Everyday, most of us in the United States encounter evidence of relentless economic globalization. Gone are the days when American-brand automobiles dominated our roads. As a result of NAFTA, fresh Mexican produce fills the shelves of our local supermarkets. You are perhaps just as likely to fly overseas on Japan Air Lines, Aer Lingus or Lufthansa as on Northwest-Delta, American or United. As a result of the world financial crisis that reared its Medusa-like head last fall upon the collapse of Lehman Brothers, American businesses are now experiencing an additional and different dose of globalization through their involvement in foreign bankruptcy proceedings. It is common now for American businesses to be significant creditors of overseas companies in insolvency administration in Asia or Europe. In addition, American corporations with financially troubled foreign subsidiaries sometimes decide to seek relief for these subsidiaries by commencing proceedings under the insolvency laws of countries such as Germany, France or Canada.
One’s initial exposure to a foreign business bankruptcy proceeding is likely to surprise in many ways. In the United States, we have been conditioned to expect certain events and developments in Chapter 11 cases. We know that, in large insolvency cases, the reorganizing business will more often than not obtain post-bankruptcy financing, commonly referred to as “debtor in possession financing,” to provide the debtor with funds to operate its business. If your company has a long-term supply contract with a Chapter 11 debtor, such as a multi-year requirements contract common in the automotive industry, the nonbankrupt supplier knows that it cannot terminate the contract upon the bankruptcy filing but must, in absence of a bankruptcy court order to the contrary, continue to ship goods to the debtor under the contract. Finally, American creditors of a domestic debtor in Chapter 11 will expect the debtor to propose a plan for the reorganization or liquidation of its business (or some combination of both). Recently, as was evident in the recently concluded Chapter 11 cases of automakers Chrysler and General Motors, the debtor often adopts a reorganization strategy that will split assets between “Oldco,” as the repository of the “bad” assets, and “Newco,” as the transferee of the “good” assets, coupled with a debt-for-equity swap.
Many, if not most, insolvency laws of other nations, however, focus less on the financially troubled company’s rehabilitation, than on enforcing the rights of creditors. This focus is often to the detriment of the debtor’s reorganization. In many of these countries, a debtor in insolvency proceedings suffers from a heavy social and economic stigma in contrast to American Chapter 11 debtors who are afforded an “umbrella of protection” in order to put their financial affairs in order and thereby make a “fresh start.” Foreign bankruptcy laws, particularly those of Continental Europe that have a basis in Roman law or the Napoleonic Code, have been recently changing, albeit slowly, to emphasize the debtor’s rehabilitation.
To illustrate some of the differences between American bankruptcy law and the insolvency laws of other nations, as well as the recent statutory reforms stimulated, in part, by the American rehabilitation-oriented example, we will now engage in a brief review of the insolvency laws of Germany, France and Canada.
Insolvency Proceedings in Germany
Germany’s economy has been long regarded as the driving force of the Eurozone area, i.e., those European Union countries that have adopted the single- currency Euro. The critical element of Germany’s national economy is exports, particularly those of heavy industrial machinery and automotive products. Just recently, economists announced that Germany, along with France, officially exited the worldwide recession by experiencing positive GDP growth (.3% in both cases) during the second quarter of 2009. At the same time, however, Germany has experienced a significant number of large corporate bankruptcies (e.g., the department store conglomerate Arcandor) and near-bankruptcies (General Motors’ German subsidiary, Adam Opel GmbH). Although popular sentiment in Deutschland believes that “happy days are here again,” the German economy is not yet out of the woods. Unemployment is at 8.3% and is expected by many to increase in the immediate future.
German insolvency law, first enacted in 1877 in the days of Chancellor Otto von Bismarck, was completely overhauled by Germany’s legislature, the Bundestag, in 1999 when it adopted the new Insolvency Code (“Insolvenzordnung”). One of the primary stimuli for this statutory revision was the inadequacy of prior law to deal satisfactorily with the increasing number of business insolvencies. Prior to this change, an analysis of court statistics demonstrated that (i) 75% of all insolvency petitions filed in Germany were dismissed because of the insufficiency of the debtor’s assets; and (ii) successful business reorganizations occurred in less than 1% of the filed cases.
