How will Brexit impact cross-border insolvencies?
Prior to 1 January 2021, recognition and enforcement of restructuring and insolvency procedures and judgments between the UK and EU Member States was subject to common EU regulations which had direct effect and broadly offered automatic recognition. Those common regulations no longer apply to the UK.
Notwithstanding the loss of these regulations, there remains an effective legal framework for recognition of inbound proceedings and judgments from EU Member States to the UK, including the Cross-Border Insolvency Regulations 2006 (Great Britain’s enactment of the UNCITRAL Model Law on Cross-Border Insolvency). Recognition of UK proceedings and judgments (including schemes of arrangement) in the EU will be subject to the local laws (including EU law) of the individual Member States concerned; this is not expected to be unduly difficult in most cases but, as matters stand, will not be as straightforward as it was prior to Brexit. Additional court applications and procedural hurdles are likely to be encountered, requiring expert navigation.
The recast EU Insolvency Regulation 2015 (the EIR) determines the proper jurisdiction for a debtor's insolvency proceedings, the applicable law to be used in those proceedings and provides for mandatory recognition of those proceedings in EU Member States. The EIR no longer applies to the UK.
Where a debtor’s centre of main interests is within a Member State, the EIR recognises that Member State as the appropriate forum for main insolvency proceedings concerning the debtor, and provides for automatic recognition of those proceedings by the courts of other Member States. Any further proceedings in other Member States (which no longer includes the UK) where the debtor has an “establishment” are secondary to those main insolvency proceedings and relate only to assets in that secondary Member State.
The EIR – which, in its original form, came into force in 2002 – has been a useful tool in European cross-border restructurings and insolvencies. The amendments made when the EIR was recast with effect from June 2017 implemented changes which, amongst other things, introduced a mechanism for co-ordinating insolvencies within cross-border corporate groups.
The Withdrawal Agreement agreed between the UK and the EU on 17 October 2019 and implemented in English law on 23 January 2020 by the European (Withdrawal Agreement) Act 2020, provided for the EIR to continue to apply to insolvency proceedings provided the main proceedings were opened before 31 December 2020. It did not, however, specify whether the Insolvency Regulation will continue to apply where only secondary proceedings have been opened. This means that the UK will continue to recognise insolvency proceedings commenced in other Member States, and will receive reciprocal recognition of UK insolvency proceedings where the main proceedings were started before 1 January 2021.
The Insolvency (Amendment) (EU Exit) Regulations 2019 (as amended by the Insolvency (Amendment) (EU Exit) Regulations 2020) (the Insolvency Amendment Regulations) dealt with necessary amendments to EU insolvency legislation which formerly had direct effect in the UK. They came into force on 31 January 2020, exit day, and set out how the EIR would operate on a “no deal” exit. The UK-EU Trade and Co-operation Agreement agreed between the UK and remaining EU Member States did not address the EIR. Broadly, the effect of the Insolvency Amendment Regulations is to give jurisdiction to UK courts to open insolvency proceedings following the exit date, where the proceedings are opened for the purposes of rescue, adjustment of debt, reorganisation or liquidation and:
- the centre of the debtor’s main interests is in the United Kingdom; or
- the centre of the debtor’s main interests is in a Member State and there is an establishment in the United Kingdom.
These tests are consistent with the EIR for determining the proper jurisdiction for a debtor's insolvency proceedings and the applicable law to be used in those proceedings. However, the Insolvency Amendment Regulations go on to say this jurisdiction will be in addition to any grounds for jurisdiction to open such proceedings which apply in the laws of any part of the United Kingdom. This effectively extends the UK court’s jurisdiction (i) to wind up any foreign company which might be wound up as an unregistered company under UK insolvency laws regardless of whether the centre of main interests is in a Member State, provided the court considers there to be sufficient connection to warrant this; and (ii) to place a company incorporated in an EEA state, or having its centre of main interests in an EEA state, into administration in the UK. This gives rise to the possibility of races to open proceedings in competing states.
