The EU Adaption of Important Chapter 11 Provisions
By Ken Baird, Katharina Crinson, Guilhem Bremond, Michael Broeders, Charlotte Ausema, Jan-Philip Wilde, Ana López, Silvia Angós, Mark Liscio and Samantha Braunstein (Freshfields Bruckhaus Deringer)
Introduction
In July 2019, the Directive on Insolvency, Restructuring and Second Chance (the Directive) came into force in the European Union. The aim of the Directive was to ensure that a statutory restructuring framework was enacted in each EU member state to maximise the chances of restructuring the debts of a company with a viable business rather than being forced into liquidation, which historically has often been the case. EU member states had until summer 2021 to implement the Directive (unless they applied for a one-year extension). At the time of writing, most EU member states have implemented the Directive with very few countries lagging behind. Although EU member states have a significant degree of flexibility in the implementation, if all aspects are fully embraced, the restructuring framework for countries in the European Union would move substantially closer to the tried and tested Chapter 11 plan available under the US Bankruptcy Code.
Germany and the Netherlands have both been model EU member states, embracing the Directive and introducing new laws well ahead of the deadline in late 2020 and early 2021.
While the UK has exited the European Union, it was first to push ahead with reforms and introduced the restructuring plan in June 2020, which was heavily influenced by the content of the Directive (which the UK had been a part of shaping while it was a member of the European Union).
Last, France and Spain pushed ahead with changes to their insolvency and restructuring regime, keen not to miss out on valuable restructuring opportunities and, of course, cognisant of the need to comply with the timelines set by the European Union. So, France moved first and promulgated Ordinance No. 2021-1193 in September 2021, which incorporated elements of the Directive not already incorporated in French insolvency law, and the reform became effective on 1 October 2021. Spain followed in September 2022 when, additional amendments to the current regime were introduced by Royal Decree-Law 16/2022 and came into force.
In terms of content, most of the individual domestic regimes have, like the Directive itself, taken significant inspiration from US Chapter 11, but none have exactly replicated it. Instead, all have adapted the Chapter 11 model to best suit their domestic insolvency history to produce:
- a court-sanctioned process;
- debtor-in-possession governance;
- classification of creditors based on similarity of rights (and sometimes interests) for the purposes of voting; and
- an ability to effect a Chapter 11-style cramdown of dissenting creditors in a particular class.
In this article, we will very briefly discuss some of key concepts of the different procedures but foremost we will take a look at some of the lessons learned from use cases to date and what this can mean for the future.
What are the gateways to establishing jurisdiction?
Some jurisdictions have long been known to be more receptive to or have been used for ‘forum shopping’. The practice of forum shopping has, historically, been driven by the result that a particular process can offer, as well as the specific criteria that must be established for the local courts to accept jurisdiction. An assessment of both factors will feature heavily in the initial deal structuring phase.
One of the many attractions to Chapter 11 has always been the relatively low jurisdictional threshold needed to be established to access the process. For foreign companies to qualify as a debtor under the US Bankruptcy Code (and thereby establish jurisdiction), they need only minimal contacts, such as having retainer monies in a bank account in the United States. While none of the other jurisdictions in focus in this article have set the bar as low as the United States has, different levels apply – from the concept of sufficient connection (in the Netherlands and the United Kingdom), which can be achieved for example in the United Kingdom by showing that the underlying debt documents are governed by English law – to a more traditional centre of main interest (COMI) or registered seat concept (Spain, France, Germany and the Netherlands). Some countries have also started to play more creatively with the jurisdiction threshold – for example, the Netherlands, which provides different routes to jurisdiction (which then in turn have an impact on recognition globally).
What are the criteria for cross-border recognition?
While the initial question of jurisdiction is a key gating item to any restructuring, this should be considered in conjunction with an assessment of the other jurisdictions in which the chosen process will need to be recognised. It is clear that, to deliver an effective restructuring, there must be certainty that the chosen process will be recognised in all jurisdictions in which the company has assets, operations or creditors.
Recognition will be a matter of local law and different avenues may be open to establish this. Two avenues, however, deserve particular mention:
- the UN Model Law on Cross-Border Insolvency (the Model Law); and
- the European Insolvency Regulation (the EIR).
