The EU Adaption of Important Chapter 11 Provisions
Chapter 11 has been both a model and a vision for the EU restructuring community for the past 20 years. Following the enactment of the EU Restructuring Directive in 2019, the United Kingdom, the Netherlands and Germany have adopted insolvency and restructuring laws that have many of the same features of Chapter 11. This chapter compares a number of the new ‘Chapter 11-like’ laws in those countries with their US Bankruptcy code counterparts.
- EU Restructuring Directive in 2019
- Steps the United Kingdom, Netherlands and Germany have taken to comply
- Specific components of new ‘Chapter 11-like’ laws in those countries
Referenced in this article
- The European Union
- EU Restructuring Directive
- European Regulation on Insolvency Proceedings
- The ‘Dutch Scheme’ (Wet Homologatie Onderhandsakkoord)
- UK Corporate Insolvency and Governance Act
- United States Bankruptcy Code
- Chapter 11
- Debtor-in-possession financing
- The cramdown of classes of claims
In July 2019, the Directive on Insolvency, Restructuring and Second Chance (the Directive) came into force in the European Union (EU). The aim of the Directive was to ensure that a statutory restructuring framework was enacted in each EU Member State to maximise the chances of restructuring the debts of a company with a viable business rather than being forced into liquidation, which historically has often been the case. EU member states now have until summer 2021 to implement the Directive. Although EU member states have a significant degree of flexibility in the implementation, if all aspects are fully embraced, the European Union’s restructuring framework would move substantially closer to the tried and tested Chapter 11 plan available under the US Bankruptcy Code.
EU member states are now well over halfway through the two-year implementation period and several countries have taken significant steps towards upgrading their domestic restructuring regimes. Among the most recent developments are the publication on 18 September 2020 by the German Federal Ministry of Justice of draft legislation including the introduction of the German restructuring plan and the adoption by the Dutch Senate on 6 October 2020 of the long-awaited legislative proposal for the act providing for the introduction of the ‘Dutch scheme’ (Wet Homologatie Onderhandsakkoord (WHOA)), which will enter into effect at the beginning of 2021 at the latest. The German legislation is due to follow a similar timeline and is anticipated to enter into effect in January 2021.
Of course, there has also been much discussion and attention to date on the new restructuring plan enacted on 26 June 2020 by the UK government under the Corporate Insolvency and Governance Act. Importantly, despite being in a transition period, having officially left the European Union on 31 January 2020, the United Kingdom has largely modelled its restructuring plan in line with the Directive in order to ensure that it remains consistent with cutting-edge EU restructuring regimes.
In terms of content, most of the individual domestic regimes have, like the Directive itself, taken significant inspiration from US Chapter 11, but none have exactly replicated it. Instead, all have adapted the Chapter 11 model to best suit their domestic insolvency history to produce:
- a court-sanctioned process;
- debtor-in-possession governance;
- classification of creditors based on similarity of rights (and sometimes interests) for the purposes of voting; and
- an ability to effect a Chapter 11-style cramdown of dissenting creditors.
In this chapter, we will take a comparative look at some (but not all) of the key components of the following, which might be considered by advisers and companies when initially structuring a deal to determine the most appropriate forum for a restructuring:
- the Chapter 11 process;
- the UK restructuring plan;
- the WHOA; and
- the German restructuring plan.
What are the gateways to establishing jurisdiction?
Some jurisdictions have long been known to be more receptive to or have been used for ‘forum shopping’. The practice of forum shopping has, historically, been driven by the result that a particular process can offer, as well as the specific criteria that must be established in order for the local courts to accept jurisdiction. An assessment of both factors will feature heavily in the initial deal structuring phase.
One of the many attractions to Chapter 11 has always been the relatively low jurisdictional threshold needed to be established in order to access the process. For foreign companies to qualify as a debtor under the US Bankruptcy Code (and thereby establish jurisdiction), they need only have retainer monies in a bank account in the United States. This administrative hurdle should be readily achievable by any company that is seriously considering a restructure via Chapter 11. By comparison, while the United Kingdom has long been considered a jurisdiction that is receptive to forum shopping (and indeed one in which it is relatively straightforward to establish jurisdiction), the bar is not quite as low as in the United States. For a non-English company to propose a restructuring plan in the United Kingdom, it must either have its centre of main interests (COMI) in the UK, or it must establish that it has a ‘sufficient connection’ to the UK. With respect to what can constitute a ‘sufficient connection’, having the underlying debt documents governed by English law (or indeed changing the governing law of the documents to English law) will be sufficient. In order to establish jurisdiction to access the public version of the WHOA, the Dutch Court, the Dutch court will have jurisdiction on the grounds of the European Regulation on Insolvency Proceedings (the EIR), provided the debtor’s COMI is located in the Netherlands. If, however, the debtor’s COMI is outside the European Union (or in Denmark), then Dutch courts can still exercise jurisdiction over the debtor by reference to the Dutch Code of Civil Procedure generally, which includes independent grounds for jurisdiction of the Dutch court, such as close ties with (eg significant group activities) or an establishment in the Netherlands. By comparison, the German restructuring plan will be accessible only by debtors who have their COMI in Germany.