For proceedings opened under the EIR prior to exit day, transitional provisions provide that the UK court will continue to apply the terms of the EIR unless the court considers the interests of a creditor, the debtor, or shareholders of a corporate debtor, would be materially prejudiced; or if the court considers it would be manifestly contrary to public policy. The UK courts would then have authority to apply relevant UK law and make any other order thought fit. Insolvency Service guidance explains this is necessary since Member States will no longer afford UK insolvency proceedings recognition on a “no deal” exit.
What are the alternatives to relying on the EU Insolvency Regulation?
The EIR is not the only cross-border insolvency measure available under English law. The Cross-Border Insolvency Regulations 2006 implemented the UNCITRAL Model Law on Cross-Border Insolvency, providing a framework for recognition by the English courts of proceedings started in another country and assistance to foreign representatives.
Legislation based on the Model Law, which would provide for recognition of, and assistance with, English collective insolvency proceedings, has been enacted in a variety of forms in other key jurisdictions such as the United States, Singapore, Japan, Dubai, South Korea, Australia, New Zealand and Canada, but the only EU Member States to do so presently are Poland, Slovenia, Greece and Romania.
In July 2018, UNCITRAL also adopted a Model Law on Recognition and Enforcement of Insolvency-Related Judgments which it recommends to complement the Model Law on Cross-Border Insolvency and which provides for insolvency-related judgments to be recognised and enforced where enforceable in the originating state. As with the Model Law on Cross-Border Insolvency, the new Model Law has no independent force of law and will therefore need to be adopted and enacted locally by states.
Section 426 of the Insolvency Act 1986 enables any court in the UK to assist those courts with corresponding insolvency jurisdiction in any other part of the UK or any relevant country or territory, and to apply comparable insolvency law applicable by either court. Such territories include the Channel Islands, the Isle of Man, the Republic of Ireland and a number of Commonwealth and former Commonwealth members whose laws are based on common law systems, some of which have similar provisions to assist courts in the UK. Requests for assistance must come from foreign courts rather than directly from foreign officeholders, albeit that the latter must first apply to foreign courts to request that a letter of request be sent to the relevant court in the UK.
The English courts may also assist overseas officeholders under common law principles but this does not assist in any way with reciprocal recognition of English proceedings in remaining EU Member States which will be determined now by the laws of the relevant Member State. In many cases there are pre-existing frameworks that can be applied to mitigate the effects of losing reciprocal recognition under the EIR. The Insolvency Service has published a guide summarising the applicable frameworks in the different EU Member States on recognition and enforcement of foreign insolvency proceedings as a starting point.
Although not an insolvency proceeding falling with the ambit of the EIR, the English courts have accepted jurisdiction in approving schemes of arrangement under Part 26 of the Companies Act 2006 in relation to overseas debtors where there is a sufficient connection with English law, including in circumstances where a scheme would be recognised by an EU Member State in which the debtor has its centre of main interests. English law schemes have an established track-record as being a useful tool in effecting restructurings of EU-incorporated companies. The sufficient connection test for overseas debtors has similarly been adopted for the new “Restructuring Plan” under Part 26A of the Companies Act 2006 (introduced by the Corporate Insolvency and Governance Act 2020 (CIGA)) and it is anticipated that companies in the EU – as well as further afield – will count Restructuring Plans among their options when considering how best to effect a restructuring.
Insolvency law reform in the EU and in the UK
On 20 June 2019, as a key part of the EU’s wider Capital Markets Union Action Plan, 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 seeks to introduce a minimum standard among EU Member States to adapt national pre-insolvency procedures to enable debtors in financial difficulties to restructure their debt before insolvency by the implementation of a preventive restructuring framework across EU Member States, introducing a four-month period of protection from enforcement action to facilitate a restructuring plan, preventing dissenting minority creditors and shareholders blocking restructuring plans and protecting new financing for restructured companies.
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, schemes of arrangement in the UK (and other common law jurisdictions) and Restructuring Plans in the UK. Continuing Member States are required to implement the Restructuring Directive into national law by 17 July 2021, subject to a one-year extension.
