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The legal background
Prior to independence in 1960, Cyprus was a British colony, and, like most British colonies, most of its laws were based on the corresponding British laws. When it became independent, the Constitution provided that the laws previously applicable should remain in force in the new Republic of Cyprus until they were repealed or amended by new laws.
As a consequence, the legal framework governing restructuring and insolvency would be very familiar to the British practitioner of the mid to late 20th century. The Companies Law, which contains the basic restructuring and insolvency legislation, dates back to the 1950s. It has been amended and added to since independence, particularly to comply with the acquis communautaire of the European Union, which Cyprus joined in 2004, but large sections of it, including those relating to restructuring, reorganisation and insolvency, can be directly traced to the British Companies Consolidation Act of 1908.
One of the reasons that Cyprus did not modernise its insolvency legislation is that it was hardly ever used. For the first 50 years after independence, the island enjoyed a period of virtually uninterrupted prosperity, during which insolvencies were almost unheard of. Because of the island’s role as an international financial centre, most Cyprus companies are holding companies for companies carrying on business elsewhere. Liquidations did take place from time to time, but they were almost always solvent liquidations carried out to reorganise corporate structures to improve tax efficiency.
However, things changed substantially in 2013, with the culmination of a financial crisis that resulted in the closure and effective liquidation of the second-largest commercial bank on the island and a ‘bail-in’ of all deposits above €100,000. As a condition for an international support package, the government undertook to modernise the insolvency and restructuring regime and promote an enterprise culture. In the years following the crisis, new laws were passed to introduce a process known as examinership, which would allow an independent professional to take control of a failing company and restructure it, subject to creditors’ agreement. In addition, other changes to the Companies Law streamlined the liquidation process and lowered the thresholds required to execute a ‘cramdown’ against the wishes of dissenting creditors. Cyprus exited the post-crisis adjustment programme in 2016 and its economy is recovering. The new restructuring procedures were not widely used and it remains to be seen how effective they will be.
Insolvency and restructuring procedures
The Companies Law provides five main procedures for dealing with financially troubled companies. In ascending order of finality and rigour, they are:
- arrangements and reconstructions under sections 198 to 201, including the provisions for the merger and division of public companies introduced by Law 70(I) of 2003;
- the appointment of a receiver by a charge-holder or by the court;
- the appointment of an examiner, whose objective is to restructure the company and preserve it as a going concern;
- voluntary winding up, also known as voluntary liquidation; and
- winding up by the court, also known as compulsory liquidation.
In order to understand the context in which the procedures take place, it is useful to set out some general principles that apply to all types of insolvency, starting with the fundamental issue of what constitutes insolvency. Under Cyprus law, insolvency is defined as the inability of a company to pay its debts. There are two bases on which a company may be considered to be insolvent. The first is inability to pay debts as they fall due and the second is an excess of liabilities over assets. Some companies may be insolvent on both bases. Others may be suffering temporary illiquidity, which, if not dealt with, will precipitate their collapse.
Under section 212 of the Companies Law, a company is unable to satisfy its debts if it fails to comply with a statutory demand for payment of a debt of more than €5,000 if execution of a judgment over its assets is returned unsatisfied in whole or in part, or if it is proved to the satisfaction of the court that the company is unable to pay its debts. In making its assessment, the court is required to take the contingent and prospective liabilities of the company into account.
A second fundamental principle is that once insolvency is recognised, no stakeholder should be allowed to improve his or her position at the expense of other stakeholders, for example, by seizing goods or obtaining payment ahead of other creditors of the same class, and any alteration in the status of the members of the company is void.
The order of distribution of assets in a winding up is set out in the Companies Law, as follows:
- First, the costs of the winding up, including the liquidator’s fees and expenses, as well as the legal costs of the petitioning creditor.
- Second, the preferential debts listed in section 300 of the Companies Law, principally comprising government and local taxes and duties due at the date of liquidation that have become due and payable within 12 months before that date and sums due to employees including wages, up to one year’s accrued holiday pay, deductions from wages (such as pension fund contributions) and compensation for injury.
- Third, any amount secured by a floating charge.
- Fourth, amounts owed to the unsecured ordinary creditors.
- Fifth, any deferred debts, such as sums due to members in respect of dividends declared but not paid.
- Finally, any share capital of the company. Where there are different classes of share capital, such as preference shares, their respective rankings will be determined by the terms on which they were issued.
Within each category of claim, claimants rank equally and abate in equal proportions if there are insufficient funds to pay them in full.
