While the current progress on the COVID-19 health crisis offers a summer respite, which everyone hopes will last, Mayday offers a progress report on restructuring in Europe and their governments’ responses to adapt their rules during this pandemic period. Have the responses of the old continent’s main economic powers been equal to the challenge? Has the European Union had the opportunity to demonstrate the relevance of its model in light of United Kingdom that is now going it alone? Will the crisis lead to structural legal changes? Elements of an answer with Guillaume Cornu, partner at EY Restructuring France, Guilhem Bremond, David Ereira and Mei Lian, partners at Paul Hastings in Paris and London, Avvti Stefano Parlatore, and Daniele Geronzi, as well as Marialuisa Garavelli and Sara Colombera, respectively, partners, senior counsel and managing associate at Legance in Milan, Alexandra Bigot, Thomas Doyen, Frank Grell, Simon Baskerville, Yen Sum, Ignacio Gomez-Sancha, partners and counsel at Latham & Watkins in Paris, London, Hamburg and Madrid, and Graham Lane, partner at Willkie Farr in London.
Battered by health crises such as the Black Death, which caused a recession estimated at 23.5% of the English economy according to the Bank of England and the death of about 30% of Europeans, climatic episodes such as the Little Ice Age, wars and banking crises, Europe is an old continent that is not facing its first storm. Better armed than before to face health crises, more experienced and equipped with more powerful state and community institutions, Europe has for the moment contained the health consequences of the virus and made the choice to maintain its productive apparatus. But has it been able to cope? How did the United Kingdom manage the crisis in the midst of Brexit? What are the challenges of recovery? What reforms and structural changes should be anticipated? Marked by a fall in GDP of around 8% for the year 2020 across the whole continent, correlated with an unexpected fall in bankruptcies in most countries and an explosion of public debts, the crisis has not yet revealed all its lessons. To answer this question, Mayday went on a European tour to London, Paris, Berlin, Madrid, and Milan.
Economic support and adjustment of rights
“The State and the banks have played an extremely positive role in this crisis,” says Guillaume Cornu. Indeed, “we can only salute the response of the French government, which has shown great reactivity and proposed strong and constantly renewed responses,” note Alexandra Bigot and Thomas Doyen. Intervening through financial aid measures and temporary amendments to the law governing distressed companies, the French government has mainly decided to solve “the current crisis through debt, via the EMP,” emphasizes Guilhem Bremond. If this was “a useful and salutary measure, many subjects have been postponed and will “therefore” have to be treated” adds the lawyer. “The State bought time, time to make a diagnosis and prepare the recovery and the rebound, as we would have done for any company” continues Guillaume Cornu.
Faced with highly indebted companies, are we heading for debt trading or a write-off? “The question of restructuring PGEs is inevitable,” confirm Alexandra Bigot and Thomas Doyen. The lawyers add that “subject to increased flexibility on the part of the European Commission, we believe that PGEs could be effectively restructured under the new regime that will emerge from the transposition of the European directive, because everything suggests that in view of the State guarantee such creditors benefit from, the PGEs will have to be isolated in a specific class on the basis of a community of interest sufficiently distinct from that of other unsecured creditors which are left unprotected for o the totality of their claim”.
Across the Channel, if the UK’s government was criticised in the early stages of the COVID-19 pandemic for failing to contain the virus quickly enough, Graham Lane points out that “the UK government has strived to find a balance between the health risks and the risks to the economy”. Indeed, as Simon Baskerville and Yen Sum note: the government’s response “to protect the economy, businesses, and people’s livelihoods was quick, decisive, and, on the whole, effective”. Graham Lane notes that similar to other European governments, “the UK government placed significant focus on helping businesses survive lockdown by implementing a number of measures including the furlough scheme, which paid 80% of employee’s wages (subject to a numerical cap), and financial support for businesses in the form of state-guaranteed loans and VAT deferrals. In addition, it temporarily suspended a creditor’s ability to commence the winding up of a defaulting debtor and a landlord’s ability to recover property from a defaulting tenant. These temporary measures are currently expected to stay in place until summer 2021 at the earliest” – the temporary restrictions on winding up petitions have recently been further extended to at least the end of September.
