EU Regulations on Insolvency and Brexit

The EU Regulation on Insolvency Proceedings 2015^[1] (the Recast Regulations) came into force on 26 June 2017 revising its predecessor, the EC Regulations on Insolvency Proceedings 2000^[2] (the Original Regulations). Incorporating 15 years of practice gained from the application of the Original Regulations, the Recast Regulations made a number of subtle changes to key concepts and introduced some novel procedures to provide further coordination with respect to insolvency of European debtors operating across member states.

It is fundamental to the European single market that corporates and individuals be entitled to freely move throughout the EU and to freely carry on business across member states. It is, therefore, also fundamental to ensure an effective system is in place to govern which courts have jurisdiction over the insolvency of a debtor. Such a system was introduced by the Original Regulations and has been beneficial to creditors and debtors alike, increasing certainty and reducing cost. The modifications incorporated by the Recast Regulations, which seek to limit abuse to the detriment of creditors and encourage greater cooperation and coordination, are expected to further enhance recoveries for creditors in pan-European insolvencies. While the rest of Europe converges, the United Kingdom, which has been a major beneficiary of the Original Regulations, is diverging as a result of Brexit.

This chapter describes some key developments of the Recast Regulations in the light of past experience and highlights how the UK might be impacted if it seeks to detach itself from the cross-border cooperation of European insolvencies following Brexit.

Background to the Recast Regulations

In accordance with Article 36 of the Original Regulations, the Commission adopted a report on 12 December 2012 that considered the experience of how the Original Regulations had been implemented since their inception. The report recognised the Original Regulations had functioned well in general, but recommended certain adaptions to reflect:

• the new insolvency regimes introduced by certain member states, including pre-insolvency and hybrid schemes that protect a debtor from its creditors and allow a business to continue as a going concern; and
• changes to the economic and corporate landscape with the expansion of pan-European corporate groups.

It was also recommended that amendments should be implemented to:

• move away from the original focus on liquidation procedures to a culture of ‘rescue and recovery’;
• increase coordination of insolvency proceedings involving groups of companies; and
• harmonise specific aspects of insolvency law and the creation of an EU register for insolvency cases, incorporating a number of new concepts and processes.

In accordance with these recommendations, the Recast Regulations were adopted and took effect on 26 June 2017.

Protections against abusive or fraudulent forum shopping

Pursuant to article 3 of the Recast Regulations, jurisdiction to open ‘main’ insolvency proceedings is given to the courts of the member state within the territory of which the debtor’s centre of main interests (COMI) is situated. For the first time, COMI is defined in the body of the Recast Regulations (having previously been set out in the preamble) as ‘the place where the debtor conducts the administration of its interests on a regular basis and which is ascertainable by third parties’. The Recast Regulations also retain the rebuttable presumptions that the COMI is in the place in which the registered office is situated with respect to a company or a legal person, or the principal place of business (if the debtor conducts a business) or habitual residence with respect to individuals. It has been recognised that the ability of the debtor to move its COMI has been open to abuse.

The Recast Regulations have therefore introduced certain safeguards to prevent ‘fraudulent or abusive forum shopping’.^[3] In Shierson v Vlieland Bobby,^[4] Chadwick LJ highlighted that ‘it is a necessary incident to the debtor’s freedom to choose where he carries on these activities which fall within the concept of “administration of his interests”, that he may choose to do so for self-serving purposes’. This has led to attempts by debtors to assert that their COMI is in fact in a different member state to benefit from a more favourable insolvency regime to the detriment of their creditors. Cases of fraudulent or abusive forum shopping have principally concerned individuals seeking to avail themselves of the UK’s more favourable bankruptcy regime, which allows for the discharge of a bankrupt after one year, based on unjustified COMI shifts. In such cases, the debtors rented properties in the UK for a short time with the intention of returning home after the bankruptcy order was made. These assertions were found to be a sham.

