Overview of Insolvency Rules and Restructuring Procedures Pursuant to Italian Bankruptcy Law
Prior to 2005, the Italian bankruptcy system was centered on the idea that failed businesses should be liquidated and insolvent debtors expelled from the economic system. As a result, the usual outcome of Italian insolvency proceedings was the liquidation of the debtor’s assets, with pre-insolvency restructurings kept out of court and, therefore, outside a clear framework of legal protection. As a consequence, both the debtor and creditors were exposed to claw back actions and criminal liability risks in the event of the debtor’s subsequent bankruptcy.
In an effort to address these negative effects, the law governing Italian bankruptcy proceedings (Royal Decree No. 267 of 16 March 1942, the “Italian Bankruptcy Law”) was substantially reformed in 2005 by Law No. 80 of 14 May 2005, with further amendments adopted in 2006, 2007, and 2009 (the “Reform”).
Through the Reform, lawmakers sought to introduce more efficient regulation of pre-bankruptcy procedures and debt restructuring agreements. In particular, one of the principal goals of the Reform was to support and facilitate the turnaround of companies and provide consensual pre-bankruptcy solutions for companies in financial crisis, in order to limit the high social costs associated with value destruction and reduce the risks arising out of “private” arrangements with creditors.
The restructuring procedures contemplated in the Italian Bankruptcy Law following the Reform are:
- Pre-Bankruptcy Agreements. The “Pre-Bankruptcy Agreement” (concordato preventivo) refers to the traditional pre-bankruptcy arrangement with creditors, that was – and still is – the sole Italian insolvency procedure allowing cram-down without a public receiver overruling the board of directors. As discussed below, the Pre-Bankruptcy Agreement was completely overhauled by the introduction of a significantly higher degree of flexibility under the Reform.
- Debts Restructuring Arrangements: o debt restructuring agreements contemplated by Article 182-bis of the Italian Bankruptcy Law (accordo di ristrutturazione dei debiti) (the “Debt Restructuring Agreement”); and o out-of-court debt restructuring plans contemplated by Article 67(3)(d) of the Italian Bankruptcy Law (piano attestato di risanamento) (the “Debt Restructuring Plan”).
- Pre-Bankruptcy Agreements
Only debtors that are business enterprises meeting one of the following conditions may utilize the Pre-Bankruptcy Agreement procedures available under the Italian Bankruptcy Law. The debtor must have:
- assets – on an annual basis – over the last three years greater than €300,000;
- annual gross revenues over the last three years greater than €200,000; and/or
- indebtedness – whether or not due – in the aggregate greater than €500,000.
In addition, the debtor has to be in a “state of financial distress.” This requirement is broader than the previously required “state of insolvency.”
Prior to the Reform, a debtor could only propose a Pre-Bankruptcy Agreement to its creditors that offered a series of guarantees satisfying at least 40% of its creditors’ unsecured claims and/or pursuant to which the debtor assigned all of its assets to its creditors, provided, that such assets were deemed sufficient to satisfy at least 40% of the creditors’ unsecured claims. This is no longer the case.
Pre-Bankruptcy Agreements under the Italian Bankruptcy Law are now more flexible and a debtor may propose a recovery plan to its creditors that provides for, among other things, the restructuring of its indebtedness and the payment of claims in any form, including the assignment of shares, securities or other financial instruments to creditors.
The recovery plan may also provide for the assignment of the debtor’s assets, but a debtor is now permitted to assign less than all of its assets. Further, the assigned assets are no longer required to satisfy a minimum percentage of unsecured claims. The plan can also provide for the assignment of the debtor’s assets (and some of the related liabilities) in favor of a third party assignee.
Furthermore, a debtor can now split its creditors into different classes and treat them differently according to their respective class. In addition, under the new rules creditors with liens or in rem security interests (i.e. pledges and mortgages) can be partially satisfied, provided, that their claims would not be more fully satisfied through the sale of their secured assets.