What are the criteria for cross-border recognition?
While the initial question of jurisdiction is a key gating item to any restructuring, this should be considered in conjunction with an assessment of the other jurisdictions in which the chosen process will need to be recognised. It is clear that, in order to deliver an effective restructuring, there must be certainty that the chosen process will be recognised in all jurisdictions that the company has assets, operations or creditors in.
Recognition will be a matter of local law and different avenues may be open to establish this. For example, where a country has adopted the UN Model Law on Cross-Border Insolvency (the Model Law), this will enable recognition locally of a Chapter 11 case where the debtor has its COMI or an establishment in the United States. Where this is not the case (eg, because the debtor simply availed itself of the lower jurisdictional threshold of a retainer) other avenues under domestic law may be possible.
In addition, other domestic restrictions will need to be carefully considered. For example, in the United Kingdom, the rule in Gibbs provides that debt obligations governed by English law can only be discharged by an English process. In cases where this factual matrix presents, it would therefore be necessary to run a parallel UK process (ie, a scheme of arrangement or a restructuring plan) in order to compromise the English law governed debt obligations.
By comparison, if a debtor accesses a UK restructuring plan (and where such plan is treated in similar terms as schemes of arrangement have been to date), recognition is available in:
- countries that have adopted the Model Law, provided the debtor has its COMI or an establishment in the United Kingdom;
- EU member states under the EU Judgments Regulation (until the end of the Brexit transitional period which expires on 31 December 2020); and
- pursuant to private international law concepts and international agreements on the effect of governing law clauses.
In the Netherlands, if a debtor has accessed the WHOA, recognition depends on whether the public version or the private version has been chosen. If the pubic version is chosen, a scheme that has been sanctioned by the court will be automatically recognised in other EU member states under the EIR. The private version, which is exempt from publication requirements, would not be automatically recognised under the EIR. However, it is likely that recognition would be available under the EU Judgments Regulation or based on other national recognition procedures more generally. Similarly, in Germany, a restructuring plan that has been confirmed by the court as a result of the public procedure will automatically be recognised in other EU member states under the EIR. The position in respect of recognition of the undisclosed version of the German plan is the same as that of the WHOA.
Who can initiate the process and what are the entry requirements?
The question of whether some form of financial difficulty needs to be shown in order to access a particular regime will also feature in the decision-making process of where to implement a restructuring. Even though, in most cases, companies will be experiencing or anticipating some form of financial difficulty, the evidential threshold (if any) that must be satisfied prior to entry into a process should be analysed carefully.
In the United States, a company need not demonstrate any financial hardship to commence a Chapter 11 proceeding and, while the company or in limited circumstances, the company’s unsecured creditors can commence the proceeding and the company initially has the exclusive right of 120 days to present the plan. In contrast, in the United Kingdom, a restructuring plan can be proposed by the company, a creditor, members or, in the case of an existing insolvency, by an administrator or liquidator. In order to access the restructuring plan, it will be necessary to show that the company has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern. The legislative threshold for establishing financial difficulty has been very broadly drafted and, subject to interpretation by the courts on a case by case basis, should not make it difficult for a company to access the restructuring plan.
In the Netherlands, the list of who can propose a scheme is expansive and, in addition to the company itself, creditors, shareholders or works councils and trade unions can request that the court appoint a restructuring expert who will have the right to propose a scheme. With respect to the financial difficulty criteria, the company does not have to be technically insolvent, but must be in a state in which it is reasonably plausible that it will be unable to pay its debts when due. The procedure is also available when the company foresees that it will be unable to pay its debts when due in the (near) future (eg, even in six months or a year). By contrast under the German regime, the company is exclusively entitled to submit a restructuring plan (although those affected have the right to make proposals to amend the plan). The plan itself is available to a company upon the occurrence of imminent illiquidity in the forecast period of (generally) 24 months.