Arrangements and reconstructions
Sections 198 to 201 of the Companies Law contain the provisions governing company arrangements and reconstructions. Sections 201A to H were inserted by Law 70(I) of 2003 and align the regulation of mergers and divisions of public companies in line with the relevant European directives. Sections 201I to 201X transpose EU Directive 2005/56 on cross-border mergers into domestic law.
Until the very recent past, company arrangements have generally been used to implement cross-border mergers of companies rather than to deal with insolvency, but they are now also being used to restructure problem debt. The procedure applies to all Cyprus-registered companies apart from banks and insurance companies, which have separate restructuring regimes.
Under section 198, where a compromise or arrangement is proposed between a company and its creditors or between the company and its members or any class of them, the company or any creditor or member or, in the case of a company being wound up, the liquidator, may apply to the court for an order convening a meeting of the creditors or the members of the company in whatever way the court directs. The notices of the meetings sent to creditors and members must be accompanied by a statement explaining the effects of the proposals. This statement must identify any interests of the directors and the effect of the proposals on those interests.
Subject to the sanction of the court, any compromise or arrangement passed by a simple majority in value of those voting at the meeting of creditors or members will be binding on all the creditors or members and also on the company and, in the case of a company being wound up, on the liquidator and contributories of the company. The sanction of the court is required for any proposal to become effective. This provides a cramdown mechanism allowing the reorganisation plan to be imposed by the court regardless of the objection of some creditors or shareholders. The order sanctioning the arrangement must be filed with the Registrar of Companies and a copy must be attached to every copy of the company’s memorandum of association or equivalent document issued after the making of the order. The procedure is flexible and fast, and reorganisations can be completed within days with proper planning, particularly if the court is persuaded that they have the support of the majority of creditors.
Until the law was changed in 2015, the requisite majority was a majority in number representing three-quarters in value of creditors present and voting. The reduction to a simple majority is intended to make it easier to bind dissenters and to avoid liquidation. The change is undoubtedly bold but it has been criticised as a charter for abuse, given the absence of an established, experienced insolvency profession and all the regulatory and other infrastructure that goes with it. There is no detailed guidance on implementation of the new provisions in the form of regulations or statements of required practice, for example, on the status of related-party debt, and the only safeguard appears to be the requirement for the court to approve any arrangement before it becomes binding.
A creditor holding a charge over assets may appoint a receiver to realise the assets subject to the charge and discharge his debt out of the proceeds. If the charge is a floating charge covering substantially all the assets of the company, the creditor may appoint a receiver and manager with power to run the business of the company. The purpose of receivership is recovery of the secured creditor’s debt. It does not bring the existence of the indebted company to an end, as liquidation does, and it therefore offers a greater possibility of the debtor continuing as a going concern. The procedure applies to all Cyprus-registered companies apart from banks and insurance companies, which are subject to their own regimes.
A receiver may be appointed by the charge-holder under a specific power contained in the charge or by the court on an application by debenture holders or other creditors. The court will make an appointment if it considers that the interests of the creditors concerned require protection by the appointment of a receiver, for example, if the assets are at risk of dissipation. An appointment under a charge is much simpler, merely requiring compliance with the procedure set out in the charge.
The appointment of a receiver suspends the directors’ powers of management over the assets encompassed by the receivership. Within seven days of appointing a receiver, the charge-holder must notify the Registrar of Companies. If the appointment is under a floating charge covering substantially all the assets of the company, the receiver must immediately notify the company, which in turn must submit a statement of affairs, including a statement of all assets and liabilities, to him or her within 14 days. Based on this, the receiver will decide a strategy for the receivership, including whether to allow the company to continue to trade under his supervision and whether to realise assets as a going concern or piecemeal.
Once the receiver has repaid the sum due to the appointor (or has concluded that it is uneconomic to continue the receivership) he will account to the appointor and the company and notify the Registrar of Companies that he has ceased to act. He must send an account of his receipts and payments account to the appointor, to the company and to the Registrar of Companies within two months of ceasing to act. If the appointment lasts for more than one year, he must submit annual accounts to the same people at each anniversary.
The 2015 amendments to the Companies Law also introduced a procedure called examinership, which is based on Irish legislation and is akin to the administration process in the United Kingdom. It provides for the appointment of an insolvency practitioner as ‘examiner’, whose role is to develop restructuring proposals and agree them with stakeholders during a four-month moratorium in which the company is protected from creditor action.
