EU Parliament adopts directive on preventive restructuring

The EU Parliament adopted the Directive on future "Preventive Restructuring Frameworks", which creates the basis for uniform preventive restructuring across the European Union and will fundamentally change how companies deal with financial difficulties and restructuring.

Until now, the EU has suffered from a regulatory patchwork in this area with no regulations in some markets and sophisticated procedures in others. The new directive mitigates the dangers and risks posed by the former uneven regulatory landscape.

The Directive on Preventive Restructuring Frameworks resulted from talks between the EU Parliament, the European Council and the EU Commission on draft directive COM(2016) 723 final dated 22 November 2016. This draft was based on a recommendation of the EU Commission dated 12 March 2014, which was called the "new approach to business failure and insolvency".

In passing this directive, another cornerstone has been laid on the path to establishing a preventive restructuring framework in Germany and Europe. With the directive's publication, EU member states have two years to transpose these provisions into national law. In exceptional cases and upon request, this transposition period can be extended by one year.

In Germany, the transposition of these proposals into law are expected to begin soon, and at the same time the law will be brought into line with the results of the October 2018 evaluation of German Facilitation of the Reorganisation of Enterprises Act (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen or ESUG).

Preventive restructuring frameworks in Germany from 2022

By 2022 at the latest, Germany will have preventive restructuring frameworks, which are also known as "pre-insolvency restructuring proceedings" and may be made up of one or more proceedings or isolated measures.

Representing a fundamental change in how companies deal with financial difficulties and restructuring, this new situation creates a legal framework outside of insolvency proceedings that opens up the possibility of coordinating and implementing restructuring measures under protective conditions and in a uniform manner with the concerned parties. Under this directive, there is now no need to reach a consensus or are individual parties able to block a project.

At the heart of the new directive lay restructuring plans that are able to provide a variety of provisions to restructure a debtor. Creditors affected by those provisions vote on a restructuring plan in accordance with the majority principle. As with insolvency plans, the vote takes place in groups or classes classified by economic interests. If individual creditors or groups are out voted, the restructuring plan must be confirmed in court where compliance with rules of procedure and the question of any unreasonable disadvantage of the parties will be examined. Only then – and only to the extent that the affected parties have been involved – will the restructuring plan be binding.

During the preparation and negotiation of a restructuring plan, business operations must be protected from disruptions caused by enforcement measures taken by individual creditors or by the loss of essential contractual relationships. To guarantee such protection, a court can order a moratorium — a "protection period" similar to preliminary insolvency proceedings when the interests of creditors may not be unreasonably disadvantaged. Strict rules have been applied to the creation and lifting of moratoriums. In particular, the directive initially limits moratoriums to up to four months, with the possibility of extensions up to 12-month.

In addition, the new directive protects new financing granted during a preventive restructuring scheme from claw-back actions by an insolvency administrator in the event of subsequent insolvency.

Improving the restructuring culture, but allowing flexibility

Binding for all member states, the new directive is expected to make restructuring and reorganisation of companies in Europe easier as a whole, thus preventing insolvencies. Also by harmonising the differing regulations of member states, the directive is expected to promote trade and investment, and enable market participants to better assess entrepreneurial risks.

To increase their chances of success, however, restructuring measures should be undertaken earlier. The costs of restructuring should also be reduced in order to give small and medium-sized companies easier access.

One controversial point about the new directive is that it allows member states considerable flexibility in transposing the provisions of several detailed issues into national law. As a result, it is feared that some member states will introduce regulations that are highly functional, but offer lower levels of protection to the parties involved. Other member states could implement stricter proceedings with high barriers, thereby guaranteeing high degrees of protection. Such disparity could result in a short-term competition between jurisdictions, since a well-functioning legal framework also offers economic advantages. Ultimately, only time will tell which constructions will prove their worth in practice.

For more information in this eAlert and how it could affect your business, please contact the following local CMS expert:

Dr Alexandra Schluck-Amend, Partner, (Certified lawyer for insolvency law), Head of Restructuring and Insolvency Group, CMS Germany