Recent activity points to the welcome revival of pre-packs in the Netherlands

Pre-packs were often used in the aftermath of the global financial crisis in the Netherlands, but their use came to an almost complete halt after a European Court of Justice decision in 2017. Recently, there have been two important developments which could revive the use of pre-packs in the Netherlands.

Introduction

In the aftermath of the global financial crisis, the restructuring market witnessed an increase in the use of pre-packs in the Netherlands. Most Dutch courts took a pragmatic approach and facilitated pre-packs, even though prepacks lacked a statutory basis in the Dutch Bankruptcy Code ("DBC").¹ Back then, as the global financial crisis evolved and more enterprises suffered financial distress, debtors and their creditors searched for creative restructuring tools and solutions. The pre-pack was one of the tools applied in practice to liquidate part of the business while restructuring another part through bankruptcy proceedings.

As part of a recalibration of Dutch insolvency law in 2012, a codification of pre-packs in the DBC was considered as well as the codification of the 'Dutch scheme' (please refer to the Q1 2020, Q4 2020 and Q2 2021 issues of our International Restructuring Newswire for articles on the Dutch scheme). In 2015, a legislative proposal was drafted to codify pre-packs in the DBC: a draft bill for the Act on Continuity of Enterprises I (Wet Continuïteit Ondernemingen I; "WCO I"). However, the legislative process for WCO I was put on hold when litigation ensued in some pre-packs regarding matters relating to the European Directive on 'Transfer of Undertakings and Protection of Employees' ("TUPE") concerning the treatment of employment contracts.²

Some of the pre-packs had resulted in litigation on questions involving transfer of undertakings—being a business, business unit or a part thereof—and protection of employees. Pursuant to TUPE, in a transfer of an undertaking employees of a business are transferred to the purchaser of such business by operation of law without changes in the terms of their employment contracts. However, an exception applies in the event of bankruptcy: if the seller is in bankruptcy proceedings, the main rule that all employees are automatically transferred to the purchaser does not apply (the "bankruptcy exception"). Generally, the restructuring market assumed that the bankruptcy exception applied in pre-packs, given that as part of a pre-pack the seller formally enters bankruptcy proceedings.

Nevertheless, in the Estro case the European Court of Justice ("ECJ") upset market expectations and ruled instead that the bankruptcy exception did not apply to the Dutch pre-pack of Estro.³ This resulted in legal uncertainty and the Dutch market witnessed a decline in the use of pre-packs. Two recent developments may alter the pre-pack landscape: (i) in the Heiploeg case,⁴ the Dutch Supreme Court in 2020 took a contrary position and ruled in an interlocutory decision that the bankruptcy exception does apply in the pre-pack of Heiploeg; and (ii) the Dutch government separately launched a public consultation to introduce WCO I for pre-packs with a limited scope focusing on enterprises with activities with "societal interests."

Background of pre-packs in the Netherlands

In the last decade, various debtors used pre-packs in the Netherlands to restructure their liabilities, including liabilities under employment contracts. A debtor in financial distress, that had a purchaser for the viable parts of its business, would request the court to ´appoint´ a prospective bankruptcy trustee and a prospective supervisory judge (formally, there was no appointment given that there was no legal basis for pre-packs in the DBC, but the courts would disclose to the debtor the names of the individuals that would be appointed as bankruptcy trustee and supervisory judge in a subsequent bankruptcy of the debtor). The prospective bankruptcy trustee would—under supervision of the prospective supervisory judge—monitor the preparation of the sale of the viable parts of the business of the debtor to a purchaser through an asset deal. Once all elements of the deal were agreed upon, the debtor would file for bankruptcy; upon the declaration of bankruptcy proceedings, the prospective bankruptcy trustee and the prospective supervisory judge were appointed as bankruptcy trustee and supervisory judge respectively; and the deal was signed and closed by the bankruptcy trustee with approval of the supervisory judge.

