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An Overview of Global Regimes Mark Broude, Hervé Diogo Amengual, Frank Grell, John Houghton and Jake Redway, Latham & Watkins LLP

INTRODUCTION equitable as possible. The main goals of Chapter 11 are to: 1) Rehabilitate financially viable – preserving The insolvency regime or regimes that may be applicable to a operations and saving jobs particular borrower will often be a pivotal issue in work-out or 2) Ensure equality of distribution of value of the insolvent transactions, even where the transaction is company among the insolvent ’s similarly-situated intended to be out of court.The applicable will determine when, for example, the directors' duties might change from 3) Maximise the value of assets and distributions to creditors being owed to the shareholders to the general body of credi- 4) Provide discharge from indebtedness and a “fresh start” to tors, and will often determine the point at which insolvency the debtor practitioners can look back at the antecedent transactions in an 5) Provide the debtor with time and ability to restructure bal- attempt to unwind them under the applicable insolvency laws. ance sheet and They will also provide the backdrop for any negotiations, as the constituencies will measure any proposed recovery against These goals point out the primary reasons why a Chapter 11 the possible results from an in-court insolvency proceeding. case is substantially different from a case under chapter 7. In Furthermore, as more and more cross-border financing trans- a case under chapter 7 the debtor’s pre-petition management actions are being created, understanding the interplay between is replaced by a chapter 7 trustee whose sole purpose is not multiple insolvency regimes, and how one jurisdiction may the preservation of the debtor as a going concern but rather give effect to an insolvency proceeding commenced in anoth- the of the debtor’s assets for the highest price and er jurisdiction, will become increasingly important to the the distribution of the proceeds of sale in strict conformity negotiating dynamics in any attempt to craft an out-of-court with the absolute priority rule. Chapter 7 cases generally resolution to a "stressed" or "distressed" situation. involve businesses that have already ceased operations, and thus where there is no going concern value to preserve. Owing to internationalisation and the vast differences between insolvency regimes throughout jurisdictions, an Petitions and Automatic Stays overview of each of the regimes will now be provided for cer- In the US, a case is commenced by filing a peti- tain key markets throughout Europe and Asia Pacific. The tion, which is a form document listing estimates of the U.S is taken as a starting point, with a detailed look at debtor’s assets and liabilities and indicating its intention to Chapter 11 and Chapter 15. reorganise (Chapter 11) or liquidate (Chapter 7). Petitions can be either voluntary or involuntary. As soon as the volun- 1. THE UNITED STATES tary petition is filed, or an order for relief on an involuntary petition is entered, an automatic stay is in place. CHAPTER 11 OVERVIEW An automatic stay in the US Bankruptcy Code is a nation- Introduction to Chapter 11 wide injunction which comes into effect automatically and Chapter 11 of the US Bankruptcy Code was created with the instantly upon the filing of the petition or entry of the order intention of making the corporate reorganisation process as for relief, as the case may be, without regard to affected par-

This article was first published in The Guide to Distressed and Turnaround Investing by Private Equity International 32 The Guide to Distressed Debt & Turnaround Investing

ties’ notice of bankruptcy filing or opportunity to contest the and thereby achieve the greatest return practicable for all con- imposition of the stay. The purpose of an automatic stay is to stituencies within the bounds of the absolute priority rule. provide a breathing spell for the (DIP), so that the DIP and other parties in have time to work out United States Trustee: is an arm of the US Department of the debtor’s financial problems and negotiate a plan of action. It Justice which oversees the conduct of bankruptcy cases. The also serves as a buffer from creditors, whose actions could other- US Trustee is responsible for the of most wise potentially destroy the debtor in the creditors’ scramble for bankruptcy cases. The US Trustee system was developed to relief. ensure that bankruptcy judges were freed from holding any administrative responsibilities for the debtor.The US Trustee The automatic stay applies to all of the debtor’s property and possesses standing to be heard as a party of interest and creditors, no matter where they are located. As a practical mat- enjoys broad immunity for acts taken in its official capacity. ter, it is difficult to enforce the automatic stay (or the US Bankruptcy Court’s jurisdiction generally) against a that Chapter 11 Trustee: appointed in cases of major fraud or mis- does not do business, or otherwise have a presence, in the US. management. There is no automatic appointment of a Where a stay of actions by creditors who have no trustee in a Chapter 11 case. If appointed, the trustee may connection with the United States is important for a debtor, operate the debtor’s business during the pending Chapter 11 commencing an additional insolvency proceeding in the appro- case. Unless a creditor or other party in interest can show that priate jurisdiction may be required. In most situations involving there has been fraud, gross mismanagement or other malfea- such creditors, however, frequently seek some authority sance, management will usually remain in place. from the bankruptcy court to pay foreign creditors (or at least those with no connection with the United States in the ordinary Official Committees: it is the norm for a committee of unse- course of their business). cured creditors to be formed during Chapter 11 cases. Such committees are typically composed of the seven unsecured Parties in Interest creditors with the largest unsecured claims who are willing to The US Bankruptcy Code has a very broad definition of “parties serve. The committee has duties to all unsecured in interest”, who are the parties that have a right to be heard in creditors, but not to the other constituencies in the case. The a Chapter 11 case. Generally, any creditor (whether the credi- US Trustee may appoint as many additional committees as it tor’s claim is fixed, contingent on a future event, disputed or deems appropriate to assure adequate representation of cred- undisputed) and any stockholder (referred to in the Bankruptcy itors or of equity secure holders. In addition, a court may Code as an “equity holder”) has a right to be heard by (though this is not frequent) direct the United States Trustee the bankruptcy court. Nevertheless, individual creditors or to appoint an official committee of equity holders or of shareholders generally will only come to court or negotiate with another constituency that the court determines to merit rep- the debtor on issues affecting them specifically. The rest of the resentation through an official committee. An official com- time, they will rely on the major players in the case to represent mittee has broad negotiating powers on behalf of the credi- the various constituencies. tor or shareholder body it is appointed to represent. Each official committee is generally empowered to employ, at the The major players in a Chapter 11 case are: expense of the debtor estate, accountants, lawyers and other Debtor in Possession (DIP): the debtor itself has fiduciary duties professionals to perform services for the committee. These to all of its creditors and shareholders. The DIP is supposed to professional advisors must meet a stringent standard of “dis- take those actions it believes will maximise the value of the estate interestedness” in order to serve on the matter. For instance, An Overview of Global Insolvency Regimes 33

to meet this standard, the advisor must not be a creditor of lease out of the ordinary course requires court approval, which is the debtor, meaning that claims for fees to be paid before a sought by motion, usually on at least 20 days’ notice. case is settled would disqualify the advisor from service. Cash Agent (s)/Steering Committee: a secured bank group that Cash collateral is defined as the cash and cash equivalents in generally does not constitute an “official” committee. The possession of the estate, including any proceeds, product, off- Agent bank and a handful of other with large stakes spring, rents or profits of the estate, but solely to the extent that in the will usually negotiate on behalf of the entire such cash or equivalents are subject to a valid, perfected security group of creditors and, although they cannot bind the entire interest. A DIP or a Trustee is limited in its use of cash collat- group, they can help build consensus. The bank group rep- eral. It cannot use cash as collateral unless the resents only the of its members; it does not have consents or the Bankruptcy Court authorises its use on the any obligations to other creditor constituencies. grounds that “adequate protection” is provided.

