On the occasion of the transposition into French law of European Directive No. 2019/1023, which introduces new mechanisms and concepts directly inspired by the US Chapter 11, Hogan Lovells organised a conference in Paris entitled “The reform of French insolvency law and the US practice of Chapter 11”. As pioneering legislation on financial restructuring, US law offers us half a century of enlightening experience in applying these new concepts. What are the challenges associated with this new legal practice for companies in difficulty? From the formation of classes and the notion of community of interest, via the treatment of capital holders, to the impact of the valuation of creditors’ collateral, the forced application between classes (cross-class cram-down) and the new concepts of valuation of the debtor, France is experimenting with its new tools in a context of post-pandemic crisis. Astrid Zourli, partner in the Business Restructuring & Insolvency team at Hogan Lovells in Paris, Professor François-Xavier Lucas, director of the ALED Master’s program at Paris 1 Panthéon Sorbonne University and a specialist in French insolvency law, Hélène Bourbouloux, judicial administrator at FHB, Chris Donoho, partner with Hogan Lovells in New York and head of global restructuring practice, and Kevin J. Carey, former judge and of counsel at Hogan Lovells in Philadelphia and President of the American Bankruptcy Institute conducted a review of this morning’s discussions.
Introducing new mechanisms into French law directly inspired by the US procedure of Chapter 11, the legislator has caused financial restructuring to
evolve by promoting a rebalancing between the rights of the debtor, its shareholders and those of creditors. Through this reform, classes of affected parties replace creditor committees, with it now possible to impose the plan on a reluctant class, with the valuation of the company becoming the key for the development of the plan, the concept of the ‘best interest of creditors test’ introduced and the rule of absolute priority strengthening the powers of creditors termed “in the money”, supporting the recognition of subordination agreements. In this way, according to the Hogan Lovells’ associate, if “French law has not become US law”, the US experience “offers us a valuable insight”.
The formation of classes of affected parties, a key moment in the restructuring
While Professor François-Xavier Lucas pointed out that the texts leave “a great deal of freedom for practitioners who have to compose the classes of affected parties”, these must be “in the light of a few major principles”: (i) affected parties are defined as those concerned by the plan; (ii) the criteria for composing the classes must be objective and representative of a community of interest; (iii) at least two classes must be established and subordination agreements must be respected.
According to Chris Donoho, by becoming a “central point of restructuring”, their composition is a major strategic issue. Will it be necessary to create a small number of classes with as many creditors as possible, in order to dilute recalcitrant minority creditors? Or, on the contrary, would it not be strategic to subdivide creditors into as many classes as possible, in order to have as many classes as possible voting for the plan? These are so many possible strategies which will have to find an answer in the light notably of the following questions: “Who do you represent in the case: a creditor affected by the plan? A secured creditor? A company? Its shareholder? …”.
In this regard, if American lawyers teach us that negative votes from a class are rare in the United States, it is “because negotiation is largely conducted upstream, during this phase of composition of the classes and which forms the object of significant discussion with the stakeholders”.
In this way, allowing an extremely variable number of classes to be composed from one case to another, the US bankruptcy code certainly requires that in each class, creditors must be similar, “but does not demand that all similar creditors be included in the same class”, Chris Donoho recalls. In this way, “it is possible to create as many classes as you want”, Kevin J. Carey continues, depending on the strategy that you are seeking to implement.
In France, practitioners “who already have fifteen years’ experience handling creditor committees” will also learn “to devise tailor-made solutions, case by case” says Hélène Bourbouloux. In this case, although it must take into consideration both the subordination agreements, in order to observe the rule of absolute priority, and the collateral, in order to observe the best interest of creditors test, the FHB partner recalls that judicial administrators may also rely on “the usefulness of a creditor in the turnaround plan and the role that it intends to play in the future”. Certain questions therefore become decisive: “Is the creditor a strategic supplier? Does it want to take control of the company? Or, on the contrary, is it thinking of selling its receivable in a few hours?” In this context, one factor seems to be crucial for the success of a negotiation: “Proof of transparency must be provided, with us taking the time to explain our choices”, the judicial administrator continues, since “at the end of the day, as many stakeholders as possible must agree with what you are proposing and we must avoid challenges to the composition as far as possible”. From this perspective, Chris Donoho was able to “observe that creditor suppliers are often the most constructive. “They want the business to continue and agree from time to time to waive almost all of their receivable”.
In this regard, although US law allows subjective criteria to be considered which, in certain regards, inspire French restructurings, “these criteria must nevertheless comply with the notion of community of interests”, Astrid Zourli recalls. In this capacity, if “the US judge has broad powers of interpretation to do so”, Kevin J. Carey confirms, the classification “must not appear to be unfair”, the lawyer recalls. In other words, creditors with equivalent claims must not have been arbitrarily separated in order to satisfy the needs of a given negotiation.
