Bankruptcy courts and cram down: 2021 countdown
2021 will be an exciting year for many reasons. One of these is the mandatory implementation of Directive 2019/1023, the so-called Restructuring Directive. This Directive imposes minimum harmonization with regard to (corporate) pre-insolvency proceedings. These are procedures that allow a debtor with payment difficulties to submit a proposal for relaunch and reorganization and to be protected for a certain period of time. The Directive is based on the conviction that bankruptcy, with its associated liquidation, should be an exceptional measure; the continuity of companies is the main goal.
The Directive goes back a long way. At the end of 2011, the European Parliament adopted a resolution calling for harmonization of national insolvency laws with regard to restructuring plans. In 2012, the European Commission identified the modernization of insolvency rules as "a key action to improve companies' chances of survival and give entrepreneurs a second chance". In the Communication A new European approach to insolvencies, the European Commission highlighted the differences between national insolvency rules (COM (2012) 742 final). The Entrepreneurship 2020 Action Plan (COM (2012) 795 final) called on Member States to "provide early restructuring services to companies by 2020". Over time, the proposals became more concrete. A European Commission Recommendation of 12 March 2014 encouraged European Member States to recast their legislation to allow companies to restructure early. ‘Restructuring' was already very broadly understood at that time: it could be split-up, sale, turnaround (change of management, of production line), bail-out (new financing) or bail-in (payment by shareholders and bondholders). Insolvency would thus be avoided, resulting in greater overall value for creditors, employees, owners and the economy as a whole. Continuity of activities was the objective.
Thirty years ago, who would have thought that by 2020 it would be difficult to harmonize bankruptcy and reorganization procedures? At that time, most European Member States had insolvency legislation that was based to a large extent on creditors' decisions. Insolvency proceedings back then allowed both composition and liquidation to be chosen but after a formal decision on the debtor’s insolvency. This was a straightforward approach. There was one gateway; enterprises with financial difficulties were first declared insolvent before they could be saved. Of course, in most cases they weren’t. Declaration in insolvency usually ended up in a going concern sale or liquidation.
For this reason, since the 1990s, most EU countries have changed their legislation considerably. Pre-insolvency became the new paradigm. Firms are now bringing forth financial problems, not insolvency; the goal of targeted proceedings is to restructure. In their legislative approaches, some countries (e.g. France) are more at the forefront than others. And it is typical of the rapidly changing views on reorganization that countries that reformed their bankruptcy laws only ten years ago now have to adapt their already outdated legal framework. Belgium is an example thereof. In 2009 the transition to a reorganization approach was made. And the 2009 law bears traces of American insolvency law. The debtor has a right of initiative and proposition. He declares the payment difficulties and makes his own proposals about the restart. In addition, the rights of creditors with security during the automatic stay are limited; this also demonstrates US influence. But there was also the weight of tradition. The creditors can vote on the reorganization plan, but they are hardly involved in its drafting. The vote is a "yes" or a "no". Differential treatment of creditors and shareholders is possible but lacks backing in the law. The debtor has considerable leeway to tailor the proposition, to accommodate certain creditors over others. Typically, even if creditors have to accept reductions, shareholders still receive some cents on their dollars. All this reflects nineteenth-century ideas. In that period, the accord (concordat) was exceptional and proposed by the debtor. The court did not step in.
The EU Recommendation of 12 March 2014 proposed concrete elements which should include a reorganization procedure, such as the so-called "cram down". Member States should create a legal framework that allows judges to adopt restructuring plans even if they are rejected by one or a few categories of creditors. Conditions are the invitation of all creditors, the protection of the rights of dissident groups, a payment to those groups not less than what they would receive in the event of liquidation or going concern sale, and the necessity and proportionality of funding to be included in a reorganization plan. The cram down is a decisive set of rules applicable in the US chapter 11 procedure. In this proceeding creditors are divided into classes. Each class must approve the reorganization plan by a majority before it can take effect. However, if a class votes against, the judge can take its place if the refusal is not beneficial to the class. After all, the judge examines what the "best interests" are. If in the event of a liquidation or sale as a going concern the opponents would not fare better, the court approves the plan.
This cram down is also part of the aforementioned European Directive. Member States must make it possible for a reorganization plan rejected by one or more classes to be approved by the courts. In this respect, the proposal for a directive of 2016 has been substantially rewritten. Initially, the cram down was possible when a restructuring plan was not approved by all voting classes, at least one class (other than a class of shareholders) approved the plan and it passed the "best interest of creditors" test (Art. 11.1). This is slightly different in the final directive (the new Art. 11.1). Now, for application of the cram down, a majority must include a class of secured creditors. If this is not the case, the court can also approve the plan if at least one of the classes (other than equity holders) would receive nothing in the event of a liquidation or sale as a going concern. The intention seems to be that the judge can reverse the vote of a class of creditors in order to achieve a majority of categories, largely irrespective of the rank of claims represented by the categories. The plan cannot favor lower classes over higher classes. But in spite of this, absolute priority may be turned into relative priority, when creditors have to accept a reduction of their claims, while consenting shareholders still receive a part of their investments. Shareholders can be excluded by Member States, but if they are acknowledged in the voting procedure, this is a possible outcome.
What will the new year bring in France and Belgium? France has no real cram down, although the sauvegarde allows groups of creditors to vote and some of them can be ignored in the interests of continuity. In Belgium, however, the court is legally obliged to abstain from an economic or feasibility test. This is a direct consequence of nineteenth-century bankruptcy law, when the court was the forum for negotiations between debtor and creditor, and nothing more. The court merely acted on the decision and refrained from interfering. But that has to change now. The Directive must be transposed into national law by July 2021. Europe is giving more power to the bankruptcy court. Thus ends a tradition. And from now on the court can fully seek to balance the interests of all stakeholders, and not restrict itself to limited control on a debtor-steered process.