Italy’s New Code of the Business Crisis and Insolvency: Focus on early detection of the debtor’s state of crisis and safeguarding the going concern

For nearly 80 years, the Italian bankruptcy system was regulated by the Royal Decree 16 March 1942, No. 267 (the Bankruptcy Act). Although amended several times, especially in the last 15 years, the original structure of the Bankruptcy Act remained more or less the same.

But now, the dawn of a new era is coming for Italian restructuring and insolvency cases.

On January 12, 2019, the Italian Government issued Legislative Decree No. 14, which introduced the Code of the Business Crisis and Insolvency (hereinafter, the New Code). The New Code is designed to replace the Bankruptcy Act. The New Code applies the general principles and guidelines set forth by the Italian Parliament with Law No. 155 of 19 October 2017, and also takes into account suggestions from the European Union.

For the most part, the New Code should have entered into force in August 2020, but this date was pushed to September 1, 2021 to give time to a parliamentary committee to adapt the New Code to circumstances related to the COVID-19 pandemic. The implementation of the New Code may be further postponed. Until the New Code enters into force, insolvency proceedings will continue to be governed by the Bankruptcy Act.

Given the importance of bankruptcy law reform both globally and in Europe, the following is a brief review of the New Code and some of the regulatory amendments that are expected.

The aim of the New Code: Rehabilitation

As to the structure, the New Code appears to be more in line with the legal systems at a European level. In this sense, the scope of the New Code is to create functional instruments to facilitate the early identification of the debtor's financial crisis in order to prevent the insolvency and, where such efforts fail, to manage the insolvency with the aim of overcoming the crisis and restoring the company to profitability.

In a departure from the Bankruptcy Act, the primary goal of the New Code is the restructuring of companies in crisis and the preservation of going concern values. Liquidation procedures will be a means of last resort.

In this sense, the New Code introduces for the first time a clear distinction between the "state of crisis" and the "state of insolvency," concepts that the Bankruptcy Act tended to treat in a similar way. The New Code defines "state of crisis" as a state of economic and financial condition that makes it likely that the debtor will become insolvent in the future. For the company, this may be reflected in the inadequacy of the cash flows necessary to regularly meet its future obligations. By contrast, "insolvency" continues to mean the state where the debtor is no longer able to regularly meet its exiting or current obligations. Therefore, the "state of crisis" becomes the first formal step before the "state of insolvency."

Another important novelty introduced by the New Code is the elimination of the term "bankruptcy", which is replaced by the term "judicial liquidation." The rationale for this modification lies in the intention to reduce the reputational damage and negative social stigma historically linked to the word "bankruptcy," with the aim of offering to any entrepreneur, which has been declared insolvent, a better chance of a fresh start and the restarting of its business. The judicial liquidation (formerly, "bankruptcy"), therefore, represents the last resort to be initiated only when the debtor has been unable to identify other suitable solutions.

The Out-of-Court Early Warning and Assisted Negotiation Procedure

Generally, the New Code requires companies to adopt specific and appropriate administrative and accounting structures to help identify a crisis situation at an early stage.

Among the measures geared to the early detection of a state of crisis, the New Code introduces the "Out-of-Court Early Warning and Assisted Negotiation Procedure." This is a confidential out-of-court procedure that encourages the early detection of a crisis situation and facilitates negotiations between the debtor and its creditors through the intervention of the OCRI, Organismo di Composizione della Crisi, an entity of a non-judicial nature and with adequate professionalism, set up at each Chamber of Commerce.

The Out-of-Court Early Warning and Assisted Negotiation Procedure can be activated upon request of the company's supervisory bodies and qualified public creditors when certain crisis metrics are present, for example: income, equity or financial imbalances in relation to the specific characteristics of the company and the activity carried out by the debtor.

The New Code states that the company's supervisory bodies (board of statutory auditors, auditors and auditing firms), must : (i) review the adequacy of the company's governance; (ii) notify the board of directors of any potential situation of crisis; and (iii) in the event that the board of directors fails to take any required corrective action in a timely manner, promptly report this failure to the OCRI. It is important to note that such timely reporting to the OCRI constitutes an exemption from liability for the legal consequences of the omissions or actions carried out by the management of the company.

The New Code imposes similar reporting requirements on qualified public creditors (Revenue Agency, National Social Security Institute and Collection Agent), who are obliged to give notice to the debtor when its debt exposure exceeds a certain threshold. If, within 90 days after receiving such notice, the debtor has not (i) discharged its debt or at least settled his debt in full; or (ii) initiated one of the restructuring procedures provided for by the New Code, the public creditors must notify the OCRI.

Once the OCRI has received any such reports by the supervisory bodies or qualified public creditors, it convenes an investigation of the debtor and, after a series of technical evaluations, if the state of crisis is confirmed, the OCRI discusses the situation with the debtor in order to better identify the measures to be taken and the timeframe for compliance; all of these steps involve a rapid and confidential out-of-court procedure.

