Introduction
Admission to composition proceedings
Bankruptcy court's scrutiny of petitions for composition
Supreme Court guidance


Introduction

Under Italian law, composition with creditors is one of several procedures available to an entrepreneur in financial difficulty. Its aim is to allow debtors to overcome temporary difficulties or otherwise avoid bankruptcy.

Composition with creditors is governed by Articles 160 et seq of the Bankruptcy Act (267/1942). Over the past few years, the relevant provisions have been revised on several occasions - most significantly by Legislative Decrees 5/2006 and 169/2007 - in order to bring the procedure more closely into line with modern corporate and business needs. In particular, composition has become more focused on agreements between the debtor and the majority of its creditors.

In keeping with the greater emphasis on the private autonomy of the parties, the court's powers have been reduced. At present, the judge who is seised of the case is mainly required to act:

  • when the petition for admission to the composition procedure is scrutinised pursuant to Article 163 of the act;
  • if admission to the composition procedure is overruled pursuant to Article 173 (either because the statutory conditions for admission are not met or on the grounds of fraudulent acts to the creditors' prejudice); and
  • when the composition agreement is approved pursuant to Article 180 of the act, once the creditors have agreed to the debtor's composition proposal.

This update concerns the scope of the judge's powers at the time that admission to composition proceedings is considered.

Admission to composition proceedings

The procedure begins with a petition for composition being filed by an entrepreneur in financial difficulty. In a departure from the old provisions, the debtor is no longer required to meet the subjective standards of probity and creditworthiness that used to be prerequisites for admission to composition. Rather, the emphasis has shifted to the company's objective qualities and its business characteristics and conditions. To this end, the debtor must provide the court and creditors with as accurate a 'snapshot' of the company's position as possible. Thus, Article 160 of the act now requires that in addition to the petition, the debtor must file:

  • an up-to-date report on the firm's capital, business operations and financial position;
  • an analytical estimate of the company's assets and a list of the creditors by name, specifying their respective claims and any basis for preference;
  • a list of the holders of real or personal security interests in property owned by, or in the possession of, the debtor; and
  • a statement of the overall value of the assets and the names of the personal creditors of any shareholders or partners with unlimited liability.

It is advisable for the debtor to file the company's books and records, as this allows the creditors to base their view on the truest and fairest assessment of the company's position. The most significant feature of the revised legislation - and the aspect that best demonstrates the private and autonomous nature of the procedure - is the onus on the debtor to:

  • supplement the composition proposal with a plan which details the steps and timeframe whereby it aims to meet the targets in the proposal; and
  • file a report, compiled by an expert,(1) to certify the reliability of the debtor's equity, business and financial position, and the feasibility of the actions proposed for the satisfaction of the creditors' claims under the plan.

The plan and expert's report are at the core of the proposal for composition - they are the basis for the creditors' belief in the soundness of the proposal submitted to them.

Bankruptcy court's scrutiny of petitions for composition

Given the innovative approach set out above, it is no surprise that new approaches have evolved in the judicial scrutiny of petitions for admission to the composition procedure.

While the old rules were in force, the mainstream approach - supported by a number of Supreme Court judgments - was that no limitations should be placed on the court's power to test the debtor's compliance with the objective and subjective conditions for admission. The prevailing view was that judges were free to:

  • examine the substance of the composition proposal;
  • assess its probity, feasibility and economic viability; and
  • rule it inadmissible even before the creditors had been heard.

For example, in the typical case of a proposed agreement with creditors for the surrender of goods, the court would normally conduct an assessment in which it would attempt to foresee whether, theoretically, the debtor's assets could be assigned to satisfy at least 40% of the unsecured creditors' claims, in addition to full payment of preference claims.

Thus, before the reform, the predominant view was that the court was vested with the power to engage in a process of assessment and prediction. It could attempt to ascertain whether the targets specified in the plan could be met and to determine the expediency of such targets in the creditors' best interests. However, this approach was not universal. Even before the reform, some commentators emphasised the parties' autonomy. They viewed the court's role as being chiefly limited to an appraisal of the relevant legal issues. This function, they argued, should not be extended to considering the merits of a proposal, this being an assessment for the creditors alone.

This conflict of interpretations seems to have survived the in-depth innovations in Legislative Decrees 5/2006 and 169/2007. A minority of commentators still maintain that the new statutory rules on composition do not restrict the court's powers when considering the admissibility of a composition proposal. In their view, the bankruptcy judge should be granted the greatest possible freedom in assessing the merits of the composition proposal and its economic suitability for the creditors.

However, this view seems to disregard the rationale behind the reform. One of the main reasons for revising the internal rules of insolvency law was the belief that other solutions should be preferred to bankruptcy and winding-up - companies in financial distress should be rescued or be helped to continue all or part of their business. The widely recognised importance of this objective is clear from the preference accorded to forms of agreed settlement, such as so-called 'preventive composition', and from the more contractual nature of this and similar mechanisms, which rely to a greater or lesser extent on an agreement between the debtor in difficulty and a majority of its creditors.

The statutory requirement of an expert report has led some commentators to conclude that the judge's role is limited to a merely formal compliance check of the debtor's petition and the requisite documents. On this view, the court no longer has powers to enquire into the merits of the plan, much less to assess the economic suitability of the proposal to the creditors.

However, neither view seems to have had an impact in case law. Bankruptcy courts have been compelled to acknowledge the enhanced private law character of the new composition procedure and the new emphasis on the parties' private autonomy in settling business crises, based on an awareness that it is for the creditors to judge the suitability of proposals submitted to them. Nonetheless, the courts have not entirely ceded their former powers to assess the merits of the plan and the proposal. Thus, a new approach is increasingly gaining ground. It recognises the judge's power of supervision over substantive factors (ie, the power to scrutinise the plan and its feasibility through the assessment provided by the expert report, in terms of its thoroughness and compliance with set criteria). On this basis, judges are no longer authorised to assess the plan itself, partly because it is a technical instrument which a judge cannot be expected to review and appraise fully without expert advice. However, they may establish whether the report is well grounded, thoroughly thought-out and free from errors of logic and unreasonable or arbitrary assumptions. The judge is expected to ensure that the report is independent and unbiased. It should present a sufficiently detailed and reasoned opinion, in addition to a statement of its methodology and criteria. Therefore, a poorly structured or insufficiently detailed report, with no critical analysis, will be deemed an inadequate basis for determining the admissibility of a debtor's composition proposal and the advisability of commencing a composition procedure.

Supreme Court guidance

This approach has been upheld by the Supreme Court, which considered certain aspects of the issue in two recent judgments.(2) It found that the role of a bankruptcy court is not to enquire into the merits of the proposal and assess its economic suitability, but to establish whether the proposal allows the creditors to arrive at an informed and well-considered view as the basis for their vote. Such a condition is fulfilled only if the report is sufficiently clear, consistent and well reasoned to allow the reader to verify the grounds for its conclusions and the soundness of the arguments advanced in support. The judge may not assume a superior position to the expert or the creditors - which may be willing to accept the proposal even if the plan is unconvincing. Rather, his or her duty is to see that the creditors are allowed to cast their vote on the basis of adequate documentary information.

For further information on this topic please contact PierDanilo Beltrami or Giacomo Bertone at Lombardi Molinari e Associati by telephone (+39 02 896 221), fax (+39 02 8962 2333) or email ([email protected] or [email protected]).

Endnotes

(1) The expert must meet special requirements of professional integrity and independence.

(2) Decision 21869, October 25 2010; Decision 3586, February 14 2011.