When the Dust Settles: Cross-border restructuring and insolvency after Brexit

As the dust begins to settle after the EU referendum and the potential ramifications of Brexit continue to be digested, we examine the potential impact of Brexit on the UK cross-border restructuring and insolvency regime and its consequences for the UK’s reputation as a leading creditor-friendly restructuring jurisdiction. This article is the first of a series of articles from our Restructuring & Insolvency team in London and across our 18 European offices on the impact of Brexit on the international restructuring and insolvency regime as we know it, with particular emphasis on the effect of Brexit on the EC Regulation on Insolvency Proceedings (the “EC Regulation”) which was adopted in 2000, came into effect in 2002 and applies to all member states except Denmark.

CMS is ideally positioned to comment on these issues given its presence across 18 EU countries and we plan in this series of articles to look at Brexit not just from a UK perspective but the perspective of professionals in other member states.

The cornerstone of the UK’s reputation in this arena is undoubtedly the highly regarded restructuring procedures available, particularly the pre-packaged administration sale, which as a result of the EC Regulation is automatically recognised across Europe (except Denmark). It follows that, in the absence of agreement to the contrary, the most significant impact of Brexit is likely to be the loss of automatic recognition of UK insolvency proceedings under the EC Regulation which would cease to have effect upon Brexit.

With a question mark hanging over the UK’s mode of exit and the arrangements between the UK and the EU going forward, the precise impact of Brexit on the cross-border restructuring and insolvency legal landscape remains uncertain. The only certainty we can derive is that the UK will remain a member state of the EU until such time as it concludes an agreement in respect of its withdrawal from the EU or the two year Article 50 notification period expires once triggered. Until either of these events has occurred (unlikely to be before 2019) there will be no immediate change to the restructuring and insolvency legal framework in the UK, but it is important for those involved in cross-border restructurings and insolvencies to look ahead to what a new regime may look like and consider whether pre-emptive action to protect their position should be taken ahead of any changes to the law.

The current legal framework

Domestic legal framework

UK restructuring and insolvency legislation is not derived from EU legislation and so there would be no effect on the existing domestic legislation governing insolvencies once the UK ceases to be a member state of the EU.

International legal framework

The matrix of cross-border insolvency laws applicable within the UK is set out in the table below.

These frameworks support the centralisation of insolvency proceedings in the debtor’s home country, which is its COMI, i.e. its real economic hub, subject to a rebuttable presumption that this is where its registered office is located.

It should be noted that with the advent of the Recast EC Regulation (the “Recast Regulation”) which is due to come into force on 26 June 2017, the international legal framework set out above will likely change before the UK formally leaves the EU. The Recast Regulation will then apply until the UK leaves the EU.

Cross Border Insolvency Proceedings Now and Beyond Brexit

The EC Regulation is an integral part of the UK cross-border insolvency regime. Its primary purpose is to facilitate mutual recognition of insolvency proceedings involving companies or individuals with assets and affairs across the EU and to avoid forum shopping. The EC Regulation applies to compulsory liquidations, creditors’ voluntary liquidations, administrations, company voluntary arrangements, bankruptcies and English IVAs and Scottish protected trust deeds in the UK.

‘Main’ proceedings can be opened in the UK if the debtor’s COMI is in England and Wales, Scotland or Northern Ireland. ‘Secondary’ proceedings can be opened if the debtor has an establishment in those countries. At the time of writing, secondary proceedings can only be winding up proceedings, but this will be extended to administrations when the Recast Regulation comes into force.

As it stands, the opening of main proceedings in the UK will, subject to a public policy exception, automatically be recognised across the EU member states. In practice this means that an office holder in UK main proceedings can deal with assets situated in other member states without the need to open secondary proceedings in those jurisdictions. It is this automatic recognition of proceedings which is key to the UK’s reputation as a destination of choice for creditors of an insolvent entity, as evidenced by a number of high profile cases where the European subsidiary companies of large corporate groups have been able to use the UK insolvency procedures on the basis that their COMI was in the UK and the filings enabled the coordination of insolvencies of all group companies e.g. Nortel and MG Rover.