Where a country has adopted the Model Law, local recognition will occur where the debtor has its COMI or an establishment in the ‘restructuring jurisdiction’. Where this is not the case (eg, because the debtor simply availed itself of the lower jurisdictional threshold), other avenues under domestic law may be possible.
For EU member states, if the restructuring process is listed in the Annex to the EIR (and COMI was stipulated as the jurisdictional gateway), automatic recognition of the process (eg, the New German Restructuring Regime (StaRUG) or the public version of the Court Approval of a Private Composition Act (WHOA)) will apply within the European Union.
Who can initiate the process?
The question of whether some form of financial difficulty needs to be shown to access a particular regime will also feature in the decision-making process of where to implement a restructuring. Practitioners should note that there may be an evidential threshold to be satisfied prior to entry into a process that should be analysed carefully.
This is not the place for a detailed consideration, but as a comparative base, in the United States, France, Germany and the Netherlands the debtor has some form of exclusivity to present a restructuring plan. By contrast, in Spain and the United Kingdom, creditors can propose the plan. It is notable that Spain’s first big ticket restructuring using the new process (Celsa) was initiated by a group of creditors. In France, creditors only have a right to present a plan in case the debtor’s safeguard plan is rejected.
Does the process offer a stay on enforcement?
The chances of implementing a successful restructuring are significantly heightened where creditors are prevented from taking enforcement action against the company, thereby allowing it to stabilise and, most importantly in many cases, to continue to trade while working towards implementing the restructuring. In some cases, it will be possible to agree to a consensual standstill with creditors. However, in cases where this is not possible, the presence of a statutory stay can be vital to the success of the process.
Chapter 11 is the only process discussed in this chapter that gives rise to an automatic and wide-ranging stay on enforcement. In practice, due to the wide reach of the US bankruptcy courts, coupled with the fact that many creditors of companies that file Chapter 11s will also have operations based in the United States, the automatic stay is generally respected worldwide (even in cases where there may not be formal recognition processes in place).
While different in extent to the US stay, both France and Spain do provide for an automatic stay. The Netherlands and Germany do not provide for an automatic stay, but the debtor does have the ability to request the court to impose a stay. By comparison, there is no automatic stay in the United Kingdom upon the filing of a restructuring plan.
What is the impact on operations?
In many cases, the ability of the company to continue to trade through a restructuring will be closely linked to whether it is possible to obtain protection against counterparties terminating contracts on the grounds that the debtor has proposed a restructuring (ipso facto clauses).
The United States provides companies with broad protection against ipso facto clauses. In the United Kingdom, counterparties supplying goods or services will be prevented from terminating the contract when a court summons a meeting relating to a compromise or arrangement under the restructuring plan.
In the Netherlands, upon commencement of the procedure, ipso facto clauses remain inoperative. In addition, it is possible to apply for a targeted stay against one or more suppliers. Under the German restructuring regime, if the debtor has applied to the court for a moratorium, ipso facto clauses are also invalid. In Spain, if the debtor has notified the court of the existence of negotiations with its creditors regarding a potential restructuring plan or of its intention to start them immediately, ipso facto clauses are ineffective. In France, upon the opening of a safeguard proceeding, ipso facto clauses are invalid, only the judicial administrator has a right to terminate contracts.
Is debtor-in-possession financing available?
For many companies, entering a restructuring process where forecast liquidity to completion is tight, the ability to introduce and access alternative financing during the process will be key.
In the United States, debtor-in-possession (DIP) financing is permissible with court approval in Chapter 11 to continue to operate the business and pay the costs of the restructuring process. Super-priority claim status and liens can be granted to DIP lenders if certain conditions are met. Spain comes closest among the European contenders. Here interim and new financing has priority over certain other debts. New money and interim financing will be also protected against clawback actions.
By contrast, in the United Kingdom, there are no provisions for priority financing to be introduced after a company has filed for a restructuring plan – although the restructuring plan itself can and indeed is often used to arrange and implement new super-priority funding. In the Netherlands and Germany, emergency funding (including related security) does not obtain super-priority treatment but can benefit from clawback protection (if certain court-supervised tests are met in the case of the Netherlands). France now has a DIP financing possibility allowing related security but the system has never been tested yet.
