Alert The Impending First Revision to the EU Insolvency Regulation: An Update 16 December 2014 The latest draft of the First Revision published on 20 Nov. 2014 indicates measured but extensive amendments to the EU Insolvency Regulation (‘EIR’). The most significant is the EU policy shift evidenced by the proposal to extend the EIR’s application from its currently narrow and primarily liquidation-based proceedings to a broader range of measures that are focused on rescue and that have recently been implemented in various jurisdictions. The advisers to the European Commission have clearly drawn on the challenges in cross-border insolvencies experienced over the 12 years since the EIR was introduced in an effort to improve efficiency and effectiveness. It is expected that this draft of the First Revision, without further (material) amendment, will be voted on in the coming months by the European Parliament (though it will not take effect for another 24 months thereafter (i.e. in the course of 2017 at the earliest)). This Alert looks at the more substantive and important proposals of the First Revision. Brief Background In 2002, the EIR was implemented to improve the functioning of the European internal market by requiring that an insolvency proceeding that was opened in one EU member state should operate efficiently and effectively in all EU member states where those proceedings may have relevance.1 Whilst this was a good starting point, it was at the same time recognised that the development of case law and commercial practice would require that the EIR should be periodically updated.2 As soon as the EIR came into force, the challenges for European-wide group insolvencies became evident, with cases involving entities such as Budget Rent-A-Car, Collins & Aikman and MG Rover, and following the financial crisis in 2008, with cases involving entities such as Nortel, SEAT Pagine Gialle and Petroplus. In short, the intention of the amendments to the EIR (the ‘Proposed Amendments’ 3 ) is to update the EIR by reflecting key developments in case law and practice during the first 12 years of EIR’s operation, and 1 Recital (2) EIR. 2 Pursuant to Article 46 (now Article 91 in the Proposed Amendments) of the EIR, the European Commission is required to reassess the EIR (a first report on its application was due no later than 1 June 2012). 3 As set out in the 15414/14 Addendum to the Interinstitutional File 2012/0360 (COD) dated 20 Nov. 2014 by the Council of the European Union.© 2014 Schulte Roth & Zabel LLP | 2 to thereby further enhance the effective administration of cross-border insolvency proceedings in the 27 EU member states4 in which the EIR applies. 5 As clearly stated in Recital 11, 6 the EIR was never an attempt to harmonise the widely differing substantive laws on insolvency in each of the member states. It was acknowledged that the introduction of one set of insolvency laws and proceedings with universal scope across all member states would not be practical, let alone achievable. Instead, Recital 6 of the Proposed Amendments clarifies that the EIR should encompass provisions in respect of the following three key areas: • Provisions governing jurisdiction for opening insolvency proceedings (and actions that derive directly from the insolvency proceedings and that are closely linked with them) (‘Jurisdiction’); • Provisions regarding the recognition and enforcement of insolvency proceedings7 and judgments issued in such proceedings and provisions regarding the laws applicable to insolvency proceedings (‘Recognition, Enforcement & Applicable Law’); and • Provisions on the coordination of insolvency proceedings which relate to the same debtor or to several members of the same group of companies (‘Coordination’). For those accustomed to the U.S. federal-style Bankruptcy Code containing substantive law on insolvency that is applicable in each U.S. state, the EIR may be perceived to be far less ambitious and appear unsatisfactory. However, in Europe, harmonisation of substantive insolvency laws would also involve the harmonisation of other substantive local laws such as security and creditor priority laws, each of which varies widely amongst the member states. The wide divergence of these fundamental laws as well as the fact that some member states operate under the civil code system, and others under the common law system, makes a U.S. federal-style insolvency law much harder to accomplish in Europe. Impact of Certain Key Updates of the EIR Contained in the Proposed Amendments In this Alert we will briefly address the likely impact of each of the following Proposed Amendments: • Extension of Annex A: It is proposed to extend the scope of Annex A of the EIR to include proceedings which promote the rescue of economically viable but distressed businesses; 8 • Forum Shopping: The forum shopping prohibition contained in the Recitals9 is proposed to be adjusted, as are certain rules regarding establishment of jurisdiction based on the debtor’s COMI; 10 4 The Institutions of the European Union are the Commission, the Council and the Parliament. The Commission is the executive of the European Union, responsible for proposing legislation and implementing decisions. The Council is the main decision-making body of the European Union and the Parliament is involved as a co-legislator in drafting European legislation. 