The company, a creditor, a member holding at least 10 per cent of the paid up voting share capital or a guarantor of the company’s obligations may present a petition for an examiner to be appointed. The petition must be accompanied by a report by a licensed insolvency practitioner providing the information required to demonstrate that the company has a viable future and outlining a recovery plan, which must provide for the company to continue as a going concern; disposal of the assets or business is not permitted.
On hearing the petition, the court may make the order requested, dismiss it, or make any order it deems appropriate, including a winding-up order. The initial period of court protection is four calendar months from the date of presentation of the petition, and the examiner may apply for the protection period to be extended by up to 60 days. Before the end of the period, the examiner must prepare proposals for a scheme of arrangement and present them to the court. If the examiner concludes that he or she cannot put forward viable proposals, they may apply to the court for directions and the court may give such directions or make an order as it deems fit, including an order for the company to be wound up. If the examiner’s report recommends a voluntary arrangement the court may extend the moratorium period to allow time to vote on the proposed arrangement. The procedure concludes either with the approval of the examiner’s proposals for a voluntary arrangement or with their rejection.
It remains to be seen how useful and how widely used the examinership process will be. One major issue is the congestion and delays in the Cyprus courts. Hearings can take months to arrange, which means that by the time a petition for the appointment of an examiner is heard, most of the limited breathing space allowed by the law may have elapsed. Furthermore, judges have little experience in insolvency matters and will be inclined to err on the side of caution when making decisions, which will further slow the process.
Furthermore, although the basic legislation is in place, there is none of the essential infrastructure (in the form of secondary legislation and codes of practice) that is needed to apply it to practical cases, and no specialist insolvency courts.
Members’ voluntary liquidation
Members’ voluntary liquidation is the procedure used to wind up a solvent company that is no longer required and distribute the assets to the members. It is frequently undertaken as a housekeeping or tax planning measure, particularly in a group context.
The liquidation is initiated by the passing of a resolution of members to wind up the company. A special resolution is required unless the articles of association of the company specify a fixed period for the duration of the company that has expired, or specify that a certain event should trigger a winding up, in which case an ordinary resolution is adequate. The resolution to wind up will usually be accompanied by a further resolution to appoint a named individual as liquidator. The members may also appoint a committee of inspection to oversee the liquidation.
Before a resolution can be passed to initiate a members’ voluntary winding up, the directors (or a majority of them if there are more than two) must have made a statutory declaration that, having enquired fully into the affairs of the company, they consider that the company will be able to pay its debts in full within a maximum of 12 months. The statutory declaration must be made no earlier than five weeks before the date of the resolution to wind up, and must be delivered to the Registrar of Companies before the date of the proposed resolution to wind up.
The effect of passing the resolution to place the company into liquidation is to vest the assets in the liquidator as trustee. The company may no longer trade except to the extent required for beneficial realisation of the assets. The liquidator has the same extensive powers as a liquidator in a compulsory liquidation to do whatever is necessary to achieve a beneficial winding up. The liquidator requires the sanction of the court or the committee to settle any category of claims in full, or to make compromises of claims, but he or she may exercise his other powers without reference to anyone. The liquidator may also apply to the court to determine any issue or to exercise any of the powers available to the court in a compulsory liquidation.
By definition, all creditors in a members’ voluntary liquidation have to be paid in full within a year of the date of liquidation. If at any time the liquidator forms the opinion that this will not be possible, he or she must immediately convene a meeting of creditors and the liquidation must be undertaken as a creditors’ voluntary liquidation.
As long as the creditors have been paid in full, the liquidation may continue as long as it takes to realise all the assets and distribute the proceeds to members. At the end of each year the liquidator must convene a meeting of members and lay accounts before them.
Once the liquidator has discharged the company’s liabilities and distributed the remaining assets among the members, he or she must convene a final meeting of members and lay before it an account of his or her receipts and payments. The meeting must be advertised by one month’s notice in the government Gazette. The liquidator must notify the Registrar of Companies of the meeting within a week of its having taken place, and the company is deemed to be dissolved three months after the filing of the return of the meeting, subject to the right of the liquidator or any other interested person to apply to the court for the three-month period to be extended.
Section 270 of the Companies Law allows the liquidator in a members’ voluntary liquidation to effect a reconstruction with the sanction of a special resolution of the company by transferring the assets of the company to a new company in exchange for shares or other securities of the new company.