What level of support is needed to implement, and is there an ability to bind dissenting creditors or to implement a cramdown of other classes of creditors?
One of the first questions (if not the first question) that will be considered when assessing where to base a restructuring will be the level of support required to approve the proposed restructuring. The relevant consent thresholds and the presence (or absence) of a numerosity test may have a significant influence in the decision-making process. Indeed, where there is expected to be material resistance from dissenting classes of creditors, the ability to implement a cramdown (together with the conditions required to do so) will be key to the viability of the proposed restructuring.
The good news is that all procedures provide for a cross-class cramdown as mandated by the Directive for EU countries. However, as between the different jurisdictions the devil is in the detail and the test (both in terms of required majority but also in terms of denominator (ie, whose vote is counted)) varies. Most jurisdictions (the US, Germany, Spain, France and the Netherlands) have included (some form of) the (absolute) priority rule (APR), namely that a more senior class must receive payment or recovery before a more junior class can see recovery – although some provide for more exceptions than others. The United Kingdom, however has not adopted the absolute priority rule. Indeed the United Kingdom’s absence of the APR has proved to be a significant attractive feature for the UK plan.
The ability to implement ‘gifting’ plans also differs between the jurisdictions. In Chapter 11 proceedings, gifting garners support from impaired creditor classes in order to implement a cross-class cramdown (as at least one impaired (non-insider) class must vote in favour) or a consensual plan whereby all the classes vote to accept the plan. Under US jurisprudence, a traditional gifting plan contemplates a senior creditor gifting a portion of its Chapter 11 plan distribution to a junior creditor class, while an intermediate creditor class ranking above such junior creditor class is not paid in full. These plans, in concept, circumvent the APR, such that if a creditor from a dissenting class objects, they should not theoretically be confirmable. However, if there is a strong business justification, gifts made by a senior creditor class to a junior creditor class without a comparable gift to a similarly ranked junior creditor class (eg, a gift to unsecured trade creditors without a comparable gift to holders of unsecured notes) or a ‘horizontal’ gift from one similarly situated class to another may escape being deemed ‘unfair discrimination’ – a Chapter 11 cross-class cramdown requirement – and thereby be permissible. Gifts not deemed to be the debtor’s property, via a court-approved settlement or otherwise, can also be permissible gifts. While gifting plans have long been part of the Chapter 11 toolbox, with new cross-class cramdown options in other jurisdictions, approaches to gifting are being considered. Where gifting has been relevant in the case studies discussed below, jurisdictional attitudes towards gifting has been noted.
Which cases have we seen using the new procedures?
United Kingdom
So, with three years on from the introduction of the UK restructuring plan, what cases have emerged? We have seen 23 restructuring plans to date with 15 utilising cross-class cramdown, so the choice to single out one case is large. For these purposes, the German real estate group Adler is worth highlighting. It showcases in particular the continued pull factor of the United Kingdom for international restructurings. Adler’s debts were governed by German law and the group’s COMI was in Germany – so on the face of it, there were no touchpoints with the United Kingdom (in particular, not the common touchpoint of English law governed debt documents that draws debtors to the United Kingdom due to the rule in Gibbs). Despite this, the company chose to incorporate a new English company (with COMI in England) to acceded to the debt and to propose the restructuring plan. The court sanctioned the restructuring plan using cross-class cramdown following strong opposition. The opposing creditors’ main arguments were that because the plan did not collapse the existing maturities into a pari passu ranking, the later dated noteholders would lose out. Additionally, the opposing stakeholders disputed the company’s evidence that the dissenting class would achieve better recoveries under the plan than in the relevant alternative. Despite the fact that there was relative scarcity of case law dealing with valuation in the United Kingdom in the context of schemes and therefore restructuring plans, the courts found themselves having to make clear valuation choices. Experts were cross-examined in a three-day hearing, but the case demonstrates that it is incredibly difficult for creditors challenging a plan to convince the court that the debtor’s valuation evidence should not be accepted. This is in particular the case given that first, the debtor has had weeks if not months to prepare the evidence and, second, there will always be an information imbalance. The case also demonstrates the lack of the absolute priority rule in the United Kingdom as shareholders in Adler retained their shareholding despite creditors writing off some of their debt. A further case to highlight is the case of ED&F Man, which used the restructuring plan to rewrite the equity including shareholder agreements.