To combat such abuse, the Recast Regulations disapply the presumption of COMI in circumstances where:

the debtor has relocated its registered office or principal place of business to another Member State within the 3-month period prior to the request for opening insolvency proceedings, or, in the case of an individual not exercising an independent business or professional activity, the debtor has relocated his habitual residence to another Member State within the 6-month period prior to the request for opening insolvency proceedings.^[5]

In such circumstances, the debtor must demonstrate to the satisfaction of the court that its COMI is as stated. The test to be applied in determining the COMI has not changed. It was first established by the European Court of Justice (ECJ) in Eurofoods IFC Ltd.^[6] At that time, paragraph 13 of the preamble to the Original Regulations stated that COMI should ‘correspond to the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties’. The ECJ determined that the presumption of COMI in favour of the debtor company’s registered office can only be rebutted by ‘factors which are both objective and ascertainable by third parties’ that ‘enable it to be established that an actual situation exists which is different from that which locating it at that registered office is deemed to reflect’. In the case of Interdril Srl v Fallimento Interdril Srl,^[7] the ECJ further developed the test stating that the requirement ‘for objectivity and that possibility of ascertainment by third parties may be considered to be met where the material facts taken into account for the purpose of establishing the place in which the debtor company conducts the administration of its interests on a regular basis have been made public, or, at the very least, made sufficiently accessible to enable third parties, that is to say, in particular or the company’s creditors, to be aware of them’. Paragraph 28 of the preamble to the Recast Regulations emphasises the necessity that in determining whether the COMI is ascertainable ‘special consideration’ should be given to the creditors and to their perception as to where a debtor conducts the administration of its interests. Moreover, the preamble specifically references that where there is a shift of the COMI, creditors should be informed of the new location from which the debtor is carrying out its activities. In the practice of shifting the COMI, this is generally a common feature.

While the disapplication of the presumption of the COMI is likely to be helpful in the case of individuals claiming to have moved their domicile, the practical impact is likely to be less significant for corporate entities. It is generally not legally or practically possible to move the registered office of corporate entities. However, judges in England (and we suspect in other member states) do pay due regard to the timing of when a ‘COMI shift’ was commenced, regardless of whether the registered office remains the same in considering whether relevant factors are objective and ascertainable.

As an additional safeguard to abusive or fraudulent forum shopping, the preamble to the Recast Regulations emphasise the requirement on courts to ‘carefully’ consider whether the COMI of a debtor is ‘genuinely’ located in that member state. Article 4 of the Recast Regulations states that the courts in the member state in which proceedings are seised are required to examine whether the debtor has its COMI in that jurisdiction and therefore whether the court has jurisdiction to open main proceedings. This is an addition that codifies the decision of the ECJ in the Eurofood case.^[8] In that case, a provisional liquidator had been appointed in relation to an Irish subsidiary of an Italian group. Before the hearing for the winding-up of the company, an Italian court made an order to put the company into extraordinary administration, having determined that the COMI of the company was in Italy. Notwithstanding the opening of the Italian proceedings, the Irish courts determined at the winding-up hearing that the appointment of the provisional liquidator in Ireland constituted the opening of main proceedings. The case was appealed all the way to the ECJ. The ECJ held that a court in one member state has no jurisdiction to override the decision of a court in another member state that COMI was in its jurisdiction. In this case, the decision of the Irish courts was automatically recognised in Italy (and other member states). It was further held that the only recourse that the Italian court would have with respect to the Irish court’s decision would be to appeal the decision in the Irish courts.

Secondary and territorial proceedings

Where the COMI of a debtor is in one member state, the Recast Regulations only permit the opening of secondary or territorial proceedings in another member state where the debtor possesses an ‘establishment’. In the Original Regulations, secondary proceedings could only be liquidation proceedings. This has been abolished by the Recast Regulations.

However, it has been recognised that opening any secondary proceedings can be disruptive to the main proceedings to the detriment of creditors. The introduction of ‘synthetic’ secondary proceedings seeks to alleviate these concerns, drawing on the experience of MG Rover, Collins & Aikman Europe SA and Nortel Networks SA.

