The European Commission’s proposed directive harmonising certain aspects of insolvency law

Introduction

International insolvency law has been an important topic in the corridors of power in the European Union (EU) during the past several years. We have seen the Recast Insolvency Regulation¹ of 2015, which applies to insolvency procedures opened after 26 June 2017. In 2019, the Preventive Restructuring Directive² followed, resulting in legislative amendments in all key jurisdictions in the EU. On 7 December 2022, the European Commission stepped forward again and published a Proposal for a Directive of the European Parliament and the Council harmonising certain aspects of insolvency law (the Insolvency Law Proposal). In this article, we will focus on this most recent Insolvency Law Proposal.

The Recast Insolvency Regulation provides for rules of private international laws in relation to cross-border insolvency proceedings while the Preventive Restructuring Directive prescribes (among other things) the implementation of preventive restructuring frameworks in the EU Member States. Neither of these instruments seek to harmonise insolvency procedures across Member States. The Insolvency Law Proposal, as its title gives away, steps into the breach and seeks to harmonise certain aspects of the substantive insolvency laws in the Member States. The initiative is rather ambitious since the insolvency laws of the various Member States are deeply rooted in the cultural background of the Member States and very much interlinked with the other substantive laws of the relevant Member State. The harmonisation of substantive insolvency laws across the Member States, however, would contribute to achieving the EU’s plan to create a Capital Markets Union to enhance the financial and economic integration within the EU.

We will address a number of key topics in the Insolvency Law Proposal. We will also discuss how it may impact the restructuring landscape in the EU, and to what extent all or parts of the Insolvency Law Proposal may be difficult to finalize as an actual directive. We will conclude with some observations regarding the status of the Insolvency Law Proposal and the lack of movement on its approval.

Purpose and scope

The purpose of the Insolvency Law Proposal is to achieve minimum harmonisation on certain insolvency law topics across Member States. This means that the Insolvency Law Proposal sets minimum rules that each Member State must have, but with the freedom to implement further-reaching rules than those prescribed as minimums in the Insolvency Law Proposal. This is important because, although the Insolvency Law Proposal may provide guidance as to what rules each Member State should have, the rules may still in the end differ per Member State. A few examples are described below.

Although its name clearly indicates that the Insolvency Law Proposal seeks to provide for minimum harmonisation of insolvency proceedings, the first point to ponder is that Insolvency Law Proposal does not explicitly and clearly define what are ‘insolvency proceedings’. The Insolvency Law Proposal could be improved by explicitly mentioning which insolvency proceedings fall within the scope of the proposal. Reference to the Recast Insolvency Regulation may contribute to this improvement, but not all insolvency proceedings listed on Annex A to the Recast Insolvency Regulation may need to be covered by the definition, as this will then also include preventive restructuring proceedings. Further, as will be discussed below in connection with the obligation to file for insolvency, the Insolvency Law Proposal lacks a definition of ‘insolvency’ or ‘insolvent’. Moreover, the Insolvency Law Proposal does not apply to insolvency proceedings relating to—in short—financial institutions, public enterprises, and private individuals not running a business.

Avoidance actions

The Insolvency Law Proposal aims at harmonising certain rules relating to avoidance actions. Avoidance actions seek to annul legal acts that have been concluded prior to the opening of insolvency proceedings and which are detrimental to the general body of creditors. Avoidance actions aim at the reversal of those detrimental effects in order to protect the value of the insolvency estate. These avoidance actions rules are currently characterised by significant differences between jurisdictions across the EU. 

The Insolvency Law Proposal outlines three different grounds for avoidance actions: 

• legal acts benefitting one or more creditors; 
• legal acts made for no consideration or at undervalue; and
• legal acts which are intentionally detrimental to the general body of creditors.

According to the Insolvency Law Proposal, the effect of an avoidance action should be four-fold. First, the counterparty may not assert against the insolvent estate any rights, claims, or obligations it has obtained from the transaction that is the subject of an avoidance action. Second, the party that benefited from the legal act that is the subject of the avoidance action is bound to compensate the insolvent estate for the damages suffered by the other creditors due to the voidable legal act. Third, the avoidance action damages cannot be set off by the counterparty against a claim it has on the insolvent estate. Lastly, the avoidance action claim against the counterparty for compensation is assignable.