5 The EIR does not apply in Denmark. 6 Recital 21 Proposed Amendments. 7 Recognition includes matters such as respecting the moratorium on enforcement of creditors’ rights against the debtor that may arise under the laws of the member state in which the opening of main proceedings occurs. 8 Recital 10 Proposed Amendments. 9 Recital 5 Proposed Amendments, which used to be Recital 4.© 2014 Schulte Roth & Zabel LLP | 3 • The Opening of Secondary Proceedings: Additional provisions are proposed to be introduced for determining when and how to open secondary proceedings alongside or instead of main proceedings (including provisions that will prevent the opening of secondary proceedings altogether (where, for example, it is determined that secondary proceedings may hamper the efficient administration of the insolvency estate)); 11 • Co-ordination of Group Insolvencies: New provisions requiring coordination in respect of the opening and operation of insolvency proceedings for group companies are proposed to be introduced; 12 • Introduction of the Register: A web-based EU-wide system of insolvency registers (the ‘Register’) is proposed; 13 and • Miscellaneous: Also worthy of mention are some of the provisions (whether in the nature of clarification, codification of existing law or practice or new rules) covering employees, jurisdiction and pending lawsuits and filings. Some of these are also briefly discussed. Extension of Annex A14 The Proposed Amendments extend the application of the EIR from a fairly narrow range of insolvency proceedings involving collective judicial or administrative proceedings involving the divestment of the debtor to include pre-insolvency and hybrid insolvency proceedings (including those that leave the company or the company’s management fully or partially in control of their assets and affairs (‘debtorin-possession’ proceedings)).15 As a result, such procedures will also benefit from European-wide recognition. While there was some initial concern that Annex A would be extended to capture non-insolvency processes, such as the UK Scheme of Arrangement (‘Scheme’), 16 it is now clear that it will not. The Proposed Amendments clearly state in Recital 15 that the EIR ‘should apply to proceedings which are based on a law relating to insolvency’ but that ‘proceedings that are based on general company law not designed exclusively for insolvency proceedings should not be considered to be based on a law relating to insolvency’. Therefore, since Schemes are regulated by the Companies Act 2006, and apply to companies whether insolvent or not, the EIR will not apply to Schemes. 10 ‘COMI’ is an acronym for ‘centre of main interests’. COMI determines the member state for the opening of main (insolvency) proceedings for the debtor company (as per Article 3(1) of the EIR). The effect of any secondary (insolvency) proceedings opened in a second member state where the debtor company has an establishment is limited to the assets located in that member state and the secondary proceedings are subservient to the main (insolvency) proceedings. 11 Recitals 36, 39 and 40-45 Proposed Amendments and Article 3. 12 Recitals 48-58 Proposed Amendments. 13 Recitals 72-75 Proposed Amendments. 14 The EIR applies to those insolvency proceedings which are listed exhaustively in Annex A of the EIR (Recital 9 Proposed Amendments). 15 Recital 10 Proposed Amendments. Article 2(3) defines ‘debtor in possession’ as ‘a debtor in respect of whom insolvency proceedings have been opened which do not necessarily involve the appointment of an insolvency practitioner or the complete transfer of the rights and duties to administer the debtor’s assets to an insolvency administrator and where therefore the debtor remains totally or at least partially in control of his assets and affairs’. 16 A Scheme is a UK Companies Act 2006 court-approved procedure that can be utilised by distressed companies to reach an arrangement between its members or creditors in order to either: (1) avoid going into formal insolvency proceedings; or (2) effect a solvent reorganisation of that company or its wider group structure. From a non-insolvency perspective, a Scheme can also be used in solvent corporate reorganisations, acquisitions and demergers to return capital to shareholders and remove minority shareholders.© 2014 Schulte Roth & Zabel LLP | 4 Had it been decided to include Schemes in the EIR, an English court would only have jurisdiction to sanction a Scheme if the COMI of the Scheme company were properly determined to be located in England (assuming that the Scheme constituted the opening of main proceedings and not secondary proceedings).17 Given the absence of application of the EIR to Schemes, the question arises whether the so-called Judgments Regulation18 determines the question of jurisdiction in respect of Schemes. Recital 7 of the Proposed Amendments clarifies that the interpretation of the EIR should, as much as possible, avoid regulatory loopholes between the EIR and the Judgments Regulation. This seems to suggest that if Schemes are not covered by the EIR, they should be covered by the Judgments Regulation. 