In addition to these very important financial and legal measures, Simon Baskerville and Yen Sum point out that “the government accelerated through Parliament insolvency reforms that it had been consulting on for nearly five years”. The intention was to introduce a regime akin to Chapter 11 in the United States and similar to the reforms envisaged by the EU directive on preventive restructuring frameworks. “The biggest change was the introduction of the Restructuring Plan, which closely follows the UK Scheme of Arrangement but allows for cross-class cram-down between creditors and shareholders (the plan was used effectively in restructurings that saved businesses such as PizzaExpress, Virgin Atlantic,Virgin Active and Smile Telecomms and Pizza Express in the depths of the crisis). Another permanent change was the introduction of a “pre-insolvency” moratorium. However, the limited scope and extensive exceptions to the pre-insolvency moratorium process (a far cry from the Chapter 11 moratorium process) render it of limited practical use for mid-large cap companies, and it has not been widely used since its introduction. Finally, the UK legislature restricted the use by goods and services suppliers of insolvency termination (or ipso facto) clauses in contracts. This restriction will be a useful tool to help more businesses survive through UK insolvency processes such as administration”.
Also, at the bedside of its economy, “the Italian Government has been intervening with continuous emergency decrees to contrast the effect of the pandemic, also at an economic level, in compliance with the Temporary Framework on State aid and in line with those adopted by other countries, based on financings to companies and the suspension of various civil and insolvency law institutions” emphasize Legance’s lawyers. “Among the most impactful interventions, we can mention the introduction of several schemes for financial assistance, the possibility for employers to use social funds (wage subsidy schemes) in case of suspension or interruption of business activities, the ban on dismissals, the deferral of payments of certain taxes and of social security contributions and the suspension of certain civil and enforcement proceedings. The legislator intervened in the insolvency sector too, with provisions able to have an impact both in the shortf and in the long term. Probably, the most radical intervention concerned the inadmissibility of petitions for bankruptcy and for insolvency of large companies filed between 9 March 2020 and 30 June 2020 and the possibility to extend the terms of performance of certain restructuring instruments (if already approved) and the chance to obtain exceptional deferrals of the terms for the filing of such restructuring instruments (if under negotiation)”.
It is important to point out that the Covid-19 emergency revolutionized the insolvency reform that Italy was ready to implement after many years in the making. Indeed, one of the first decision of the legislator during the Covid-19 emergency was to postpone the entry into force of the new Code of Crisis and Insolvency to 1 September 2021, instead of 14 August 2020. This new Code will repeal and substitute in its entirety the current Italian Bankruptcy Law (Royal Decree no. 267/1942, as subsequently amended).
Based on the above, considering that the situation is yet to be stabilized, “it is possible to imagine further postponements, with a clear impact on the insolvency sector” for Avvti Stefano Parlatore, Daniele Geronzi, Marialuisa Garavelli and Sara Colombera. They add “It is also possible that the legislator may decide to review the crisis indicators contained in the Code that force companies to use one of the instruments therein provided or may want to intervene on the procedural aspects of the Code, providing more flexible and fast-forward instruments, to help courts cope with the high number of petitions that is expected”.
On the other side of the Rhine, Frank Grell emphasizes the quick and strong reaction of his government “by making available emergency funding (mostly by state or state-guaranteed loans) to companies affected by the shutdowns and other COVID-19-related impacts”. In addition, the German government “suspended the statutory obligation to file for insolvency, a suspension that ended for cases of illiquidity as of 30 April, 2021” in order to anticipate and prevent an increase in bankruptcies “and allowed many companies to survive the crisis”. In the long term, the pandemic caused the German government to speed up implementation of the EU regulation on preventive restructuring measures “by enacting the so-called StaRUG, which establishes an out-of-court restructuring regime and is an equivalent to the well-tested UK Scheme (in addition and as an alternative to the already established in-court restructuring proceedings)” according to the German lawyer.
