EU Directive to change UK insolvency regime?
The European Commission has published its proposal to issue a directive in relation to business insolvency.
The proposals are subject to the approval of both the Council (i.e. the member states) and the European Parliament and it is likely that amendments will be made through this process. Once the draft is final, Member States will have 2 years to implement the measures required.
The likely effect of the Directive in the UK is clearly uncertain until we know the detailed result of Brexit negotiations. Many of the Directive requirements however are either already largely provided for within UK legislation or are likely to form part of separate proposals which the UK Government has already consulted upon.
The proposed Directive builds on the 2014 recommendation on restructuring and second chance. A review of the implementation of the Recommendation by Member States showed that, despite reforms in the area of insolvency, rules still diverged and remain inefficient in some countries. In several Member States, it is still not possible to restructure a business before it is insolvent. As regards the second chance, important discrepancies remained as to the duration of the discharge period.
The proposed Directive has three distinct main parts:
- Preventive restructuring frameworks;
- Second chance for entrepreneurs; and
- Measures to raise the efficiency of restructuring, insolvency and second chance.
All measures within the proposed Directive are proposed as minimum requirements and are presented as high level objectives. This means that the way the Directive is implemented will be determined by each Member State.
Preventative restructuring frameworks
Each Member State will be required to ensure, where there is a likelihood of insolvency, debtors [companies] have access to an effective preventative restructuring framework (involving one or more procedures) that enables them to restructure their debts or business, restore viability and avoid insolvency. The procedures should limit the involvement of judicial or administrative authority and the frameworks should be available on application of debtors, or creditors with the agreement of debtors.
Other key features of the restructuring framework are:
- The debtor is to be left in possession of its assets and the day-to-day operation of its business. A supervisor or mediator may be appointed, but should not be as a matter of course in each case.
- The debtor should be able to apply to court to stay individual enforcement actions (apply for a moratorium). This is subject to certain safeguards (maximum duration of 4 months but extendable to 12 months with permission and that the stay may be lifted where it become apparent that a proportion of creditors could block the restructuring plan being passed). Any mandatory insolvency filing rules should be disapplied during the period of the stay. The debtor should also be able to count on the continued performance of contracts with suppliers (provided that the debtor fulfils its obligations under such contracts).
- Each Member State is to make a model for restructuring plans available online, although the use of the model will not be mandatory.
- Creditors are to be divided into classes to adopt the plan. As a minimum, secured creditors should be treated separately from unsecured creditors. Where judicial or administrative authority is required to confirm a restructuring plan that decision must be made without undue delay and in any case within 30 days from application being made. Cross-class cram down is to be available if the plan is confirmed by the court.
- Shareholders should not be able to obstruct a restructuring.
- Where a restructuring plan is challenged, it will be assessed against a ‘best interest of creditors test’. This means that no creditor should be worse off under restructure than under a piecemeal or going concern sale under liquidation.
- Where restructuring plans are confirmed by judicial or administrative authorities they must be binding on each party identified in the plan. Creditors not involved in the adoption of the plan cannot be affected by the plan.
- Member states are to impose specific duties on directors to incentivise them to pursue an early restructuring where the business is viable. Directors will be obliged to take immediate steps to minimise loss for creditors, workers, shareholders and other stakeholders, take reasonable steps to avoid insolvency and avoid deliberate or grossly negligent conduct that threatens the viability of the business.
- The law should ensure a minimum protection for new financing necessary to implement a restructuring and/or granted in connection with a restructuring.
Much of the restructuring plan elements are consistent with the proposals contained in the consultation on corporate insolvency framework published by the UK Government earlier this year. It is likely however that some amendment to UK legislation would be required on director’s duties where there is a likelihood of insolvency. The specific focus on avoiding loss to workers would give renewed focus to the concerns around collective redundancy consultations for financially distressed companies and the current tensions that exist between insolvency and employment legislation.
Second chance for entrepreneurs
Although the provisions in the draft Directive are restricted to entrepreneurs (that is natural persons who exercise a trade, business, craft or profession), it is explicitly stated that Member States may extend those provisions to all natural persons to ensure consistent treatment of personal debt.
The draft Directive requires that entrepreneurs should obtain an automatic discharge from all debts no longer than 3 years from the start of the relevant proceeding liquidating their assets or a repayment plan starting. This may mean that if the draft Directive were implemented in the UK that an entrepreneur would only be able to enter DAS if they could repay their debts within 3 years.
