Restructuring Landscape in Europe - Keeping up with the Competition

Two ambitious European projects

Two of the EU's flagship economic projects impact restructuring and insolvency: completion of the Banking Union and creation of the single Capital Markets Union (see boxes). Both of these projects involve a comprehensive package of measures.

Minimum restructuring standards initiative

One work stream is concerned with the diversity of the EU's 28 member states' insolvency regimes, which the EU Commission found to be a barrier to foreign investment in the EU. Some level of harmonisation of substantive insolvency law was thought to be essential to the success of the Capital Markets Union. 

Of course, this is not the first time the EU has suggested harmonising insolvency law. And the reasons why the proposal has always floundered in the past have not changed: consider the different cultural philosophies underlying the various insolvency regimes, or the different national security and corporate laws upon which insolvency laws sit, or even the fact that some regimes regard transaction avoidance as a restorative tool and others a punitive one, to name but a few.  These differences make a meeting of minds about what any harmonised insolvency law should look like an elusive goal.

However, since some degree of insolvency harmonisation has (rightly or wrongly) been declared part of the CMU agenda, there has been a renewed push, resulting in November 2016 in the publication of a draft directive proposing minimum standards for restructuring legislation in each EU member state.³  Under the proposal, each member state will legislate for a restructuring tool with a temporary creditor stay, a reorganisation plan voted on by classes and approved by the court, with the possibility of cross-class cram-down of junior impaired classes, and protection from termination of essential contracts (for more details on this see our briefing, here).  While this proposal has found support in some quarters, unsurprisingly, progress on the detail has been slow. After winding its way through the legislative process, and the European Parliament's various committees, it has now been remitted back to the EU Council for a policy debate on a viability test for a debtor wishing to use the proposed restructuring procedure, and the acceptability in principle of cross-class cram-down.  Some of these concepts are quite big policy steps for those member states with relatively undeveloped insolvency regimes.    Even so, the European Commission is keen to finalise the draft directive in 2018.  

Since the aim of the draft directive is a degree of harmonisation, it is ironic that the end product restructuring tool will not behave identically in different jurisdictions.  This is in part because each member state will put its own spin on the tool when legislating, but more significantly, the speed, quality and attitude of the courts and the restructuring professionals in each member state will also determine how the tool behaves in practice.

Even without perfect harmonsiation, the proposal is not necessarily a bad thing as long as sensible agreement can be reached on some of the trickier points, such as the valuation provisions that trigger the cross-class cram down of impaired junior classes. The fact that each EU member state will eventually have a credible restructuring tool may be sufficient for external investors and CMU purposes, and perhaps it will not matter too much that it does not behave identically in every member state. 

It is just possible that the UK will have to implement the directive as part of the Brexit transition deal. Our English scheme of arrangement gets us quite close, so that it would not be such a massive leap conceptually to bolt on a creditor moratorium, cross-class cram-down of impaired junior classes and beef up our protection of contracts if we have to, or want to anyway.  These concepts are not easy to legislate for in practice, however, and it will be crucial to ensure we legislate carefully.  Ill-considered amendments could upset the careful creditor/debtor balance of our regime that has stood the test of several recessions pretty well.  

Even if the UK does not have to implement the directive, there are good reasons why we might want to do something similar anyway.  When it becomes law, the draft directive will mean that the UK's tried and trusted scheme of arrangement, which has served well as the restructuring tool of choice for many big international corporate rescues, will face more European competition. We should not rest on our laurels.

Enhanced NPL recovery initiative

The other measure directly affecting restructuring and insolvency regimes is a new enforcement right for secured creditors to provide them with a more efficient method of value recovery from secured loans in default. The measure is contained in the latest proposed new directive on credit servicers, credit purchasers and the recovery of collateral, published on 14th March 2018.⁴  The right is described as an expedited and efficient out-of-court enforcement mechanism which enables secured lenders to recover value from collateral granted solely by companies and entrepreneurs to secure business loans.  The Commission has named its new creation unsnappily: "Accelerated Extrajudicial Collateral Enforcement" or "AECE" for short. The AECE bears resemblance to an English mortgagee's power of sale. It might behave in much the same way, except it is intended that this right is not available for consumer loans or where the collateral is the borrower's primary residence. Enforcement can be by way of private sale or public auction (at the choice of the implementing member state), but not, it would seem, by appointing a receiver.

