Key legal and regulatory developments driving and shaping M&A
On 20 June 2019, the European Parliament and the Council published in the Official Journal of the European Union the text of Directive 2019/1023 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (the "Restructuring Directive"). The Restructuring Directive forms a key part of the EU’s wider Capital Markets Union Action Plan.
The Restructuring Directive seeks to introduce a minimum standard among EU Member States for preventive restructuring frameworks available to debtors in financial difficulty and to provide measures to increase the efficiency of restructuring procedures. These new standards, once implemented, will represent a move for EU Member States further in the direction of debtor-in-possession-type insolvency regimes like chapter 11 in the United States and schemes of arrangement in the United Kingdom (and other common law jurisdictions).
Unlike EU Regulations, EU Directives do not have automatic effect and so Member States must implement the Restructuring Directive into national law by 17 July 2021, subject to a one year extension.
And, of course, Brexit must enter the discussion, since it is expected that by the implementation deadline the UK will have exited the EU. In any event, the UK has proposed its own standalone reforms similar to those contained in Restructuring Directive, on which draft legislation is awaited.
The 2015 EU Insolvency Regulation (recast) provides for rules governing the allocation of jurisdiction for the opening of insolvency procedures in the EU (and, once opened, the rules applicable to those procedures), but does not seek to address or regulate disparities in national law between Member States. The aim of the 2019 Restructuring Directive is to provide for a harmonised minimum restructuring standard across the EU enabling "honest entrepreneurs" to better manage financial difficulties with a view to giving viable businesses a "second chance". Further, reducing the substantive differences in pre-insolvency regimes among Member States is expected to bring greater transparency, legal certainty and predictability.
Key elements of the procedure envisaged by the Restructuring Directive include: (a) debtors remaining in possession of their assets and day-to-day operation of their business; (b) a stay of individual enforcement of actions; (c) the ability to propose a restructuring plan that includes a cross-class cram-down mechanism whereby the plan is imposed on dissenting creditors in a class (holding no less than 25 percent of claims in that class) and across classes (subject to certain protections); and (d) protection for new financing and other restructuring-related transactions.
While the concepts are commendable in seeking to save viable businesses from liquidation, it is expected that there may be some stumbling blocks as Member States come to grips with implementing these rules into their national laws.
The Restructuring Directive lays down minimum standards for a restructuring plan with class criteria similar to UK schemes of arrangement and in some aspects US chapter 11 proceedings. It is a matter for national law to determine class segments but, under the Restructuring Directive, at the very minimum, classes should be divided between secured and unsecured creditors. The reservation of class criteria to national law permits Member States to regulate class rights, voting rights and provide a legal framework for any contested claims. In addition, under the Restructuring Directive, Member States can set their own level of what constitutes a majority for approval purposes. However, such majority shall not exceed 75 percent as a percentage of debt, which is the threshold in a UK scheme of arrangement. This leaves room for Member States to lower the threshold in an attempt to market themselves as more attractive restructuring venues.
Unlike a UK scheme, however, the Restructuring Directive allows the plan to be imposed on dissenting creditors in separate classes. Similar to a US chapter 11 plan, the Restructuring Directive incorporates a cross-class cram-down mechanic where, if the plan is not approved by a class, it may still be approved by the court as long as dissenting classes are treated "at least as favourably as any other class of the same rank" and "more favourably" than any junior classes, and the plan has been approved by (i) a majority of the voting classes of affected parties, which must include at least one class of secured creditors or creditors senior to unsecured creditors, or (ii) one class of affected parties who are not equity holders, or similar.
In an attempt to encourage ongoing negotiations of a restructuring plan, the concept of a stay of individual enforcement actions, subject to the debtor meeting certain requirements, has also been introduced. A stay can be implemented for four months in the first instance and extended to a maximum duration of 12 months, provided that the debtor can effectively demonstrate that "relevant" progress has so far been made in negotiations on the restructuring plan, and that such extension will not unfairly prejudice the rights of affected parties or result in the liquidation of the debtor under national law.
When a company enters an insolvency procedure this may trigger contractual rights allowing suppliers to terminate a contract due to the insolvency filing (so-called ipso facto clauses) – even where the relevant company has complied with all its other obligations under that contract. Undoubtedly, this can be detrimental to the continuation of the business as a going concern. In an attempt to alleviate some of the pain of struggling debtors, the new regime includes a prohibition on the enforcement of certain ipso facto clauses triggered by a debtor's entry into an insolvency procedure or, in some cases, the mere entry into restructuring negotiations. Again, this feature of the Restructuring Directive mirrors a similar right granted under chapter 11 which allows a company to preserve business-critical contracts while still carrying out restructuring negotiations. The recitals to the Restructuring Directive list certain examples of essential supply contracts to which this would be of particular importance such as, supply of gas, electricity, water, telecommunication and card payment services. It is hard to predict the impact that this change will have once implemented into national law, which will depend in large part on the approach to implementation in individual Member States; clearly, however, there is a balance to be struck between the benefits of company rescue and imposing restrictions on freedom of contract.
At the time of writing, the UK will leave the EU on 31 October 2019 unless a deal is struck or an extension agreed before such date. In any event, it is expected that the UK will have left the EU in advance of the 2021 deadline for implementation of the Restructuring Directive into national law.
The UK has been working independently to further develop and refine its own insolvency regime so as to protect its status as a key forum for cross-border restructurings. The main features of the UK's proposals, which seem likely to form part of the legislation, include (i) the introduction of a restructuring moratorium (albeit with a shorter, 28-day duration, in the first instance) for "prospectively insolvent" companies, (ii) a restructuring plan (akin to a scheme of arrangement but with the ability to effect cross-class cram-downs) and (iii) restrictions on reliance on ipso facto clauses.
It is not currently clear what form the draft legislation will take or, indeed, where it sits in the overall scheme of legislative priorities in the UK.
The Restructuring Directive is commendable in its efforts to level the playing-field for preventive restructuring measures across Member States. It is perhaps not as ambitious in its scope as it could have been–notably, it does not attempt to harmonise substantive insolvency laws and it avoids other contentious areas such as interference with workers’ rights under existing legislation.
Given experience to date under the Insolvency Regulation, we expect that there will be differences in approach and outcome as between Member States, as well as a degree of competition in the approach they take to implementation, with each Member State striving to establish itself as the top choice forum for multi-jurisdictional restructurings. Since the Restructuring Directive does not prescribe exact means of transposing its provisions into national law, we will not know the actual impact of this Directive until we have clarity around how each Member State plans to implement the EU framework. The UK will undoubtedly remain in the race too, albeit perhaps without restrictions binding on continuing Member States. In the case of a hard Brexit, it is hoped that the implementation of the UK’s reforms would be given a certain priority in order to help maintain the attractiveness of the UK as a forum for cross-border restructurings. It will be clear from the matters discussed in this article that there will be many developments still to come in the coming days, months and years!
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© Norton Rose Fulbright LLP 2021