By Urs Peter Gruber, professor at the University of Mainz and Jean-Luc Vallens, honorary judge, former associate professor at the University of Strasbourg
1. The 2019 Aachen Treaty on Franco-German cooperation and integration
Further to a joint resolution adopted by the German Bundestag and the French Assemblée nationale on 22 January 2018 and a treaty on Franco-German cooperation and integration signed on 22 January 2019, a draft “European Business Code” was launched and overseen in France by the Henri Capitant association, chaired by Professor Dupichot (http://www.codeeuropeendesaffaires.eu).
This ambitious project covers all areas of business law (such as the law on security interests, competition, transport law and trademarks). Insolvency law is one area where harmonisation is feasible and helpful.
European legislators themselves would also like the laws to converge: in 2019, the European Union adopted a Directive on prevention and insolvency which requires Member States to adopt numerous common rules (Directive (EU) 2019/1023 of 20 June 2019). The countries have therefore amended (or are in the process of amending) their insolvency law: Germany, with the Act on the Stabilisation and Restructuring Framework for Businesses of 22 December 2020 (known as “StaRUG”) and France with the Order of 15 September 2021.
It is therefore not only a question of harmonising two sets of laws but also of incorporating the guidelines imposed by the European legislator. To this end, the draft European code comprises a body of rules that extend beyond the binational context and may be proposed to other Member States. Practitioners in other countries (Spain, Italy and Luxembourg) have also been consulted. The 2019 European Directive has been an effective driver towards genuine harmonisation of domestic laws. Lastly, we must mention a recent European Commission initiative, proposing that Member States seek ever-closer harmonisation in various specific areas of insolvency law, with the purpose of improving foreseeability, reducing the risks of forum shopping and encouraging cross-border credit.
2. The structure of the draft
The draft code incorporates the traditional elements of insolvency legislation, using a structure that is compatible with the different domestic laws, although the rules on procedure and jurisdiction or sanctions may sometimes be dealt with in other texts. The draft code offers principles, but also gives each State’s legislators a margin for assessment and adaptation. In fact, there are significant points of divergence (with regard to the respective powers of the courts and of creditors, priority, privileges and rights of creditors holding security). Insolvency proceedings are more closely linked in terms of procedural rules (the parties’ participation in hearings, notice, right of appeal and deadlines).
To achieve a body of rules likely to win sufficient consensus, it was decided that several issues should be excluded: the rules applicable to corporate groups and very small businesses, the professional and criminal sanctions and also the rules of judicial organisation (while mentioning the creditors’ meeting, determination by a competent judicial authority and the role of supervisory bodies), the rules of party representation and the specific rules for consumers or even the publicity methods.
Finally, wherever it can, the draft draws as far as possible on the provisions of the European Regulation on insolvency proceedings (EU) 2015/848 of 20 May 2015, together with the rules of territorial jurisdiction, individual notice to known creditors and the methods for filing claims.
3. Contributions from domestic law
The draft code proposes four different types of proceedings. At first glance, this may seem excessive to German legal practitioners, who have long been wedded to the unitary system of the insolvency code. However, it should be noted that, with the transposition of the 2019 directive by the aforementioned StaRUG introducing pre-insolvency proceedings, this unitary system of the insolvency code was finally abandoned in Germany. The structure of the draft code is not, therefore, as different from current German law as it first appears.
The following four types of proceedings are proposed:
- preventive out-of-court proceedings, inspired by conciliation proceedings and regulated in detail by book VI of the French Commercial Code and Title II of the European Directive of 20 June 2019 on prevention and insolvency law. From a German perspective, it is the equivalent of the “Sanierungsmoderation” (rehabilitation moderation) procedure that was recently introduced into German law through the StaRUG.
- court-supervised restructuring proceedings for distressed debtors, in the first instance mirroring safeguard proceedings in the event of financial difficulties, but now comparable to the “stabilisation and restructuring framework” in part 2 of the StaRUG.
- court-supervised rescue proceedings, similar to the proceedings governed by the French Commercial Code. From a German perspective, this can be compared to the process known as “direct management”, accompanied by a draft insolvency plan contained in the eighth part of the German Insolvency Code.
- court-supervised liquidation proceedings, which apply to insolvent debtors where rescue does not appear to be possible.