This initiative is quite interesting in policy terms.  For years, the EU has been pushing the rescue agenda, not an enforcement agenda.  And where rescue has not been possible, the focus has been on court-driven collective insolvency procedures (i.e. for the benefit of all creditors), not self-help secured creditor contractual remedies (i.e. for the benefit of one creditor).  This reflects a global trend. In the UK, for example, administrative receivership (an enforcement procedure) used to be the insolvency process of choice until the early 2000s, when the government legislated to mostly replace it with administration (a collective procedure). Despite being promoted as a complement to the restructuring framework draft directive discussed above, the Commission's proposal for the AECE seems to row back against the main direction of travel.   

Plans for the AECE have come about as part of the action plan to complete the Banking Union.  The continued existence of large swaths of non-performing loans (NPLs) in some member states is having a destabilising effect on their banks (see our report on Greek NPLs on this link) and consequently an action plan to reduce them has been produced under the umbrella of Banking Union project.  The NPL problem is much bigger in some member states than others.  The AECE is supposed to help with NPLs because it will address one of the problems common to many of those member states where enforcement through the courts is too slow and/or too difficult to provide a workable solution.  Hence why the Commission has come up with the idea of a contractual, out-of-court, collateral enforcement method for secured creditors.

Like the draft directive on restructuring frameworks mentioned above, the AECE proposal might not be a bad idea if it is crafted sufficiently well.  It will not, however, help with existing NPLs in any member state because the AECE has to be agreed between the bank and its borrower upfront. It can only benefit future secured non-performing business loans.

So what might the AECE mean for the UK?  Well, probably not very much.  Our courts are some of the most respected, efficient and commercial in the world, and so court-based restructuring options already exist and work well.  In addition, we already have a secured creditor contractual remedy (i.e. the mortgagee's power of sale and receivership).  Perhaps it is not a coincidence, therefore, that the UK also no longer has much of an NPL problem.

Even so, while all this change is going on in the EU, the UK would definitely benefit from a general review of its restructuring and insolvency regime.  As we leave the EU, it would be wise to consider adopting some of the elements of the draft restructuring framework directive mentioned above (whether or not we are obliged to implement them).  Our top restructuring tool is the English scheme of arrangement, which has proved immensely flexible over the last decade.  However, it does not have a creditor moratorium (unless you couple it with administration), and neither does it allow cross-class cram-down of impaired junior classes.  Once our fellow Europeans have a tool that does these things, even though it may take years for the some of them (and their courts) to really catch up, we may feel the competition more keenly.

The UK government did have plans to upgrade our corporate insolvency framework.  It consulted on proposals back in 2016 in order to address the UK's fallen ranking in The World Bank's "Doing Business" table, but work ground to a halt after the Brexit referendum.  Which brings us full circle back to the Brexit bubble: finding legislative time to invest in our restructuring and insolvency regime in this way has been pushed off the agenda by Brexit. To maintain its competitive edge in an ever-widening international restructuring landscape is even more important for the UK, whatever Brexit deal we get.  Too greater a focus on Brexit and we are at risk of obstructing the bigger picture.

1. Action Plan on Building a Capital Markets Union http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52015DC0468&from=EN  

2. CMU in a nutshell http://ec.europa.eu/finance/docs/policy/180314-proposal-directive-non-performing-loans_en.pdf

3. Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52016PC0723&from=EN

4. http://ec.europa.eu/finance/docs/policy/180314-proposal-directive-non-performing-loans_en.pdf