Given that the Insolvency Law Proposal intends to establish only minimum standards for avoidance actions, Member States may adopt additional rules for avoidance, voidability, or unenforceability of legal acts detrimental to the joint creditors to the extent that those rules offer better protection to the joint creditors. To a certain extent, this may interfere with the Insolvency Law Proposal’s objective to promote cross-border investment. Cross-border investors may not attribute (further) comfort to the minimum rules, as there likely will remain discrepancies between the avoidance rules of various Member States with which those cross-border investors may not be familiar with. Such comfort could have been provided if the avoidance rules mandated in the Insolvency Law Proposal were required to be the same across Member States. That is easier said than done since avoidance action rules are interlinked with the substantive laws of the relevant Member States.

Enhancing transparency in relation to asset tracing under the Insolvency Law Proposal

Asset-tracing related to insolvency estates is one of the main topics of the Insolvency Law Proposal. Asset-tracing can be described as the legal process of identifying and locating misappropriated assets or their proceeds. It includes both the preservation (i.e. freezing) of the assets identified and the repatriation of assets that are located in another Member State.

Pursuant to the Insolvency Law Proposal, insolvency practitioners within the EU should gain access to centralised registers of the EU in respect of bank accounts, UBO-information and asset title information, simplifying and improving the process of identifying assets located in Member States. If implemented, this would enable insolvency practitioners to trace debtors’ assets easier, faster and at lower cost, which is expected to result in (among other things) higher recovery in cross-border (European) insolvency proceedings. As the registers contain sensitive information, belts-and-braces in the form of judicial control entrusted to designated courts are put in place to safeguard the rights and interests of European citizens and companies. 

Under the Insolvency Law Proposal, insolvency practitioners appointed in any of the other Member States should be equipped with the same access to various registers as ‘local’ insolvency practitioners of a Member State and stipulates that such insolvency practitioners may not be subjected to further professional standards.

An important limitation in this respect is that under the Insolvency Law Proposal insolvency practitioners will not have access to information on accounts held with certain payment providers (i.e. crypto-currency service providers and service providers that do not offer accounts with IBAN codes). This gap is driven by the absence of European legislation requiring these types of payment providers to include identification data in centralised electronic systems. Considering the intensive (crypto) monetary traffic that takes place through payment providers such as ICS, Paypal, Klarna and Strike, potentially important assets therefore cannot adequately be traced back to an insolvency estate despite the Insolvency Law Proposal.

Although the Insolvency Law Proposal generally improves the ability to trace assets for insolvency practitioners, it does not equip practitioners with new instruments to recover assets belonging to insolvency estates as this was considered too controversial by the Member States. Granting insolvency practitioners access to national registers across all Member States can be considered harmonisation in a sense, but the level of accessible information is only limited. Given recent case law in the European Court of Justice (the ECJ), entailing that general access to UBO-registers interferes with the EU’s Charter of Fundamental Rights, equipping insolvency practitioners with access to the UBO-registers across all Member States could instigate interesting litigation and court rulings.

The harmonisation of pre-pack procedures

The Insolvency Law Proposal also addresses the harmonisation of pre-pack procedures within the EU. In the EU, a pre-pack procedure is usually characterised by the sale of a debtor’s assets or enterprise in an insolvency procedure with court approval (the liquidation phase), but with the deal having been agreed upon prior to the commencement of the insolvency procedure (the preparation phase). The (brief) insolvency procedure is utilised to leverage the benefits of such a procedure to, for instance, terminate employment contracts to right-size the workforce. By preparing the sale prior to the actual insolvency procedure, the pre-pack minimises potential loss of creditor value at an early stage since the negative effects of a formal insolvency procedure are less likely to materialise between the opening of these proceedings and the actual sale. As such, pre-pack procedures are seen to maximise creditor recovery in insolvency proceedings. 

