In this Ropes & Gray podcast, U.S.-based capital solutions partner Alyson Gal is joined by her London-based business restructuring colleagues, partner Matt Czyzyk and associate Natalie Raine, to discuss recent developments in European restructuring regimes and the implications of these changes on the tools available to investors in European distressed situations. The discussion includes how restructurings have historically been handled in Europe; the impact of the 2020 Corporate Insolvency and Governance Act (CIGA), including the introduction of a new pre-insolvency tool known as the Part 26A restructuring plan; the various applications of the 2019 European Union directive on preventative restructuring frameworks by the Member States; as well as temporary measures put into place in Europe to support companies impacted by the global pandemic.
Alyson Gal: Hello, and thank you for joining us today on this Ropes & Gray podcast. I am Alyson Gal, a partner in our finance and capital solutions group, based in the U.S. Joining me today are my colleagues in our London-based business restructuring group, my partner Matt Czyzyk and our associate Natalie Raine. Today's podcast is the latest in our series of podcasts on issues of interest to credit funds and we will talk today about recent changes in European restructuring regimes, and the implications of these changes on the tools available to investors in distressed loans.
Matt, Natalie, before we talk about the recent changes that have gone into effect this year, and that are on the horizon, could we first set the stage by explaining how restructurings have historically been done in Europe?
Matt Czyzyk: Thanks, Alyson. I am happy to do that. So I know that many in the audience will be more familiar with U.S. Chapter 11 restructurings than with European restructuring proceedings. In contrast to Chapter 11, which provides a mechanism for a company to go through a restructuring in a court supervised process, a significant number of restructuring processes in Europe are done out of court, or with limited court involvement. A lot of European restructurings are carried out either consensually, pursuant to the relevant documentary terms, or through an enforcement. In a number of jurisdictions, that enforcement can be carried out without court involvement. If a consensual or enforcement-based deal is not viable, stakeholders may then turn to what we call “pre-insolvency” tools, which allow a company to restructure, under court supervision, in order to avoid what we would call “entering into insolvency,” or what our U.S. colleagues would call “bankruptcy.” But of course, there are out-of-court processes in the U.S. as well. For example, Article 9 secured creditor foreclosures. However, larger restructurings are typically implemented in court through Chapter 11.
One other thing to keep in mind is that there is not a single restructuring or insolvency regime in Europe. There are different rules for each individual country. So the UK has been the most significant restructuring jurisdiction historically in the European market, and that is because financing documents tend to either have a U.S. or UK choice of law and jurisdiction. It is also worth noting that processes in certain European jurisdictions are more “user-friendly” than others. So for example, Italian processes have traditionally been viewed as borrower-friendly—slow and politicized—but this is starting to change, as all European jurisdictions have, or will shortly introduce, reforms to facilitate restructurings.
Starting with the UK, English law has four types of formal insolvency proceeding. The first is liquidation, which is relatively similar to Chapter 7 in the U.S., whereby assets of a company are realised and distributed to creditors. The second is administration, whereby a company may be reorganized or its assets are realised. The third is what we call company voluntary arrangements, which is a compromise with unsecured creditors, and this is often used in retail and hospitality restructurings. And fourthly, we have a tool called receivership, or administrative receivership, but this is a remedy of secured creditors to allow for realisation of assets, but it is actually very rarely used into those markets.
Now importantly, we also have two “pre-insolvency” processes, whereby the court’s involved in the sanctioning of a restructuring that would otherwise not be achievable on a consensual basis. So the first of these, and probably the best known, is a scheme of arrangement, or scheme, which is a company law tool that allows a company to impose an arrangement or compromise on either its shareholders or its creditors (or any class of those), subject to approval by a requisite majority and the court’s approval. So the consent threshold here is 75% by value and greater than 50% of those voting, within each class. So you can see that this could be very helpful where you are trying to do a deal consensually, under the terms of the documents, and you can not get that because of a higher approval threshold—the scheme allows you to get there using this lower 75% by value or 50% by voting threshold. And the scheme is being used as a means to implement restructurings, both for English and for overseas companies for many years, and is very popular. The second pre-insolvency tool, is the newly introduced Part 26A restructuring plan, or in short “the Plan,” which builds on the scheme of arrangement and adds certain new features.