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 for an initial period of four months with an option to extend to 12 months; (c) the ability to propose a restructuring plan that includes a cross-class cram-down mechanism whereby the plan may be imposed on dissenting creditors in a class (by a majority not to exceed 75% of debt by value) and across classes (subject to certain protections); and (d) protection for new financing and other restructuring-related transactions. It is not clear what form these procedures will take once transposed into national law, particularly since Member States are accorded a high degree of optionality under the Restructuring Directive. Nevertheless, we expect competitive tension to emerge amongst Member States in implementing preventive restructuring frameworks, as has been displayed in the culture of forum-shopping under the existing EU insolvency regime.
The Restructuring Directive does not seek to harmonise core aspects of insolvency law, such as rules on conditions for opening insolvency proceedings, a common definition of insolvency, ranking of claims and avoidance actions. It is commendable that, through the Restructuring Directive, the Commission has sought to address conflict of law issues, encourage cooperation between national authorities and enhance the efficiency of often-fragmented national insolvency regimes. However, advocating for changes in national laws in this area will be a longer term challenge, since insolvency regimes vary greatly across the EU and are deeply entrenched in national law, given the numerous links between insolvency law and connected areas of national law, such as tax, employment and social security law.
In the long-term, harmonising these aspects would be useful for achieving full cross-border legal certainty. However, prescriptive harmonisation could require significant Member State resources and far-reaching changes to commercial law, civil law and company law.
Meanwhile, the Commission is working towards establishing a decentralised system to interconnect insolvency registers and to support cross-country access to information about whether directors have been disqualified. The former has been legislated for in the EIR (as recast), with the requirement to establish national insolvency registers by 26 June 2018, and the implementing Regulation in relation to an EU interconnected register took effect from 24 June 2019, with the register to be in place by 30 June 2021.
The Commission also aims to increase legal certainty on the effects of assignment of claims on third parties (where the original creditor transfers the claim to someone else) in jurisdictions where this is not already clear. In March 2018, the Commission published a proposal for a Regulation of the European Parliament and of the Council on the law applicable to the third-party effects of assignments of claims, although this proposal remains under discussion.
As part of its package of proposals on non-performing loans, the Commission has included (in its proposal for a Directive of the European Parliament and of the Council on credit servicers, credit purchasers and the recovery of collateral) that Member States implement a form of accelerated extrajudicial collateral enforcement.
The UK is not bound to implement the Restructuring Directive. The UK restructuring regime already included many of the elements required by the Restructuring Directive and this has now been supplemented by CIGA, which has introduced wide-ranging reforms that are broadly consistent with the Restructuring Directive.
CIGA was enacted according to an accelerated timetable at the height of the COVID-19 pandemic and follows on from consultations begun in May 2016 by the UK Insolvency Service seeking views on whether the UK’s regime required updating in light of international principles developed by the World Bank and the United Nations Commission on International Trade Law (UNCITRAL), recent large corporate failures and an increasing European focus on providing businesses with the tools to facilitate company rescue. Further consultations by BEIS in 2018 led to Government proposals published on 26 August 2018 (albeit without draft legislation), certain of which are reflected to varying degrees in the reforms introduced by CIGA, including:
- A new standalone moratorium in Part A1 of the Insolvency Act 1986 against creditor action for companies which are insolvent or facing prospective insolvency where it is likely to result in the rescue of the company as a going concern, with a view to existing management seeking resolution through an informal restructuring with creditors, or a formal insolvency procedure. The moratorium is implemented by the existing management supervised by an insolvency practitioner appointed as monitor. The moratorium is for an initial period of 20 business days. This period can be extended by 20 business days by the directors filing certain documents with the court and further extended for up to a year with the agreement of the creditors or the permission of the court. Extensions of the initial four-week period are dependent on payment of moratorium debts and certain pre-moratorium debts for which there is no payment holiday, which notably include debts due under financial services contracts. During the moratorium period the company must continue to pay certain amounts falling due in the period in relation to rent, employee wages and redundancy payments, supplies and services requested during the period, and amounts due to lenders or the moratorium will be brought to an end. During the moratorium period, restricted creditors are not entitled to issue or continue legal proceedings, enforce judgments, or repossess goods, or take steps to put the company into an insolvency procedure.