The new Insolvency Code now contains provisions permitting debtors to formulate reorganization plans. Petitions for insolvency are within the exclusive jurisdiction of the Insolvency Court of the various District Courts (“Landgericht”). Insolvency proceedings are handled by judges and “referees,” which may be excluded by the judge from taking any role in a particular proceeding.
During the first phase of an insolvency case, which lasts approximately three months from the filing of a petition, the German court gathers information concerning the case to determine if the debtor qualifies for relief. If the court determines that the debtor so qualifies, the court will enter an order commencing the case and appointing an insolvency administrator. Unlike our Chapter 11, the German Insolvency Code permits the debtor’s creditors to decide whether to opt for the debtor’s liquidation or reorganization. This decision is usually made after the administrator reports on the present state of the debtor’s business and the reasons why the debtor is applying for insolvency relief. If the creditors opt for reorganization, then a plan will normally be proposed to either transfer the debtor’s business assets to a third party free and clear of claims (with the debtor thereafter being liquidated) or by reorganizing the debtor’s business.
The debtor’s reorganization may only be accomplished via a reorganization plan which can only be submitted by the administrator and the debtor. An appointed creditors committee and the appropriate worker’s council will normally participate in plan drafting and negotiations. After the plan is prepared and submitted to the Insolvency Court, the judge will review the plan to determine whether it complies with the applicable statutory requirements. If the plan does not withstand this scrutiny, it will be rejected. A plan may also be rejected because there is little or no creditor support for its provisions or when the plan cannot satisfy certain creditors claims.
Creditors holding claims not previously objected to have the right to vote on the plan at a hearing scheduled by the Insolvency Court. In order to become legally binding on the debtor, its creditors and its equity holders, the Insolvency Court must confirm the plan. The Court may deny confirmation in the following circumstances:
- the procedural requirements for the formula tion, submission and acceptance of the plan have been violated and are incapable of being cured;
- creditor acceptance of the plan has been obtained through fraud, e.g. by purchasing votes;
- a creditor disadvantaged by the plan and timely objecting to its confirmation would, upon confirmation, be placed in a less favorable position than that creditor would occupy vis a vis the debtor in the absence of a plan;
- the plan has no chance of being accepted by the creditors or confirmed by the court; or
- the plan cannot satisfy the claims treated by the plan (i.e., the plan is not feasible).
After the German court confirms a plan, all parties affected by the plan will be legally bound by its provisions. Plan confirmation discharges the debtor from all debts except for those to be paid pursuant to the plan. After confirmation, the Insolvency Court will then terminate the insolvency proceedings. If the plan so provides, the administrator will monitor the debtor’s compliance with the obligations imposed upon it by the plan and must report annually to the court and the creditors committee as to the debtor’s performance under the plan.
Insolvency Proceedings in France
On January 1, 2006, the ability of French, financially troubled business enterprises to reorganize was significantly enhanced by new insolvency legislation adopted in France. This legislation, which facilitates rehabilitation, was stimulated by statistics assembled by the French Ministry of Justice demonstrating that, of the 44,699 French insolvency proceedings pending in 2003, 89% ended in liquidation. Central to French insolvency law is the concept of cessation des paiements, which is similar to the so-called “equity” test of insolvency of American bankruptcy law. According to this concept, the debtor is unable to repay its debts from its available assets. The French Commercial Court, administered by a bankruptcy judge, a Juge-Commissaire, has jurisdiction in insolvency cases commenced in this country.
First of all, there are two court-supervised procedures that are often used to reorganized businesses in France. The first is titled a mandataire ad hoc, which can be commenced by a business debtor that is not insolvent under the cessation test described above. The bankruptcy judge will appoint a receiver with directions that are tailor-made to the debtor and its present difficulties. The negotiations for a voluntary restructuring involving the company, its creditors and the receiver will normally take place out of court although the receiver is required to report to the court on the progress of these proceedings. The second procedure is conciliation, which was formerly referred to as a “voluntary arrangement.” This process involves the filing of a petition with the Commercial Court, after which the court will appoint a conciliator who is responsible for supervising and facilitating an agreement for the company’s restructuring. This relief is not available for debtors who have been insolvent for longer than 45 days. Like a receiver appointed in a mandataire ad hoc proceeding, the conciliator is required to report to the Commercial Court and any restructuring agreement must be officially recognized (“homologated”) by that court. In both mandataire ad hoc and conciliation proceedings, the company’s management will continue to operate the business.