Creditors’ voluntary liquidation
Creditors’ voluntary liquidation is appropriate where the directors and members wish the company to be wound up on a voluntary basis but where the company is insolvent, making it impossible to make a declaration of solvency. As the creditors of the company are not guaranteed payment in full, they take a much larger role in the liquidation.
The first step in a creditors’ voluntary winding up is the convening of separate meetings of members and creditors. The purpose of the members’ meeting is to pass a resolution to wind up the company and appoint a liquidator. The creditors’ meeting must be convened for the same day as the members’ meeting or the following day, and notice of the meeting must be posted to creditors simultaneously with the notice to members, and advertised in the Official Gazette and two local newspapers. The purpose of the meeting is to present creditors with a statement of the company’s financial position and a list of creditors’ claims; to give creditors the opportunity to nominate a liquidator to act in place of or jointly with the liquidator appointed by the members; and to appoint a committee of inspection of up to five persons to assist and oversee the liquidator and fix his remuneration. If the creditors and members nominate different people to act as liquidator, the wishes of the creditors will prevail, subject to a right to apply to the court.
The effect of the resolution to liquidate the company and appoint a liquidator is to vest the assets in the liquidator as trustee. The company may no longer trade except to the extent required for beneficial realisation of the assets. The liquidator has the power to do whatever is necessary to achieve a beneficial winding up. Apart from needing the sanction of the court or the committee to settle any category of claims in full, or to make compromises of claims, he may exercise those powers without reference to any other person or body.
In line with the principle that no stakeholder should gain advantage after the commencement of liquidation, no action against the company may be commenced or continued except by leave of the court, and subject to such terms as the court may impose. Furthermore, any disposition of the company’s property that takes place after the beginning of the liquidation (the passing of the resolution to wind up) and any transfer of shares or alteration in the status of the members of the company after the beginning of the liquidation will be void unless the court orders otherwise. The liquidator has the power to set aside transactions that are deemed to confer undue preference.
Section 301 of the Companies Law extends the ‘fraudulent preference’ provisions of the Bankruptcy Law to companies. Any transaction undertaken within six months before the commencement of liquidation may be deemed a fraudulent preference against the creditors and be invalid accordingly, unless there is full consideration for the company having entered into it. In determining whether there was a fraudulent preference, the court looks at the dominant or real intention and not at the result. The onus is on the liquidator to show that the dominant intention was to prefer.
Any charge over the company’s assets that has not been properly registered is void against the liquidator and any creditor of the company, and a floating charge created within 12 months of the commencement of winding up is valid only to the extent of any cash paid to the company at the time of, or subsequently to, the creation of and in consideration of the charge, unless the holder of the floating charge is able to prove that immediately after the creation of the charge the company was solvent, not only in terms of having an excess of assets over liabilities, but also in having the ability to pay debts as they become due.
Creditors are required to submit proofs of debt to the liquidator. After examining the proof the liquidator may accept the claim in full, accept it in a reduced amount or reject it. The creditor may apply to the court to review the liquidator’s decision. Secured creditors may realise their security and account to the liquidator for any surplus or claim in the liquidation for any shortfall.
If, as is the norm, the liquidation lasts longer than a year, separate annual meetings of members and creditors must be held within three months of each anniversary to consider the conduct of the liquidation and the liquidator’s receipts and payments account. The 2015 amendments to the Companies Law inserted a new provision allowing the liquidator to apply to the court for an order bringing the liquidation to an end and dissolving the company if the assets are insufficient to cover the cost of liquidation.
As soon as the liquidator has realised and distributed all the company’s assets and completed his or her investigations, he or she must call separate final meetings of members and creditors and lay an account of his or her receipts and payments before each meeting. He or she must notify the Registrar of Companies of the meetings within a week afterwards. The company is deemed to be dissolved three months after the registration of the return of the meeting, subject to the right of the liquidator or any other interested person to apply to the court for the three-month period to be extended.
Section 281 of the Companies Law gives the liquidator similar powers to reconstruct the company as in a members’ voluntary liquidation, but in the context of a creditors’ voluntary liquidation the exercise of these powers requires the sanction of the court or the committee of inspection.
Winding up by the court, or compulsory liquidation
Section 211 of the Companies Law provides that a company may be wound up by the court if:
- it has resolved by special resolution to be wound up by the court;
- default is made in delivering the statutory report to the Registrar of Companies or in holding the statutory meeting;
- the company does not commence its business within a year from its incorporation or suspends its business for a whole year;
- the number of members is reduced below one in the case of a private company or below seven in the case of any other company;
- the company is unable to pay its debts; or
- the court is of the opinion that it is just and equitable that the company should be wound up.