Judicial System: The US has two levels of judicial oversight The Chapter 11 Claims Process for Chapter 11 cases, the US Bankruptcy Court and the There are two types of claims that can be filed under Chapter District Court or Bankruptcy Appellate Panel. The 11: secured claims and unsecured claims. A secured claim is a Bankruptcy Judge does not enjoy life tenure once appoint- claim by a creditor that is secured by assets of the debtor in the ed, unlike most federal US judges. The District Court and event of non-payment. An unsecured claim is a claim, the pay- the Bankruptcy Appellate Panel provide alternate routes ment of which is not backed by the debtor's collateral or a of appeal from bankruptcy courts in many US jurisdic- on property of the debtor. tions. Any claims must be filed by the court-established “bar date”and Securities and Exchange Commission: has a nearly unlimited right claimants must file proof of claim asserting their entitlement to to be heard in Chapter 11 cases, but may not appeal any ruling, payment. The only exception is where the debtor, in its sched- order or decree entered in the case. This right applies even if the ule of assets and liabilities that it is required to file with the debtor has no publicly registered securities and is not otherwise bankruptcy court early in its case, schedules a given creditor’s subject to SEC jurisdiction; however, as a practical matter the claim in an amount with which that creditor agrees, and the SEC does not become actively involved in cases where no SEC schedule does not list that claim as contingent, unliquidated or jurisdiction is otherwise implicated. disputed – in that situation the creditor is not required to file a proof of claim (though it may be advisable to file the proof of Property Definition under Chapter 11 claim even in that circumstance). Under Chapter 11, property of the estate is defined as “all legal or equitable interests of the debtor in property as of the com- Any party in interest has the right to object to any proof of mencement of the case”. This includes property owned by the claim filed. Usually the bankruptcy court will adjudicate debtor, collateral, leased property, property in possession of the the validity of the disputed claim, but sometimes it will debtor and the debtor’s property in the possession of a third allow the claim to be litigated in another (non-bankruptcy) party, as well as any proceeds, rent or other profits borne from court. The other court would determine whether the debtor the debtor’s property. A debtor can use, sell or lease its property is liable on the claim and the amount of the liability, but the in the ordinary course of its business without special court claimant would then have to seek payment through the authorisation during Chapter 11 proceedings. Any use, sale or bankruptcy process. 34 The Guide to Distressed Debt & Turnaround Investing

Where a debtor has a dispute with a non-debtor and reaches where a exists, as long as assumption of the defaulted an agreement to resolve that dispute (which may involve liti- contract is conditioned upon 1) cure or adequate assurance of gation claims as well as any other claim that either party asserts prompt cure; 2) compensation for actual pecuniary damages against the other), then the settlement must be approved by from default or adequate assurance of prompt compensation; the bankruptcy court. The standard for approving a settlement and 3) adequate assurance of future performance under the is that the settlement must fall anywhere within the “range of assumed contract or lease. Some defaults do not count for reasonableness”. these purposes, however. If the DIP or trustee assumes a contract or lease and later breaches the assumed agreement, Oversecured creditors are entitled to post-petition interest up to damages will be assessed as an administrative expense claim the value of the collateral – whether the was cre- because the contract is a transaction with the estate. ated by an agreement or by statute. Unsecured or undersecured creditors’ claims for “unmatured interest” (also called post-peti- The Plan Process tion interest) are disallowed under the US Bankruptcy Code. The goal of a Chapter 11 case is to reorganise the debtor pur- suant to a plan of reorganisation. At the outset of a Chapter Certain pre-petition claims are given priority over other claims 11 case, the debtor has the exclusive right to propose a plan according to the statue. There are 10 statutory priorities, includ- of reorganisation. That initial exclusivity right lasts for 120 ing pre-petition wage and employee benefits up to $10,000 per days, but may be extended by the court for “cause”, but not employee for cases filed after October 17, 2005 and up to $4,000 beyond 18 months in cases filed after October 17, 2005. per employee for cases filed before that time. In addition, pre- After expiration of the debtor’s exclusive period, any party in petition tax claims (unless stale) are a priority claim. interest can file a plan.

In the post-petition phase, administrative expense claims and Confirming a plan of reorganisation presupposes negotiating necessary costs and expenses for preserving the debtor’s estate the plan in good faith with sufficient constituencies to max- constitute priority claims. These claims require a transaction imise the chances of successful confirmation. Generally, the with the estate or a tangible benefit to the estate. debtor would negotiate plan terms with a representative of its significant secured lenders, official committees, exit financing Executory Contracts and Unexpired Leases sources (both investors and lenders) and any other entity that A DIP or trustee can reject a contract or a lease upon showing has a unique and critical claim against the debtor. The plan that rejection is in its business judgment. Rejection does not must comply with the Bankruptcy Code requirements for equate with avoidance or termination of the contract. Instead, plan content and the proponents must comply with the rules rejection constitutes a breach of the contract that relates back to for solicitation of votes and confirmation. the date immediately preceding the petition-filing date. This allows the debtor to pay the damages for this breach of contract Classification: The plan must divide the claims and interests with “bankruptcy dollars” as an unsecured claim against the to be addressed by the plan into classes, and specify the estate. treatment for each class in conformity with the absolute pri- ority rule (subject to any agreement to the contrary). The A DIP can also assume the contract, which turns the contract absolute priority rule dictates that no junior class can receive between the debtor and the contracting party into a contract distributions until the senior classes have been paid in full. between the bankruptcy estate and the party. The DIP or the The classes generally include: Secured Claims; trustee has the right to assume a beneficial contract even Administrative Claims; Priority Prepetition Claims; An Overview of Global Insolvency Regimes 35

General Unsecured Claims (including , nonpriority the votes of insiders) must vote to accept the plan, or the employee claims, contract/lease rejection claims, any “defi- court cannot confirm the plan. ciency” claims); Contractually Subordinated Claims; Statutorily Subordinated Claims (claims for damages arising Other Confirmation Requirements include: out of the purchase or sale of a security); and Equity (includ- (a) plan must be “feasible”— the court must find that confir- ing rights to additional equity). mation is not likely to be followed by the need for further reorganisation or liquidation; Disclosure and Solicitation: Any holder of a claim (debt) (b) except to the extent that a particular claim holder has against or interest (equity) in the debtor who will not agreed to different (less favourable) treatment of its claim, receive everything it would be entitled to under applicable administrative (post-petition) claims must be paid in cash in nonbankruptcy is “impaired” and therefore entitled to full on the effective date (or when they are due); vote to accept or reject the plan. A plan proponent may (c) priority claims must receive over time payments equal to only solicit votes on a plan if it has provided a court- the value of the allowed amount of the claim (if the class has approved disclosure statement to the parties whose votes accepted) or (if the class has not accepted) must be paid in are being solicited. A disclosure statement must contain cash in full on the effective date; “adequate information” of a kind that will allow a hypo- (d) priority tax claims must be paid in full within 6 years; and thetical investor typical of the class being solicited to make (e) each holder of a claim or interest in an impaired class an informed judgment about the plan. Normally, a hearing must have accepted the plan or will receive (or retain) at least on the adequacy of a disclosure statement is held on a as much under the plan as it would in a Chapter 7 liquida- month’s notice; the court will set the deadline for ballots on tion (the “best interests test”). the plan and date of the confirmation hearing when it approves the disclosure statement. Generally, a month’s In a “”, the court may confirm the plan over the notice of the confirmation hearing is required, but the time rejection of one or more classes if the plan (1) does not period may be shortened or lengthened depending on the discriminate unfairly with respect to the dissenting class size and complexity of the case and the number of parties (which in general means that similarly situated classes entitled to vote on the plan. receive similar treatment) and (2) is “fair and equitable” with respect to the dissenting class (which generally Plan Acceptance. For a plan to be confirmed, the court must requires (i) with respect to a class of secured claims, it find that each class of claims and interests that is entitled to must receive distributions with a present value equal to the vote has accepted the plan or that the plan can be “crammed value of its interest in its collateral and (ii) with respect to down,” or confirmed over the objection of a dissenting class a class of unsecured creditors that either that class receive of claims. Acceptance by a class of claims requires accept- property (payments, securities, other assets) with a present ance by 2/3 in amount and more than half of claims in the value equal to the allowed amount of its claim (or fixed class that actually vote on the plan. Acceptance by a class of liquidation preference of its interest), or no junior class is interests requires acceptance by holders of 2/3 in amount of receiving anything under the plan). the interests in the class that actually vote on the plan. A class that is not “impaired” is deemed to accept without a Effect of Confirming a Plan vote. A class that receives nothing under the plan is deemed Once a plan is confirmed, it must be “consummated”, to reject the plan without a vote (and must be “crammed which means that the closing of the transactions called for down”). At least one impaired class of claims (not including under the plan takes place and distributions are made in 36 The Guide to Distressed Debt & Turnaround Investing

