Legislation is currently being prepared, at both the European and the national levels, to introduce proceedings that aim to rescue ailing businesses before formal insolvency proceedings are begun. Such proceedings are commonly referred to as “pre-insolvency” proceedings. They provide for the right, outside formal insolvency proceedings, to propose a restructuring plan to creditors and other capital providers that, under certain circumstances, can be imposed upon opposing parties.
On 22 November 2016, as part of the Action Plan for a Capital Markets Union, the EC published a draft directive on preventive restructuring frameworks which, upon adoption, will compel the Member States to introduce pre-insolvency proceedings into their national systems. At the same time, the Dutch Government is working on a draft of the Continuity of Enterprises Act (Voorontwerp Wet Continuïteit Onderneming II), which seeks to introduce pre-insolvency proceedings in the Netherlands.
Dr. Nicolaes Tollenaar has kindly provided us with the following summary of his recent research regarding the normative foundation and framework of such pre-insolvency proceedings.
Summary of research
The book opens with a general discussion of the normative theory for insolvency proceedings in general. It takes the influential creditors’ bargain theory as a starting point, but suggests an important refinement for non-cash distributions. It then goes on to develop a normative theory for pre-insolvency proceedings.
Next, the book discusses the governance of pre-insolvency proceedings. It explains the system of voting in classes and the acceptance, confirmation and cram down of restructuring plans and the need for judicial valuation.
The book then goes on to provide and in-depth discussion of valuation in the context of restructuring. It clarifies valuation terminology and sets out the applicable valuation standards to be applied. The following section offers a comparative analysis and critique of the US Chapter 11 plan procedure and the UK scheme of arrangement, highlighting the strengths and weaknesses of each of these systems.
Against this background the book offers a high-level outline of what pre-insolvency proceedings should look like ideally. A key part of this section is dedicated to formulating the different economic criteria and identifying the appropriate valuation standards to be applied in the exercise of the power to cram down dissenting “out-of-the-money” classes and dissenting “in-the-money” classes. This discussion builds on the normative theory developed in the earlier parts.
The last parts of the thesis analyse the legislative initiatives of the EC and the Dutch Government. The book features a comprehensive discussion of the key principles underlying restructuring proceedings. It offers answers to a number of important issues that are still undecided and the subject of debate.
A number of insights and conclusions emerge from the thesis.
A first conclusion is that there is no justification for proceedings that interfere with parties’ rights where the debtor is not insolvent or where insolvency is not imminent and there is still a real likelihood that the debtor will remain solvent. There is thus no basis for true “pre-”insolvency proceedings.
A second conclusion is that pre-insolvency proceedings, in the conceptualised form, are not a rehabilitation instrument that works for the benefit of the debtor, but rather a debt-collection instrument that works for the benefit of the creditors. The purpose of the new generation proceedings should not be to provide the debtor with an instrument to prevent creditors from enforcing their rights in order to avoid liquidation. Their purpose should be to enable creditors to enforce their rights in a better and more flexible manner than is possible with the current generation of traditional insolvency proceedings.
The developed normative theory further leads to a number of conclusions for the different economic requirements and valuation standards that must be applied when a plan is being imposed over the objections of individual creditors and dissenting classes. One of these conclusions is that it should only be possible to impose a plan over the objections of a dissenting class of creditors who would receive a cash distribution in a liquidation, if the creditors within that dissenting class are offered a payment in cash under the terms of the restructuring plan.
The research criticises the EC initiative for failing to provide that not only the debtor, but also creditors be given the right to propose a restructuring plan. Indefinite exclusivity in favour of the debtor gives controlling shareholders the ability to offer creditors only marginally more than they might receive in a liquidation. If creditors do not have the right to put forward an own plan and develop an alternative, in practical terms, they have no other option than to accept the plan put forward through the debtor by the controlling shareholder. This leads to a transfer of wealth from creditors to shareholders.
The research also criticizes that the EU initiative contains insufficient safeguards to protect the interests of creditors who would receive cash in a liquidation.
A final point of criticism is the EC’s silence on the need for efficient liquidation proceedings. It focusses only on restructuring proceedings. The EC’s policy objectives, however, are focused on small and medium enterprises (SMEs). For these enterprises efficient liquidation proceedings are the more important of the two. An efficient liquidatieprocedure often offers a more effective instrument to rescue a business than a restructuring procedure and this this is almost always the case for SMEs.
The book (in Dutch) can be ordered here (an English translation is currently being prepared).