Paul Varul Leonid Tolstov May 18 2012 Developments in pre-insolvency procedures Law Firm VARUL | Insolvency & Restructuring - Estonia Paul Varul, Leonid Tolstov Insolvency & Restructuring IntroductionMoving towards pre-insolvency proceedingsRegulation of 'fresh money'CommentIntroductionOn December 26 2008 the Reorganisation Act entered into force in Estonia, aiming to breathe new life into businesses that are experiencing financial difficulties. Furthermore, on April 25 2011 the Debt Restructuring and Debt Protection Act entered into force. Although similar in nature to the Reorganisation Act, this act aims to help out natural persons who are experiencing financial difficulties. There is not yet much court practice regarding the application of the Reorganisation Act, but it is nonetheless clear that the act has not fulfilled its expectations. Entrepreneurs have complained that, due to the complexity of the proceedings and the meticulous nature of the courts' inquiry, reorganisation plans are often not approved until it is too late. Courts in turn accuse entrepreneurs of being too late in submitting their applications for reorganisation. Arguably, both are right. This situation can be compared to a person developing a cough - medics will state that the person should see a doctor immediately, but people do not as a rule go to a doctor merely for a cough. In the context of insolvency and reorganisation, the situation therefore could be compared to a person developing a cough (temporary financial difficulties) and immediately being recommended surgical intervention (that an application for reorganisation be submitted). Naturally, in such a situation, entrepreneurs tend to be cautious and wait as long as possible (and often too long) before submitting an application for reorganisation.Moving towards pre-insolvency proceedingsRegrettably, the recent economic difficulties are far from over, and according to many analysts the 'real' economic crisis is still ahead. However, this has caused European legislatures to depart from the traditional approach to insolvency law (the purpose of which is to satisfy creditors' claims by selling the debtor's assets), with many legal systems implementing reforms in order to provide entrepreneurs with different judicial and non-judicial solutions for reorganisation. The reality is that, in addition to protecting the interests of creditors, it is important to pay attention to preserving businesses that have encountered difficulties, but are otherwise viable. Such action may rescue jobs, thus ultimately also serving the interests of creditors that would receive nothing (or very little) if their claims were satisfied in bankruptcy proceedings that terminate with liquidation. When implementing pre-insolvency reorganisation measures, despite the temptation to implement efficient supervisory measures in the interests of creditors (eg, judicial supervision of the reorganisation, involving consultants), it is evident that the actual reorganisation is best done by the company's management. Therefore, the less judicial supervision that hinders the operation of the company, the better. Furthermore, the everyday practice of courts of lower instance indicates that if a company that is experiencing financial difficulties is drawn into protracted court proceedings (whether inspection before reorganisation, the appointment of an interim trustee or a declaration of bankruptcy), and the proceedings are reported in official notices and the media, the company will most likely face bankruptcy and liquidation. However, reducing judicial control brings the danger that the status of directors in pre-insolvency proceedings may be abused. Regulation of 'fresh money'A new instrument has been introduced into European legislation involving the regulation of so-called 'fresh money'. It allows a company that is experiencing financial difficulties to request that a creditor, pursuant to conditions stipulated by law, be provided with additional security or refinancing before bankruptcy. The concept of fresh money offers a creditor additional guarantees if it is willing to finance a business that is experiencing financial difficulties.CommentOther legal policy measures have also been suggested for the swift non-judicial reorganisation of a business that is experiencing financial difficulties. For instance, ideas have been proposed for: an obligation to continue the performance of reciprocal agreements (in a situation where the debtor has not fulfilled its obligations), in line with certain preconditions stipulated by law; the extension of contractual deadlines;the extension of a lease contract that has been cancelled; or the temporary suspension of employers' collective agreements. However, it could be asked why a party that has duly fulfilled its obligations should meet the party that has breached its obligations halfway, especially if the latter is faced with bankruptcy. The answer lies in court practice and relevant statistics - where, for example, in Estonian law the company has no alternatives to bankruptcy other than a complex insolvency procedure, most companies end up in bankruptcy proceedings terminated by abatement, and the creditors receive nothing. An alternative would be simply to negotiate out of court, which companies already do every day. However, a company that is experiencing financial difficulties is often forced into a corner without support from above (whether a court or a special representative), thus allowing creditors to force it to accept unacceptable conditions. Although the abovementioned last chance offerings may not always save a company, without such opportunities it would definitely not escape bankruptcy. There is no reason to believe that Estonia's insolvency law is complete. Indeed, this is arguably one of the fastest-growing areas of law during the current time of crisis. The legislature should therefore keep a close eye on new trends and solutions regarding insolvency law.For further information on this topic please contact Paul Varul or Leonid Tolstov at Law Firm VARUL by telephone (+372 626 4300), fax (+372 626 4306) or email ([email protected] or [email protected]).