19 However, Recital 7 also states that the mere fact that a national procedure is not listed in Annex A to the EIR should not necessarily imply that this procedure is covered by the Judgments Regulation. If Schemes are covered neither by the EIR nor the Judgments Regulation, the English courts will nevertheless accept or reject jurisdiction by applying the current test under the Companies Act 2006 that has developed in English case law. In essence, this means that an English court will find jurisdiction to sanction a Scheme even if it relates to a foreign company if the court is satisfied that: (1) the company has a ‘sufficient connection’ to the English jurisdiction; and (2) it has sufficient comfort that its order sanctioning the Scheme will have ‘effect’ in the relevant foreign jurisdiction. 20 It is further well-established in English case law that a company has ‘sufficient connection’ to invoke the jurisdiction of the English court under a Scheme if the finance documents to which it is subject and in respect of which the restructuring is proposed are governed by English law and subject to the jurisdiction of the English courts.21 Forum Shopping Recital 5 of the Proposed Amendments now reads: ‘It is necessary for the proper functioning of the internal market to avoid incentives for the parties to transfer assets or judicial proceedings from one member state to another, seeking to obtain a more favourable legal position to the detriment of the general body of creditors (forum shopping).’ 22 This clarifies that there is only a prohibition on so-called ‘bad forum shopping’. The EIR contains a number of safeguards aimed at preventing fraudulent or abusive forum shopping. 23 One of these new safeguards relates to the rebuttable presumption that the COMI of a debtor company is the place of its registered office.24 Article 3(1) of the EIR now clarifies that this rebuttable presumption will only apply if the registered office has not been moved to another member state within a period of three months prior to the request for the opening of insolvency proceedings. In essence, the aim of this amendment 17 Recital 32 Proposed Amendments. 18 Regulation (EU) No 1215/2012 of 12 Dec. 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters. 19 Jurisdiction under the Judgments Regulation can be created in a number of ways, including, based on Article 8 (if one of the Scheme creditor resides in the United Kingdom) or Article 25 (when parties have contractually chosen the jurisdiction of the English courts). 20 Through recognition or otherwise. The Proposed Amendments will not change the English courts’ application of the second limb of the test. To date, no Scheme that has been sanctioned by an English court has been overturned or interfered with by a court of another member state. Nonetheless, absent automatic recognition that would be afforded by application of the EIR or the Judgments Regulation to Schemes, such interference is possible. 21 The ability of Schemes to come to the aid of restructuring foreign companies is discussed in the SRZ Alert titled ‘Popularity of UK Scheme of Arrangements to Restructure Foreign Companies Continues – Boundaries of Application Further Extended’, dated 1 May 2014. 22 The emphasis is added and shows the change to the original Recital 4 EIR. 23 Recital 28 Proposed Amendments. 24 Recital 30 Proposed Amendments.© 2014 Schulte Roth & Zabel LLP | 5 seems to be that any purported COMI shift by means of changing the registered office within three months of the opening of an insolvency proceeding will have to be evidenced by something more. In practice, if there could be any doubt on where the COMI resides, any prudent entity would typically already provide more extensive evidence in any event. In respect of the COMI, the Proposed Amendments have also specifically codified certain of the developments that have derived from case law and in practice. 25 So in this context, the amendments are helpful but do not contain any surprises. The Opening of Secondary Proceedings A long-awaited amendment contained in the Proposed Amendments is that secondary proceedings no longer have to be winding-up proceedings.26 The Recitals of the Proposed Amendments27 further codify the ‘undertaking to local creditors’ solution that was found in practice to avoid the opening of secondary proceedings (which could only be windingup proceedings).28 In short, in circumstances where an insolvency practitioner determines that secondary proceedings should be avoided, he or she will be permitted29 in the ‘main proceedings’ (and subject to the fulfillment of certain conditions) to provide an undertaking to distribute assets located in another member state as if secondary proceedings had been opened in that other member state. One of the conditions is that a qualified majority30 of local creditors in that member state approves the undertaking. In the context of the undertaking, the assets and rights located in the member state where the debtor has an establishment31 (and where secondary proceedings could have been opened) should form a sub-category of the insolvency estate in the main proceedings, and when distributing them or the proceeds resulting from their realisation, the insolvency practitioner in the main proceedings should respect the priority rights that local creditors would have had if secondary proceedings had been opened in that member state. Coordination of Group Insolvencies While the Proposed Amendments address group insolvencies specifically32 in a new Chapter V to the EIR (on Insolvency Proceedings of Members of a Group of Companies), the so-called ‘entity-by-entity’ approach of the EIR is not changed when dealing with a group insolvency. Therefore, for the purpose of 25 See in particular Recitals 26-33 Proposed Amendments (e.g. Recital 29 specifies the company’s COMI as being indicated by the place of ‘central administration’ and ‘actual centre of management and supervision’, in each case, ‘in a manner ascertainable by third parties’. And Recital 27 further codifies case law insofar as a COMI shift must be ‘ascertainable’ by special reference to creditors and their ‘perception as to where a debtor conducts the administration of his interests’). 