While the Spanish economy took the worst economic hit in the Eurozone given its reliance on some of the worst-affected sectors across services, in particular tourism, the GDP shrunk by 11% last year, which represents the largest contraction since the 1936-1939 Civil War. In this context, “the government responded quickly to counter the economic fallout with a variety of measures, including several packages of state-backed loans that have been effective” clarified Ignacio Gomez-Sancha. “The government also approved a solvency support plan with financial aid for companies in the form of equity or convertible debt, but this support has been perceived as slow and difficult to get, and companies are still waiting for this recapitalization to materialize”. From a legal standpoint, the response of the government to the crisis has been quite effective. Four different direct or indirect amendments to the Spanish Insolvency Act have given debtors more flexibility and time to restructure their balance sheet. “In particular, these amendments: extend the period of obligation to file for insolvency, from two months to the end of 2021; establish that accounting losses during the pandemic will not count for the purposes of the “negative equity test”; allow for debtors to renegotiate existing CVAs in a favorable way; and allow shareholders to contribute new debt to a company without being subject to equitable subordination. Other measures include a restriction on landlords terminating leases or exercising other recovery rights for non-payment of rent, and the capacity to impose temporary furloughs”.
While most of the measures taken to manage the crisis are temporary, practitioners agree that such mesures will bring about lasting changes in the law. In France, “the development of dematerialized hearings which do not necessarily require the “formal” presence of the protagonists, the duration of the plans which are already adjusted thanks to the so-called “Covid-19” provisions but which will have to be adjusted beyond that and within a more stabilized legal framework, the simplification of the debt to equity swap mechanisms in order to stabilize the balance sheet situation of weakened companies” are points which will have to be introduced in the long term for Guilhem Bremond.
If, for Graham Lane « the UK’s insolvency law toolbox was already relatively sophisticated before the pandemic”, the pandemic accelerated the UK government’s implementation of new restructuring laws “that had been consulted on in the previous few years, namely the restructuring plan (or “super-Scheme”) and free-standing moratorium procedures. The new restructuring plan allows a company in financial difficulties to propose a compromise of its financial debt in a similar manner to the scheme of arrangement but with the added benefit of a cross-class cram down. While there is always room for improvement (e.g. the new free-standing moratorium contains restrictions, which limit its efficacy for most large financial restructurings) and while Brexit has caused added complications (e.g. EU recognition of UK insolvencies and schemes of arrangement / restructuring plans) I believe that the UK’s current insolvency and pre-insolvency tool box remains competitive. It will be interesting to see what leverage the UK government may exercise in future restructurings in its capacity as creditor under COVID support loans. The main evolution we are likely to see is in the context of cross-border recognition, which has become more urgent because of the pandemic and Brexit”.
Economic recovery as sharp as the deceleration
Highly indebted, companies are waking up from a state-induced coma. Certainly, “there is a lot of fragility in the companies, but we have avoided an economic catastrophe“, underlines Guillaume Cornu, and “I do not see how it would have been possible to do otherwise“. Reawakening economies that had been put in hibernation, Guilhem Bremond believes that “the State will have to continue its efforts over the long term and above all understand the situations on a case-by-case basis. The stakes will be in sorting out the companies that can seriously recover, and those that have only been kept artificially alive“. In this respect, cash management will remain essential, especially at the time of economic recovery, which should be, “as in any turnaround, particularly cash consuming” insist Alexandra Bigot and Thomas Doyen. If this issue is not new, it is increased tenfold by the effect of the health crisis: on the one hand, “companies are rich in cash because they have benefited from all the state aid and other debt rescheduling, but they have also reduced their WCR by selling their stocks and collecting their accounts receivable. It will be necessary to reconstitute this WCR and especially to finance it”, reminds Guillaume Cornu, and on the other hand, they have in France a “structural insufficiency of equity capital“, underline the Parisian lawyers of Latham & Watkins. Once the effects of the Covid scheme have faded, the balance sheets of many fragile companies will have to be consolidated. And if, considering the importance of the liquidities to be placed on the market, in particular for the Anglo-Saxon funds, “solutions should be found for the ETI and the large companies through in particular debt to equity swaps” the situation seems more complex for the small companies. Overall, it is possible to expect “less amend and extend and more M&A or capital takeovers by creditors“, according to Guillaume Cornu, who also observes that banks are increasingly asking for a strategic vision of the company beyond the audit of the figures. And beyond the phenomenon of catching up due to a high savings rate and important liquidity on the market, “many agree that growth could remain weak for a long time after a sustained short-term recovery from the health crisis ” reminds Guillaume Cornu. Faced with these uncertainties, “we must not limit ourselves to the figures and finance, but we must integrate the strategy and operational analysis of the turnaround plan to have an idea of what the topline could be tomorrow and the levers for optimizing profitability. In fact, more and more, we have to study all the possible scenarios at the same time” insists the financial expert.