- The Restructuring Plan – that is, an alternative form of scheme of arrangement for companies specifically in financial difficulties to facilitate the implementation of a restructuring plan with the aim of achieving a compromise or arrangement with creditors or shareholders to eliminate, reduce or prevent financial difficulties. The Restructuring Plan differs from the existing scheme of arrangement process in that it can facilitate a cross-class cram down of creditors provided that certain conditions are satisfied, and that the arrangement or compromise is sanctioned by the Court. The procedure is available to companies registered in England and Wales or, as noted above, overseas companies with a sufficient connection to England and Wales.
Similarly to an existing scheme of arrangement, the following conditions must be satisfied for a Restructuring Plan to be implemented: (a) a vote in favour of the compromise or arrangement must be supported by creditors or members representing at least 75 percent in value of any class of creditors or class of members present or voting by proxy at the meeting (there is no requirement for a majority of creditors by number to vote in favour as is required in a scheme of arrangement); and (b) the court sanctions the compromise or arrangement.
If any class of creditors or members does not approve the proposed plan, then the court may still approve the plan if: (a) the dissenting creditors or members would not be worse off in the “relevant alternative”; and (b) one class of creditors or members who have a genuine interest in the relevant alternative have approved the arrangement or compromise. In effect, a Restructuring Plan enables the court to make orders to ‘cram down’ classes of creditors or members, which could even allow senior creditors opposing the plan to be ‘crammed up’ and bound by the plan provided that the court was satisfied that they would not be in a worse position in a “relevant alternative” which could be administration, liquidation, or, in the case of a foreign debtor, the relevant insolvency proceedings in the debtor’s jurisdiction of incorporation.
- A new prohibition in the Insolvency Act 1986 on a supplier of goods and services from terminating, varying or exercising any rights under a contract due to the counterparty entering into a relevant insolvency procedure (which is defined to include Restructuring Plans, from the point of the class convening order (if made), but not “old-style” schemes). As a result, suppliers will be obligated to continue to supply the debtor company on the same terms and will not be able to demand payment of any arrears before the commencement of the insolvency procedure as a condition to ongoing supply. There are a number of exclusions relating to the contracting parties and type of contract, notably financial services contracts.
A supplier may separately terminate their agreement during the insolvency proceeding if: (a) the insolvent debtor company consents to the termination, (b) the office-holder consents to the termination on the debtor company’s behalf, (c) the court is satisfied that the continuation of the contract would cause the supplier hardship and accordingly grants the supplier permission to terminate, or (d) another termination right not related to the insolvency proceeding is triggered (e.g. termination rights relating to a failure to pay for new supplies or defects in the goods supplied). “Hardship” is not defined for these purposes and its precise meaning is expected to be developed in case law.
During a moratorium (as described above), the debtor company will need to pay for the continued supply that it is receiving or the monitor must bring the moratorium to an end. If any such amounts incurred during the moratorium are unpaid, they may receive super priority in a subsequent insolvency procedure, if it follows within 12 weeks of a failed moratorium, ranking prior to expenses of the insolvency practitioner. Supplies procured by an insolvency practitioner should be expenses of the relevant procedure. It seems likely that the UK reforms introduced by CIGA – and Restructuring Plans, in particular – will help to maintain the attractiveness of the UK as a forum for cross-border restructurings.
What does the future hold?
Whilst the post-Brexit landscape presents new challenges, for so long as there has been a corporate restructuring market in Europe, the UK’s legislature, courts, practitioners and other market participants have consistently demonstrated their ability to innovate and devise cutting-edge solutions to pan-European complexities arising in situations involving distressed debtors with operations in multiple jurisdictions. There is little reason to believe that Brexit will have any permanent impact on the lustre and appeal of the UK as a destination of choice for the implementation of cross-border restructuring transactions, particularly in view of the recently-augmented tool-kit of measures and options available in the UK.
For further reading see our Newswire article by partners Matthew Thorn and Mark Craggs “Rolling with the punches; Brexit’s impact on UK-EU cross-border restructuring”.