The Rise of “Group Solution” in Insolvency Law and Bank Resolution
By Ilya Kokorin (Leiden University)
Introduction
The outbreak of COVID-19 and the subsequent drastic governmental measures to curb the pandemic have affected many businesses, small and large. They had a significant effect on multinational enterprise groups (MEGs), dependent on global supply chains, uninterrupted liquidity flows and travels (e.g. airlines, automotive manufacturing, car rentals). LATAM Airlines Group, Norwegian Air and Hertz, early victims of the pandemic, had to file for insolvency or restructuring – the process in which several jurisdictions and courts were engaged.
For historical, economic, social and political reasons, the handling of financial distress and the application of insolvency law mechanisms have been carried out on a single-jurisdiction and a single-entity level, frequently overlooking the wider group context. In other words, the rules of insolvency but also of company law had a single-entity (i.e. single-debtor) process in mind, thus lacking provisions related to groups of companies. In many cases, this approach has been in stark contrast with the economic reality, characterized by the existence of complex group structures, described by Westbrook as “a legal armada of limited liability vehicles”. MEGs – and not single entities – have become the prevailing form of large-sized enterprises.
Currently there seems to be a clear shift in the treatment of enterprise groups, evident in the emergence of rules and soft-law instruments, which target insolvency of corporate groups. This trend is evident in the rules and recommendations addressing enterprise group insolvency and resolution of credit institutions (e.g. the Bank Recovery and Resolution Directive (BRRD), the European Insolvency Regulation (EIR recast), the UNCITRAL Model Law on Enterprise Group Insolvency (MLEGI)). A number of national legal regimes also contain rules on enterprise group insolvency (e.g. Germany with its Koordinationsverfahren).
In my recent article “The Rise of ‘Group Solution’ in Insolvency Law and Bank Resolution”, I explore the development of the group-sensitive insolvency law tools and the rise of the concept of a “group solution”, its underlying rationale, scope of application and limitations.
What is a “group solution”?
The EIR Recast establishes that cooperation in the context of enterprise group insolvency “should be aimed at finding a solution that would leverage synergies across the group”. In a similar manner, the MLEGI aims to provide effective mechanisms to address cases of the insolvency of groups of companies through facilitation of the development of group insolvency solutions for the whole or part of an enterprise group. A group insolvency solution is defined by the MLEGI as a “ proposal or set of proposals developed […] for the reorganization, sale or liquidation of some or all of the assets and operations of one or more enterprise group members, with the goal of protecting, preserving, realizing or enhancing the overall combined value of those enterprise group members.” Thus, a group insolvency solution envisaged in the MLEGI seeks to preserve and maximize the insolvency estate value.
The BRRD does not use the term “group solution”. Instead, it promotes group resolvability, where a banking group should be allowed to fail in an orderly manner, without significant adverse consequences for the financial stability and with a view to ensuring the continuity of critical functions carried out by group operating subsidiaries. Thus, the focus of bank resolution is macroprudential and goes beyond the microprudential goal of asset value maximization, transcending the boundaries of a single entity or an enterprise group.
Manifestations of group solutions
The concept of a group solution is inherently flexible. This flexibility is necessary to take into account the circumstances of a specific enterprise group, its corporate and financial structure, business model and the degree of integration between group members. There are different tools, which may be implemented to facilitate a group solution. Among these tools are:
• conclusion of cross-border insolvency protocols (as was done in the cases of LATAM Airlines and Urbancorp group);
• approval of third-party releases, entailing a total or partial discharge or amendment of claims against joint obligors or guarantors (typically, group entities) in the proceedings of the principal debtor. As a result, group debt may be restructured in one go. A third-party release is a common mechanism used in financial reorganizations performed via schemes (see the cases of Nordic Aviation Capital and Lecta Paper). It is available in many common law jurisdictions (e.g. the UK, Singapore, Ireland) and, since recently, also in the Netherlands and Germany;
• extension of an enforcement stay to group entities. Such an extension is possible under the laws of Singapore (IRDA, section 65), the Netherlands (WHOA, Article 372(3)), Germany (StaRUG, §49(3)) and, to a limited extent, in the USA;
• opening of special sui generis proceedings (i.e. group coordination proceedings under the EIR Recast and planning proceedings under the MLEGI);
• appointment of the same insolvency practitioner in separate insolvency proceedings of group members.
In the context of recovery and resolution of banking groups, the following mechanisms reflect a group-mindful regulation:
• group recovery and resolution planning. An obligation to prepare resolution plans or “living wills” has been introduced after the global financial crisis both in the USA (Dodd-Frank Act, section 165(d)) and in the European Union (BRRD, Article 12). These plans generally cover a banking group globally and reveal its corporate, operational and legal interconnectedness, and contain steps to ensure group resolvability;
• group financial support arrangements. Intra-group financing between banking group entities constitutes a significant source of funds for (cross-border) operations. To ensure access to capital and liquidity for operating subsidiaries, special regulation has been established (e.g. a “group financial support agreement” under the BRRD; source-of-strength doctrine in the USA; secured support agreements – a contractual way of securing funding of key subsidiaries through the resolution process, see the resolution plans of Citigroup and JPMorgan Chase & Co);
• models of bank resolution and pre-positioning of resources and liabilities within a group. Two main models or strategies for bank resolution are: a single point of entry model (SPOE) and a multiple point of entry model (MPOE). They should accord with the group’s corporate, operational and financial structure (i.e. centralized or decentralized) and serve as a basis for orderly resolution.
Limitations of group solutions
From the analysis of various mechanisms and tools, introduced above, it follows that a group solution has one important limitation. It cannot trump the interests of individual group members and their creditors. This limitation is based on the premise that, in the absence of substantive consolidation, group entities retain their legal separateness in insolvency, and that creditors’ pre-insolvency entitlements should be duly protected.
This protection is realized through the following safeguards: (i) the operation of the no-creditor-worse-off (NCWO) principle, applied on an entity (and not on a group) basis; (ii) entity-by-entity application of resolution measures in the context of bank resolution; (iii) restrictions aimed at minimizing the risks and negative effects of conflicts of interest in group insolvency scenarios. In practice, these restrictions could limit communication and cooperation between courts and insolvency practitioners (IPs) or the appointment of the same IP in the proceedings concerning group entities (see e.g. EIR Recast, Articles 56-58).
Conclusion
Based on the analysis of modern legal instruments and practices in corporate insolvency and bank resolution, I conclude that despite the gradual acceptance of the group phenomenon, a group solution has not yet formed as a coherent and well-defined legal principle with its own substance and distinct purpose. Instead, a group solution represents an amalgam of various tools and mechanisms, which address the problems characteristic of group failures and may pursue different societal goals. This variability reflects the flexibility, corresponding to different policy objectives, as well as the diversity of corporate, operational and financial structures of MEGs, their varying levels of integration and managerial centralization.
Importantly, the limitations generally sought to preserve the merits of corporate separateness should not bar Pareto-efficient group solutions, which promote the objectives of insolvency law and bank resolution. To make efficient group solutions possible and to realize their full potential, I argue that it is necessary to rethink how we determine creditors’ “interest” and to consider both medium and long-term direct and indirect benefits for creditors, as well as a broader enterprise group and social environment, as opposed to solely focusing on short-term direct monetary satisfaction of creditors’ claims.