Alyson Gal: Natalie, what about other European jurisdictions, aside from the UK? What are the processes there?
Natalie Raine: As Matt mentioned, each country across Europe has its own restructuring and insolvency regimes—some of which are traditionally more creditor-friendly, some are more debtor-friendly, and really each of which vary as to how user-friendly they are. What should we note about that then? Well, choice of forum is key. A company in distress needs to consider, ideally as much in advance as possible, where it would be able to file for insolvency should it need to and, in particular, whether a country offers the best tools for a company’s particular circumstances.
So let us break this down a little by looking at some specific examples. In Germany, the insolvency framework has, historically, been considered inflexible and liquidation is the most common outcome. Germany is a strict jurisdiction—if a company is within three weeks of imminent insolvency, then the directors must file for insolvency or face criminal and personal liability. There are three options that a director has if they are in this position: Germany’s sole rescue tool of “Protective Proceedings”, administration or liquidation.
- There have been some recent changes to the German insolvency landscape that have encouraged rescue through a court-supervised “debtor-in-possession” process, and that is what we mean when we say “protective proceedings.” This gives directors 90 days to prepare and file a restructuring plan, and it requires that the rescue has a real chance of success.
- If protective proceedings are not possible, then the only option really for German companies is insolvency—so either administration or liquidation.
We can see, then, that pre-insolvency tools in Germany are limited, but this is changing with the introduction of the new German Scheme. Thinking back to choice of forum, historically, this has meant that a number of companies in recent years have shifted to their center of main interest to England so they could utilize work-out tools like the English scheme of arrangement and avoid having to go into an insolvency process.
France too is a jurisdiction that, although it has more pre-insolvency tools available than Germany, it is a borrower-friendly jurisdiction, and that can lead to creditors feeling a little bit nervous about ending up in a process in France. French law, as in Germany, attaches a risk of liability on directors that fail to file for insolvency within 45 days of becoming aware of an impending inability to pay debts. Directors have available to them a number of proceedings that include various well-tested “out-of-court” options. The most common processes are “amicable proceedings”—these are the Mandat Ad Hoc and Conciliation—these each provide a confidential framework for negotiations that aim to resolve financial difficulties under the supervision of a court-appointed third party. Alternatively, French law provides what is known as a “Sauvegarde”—a rehabilitation or a fast-track Sauvegarde—these do still allow companies space to reorganize their debts and continue operating as a going concern, but they are court processes. If a company is insolvent, then a company will enter into liquidation proceedings to wind-up and distribute its assets. Whilst the French tools are viewed as being a bit more flexible than the traditional German tools, creditors can be nervous of a French process, as we have said, given the predisposition to favour companies and the borrowers in France. It is worth bearing in mind that France has yet to implement the EU Restructuring Directive, and it is expected that a new French process will be introduced that is similar to the English Restructuring Plan and to the new German Scheme that we mentioned, that will include a debtor-in-possession work-out tool with cross-class cram-down features.
Alyson Gal: Thank you for that summary. So it seems like restructuring options in many of the non-UK European jurisdictions have not been particularly useful to companies’ creditors seeking to restructure as going concerns, at least historically. Is that a fair takeaway?
Natalie Raine: That is definitely a fair summary, Alyson. It really comes down to two points. First, that many European jurisdictions have strict insolvency filing regimes—these require directors to put a company into insolvency pretty quickly once they have realised the company is facing difficulties. Due to strict penalties from not filing, directors are often nervous about any delay and may choose to file even whilst creditors are looking at options to support the company and avoid an insolvency. Second, even if directors have not immediately filed, the insolvency regimes in many European countries offer little flexibility or limited timeframes for a work-out to be agreed and implemented. It can be a real race against time to agree a deal and keep directors comfortable enough that they do not file and, as you would expect, for larger insolvencies, a work-out solution can be difficult to agree in time.
Alyson Gal: Thanks, Natalie. So turning to the recent changes, Matt, I understand that 2020 has seen the most significant changes in UK insolvency law in decades. Can you tell us what has been going on?
