How does the EU Restructuring Directive compare to Chapter 11?
On June 26, 2019, the European Parliament and the Council of the European Union published a new EU Restructuring Directive on preventive restructuring frameworks, discharge of debt and disqualifications, and measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt (“Directive”).
This is an extraordinary achievement given the existing differences in restructuring regimes across EU Member States.
The Directive applies to all Member States and is intended to create a uniform system throughout the continent to address financial distress, avoid the build-up of non-performing loans, and address distress prior to default, ultimately aimed at reducing the likelihood of formal insolvency proceedings.
The Directive’s primary objectives are to ensure:
(a) viable enterprises and entrepreneurs that are in financial difficulties have access to effective national preventive restructuring frameworks which enable them to continue operating;
(b) over-indebted entrepreneurs can benefit from a full discharge of debt after a reasonable period of time, thereby allowing them a “second chance”; and
(c) the effectiveness of restructuring and insolvency procedures and discharge of debt is improved.
EU Member States are required to implement the Directive by July 17, 2021 (although an extension is possible).
Whilst modeled after Chapter 11 in the United States, the Directive’s framework is arguably more streamlined (and therefore more cost effective) than the Chapter 11 reorganization process because it minimizes judicial intervention. However, it transposes many Chapter 11 concepts including:
Debtors will remain in possession of their property and business.
A restructuring plan must be approved by at least one class of affected voting parties (other than the class of equity-holders or any class of creditors) who would not receive any payment in a liquidation. This rule seeks to make sure that the plan is approved by at least one class of creditors who is “in the money” but will require a valuation of the debtor’s assets as a going concern. This valuation may give rise to expert disputes and is likely to be expensive and time consuming.
Cross-class cram down (with certain elements similar to section 1129(b) of the U.S. Bankruptcy Code) in respect of dissenting classes of capital providers.
Member States may choose between the U.S. style absolute priority rule or opt for a certain “relative priority rule” (the “European Relative Priority Rule”) which means that dissenting voting classes are to be treated at least “as favourably” as any other class of the same rank and “more favourably” than any junior class.
The European Relative Priority Rule is less rigid than the U.S. absolute priority rule and ironically may lead to forum shopping within the EU, which is contrary to the objective of the harmonization of European preventive restructuring frameworks.
To protect senior creditors’ exit rights – and this is different compared to the US system – creditors in a dissenting class must also have the right under the plan to opt for a distribution in cash equal to their share in accordance with their ranking of the liquidation value (cash-out option).
However, unlike Chapter 11, the Directive does not provide for debt financing on a super-priority basis, an absence that some view as a weakness.
Key elements of the Directive include
Early warning and access to information
This is to help companies detect circumstances that could give rise to a likelihood of insolvency much earlier and alert them to the need to act quickly to avoid a formal insolvency.
Preventive restructuring frameworks
In so far as a Member State does not already have such, the Directive provides for the introduction of preventive restructuring framework.
This is to enable a debtor to restructure, with a view to preventing insolvency and ensuring their viability, thereby protecting jobs and business activity. Those frameworks may also be available at the request of creditors and employees’ representatives.
It is not mandatory, but in certain cases and to facilitate negotiations around a restructuring plan, a restructuring practitioner will be appointed.
The Directive envisages that a practitioner will be appointed if the debtor would benefit from a general stay of individual enforcement actions; the restructuring plan needs to be confirmed by means of a cross-class cram-down; the restructuring plan includes measures affecting the rights of workers; or the debtor or its management have acted in a criminal, fraudulent, or detrimental manner in business relations.
The Directive requires the plan to include certain elements, including a description of the economic situation, the affected parties and their classes, and the terms of the plan.
Similar to Chapter 11, a restructuring plan may provide for the sale of assets and modifications to the debtor’s capital structure.
Stay of individual enforcement actions
Debtors may benefit from a stay of enforcement actions to support the negotiations of a restructuring plan in a preventive restructuring framework and avoid formal insolvency.
The initial duration of a stay is limited to a maximum period of no more than four months.
Discharge of debt
The Directive sets out conditions that would enable over-indebted entrepreneurs to enter a procedure that would lead to a full discharge of their debt after a maximum period of 3 years, thereby giving them a “second chance”.
The Directive also seeks to reduce the length and costs of restructuring procedures, supporting the aim of the Directive to increase the efficiency of restructuring procedures.
For a number of Member States the Directive will see an overhaul of existing restructuring processes and procedures, for others the concepts and aims of the Directive are in line with existing procedures and will, therefore, be more familiar.
Unless extended, all EU member states should have implemented the new provisions by 17 July 2021 and once in the new rules will provide a more uniform approach to restructuring in the EU.