In late 2022, the European Commission proposed a new Directive with a view to harmonise certain aspects of insolvency law. One of the most important innovations to be introduced in this Draft Directive is pre-pack proceedings.
What is a pre-pack sale?
In essence, pre-pack proceedings are expedited liquidation proceedings that allow for the sale of the business of a debtor, in whole or in part, as a going-concern to the best bidder with a view to liquidating the assets of the debtor due to the business’s insolvency.
The Draft Directive is intended to expand the legal systems of EU member states by allowing preparatory actions related to the sale of all or part of the debtor's business prior to the official commencement of insolvency proceedings. This would facilitate the execution of the sale shortly after insolvency proceedings are formally opened, with the aim to liquidate the debtor's company.
According to the Draft Directive, pre-pack proceedings will be comprised of two phases: (i) the "preparation phase" and (ii) the "liquidation phase".
(i) The preparation phase aims at finding an appropriate buyer for all or part of the debtor’s business, which is done by the court-appointed monitor (and assisted by the debtor). This phase does not qualify as an insolvency procedure.
(ii) The subsequent liquidation phase, which qualifies as insolvency proceedings, would follow shortly after. In this phase, the court (a) grants authorisation for the sale of the debtor’s business or a part thereof to the selected acquirer. (The selection is done by the monitor and based on the outcome of the preparation phase). Generally, member states must ensure that the processes within the preparation phase are competitive, transparent, fair and meet market standards. This is not a hard rule and member states are allowed to depart from these requirements. In such a case, the liquidation phase takes a distinct form, whereby (b) the court conducts a quick public auction and the offer selected by the monitor serves as the initial bid.
The benefits of a sale through pre-pack proceedings may be numerous and range from helping to maximise the sale price of the debtor's business to increasing recovery rates for the creditors as well as reducing the length and lowering the costs of insolvency proceedings.
Current insolvency framework in Croatia
The framework currently in place in Croatia does not provide rules on the preparation of the sale of the debtor's business before insolvency proceedings are formally opened. While such a sale is possible, it would need to be conducted outside the framework of insolvency regulations (i.e. as an unregulated practice).
At the moment, the sale of all or part of a debtor's business may be negotiated and conducted only after opening either of the following insolvency proceedings: (i) pre-bankruptcy proceedings or (ii) bankruptcy proceedings. There is also the (iii) extraordinary administration procedure, a special insolvency proceeding that is similar to regular bankruptcy proceedings. However, the applicability of the extraordinary administration procedure is limited and only joint-stock companies of systemic importance and its affiliates can undergo such as procedure, which has been applied only once since it was introduced in 2017.
(i) Aside from the timing of a sale, the fundamental difference between the existing pre-bankruptcy proceedings and the proposed pre-pack proceedings lies in their objectives. Pre-bankruptcy proceedings focus on preserving and maintaining the debtor's business activities and in these proceedings any sale of the business may only be done only to serve this preservation objective. In contrast, the aim of pack proceedings is ultimately the liquidation of the company.
(ii) The sale of all or part of a debtor's business may be done in bankruptcy proceedings by way of a bankruptcy plan, but only after being formally initiated and if the prescribed majorities of creditors agree. Also, within bankruptcy proceedings, the creditors may decide to sell the debtor's assets as a whole. In both cases, the decision to recover the claims by means of a sale is brought by the creditors, whereas in comparison, the introduction of pre-pack proceedings would shift the momentum towards the debtor.
The practice in Croatia shows that in around 65% of pre-bankruptcy proceedings the parties fail to reach an agreement on terms of maintaining the debtor's business activities and, consequently, bankruptcy proceedings are initiated against the debtor.
The bankruptcy proceedings almost always result in liquidation of the debtor and its assets are often sold piece by piece.
Considering the above, the insolvency regime currently in place in Croatia can certainly be improved.
What needs to be done to implement the Draft Directive
If the Draft Directive enters into force in its current content, the Croatian legislator will need to undertake several amendments to the actual legal framework.
These efforts will need to focus on introducing the preparation phase, since at the moment there are no rules on the preparation of sale of the debtor's business before insolvency proceedings are formally opened. The most important rules to be introduced relate to initiating the proceedings and the role and authority of the monitor.
The implementation of the liquidation phase will require less engagement because the current rules on court authorisation of the sale of a debtor’s business or the rules on conducting a public auction (depending on which liquidation-phase mechanism Croatia adopts) may be applied accordingly to the liquidation phase of the pre-pack proceedings.
What is to be expected from the pre-pack proceedings
The changes outlined in the Draft Directive and the envisaged pre-pack proceedings are welcome from the point of view of Croatian legal practice. If implemented properly, this legal instrument has the potential of becoming a valuable tool in complementing Croatia's current insolvency framework, as well as addressing some of its shortcomings.
For more information on how proposed Directive and how it could affect your Croatia-based business, contact your CMS client partner or these local CMS experts.
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