accordance with the plan terms. The date on which the and remedies at his or her disposal. A proceeding is consid- plan is substantially consummated is referred to as the ered a main proceeding if brought where the debtor’s centre “effective date”. of main interests lies – a location presumed to exist in the country in which the debtor is incorporated or registered. Confirmation and consummation of a plan results in a dis- charge of all pre-petition claims against the debtor. The Filing of a Petition – Eligibility discharge means that the reorganised debtor is not respon- New Section 1515 permits a foreign representative, such sible for paying such claims under their original terms; as a court-appointed administrator, to seek recognition of rather it is only responsible for treating the claims in the foreign proceeding in the US by filing a petition for accordance with the plan: if the plan says the claims get recognition. In order to obtain recognition of the foreign paid in full, they get paid in full, but if the plan says they proceeding, it must merely be shown that a “foreign pro- get 10 cents on the dollar in notes or it says they get noth- ceeding” has been commenced and that the petitioner is a ing, then that is all the holders of the claims are entitled “foreign representative”. to receive from the reorganised debtor. Chapter 15 changes the definitions of “foreign proceed- CHAPTER 15 OVERVIEW ing” and “foreign representative” as previously interpreted by courts in proceedings under Section 304 of the Chapter 15 of the US Bankruptcy Code was signed into Bankruptcy Code. Although the change to the definition US law on April 20, 2005. It deals with the recognition in of “foreign representative” is not particularly significant, US courts of foreign bankruptcy or insolvency proceedings the definition of “foreign proceeding” is expanded. Under and replaces Section 304 of the Bankruptcy Code in cases Section 304, three aspects of the definition of a foreign commenced more than 180 days after the date of enact- proceeding were required before ancillary proceedings ment (October 17, 2005). were recognised: (1) the foreign proceeding must have been considered as a Chapter 15 is taken from the Model Law on Cross Border “proceeding;” Insolvency prepared by the United Nations Commission (2) the proceeding must have been conducted for the pur- on International Trade Law. It is principally intended to pose of liquidation, debt adjustment, discharge or reorgan- provide a coherent procedural framework for co-operating isation; and with foreign courts in the management of the United (3) the proceeding must have been pending in a foreign States assets of a debtor involved in insolvency proceed- country where the debtor’s domicile, residence, principal ings overseas. An insolvency representative appointed by place of business or assets were located. a foreign court may petition for recognition of the foreign proceeding in a US Bankruptcy Court. Temporary reme- Along with the enactment of Chapter 15, the definition of dies are available prior to the approval of the petition. “Foreign Proceeding” was amended in three ways. First section 101(23) of the Code was amended to define a foreign proceed- After the foreign proceeding is recognised, the remedies ing as a “proceeding in a foreign country, including an interim available will depend on whether the US court determines proceeding, under a law relating to insolvency or adjustment of that the foreign proceeding is a main or a non-main pro- debt in which proceeding the assets and affairs of the debtor are ceeding. If a proceeding is determined to be a main pro- subject to control or supervision by a foreign court”. This rep- ceeding, the foreign representative will have greater rights resents an expansion of the prior definition, which had pro- An Overview of Global Insolvency Regimes 37

vided that a foreign proceeding means a “proceeding, In addition, the evidentiary requirements for recognition of whether judicial or administrative”. Courts had interpreted foreign proceedings have been simplified. New Section 1516 this to mean that an insolvency or that provides that a certified copy of the decision commencing the was not supervised by a court did not qualify as a proceed- foreign proceeding indicating on its face that such proceed- ing and was therefore not entitled to recognition under ing is a foreign proceeding and that the representative is a Section 304. foreign representative allows the court to presume that such assertions are true. Second, section 101(23) of the Bankruptcy Code was amend- ed to require that the foreign proceeding takes place “under a Effects of Filing - Temporary Remedies Available law relating to insolvency or the adjustment of ”. The ref- A representative of a foreign proceeding will be able to obtain erence to a relevant insolvency law did not appear in the prior remedies more immediately under Chapter 15 than under definition, which instead required that the proceeding was for Section 304. Under new Section 1519(a), temporary reme- the purpose of “liquidating an estate, adjusting debts by com- dies are available upon application by the foreign representa- position, extension, or discharge, or effecting a reorganisation”. tive until the petition for recognition of the foreign proceed- It would appear that, by requiring only a relationship to insol- ing has been decided by the court, so long as such remedies vency laws, the new definition is broader than the earlier defi- are “urgently needed to protect the assets of the debtor or the nition with its enumerated purposes. interests of the creditors…” Under Section 1519(a)(1), these provisional remedies can include: Third, Section 101(23) of the Code was amended by remov- (1) staying of execution against the debtors assets; ing the requirement that the foreign proceeding be com- (2) entrusting the debtor’s United States assets to the foreign menced in a foreign country where “the debtor’s domicile, representative; residence, principal place of business, or principal assets are (3) suspension of the right to transfer assets of the debtor; located”. The amended definition merely requires that the (4) provision for examination of witnesses and collection of proceeding be commenced in a foreign country. Even if a information concerning assets and liabilities; and court were to find that the particular jurisdiction was neither (5) the granting of additional relief excluding relief related to the debtor’s domicile nor the location of its principal assets, avoidance actions. it would not preclude recognition of a foreign proceeding. However, it would affect the determination as to whether All of these remedies were available under former Section the foreign proceeding should be considered a foreign main 304, either directly in the statute or as a result of case law. proceeding or a foreign non-main proceeding, as well as However, Section 1519 makes these remedies available other rights and remedies. upon request before the petition is approved, whether or not the underlying application for recognition is contro- Finally, Section 101(24) of the Bankruptcy Code was verted. Thus, Chapter 15 provides for provisional reme- amended to elaborate on the definition of a foreign repre- dies that the representative of a foreign proceeding can sentative, without significantly changing the substance of request based simply upon the filing of a petition for the definition. Therefore, it is now made clear that a foreign recognition. representative is an individual “authorised in a foreign pro- ceeding to administer the reorganisation or the liquidation Section 1506 permits the court to deny relief if it would be of the debtor’s assets or to act as a representative of such for- “manifestly contrary to the public policy of the United eign proceeding”. States”. The ability of the court to grant or terminate 38 The Guide to Distressed Debt & Turnaround Investing

relief is also modified by Section 1522(a), which requires dence to the contrary”, the location of the debtor’s registered that the court ensure that “the interests of the creditors office is the centre of its main interests. It is not clear how this and other interested entities, including the debtor, are suf- presumption will be applied in the context of an organisation ficiently protected”. with multiple registered offices, but courts may be persuaded to rely on interpretations of the same phrase found in the Effects of Recognition – Remedies Available in any European Union’s Regulation on Cross-Border Proceeding (the EU Reg.). In the end, the determination may come down If a foreign proceeding is recognised by the US Bankruptcy to a factual inquiry which leaves some potential for conflicting Court, any temporary remedy granted pursuant to proposed results. For example, in the 2003 Daisytek case, a United Section 1519 is automatically extended under new Section Kingdom judge ruled that the debtor’s centre of main interests 1521. In addition, the court may stay the commencement or was in the despite the fact that the company’s continuation of any action concerning the debtor’s assets, rights, German subsidiaries had their registered offices in . obligations or liabilities. As with temporary relief available under Section 1519, the court is empowered to grant “addition- A foreign non-main proceeding is defined in Section 1502(5) as al relief ”. These powers are not without limits, however. Section a proceeding “pending in a country where the debtor has an 1521 provides for specific limitations on available relief. For establishment”. Section 1502(2) goes on to define an establish- example, under Section 1521(d), the regulatory or police actions ment as “any place of operations where the debtor carries out a of a governmental unit may not be stayed and Section 1521(f ) non-transitory economic activity”, similar to the definition of provides that the set-off of specified financial transactions can- the term “establishment” used in the EU Reg. not be stayed. To the extent that the US Bankruptcy Court determines that a The remedies available to the foreign representative also exclude foreign proceeding is non-main, the relief granted under Section the avoidance of transfers at the time of commencement in gen- 1521 would be subject to the requirement that the court is sat- eral and the avoidance of preferential and fraudulent transfers in isfied “that the relief relates to assets that, under the law of the particular. In order to obtain a remedy on such grounds, the for- United States, should be administered in the foreign non-main eign representative would be required to commence a full proceeding or concerns information required in that proceed- Chapter 11 case, which he/she is empowered to do pursuant to ing”. Furthermore, the determination that the foreign proceed- Section 1511. ing is main or non-main is also relevant to the extent that the foreign representative seeks to commence a full Chapter 11 case The nature of the further remedies available to the representa- in order to avoid preferential or fraudulent transfers. The for- tive of a foreign proceeding will vary depending on whether the eign representative of a foreign proceeding (main or non-main) court finds the foreign proceeding to be a main or non-main for- would have standing to commence a full Chapter 11 case pur- eign proceeding. Although remedies under Section 1521 are suant to Section 1511, but is entitled to commence a voluntary generally available in the case of any recognised foreign proceed- case only if the foreign proceeding is main. If the foreign pro- ing, in granting permanent relief, Chapter 15 draws a distinction ceeding is non-main, the representative would only be able to between “main” and “non-main” proceedings. commence an involuntary case.