When the UK leaves the EU, the EC Regulation (and the CIWUR and the IWUR) will cease to apply to it. As a consequence, absent alternative arrangements, insolvency proceedings opened in the UK will no longer benefit from automatic recognition in the EU, and vice versa. Whilst it is possible that domestic legislation and/or bilateral agreements or treaties between the UK and the EU member states may be enacted in order to retain the key provisions of the EC Regulation, there are no certainties in this respect and so we must consider the UK’s position in the absence of any such arrangements.

Once the EC Regulation and the benefits of automatic recognition cease to apply, practitioners involved in UK insolvency proceedings will need to consider whether the remaining strands of the international restructuring and insolvency legal framework (set out above) will facilitate recognition in EU states - for example, the Model Law, to the extent that it has been adopted by the member state in which recognition is sought. Officeholders in the UK will struggle to rely on the Model Law as a means to obtain recognition and assistance from EU member states because only Greece, Poland, Romania and Slovenia alongside the UK have implemented it. Whilst helpful for those jurisdictions which have adopted it, the level of assistance available under the Model Law is much more restrictive than the automatic recognition regime currently available under the EC Regulation. For example, Articles 4 – 15 of the EC Regulation, which set out the conflict of laws rules and provide supremacy to the laws of the state in which insolvency proceedings have been opened, have not been replicated in the Model Law. Accordingly, the Model Law is not a comprehensive alternative to the EC Regulation. Aside from this, the CBIR requires an application to Court and relief is more discretionary making it more expensive and uncertain.

Those seeking recognition of foreign proceedings in the UK may therefore need to look to alternative strands of the international restructuring and insolvency legal framework such as Section 426 of the Insolvency Act 1986 which provides for mandatory reciprocal enforcement of orders made by courts exercising insolvency jurisdiction in relation to cross border cases. However, the scope of this provision is also limited as there are only 21 signatory states (mainly Commonwealth countries) and other than the Republic of Ireland there are no other EU member state signatories, so again not a meaningful alternative to the EC Regulation.

The final strand of the international restructuring and insolvency legal framework upon which one could seek to rely, where recognition is not available under any of the other strands within the framework discussed above, is the common law principle of 'universalism'. This concept promotes the idea of a single and uniformly applicable set of insolvency proceedings worldwide, instead of various unconnected proceedings taking place across multiple jurisdictions against the same debtor. However, absent a formal treaty, it will be up to each country to balance its own domestic insolvency laws with this concept. In the event of a conflict, the relevant court will need to determine how to apply these principles.

To the extent that recognition of UK insolvency proceedings in an EU member state will not be available under any strands of the international restructuring and insolvency framework set out above and absent alternative treaties or arrangements being put in place, the UK will return to its pre-2002 position on the global stage without a cross-border recognition framework. This will mean a possible return to the chaos resulting from the application of conflicting domestic private international laws, or the negotiation of separate bilateral agreements with member states (in the absence of any such agreements which pre-dated the EC Regulation and which have not fallen away). However, it should be noted that whilst a common law alternative may be uncertain, this type of arrangement is not unprecedented. Most notably, Denmark, which is part of the EU, but not a party to the EC Regulation, has negotiated a separate convention with other Nordic countries to ensure the recognition of cross border insolvency proceedings.

What are the practical implications of Brexit on the existing restructuring and insolvency legal landscape?

The true impact of Brexit on the cross border restructuring and insolvency legal framework will be predicated on the exit deal negotiated between the UK and the EU and the legislative changes required to be implemented in the wake of those negotiations. It follows that the consequences for the legal framework in this field are currently uncertain.

The potential lacuna regarding automatic recognition of cross-border insolvencies and, therefore, the need to clutch at the remaining strands of the international restructuring and insolvency legal framework (to the extent that they are available) will create uncertainty, increased costs and delays and potential adverse outcomes for creditors seeking recognition of UK insolvency proceedings in the EU, and vice versa. The primacy currently enjoyed by the UK on the global stage as a leading creditor-friendly restructuring and insolvency jurisdiction could therefore be damaged. This could lead to COMI shifting, by individuals and corporates, from the UK to other EU member states in order to benefit from automatic recognition of main proceedings across member states.