Although Grahame Lane points out that it is still “too early to gauge the pandemic’s true impact on the UK economy”, Simon Baskerville and Yen Sum consider that “the UK’s economic recovery should be relatively robust in the medium term whilst providing opportunities in the near-term for investors. The high levels of household savings accumulated in the last 12 months point toward a strong consumer-led rebound in certain afflicted sectors, and significant state stimulus packages in the UK, the EU, and the US, coupled with investors’ appetite for yield, is already leading the markets to step into finance and save businesses and companies that would otherwise have faced funding shortfalls and potential insolvency”. There is indeed “a lot of liquidity, both in the debt market and private equity” confirms Guillaume Cornu who observes a euphoric transaction market. However, it is also possible that the rapid recoveries run out of steam quickly and given the hangover of tax, rent arrears and UK Government backed loans there may be a significant uptick in restructurings and bankruptcies. From this point of view, “in the medium-to-long term, companies of all sizes will need to deal with leverage incurred during the crisis”. Simon Baskerville and Yen Sum also add that “the government is consulting on how to address the relationship between those landlords who have not been paid rent in many months during the crisis and tenants who have amassed a large bill for such unpaid rent but need some form of relief or compromise to restart their business and replenish trading profits. The solution for this is not yet finalised, but the legislation will be released shortly and is expected to include a compromise process.”
The question arises in the same way in Germany where many companies that accepted state or state-guaranteed loans as part of emergency funding measures will have difficulty repaying them. The lawyers of Latham Germany emphasize that “This difficulty is likely to give rise to the need for restructuring even in cases that benefit from the anticipated recovery”.
In Italy, the measures adopted by the Italian Government were also “able to mitigate – at least temporarily – the economic consequences of the pandemic”. The lawyers of the Legance firm remind us that the Italian economy, “already burdened by low levels of growth, will have to deal with the progressive removal of the emergency support measures that were adopted until now”. In this context, the implementation of adequate crisis management tools is therefore necessary and appears to be the biggest challenge. In this respect, a suitable revision of the new Code of Crisis and Insolvency and the implementation of the Directive (EU) 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”, will constitute two essential moments in the road to recovery.
In Spain, the speed of the recovery will partially depend on how the tourism sector opens up and when it will fully recover. On the other hand, as Ignacio Gomez-Sancha points out “Spain is the second biggest beneficiary after Italy of the European Union recovery fund and has already started to allocate resources to projects. But there have been delays to the distribution of funds, which Spain now expects to arrive at the end of the year. This delay will postpone the bulk of the economic impact to 2022. Spanish banks are among the least well-capitalized in Europe, and there could be a resurgence of non-performing loans in the imminent future, particularly when government support begins to unwind”.
Systems for handling difficulties that have demonstrated their strengths and weaknesses
“The confidentiality of amicable procedures, their flexibility and the existing bridges with accelerated collective procedures have proven to be effective tools” under French law, according to Alexandra Bigot and Thomas Doyen. Moreover, they add that “the existence of the regulated profession of judicial administrators, which guarantees their independence, is also a French specificity and a real asset” as well as “the existence and functioning of consular jurisdictions” adds Guilhem Bremond.