Section 1502(4) defines a foreign main proceeding as a pro- Effects of Recognition – Automatic Remedies in Main Proceedings ceeding in country where “the debtor has the centre of its main The representative of a foreign proceeding is afforded more interests”, and Section 1516 states that, “in the absence of evi- remedies under new Chapter 15. Under new Section 1520, An Overview of Global Insolvency Regimes 39

recognition of a foreign main proceeding triggers certain auto- Next follows an overview of insolvency laws outside the US matic remedies. In particular, recognition of a foreign and review of major markets. proceeding will trigger the automatic stay of Section 362. This would mean that no judicial proceeding against the 2. EUROPE foreign debtor can be commenced or continued in the US to the extent that the cause of action arose before the com- CENTRE OF MAIN INTEREST mencement of the ancillary case under Chapter 15. Section 362 would also prevent enforcement of judg- On May 31, 2002, the EU Regulation on Insolvency ments, and set-offs obtained before the commence- Proceedings (the EU Regulation) came into force in all ment of the case, as well as other acts to obtain control of EU jurisdictions except Denmark. Its aim was to intro- the property of the debtor’s estate. duce uniform conflict of laws rules for insolvency pro- ceedings and connected judgments. In broad terms, the It should be noted that Section 1520(4)(b) explicitly permits EU Regulation provides that the main insolvency pro- the commencement of “an individual action or proceeding in ceedings are to be opened in the EU Member State where a foreign country to the extent necessary to preserve a claim the debtor has its “centre of main interests” (COMI). against the debtor”. Thus, creditors of a foreign debtor would Main proceedings have universal scope and encompass all retain a limited right to proceed against the company in the of the debtor’s assets and affect all creditors, wherever jurisdiction where the foreign proceeding is pending and located. elsewhere. The date of effectiveness of the automatic stay is likely to be the date of recognition of the foreign proceeding COMI has become the main judicial focus in the applica- (excluding any period of interim relief ). Therefore, actions tion of the EU Regulation. The Regulation states that it that were or could have been commenced prior to the filing is presumed to be the company’s place of incorporation of the petition for recognition of the foreign proceeding will and should be ascertainable by third parties. The EU be stayed, and the date of commencement of the foreign pro- Regulation was intended to avoid forum shopping but it is ceeding itself will not be pertinent to the application of the apparent from judicial interpretation that the courts are automatic stay. prepared to apply main proceedings to groups of compa- nies, even when these are not incorporated within the EU. Section 1520 also provides certain other automatic remedies and protections. First, the foreign representative in a foreign Once main proceedings are opened in one EU state, sec- proceeding would have the ability to use, sell or lease the cash ondary proceedings may be opened in another. collateral (including cash equivalents) of the foreign debtor Secondary proceedings may be opened in any state where upon notice and hearing or upon consent of the secured party the debtor has an “establishment”, i.e., “the place where pursuant to Section 363 of the Code. Second, pursuant to debtor carries out a non-transitory economic activity with Section 549, a foreign representative would also be able to human means and goods”. These proceedings can only be avoid transfers of property of the estate occurring “post- liquidation or winding up proceedings and are limited to recognition”. Third, pursuant to Section 552, any property realisation of the debtor’s assets within that jurisdiction. acquired by the foreign debtor (that is within the territorial jurisdiction of the United States) would be free from any Given the universal effect of opening main proceedings, security interests that existed before the commencement of in many cases this has resulted in “a race to the courts” to the ancillary case. open main proceedings. If a judge can be convinced at an 40 The Guide to Distressed Debt & Turnaround Investing

ex parte hearing that the COMI of a company is in your may entitle directors to conclude there is a reasonable country, then you can establish main proceedings that prospect of avoiding an insolvent liquidation. Moreover, take precedence everywhere in the EU. there is no criminal liability for in the UK, although the offending director may be disqualified from 3. UNITED KINGDOM acting as a director or other manager of a company for a period of time. This flexibility provides a better opportuni- Introduction – The Enterprise Act of 2002 ty for achieving out-of-court than is often In the UK, the restructuring process was brought marginal- provided elsewhere in Europe. ly closer to that of the Chapter 11 process in the US through the enactment of the Enterprise Act of 2002. The UK Procedures Generally principal effect of the Enterprise Act is the elimination of In addition to liquidation (of which there are three kinds), the ability of a holder of a created after there are basically two kinds of formal insolvency proceedings September 15, 2003 to appoint an administrative receiver, commonly used for UK companies. One of these, the admin- whose duties run solely to the charge holder, or to dispose istrative , will become less common over time and of an insolvent company’s assets subject to the charge for will eventually disappear entirely as a result of the aforemen- the benefit of the charge holder. Instead, the charge holder tioned Enterprise Act provision (but for certain limited excep- will be required to commence an administration by tions in the capital markets and structured contexts). appointing an administrator whose duties will run to all An administrative receiver appointed by the floating charge creditors. holder completely displaces management, but it can – and often does – temporarily continue the operations of a com- Directors’ Duties pany. However, an administrative receivership cannot be The directors of a UK company have substantially greater used to effectuate a restructuring. Instead, the administrative flexibility than their counterparts in countries such as receiver will simply sell the assets of the company as soon as France and Germany to allow an insolvent UK company to reasonably possible – as part of a going concern if feasible, attempt to achieve an out-of-court restructuring. There is piecemeal if not – for the benefit of the charge holder. no absolute deadline by which the directors of an insolvent UK company are required to cause the company to com- Administration mence an insolvency proceeding. A director who allows a The closest parallel to a Chapter 11 proceeding in the UK is company to continue trading operating outside of any administration. As a result of the Enterprise Act, administra- insolvency proceeding when he or she knows, or should tion is becoming the major corporate bankruptcy procedure in know, that there is no prospect of avoiding an insolvent liq- the UK. An administration may be commenced in-court or uidation, risks personal liability for the company’s debts out-of-court. The company, its directors or a creditor, includ- incurred at that time and thereafter under the theory of ing a secured creditor, may apply to the court for the appoint- “wrongful trading”. ment of an administrator if the company is insolvent or likely to become insolvent. The company, its directors or the hold- The director can escape such liability by demonstrating that er of a floating charge on all or substantially all of the compa- he or she took every reasonable step that should have been ny’s assets may also appoint an administrator out-of-court. taken under the circumstances to avoid or minimise loss to creditors. In addition, continuing support from a compa- If the appointment of an administrator is sought by a party ny’s creditor group whilst a restructuring is being effected other than the floating charge holder, whether in-court or An Overview of Global Insolvency Regimes 41