It is envisaged that it will be possible to move from one set of proceedings to another at the initiative of the debtor, the supervisory body or the practitioner.
In addition to these proceedings, the draft code provides for the ability for distressed debtors to resort to amicable, preventive out-of-court proceedings. This is subject to the debtor notifying the court with jurisdiction that it is taking this step and applying to the court to obtain a stay of individual proceedings or the approval of a business restructuring agreement. This option is inspired by one of the provisions introduced into German law by the StaRUG.
II. General principles
1. The insolvency criterion
In the draft code, insolvency is defined as the debtor’s inability to pay any undisputed debts that have fallen due. Insolvency determines whether a claim is admissible: if the debtor is already insolvent, court-supervised rescue proceedings apply. Where such a rescue does not seem possible, court-supervised liquidation proceedings apply. If, on the contrary, the debtor is not yet insolvent, it may choose between preventive out-of-court proceedings and court supervised restructuring proceedings.
Unlike under current German law, debtors who are not yet insolvent are unable to place themselves directly in proceedings requiring insolvency, at their sole discretion. In the draft code, such an option seems superfluous because preventive out-of-court proceedings and, in fact, court-supervised restructuring proceedings already contain all the necessary tools to safeguard the business.
The insolvency criterion has been adopted because it is known in all legal systems (including France and Germany) and is relatively easy to define and apply. Nevertheless, the draft code does not use the (complex and controversial) criterion of the over-indebtedness of the business.
2. The debtor’s powers during the insolvency proceedings
One major distinction between contemporary insolvency laws concerns the rights of an insolvent debtor during the proceedings: it is a matter of supervising its powers as part of a rescue, for which the debtor is best able to prepare itself. Inspired both by the “debtor in possession” concept from the US Bankruptcy Code and self-administration under the German Insolvency Code, the draft therefore adopts the principle of a debtor’s right to continue to manage its business. This concerns court-supervised restructuring and court-supervised rescue proceedings, as regards day-to-day management of the business. This management is overseen by a practitioner appointed by the judicial authority. The judicial authority can only appoint the insolvency practitioner as a “joint manager” as part of a court-supervised rescue, which the French code categorises as “assistance”.
3. Management and termination of existing contracts
As a general rule, the commencement of collective proceedings has no direct impact on existing contracts. These will remain in effect by operation of law.
However, on certain conditions, debtors or even insolvency practitioners have the option to terminate a bilateral contract that has been performed only partially or not at all. In preventive restructuring or court-supervised rescue proceedings, this option is subject to the condition that the contract does not further the pursuit of the activity of the business or that its performance constitutes an imminent risk to the business and that it does not excessively damage the contracting partner’s interests. The purpose of this rule is to seek to strike a fair balance between the interests of the creditor and the contracting partner.
However, the ability to unilaterally terminate certain contracts would be incompatible with the contracting partner’s interests. In such cases, the termination right is removed and such contracts remain in effect by operation of law. This affects employment contracts and licensing agreements. Furthermore, the draft code provides for a specific rule for leases.
4. Verification of liabilities
An essential stage in insolvency proceedings, the verification of liabilities enables us to establish how indebted the debtor is and to prepare a restructuring plan. It is addressed in the draft code as part of court-supervised restructuring, rescue or liquidation proceedings. Notice to creditors is governed by reference to the corresponding provisions in the European Regulation on insolvency proceedings: notice in a legal publication and through an entry in an insolvency register and individual notice to known creditors. Each State is responsible for making regulations regarding the formalities and deadlines to be observed. The insolvency practitioner is exclusively responsible for notifying the creditors accordingly. It is proposed that the verification and acceptance of debts be entrusted to the insolvency practitioner, and that provision be made for its decisions to be appealed before the judicial authorities. Furthermore, as part of a court-supervised liquidation, the verification would only concern claims filed that are likely to be paid having regard to the estimate of the liabilities. The objective is to lighten the workload of the practitioner and judicial authority. The sanction for failing to file a claim is set by the domestic law of each State. This may also be the case for the requirement or dispensation from filing a claim, from which certain creditors, such as those owed maintenance or salaries, benefit under French law.
5. The realisation of assets
The insolvency practitioner is responsible for selling the debtor’s assets and movable and immovable property rights under the supervision of the judicial authority or, if domestic law so provides, a creditors’ committee. The insolvency practitioner may, with the authorisation of the judicial authority, sell the whole´business or shares of the debtor company at any point in the proceedings.