The procedure is initiated by presenting a petition to the court. A petition may be presented by the company; by any creditor (including a contingent or prospective creditor); by a contributory (a person who is liable to contribute to the assets, such as the holder of partly paid shares); or by a member. The Official Receiver may present a petition against a company that is being wound up voluntarily.
On hearing the petition, the court may dismiss it, adjourn it, or make any order that it deems fit. If an order to wind up the company is made, the liquidation will be deemed to have commenced at the time the petition was presented unless a resolution has previously been passed for a voluntary winding up, in which case, liquidation will be deemed to have begun when the resolution was passed.
When a winding-up order is made, the company may no longer trade, except with the permission of the court (or the committee of creditors, if there is one) for the beneficial realisation of assets. No action against the company may be commenced or continued except by leave of the court and subject to such terms as the court may impose. Any disposition of the company’s property that takes place after the commencement of winding up and any transfer of shares or alteration in the status of the members of the company after the commencement of winding up will be void unless the court orders otherwise. The liquidator has the power to set aside transactions that are deemed to confer undue preference.
The company’s assets vest in the Official Receiver, who is responsible for realising them and distributing the proceeds to the creditors according to the prescribed order of priorities. The directors are required to provide the Official Receiver with a statement of affairs detailing all the company’s assets and liabilities, including prospective and contingent assets and liabilities. Section 233 of the Companies Law gives the liquidator comprehensive powers to realise the assets and determine claims, including the power to disclaim onerous property. Certain of these powers require the approval of the court (or the committee of creditors if one has been appointed) and all powers are subject to the control of the court. Any creditor or contributory may apply to the court for a review of the exercise of the liquidator’s powers.
The liquidator has extensive powers to investigate the conduct of persons involved with the company, including power to apply to the court for the public examination of any officer of the company or anyone involved in its promotion, and to apply to the court for the arrest of any person it considers liable to abscond and the seizure of any relevant records.
The Official Receiver may convene general meetings of creditors and contributories at which they may elect another person to act as liquidator under the supervision of the Official Receiver, and a committee of creditors to oversee the liquidator. The Official Receiver can be appointed as the permanent liquidator.
The liquidator in a compulsory liquidation has the same powers as the liquidator in a voluntary liquidation with regard to the setting aside of preferences and invalid charges.
Procedures for the submission and determination of creditors’ claims are similar to those in a voluntary liquidation. Secured creditors may realise their security and account to the liquidator for any surplus or claim in the liquidation for any shortfall.
The liquidator may apply to the court under section 198 of the Companies Law to convene meetings of creditors and members in order to consider an arrangement or compromise of the company’s debts. If the proposed compromise is approved by the requisite majorities it will, subject to the approval of the court, be binding on all the creditors or the class of creditors, or on the members or class of members, as the case may be, and also on the company, the liquidator and the contributories.
While the liquidation is in progress, the liquidator must submit an account of his or her receipts and payments to the Official Receiver every six months. Once the assets have been realised and the funds have been distributed the liquidator may apply to the court for the dissolution of the company. The company is dissolved with effect from the date of the order. The liquidator is required to send a copy of the order to the Registrar of Companies.
The amendments made to the Companies Law in 2015 require compulsory liquidations to be completed within 18 months from commencement unless the court grants an extension: it remains to be seen how practicable this change will prove to be. In addition, the liquidator may apply to the court for an order bringing the liquidation to an end and dissolving the company if the assets are insufficient to cover the cost of liquidation.
Winding up subject to the supervision of the court
Section 293 of the Companies Law provides that a when a company has passed a resolution for voluntary winding up, the court may make an order that the voluntary winding up shall continue subject to supervision of the court. The court has a wide discretion as regards the terms on which the liquidation is to continue, including the power to order the appointment of an additional liquidator.
Cyprus has a two-tier restructuring and insolvency framework. The provisions dealing with arrangements, receiverships and liquidations are long-established, and there is a wealth of case law from the English and other courts to assist in their interpretation. These traditional provisions have been supplemented by a new procedure designed to promote an enterprise culture by facilitating restructurings. The new procedure is untested and many professionals believe that it is incomplete, and that a good deal more flesh needs to be put on the bones in order to make it effective. Meanwhile, the traditional form of voluntary arrangement and compromise has been used to successfully complete restructurings.