out-of-court, the floating charge holder is entitled to advance the value of the collateral sold. More than 50 percent in value of notice and is given the ability to appoint its own choice as the creditors must be present in person or by proxy at the initial administrator. However, the duties of the administrator will meeting of creditors and must approve the administrator’s pro- run to all creditors, unlike those of an administrative receiver, posal for dealing with the company, and this requirement leads which run exclusively to the appointing charge holder. Under to extensive consultation between the administrator and the law, the administrator must be a “licensed insolvency practi- creditors beforehand. While a creditor’s committee may be tioner”, most of whom come from the large firms. formed, it will have no ongoing power to control the adminis- trator or the direction of the administration other than indirect- Once appointed, the administrator basically displaces the ly through its power to approve the administrator’s fees (which company’s directors and assumes broad executive authority can also be approved by the court). A reorganisation ends 12 and powers. Significantly, the Enterprise Act did not provide months after it is commenced unless it is extended by the con- for the retention in an administration of the insolvent com- sent of the creditors or by the court. pany’s management (i.e., for a DIP). Under a court approved protocol, it is possible that the administrator may leave much Administration Exit of the day-to-day management decisions to existing manage- While restructurings can be, and occasionally are, accomplished ment under the administrator’s supervision; however, the in an administration through a “company voluntary arrange- administrator retains the ultimate executive authority. ment” or “”, the more likely outcome by The administrator is charged with attempting to realise as far will be either the going-concern sale on a relatively acceler- quickly, efficiently and reasonably as possible, the following ated basis or the piecemeal liquidation of the debtor’s assets. goals in order of priority: Within administrations, these sales and are com- 1) the rescue of the company (or of its operations) as a going mon, and restructurings uncommon, for several reasons. To concern, begin with, if the administrator can meet the first two goals of 2) the achievement of a better realisation on the company’s an administration by selling the assets of the company as a assets than would be obtained in a liquidation, and going-concern at a price in excess of liquidation values, then that 3) if 1 or 2 is not reasonably practical, the realisation on assets will be the safest, and therefore preferred, course for the admin- for the benefit of secured or preferential creditors. istrator to take in most cases, regardless of the fact that certain creditors might prefer that the administrator attempt a restruc- Once an administrator is appointed, a broad automatic stay turing. Moreover, an administrator who attempts to achieve a on creditor enforcement actions will come into effect. Once restructuring will be faced with numerous practical problems. a notice of intention to appoint an administrator is given to qualifying floating charge holders, an interim stay is effective The automatic stay or moratorium does not prevent non-debtor until such times as the administrator is actually appointed, parties from exercising their right to contractual set-off. Unlike affording immediate protection for the company. in the US and certain other countries, the administrator lacks the ability to assume, or to assume and assign, an executory con- An administration will proceed with minimal court involve- tract if the non-debtor party has the contractual right to termi- ment. In particular, the administrator has the power to sell the nate the contract (including as a result of the commencement of company’s business without court review of the sale process or the administration) or to withhold its consent to the assignment court approval of the sale. The administrator is empowered to of the contract. Similarly, the administrator does not have the sell the company’s assets free and clear of the interests of a right to reject unprofitable or otherwise burdensome executory charge holder but has a duty to account to the charge holder for contracts. A moratorium or administration itself does not pre- 42 The Guide to Distressed Debt & Turnaround Investing

vent the termination of contracts, as often administration is through company voluntary arrangements (CVAs) or deemed to be an event of default and so an administrator may schemes of arrangement (Schemes). A CVA is a restructur- have to negotiate with important suppliers/ customers to enable ing arrangement between a company and its creditors pur- him to continue trading. suant to which the creditors agree to accept discounted pay- ments on their claims, which can be made over time, as an No Direct Equivalent to DIP Financing; but Priority alternative to receiving less than they would likely receive in Lending Possible a liquidation. While a CVA can be implemented out-of Moreover, neither the Enterprise Act nor prior existing UK court, a CVA is typically effectuated as part of an administra- law makes any specific provision for the US-style DIP tion because a CVA does not provide for a moratorium on lending. While lending to a company in administration is creditor enforcement actions (except for very small compa- theoretically possible, the lender will be provided with nies). Like an administration, a CVA has the advantage of nothing like the protections and security a DIP lender requiring minimal court involvement. If creditors holding at would enjoy in Chapter 11. The new will be subject least 50 percent in value of all creditor claims, and 75 percent to fixed charges and receivable assignments (factoring). or more in value of the claims of creditors actually voting (in While the administrator is empowered to grant the new person or by proxy) at a meeting held for the purpose of vot- lender liens on unencumbered assets, he or she has no abil- ing on the proposed CVA, vote in favour of the proposed ity to provide the lender with the benefit of a priming lien CVA, then the CVA is binding on all creditors who received over a fixed charge, and the administrator’s ability to obtain notice. Court approval of a CVA is not required. However, court approval to override existing negative pledges without the utility of the CVA is limited by the fact that it cannot the consent of the pledge is limited. The new loans will bind secured creditors without their consent. enjoy priority over existing floating charges if the adminis- trator accepts personal liability for the loans; however, the A Scheme is also a statutory compromise between a company administrator will generally be reluctant to accept such lia- and its creditors, and like a CVA can be combined with an bility, and even if he or she accepts such liability, the new administration. Unlike CVAs, however, Schemes are court- loans, except to the extent secured by unencumbered assets, intensive procedures which are more difficult and expensive to will share priority with other contractual obligations of the implement. Also unlike in a CVA, where all creditors vote as company incurred during the administration. part of a single class, creditors in a Scheme will vote in sepa- rate classes of creditors holding common interests. If a major- As a result, US DIP-style lending will be impossible, except ity in number of creditors holding 75 percent or more in value perhaps in the occasional case where the debtor has substan- in a class of creditors agree to support a Scheme, then once tial unencumbered assets that are free of a negative pledge. approved by the court the Scheme becomes binding on all While it is not uncommon for the existing lender or lending creditors of that class, regardless of whether or not they had group to continue to finance a company in administration, notice of the Scheme. However, like a CVA, a Scheme can- such financing is purely defensive and generally done solely not be used to bind secured creditors without their consent. for the purpose of preserving going-concern value pending a sale of the assets by the administrator as a going concern. Formerly, Schemes had an advantage over CVAs in that CVAs could not be used to bind creditors who did not have notice of Schemes of Arrangement and CVAs the meeting at which the vote on the CVA was held. However, Notwithstanding these limitations, in-court restructurings, due to a change in the law made effective as of January 1, 2003, including debt-for-equity “swaps”, are possible in the UK a CVA approved by the requisite creditor vote will also be An Overview of Global Insolvency Regimes 43

binding on all creditors who did not receive notice, although become due, with its available assets) or its management sub- such creditors will have the right to challenge the CVA in jects itself to civil sanctions. Upon a company's insolvency, any court within 28 days of becoming aware that the meeting has creditor, the commercial court or the public prosecutor may taken place. Given the relative advantages and disadvantages also properly commence an involuntary bankruptcy proceed- between CVAs and Schemes, the trend is towards using CVAs ing against it. In addition, as from 1 January 1,2006, compa- more and Schemes less. nies experiencing difficulties which they cannot overcome and which lead to their becoming insolvent on a cash-flow basis Out of Court Restructurings now Becoming the Norm are entitled (but not required) to commence certain voluntary As a result of the many practical difficulties involved in trying bankruptcy proceedings known as safeguard proceedings.The to achieve an in-court restructuring in the UK, consensual out- bankruptcy court may look back up to 18 months prior to the of-court restructurings, are the preferred approach whenever date on which it opens the bankruptcy proceedings to deter- practical. This preference is supported by the general under- mine, if such is the case, at what date during that period the standing that the commencement of an administration may be company became insolvent. destructive of value, particularly in certain industries such as telecom. Notwithstanding the difficulties in effectuating a Directors’ Duties and Lender Liability restructuring in the UK through an in-court process, a large The borrower's directors and managers can all incur liabili- and active market has developed in the UK for the trading ty if the borrower is allowed to continue transacting busi- of both senior loans and bonds. Buyers in this market include ness once it has become insolvent on a cash flow basis, with- hedge funds and other distressed debt traders, many of which out (i) filing for bankruptcy within the prescribed 45 day are US-based and including those who purchase distressed period or (ii) requesting the opening of conciliation proceed- debt with an eye to potentially acquiring equity in debt-for- ings (see below). The managers and directors would then equity restructurings. These different holders are typically subject themselves to civil liability, including liability for represented on both bank group steering committees and ad some or all of the company's debts, a prohibition against hoc bondholder committees in large restructurings. managing, directing or controlling any other company for a maximum of fifteen years, and a prohibition, for a maximum 4. FRANCE of five years, of holding any public office.