Nevertheless, Alexandra Bigot and Thomas Doyen point to “the absence of a real culture of transparency and negotiation with all the players involved in insolvency cases” as the main weakness. A point that could be corrected by “the reform expected in July [that] will change the deal” underlines Guilhem Bremond.
In London, the world’s leading financial center, “the UK’s restructuring and insolvency toolbox is relatively well equipped, and I expect it to be sufficiently flexible and fit for the purpose of assisting economic recovery” ensures Grahame Lane. David Ereira and Mei Lian of Paul Hastings confirm that “The Scheme of Arrangement and now the Restructuring Plan offers a highly flexible, adaptable and creative tool for restructuring larger businesses outside of formal insolvency which have proven to be very attractive”. Moreover, Simon Baskerville and Yen Sum note that “a strong centralized judiciary that provides swift judgments based on a large body of precedent-based law, provides the flexibility to address balance sheet restructurings in a quick, focused, and predictable manner, with limited negative impact on a company’s trading and operations”.
That said, a key missing link in this post-Brexit environment is the uncertainty regarding recognition of UK insolvency proceedings in Europe. In this regard, the Brexit, coupled with a lack of cooperation on future recognition, such as the EU Commission’s opposition to the UK’s application to re-join the Lugano Convention, “could make the UK a less frequent forum for cross-border insolvency proceedings of EU companies. However, the English law principle that English-law governed debt can only be compromised by an English law process (known as the Gibbs Rules from the eponymous case) is likely to keep English lawyers and courts busy in restructurings involving English law debt. Either way, the board looks set for potentially expensive local law parallel proceedings required for both UK and EU restructurings”, explained the London partners of Latham & Watkins.
In Germany, it should be noted that “the new German scheme (StaRUG) presents a new instrument to handle upcoming large and complex financial restructuring matters.”, notes Frank Grell. However, “to the extent that there is a need for operational restructuring, especially due to disruptive effects, the so-called self-management procedure (the equivalent of Chapter 11 of the US Bankruptcy Code in German insolvency law) is a well-established tool that may well experience a renaissance in parallel with the increased use of out-of-court instruments.”
In Italy, the missing link is in the lack of an early warning mechanism to contrast insolvency and in the excessive cumbersomeness, length, and rigidity of the restructuring instruments available to companies in distress or in state of insolvency. The lawyers of Legance point out that “With regard to the first issue, the current legislation does indeed provided instruments to turn around a state of crisis and / or insolvency that is already substantiated and apparent but does not provide any instruments to prevent the emerging of the crisis or insolvency”. Although a first step forward in this sense has been made – at least at the level of corporate law – with the new Article 2086 of the Civil Code, in force since March 2019, that introduced a system of crisis prevention within the company, based on the obligations of monitoring and intervention of the directors, which is completed in serious cases of inaction of the latter, with the complaint to the Court by the auditors. The Italian lawyers state that “This gap in the regulatory system should be filled with the entry into force of the new Code of Crisis and Insolvency, however, as said above, there are doubts on the actual efficiency and adequacy of the mechanism provided therein to properly address today’s crisis”. The strongest link in the Italian insolvency legal system, “appears to be the variety of restructuring instruments and solutions available to companies Indeed, distressed companies can access to different schemes and solutions, with varying degrees of intervention and interference by courts and creditors and with different possible outcomes”.
From the Iberian Peninsula, Ignacio Gomez-Sancha indicates that “the strongest link is the regulation of the Homologación (the equivalent to the Spanish Scheme of Arrangement), which has proved effective”. “The missing link is that if the homologation is challenged by dissenting creditors, it might take up to a year to solve the challenge, which creates great uncertainty. Also, the Spanish courts are jammed, and this makes the pre-insolvency and insolvency processes much slower than desired”.
Brexit, a threat, or an opportunity to manage the crisis?