We anticipate that the uncertainty surrounding the UK’s future as a destination of choice for restructuring and insolvency proceedings may, on the other hand, lead to corporates considering strategic COMI shifting to the UK either prior to or during the period between the UK triggering Article 50 and its eventual departure from the EU. The concept of forum shopping is something which the EC Regulation sought to avoid, however in the absence of certainty as to what the cross-border insolvency regime will look like after Brexit, debtors who are considering a contingency plan which involves a COMI shift may now seek to accelerate those plans to avail of the perceived benefits of establishing their COMI in the UK with a view to giving them increased optionality and certainty in the future. If a jurisdiction was to open main proceedings on the basis of a manufactured shift of COMI then these proceedings may not be recognised in other member states where the recognition or enforcement sought is contrary to the public policy exception under Article 26 of the EC Regulation. This permits a state to refuse to recognise a judgment given by another member state where to do so would be manifestly contrary to the public policy of the recognising state. Public policy is a national law concept and, therefore, its meaning may differ from state to state, but it is noteworthy that Article 26 only applies where the recognition or enforcement of the judgment would be manifestly contrary to the recognising state’s public policy, in particular its fundamental principles or constitutional rights and liberties of the individual. There could be an argument that if a company was to shift its COMI to the UK following the exercise of notice under Article 50, another state could challenge the shift on public policy grounds on the basis that at the end of the two year period there would be complete uncertainty as to the recognition of the UK regime, the powers of its officeholders and hence the impact on creditors. However, the public policy exception is a narrow one and is only invoked in exceptional circumstances, and unless recognition of UK insolvency proceedings has grave implications for the maintenance of basic rights and freedoms within the recognising state, a public policy challenge is unlikely to succeed. That said, we anticipate closer judicial scrutiny of insolvency proceedings where there has been a recent shift in the debtors COMI.

With these potential ramifications in mind, those involved in pan-European restructuring and insolvency matters may need to consider the following factors before and after Article 50 is triggered and once the UK has left the EU:

• Requirement for recognition of UK insolvency proceedings in EU states – Consideration should be given to whether a UK insolvency practitioner will need recognition to deal with and realise a debtor’s assets which are situated in a remaining member state. Where significant assets are located in a member state it may be more efficient to open main proceedings in that member state which is afforded automatic recognition in other member states.
• Existing UK insolvencies with an EU element – To the extent that creditors outside of the UK have participated in the UK process by voting or proving their debt it is arguable that by doing so they have submitted to the jurisdiction of the UK courts and, therefore, recognition under the EC Regulation may not be required now or once the EC Regulation ceases to apply in the UK.
• COMI shifting – In order to take advantage of the benefits of the UK’s current restructuring and insolvency regime, individuals and corporates may wish to consider moving their COMI to the UK, to minimise the risk of closer judicial scrutiny and possible challenges on public policy grounds by recognising member states.
• Timing – Where recognition of UK insolvency proceedings is necessary consideration should be given to the impact this will have on the time taken to complete transactions. For example, where insolvency proceedings are being used as a restructuring tool to effect a pre-pack administration what might the timing implications be for obtaining recognition and what action can be taken to minimise delays?
• Governing law clauses – These should be checked in any relevant documentation, for example loan and security documents. Where the governing law is stated to be English law, parties may seek to rely on the common law principle that only English insolvency proceedings would be appropriate to discharge the parties’ obligations under those documents.

Conclusion

The outcome of the EU referendum has cast considerable uncertainty on the future regime for cross-border insolvencies involving the UK. Unless the UK successfully negotiates its continued participation in the EC Regulation regime or a similar alternative is negotiated between the UK and the EU, the UK may lose its primacy on the international stage as a leading restructuring and insolvency forum.

Ultimately, the impact of the UK’s departure from the EU on the restructuring and insolvency legal framework will be predicated on the terms of the exit deal negotiated between the UK and the EU once the UK has pressed the button on Article 50.