The determination of the creditors affected or not by the plan, which, under French law, is left to the discretion of the debtor and its judicial administrator “is also a central point, which will form the object of bitter negotiations” according to Chris Donoho. “The question will arise in France on a recurring basis with, e.g. creditors holding conciliation privileges”, Hélène Bourbouloux confirms. If they are not legally subject to the provisions of the plan, but accept payment terms, “is it possible to place them in a class? We have just done so in a case but do not yet know the position of the court”, the judicial administrator asks. In this capacity, if “everything depends on the specific context, US law may permit this type of mechanism”, the US lawyer confirms.
While Professor Lucas recalls that another important change in this reform is that “shareholders are now considered as affected parties”, a small revolution in a country in which property rights are enshrined in the constitution. This will permit the implementation of dilution mechanisms, which can henceforth be imposed on them. On the contrary, if, in the United States, the shareholder “plays a role that is perhaps more important than in France in the conduct of a company’s business, its rights are not as sacred as in France”, the US lawyer states. This being the case, while “the law is not favourable to the existing shareholders, some are still able to highlight their added value to the company and the need to continue with them”, says the New Yorker, even though it is sometimes “poorly perceived that historical shareholders can take advantage of the new subscription conditions which they have helped to create”. In any case, Hélène Bourbouloux and the American practitioners agree on another point: the restructuring of groups of companies must benefit from a “global approach, even if US law, like French law, requires a company-by-company restructuring”.
A rebalancing of power relations in the adoption of the plan
While the reform will allow the court to impose a plan approved by the classes of affected parties on a recalcitrant class, the former parties must “nevertheless ensure compliance with the best interest of creditors test”, Professor Lucas recalls. In this way, in the United States, the Court ensures that “creditors who are members of the relevant class will receive at least what they would receive in the event of a liquidation procedure”, the US lawyer recalls. This is a point which is both central and at the same time “quite theoretical”, they indicate to us.
Indeed, in practice, practitioners include elements in their business plan and asset valuation which demonstrate the opportunity of restructuring. And if “some creditors sometimes assert individual positions which differ from the positions of the classes on this question of the best interest of creditors test, considering, for example, that the assumption of the net asset value has been poorly assessed”, this point does not raise as many disputes as one might fear. For its part, French law now requires practitioners to evaluate the best interest of creditors test in a liquidation scenario, as in a hypothesis of a disposal plan. “This is the most delicate point” for Hélène Bourbouloux, since “this becomes more subjective”, she insists. Everything will be a question of anticipation for the US lawyers. “The issue of asset valuation must be discussed well before the restructuring” so as not to raise any difficulties. “In the United States, no party wants the valuation to be decided by the court, so they agree beforehand”. The question will arise in France with the same acuity. And “everything will depend on the degree of detail that we want to put into the classes and the objective elements of valuation and transparency notably proposed by the secondary debt market, when it comes to valuing a financial debt” says Hélène Bourbouloux.
In this way, in a second scenario in which the plan has not been approved by all classes, the court may impose it on the recalcitrant class(es), provided that it has been adopted by one or more classes of creditors termed “in the money”, as has the best interest of creditors test, in strict compliance with the absolute priority rule. The objective of this rule is to ensure that no class ranking below the dissenting class is compensated before it. This is the French cross-class cram-down. “We will therefore no longer be able to impose sacrifices on creditors who are in the money, but we will be able to impose greater sacrifices on those who are no longer in the money”. This new method of discussion, which is intended to be more objective and predictable, will have at least two effects raised by Professor Lucas: restructurings will cost more and lawyers will have to understand the constitution of upstream banking documentation differently.
“Each party has its own idea of where the value lies”, Chris Dohono confirms. In the United States, it is the judge who decides on the basis of reports often drawn up by experts appointed by each party, but without being bound by them. When it is the business assets which must be evaluated, this is done in principle on the basis of a business plan which “by nature is very volatile”, the US practitioners indicate. “A business plan, the credibility of which will depend on the signature of the financial firm that validated it”, Hélène Bourbouloux adds.
In any case, French practitioners will have to come to terms with this new text. And if it already has “holes in it”, we shall expect several quick adjustments. In this case, there is no doubt that with nearly half a century of case law, the United States will be an inexhaustible source of inspiration for the practical implementation of these rules! For this reason, “leave us a few years of case law to refine the application of the text, before changing everything again”, François-Xavier Lucas concludes.
By Cyprien de Girval
