Composition with creditors

Composition with creditors – a process governed by Articles 160 and following of the Bankruptcy Act (Royal Decree 267/1942) – is one of the tools that Italian legislation has made available to business entities to avoid them being declared bankrupt. It allows a debtor in difficulty to submit a proposal to a majority of creditors for approval on the basis of a plan that provides for the appropriate manner and timing of debt extinguishment, all of which takes place under a judicial procedure supervised by the court of competent jurisdiction and a court-appointed judicial commissioner, known as a 'composition'.

Pre-composition

One of the most important changes introduced to the statutory rules governing such tools by reforms in 2012 is the new sixth paragraph of Article 161 of the Bankruptcy Act. The new provision affords a debtor in crisis the possibility to file a reserved or blank application for arrangement – a 'pre-composition' – whereby it undertakes to supplement the documents statutorily required for admission to the composition within a specific term fixed by the court – with the alternative option to file a petition for the homologation of a debt restructuring agreement pursuant to Article 182-bis of the Bankruptcy Act.

The merit of a pre-composition is that the debtor can benefit from the acceleration of the protective effects typical of a composition, even before filing the requisite statutory documents. Filing an application for pre-arrangement creates a protective shield around the debtor in the form of an automatic stay – a phrase that usually refers to the automatic suspension of any enforcement or interim relief actions brought by creditors against the debtor's assets. The effect of pre-arrangement extends until the expiry of the term specified by the court within which the composition documents (or a petition for the homologation of a debt restructuring agreement) must be filed. It is precisely the protection afforded by the automatic stay, together with the lower volume of documents statutorily required, that has resulted in the widespread adoption of the pre-composition procedure since its enactment in 2012.

Documents required

A major element differentiating composition from pre-composition are the documents that must be filed as annexes to the relevant application form. In preparation for composition, the debtor must produce a copious amount of documents as annexes, which the court needs to inspect in order to have a comprehensive view of the debtor's business performance and compliance with the requirements for composition. In contrast, because of its mere reserving function, an application for pre-composition requires a smaller set of annexes.

Composition with creditors application

When applying for composition with creditors, the debtor is required, pursuant to Article 161 of the Bankruptcy Act, to submit certain documents intended to disclose its assets, liabilities, profits, losses and financial position upon filing the application. In particular, the core element on which an application for composition is supported is a "plan containing an analytical description of the manner and timing of implementation of the proposal". This particular document is usually drafted by the business entity concerned with the assistance of a specially appointed adviser, and must be appended to the proposal for arrangement with creditors. As a departure from past statutory requirements, the debtor must now complete the application for composition with a document specifying how and under which terms the commitments it proposes to undertake after the composition is homologated will be discharged.

However, although the plan plays a central role in a composition, it is not the only document to be appended to an application for admission to the relevant procedure. Pursuant to Article 161 of the Bankruptcy Act, the application must also be accompanied by the following documents:

  • an up-to-date report on the firm's assets, liabilities, results and financial position, which provides a view of the firm's situation at the time of drafting the plan and is prepared in compliance with code-based financial reporting standards. Some commentators maintain that the report should be understood as tantamount to an extraordinary balance sheet;
  • an analysis and estimate of assets, which discloses the amount and value of the debtor's net worth and should preferably be accompanied by an expert report conducive to the identification of the likely realisable values, in case some of the debtor's assets should be liquidated or divested;
  • a list of creditors specifying their individual claims and causes of preference, which identifies the creditors that are the addressees under the procedure of the proposal for arrangement on the basis of the accounting figures as reported, and which must also state any debts made subject to terms or conditions, as well as any debts disputed, whether in or out of court;
  • a list of rights holders in rem or in personam in assets owned by or in the possession of the debtor, which discloses any third-party security interests in property (eg, pledges or mortgages) or the debtor's obligatory commitments (eg, a preliminary agreement) that may affect the free disposition of the debtor's assets; and
  • the value of assets and the particular creditors of unlimitedly liable members, which allows the creditors to express opinions about the expediency of the arrangement as opposed to the bankruptcy of the company or the bankruptcy of unlimitedly liable members by extension.

Finally, an application for composition must contain "a report by a practitioner… certifying the truthfulness of the firm's financial figures and the feasibility of the plan". The report must be drawn up by an independent professional identified by the debtor, who must meet specific statutory requirements, such as registration in the register of certified auditors (Article 67(3)(d) of the Bankruptcy Act).

In particular, the certifying practitioner's tasks include providing a professional opinion about the reliability and accuracy of the presentation of the debtor's assets, liabilities and financial position, and a predictive opinion about the viability of the form and the extent of satisfaction of creditors as outlined in the proposal.

Pre-composition application

Pursuant to Article 161(6) of the Bankruptcy Act, a debtor submitting an application for pre-composition must file – in addition to "a list of creditors specifying their individual claims", a document with the information described in the third bullet point above – its financial statements for the previous three fiscal years. These documents are not required, as a rule, for a composition application.

Comment

Because of the protracted economic crisis, in which many Italian businesses are ailing, and the widespread acceptance of pre-composition, some issues have been raised in relation to the pre-composition procedure.

In particular, as the Italian term for financial statements as a whole is a singular word (bilancio), which is often used to refer to the balance sheet alone, most commentators have elected to interpret it restrictively in this sense. As a result, a cursory report on the company's financial position and/or similar documents informally drafted by the applicant's managing body are deemed inadequate for a pre-composition application to be granted. Likewise, case law on the merits has held that this requirement cannot be deemed to have been met where the debtor in difficulty has filed mere draft statements (and/or preliminary annual reports) not adopted by the shareholders' meeting.

According to this interpretation, for an application for pre-composition to be deemed admissible, it must include the annual accounts prepared in accordance with Articles 2423 and following of the Civil Code. Accordingly, they are expected to include the notes to the accounts and the directors' report on operations, and must also have been adopted by the shareholders' meeting and filed with the Companies Registry.

For further information on this topic please contact PierDanilo Beltrami or Giacomo Bertone at Lombardi Molinari Segni by telephone (+39 02 896 221) or email (p.beltrami@lmlaw.it or g.bertone@lmlaw.it). The Lombardi Molinari Segni website can be accessed at www.lmlaw.it.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.