Pre-packs have proven to be a useful restructuring tool with various advantages in practice. By making use of a pre-pack, the (viable part of a) business of a debtor is sold as a going-concern. The proceeds of such sale are expected to exceed the proceeds of a piecemeal sale of the assets of the debtor in liquidation. This also safeguards business continuity and jobs, while at the same time it does allow the buyer to right size the workforce as part of the restructuring of the debtor. This latter point proved to be the topic of much debate as well as litigation in the Netherlands as a result of which the legislative process for WCO I was delayed—eventually leading to the judgment of the ECJ in the Estro case on 22 June 2017. In short, the ECJ ruled that in a pre-pack sale, the employees of a business transfer to the purchaser of such business by operation of law without changes to the terms of their employment contract.

Unfortunately, the Estro case limited the options to restructure employment liabilities while increasing legal uncertainty around pre-packs. Consequently, the use of pre-packs came to an almost complete halt in the Netherlands. However, two significant developments may lead to welcome revival of the use of pre-packs in the Netherlands.

The Dutch Supreme Court in the Heiploeg case

Heiploeg is one of Europe's largest processors of shrimp. In 2011, the financial position of Heiploeg deteriorated. As part of its financial restructuring, Heiploeg sold the viable part of its business in a pre-pack. The purchaser offered two-thirds of all employees an employment contract, while the employment contracts of the remaining one-third of the employees were terminated. However, litigation ensued on the question whether all employees were transferred by the operation of law to the purchaser of the business, despite the sale being conducted through a pre-pack.

Contrary to the ECJ ruling in Estro, the Dutch Supreme Court came to the (preliminary) conclusion that the bankruptcy exception applies because all three conditions for the bankruptcy exception in TUPE were met: (i) the seller was in bankruptcy proceedings; (ii) the bankruptcy proceedings were instituted with the purpose of liquidating assets of the seller; and (iii) the bankruptcy proceedings were under the supervision of a competent public authority. The latter two conditions were at tension with the judgment in the Estro case. On the second requirement, the Dutch Supreme Court found that the purpose of the pre-pack was to liquidate the assets of the bankrupt debtor given that the bankruptcy of Heiploeg was inevitable, the purchaser of the business was not affiliated with Heiploeg and the District Court had appointed a prospective bankruptcy trustee and prospective supervisory judge with the aim to achieve the highest possible return for the creditors of the (soon to be) bankrupt company. On the third requirement, the Dutch Supreme Court concluded that pre-packs involve actual supervision by a competent authority, because the prospective bankruptcy trustee has the opportunity to monitor the negotiation of the deal pre-bankruptcy and in the subsequent bankruptcy the pre-pack sale is actually signed and closed by the bankruptcy trustee with approval of the supervisory judge.

Given that the preliminary finding of the Dutch Supreme Court in the Heiploeg case may be at odds with the judgment of the ECJ in the Estro case, the Dutch Supreme Court referred to the ECJ with preliminary questions on whether—in the view of the ECJ—a Dutch pre-pack does not fulfil the requirements of the bankruptcy exception. In addition to finding that the bankruptcy exception applies in the Heiploeg case, the Dutch Supreme Court set out the purpose and process of Dutch bankruptcy proceedings as well as the pre-pack and asked the ECJ to consider each point while giving its preliminary ruling to the questions raised by the Dutch Supreme Court. As a subsequent step, the Advocate General of the ECJ will provide its conclusion, followed by decision by the ECJ. The Dutch market is awaiting the decision with much interest.

WCO I continued: Pre-packs for enterprises with activities with societal interests

As mentioned above, WCO I was put on hold when disputes arose on the bankruptcy exception under TUPE, initially to await the outcome of the ECJ's ruling in the Estro case. To address the legal uncertainly created by the ECJ ruling in the Estro case, the Dutch legislature launched a draft bill for the 'Act on Transfer of Undertaking in Bankruptcy' (Wet overgang van onderneming in faillissement; "WOVO") for public consultation in May 2019. The intent of this draft bill was to set up a new legal framework for transfer of undertakings in bankruptcy (irrespective of whether that is through a pre-pack or a 'regular' bankruptcy). However, the interlocutory decision of the Dutch Supreme Court in the Heiploeg case illustrated that a completely new legal framework may not be required. As a result, the legislative process for both WCO I and WOVO were put on hold again.