Spain
In Spain, several restructuring plans have been approved since September 2022, of which the restructuring plan of the Celsa group (a multinational group of steel companies with COMI in Spain) is the first one that has been filed and approved by creditors only.
The Celsa ruling relates to debt that was the subject of a prior homologation back in 2017 and includes a full takeover of the equity following a debt conversion, the sale of essential assets and a cross-class cramdown implemented in the face of opposition from shareholders and just one working capital creditor. As this was a creditor-led plan, the group had no right to oppose it.
The whole ruling is the very first helpful approach to homologate and implement a creditor-led plan without the collaboration of both the company and its shareholders.
Among others, the court replaced the compulsory list of information that the plan must include with a sufficiency test consisting of the information that is required to enable affected parties to make informed decisions and exercise their rights and provided for a more limited construction of the short-term viability test that the plan must comply with, by referring to the removal of the insolvency situation only. Finally, the court replaced certain compulsory corporate requirements to implement the plan with alternative measures that are feasible in the absence of other stakeholders and management cooperation and granted broad powers to the creditor-appointed expert to implement the plan, including the ability to access the group’s premises, execute agreements on behalf of all parties and remove the group’s directors.
Valuation takes up most part of the court ruling. There are four valuations that each apply the same method (cash flow discount) but with different data, the result of which showed a deficit in excess of €4 billion. The company’s valuations used management’s projections (verified by an audit law firm), while the creditors’ valuations use external data. The court ruled that the key was not the source but the quality of the data. The court’s view was that management’s projections were exceptionally optimistic, not aligned with the market’s expectation and lacked a proper explanation of the reasons behind the deviation. Accordingly, the court decided to go with the creditors’ valuations that factored in (but ultimately disregard) management’s projections and used external data only.
Additionally, the court confirmed the validity of the different treatment of secured classes on the basis that equal treatment meant equivalent and non-discriminatory treatment only. In this sense, the court ruled that both the five-year refinancing of available commitments and the capitalisation of existing (drawn) debt were ways to finance the group and that the latter was not per se a preferential treatment of the existing (drawn) debt.
The court ruling is final and not subject to appeal – this is because the creditors asked the court to open the opposition phase before the homologation was ruled out.
Germany
The restructuring of LEONI AG, a publicly listed German automotive supplier, under the StaRUG marks a significant milestone in the German legal landscape. The LEONI AG restructuring plan encompassed an A&E of existing financial liabilities, a debt to (virtual complete) equity swap as well as a delisting and disenfranchisement of existing shareholders by way of cross-class cramdown.
Following the voting meeting and the restructuring court’s approval of the plan the disenfranchised shareholders contested the plan through litigation across various court levels, including the German Constitutional Court. All challenges brought by these dissenting shareholder were promptly dismissed, and the plan successfully became effective in August 2023.
The efficient court approval process and the ensuing prompt rejection of shareholder objections demonstrates that German courts are ready and willing to effectively evolve the new legal framework and provide German corporations with a reliable restructuring tool.
France
A number of cases have proven the efficiency of the system – for instance, Pierre et Vacances, Orpéa and, currently, Casino. All cases were strongly related to France, and no significant COMI shift has been tested. Orpéa was concluded in July 2023 as the first case where a cross-class cramdown was imposed on shareholders. The best interest test was based on two valuations conducted on one side at the request of the company and on the other side by a court-appointed expert. Courts have shown very careful in apprehending common interest in the classes constitution, taking into account crossholding in Orpéa.
The Netherlands
The Dutch WHOA is actively seeking to become a cross-border restructuring hub; it has proven to be an effective restructuring instrument not only for small to medium-sized companies, but also for large companies in more complex and international cases. Examples are the successful restructurings of Steinhoff, Diebold Nixdorf, Vroon and Royal IHC.