III. Restructuring and rescue plans
1. Class formation
Restructuring and rescue plans play a key role. The draft code makes class formation compulsory where the distressed business has turnover and employee numbers greater than the thresholds set by domestic law.
The rules regarding class formation voting on a plan have been inspired by German law. Under the draft code, a distinction needs to be drawn between various categories of creditors: at least one class of preferential creditors (if preference is provided for by domestic law), a class of creditors holding security over assets and a class of non-preferential creditors. There may be another class consisting of public creditors and social bodies. Domestic law can provide for additional classes. Creditors in each class must receive equal treatment in proportion to their claims.
If classes of creditors are not put in place (below the thresholds set by domestic law) the insolvency practitioner will consult the creditors on the proposed restructuring plan. The judicial authority or, if domestic law so provides, the creditors’ meeting, will rule on the draft plan. The intention behind this rule is to help small businesses to make use of a plan.
2. The required majorities; cross-class cram down
In the event of class formation, the judicial authority will approve the plan when the majority of classes have approved it by a majority representing two-thirds of the claims in question.
Where the required majorities have not been reached, a cross-class cram down may take place under the code. The agreement of a class of voting creditors is deemed to have been obtained if the following three conditions are met:
- the treatment reserved by the plan for members of this class does not appear to be less favourable than that from which they would benefit in the absence of the plan;
- the members of the relevant class will share equitably in the division of the financial value under the plan; and
- at least one of the classes, other than a class of holders of capital or any other class which, after the value of the business as a going concern has been determined, would have no right to any payment.
In the context of equitable sharing in the division of the financial value of the business according to the provisions of the plan, the absolute rule of priority applies: the agreement of a class of creditors that is not entirely satisfied by the plan may be replaced only where the plan would not provide for any payment for the members of the subordinated classes.
3. Conversion of debts into capital
Under the draft code, a plan may allow creditors to convert their claims into shares or corporate interests in the debtor company. In such cases, the shareholders form a class to vote on the restructuring or rescue plan. Where the vote rejects the plan, a cross-class cram down as described above would still be possible (III.2.).
4. Approval of the plan by the judicial authority
Approval of the plan may only be rejected in certain circumstances, particularly if the dissenting creditors are disadvantaged by the plan in terms of what they would receive in the event of a court-ordered liquidation, if these creditors suffer excessive, disproportionate or unjustified harm or if the plan does not respect the absolute order of priority unless the disadvantaged class voted in favour of the plan.
Approval of the plan by the judicial authority means that it is enforceable against everyone.
IV. Specific issues
The draft code is restricted to setting out general principles in accordance with which suppliers of goods may exercise a right to make a claim if they have not been paid when insolvency proceedings are commenced, where their right is based on a rental agreement, leasing agreement or sales contract with retention of title. The supplier must apply to the insolvency practitioner within the deadline for filing claims and the practitioner’s decision may be appealed before the judicial authority.
However, the French Commercial Code limits the right to claim to assets that have not been paid for and to the resale price not yet paid by the subsequent purchaser, whilst German law allows suppliers to claim for unpaid goods in the hands of the subsequent purchaser. In light of the differences noted, the draft does not provide any more detail regarding the terms of a claim for the goods in respect of which claims may be made.
2. Actions to set aside
The regulations in relation to actions to set aside is based on striking a reasonable balance between diverging interests: on the one hand, the collective interest of creditors who seek to safeguard and increase the assets and on the other hand the protection of good faith and legal security. As a general rule, an act may be set aside if the debtor was insolvent at the date of the act and if, on that date, the creditor knew, or should have known, or if a claim to commence insolvency proceedings had been submitted.
The application to set aside is made by the insolvency practitioner even where the debtor or the manager has retained its authority over its assets and management of the business. The burden of proof lies with the practitioner. However, if the third party was a person who had preferential access to the debtor’s financial information, it is presumed to have known about the debtor’s insolvency. The act may only be challenged if it was made in the twelve months before the application to commence the proceedings.
In addition, in certain circumstances, it is envisaged under the draft code that there may be additional claims to set aside, particularly if the debtor intentionally caused detriment to its creditors or if the third-party beneficiary knew, or should have known, the debtor’s intention (actions by creditors to have certain transactions by their debtors declared void as prejudicial to their interests). Furthermore, it is proposed that specific rules should be laid down for the debtor’s free services or acts having procured a payment or security in relation to repayment of a loan from a shareholder.
