restructuring plan procedure and, at the same time, of creating mechanisms to prevent a blockade by shareholders in other ways. It is important that the company's representatives remain entitled to manage the business and dispose of the assets.

Breathing space from claims

The directive provides debtors with breathing space from claims that may be brought against them to enforce payments, for example, and enable them to negotiate restructuring plans under the new regime. It means that if a contract contains clauses that resolve a contract related to a preventive restructuring framework, these clauses may be ineffective.

Discharge

The principle that a business should be provided with a second chance at making a commercial success is enshrined into provisions relating to the discharge of debt.

According to the Directive, the preventive restructuring framework should now lead to a full discharge of debt after a maximum of three years. The aim of this provision is to avoid possible 'forum shopping' where businesses seek out the most favourable national discharge regulations within the EU.

New and interim financing

Under the new Directive, businesses in financial crisis should find it easier to access capital. This is because it introduces protections for new and interim financing for both the borrowing businesses and their lenders, though some exceptions can be applied by member states.

Member states must ensure that new or interim financing arrangements cannot be declared void, voidable or unenforceable, and finance providers will not be able to be held liable for detriment caused to creditors by the financing. Credit institutions are therefore exposed to a reduced risk of default on loans under the new regime.

Potential conflict in the rules

The introduction of early warning tools and the concept of second chance should increase the efficiency of restructuring, insolvency and debt relief procedures, and the reduction of restrictions on new and interim financing should help businesses recover from financial crisis easier and increase the attractiveness of doing business in the EU.

However, there is potential for the new rules to conflict with member states' existing insolvency regimes. The conflict could arise as a result of how insolvency is defined in national frameworks.

In Germany, for example, the concept of insolvency is already said to apply to impending insolvency. The distinction between insolvency and likelihood insolvency has already been the subject of numerous discussions and controversies.

The new Directive does not address the distinction so it will be up to each EU country to ensure the restructuring procedure under the new legislation does not collide with current rules defining the occurrence of a reason for insolvency.

Johanna Storz and Dr. Attila Bangha-Szabo are experts in restructuring law at Pinsent Masons, the law firm behind Out-Law.