- Debt Restructuring Agreements
Debt Restructuring Agreements pursuant to the new Article 182-bis of the Italian Bankruptcy Law resemble prepackaged reorganization plans under Chapter 11 of the United States Bankruptcy Code. In particular, a Debt Restructuring Agreement is an out-of-court agreement entered into without court involvement by and between a business in a state of distress and creditors representing at least 60% of all claims against the debtor. Unlike a Pre-Bankruptcy Agreement, a Debt Restructuring Agreement is only effective between the participating parties.
In Italy’s bank-centric financial system, it is common for banking institutions to hold 60% or more of the total claims against a debtor. Banks are therefore central players in debt restructuring proceedings in Italy.
A Debt Restructuring Agreement is subject to approval by the bankruptcy court where the debtor has its current registered office. The debtor is required to file the Debt Restructuring Agreement with such court, along with required documentation, including a report by an expert ascertaining the feasibility of the agreement, particularly with respect to the regular payment of debts held by creditors who have not entered into the Debt Restructuring Agreement. Following the filing with the bankruptcy court, the debtor publishes the Debt Restructuring Agreement in the companies’ registry where the company has its registered office.
A Debt Restructuring Agreement takes effect the day it is published in the companies’ registry. Creditors whose claims arose prior to the date of publication cannot commence or initiate restraining actions or enforcement proceedings against the assets of the debtor for 60 days following publication. Further, any interested party can oppose the Debt Restructuring Agreement within 30 days of publication.
The bankruptcy court can grant its judicial approval of the Debt Restructuring Agreement once it has ruled on any opposing actions. The court’s decree of approval is then published in the companies’ registry. All transactions, payments and security interests carried out or granted pursuant to a judicially approved Debt Restructuring Agreement are protected against bankruptcy claw-back actions.
- Debt Restructuring Plans
The Italian Bankruptcy Law also provides some protection against claw-back actions for agreements between a debtor and any of its creditors that provide for new financing and the granting of security interests in connection with such new financing or the rescheduling of indebtedness.
Under the Italian Bankruptcy Law such agreements must be based on a restructuring plan prepared by the company – usually with its financial or industry adviser – pursuant to Article 67(3)(d) (the “Plan”). The Plan has to ensure repayment of the company’s outstanding debt and financial re-balancing of the debtor.
Plans generally include, among other items, an industrial and financial plan, a moratorium, a debt refinancing or rescheduling plan, and an analytical description of all transactions, payments and security interests that, pursuant to the Plan, are to be made or granted with respect to the assets of the debtor.
Finally, prior to entering into an out-of-court agreement based upon a Plan, creditors require that the Plan be reviewed by an expert accountant who issues an opinion on the reasonableness of the assumptions under Plan and the ability of the debtor to fulfill its payment obligations. The expert opinion is intended to provide protection for the creditors against claw-back actions based on the transactions, payments and security interests made or granted pursuant to the Plan and related agreements.
The Italian Bankruptcy Law does not expressly require that the Plan and the expert opinion bear a date certain. However, specifying a date helps demonstrate that the Plan was approved and the expert opinion was issued prior to any subsequent bankruptcy of the debtor and prior to entering into transactions, making payments and granting security interests contemplated by the Plan and related agreements.
Recent Developments Relating to Italian Restructuring and Insolvency Rules
After the worsening of the financial crisis in late 2008, new rules were introduced aimed at further encouraging the use of Debt Restructuring Agreements by addressing one of the most significant pitfalls of the previous reform: the lack of safe harbor provisions and super-priority rules for interim and new financing extended in the context of restructuring proceedings.
Historically, the Italian bankruptcy system provided strong disincentives to the granting of financing to distressed businesses. In the event of the debtor’s subsequent bankruptcy, such lenders did not enjoy any priority vis-à-vis other creditors and, more importantly, could even face criminal liability, together with the borrower, for aggravating the company’s insolvency.
In 2010, in order to address these issues, a super-priority rule was introduced for interim and new financing extended by financial institutions pursuant to a restructuring agreement. It was coupled with safe harbor provisions against criminal liability for transactions carried out pursuant to, among other proceedings, restructuring agreements. These changes have made Debt Restructuring Agreements less risky for banks and other financial institutions.