There is no straightforward answer to this question – the response is, “it depends!” according to Graham Lane. “It is too early for any major disabling factors to have manifested themselves, but there are a couple of examples I can point to where Brexit appears to have made either no discernible difference, or a noticeable difference. Take state aid as an example of the first category: while the UK was still subject to the transition agreement in 2020 and therefore bound by EU rules on state aid, the EU has suspended or modified its rules in response to the pandemic to allow member states to financially support key businesses. As a result of the Trade and Cooperation Agreement (TCA) between the EU and the UK, state aid rules in the UK will likely remain broadly the same post-Brexit, at least in the short term”.
Transposition of the EU directive awaited
In France, practitioners are impatiently awaiting this reform: “The class systems will make it possible to meet an essential objective that is too often absent in our current law: considering the true value of the company. With the future system, and to simplify, only in the money creditors in the money will have any say in the matter. It will repair certain incongruities that we, as practitioners, have seen in recent years” underlines Guilhem Bremond. Indeed, the enterprise value will be central, confirm Alexandra Bigot and Thomas Doyen who recall that “The main changes are well known and have been widely commented on while waiting for the final transposition of the directive: namely (i) the introduction of classes of creditors constituted on the basis of the nature of the claim (in particular with regard to the securities attached to it and its repayment rank) and a sufficient community of interest and (ii) the cross-class cram down mechanism“, Latham & Watkins lawyers concluding that “these new features, along with other new mechanisms provided under the EU directive, appear more respectful of creditors’ financial and legal rights and should strengthen, transparency but also the economic efficiency of resulting from restructuring plans”.. “We are getting closer to the Anglo-Saxon model which takes more into consideration the creditor, with an analysis of the files based on the value of the company rather than only on its forecast cash flow capacity to service its debt” adds Guillaume Cornu.
It should be noted that Italy asked the European Commission for a one-year postponement of the deadline by which to implement the EU Directive. It was only on 20 April 2021 that the Italian Parliament approved a law delegating to the Italian government the implementation of a series of European directives, including the European directive on restructuring. According to Legance lawyer’s “this, combined with the fact that the new Code of Crisis and Insolvency is still a work in progress, it is difficult to envisage how the EU Directive will be implemented and how our current legal framework will change”.
However, the Code of Crisis and Insolvency – which is set to replace the Italian Bankruptcy Law soon – the code has already adopted some of the principles of the directive and we do not expect, therefore, any dramatic changes.
Based on the content of the European directive in question, as opposed to the Italian bankruptcy law currently in force and the new crisis and insolvency code, over the next year, developments will focus on the following:
- improvement of the early warning system, also by providing the participation of stakeholders in the process, and in particular of employees’ representatives which is something that the EU Directive requires and that our legislator has yet to contemplate;
- improvement of the efficiency and flexibility of restructuring systems, especially of those to be implemented out-of-court, which, right now, are not particularly regarded”.
In Germany, the transposition of the EU directive into German law allows out-of-court restructuring by way of changing i.a. credit agreements with 75% majority in the affected creditor group (or in case of cross-class cram-downs by most creditor classes approving the plan with 75% majority). “This provides a viable option for minimal-invasive financial restructurings while operative restructurings are likely to still require an in-court process” according to Frank Grell.
On the other hand, the transposition of the EU Directive will introduce some fundamental changes in the Spanish insolvency regulations. In this regard, Ignacio Gomez-Sancha notes that “in particular, the “absolute priority” rule in the homologation of refinancing agreements, according to which no value can be attributed to a junior creditor until all more senior creditors are satisfied, and the possibility of voting by classes (not just secured and unsecured) will bring us closer to some other EU jurisdictions”.
While the United Kingdom has left the European Union, the London based of Latham & Watkins anticipate “perhaps there will be a slow “re-evolution” toward reaching an agreement on mutual recognition of insolvency procedures between the UK and the EU (substantial trading partners and neighbors) akin to what was lost through the withdrawal process”. What is certain is that “the UK will need to call on the talent of the legal community in the UK and in EU Member States to find workable solutions for recognition of insolvency procedures involving businesses with material operations and interests in the UK and across EU Members States” they point out. An appeal to their European counterparts to keep the bridges between our countries open.
By Cyprien de Girval
