EU proposes Directive on harmonisation of insolvency law

The lack of harmonised insolvency laws has long been regarded as one of the greatest obstacles to the free movement of capital in the EU in general and to cross-border investments, insolvency proceedings and restructuring in particular. On 7 December 2022, the European Commission published a draft directive harmonising certain aspects of insolvency law with the aim of facilitating distressed M&A and reducing legal uncertainties for investors in cross-border investments.

In this introductory article to our new Law-Now series "Harmonisation of Insolvency Laws in the EU", we will provide an overview of the EU Commission's draft directive, including the most important objectives and planned measures. The series itself will deal with the two exciting topics of the draft directive, "pre-pack proceedings" and "insolvency avoidance actions" and show how these topics are being discussed in the Member States and what the situation is like in individual non-Member States.

This article provides an overview of the EU Commission's draft directive, including the most important objectives and planned measures.

Uneven insolvency laws hinder free EU capital movement

Until now, the national insolvency regulations of the EU's 27 member states have differed massively in some cases, leading to different results, especially regarding the duration of proceedings, the proceeds of realisation and the costs of proceedings. Lengthy insolvency proceedings, low realisation proceeds and high procedural costs not only affect the efficiency of the liquidation of the insolvency estate, but also the determination of the amount of the risk premium to be expected on an investment. The lower the efficiency of the national insolvency regime, the higher investors will set the risk premium, all other things being equal. A high-risk premium increases the cost of capital for the company and discourages investors from lending where the risk is particularly high. This, in turn, limits the choice of financing options available to the company and, more generally, limits its ability to raise affordable finance to expand its business.

The different national insolvency regimes are therefore particularly problematic for cross-border investors since they potentially must consider 27 different insolvency laws when evaluating an investment opportunity outside their home member state. This leads to great legal uncertainty, especially for investors who do not have the means to have a multitude of insolvency regimes assessed.

Furthermore, the different national insolvency regimes lead to an uneven playing field as investments in member states with more efficient insolvency regimes are seen as more attractive than comparable investments in member states with less efficient insolvency regimes. In addition, companies in member states with more efficient insolvency regimes gain access to cheaper financing, which also gives them a competitive advantage over companies from other member states with less efficient insolvency regimes.

Proposal for a directive on the harmonisation of insolvency law

The draft directive is divided into nine titles dealing with the following subjects:

Title I contains general provisions on the scope of application and definitions.

Title II contains minimum harmonisation provisions aimed at protecting the insolvency estate against the illegitimate removal of assets conducted prior to the opening of insolvency proceedings. They lay down the general requirements for voidness, voidability or unenforceability of legal acts that are detrimental to the general body of creditors. Member states may introduce or maintain rules that ensure a higher level of protection of creditors, for instance, by providing for more avoidance grounds.

Title III contains rules on the tracing of assets belonging to the insolvency estate (referred to as "asset tracing").

Title IV deals with "pre-pack proceedings", in which the sale of the debtor’s business (or part of it) are prepared, negotiated (referred to as the "preparation phase") and executed (referred to as the "liquidation phase") before the formal opening of insolvency proceedings. In order to avoid fire sales or what is known as the "Phoenixism" phenomena, the draft directive provides member states with the possibility to either have the sale process conducted in the (normally confidential) "preparation phase", which is competitive, transparent and fair, or to hold a fast public auction in the "liquidation phase" after the opening of formal proceedings. The debtor should remain in possession of the business’s assets and affairs throughout the proceedings. It is assisted in the preparation phase by a monitor who is appointed as insolvency practitioner in the liquidation phase.

Title V contains minimum harmonisation provisions dealing with the obligations of the company management to file an application for the opening of insolvency proceedings in due time. It provides a time limit for the fulfilment of this obligation and links this to civil liability. Again, member states are free to maintain or introduce stricter obligations for the management of insolvent companies.

Title VI contains rules on simplified winding-up proceedings for microenterprises. The aim is to ensure an orderly liquidation of microenterprises, including those without assets, in a speedy and inexpensive procedure by simplifying the process and reducing the associated administrative costs. For example, as a rule, no insolvency practitioner should be appointed and the debtor should remain in possession of the business’s assets and affairs throughout the proceedings.

Title VII contains provisions on the creditors' committee. The aim is to strengthen the position of creditors in the proceedings by ensuring that a creditors' committee is formed if the creditors' meeting agrees and by providing for minimum harmonisation rules on key aspects such as the appointment of members and the composition of the committee, the working methods, the function of the committee and the personal liability of its members.

Title VIII provides for measures to strengthen the transparency of national insolvency laws on insolvency proceedings. Member states are required to draw up and regularly update a clearly defined, standard factsheet with practical information on the main features of their national insolvency regimes. The factsheet has to be made available on the e-Justice Portal.

Title IX contains the final provisions of the proposed directive.

Outlook

Currently, member states are intensively negotiating the draft directive. There is little doubt that the proposal will actually be adopted, but what form it will take and, above all, when it will be adopted remain to be seen. It is possible that it will not be adopted until after the European elections in June 2024.

For more information on this directive, contact your CMS client partner or local CMS experts.

This article is part of our Law-Now blog series "Harmonisation of Insolvency Laws in the EU", which will provide an overview of the EU Commission's draft directive, including the most important objectives and planned measures. The series itself will deal with the two exciting topics of the draft directive, "pre-pack proceedings" and "insolvency avoidance actions" and show how these topics are being discussed in the Member States and what the situation is like in individual non-Member States.