3. The ranking of claims
The creditors’ ranking varies depending on the domestic legal system. At present, the conditions for full harmonisation are not met. Drawing on the United Nations Commission on International Trade Law (UNCITRAL) Legislative Guide, the draft code offers a general ranking which reflects most domestic systems, without taking a stance on the rankings provided for in each system of domestic law in more detail.
4. Employees’ rights
Under the draft code, proposed restructuring or rescue plans must be notified to the body representing employees. In France, this is the Social and Economic Committee. In particular, this body must be informed of offers relating to employment contracts and must be able to present its observations to the body governing the proceedings or the judicial authority. The detail is, of course, left to domestic law. It is also specified, following the example of the two domestic legal systems, that amounts owed to employees are unaffected by a plan and that the employees are, therefore, not part of the classes or groups of creditors called upon to vote on this plan.
The question of unpaid wage guarantees, in respect of which there are considerable differences between the domestic systems, is not addressed.
V. Closure of proceedings
1. Execution of the plan
The judicial authority gives the insolvency practitioner responsibility for taking the necessary action to implement the plan and to monitor its execution. The judicial authority will end the plan if the debtor does not comply with its obligations.
2. Discharge of debts
The discharge of debt mechanism has been introduced into several European legal systems, being influenced by English and US law. It operates at the end of liquidation proceedings relating to an individual entrepreneur. The discharge of debt mechanism has been part of domestic law for around 30 years. In France, it takes the form of a prohibition on creditors from pursuing individual proceedings and, in Germany, of releasing debtors from residual unpaid debts. The two legal systems differed regarding the procedure for the grant of such discharge. In France, it takes place automatically when the proceedings are closed and in Germany it follows a court decision at the end of a longer period during which the debtor has had to agree to transfer its revenue to its creditors. Under the Directive of 20 June 2019, alignment of these mechanisms is required within a maximum period of three years. The draft code naturally incorporates the European legislator’s desired change. Exceptions are provided for, to take account of the debtor’s behaviour (such as management failings and conviction for fraud) or the nature of the debts (such as maintenance claims). The draft code nevertheless chooses to give the States room for manoeuvre to tailor the exceptions applied to the general forgiveness of unpaid debts. Here, it is simply drawing from the European Directive and the US Bankruptcy Code, which allow each State to adapt exemptions to the discharge.
The authors of the draft code are fully aware that there may be other conceivable solutions to the issues addressed and that the proposals will be subject to comment and criticism. This is natural and, indeed, desirable. This draft at least shows that Franco-German, or indeed European, harmonisation of insolvency law is possible.
This Franco-German draft is part of a recent strategy undertaken by the European Commission, known as Insolvency III, with the aim of identifying the areas of insolvency law where closer harmonisation is practicable.
Urs Peter Gruber is a professor at the University of Mainz. He teaches courses including private international law, procedural law and the law relating to distressed businesses. In private international law, he is a member of Deutscher Rat, an advisory group to the German Ministry of Justice. Within the Faculty of Law at the University of Mainz, he is responsible for international relations and directs integrated courses with partner universities in Dijon, Nantes and Paris Est Créteil Val de Marne. He has built up considerable teaching experience abroad, including in the USA, China, Japan, Turkey and France. In 2017, he was a visiting professor at Sciences Po (Nancy Campus) under the Alfred Grosser Chair programme.
Jean-Luc Vallens holds a doctorate in law and is an honorary judge, specialising in commercial law and collective insolvency proceedings. He has been an Associate Professor (with accreditation to supervise research) at the University of Strasbourg. He has taught European law and international private law on the Master’s course on distressed businesses, in Paris. He also teaches at the École Nationale de la Magistrature. He is a member of the Society of Comparative Legislation and INSOL Europe. A French expert advising the European Union, he was involved in drafting the EU Insolvency Regulation and in the drafting work on the European Directive on prevention and insolvency. He was France’s representative to UNCITRAL in relation to the drafting of the Model Law on Cross-Border Insolvency and the Legislative Guide on Insolvency Law. He was a co-editor of Lamy Droit commercial.
The essay is available for download here.