The restructuring of Royal IHC was the first case since the introduction of the WHOA, whereby the cramdown option was used within a syndicate of lenders to secure IHC’s financial restructuring and an M&A transaction. The effectiveness and legal certainty of the WHOA was significantly increased by the case. The court permitted an amendment of (all) lenders’ consent rights in credit documentation. By doing so, the court took existing case law – based on which a modification of maturity dates, interest payment obligations and covenants was possible as part of a restructuring plan – one step further. In addition, IHC used the (recently introduced) possibility under the WHOA to explicitly request the court to approve its intended transaction to sell its subsidiary as part of the restructuring, provided that such transaction is reasonable and immediately necessary for the restructuring plan and is not ‘unfair’ to the creditors. The court approved IHC’s request and as a result, the transaction could not be challenged in a later stage. The court also decided that in principle, the WHOA may be used to force creditors to continue financing a company’s working capital under existing credit facilities; it also allowed a contractual change of ranking (amendments to the waterfall in an inter-creditor agreement). The IHC restructuring was implemented in private proceedings that do not fall under the scope of the EU Insolvency Regulation (contrary to public WHOA proceedings). As a result, jurisdiction of the Dutch Court is not solely based on the debtor’s COMI, but instead on the more flexible criterion ‘sufficient connection to the Dutch legal sphere’. Here, the Dutch courts were comfortable to take jurisdiction over four English companies in the IHC group.
Another significant case involving a successful WHOA is the cross-border restructuring of the international Vroon Shipping group, where a restructuring was implemented in the form of an orderly disposal of certain assets and a debt-to-equity swap. The restructuring involved inter-conditional processes: the Dutch WHOA and the English scheme of arrangement were applied in such a way the restructuring could only be implemented if both the Dutch and English courts sanctioned the respective restructuring processes.
Conclusions and trends
So, drawing it all together and taking a step back, what lessons have we already learned? Speaking for all EU jurisdictions in focus here and the United Kingdom: the reform is working. While reform always takes time to implement in a meaningful way, the United Kingdom has now had more than 23 restructuring plans over the years, and each of the other jurisdictions covered in this article has had at least one large restructuring core testing the system. More are undoubtedly to follow. Despite the new options, the United Kingdom has seen more than its domestic share of restructurings, with a number of foreign companies (most notably German real estate conglomerate Adler) choosing the use the United Kingdom restructuring plan over domestic options (such as the German StaRUG).
The million (or billion) dollar question is, are we seeing any of the newcomers take over from the tried and tested US Chapter 11? Are we maybe even moving away from the United States being best in class and the model upon which others rely?
There are a few factors at play. The level of Chapter 11s is declining – the question is whether that is because companies are staying on the other side of the pond. On balance, that is probably not the case, and there are different macroeconomic reasons for the low number of Chapter 11 cases during 2021–2023, such as the preference of credit funds to effectuate balance sheet restructurings through out-of-court liability management transactions and debt for equity restructurings, only resorting to bankruptcy proceedings when unanimity cannot be achieved (in which scenario, pre-packaged Chapter 11s are fully negotiated in advance and implemented on a rapid basis). However, there is much greater choice now available to debtors and the (at least perceived) costs of a Chapter 11 case will be weighing against its use. As we are seeing more and more EU cases develop that will establish a more predictable restructuring regime and certainty of outcome, more debtors may start to choose the domestic option.
What will be the most important factor for companies to choose where to go? With a bit of planning many jurisdictions are open for foreign companies (this is particularly the case for the Netherlands and the United Kingdom). The Netherlands has had some big ticket restructuring, but for the moment is lacking a track record – but this is something that time will provide.
There is a trend of interlocking schemes emerging. Often, this is driven by the rule in Gibbs referred above that dictates that where English law governed debt is at stake an English process will need to be used to effectively amend or deal with such debt. Therefore, even the use of a Chapter 11 alone would not solve the problem and we have seen interlocking schemes of an Italian concordato or a Dutch WHOA combined with an English restructuring plan to deal with the English law debt. So, maybe the future is not in one regime that takes over from Chapter 11 but a proliferation of choice and a patchwork of different schemes used to deal with different issues at the same time.
* This article was originally published in the Global Restructuring Review.