Does the process offer a stay on enforcement?
The chances of implementing a successful restructuring are significantly heightened where creditors are prevented from taking enforcement action against the company, thereby allowing it to stabilise and, most importantly in many cases, to continue to trade while working towards implementing the restructuring. In some cases, it will be possible to agree to a consensual standstill with creditors. However, in cases where this is not possible, the presence of a statutory stay can be vital to the success of the process.
Chapter 11 is the only process discussed in this chapter that gives rise to an automatic and wide-ranging stay on enforcement. A statutory injunction known as an ‘automatic stay’ automatically comes into effect on the filing of a Chapter 11 proceeding, which prohibits all actions against the company by creditors, wherever they are located. In practice, due to the wide reach of the US bankruptcy courts, coupled with the fact that many creditors of a company who files for Chapter 11 will also have operations based in the United States, the automatic stay is generally respected worldwide (even in cases where there may not be formal recognition processes in place). By comparison, in the United Kingdom, there is no automatic stay upon the filing of a restructuring plan. Although, for eligible companies, the process can be combined with the new freestanding moratorium process (also introduced under the Corporate Insolvency and Governance Act). There are, however, broad exclusions to the type of company that is eligible for the moratorium, including companies that are party to capital market arrangements. In cases where the moratorium is not available, it would be possible to request a stay from the court under the court’s inherent jurisdiction. It has not been common for stays of this nature to be granted in the context of a scheme of arrangement, although, in certain circumstances, short stays have been obtained (and have largely been granted in cases where significant progress had been made in the restructuring). Although untested at the time of writing, it is expected that UK courts will adopt a similar approach to a stay request in the context of a restructuring plan.
In the Netherlands, under the WHOA, an automatic stay does not come into being, although the debtor does have the ability to request the court to allow a stay for a maximum of four months, with the possibility of an extension for up to a maximum of eight months in total. When granted, the stay prevents all parties from claiming or taking recourse against the company’s assets, unless they have court consent. Similarly, under the German restructuring plan, the company may apply to the court for a moratorium on foreclosure and enforcement. If granted, the moratorium will initially last for three months with the possibility of being extended for up to eight months.
What is the impact on operations?
In many cases, the ability of the company to continue to trade through a restructuring will be closely linked to whether it is possible to obtain protection against counterparties terminating contracts on the grounds that the debtor has proposed a restructuring (ipso facto clauses).
The United States provides companies with broad protection against ipso facto clauses. The US automatic stay renders most contractual provisions entitling a counterparty to terminate unenforceable. Only those entities that have filed for Chapter 11 are protected – so there may be cross-defaults in other group entities who have not filed. In the United Kingdom, counterparties supplying goods or services will be prevented from terminating the contract when a court summons a meeting relating to a compromise or arrangement under the restructuring plan. Similar to the United States, only those entities that have filed are protected, and this may also result in possible cross-defaults in other group entities where no protection is granted.
In the Netherlands, upon commencement of the procedure whereby the debtor proposes a scheme, ipso facto clauses remain inoperative. In addition, it is possible to apply for a targeted stay against one or more suppliers; for example, to prevent a lessor from repossessing machinery that the debtor needs in order to continue to trade during the restructuring. Under the German restructuring plan, ipso facto clauses are also invalid when a plan has been proposed by a debtor.
Is debtor-in-possession financing available?
For many companies, entering a restructuring process where forecast liquidity to completion is tight, the ability to introduce and access alternative financing during the process will be key.
In the United States, debtor-in-possession (DIP) financing is permissible with court approval in Chapter 11 in order to continue to operate the business and pay the costs of the restructuring process. Super-priority status can be granted to DIP lenders provided the court is satisfied that:
- the debtor cannot obtain such financing on less-burdensome terms; and
- non-consenting prepetition secured lenders that are primed are ‘adequately protected’.