On 25 May 2021, the Dutch government published a legislative amendment to WCO I for public consultation. According to the explanatory memorandum to the legislative amendment, pre-packs were no longer used in practice due to legal uncertainty arising from the Estro case and WOVO was put on hold in response to the Heiploeg case. However, there had been cases where the use of a pre-pack would have been very desirable, not only from an economic perspective, but also from a societal point of view. In the explanatory memorandum, reference is made to bankruptcies of various hospitals in the Netherlands. The application of a pre-pack would have resulted in a controlled wind down in these cases.

In essence, the legislative amendment leads to two changes to WCO I: (i) it clarifies that the purpose of a pre-pack needs to be a controlled liquidation of the activities of the bankrupt debtor (replacing previous language which stated that the purpose was continuity of the debtors' business); and (ii) it limits the scope of WCO I to enterprises with activities that serve societal interests.

Although the first change may raise the impression that pre-packs can only be used to liquidate businesses and no longer for a restart through bankruptcy, the explanatory memorandum clearly states that that is not the case and that pre-packs can still be used for pre-pack sales. However, the main purpose of the pre-pack needs to be a controlled liquidation. As discussed above, the purpose of the bankruptcy proceeding is relevant in light of the requirements that need to be met for the bankruptcy exception under TUPE. Even though the explanatory memorandum comes with a caveat that the Estro case leaves legal uncertainty on the question whether all employees are automatically transferred in case of a pre-pack sale, we believe that this clarification language on the purpose of the bankruptcy proceedings mitigates this risk considerably.

The second change is not meant to limit the scope of WCO I permanently to enterprises with activities with societal interests only. The Dutch legislature clarified that it intends a phased approach whereby pre-packs are now introduced for enterprises with activities with societal interests and that later, i.e. after the ECJ has issued its preliminary ruling in the Heiploeg case, it will be made available for other debtors as well.

The Dutch legislature demonstrates a clear sense of urgency with this legislative amendment to WCO I. According to the legislature, it is paramount that enterprises with activities with societal interests be allowed to use pre-packs. With respect to the scope of 'societal interests', examples that are given in the explanatory memorandum include companies active in the healthcare, education, energy, waste processing, internet and telecom sectors. While an explicit reference to the Covid-19 pandemic is not included in the explanatory memorandum, one cannot ignore the impression that the pandemic also played an important role in the introduction of pre-packs on an expedited basis through a phased approach. This approach stresses the acknowledgement by the Dutch government that there is a need for pre-packs in practice. The public consultation was closed on 27 July 2021. As a next step, the government may publish a formal amended draft bill for WCO I, but whether that will happen remains to be seen. We welcome the phased approach of the government: making a first step to allow pre-packs for certain sectors is commendable, so long as a further codification for other debtors follows soon thereafter.

Conclusion

Clearly, the legal uncertainty arising from the Estro case has had an adverse effect on the use of pre-packs in the Netherlands. However, companies facing financial distress have been in need of a restructuring solution that addresses a controlled liquidation of part of the business while facilitating the continuation of another part thereof. While the Dutch scheme that entered into force on 1 January 2021 provides for an effective tool to restructuring debt outside of formal bankruptcy proceedings and suspension of payments, the ability to use the 'Dutch pre-pack' would be a very welcome addition to the restructuring toolkit in the Netherlands. Both the recent interlocutory decision by the Dutch Supreme Court in the Heiploeg case and a phased introduction of WCO I allowing pre-packs for enterprises with activities with societal interests offer hope for the revival of the pre-pack in the Netherlands.