Matt Czyzyk: That is correct, Alyson. So in June 2020, the Corporate Insolvency and Governance Act, or CIGA as we call it, was introduced—and this is the most significant new restructuring legislation in many years. CIGA had been expected for a number of years in the industry, but the global pandemic meant that the new law was accelerated through the parliamentary approval process, and actually entered into force much sooner than most practitioners were expecting. However, the swift implementation was actually most welcome because not only does CIGA introduce a number of changes which will ensure that England and Wales remains a preeminent restructuring hub, but importantly, also provide companies struggling to survive the pandemic with some much-needed flexibility.
Alyson Gal: Are these permanent changes or are some of these temporary measures to address the immediate challenges presented by the global pandemic and the consequent disruptions?
Matt Czyzyk: Actually it is a mix—some of the changes are permanent and some are temporary, so let me take you through those. Three of the changes are permanent.
The first is the introduction of a standalone moratorium, and this gives a distressed but viable company breathing space from creditor action, and this is in order to facilitate a rescue as a going concern or restructuring. It is a free-standing process, meaning that it does not have to be combined with any insolvency procedure or restructuring procedure. The moratorium process itself is overseen by a licensed insolvency practitioner, known here as a monitor, and initially results in a 20 day standstill on certain creditor actions. And this can be extended further, up to a year, subject to certain creditor and court consents. There are some significant exceptions to the moratorium—for example, it is not t available to companies with bond debt in excess of a de minimis threshold of £10 million, so in practice, many of the companies that our clients invest in, will not be eligible.
The second change is a prohibition on ipso facto clauses. So many commercial contracts will include what we call “ipso facto” clauses, whereby a supplier is permitted to terminate a contract upon the insolvency of the relevant counterparty. So pre-CIGA, English insolvency legislation prohibited suppliers of essential supplies—meaning electricity, gas, water, telecommunications and IT services—from enforcing those ipso facto clauses. New provisions in CIGA broaden the scope of this prohibition to include all contracts for the supply of goods and services, with the objective of ensuring continuity of supplies for distressed businesses, and importantly, assisting continuity of operations.
Alyson Gal: That is really interesting, Matt. As listeners may know, ipso facto clauses are generally enforceable in Chapter 11 proceedings, so it sounds like these new provisions are broadening the scope of the prohibition in Europe, but not quite getting to the extent of Chapter 11 prohibition.
Matt Czyzyk: That is right, Alyson. And now thirdly, and perhaps the most significant change, is the introduction of a new pre-insolvency tool, known as the Part 26A restructuring plan. Now, this is very similar to the existing scheme of arrangement, as a means to compromise a company’s obligations to its creditors or members. And of course, this scheme has been used as a means to implement restructurings, both for English and foreign companies, for many years. But importantly, the 26A Plan introduces a “cross-class cram-down” mechanism, which our listeners in the U.S. may be familiar with through Chapter 11. So to “cram-down” the dissenting class or classes, at least one class that would receive a payment under the Plan, or would have a genuine economic interest in the context of the “relevant alternative” must have voted to approve the Plan.
So secondly, no member of the dissenting class or classes should be any worse off under the Plan than they would otherwise be under the relevant alternative. Now, I have mentioned the word “relevant alternative” there twice—what does this mean? The stakeholders will present to the court what they think the relevant alternative would be—this means the likely alternative to a successful plan. Now, this usually means, in the English context, administration or liquidation, which are the two English insolvency proceedings.
Now, finally, the other changes that I mentioned at the start are temporary, and what these do is they suspend certain elements of the law that would otherwise make it problematic for companies to continue in operations during a severe liquidity crisis, in addition to deferring certain filing requirements and providing relief from in-person meeting requirements. Now these temporary measures as of the end of March, have now been extended further through to the end of June 2021.
Alyson Gal: Thanks, Matt. Natalie, I understand there have been changes in the works in continental Europe as well. What are the drivers there and what has been going on?
Natalie Raine: Yes, that is right, Alyson. The European Union introduced back in 2019 a new Restructuring Directive that applies to all Member States of the EU. Its aim is to encourage restructurings rather than companies falling straight into insolvency and liquidation processes. How each Member State implements the Directive is left up to them, and that means there are two things to bear in mind with how this will play out in practice: (1) whilst we will see new pre-insolvency tools being introduced across the EU, the detail of these tools will vary from country-to-country; and (2) each country is operating on its own timeline to introduce their own pre-insolvency tool.