In practice, the requirement to ensure that prepetition secured lenders are adequately protected means that they cannot be primed without receiving replacement liens or in circumstances where there is a significant equity cushion. In reality, this usually means, where DIP financing is pursued in Chapter 11 proceedings, it is often provided by the existing lenders (or a subset of the existing lenders) who in effect prime themselves by putting in a priority facility. By contrast, in the United Kingdom, there are no provisions for priority financing to be introduced after a company has filed for a restructuring plan. If priority financing is needed during the restructuring, this must be introduced within the confines of the existing contractual documents or, in circumstances where this is not possible, a restructuring plan or scheme of arrangement could be used solely for the purpose of amending the contractual terms to permit the introduction of new money with a higher-ranking priority. Clearly, however, the use of the restructuring plan in this ‘interim’ manner in order to bridge to a fuller restructuring may not be feasible where liquidity levels do not permit.
In the Netherlands, emergency funding (including related security) required during the restructuring efforts that is approved by the court is protected from avoidance actions based on fraudulent preference. While this presents the possibility of introducing new financing on a protected basis, it may prove challenging for a debtor to access this if all its collateral is already secured on existing financing. In Germany, DIP financing is not available and there is no super priority for new loans. However, emergency funding can be provided so long as it is compliant with the existing documentation. Such financing, provided for no longer than three months to enable the development and implementation of a restructuring concept, is protected against claw back under existing case law in certain circumstances.
What is the effect on group guarantors?
The structure of most, if not all, corporate groups will include the provision of cross-guarantees by fellow group companies in respect of the underlying primary debt obligations. In this scenario, it will not suffice to merely compromise the underlying debt if the ability to claim against fellow group companies remains. The ability to release group guarantee claims is therefore a key factor that will be considered prior to choosing an appropriate restructuring forum.
Chapter 11 does not provide for the release of group guarantees given in support of the obligations of a debtor who has filed for Chapter 11, unless that guarantor also files for Chapter 11. In cases where there are several group guarantors that require a release, each guarantor needs to file for Chapter 11. Indeed, individual filings may also be necessary in any event for those companies to benefit from the other protections and benefits afforded by Chapter 11, such as the automatic stay and the ability to obtain DIP financing. This particular factor can add complexity (as well as time and cost) to a Chapter 11 restructuring and is something that should be considered when evaluating the efficiency of the various processes at the outset of a restructuring. By comparison, in the United Kingdom, the restructuring plan should be able to release group guarantees without the guarantor proposing a restructuring plan in circumstances where the guarantees are closely connected to the primary obligations being compromised under the restructuring plan.
In the Netherlands, the WHOA provides that it is possible for group guarantees issued by members of the same group as the company who proposed the scheme to be compromised if certain requirements are met. This can result in a surety or joint obligor being released from liability where they cannot be claimed against in respect of the underlying debt. By comparison, while the German restructuring plan can also be used to compromise third-party security granted by subsidiaries in order to avoid multiplicity of procedures for intra-group security providers, this feature is not available in respect of parent and sister companies. It is worth noting, however, at the time of writing, that this restriction has been the subject of criticism and will be reviewed further in the legislative process before the final version of the plan comes into force.
What level of support is needed to implement, and is there an ability to bind dissenting creditors or to implement, a cramdown of other classes of creditors?
One of the first questions (if not the first question) that will be considered when assessing where to base a restructuring will be the level of support required in order to approve the proposed restructuring. The relevant consent thresholds and the presence (or absence) of a numerosity test may have a significant influence in the decision-making process. Indeed, where there is expected to be material resistance from dissenting classes of creditors, the ability to implement a cramdown (together with the conditions required in order to do so) will be key to the viability of the proposed restructuring. In order for a Chapter 11 plan to be approved, the company must obtain the support of a majority in number and two-thirds in amount of such impaired class of creditors voting on the plan in order for that creditor class to accept the plan. If, however, the requisite levels of support are not received from each impaired classes, the plan may still be confirmed via cramdown , provided that
- at least one impaired (non-insider) class votes in favour;
- the plan does not discriminate unfairly toward each impaired class that has voted against it;
- the plan is fair and equitable to the dissenting class; and
- dissenting creditors will receive more under the plan than they would in a liquidation (the ‘best interests of creditors test’).
With respect to what is deemed fair and equitable to the dissenting classes, for secured creditors, the entitlement to receive either cash payments equal to the value of their collateral or the indubitable equivalent of their claims and collateral will satisfy this test. Critically, secured creditors cannot be compelled to accept equity in the reorganised company over their objection even in a cramdown. For unsecured creditors, the plan must ensure that they recover in full before any more junior class of claims or interests receives any recovery (the ‘absolute-priority rule’).