The new rules introduced by Law No. 122 of 30 July 2010 that came into force on 31 July 2010 (the “Law 122/2010”), amending Law Decree No. 78 of 31 May 2010, focus on three key issues:
- Criminal liability. Certain actions and steps generally required for a successful turnaround transaction (e.g. payments only to some creditors; financing; creating security interests; as well as delaying filing for an insolvency procedure pending the outcome of negotiations) can give rise to potential criminal liability risks for directors and, in certain circumstances, for shareholders and lenders. To address this concern, the new rules expressly state that payments and transactions implementing a Pre-Bankruptcy Agreement, a Debt Restructuring Agreement or a Debt Restructuring Plan fall outside the scope of “preferential bankruptcy” and “simple bankruptcy.”
- Interim and new financing. The prior regime was extremely unfavorable to any interim financing needed prior to the implementation of a turnaround procedure (no super-priority status, claw-back risk, no security, risks of civil and criminal liability). Following the recent legislative changes, financing granted by banks and certain regulated financial institutions either to implement a court validated Debt Restructuring Agreement or Pre-Bankruptcy Agreement or that is needed to allow for the filing of a Debt Restructuring Agreement or Pre-Bankruptcy Agreement will be given super-priority status. Moreover, financing granted by shareholders to implement a court validated Debt Restructuring Agreement or Pre-Bankruptcy Agreement will be given super-priority status for up to 80% of the financing amount.
- Moratorium. The prior regime failed to provide an effective moratorium, at least during the initial phase of restructuring negotiations. Under the new rules, pending the outcome of the negotiation of a Debt Restructuring Agreement, debtors are, subject to certain conditions, allowed to file a request for a moratorium with the competent court. The request must be published in the companies’ register and the moratorium period starts from the date of publication.
- Criminal Liability
Generally, a turnaround procedure involves several steps that, at least from a factual perspective, fall within the scope of simple bankruptcy or preferential bankruptcy. As such, if the turnaround is not successful and the distressed company is subsequently adjudicated bankrupt (or submitted to certain other insolvency procedures), such action could expose the parties to the risk of criminal liability.
Law 122/2010 deals with this issue by introducing a new Article 217-bis according to which the provisions of Article 216 (3) (“Preferential Bankruptcy”) and Article 217 (“Simple Bankruptcy”) of the Italian Bankruptcy Law do not apply to payments and transactions carried out in order to implement a Pre-Bankruptcy Agreement, Debt Restructuring Agreement, or Debt Restructuring Plan.
This exemption is subject to the following limitations:
- If the turnaround procedure fails and the distressed company ultimately defaults, the competent court will scrutinize the selected turnaround procedure to ascertain whether or not it was reasonable when originally implemented. If the court determines that it was not reasonable, the exemption from criminal liability would not apply; and
- The exemption does not extend to payments and transactions carried out prior to the implementation of the selected turnaround procedure or in the context of the negotiations of a Debt Restructuring Plan, Debt Restructuring Agreement or Pre-Bankruptcy Agreement that is not ultimately validated by the competent expert or court, as applicable.
Despite these limitations, the new provision introduced in the final text of the Law 122/2010 significantly reduces the risk of criminal charges for both debtors and lenders in connection with transactions executed in furtherance of a Pre-Bankruptcy Agreement, Debt Restructuring Agreement or Debt Restructuring Plan. In particular, under the new measures, charges relating to preferential payments and simple bankruptcy crimes for deepening insolvency do not apply to such transactions.
These amendments remove a significant obstacle to the adoption of the recently introduced restructuring procedures and encourage the use of these procedures by creating a less risky legal environment for debtors, shareholders, lenders and new equity or debt investors.