In Nortel Networks SA, UK administrators were appointed over companies within the Nortel group.^[9] The administrators considered that, owing to the interconnected relationship between the Nortel group companies, a restructuring of the whole group would achieve the best recovery for all creditors and that secondary proceedings would undermine the restructuring plan. The administrators sought to avoid the opening of secondary proceedings in relation to group companies and applied to the High Court for permission to:

• make payments out of the relevant group company’s assets to preferential creditors and employees corresponding to amounts that would have been paid out in secondary proceedings; and
• apply to the courts in relevant jurisdictions so that the administrators would be notified of any application for the opening of secondary proceedings and for an opportunity to be heard in such application.

The Court considered that such a request was within the scope of article 31(2) of the Original Regulations and that although article 31(2) was framed as allowing cooperation between the liquidators in the main and secondary proceedings it had been treated by the courts of other member states as extending to the courts that exercise jurisdiction over insolvency proceedings in their respective jurisdictions.^[10] The Court also recognised that article 33(1) of the Original Regulations provides that the court that has opened secondary proceedings may stay the process of liquidation at the request of the liquidator in the main proceedings, subject to certain measures being taken to guarantee the interests of creditors in the secondary proceedings. However, this would only stay the realisation of assets located in the member state of the secondary proceedings, but would not prevent the continuation of winding-up proceedings in the member state in which each of the companies was incorporated,^[11] the effect of which was likely to cause the relevant company to cease to trade other than for the purposes of winding-up. On that basis, the court granted permission to the administrators to seek the assistance of the relevant local courts in the terms requested.

The deficiencies of the Original Regulations in this respect have now been addressed by article 36 of the Recast Regulations, which provides a statutory framework for avoiding secondary proceedings. The new procedure allows an insolvency practitioner to provide a unilateral undertaking with respect to assets in relation to which secondary proceedings could be opened, to comply with the distribution and priority rights under local law. While the new provisions are helpful, they may also limit their own effectiveness. The undertaking must be approved by the qualified or required majority of known local creditors as determined by the laws of the member state where secondary proceedings would otherwise be opened. Where there are different member states with disparate regimes for seeking approval of local creditors, the process may become rather slow, cumbersome and costly. Local creditors may also make an application to the court of the main proceedings to require suitable measures to ensure compliance with the undertaking or to the local court where secondary proceedings would have been opened to require the court to take provision or protective measures to ensure compliance by the insolvency practitioner with the terms of the undertaking, which could also impede a restructuring to the detriment of creditors. For these reasons, it may be that, where possible, insolvency practitioners seek to follow a more flexible approach as has previously been used to avoid secondary proceedings, rather than engage in the burdensome, and likely costly, process.

Group proceedings and coordination

In the absence of a Europe-wide insolvency regime that caters for the insolvency or restructuring of a corporate group, cross-border insolvencies can be complex and costly, and consequently may not provide the best possible outcome for creditors. In an attempt to address these issues, the Recast Regulations have introduced a procedure of cooperation in group insolvency proceedings. Pursuant to articles 41 to 44 of the Recast Regulations, a group coordinator may be appointed to facilitate and oversee the coordination of an insolvency or restructuring across a group of companies and to propose a group coordination plan. The potential flaw in the process is that the group proceedings are only voluntary, and the officeholders of each group company may decide whether the company over which they have been appointed will form part of the group proceedings. Even then, the coordinator only provides recommendations that are not binding on any of the officeholders. It is questionable whether the procedure will be used or whether a more informal approach may be adopted by insolvency practitioners where they envisage some value in coordination, rather than needing to appoint a coordinator to propose a plan.

The future of the Recast Regulations and the UK

The Recast Regulations draw a distinction between ordinary forum shopping,^[12] which unless insolvency laws are harmonised across Europe cannot be avoided, and abusive or fraudulent forum shopping that the Recast Regulations seek to safeguard against. The UK has been a significant beneficiary forum shopping under the Original Regulations as a result of debtors seeking to utilise the UK’s flexible and pragmatic insolvency and restructuring regime. However, as a consequence of Brexit, while the Recast Regulations promote further cooperation in pan-European insolvencies, the UK is currently at a crossroads. On 30 January 2019, the UK adopted the Insolvency Amendment (EU Exit) Regulations 2019 (the Exit Regulations)^[13] pursuant to the powers conferred under section 8(1) of the European Union (Withdrawal) Act 2018, which was passed to give effect to Brexit.