A longer period of discharge may be provided for where a main residence is exempt from realisation (something which may become relevant if for instance the Scottish Government makes changes to the way equity is dealt with in main residences under bankruptcy and trust deeds)
The draft Directive requires that where an entrepreneur has personal debts as well as those arising from business that all debts are treated in a single or co-ordinated procedure for the purpose of receiving a discharge from debt. Given this provision, it is likely that whatever provisions a Member State makes, these are more likely to apply to all natural persons and not just entrepreneurs otherwise there would be inequality in the treatment of personal debt depending upon whether an individual also happens to run a business or not.
Any disqualification period from taking up or pursuing a trade, business, craft or profession which is connected with the prior insolvency/restructuring plan would have to cease automatically at the latest at the end of the discharge period. Exceptions to this general principle are provided for where
- The debtor acted dishonestly or in bad faith towards creditors
- Does not adhere to a repayment plan or other legal obligation aimed at safeguarding the interest of creditors
- Has had multiple access to debt discharges within a defined period
- Is a member of a profession to which specific ethical rules apply or where disqualifications were ordered by a court in criminal proceedings.
In theory while this may have an impact on the effectiveness of Bankruptcy Restriction Orders and an individual’s ability to be involved in any subsequent business including that as a director, it is likely that many (if not all) would fall within one of the exempted areas meaning that in practice there would be little impact on existing processes in the UK if the Directive were to be implemented here.
Measures to raise the efficiency of restructuring, insolvency and second chance
The draft Directive also requires steps to be taken which will maintain and enhance the transparency and predictability of procedures in delivering outcomes, as well as ensuring that insolvency procedures are completed as quickly and efficiently as possible.
The draft Directive requires Member States to ensure that members of the judiciary and of other competent authorities are properly trained and specialised in restructuring, insolvency and second chance matters.
This may mean that the Official Receiver and Accountant in Bankruptcy would no longer be exempt from the Insolvency Practitioner qualification! It may also encourage the creation of specialist insolvency courts in the UK?
The draft Directive also requires Member States to encourage the initial and further training as well as the establishment of codes of conduct for practitioners dealing with restructuring, insolvency and second chance matters. The UK regulatory system already provides for these features. Restructuring is often carried out with the support of unregulated restructuring professionals and the Directive may impact on who can supervise restructuring exercises in the future.
The draft Directive also makes provision for the appointment and remuneration of insolvency practitioners and those involved in restructuring or second chance processes. It requires minimum standards for appointing and supervising practitioners should be clear, predictable, fair and transparent. Where appointed by a judicial or administrative authority due consideration shall be given to experience and expertise. Where cross-border elements are involved then consideration shall be given to the ability to communicate and cooperate with foreign IPs and judicial or administrative authorities as well as its human and administrative resources. In the main the current UK procedures are likely to comply with the Directive’s requirements.
The draft directive also requires that fees charged by IPs are governed by rules which incentivise a timely and efficient resolution of the procedure having regard to the complexity of the case. Member States will also be required to have an appropriate oversight and regulatory structure which must include a regime for sanctioning practitioners who have failed in their duties. Again, the UK already meets most of those requirements although further changes to the fees regime could not be ruled out.
The Directive also requires Member States to ensure that debtors and entrepreneurs have access to early warning tools to detect a deteriorating business and signal that the debtor or entrepreneur needs to act as a matter of urgency.
The preamble to the draft Directive states “Possible early warning mechanisms should include accounting and monitoring duties for the debtor [company] or [it’s] management as well as reporting duties under loan agreements. In addition, third parties with relevant information such as accountants, tax and social security authorities could be incentivised or obliged under national law to flag a negative development.” This perhaps raises an expectation that banks, accountants and tax advisors may have more onerous obligations in the future to make businesses aware of the potential of impending financial difficulties.
The Directive would also require Member States to ensure that the following functions can be carried out electronically:
- Filing of claims
- Filing of restructuring or repayment plans with competent judicial or administrative authorities
- Notification to creditors
- Voting on restructuring plans
- Lodging of appeals
UK legislation is already likely to meet a significant number of the requirements within the draft Directive although some further amendments might be required if the Directive were to apply to the UK post Brexit.
Proposals contained within the Consultation on a corporate insolvency framework follow a similar theme to some of the preventative restructuring framework objectives within the draft Directive. The response to that consultation from the Government indicated that the proposals are likely to be taken forward.
Any potential post-Brexit requirement to implement the new EC Directive may end up being academic in nature as UK legislation may well und up by and large being aligned with the Directive requirements in any case.