26 This is a requirement in Article 3(3) EIR which will be changed in Article 3(3) Proposed Amendments. 27 Recitals 40-42 Proposed Amendments. 28 Article 36 Proposed Amendments, codifying case law in Re Collins & Aikman Europe Ltd , EWHC, 1343 (Ch); Re MG Rover España SA  B.C.C. 599; and Re Nortel Networks SA (No.2)  EWHC 1482 (Ch). 29 Under the Proposed Amendments the more neutral term ‘insolvency practitioner’ replaces the term ‘liquidator’. 30 Qualified majority of creditors is calculated pursuant to the rules of the relevant member state. Article 36(5) Proposed Amendments. 31 ‘Establishment’ is defined to mean ‘any place of operations where the debtor carries out or has carried out in the three months prior to the request to open main insolvency proceedings a non-transitory economic activity with human means and assets’ Article 2(10) Proposed Amendments. 32 Article 2(12) Proposed Amendments defines ‘group of companies’ as ‘apparent undertaking and all its subsidiary undertakings’, and in Article 2(13) ‘parent undertaking’ is defined as ‘an undertaking which controls, either directly or indirectly, one or more subsidiary undertakings. An undertaking which is preparing consolidated financial statements in accordance with Directive 2013/34/EU of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings … shall be deemed to be a parent undertaking’.© 2014 Schulte Roth & Zabel LLP | 6 opening insolvency proceedings for a company within a group of companies and determining its COMI, the rules remain the same as those applicable to individual companies that are not part of a group. This new Chapter V consists of 21 new articles (56-77) and focuses primarily on: (1) cooperation and communication; and (2) co-ordination. In each respect, the Proposed Amendments clearly draw inspiration from the principles included in the Report Containing Global Principles for Cooperation in International Insolvency Cases published in 2013 by Professors Fletcher and Wessels.33 One feature of cooperation requires that insolvency practitioners appointed in proceedings concerning a member of the group cooperate (including by sharing information) with any insolvency practitioner appointed in proceedings concerning another member of the same group to the extent appropriate to facilitate the effective administration of the proceedings and in a manner that is not incompatible with the rules applicable to the proceedings. As regards co-ordination, the Proposed Amendments permit group co-ordination proceedings to be opened on the application of the insolvency practitioner appointed in insolvency proceedings opened in relation to a member of the group.34 The court may grant such application provided that it is satisfied that such proceedings will facilitate the effective administration of the insolvency proceedings relating to the different group members, and that none of the creditors are financially disadvantaged.35 If applications for group co-ordination proceedings are made in more than one member state, the court in which the application was first made is the only court that may accept jurisdiction.36 Cost controls have been included so that, where the group co-ordinator estimates that its costs will exceed 10 percent of its initially estimated costs, court approval is required.37 In order to give effect to the Proposed Amendments applying to group co-ordination proceedings, a new position of group co-ordinator has been created,38 and the group co-ordinator has an obligation to perform his or her duty impartially.39 The role of the group co-ordinator is to present a co-ordination plan (the ‘Group Co-ordination Plan’) to the insolvency practitioners that identifies, describes and recommends a set of measures appropriate to an integrated approach to the group insolvency. 40 However, the Group Co-ordination Plan will not be binding on the insolvency practitioners provided reasons for deviation are provided to any creditors’ meeting or other body to which they are accountable.41 The goal is to further facilitate the possibility of restructuring the group by allowing for 33 See Recital 45 Proposed Amendments which specifies an insolvency practitioner appointed in the main proceedings should be able to interfere in secondary proceedings (e.g. by proposing a restructuring plan), provided due regard is given to ‘best practices for cooperation in cross-border insolvency cases as set out in principles and guidelines on communication and cooperation adopted by European and international organisations active in the area of insolvency law, and in particular relevant guidelines prepared by UNCITRAL’. 