It is challenging to harmonise pre-pack procedures across Member States since they are characterised by relatively little court involvement and are largely extra-judicial given the pre-filing preparation procedures. This is illustrated by the fact that the Insolvency Law Proposal provides Member States with much discretionary authority to implement the Insolvency law Proposal on pre-packs as they deem appropriate. The Insolvency law Proposal contains mostly high-level general norms and descriptions of pre-pack procedures, which are to be designed and finetuned by the Member States themselves. As a consequence, the level of harmonisation of pre-pack procedures provided for in the Insolvency Law Proposal is rather limited.

Specifically, the Insolvency law Proposal prescribes that Member States shall have in place either: (i) a procedure that protects the competitiveness, transparency and fairness of the sales procedure in the preparation phase; or (ii) a public auction shortly following the commencement of the liquidation phase. If a Member State chooses the latter alternative, the public auction in the liquidation phase does not necessarily imply that there will be no sales process in the preparation phase. Hence, it mainly serves as a market-testing exercise—similar to the usual practice for “363 sales” in US chapter 11 cases.

The Insolvency Law Proposal is aligned with the ECJ’s ruling in Heiploeg,³ by requiring the liquidation phase to be (i) an insolvency proceeding (ii) that has been instituted to liquidate the assets of the transferor (iii) under the supervision of a competent authority. In the context of a Dutch pre-pack, the Heiploeg judgment held that if the liquidation phase in a specific procedure does not meet these criteria, employees remain protected under the Transfer of Undertaking Directive⁴ meaning that the workforce cannot be rightsized using the pre-pack to complete an effective restructuring. 

To facilitate the pre-pack procedure, the Insolvency Law Proposal contains some further relevant provisions:

1. Member States are required to make available to a debtor in (the vicinity of) insolvency a stay on enforcement actions if such stay facilitates the seamless and effective roll-out of the pre-pack procedure. 
2. Member States are obliged to facilitate the appointment of a ‘monitor’ at the debtors request during the preparation phase, whose main task is to find a buyer for the distressed company while safeguarding the competitiveness, fairness, and transparency of the sale process. This monitor might be appointed as ‘insolvency practitioner’ in the liquidation phase.
3. Member States should ensure that the acquirer should receive the enterprise, in principle, free of debt or other liabilities, with the exception that executory contracts relating to the debtor may be assigned to the buyer. 
4. Priming is allowed under the Insolvency Law Proposal, which means that providers of rescue financing may rank super senior to the existing lenders. 
5. The ability to frustrate the sale is limited under the Insolvency Law Proposal. Appealing court approval of the sale in the liquidation phase will oblige the appealing party to provide adequate security for any damages following the delay caused by its appeal. 

Mandatory bankruptcy filing

The Insolvency Law Proposal stipulates that directors of a legal entity—who are deemed best positioned to realise when the company is nearing or in insolvency—are obliged to submit a request for the opening of insolvency proceedings with the court within three months after the directors become aware or can reasonably be expected to become aware that the entity is insolvent. Further, the Insolvency Law Proposal stipulates that the Member States shall ensure that directors failing to comply with this obligation are liable for damages to creditors, but also permits the Member States to adopt stricter liability rules for failure to comply with this obligation. The rationale behind this proposal is to maximise recovery by avoiding the potential loss of asset value if insolvent companies continue trading.

That all said, the Insolvency Law Proposal lacks clear and explicit definitions of ‘director’, ‘insolvency proceeding’, and ‘insolvent’. It appears that, in absence of such definitions, the harmonising effect of the Insolvency Law Proposal may be limited. After all, if each Member State applies a different definition, the way the laws work in each Member State may vary significantly. The explanatory memorandum to the Insolvency Law Proposal does set out that the term ‘director’ is to be understood broadly, referring to those persons charged with making, or who in fact are making or who ought to be making key decisions with respect to the management of a company.

However, there is no such guidance or definition of ‘insolvency’ nor as to when a legal entity is deemed to be insolvent. While this may be understandable in light of discrepancies between different Member States on these matters, it raises the question whether this aspect of the Proposal will be effective in harmonising insolvency law in the EU.

