European insolvency regulation – legal and practical implications

Until the 31st May 2002, businesses trading across Europe which became insolvent found themselves subject to a variety of different approaches from the member states in which they carried on business. The new regulation aims to create a framework whereby the insolvency office-holders of one member state will be recognised in all the other member states, and creditors throughout the European Union will have a level playing field in which to assert their claims.

The regulation provides for a two-tier structure for insolvencies of companies involving several European jurisdictions. The “main proceedings” may be instituted in the country where the debtor has its “centre of main interests” (“COMI”). In many cases this will be the subject of dispute, and the regulation itself does not help matters by giving two possible definitions of the term. The law of the country where the COMI of the insolvent company is situated will be the law governing the institution, conduct and discharge of the insolvency proceedings. Judgments handed down in connection with the proceedings in that country must be recognised by other member states, and the liquidator appointed in that country will have the power to remove assets from other member states, provided that no proceedings have been opened there.

The limitation is that the regulation will only affect businesses which are organised through a network of branches throughout the EU. Subsidiary companies, being separate legal entities from the holding company, will be subject to the insolvency rules of the member state in which they are incorporated; it is only a company’s branch offices which will be subject to the proceedings instituted in the state of the company’s COMI. As trading through a network of branches, rather than subsidiaries, is relatively unusual, the application of the regulation is likely to be limited.

Once main proceedings have been opened in one member state, any creditor may petition for “secondary proceedings” to be instituted in any other member state, without the insolvency of the debtor company being examined again. The purpose of the secondary proceedings is to liquidate assets which are situated in that member state, and may be instituted if the debtor has an “establishment” in that member state. Establishment has been defined in the regulation as a “non-transitory economic activity with human means and goods”. (In the case of the UK, this may remove jurisdiction from the UK courts if the debtor company has assets and creditors in the UK but this presence does not amount to an establishment.)

Any creditor of the debtor company can prove in the main or the secondary proceedings. The aim is that the liquidators of the various proceedings will communicate fully with each other, and will co-ordinate the proceedings, so that dividends to creditors are paid out evenly. The liquidators have a duty to communicate to each other any information relevant to the other proceedings, including the lodgement or verification of a claim, and measures proposed to terminate proceedings. It is hoped that this will avoid the ring-fencing of assets (which has been a feature of previous pan-European insolvencies), by creating a common pool of assets, and ensuring a consistent treatment of creditors.

Secondary proceedings will be governed by the law of the member state in which they are instituted. The liquidator of the main proceedings will lose control of the assets in that territory, but he will retain influence over the proceedings: he is under a duty to co-ordinate them with the main proceedings, and must be given an opportunity to make proposals: where the local law allows for insolvency proceedings to be closed without liquidation (by a rescue plan or a composition, for example) the liquidator in the main proceedings can propose such a measure. In fact, the secondary proceedings will not be permitted to be closed by a measure other than liquidation without the consent of the liquidator in the main proceedings, unless the financial interests of the creditors in the main proceedings would not be affected by the measure proposed. Any assets remaining following the conclusion of secondary proceedings are to be passed to the liquidator in the main proceedings for distribution to the main body of creditors.

Creditors across the EU will now have the option of proving in either the main or any secondary proceedings. However, arguably there are incentives for a creditor to institute new secondary proceedings, rather than prove in the main proceedings. For example, claims provable under local law may be paid first out of assets situated in that member state, and may result in a higher dividend for the creditor than would be received by the general body of creditors. Further, secondary proceedings may lead to a relatively quick recoupment and distribution of the assets in the particular member state; overseas creditors may, in practice, not get notice of the secondary proceedings in time to prove in them. The liquidator in the main proceedings has the power to apply to stay secondary proceedings if it appears that they may adversely affect the main creditors, but it is uncertain whether liquidators will take up this option as, in doing so, they would be required to guarantee the interests of the creditors in the secondary proceedings.

Although the regulation will certainly have an impact on the conduct of cross-border European insolvencies, and should remove some of the barriers and uncertainties faced by insolvency practitioners, the regulation does contain several carve-outs. For example, the regulations do not apply to insurance undertakings, credit institutions and investment undertakings: the effects of the insolvency of any such institution will be governed only by the law of the member state in which it is situated.

Receiverships are not recognised by the regulation, and so receivers which are appointed in the UK (until they are prohibited by the Enterprise Bill) will find that they face the same old difficulties in gaining recognition and enforcing claims in member states outside their own. Administrators, though (who are bound to increase rapidly in number over the coming years), will be able to take control of foreign assets much more easily.

A lender may take security over an asset situated in a member state other than its own; if the debtor’s COMI is in that country, then that country’s law will be applicable to the insolvency. However, the security itself should be unaffected, as rights against property (as opposed to against persons) are specifically excluded from the regulation. Therefore, the law affecting the security, and arguably a receiver appointed under that security, will be governed by the law of the state in which the security was taken. However, if there are surplus assets after the asset has been realised and the security holder paid, these will have to be passed to the liquidator in the main proceedings.

In the same way, rights of set-off and retention of title claims would also be preserved, and would be unaffected by the regulation. Contracts of employment will be similarly unaffected.

The regulation leaves a lot of questions unanswered, and there is no doubt that it will take liquidators some time to adjust to the new regime of co-operation and mutual recognition. However, it is to be hoped that the regulation will create a fairer and more controlled forum for creditors to make their claims, and make it easier for insolvency office holders to gather in, realise and distribute assets.

For further information please contact Robert Hickmott on +44 (0)20 7367 2987 or at [email protected]