By comparison in the United Kingdom, the restructuring plan has not replicated the numerosity test that exists in respect of a UK scheme of arrangement. Instead, for a restructuring plan to be approved by any given class, 75 per cent in value of creditors or members voting must vote in favour. Like a Chapter 11, there is now also an ability to impose a cramdown of dissenting classes for the first time in the United Kingdom in order to deliver the restructuring plan. This will be possible where the UK court is satisfied that none of the members of the dissenting class would be any worse off than in the event of the most likely relevant alternative scenario, as determined by the court, if the restructuring plan is not sanctioned, and the restructuring plan has been accepted by a class who would receive a payment or has a genuine economic interest in the company in the event of the relevant alternative. Importantly, the absolute priority rule is not a condition to imposing a cramdown of classes under the restructuring plan, meaning that it is theoretically possible to impose a form of ‘cram up’, where value is given to junior creditors having impaired more senior creditors. Ultimately, however, whether this is in fact possible will be a matter for judicial determination when a court is faced with the decision of whether to sanction a plan that seeks to impose such an outcome.
In the Netherlands, a class of creditors accept a plan if the group of creditors who vote in favour of it represents at least two-thirds in value of the total value of claims of those who voted within that class (no numerosity test). In the case of shareholders, that group needs to represent at least two-thirds of the issued capital of those who voted within that class (no numerosity test). Cramdown of classes is also possible and a debtor can request confirmation of a scheme by the court if at least one ‘in the money’ class has voted in favour. While the absolute-priority rule has not been included in the Netherlands, a slightly adapted version of it provides creditors or shareholders who voted against the scheme and who are also part of a class who voted against it with a ground of objection before the court. If raised, the court can refuse to sanction the scheme if the reorganisation value of the company is not allocated among the classes in accordance with their statutory ranking. In addition, if raised by a creditor or shareholder who voted against the plan before the court (irrespective of whether they are part of a class that voted against the scheme), it will also be necessary for a scheme to demonstrate the best interests of creditors test (ie, that the creditors or shareholders are not receiving less under the scheme than they would in a liquidation).
In Germany, the adoption of a restructuring plan requires 75 per cent in value of the voting rights in each class (and not only of those participating) vote in favour in order to approve the plan. Similar to other jurisdictions, the restructuring plan also allows for a cramdown of classes, subject to certain conditions, namely:
- the dissenting class is not any worse off than it would have been in an alternative scenario without the plan;
- the dissenting class received adequate participation in the economic value distributed under the plan by those affected by it; and
- the majority of the voting classes have approved the plan (however, this majority must not be exclusively shareholder and subordinated creditor classes).
The absolute priority rule applies, although an exception is provided for in situations where shareholders retain economic value, provided that their participation is necessary for the continuation of the company (so that the added value of the plan can be achieved) or that the impairment of the rights of creditors is minor, such as in the case of a mere 18-month deferral of the due dates of their claims.
One can certainly see how the different levels of approval required in order to implement the various restructuring processes in each jurisdiction, coupled with the different conditions that must be satisfied in order to cramdown other classes could influence the decision-making process of where to base a restructuring.
Conclusion: increased menu options can provide food for thought
The introduction of new restructuring tools by the United Kingdom, the Netherlands and (in due course) Germany (each of which are capable of delivering a restructuring in a similar (but not identical) manner to Chapter 11) is an important development for the EU restructuring community. This should provide increased optionality when considering pre-insolvency business rescue procedures. It will be interesting to see how the respective judiciaries in the Netherlands and Germany interpret the legislation (given its very recent history) when the first batch of restructurings come before the courts. Developing a consistent line of sensible judicial authority will play a significant part in the Netherlands and Germany promoting themselves as jurisdictions to seriously consider when planning a cross-border restructuring. One of the key questions will be whether those courts will be as receptive to forum shopping as the United States and United Kingdom courts have shown themselves to be.
While Chapter 11 still has the most global reach and is the most tried and tested of these processes (with over 40 years of jurisprudence), closely followed by the United Kingdom (which has an established track record of implementing cross-border restructurings) the new UK, Dutch and German restructuring tools can certainly provide some viable alternatives to Chapter 11, particularly where these processes are capable of being implemented on a less costly basis or where there is a significant nexus to those jurisdictions which warrant a non-US process.
 Involuntary proceedings are very rare and typically require the coordination of at least three of such debtor’s creditors.
 This is not a requirement for a UK scheme of arrangement, which can also be used for international restructurings but is not featured in this article due to the fact that it does not provide for a cramdown of other classes.