34 Article 61 Proposed Amendments. 35 Article 63(1) Proposed Amendments. 36 Article 62 Proposed Amendments. 37 Article 72(6) Proposed Amendments. 38 Article 68(1) Proposed Amendments. 39 Article 72 Proposed Amendments. 40 Article 72(1) Proposed Amendments. 41 Article 70 Proposed Amendments.© 2014 Schulte Roth & Zabel LLP | 7 the flexible co-ordinated conduct of insolvency proceedings.42 In furtherance of this goal, it is now contemplated that a single insolvency practitioner may be appointed for several insolvency proceedings concerning the same debtor or for different members of a group of companies, whether in the same or different member states.43 Introduction of the Register To improve the information available to creditors, each member state will be required to publish ‘relevant information’ pertaining to insolvency proceedings in a free and publicly accessible panEuropean electronic register.44 Although this will assist creditors and secondary market participants as regards their information-gathering exercises, some will be disappointed that there is no requirement to publish proved or accepted claims. Miscellaneous Employees: The Proposed Amendments indicate that future amendments to the EIR should look to address preferential rights for employees.45 For now, the Proposed Amendments confirm that jurisdiction as regards employment contracts (including termination or modification) resides with the court in the member state where secondary proceedings could be opened (even if no insolvency proceedings have been opened in that member state).46 Jurisdiction for Related Actions: The Proposed Amendments now expressly contemplate that courts of the member state in which main proceedings have been opened shall have jurisdiction for avoidance actions as well as any action which ‘derives directly from the insolvency proceedings and is closely linked with them’. But such actions are described as not including actions for the performance of the obligations under a contract concluded by the debtor prior to the opening of proceedings.47 Pending Lawsuits or Arbitral Proceeding: The Proposed Amendments confirm that the law applicable to the effects of insolvency proceedings on a pending lawsuit or arbitral proceeding concerning an asset or right which forms part of the debtor’s insolvency estate should be the law of the member state where that lawsuit is pending or where the arbitration has its seat.48 Tax authorities and Social Insurance Institutions: Special provisions clarify that these entities must be able to lodge their claims.49 And it is expressly provided that any creditor who has its ‘habitual residence, domicile or registered office’ in a member state other than the state of the opening of 42 Recital 20aa Proposed Amendments. 43 Recitals 47 and 50 Proposed Amendments. 44 Such as the type of insolvency proceedings that have been opened in respect of a company, any time limits for lodging claims. Article 24(2) Proposed Amendments. In this context it should further be noted that there are also detailed provisions regarding data protection contained in the Proposed Amendments Articles 78-83. 45 Recital 21. 46 Recital 68 and Article 13(2) Proposed Amendments. 47 Recital 23 and Article 6 Proposed Amendments. 48 Recital 69 and Articles 7(2)(f) and 18 Proposed Amendments. 49 Recital 59 and Article 53 Proposed Amendments.© 2014 Schulte Roth & Zabel LLP | 8 proceedings may lodge claims in the insolvency proceedings of a member state by any means of communication which are accepted by the law of the member state of opening.50 Localisation of the Debtor’s Assets: To assist in clarifying the member state in which various assets are properly situated, there is now a specific definition addressing the member state in which a debtor’s assets are deemed to be situated (including cash, bank accounts, shares, financial instruments and other assets).51 Conclusion Whilst there will no doubt be further developments both in practice and in case law following the implementation of the Proposed Amendments, the revised EIR is expected to result in a meaningful improvement to cross-border insolvency proceedings throughout the member states. In addition, the codification of certain developments of the past 12 years in a revised EIR makes the applicable rules in this area more accessible and transparent for both practitioners and investors alike. Authored by Peter J.M. Declercq and Sonya Van de Graaff. If you have any questions concerning this Alert, please contact your attorney at Schulte Roth & Zabel or one of the authors. This information has been prepared by Schulte Roth & Zabel LLP and Schulte Roth & Zabel International LLP (“SRZ”) for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness. Transmission or receipt of this information does not create an attorney-client relationship with SRZ. Electronic mail or other communications with SRZ cannot be guaranteed to be confidential and will not (without SRZ agreement) create an attorney-client relationship with SRZ. Parties seeking advice should consult with legal counsel familiar with their particular circumstances. The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions. 50 Article 45 Proposed Amendments. 51 Recital 38 and Article 2(9) Proposed Amendments.