An updated process
In Italy, the term 'composition with creditors' refers to an insolvency procedure whereby an enterprise in financial distress seeks an agreement with its creditors in an attempt to overcome its problems and avoid being declared bankrupt. The procedure is governed by Article 160 of the Bankruptcy Act (267/1942) and has been revised more than once in recent years, the changes being intended to promote the parties' shared interest in negotiating a solution to the debtor's difficulties.
The provisions in force before the recent reforms were widely perceived as being outdated and unsuitable for changing commercial needs. Bankruptcy is increasingly regarded as a last resort; as such, it should potentially be limited in scope in order to enable the continuation of all or part of the affected business, whether under the debtor's management or the administration of a third party.
The legislature extensively amended the act under Legislative Decree 35/2005, which itself was later amended by Legislative Decree 169/2007. The result is a structure which appears better suited to a market in which competitiveness, reactivity and flexibility in business operations are key requirements.
Composition with creditors is not the only tool available to a commercial debtor in financial difficulty. The 2005 reform provided for two additional insolvency procedures: an attested recovery plan under Article 67(3)(d) of the act and a debt restructuring agreement under Article 182(2). However, composition with creditors is likely to be the preferred tool where the debtor is in serious financial difficulties, bordering on full-scale default, or where radical remedies are needed, as the resulting composition scheme is statutorily binding on all creditors, including dissenters.
The reform made the composition procedure available to companies in financial distress - previously, it was available only to insolvent companies. Moreover, certain creditworthiness requirements have been struck out; these had led to composition being regarded as a solution available only to the honest but unlucky entrepreneur. One of the most significant changes was the relaxation of the doctrine whereby all creditors rank equally among themselves and are equally entitled to recourse to the debtor's assets, except where preference arises by law. The new rule provides that creditors may be divided into homogeneous classes, which may be treated differently.
The new Article 160 emphasises the principle of private autonomy, introducing a new conception of composition with creditors. The revised procedure is no longer limited to providing a traditional form of winding-up on insolvency; rather, it has been expanded to encourage the likelihood of a negotiated solution, widening the scope of the solutions available to the debtor. This approach is particularly apparent in the provision that debt restructuring can be achieved "in whatever form". This phrase allows for solutions other than those identified in Article 160, which accordingly should be regarded as an open set of examples.
The typical composition procedure still provides for the liquidation of the debtor's business assets in order to use the proceeds to satisfy its creditors and to discharge any remaining debt. This type of composition is generally achieved by transfer of the debtor's properties. This poses a number of issues in terms of the timing of the realisation of assets and the question of whether the debtor's is required to state a minimum percentage of claims to be satisfied and the actual value of such percentage - and, in particular, whether such statement is merely indicative or legally binding. If it is indicative, where the debtor indicates only the means by which assignment of assets will be effected, the proceeds of sale of the debtor's assets are transferred to the creditors - no minimum amount is required. If it is binding, the composition agreement may be refused court approval (if the percentages promised to the creditors are considered unachievable), or terminated (if such percentages fail to materialise on performance of the composition agreement).
The term 'liquidation' does not necessarily imply the immediate disposal of all assets. The new provisions on composition are not inconsistent with the temporary continuation of some or all of the debtor's business operations. The rationale for this approach is that it may be advisable to carry on business as usual, thereby securing the company's commercial value with a view to selling the business, not merely its individual assets. This has the potential benefit of guaranteeing a certain amount of cash flow and thus allowing the debtor to retain key suppliers and obtain vital credit facilities, while also making the business more appealing to prospective acquirers.
The procedure does not necessarily require the liquidation of all of the company's assets in all circumstances; rather, a so-called 'mixed' scheme may be proposed. Such a scheme provides for the sale of some of the firm's assets and the continuation of one or more parts of the business - under the same or different management - where this represents a better commercial prospect.
Liquidation may be pursued through the appointment of an official assignee. Article 160 expressly requires that the debtor firm's assets be surrendered to a third party, which will undertake to perform the composition agreement (ie, to pay the company's debts). However, in practice the statutory effects of transferring the company's assets to the official assignee are postponed until the latter has performed the relevant obligations in full. The official assignee can rely on a large range of mechanisms to satisfy the creditors' claims. It can perform the relevant obligations using its own funds or the proceeds of sale of the debtor's assets under the composition procedure, or by allocating shares in a special purpose vehicle to creditors.
The purpose of the reform was to ensure the satisfaction of creditors' claims "in whatever form" (eg, by safeguarding and raising the value of the debtor's assets). This can also be accomplished through a composition scheme for the rescue of a financially distressed company through debt restructuring. This has the advantage of allowing the company's operations to continue under the same ownership. In order to achieve this ambitious goal, a business plan must be prepared. The plan must demonstrate the firm's ability to withstand the pressure of its indebtedness based on its business performance, with special emphasis being placed on predictable cash flows and reliable projections on the satisfaction of creditors' claims. Creditors have the right to assess a proposed composition scheme.
In order to reconcile the objectives of creditor satisfaction and the need to preserve the entity's productive potential, the legislature allows for a wide range of asset-restructuring actions under a composition scheme. These include extraordinary transactions, such as mergers, spin-offs and business transformations, which can be carried out by companies affected by insolvency proceedings. A company in financial distress may also consider issuing capital securities, including bonds or other financial instruments, which it can assign to creditors. Business continuity can also be secured where a third party is willing to purchase the company. A scheme of this type can provide for different ways of satisfying creditors' claims, the most common being the sale of the company to a third party, often following a term of lease of all or part of its business.
On receipt of a proposal, the court usually requests - as a creditor protection measure - that a guarantee be given as a precondition for the admission or approval of the composition agreement. A guarantee may also be given after the presentation of the composition scheme, but before the creditors' meeting. However, failure to provide a guarantee may adversely affect subsequent actions and is likely to compromise the credibility of the scheme in the eyes of the creditors. Several classes of guarantee are admissible - they may take the form of security interests in real property or personal guarantees, but a comfort letter or the formation of a trust may also be considered acceptable.
In order to ensure business continuity, the legislature added Article 182(4) to the act to make it easier for companies in difficulty to obtain bridge loans before filing for composition. Bridge loans entail the granting and maintenance of credit facilities by banks or other financial institutions to provide a distressed enterprise with sufficient resources pending completion of the composition scheme. Such loans can now benefit from pre-deductibility provisions for tax purposes (applicable to claims to be paid in priority and preferred over other claims in insolvency), even while the insolvency procedure is underway - the same applies to bankruptcy proceedings if they are brought following the failure of composition arrangements.
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]).