Introduction A bank which knowingly continues to lend to an insolvent The successful work-out or restructuring of loans and other French company, thereby creating or contributing to the debts owed by a French company is largely dependent upon illusion that the insolvent company is credit-worthy, sub- how quickly the parties recognise the problem and how jects itself to potential liability if such continued lending quickly they can achieve a consensual resolution prior to the were to be deemed to be a fraud of third party rights, if commencement of formal insolvency proceedings. Several the bank were deemed to have actively participated in the factors make both quick identification of the need for a borrower's management or if the security interests taken restructuring and prompt implementation of the restructuring to secure the lending were deemed to be disproportionate. imperative. Formal Processes Under French law, a company must file for bankruptcy relief Three forms of formal bankruptcy proceedings exist in within 45 days of it first becoming insolvent on a cash flow France: basis (i.e., upon it becoming unable to meet its debts, as they 1) the safeguard, the objective of which is to help in the 44 The Guide to Distressed Debt & Turnaround Investing

reorganisation of the company in order to, in the follow- itors with the debtor may be voided. If any of the above ing order: three bankruptcy proceedings are opened, creditors would a. allow the company to continue trading, be exposed to liability in the event of either (i) fraud, (ii) b. preserve employment, clear participation in the management of the debtor or if c. settle the company's liabilities; the guarantees taken as security for financing granted by 2) the judicial reorganisation, the objectives of which are them are disproportionate. to, in the following order: a. allow the company to continue trading, Limited Creditor Rights b. preserve employment, The rights and role of creditors in a French bankruptcy pro- c. settle the company's liabilities; and ceedings differ from those of creditors in a Chapter 11 case 3) the judicial liquidation, the objective of which is the in the US. With the exception of committees of EU termination of the business or the realization of the com- licensed credit institutions and of major suppliers (i.e. those pany's estate by one or more sales. whose claim on the company is at least equal to five per cent of all of the company's liabilities to its suppliers1) that are The company requests, and the bankruptcy court determines, mandatory in larger companies and may be authorized by at the outset of the case, which proceeding shall be opened. the bankruptcy judge in others at the request of the debtor A safeguard can subsequently be converted into a judicial or the judicial administrator, there are no creditors’ commit- reorganization or a judicial liquidation and a judicial reorgan- tees, the judicial administrator has no specific duties to ization can subsequently be converted into a judicial liquida- creditors, and creditors can neither propose nor vote on any tion. Once a bankruptcy case is opened, a broad automatic plan of reorganisation. A bankruptcy official will be stay will be imposed and a presiding judge will be appointed. appointed in respect of creditor claims, but his role is essen- A judicial administrator, in reorganisation cases, and a judi- tially to consult with the debtor and the judicial administra- cial , in liquidation cases, will also be appointed. tor and to communicate with individual creditors with The bankruptcy court will decide whether the judicial respect to determining the allowance of pre-bankruptcy administrator, who is charged with preserving the debtor's claims. business will supervise, assist (the most common scenario) or completely replace (except in a safeguard where the adminis- On the other hand, the presiding judge in a French bank- trator may not replace management) the debtor's existing ruptcy has extremely broad powers, both judicially and in management. The judicial liquidator, on the other hand, has the administration of the debtor’s business, as compared to powers the effect of which is that he essentially replaces the a bankruptcy judge in the United States; he must, for exam- debtor's management. ple, approve any decision to terminate employees. One of the principal responsibilities of the judicial administrator is If judicial reorganisation or judicial liquidation proceed- to submit a report to the court containing a recommenda- ings are opened, a number of agreements entered into by cred- tion between the following:

1Within these committees, it is possible to forgive or defer debt payments virtually without limitation subject to ultimate bankruptcy court approval as indicated two sentences below. Contrary to the US there is no cram down: the credit institutions committee and the major suppliers committee must approve the plan that is proposed to them by the debtor in iden- tical term at a simple majority in number representing two-thirds of the debt of the relevant committee in value, but their vote only binds the minority members of their committee. Moreover, the bankruptcy court must also consider that the plan agreed by the committees is "protective enough of the interests of all creditors" before approving this plan. Creditors that are not members of one of the two above committees, or members of the above committees in the event that the committees fail to agree on a plan in identical terms, are consulted individually (see the section entitled "No "Cramdown Equivalent"). An Overview of Global Insolvency Regimes 45

1) that the restructured business be continued by the debtor, ee claims and to administrative claims and rank only pari either with no change in ownership or with the issuance of passu with certain other claims and because negative pledges additional shares, may not be overridden without the pledgee’s consent. 2) that the business be sold as a going concern, in whole or in part, or No “Cramdown” Equivalent: Hinders Debt for Equity Exit 3) that the business be liquidated pursuant to a judicial liq- Moreover, nothing like “cram down” exists in a judicial uidation. reorganisation. The absence of such a mechanism means that it is impossible both to subject existing shareholders to a debt-for- However, the bankruptcy court is not bound by the judicial equity “swap”restructuring against their will and to compel cred- administrator's recommendation in making the decision as itors to accept any treatment of their claims less favourable than to the debtor’s fate among the above possibilities. payment in full of the face amount of their claims over a period which does not exceed 10 years (subject to the developments Likely Exit from French Insolvency Process above relating to creditors members of one of the two creditor While a restructuring or reorganisation is possible under committees). Accordingly, while a company in a safeguard or a formal bankruptcy proceedings, the likely outcome, until 1 judicial reorganisation can be “rescued” by a plan of reorganisa- January 2006 when the safeguard proceedings first became tion that provides the company with new capital via the issuance available, for a French company that became the subject of of new equity interests (with the consent of the existing equity a bankruptcy case was either the going-concern sale or holders) or debt, safeguard or judicial reorganisation provide no piecemeal liquidation of its assets. It was generally believed effective way to de-leverage a company’s debt structure or to that in excess of 90 percent of French corporate bankrupt- cancel its “out of the money” equity interests. cies ended in such a sale or liquidation rather than in a suc- cessful restructuring of the debtor. Limited Opportunities for Distressed Investors? These limitations, coupled with the fact that creditors could not Sales and liquidations were common, and restructurings propose or even vote on a plan of reorganisation (which was through bankruptcy proceedings uncommon, for several modified by the introduction of credit committees for EU reasons. To begin with, until 1 January of this year, a com- licensed credit institutions and major suppliers as of 1 January of pany could not legally commence a bankruptcy proceeding this year, see above developments), meant that no secondary until it was already insolvent on a cash flow basis. As a market developed for the trading of bonds or loans to be used by result, a financially distressed but not yet insolvent compa- parties, such as hedge funds, interested in acquiring distressed ny was precluded from using reorganisation proactively to debt as a means to acquiring a controlling equity interest in a effectuate a restructuring that would enable it to avoid company through a bankruptcy reorganisation. The develop- insolvency. In addition, a judicial reorganisation could not ment of such a secondary market was also impeded by prohibi- last longer than 20 months, not necessarily a great deal of tions and limitations imposed by French law on the ability of time for a large, complex organisation to develop a plan of institutions – other than French banks or European banks hold- reorganisation. ing the so-called European Passport – to acquire debts owed by French companies that are not yet due and payable. No DIP Equivalent US-style “offensive” or “fresh” DIP lending is generally Out of Court Solutions impractical because such loans granted in bankruptcy pro- Given the limited utility of French insolvency proceedings in ceedings rank junior in right of payment to certain employ- effectuating restructurings, consensual restructurings negoti- 46 The Guide to Distressed Debt & Turnaround Investing

ated privately between a company, its equity holders and its that, to their knowledge, the debtor was in good standing, creditors out-of-court and prior to the company’s insolvency albeit experiencing financial difficulties. were, and are likely to remain, commonly regarded as the best solution for a financially distressed company for which The conciliation proceeding (procédure de conciliation) is the a restructuring is feasible. French law also provides for two only proceeding that provides post conciliation lenders or court-assisted, to a lesser or greater extent, proceedings suppliers providing new money or new goods/services neces- (the mandat ad hoc and the conciliation) designed to help a sary for the continued operation and the survival of the busi- company achieve a consensual restructuring and thereby ness a priority right of payment if the conciliation agreement avoid bankruptcy. Both of these proceedings are conduct- is approved by the commercial court in a public judgment. ed on a confidential basis and feature the appointment by the court of an insolvency professional to assist the compa- Pursuant to this priority right of payment such new ny in its attempt to reach a consensual restructuring. money/goods/services are paid before any claims born prior to the opening of the conciliation proceedings and, in the The mandat ad hoc proceedings can only take place in the event that a safeguard, judicial reorganisation or judicial liq- absence of the subject company’s insolvency, and the con- uidations proceedings are subsequently opened, prior to any ciliation can only take place if the company has not been claim subject to such proceedings, with the exception of cer- insolvent for more than 45 days, again emphasizing the tain employee claims and the administrative expenses relat- importance of quickly identifying the need for, and pro- ing to such proceedings. In addition, if the commercial court ceeding to implement, a restructuring. approves the conciliation agreement, the agreements made in these proceedings are no longer exposed to the risk of being Both the mandat ad hoc and the conciliation are confiden- voided if subsequent bankruptcy proceedings are opened and tial and require that the debtor request that the commer- the risk that creditors party to such agreements incur a liabil- cial court appoint a professional, a mandataire ad hoc or a ity for having provided credit to the debtor is removed, save conciliateur depending on the proceeding, to help the com- manifest fraud in both cases. pany find a consensual restructuring (the mandataire ad hoc or the conciliateur are generally chosen among the 5. GERMANY licensed administrateurs judiciaries). Once this profession- al is appointed, the restructuring is consensual, even Introduction though, in a conciliation, the court may impose a two year Recent developments in German law have brought the moratorium and a reduction of their contractual interest German bankruptcy process somewhat closer to the to the then prevailing French "legal " on dis- Chapter 11 process in the US and make a restructuring senting creditors that would not agree on a consensual effectuated through an in-court insolvency proceeding more restructuring. of a possibility in Germany than in, for example, France.