A third restructuring procedure is one established by the 2006 legislation and is entitled procedure de sauvegarde or “safeguard” proceedings. In order to qualify for this relief, the company commencing this process must not be insolvent. This procedure is commonly used by enterprises experiencing financial problems that are likely to result in an insolvency. In safeguard and in the other two rehabilitation proceedings described above, there is a stay imposed by French law that prohibits the payment of most claims arising prior to the entry of the “opening judgment” that must be published in a legal newspaper and described in the debtor’s company register. The exceptions to this stay are certain employee claims for wages and salaries and some setoff claims. If the debtor pays a claim subject to this stay, the payment will be nullified and revoked and the debtor itself may be subject to criminal sanctions. This stay in safeguard proceedings extends further to protect individuals who have guaranteed any of the debtor’s indebtedness. Safeguard proceedings are normally completed by a judgment of the Commercial Court approving a plan providing for the restructuring of the debtor or the sale of its assets.
Finally, French law provides for two additional procedures. Recovery proceedings (redressement judiciare) are available only to companies that are insolvent but have some chance of rehabilitation. In these proceedings, the bankruptcy trustee (administrateur) is empowered to supervise current management or will be directed by the court to operate the entire business. A successful recovery proceeding will be evidenced by a reorganization plan approved by a judgment of the Commercial Court. The final mode of insolvency proceedings under French law is liquidation (liquidation judiciare). This proceeding is available to insolvent companies for which any recovery by creditors is deemed to be impossible. In these cases, only the trustee manages the debtor’s business even though the debtor’s board of directors will remain in place. In liquidation proceedings, the debtor’s business activity will eventually terminate and the debtor’s assets will be sold by the trustee to satisfy creditor claims.
One major and striking difference between American and French insolvency proceedings is the treatment of employee claims for wages and salaries that arise prior to the bankruptcy filing. In the United States, these claims are limited by specific formulas written into the Bankruptcy Code and are assigned a priority lower than the priorities enjoyed by secured claims and administration expenses. In France, employee wages and certain other benefits enjoy a “superpriority” over administrative expenses and secured claims in safeguard, recovery and liquidation proceedings. French law provides a third priority for loans made to the debtor during conciliation proceedings that precede a safeguard or recovery case. This priority does not extend to post-filing capital contributions by shareholders.
Insolvency Proceedings in Canada
The insolvency regime in Canada is based on two laws, the Bankruptcy and Insolvency Act (“BIA”) and the Companies’ Creditors Arrangement Act (“CCAA”), both of which are federal statutes. Insolvency cases under both statutes are administered by the provincial courts of general jurisdiction that are staffed by federally-appointed judges. These are not specialized bankruptcy judges as exist in the United States but are judges who handle all matters of general jurisdiction. Some provincial courts, however, are organized such that a few judges are singled out to handle insolvency cases. Canadian courts, however, do not play as great a role in these cases as do bankruptcy courts in America, primarily because Canadian insolvency proceedings are less litigious than those in the United States. Assisting the judges in administering insolvency cases are federally-licensed bankruptcy trustees, the majority of whom are chartered accountants. The large accounting firms in Canada have insolvency departments headed by bankruptcy trustees.
Liquidation cases similar to Chapter 7 cases in the United States are commenced under the BIA which was last amended by the Canadian Parliament in 2007. These cases may be initiated by voluntary petitions filed by debtors or involuntary petitions filed by their unsecured creditors. A petitioning creditor filing a voluntary petition in bankruptcy may also seek the appointment of an interim receiver to take immediate possession of the debtor’s property pending the court’s ruling on the involuntary petition. In a voluntary liquidation, the debtor will designate the person to be the trustee. Shortly after a liquidation case is commenced, a meeting of creditors will be held where the creditors in attendance may appoint a group of up to five individuals, labeled “Inspectors”, who will work alongside the trustee in administering the case. In essence, Inspectors act as a creditors committee in liquidation cases. Thereafter, the trustee will liquidate the debtor’s assets, reduce them to cash, and then administer claims filed in the case either by accepting them or rejecting them. If a claim is rejected, the affected creditor can request the court to rule on the propriety of the trustee’s rejection.