Let us think about what we are expecting to happen. As mentioned, the goal is really encouraging work-outs. Company directors will retain control and they will work to restructure the company outside of insolvency. There is no requirement that a company be insolvent to make use of the new tools that will be introduced. We also expect that Member States will introduce tools somewhat similar to the U.S. implementing parts of the Chapter 11 process that they like, and also cherry picking parts of the English Scheme of arrangement. So we think there will be cross-class cram-down mechanics introduced and varying tools allowing for moratoriums or termination of contracts, or any other aspect really that companies think is helpful to encourage a restructuring to be implemented.
How is this playing out across the EU? On 1 January 2021, the Netherlands and Germany each introduced their own new pre-insolvency tools, which have been coined as the “Dutch Scheme” and the “German Scheme” respectively. In each case, we have seen a “debtor-in-possession” process introduced that has a light-touch court oversight.
The Dutch and German Schemes are both really quite flexible tools that allow a company to amend the rights of all creditors and shareholders. Really, they are quite similar to the English Restructuring Plan, but the Dutch and German Schemes do include the option of a temporary moratorium, which as Matt was going through earlier, under English law, the moratorium is a different tool. Both the Dutch and German Schemes will require that a company be likely to experience financial difficulties, but as I said, there is no requirement for a company to actually be insolvent. In terms of process, the company in the Netherlands or in Germany that are using these tools will submit a restructuring plan to its creditors and/or shareholders, who will then vote on the plan. And in terms of thresholds for approving it, in Germany the requirement is at 75% by value in support of the plan; in the Netherlands the threshold has been set slightly lower at two-thirds in value. The final key feature to bear in mind with these tools is that they introduce cross-class cram-down, allowing one or more classes to vote in support of the scheme and impose it against a dissenting class. Unlike the English Restructuring Plan, the Dutch and German Schemes have applied a rule that will be familiar to our U.S. listener, which is the absolute priority rule, albeit that they have applied it in a slightly more relaxed version than is typically seen in U.S. bankruptcy proceedings.
Alyson Gal: Wow, there are a lot of changes in the works. Are there also temporary measures, as in the UK, to respond to pandemic-related issues?
Natalie Raine: Absolutely. We have seen measures introduced at both the EU level and by individual Member States.
At the EU level, the main change has been to relax state aid rules until the end of December of this year, which will allow Member States to support companies directly that have been impacted by the pandemic. So what we have seen in response to this relaxation is individual Member States have been introducing their own loan programmes with national financial institutions so that they can lend money directly to companies and/or offer state-backed guarantees on the loans.
We have also seen a number or EU Member States introducing legislative changes that are targeting insolvency filing obligations and directors’ duties. As a general point on that, what we have seen is that insolvency filings that have been introduced across the EU have been perhaps less sweeping than those that we have had through CIGA in the UK, but broadly it has helped all over the UK and EU to stave off company insolvency filings whilst companies are remaining closed due to lockdown measures across Europe.
Taking, for example, Germany—as we mentioned earlier, Germany has got very strict filing obligations on directors.
- The main change in Germany has been to suspend the obligation to file for insolvency until at least the end of April 2021, however, a company has to have applied for, or be eligible for, financial aid in order to be able to avoid filing for insolvency.
- Secondly, it is quite a technical change in Germany, which is with regard to one of its insolvency tests specifically. Germany has a balance sheet insolvency test that is one of two tests that apply in Germany. This balance sheet test requires a company to assess its chances of survival over a 12-month period and demonstrate that it will more likely than not remain in business as a going concern. The German government has recognised that due to the ongoing COVID impact on businesses, 12 months might be a difficult hurdle for companies to meet at the moment, so they have temporarily reduced the period to four months, and that rule will stay in place until the end of December.
As another example, France has been much more tempered in its amendments to the insolvency framework. So the main change in France that was to suspend the 45-day filing obligation on directors in fact expired in August of last year. Certain other temporary changes have remained in effect, but these do not limit the filing obligations or minimize directors’ duties to any great degree.