The absence of insolvency implied by the existence of a Nevertheless, out-of-court restructurings, where possible, mandat ad hoc reduces, for participating creditors, the risk: are still the preferred approach. Once again, certain factors (a) that their agreements with the debtor be subsequently make both the prompt identification of the need for a voided, and restructuring and the prompt implementation of the restruc- (b) that they incur a liability for having provided credit to turing, in each case before the company becomes insolvent, the debtor as it provides them with a good faith argument very important. An Overview of Global Insolvency Regimes 47

Directors 'Duties and Lender Liability Moreover, a new extended by an existing lender in Under German law, the managing director of a company is its borrower’s crisis might be found to be extended in required to file a petition for the commencement of insolven- violation of good morals, causing not only any security to be cy proceedings without undue delay, but no later than three invalidated, but also putting the lender at risk of being liable weeks, after the company has become insolvent on either a cash to third party creditors who have relied on the borrower’s flow or basis. Moreover, the full three-week peri- continued existence. To avoid such lender liability, before od may only be utilised if the directors are making a legitimate extending credit to an existing borrower in distress, lenders effort to achieve an out-of-court restructuring. In case of an seek (mostly third party) opinions on the merits of such bor- insolvency on a cash flow basis, the only way that this three- rower’s restructuring plan. week period can be extended is if all of the creditors explicitly agree to an extension of the dates on which payments to them The Effect of Filing in Germany are due; this is not necessarily possible in an insolvency on a bal- The filing of an insolvency proceeding in Germany com- ance sheet basis. mences a "provisional administration" period, mostly lasting three months, in which a provisional administrator is A creditor can also file a petition for the commencement of an appointed by the presiding court to secure the debtor's assets, involuntary bankruptcy proceeding against a German company. to analyze the debtor's economic situation and continuing However, in doing so, the creditor needs to establish not only its viability and to make a recommendation to the presiding claim, but also the debtor’s inability to satisfy such claim when court as to whether an insolvency proceeding should be for- due. This most often requires attempts to enforce the claim mally opened. The administrator will usually be a lawyer which in turn requires a judgement on the existence of such from a firm specializing in insolvency practice. During this claim. Therefore, creditors’ filings are rarely seen in Germany. provisional administration period, the debtor is protected by Moreover, banks mostly do not take that ultimate step against a moratorium on creditor enforcement actions and the their clients for reputational, but also liability issues as a wrong- debtor's management will usually remain in place; however, ful creditors’ filing could make the creditor liable for damages management's acts will typically need to be approved by the caused by that (which may be severe). Instead creditors mostly provisional administrator. If an out-of-court restructuring “remind”management of their duties if they want to achieve a fil- can be achieved during this provisional administration peri- ing. od, the formal opening of the insolvency proceeding can be mooted. A managing director of an insolvent company who fails to file a petition for the commencement of an insolvency proceeding At the end of the provisional administration period the pro- within the required time period will be subject to personal civil visional administrator will recommend that the court either liability for such things as the company’s social security pay- formally open the insolvency proceeding or drop the case. If ments, withholding tax obligations and value added tax obliga- the case is dropped, individual creditors will be free to tions and to criminal liability, including imprisonment. An unse- enforce their rights and the debtor’s assets. A court will only cured lender who obtains collateral security from a borrower that formally open an insolvency proceeding if it finds that the is insolvent or where insolvency (on a cash flow basis) is immi- debtor is insolvent and if it is satisfied that the debtor has nent might subject itself not only to avoidance of the security as sufficient unencumbered assets to provide for the payment of a preference but (admittedly only under special circumstances) the costs of the proceeding. The stated objective of any also to potential criminal prosecution for requesting and accept- German insolvency proceeding is the maximum realisation ing preferential treatment. on the company’s assets for the benefit of the creditors. 48 The Guide to Distressed Debt & Turnaround Investing

“Debtor in Possession” Possible ruptcy relief upon a showing that its cash flow insolvency is A company may request that its management continue in place imminent rather than actual.The continued operations of the under the supervision of a creditor’s trustee during the penden- business may be financed by loans enjoying a priority of right cy of the insolvency proceeding. This request will be grant- in repayment over pre-petition unsecured claims, and such ed by the court unless the court determines that such self- loans may even be secured by unencumbered assets. The management will unduly delay the proceedings or otherwise restructuring plan can be proposed by the company, the disadvantage the creditors, but if the insolvency proceeding administrator or by the administrator acting on the instruc- resulted from an involuntary filing by a creditor, the consent tions of the creditors. A “pre-packaged” restructuring plan is of that creditor will also be required. even possible. Theoretically, restructuring plans are unlimit- ed in scope. In addition to providing for the company’s con- The Role of Creditors tinuing existence, a restructuring plan can, for example, pro- An administrator in a German insolvency proceeding will vide for a reduction in the debtor’s indebtedness, for the sale perform his or her duties with very little court supervision. of the company’s assets, in whole or in part, and for the ter- On the other hand, creditors have a significant role to play. mination of unprofitable activities. Creditors, for example, can replace the court-appointed administrator with their own choice for administrator at the If a restructuring plan is proposed, creditors will be organised mandatory first meeting of the creditors following the formal into “groups” (such as trade creditors, bank creditors and opening of the insolvency proceeding. While a creditors’ secured creditors) for the purpose of voting on whether the committee is not mandatory, one is regularly appointed in restructuring plan should be approved. A simple majority in larger cases. Such creditors’ committee has the power to number of holders and of the total amount of claims in a decide on the most significant actions by the insolvency creditor group is sufficient to constitute the approval of that administrator such as sale of relevant assets or starting or group. The restructuring plan must also be approved by the continuing major lawsuits. The creditors’ committee decides court. A “cram down”is possible, as the court can approve the by simple majority of heads, it is appointed by a majority vote plan over the rejection of a creditor group if a majority of the in the creditors’ meeting (determined on the amounts of groups have accepted the plan and if the court is satisfied that claims, not on the number of creditors). If a restructuring the dissenting creditors will receive at least as much under plan is proposed in the insolvency proceeding, creditors will the plan than they would in a liquidation. be able to vote on whether that plan should be adopted, and while creditors cannot generally give binding instructions to Since 2002, in-court restructurings have become more com- the administrator, they can collectively instruct the adminis- mon in Germany. Nevertheless, as an insolvency proceeding trator to propose a restructuring plan. in Germany is still more likely to end with the going concern sale or piecemeal liquidation of the debtor's assets than with Restructuring Plans a restructuring, in-court restructurings are still generally nei- The new German insolvency law, adopted in 1999, provides ther the debtor’s nor the creditors’ first choice. the opportunity to propose a restructuring plan, a corporate rehabilitation alternative to the two traditional outcomes of a While “DIP-style” lending is a theoretical possibility, a German bankruptcy: the sale of the company’s assets as a German debtor lacks the ability to provide a DIP lender with going concern and the piecemeal liquidation of the compa- a “priming lien” with priority over pre-petition secured inter- ny’s assets. A company seeking to take advantage of this new ests, cannot override negative pledges without the pledgee’s ability to do an in-court restructuring can now file for bank- consent (which however only results in a breach of such neg- An Overview of Global Insolvency Regimes 49