Furthermore, upon request of the debtor at the conclusion of the technical evaluations, the OCRI may also be entrusted to conduct an "Assisted Negotiation Procedure." In this case, the OCRI establishes a term not exceeding nine months (which can be extended for a further three months in the presence of positive negotiations) in order to verify whether the conditions exist for a viable negotiated solution to the business crisis can be reached with the creditors. If the procedure has a positive outcome, the agreement between the debtor and its creditors is reflected in a written document, which is binding only on those parties who have signed it. If, on the other hand, the outcome is negative, the OCRI invites the debtor to apply for access to one of the other procedures as per articles 37 et seq. of the New Code (for example, composition with creditors proceedings, debt restructuring agreements, judicial liquidation).

Unified procedures for the regulation of crisis and insolvency

The New Code provides for a more efficient, consolidated procedure of judicial ascertainment of the crisis or insolvency before the Court where the debtor has its center of its main interests. In this context, all the requests and petitions, even opposing ones, presented by creditors, supervisory bodies, the public prosecutor's office, and the debtor himself, are collected and examined at the same time, in order to adopt the most appropriate solution. The New Code, therefore, establishes a form of connection, compulsory by law, for all legal initiatives originating from the same crisis or insolvency.

Moreover, in line with the purpose of the New Code, when examining the various requests and petitions, the Court will give priority to those aimed at overcoming the crisis by means of procedures other than judicial liquidation, provided that they are accompanied by a plan that recognizes the position and interests of the creditors.

The main amendments to composition with creditors and debt restructuring agreements

An important feature of the composition with creditors proceedings (concordato preventivo) under the Bankruptcy Act, was the automatic suspension of enforcement and precautionary actions by its creditors upon the mere filing of a petition for composition. Even the filing of a "blank" petition by the debtor - one that did not contain all the formal elements of a complete plan—was sufficient.

The New Code provides that this suspension will no longer be automatic. Rather, it must be explicitly requested by the debtor and confirmed by the Court, which will establish its duration, or revoke it at the first hearing following the filing of the petition. In any case, such suspension may not last longer than 12 months.

As stated above, the intention with the New Code is to favor going concern solutions rather than liquidation. In this context, the composition procedures that envisage the complete liquidation of the debtor's assets will be permitted only in the following circumstances: (i) payment to unsecured creditors of not less than 20% of the total amount of their claim and (ii) contribution of external resources from third parties that increases the payment to unsecured creditors by at least 10% as compared to the distribution that would be made in a judicial liquidation scenario.

With regard to the debt restructuring agreements, the New Code provides that support from a limited percentage of creditors representing not less than 30% of the overall debt of the debtor can be sufficient to enter into a restructuring procedure in the cases in which: (i) a moratorium in the payment of the non-consenting creditors is not requested; and (ii) no temporary protective measures are requested. In all other cases, 60% of the overall debt of the debtor is required.

Corporate group restructuring

The New Code also fills a gap in the current Bankruptcy Act: the law introduces a set of rules governing the crisis of corporate groups. Therefore, in the event that the crisis affects several companies belonging to the same group, all having the center of their main interests in Italy, it is possible to present a single petition for access to the procedures for composition with creditors or approval of a debt restructuring agreement. The petition must be filed with the Court where the parent company has its main center of activity or, in the alternative, the Court of the place where the affiliated company with the greatest debt exposure is located.

Even though the separateness of the respective assets and liabilities of the companies remains unaffected, the concordato plan may envisage the continuity of the business of some of the companies and the liquidation of others. It may also envisage intra-group transactions involving the transfer of resources from one company to another, provided an independent expert certifies that such transfer of resources is required for business continuity and is the best way to satisfy the creditors of all the companies. The group plan cannot be terminated or cancelled when the conditions for termination or cancellation only occur with regard to one or some companies in the group. Instead, the status of the entire group as a whole must be considered, before declaring that the group composition agreement be terminated.

By the same token, if several companies belonging to the same group having the center of their main interests in Italy are insolvent, it is possible to unify the judicial liquidation procedures for reasons of economy and to ensure uniform treatment of creditors, without prejudice to the separateness of the respective assets and liabilities.

Conclusions

The New Code certainly represents a significant step forward with a view to aligning Italian legislation with the most recent provisions and principles issued by the European Union and other member states such as Germany and The Netherlands. The warning measures, together with the various provisions aimed at the early detection of a business crisis, as well as the support given to the continuity of the business of the going concern, constitute a concrete step forward in Italian bankruptcy law.

In practice, the implementation of this new system is still to be tested. We will know much more in the second half of 2021.

Undoubtedly, legal advisors will have to quickly become familiar with the new set of rules and guide companies to ensure compliance. Challenging situations with no direct precedent may arise. At the same time, however, there will be opportunities to create new case law and precedent, aimed at supporting companies in crisis and helping them overcome the difficulties presented by disruptive and unforeseeable situations, such as those experienced as a result of the COVID-19 pandemic.