The creditors’ committee

Another area in which the Insolvency Law Proposal seeks harmonisation between Member States is the introduction of a creditors’ committee. The idea behind the creditors’ committee, which is only installed pursuant on agreement of the general meeting of creditors, is to strengthen the position of creditors in insolvency proceedings in ways that individual creditors who would otherwise not participate in the proceedings due to limited resources or geographical distance are represented. This will enable creditors to become more involved in the proceedings and, where necessary, give direction to the proceedings. Creditors’ committees can help cross-border creditors in particular to better exercise their rights and ensure their equitable treatment. 

Member States are allowed to exclude the establishment of a creditors’ committee in insolvency proceedings when the cost of setting up and operating such a committee is not commensurate to the value it may generate. This may be the case where there are too few creditors, where the vast majority of creditors have a small share in the overall claims against the debtor, or where the expected recovery from the estate is significantly lower than the costs of the set-up and operation of the committee (e.g. where the debtor is a micro-enterprise). 

The Insolvency Law Proposal provides rules on key aspects of the creditors’ committee such as the appointment of committee members and their composition, working methods, the function of the committee, and the personal liability of its members. The Insolvency Law Proposal also indicates that the creditors’ committee is independent from and should supervise the insolvency practitioner (although it is not spelled out that the insolvency practitioner should actually be accountable to the creditors’ committee).

In addition, the Insolvency Law Proposal provides that the creditors’ committee be granted certain rights and duties such as the right to be heard in court, the right to seek external advice and to be informed and consulted on matters in which creditors have an interest (e.g. the sale of assets outside the ordinary course of business), and the duty to provide information to the creditors represented by the creditors’ committee as well as the right to receive information from those creditors. 

The Insolvency Law Proposal aims at strengthening the position of creditors in cross-border insolvencies, which is advanced by the proposals regarding creditors’ committees. The scheme is well delineated in that Member States can still make their own interpretation to an extent. However, a further improvement could be realised if the Proposal not only provided for the rights, powers, and obligations of the creditors’ committee as a collective, but also contained provisions on the rights of the individual creditors if a creditors’ committee has not been established. 

The introduction of the key information fact sheet 

Another significant aspect of the Insolvency Proposal concerns the introduction of the 'key information fact sheet’, which is envisaged to set forth the various essential elements of the national insolvency laws across Member States for cross-border investors engaging with these diverse legal jurisdictions. Its introduction is aimed at not only strengthening, but also streamlining the distribution of cross-border investments within the EU.

The key information includes, among other things, information relating to the conditions triggering the commencement of insolvency proceedings within each Member State, the rules governing the claims and the obligations involved in such proceedings, the mechanisms for the priority and the ranking of creditors' claims, and the subsequent distribution of proceeds following the completion of insolvency proceedings. Additionally, it will provide statistical insights into the average duration of national insolvency proceedings in individual Member States. The information is promised to be carefully established and presented in clear language avoiding any discrepancies relating to different interpretations, thus ensuring its comprehensibility across a broad spectrum of stakeholders, particularly catering to cross-border investors. 

Ultimately, the key information fact sheet strives to empower cross-border investors with indispensable insights into the insolvency frameworks of various Member States. Its goal is to increase transparency regarding the discrepancies that exist between Member States in order to enable informed decision-making and to facilitate cross-border investments within the EU. 

Concluding observations

The Insolvency Law Proposal is part of a broader push within the EU to further develop, harmonise, and enhance insolvency laws across continental Europe. It has been the latest in a stream of legislative efforts—including most notably the Recast Insolvency Regulation and the Preventive Restructuring Directive—to contribute to the development and cohesion of international insolvency law across the EU. Whilst the objective of the Insolvency Law Proposal was applauded, its execution has also been received with some criticism. In particular, the (albeit minimum) harmonisation on certain topics, such as the rules for mandatory bankruptcy filing and directors’ liability, do not necessarily create a set of legal rules that have broad support across the European jurisdictions. It may have been partially due to these various concerns and others mentioned above that over a year after its publication the Insolvency Law Proposal has not gained much traction and seemingly has ended up in the drawer. That will, however, certainly not be the end of it given that the project is still ongoing at the level of the European Commission. Stay tuned for further developments out of the EU on these efforts.