- Interim and New Financing
The main legislative changes affecting interim and new financing include:
- Financing granted by banks and certain regulated financial institutions to implement a Debt Restructuring Agreement or a Pre-Bankruptcy Agreement duly validated by the competent court (i.e. new financing after the procedure has been approved) will be given super-priority status;
Financing granted by shareholders to implement a Debt Restructuring Agreement or a Pre-Bankruptcy Agreement previously validated by the competent court (i.e. new financing after the procedure has been approved) will be given super-priority status for up to 80% of the financing amount; and Financing granted by banks and regulated financial institutions necessary to allow for the filing of a Debt Restructuring Agreement or a Pre-Bankruptcy Agreement (i.e. bridge financing during the procedure) may be given super-priority status provided that certain conditions are met. Such requirements are:
- The lender is a bank or a financial institution registered with the Bank of Italy under Articles 106 and 107 of the Legislative Decree No. 385 of 1 September 1993 (i.e. the Italian Banking Law);
- For new financing provided in the context of, or to implement, a Pre-Bankruptcy Agreement, the court grants priority claim status within the decision that admits the petition for the Pre-Bankruptcy Agreement, or finally approves the Pre-Bankruptcy Agreement; and
- For new financing provided in the context of, or to implement, a Debt Restructuring Agreement, the court approves the final agreement.
In addition, to avoid conflicts of interest, the new legislation states that the holders of priority claims are not allowed to vote on the Pre-Bankruptcy Agreement proposal, nor are they considered in calculating the majorities required for the approval of a Pre-Bankruptcy Agreement or the 60% threshold required for a Debt Restructuring Agreement. This is intended to avoid any potential abuse of position by the providers of new financing against the interests of pre-existing lenders.
These new provisions will have several positive effects. First, lenders may be more inclined to provide new financing even in those situations in which there are insufficient assets to secure the new financing, as they may benefit from a priority status for their claims by operation of law.
Second, the changes may increase the availability of financial resources to distressed companies, by freeing company assets that can be used as security for additional financing. Typically, the providers of new financing in distressed situations are willing to make additional cash available only if the new loans enjoy priority over the preexisting debt of the borrower in the event of insolvency. This is achieved by securing the new loans with any unencumbered assets and/or by entering into appropriate contractual arrangements with the other financial creditors of the debtor and the debtor itself. Following the new measures, the providers of new financing will now be protected by operation of law and may, therefore, allow the debtor to use its unencumbered assets to obtain additional financing from third parties.
Third, the complex negotiations and arrangements normally used to secure a contractual priority position will, in certain cases, not be necessary. This may streamline the restructuring process, reducing the transaction costs and shortening the amount of time necessary to close a restructuring.
Finally, the grant of super-priority status under the new provisions for up to 80% of the financing provided by shareholders to implement a court validated Debt Restructuring Agreement or Pre-Bankruptcy Agreement, will make additional financial resources available to address distressed situations by providing an opportunity for shareholders to inject cash with an investment risk similar to that of a debt provider, rather than the higher risk faced by an equity provider.
Law 122/2010 has introduced a new paragraph in the Article 182-bis of the Italian Bankruptcy Law pursuant to which a debtor may request a moratorium during the negotiations of a Debt Restructuring Agreement. To request a moratorium the debtor must file the following documents with the competent court:
- the request for the moratorium;
- an up to date economic and financial statement;
- a detailed list and estimate of the value of its assets and a list of its creditors (including all relevant receivables owed to the company) and security interests;
- a list of holders of in rem or personal rights over assets of the debtor (owned or in use);
- a proposal for a Debt Restructuring Agreement;
- a statement of the debtor confirming that negotiations with creditors representing at least 60% of its debts are on-going; and
- a statement by an expert, meeting the requirements for the certification of the Debt Restructuring Agreement, confirming that the restructuring proposal, if accepted by the relevant creditors, allows for the regular payment of creditors that are not participating in the negotiations of the Debt Restructuring Agreement or that have already confirmed that they are unable to enter into such negotiations.
In particular, a debtor who carries out a restructuring under Article 182-bis is entitled to benefit from the automatic stay for a period of 60 days following publication in the companies’ register of the agreement that it has reached with its creditors representing 60% of the overall claims against the debtor, along with an expert’s assessment. This allows the debtor to obtain protection during the negotiation phase.
The automatic stay also prevents third parties from registering judicial mortgages and other preferential rights over the assets of the company unless it is consensual. In conclusion, this additional remedy would represent a further incentive for debtors to adopt the new restructuring procedures.