Debtors may also reorganize under the BIA but this procedure is mainly used by small to mid-sized business debtors. Larger enterprises routinely seek reorganization under the CCAA, which is discussed below. A reorganization case under the BIA is commenced when a debtor files either a “Proposal” or a “Notice of Intention to File a Proposal” (“NOI”). A Proposal forms the basis for a plan of reorganization. Upon the filing of a Proposal or a NOI, all proceedings against the debtor are automatically enjoined for an initial period of 30 days. This stay may be extended for periods not longer than 45 days each but no injunction may be in effect for a period in excess of six months from the date a Proposal or NOI is filed. During the stay period after the filing of a NOI, the debtor must file a Proposal. If the debtor fails to do this, its insolvency case will convert into one of liquidation.
A Proposal, which involves a compromise of debt and does not involve rejection of executory contracts other than commercial real estate leases, must be accepted (i) by 2/3 of the creditors of every class measured by the dollar value of their claims, and (ii) by a majority in number of those creditors. The debtor will normally attempt to negotiate settlements with secured creditors beyond the realm of the Proposal. The NOI/Proposal must identify a bankruptcy trustee to act as a monitor, who will report to the court and sometimes negotiate settlements between creditors and the debtor. Creditors will be required to file claims shortly after the debtor files its Proposal, which claims will then be reviewed by the debtor and be either accepted or rejected by it subject, however, to ultimate court review.
In the event that creditors fail to accept the Proposal or if the Court, after acceptance of the Proposal by creditors, denies approval of the Proposal, the CCAA case will revert to one of liquidation. The debtor’s assets will then be disposed of and the case administered as described above.
As previously noted, most large Canadian business enterprises will seek to reorganize under the CCAA. Although this statute was enacted during the Great Depression, it was not widely invoked until the 1980s when it became popular. The original statutes comprising the CCAA were few and sparsely written, permitting the courts to add a judicial gloss on the procedure over the years. The CCAA was amended by the Canadian Parliament twice in the 1990s and was recently amended again in 2005 and 2007. The final statutory changes will now take effect on September 18, 2009.
Relief under the CCAA is available to corporations or groups of related corporations having debts totaling at least $5 million Canadian. Upon the filing of a petition, the court will normally enter an initial order containing provisions for a stay of proceedings against the debtor; these orders are commonly referred to as “Stay Orders.” Debtor in possession financing is now specifically permitted by the CCAA as a result of the 2007 amendments. These amendments also permit the court to sell the debtor’s assets during the case and the debtor to reject or assign executory contracts. Newly added to the CCAA (and the BIA) is a provision permitting the recovery of “transfers at undervalue,” that is analogous to the right of a trustee or debtor in possession to recover fraudulent transfers under the United States Bankruptcy Code.
In CCAA proceedings, a Monitor is appointed at the beginning of the case and is charged generally with observing and following the debtor’s business and financial affairs and filing reports with the court concerning those affairs. A Monitor may also be required by the court in a particular case to perform other functions. In complex or highly acrimonious cases, a court may grant additional powers to a Monitor to enable him or her to compile detailed reports on the debtor’s assets and their values as well as to negotiate settlements among stakeholders. The centerpiece of a CCAA proceeding is a plan that classifies creditor claims and provides for their treatment. Each class of creditors whose claims are compromised in the plan must accept it by 2/3 in amount of their claims and a majority of their number, as determined with reference to those creditors attending the meeting of creditors held in the case. Unlike Chapter 11 cases in the United States, there is no requirement for a disclosure statement explaining the operation of the plan as a precondition to court approval of the plan. In order to confirm a CCAA plan, the court must find at a hearing that the debtor has strictly complied with the CCAA requirements and prior orders of the court, that nothing has been done in the case that violates a provision of the CCAA and that the plan is fair and reasonable. Once approved, the plan will become effective after a period of one or two months while the claims review process is concluded.