Alyson Gal: So Matt, how similar, after all of this has been taken into effect, are these European restructuring alternatives to Chapter 11? Do they now provide comparable tools to restructure large capital stacks? And are there circumstances in which they might even be preferred over Chapter 11?
Matt Czyzyk: The recent introduction of the Part 26A restructuring plan, the German Scheme and the Dutch Scheme, mean that there are now a number of European jurisdictions with pre-insolvency regimes offering similar tools to Chapter 11 that can be used to restructure large capital structures. The recent EU Directive that we have heard about has meant that the quality and scope of pre-insolvency regimes in EU Member States has not only improved significantly, but jurisdictions are increasingly aligned. That is not to say they are homogenous, but there is now a minimum standard, which sets out the base for a more level playing field than we had a few years ago.
Importantly, the new and improved tools include features such as cross-class cram-down, protection from clawback, and in certain jurisdictions, the possibility of DIP financing. All of these features will be familiar to our listeners who have a basic knowledge of Chapter 11. Now, whilst many European companies will consider Chapter 11 when planning for a restructuring, using local tools is often more attractive. For starters, they are usually quicker and cheaper. For example, a typical scheme or restructuring plan process in the UK will run for 6-8 weeks, plus relevant preparation time. So European companies will also take comfort working through a process closer to home, under a legal framework with which they are more likely to have greater familiarity.
Alyson Gal: Matt and Natalie, just listening to all of this discussion, both in terms of the range of approaches across jurisdictions and also how quickly approaches are evolving and changing really strikes me in terms of the need to consult folks like yourselves in thinking through how these loans are to be structured when European jurisdictions are in play, and which jurisdictions are likely to create issues for creditors. So this has been a very helpful discussion for me. Matt, summing up for our audience, is it possible to say whether these developments are good or bad for particular types of creditors? If you are a secured lender looking at making a loan into a European structure, is there a takeaway here?
Matt Czyzyk: Thanks, Alyson. So I think one takeaway is there is greater optionality for companies, whether they be English companies or European companies looking to restructure, because there are simply more tools available to restructure a business. And importantly, as we have heard, a lot of these tools are designed to stop companies moving into insolvency, and indeed, they are designed to give all stakeholders more options to rescue a business. So we would expect to see, from a context of a lender, what these tools mean is there are going to be more options to rescue a business without resorting to enforcement of security or indeed ending up in an insolvency process.
We have already seen the Restructuring Plan here in the UK being put into practice—so Virgin Atlantic and Pizza Express were two early examples. And then recently, we had the Transocean plan, which was sanctioned by the English courts earlier this year, and that was the first to test this principle of cross-class cram-down, which we have been hearing about. The other thing to bear in mind is Germany, and the Netherlands and other jurisdictions have also brought a compelling range of features to the table, and as we have been hearing, this will allow certain European companies to use tools in their local jurisdiction. So this means that we are going to have a more varied environment with more options available to stakeholders.
The other key point is that the impact of Brexit—now that the UK has left the EU—has meant that we do not get automatic recognition of English judgements in Europe or in the EU, and vice versa. And so what this really means is that we are going to be working more closely than ever with our European partners, and we think we are actually more likely to see restructurings in the near future combining tools from various jurisdictions. So actually I think although there are more options on the table, the landscape is becoming increasingly complex, and so that means it will be more important than ever to have clear, succinct and relevant local law advice. And of course, to revert back to our initial conversation, if we can traverse this with the U.S. and Chapter 11, I think what you have been able to glean from our conversation today is restructuring in Europe really is quite different to processes in the U.S.
Alyson Gal: It certainly seems that way, and one of my takeaways is that as these European jurisdictions evolve their own approaches to their mandates, we are going to see even more need to stay on top of this. Thank you both for that illuminating discussion. And thank you to our listeners. For more information on the topics that we have discussed or other topics of interest to the investment and credit fund communities generally, please visit our website at ropesgray.com. And, of course, if we can help you navigate any of the topics we have discussed, or consider a particular restructuring situation or issue, please do not hesitate to get in touch. You can also subscribe to this series wherever you regularly listen to podcasts, including on Apple, Google and Spotify. Thanks again for listening.
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