ative pledges without the DIP loan or the security granted company through a bankruptcy restructuring. The devel- for it being affected) and cannot borrow money without the opment of such a secondary market has been delayed for consent of the creditors assembly or the creditors’ committee. some time by the fact that German banks do not normal- As a result, in practice the financing necessary to enable a ly sell their loans to third parties because of the close his- debtor to attempt to propose a restructuring only comes from torical relationships between German banks and their existing creditors who support such attempt. borrowers, and bank secrecy, confidentiality and data pro- tection issues that would likely arise if the loan was sold Limited Moratorium without the borrower’s consent. This has changed as solu- Although there is a continuing moratorium on certain creditor tions were found to cope with bank secrecy, confidentiali- actions during the pendency of an insolvency proceeding, once ty and data protection issues. the formal proceeding has been commenced there are significant exceptions to this moratorium; for example, creditors with real Consensual restructurings negotiated privately between a com- estate security can foreclose on their collateral and factors can pany, its equity holders and its creditors out-of-court and prior proceed to collect receivables assigned to them. to the company's insolvency are commonly regarded as the best solution for a financially distressed company for which a restruc- No Debt for Equity Exit Without Shareholder Consent turing is feasible. Due to heightened concerns about lender lia- Finally, a restructuring plan cannot be used to achieve a debt- bility, however, German banks in recent years have become for-equity “swap” restructuring without the consent of the somewhat less likely than in times past to participate in restruc- company’s existing shareholders (although this impediment turings that involve additional funding obligations and the tak- can sometimes be overcome via an auction of the debtor’s ing of equity and more likely to enforce their security (which shares if the shares are pledged to a lender with such lender opens the door for foreign institutions to step in as new lenders). bidding its claims in the auction, and thereby acquiring the shares itself ). It should be noted that debt-for-equity swap 6. EAST ASIA transactions with German corporate entities are subject to restrictions under mandatory German company law, in Most jurisdictions in East Asia present challenges to the reali- particular, the issuance of new shares in consideration of a sation of value from troubled enterprises different than those in release of debt requires an audit of the company by an Europe and the United States. Although each jurisdiction has independent auditor appointed by the competent court, its own particularities, there are a number of common attrib- which must evidence that the (released) claim of the cred- utes. itor is fully valuable and enforceable, before new shares are • Despite the variety of social systems and economies, there issued and the nominal capital of the is generally is a preference for out-of-court consensual solu- increased accordingly. Thus, the creditor needs to make tions. Governments are reluctant to support foreign credi- sure that the value of the claims to be contributed is not tors’ use of domestic courts to enforce claims against domes- over-estimated. tic obligors. Domestic creditors in East Asia prefer “tradi- tional” solutions. The Distressed Investing Market in Germany • Large business groups in East Asia enjoy considerable politi- Growingly, a secondary market develops in Germany for cal influence. If government support is not available on the trading of bonds and loans that can be used by parties, acceptable terms, governments are likely to suggest “bro- such as hedge funds, interested in acquiring distressed kered” solutions, sometimes involving combinations with debt as a means to acquiring a controlling interest in a other, healthier domestic groups. 50 The Guide to Distressed Debt & Turnaround Investing

• There is little transparency. Public companies usually are con- Malaysia and Taiwan present examples of court systems trolled by families or groups which use cross-holdings to that can work and legislation which can permit of quick maintain effective control with the public float reflecting only solutions on bases readily recognisable to Anglo- a minority interest. Related party transactions can mean the American and continental European creditors. Again, control over the key asset such as land or inputs are main- however, the political context can be decisive. If the gov- tained indirectly by the principal shareholders and revenues ernment considers a court solution appropriate, the courts diverted by marketing or distribution channels controlled by can be quick and effective. Otherwise, a consensual solu- the ultimate majority shareholders. tion may be encouraged. • Domestic banks and finance companies may act on the basis of more than purely commercial considerations either to impede Two recent cross-border insolvencies demonstrate the or support solutions offered by foreign creditors. realities which can be fairly typical in the region. • Domestic insolvency statutes often are of little practical signif- icance. Black letter statute can be important but selective Asia Pulp and Paper is the largest emerging market insol- enforcement often is the pertinent aspect. vency. A parent private incorporated in Singapore issued registered bonds and privately placed China has a relatively new and untested body of insolvency bonds in the Asia, North America and European capital law. Reflecting China’s move towards a market-based economy markets on the strength of substantial Indonesian and and its tendency to adopt reforms only after a number of iso- Chinese sub-holding company and operating company lated “test cases” have demonstrated the implications, China is revenues. Such Indonesian and Chinese entities also consciously experimenting. In the right social and political incurred substantial indebtedness. Singapore declined to context, China has permitted foreign expertise to participate accept jurisdiction over any insolvency proceeding on the and commercial discipline to prevail. In other contexts, only basis that most assets were located in Indonesia and state mandated solutions have been permitted. China. This view was adopted notwithstanding the diver- sion from commonly controlled Singapore listed public Although concepts like an “automatic stay” and “DIP financ- companies of amounts equal to more than one billion ing” can be discussed, they have little practical meaning in the United States dollars. Left to Chinese and Indonesian current context. Even when relatively sophisticated approach- courts for their remedies, creditors have accepted or are es to Non Performing Loans and asset recovery models have accepting a “traditional” solution which leaves the share- been adopted, the political realities have set in leading to effec- holders in control of the group. tive deadlocks. In contrast, the Swiss cement , Holcim, suc- In contrast, Indonesia has had insolvency legislation since the ceeded in acquiring control of one of Indonesia’s largest Dutch colonial period. Although it is invoked occasionally for public cement producers on an out-of-court basis on terms minor domestic cases, the number of cases involving cross- negotiated with that company’s creditors and principal border claims can be counted on one hand. Except one case in shareholders. Having revealed that approximately two which the Bakrie Group chose to adopt a form of “pre-pack- hundred fifty million United States dollars carried on the aged” solution, foreign creditors have generally been blocked books of PT Semen Cibinong as cash did not, in fact, rep- on procedural or other grounds. Courts are widely perceived resent cash, the principal shareholders apparently deter- as corrupt and ineffective. As a result, obligors have little need mined that their negotiations either with the Indonesian for an “automatic stay” and “consensual” solutions are the rule. Bank Restructuring Agency in respect of other outstand- An Overview of Global Insolvency Regimes 51

ing obligations would benefit from a sale a portion of the turings as Eurotunnel, Gate Gourmet, Jarvis and British Energy. He is recog- proceeds of which would be paid to that agency. Having nised as an expert in his practice by Legal 500, Chambers and IFLR 1000. acquired strategic stakes in the debt of PT Semen Cibinong on the secondary market, Holcim was able to negotiate terms Mark Broude ultimately acceptable to all parties for both the restructuring Mark Broude has extensive experience in business reorganization, creditors’ rights, of the company’s debt and the acquisition of a controlling representation of unsecured creditors committees and bank finance working. Mr. stake in its equity. Broude also represents bondholders and debtors, including the Trump hotels and casinos. Mr. Broude is representing the Official Committee of Unsecured IN SUMMARY Creditors in the bankruptcy cases of Delphi, Inc. He is recognized as an expert in his practice by Chambers. As many restructurings now touch upon more than one market, it is no longer sufficient to just have the knowledge Jake Redway of insolvency laws in one jurisdiction. In particular, as we Jake Redway acted for the creditors committees in restructuring the obligations of have just explained, the differences in global insolvency laws the Republic of Colombia as well as the principal shareholders of several are boundless which leads to widespread confusion, with Indonesian banks in reaching settlements with the Indonesian Bank most companies having subsidiaries and investors spread Restructuring Agency. Jake also acted for Holcim Ltd in the acquisition and throughout the globe. It is hoped that this overview provides restructuring of PT Semen Cibinong. some clarity into the differentiators of just some of the key markets and to the legal meaning of insolvency. I

Hervé Diogo Amengual Hervé Diogo Amengual advises the various French and international parties involved in business reorganizations, corporate rescue and recovery (the compa- ny, its managers or shareholders, lenders or other creditors, prospective pur- chasers), whether out-of-court or in bankruptcy proceedings. He is known for working on major restructurings such as Eurotunnel, KPNQwest and Infogrames. He is recognised as an expert in his practice by Chambers and IFLR 1000.

Frank Grell Frank Grell specialises in advising banks, note holders, insolvency practitioners and companies on all areas of German insolvency, restructuring and distressed debt. He is known for working on such high profile restructurings as AGIV Real Estate, Callahan Kabel NRW, Deutsche Steinzeug, Kiekert, Peguform, Schefenacker, TMD Friction, Vivanco Gruppe and Walter Bau.

John Houghton John Houghton specialises in advising banks, note holders, insolvency practition- ers and companies on all areas of insolvency, reconstructions, corporate rescues and general corporate recovery. He is known for working on such high profile restruc-