Article 63 of the draft withdrawal agreement^[14] negotiated between the UK government and the EU states that the Recast Regulations will continue to apply to insolvency proceedings opened before the end of the transition period (being 31 December 2020 in the current draft). However, at the time of writing, the UK government has been unable to garner the relevant support in parliament to enter into the withdrawal agreement. If the UK exits the EU without a deal, or depending on what arrangements may be put in place after the expiry of the transitional period (if any), the amendments under the Exit Regulations will take effect.

The purpose of the Exit Regulations is to address the deficiencies that will arise from the absence of mutual application of the Recast Regulations between the UK and the EU. They retain a number of important aspects of the Recast Regulations but repeal large parts of the Recast Regulations relating to recognition, cooperation and reciprocation.

Article 3 of the Recast Regulations is amended to take effect on ‘exit day’ so that the UK has jurisdiction to open insolvency proceedings where a debtor has its COMI or an establishment in the UK, or if permitted under any other domestic law without regard for whether a debtor is registered or has its COMI in an EU member state. The English courts have often exercised a wide discretion to accept jurisdiction over the insolvency of foreign companies where:

• the debtor has a sufficient connection with England and Wales that may, but does not necessarily have to, consist of assets within the jurisdiction;
• there is a reasonable possibility of benefit to those applying for a winding-up order; and
• one or more persons interested in the distribution of assets must be persons over whom the court can exercise significant jurisdiction.^[15]

The definition of what constitutes a sufficient connection has been interpreted broadly by English courts such that it is not necessary for a foreign company to have its COMI, an establishment or any assets in the UK to establish a sufficient connection.^[16] The Exit Regulations could therefore give the UK courts a wide jurisdiction over foreign companies based in the EU, which would currently be restricted by the Recast Regulations.

While the Exit Regulations ensure that the UK’s jurisdiction is not diminished, this arguably represents a retrogressive step for the UK insolvency market. If they come into effect without a transitional arrangement, UK insolvency proceedings will no longer be automatically recognised across Europe. This could deter debtors from seeking to take advantage of the UK insolvency regime as there is increased uncertainty as to whether a UK insolvency will be recognised in relevant member states. Recognition may also require a costly and time-consuming application for recognition in each relevant jurisdiction, the outcome of which is uncertain and may require reliance on principles of comity and private international law.

Problems may also be faced with European proceedings seeking to compromise or release English-law-governed debt. In the absence of the Recast Regulations, English law will not recognise a compromise or release of English-law-governed debt by an insolvency process in an EU country.^[17] Consequently, any proceedings seeking to restructure English-law-governed debt may require a separate English proceeding or process. This could result in potential for creditors taking a ‘hold out’ position. In the absence of the Recast Regulations or the Brussels Regulations^[18] (which may also be relevant), insolvency practitioners of European debtors may have to seek reliance on the Cross-Border Insolvency Regulations 2006, which was held in the case of Bakhshiyeva v Sberbank of Russia not to permit the indefinite application of a moratorium to prevent creditor action in England where local insolvency proceedings had achieved their purpose and ended in Azerbaijan. Consequently, creditors with English-law debt were able to continue to pursue their debt claims in England against the debtor’s English assets. In such circumstances, there may be little option for debtors other than to use an English process.

Conclusion

The Original Regulations and the Recast Regulations have proved successful in increasing certainty with respect to insolvency proceedings across Europe, and the new procedures introduced by the Recast Regulations for cooperation and facilitating efficiency are conceptually sensible. Increased cooperation will ultimately result in better recoveries for creditors. Whether the UK will continue to benefit from such cooperation and whether it will be able to retain its poll position as a restructuring destination in the light of Brexit is yet to be determined.

Notes