Harmonisation of insolvency avoidance in Europe

This article continues our Law-Now series "Harmonisation of Insolvency Laws in the EU" in which we provide an overview of the articles addressing insolvency avoidance actions of the draft EU directive.

As explained in the first part of the series, the differing national insolvency regulations of the 27 EU member states creates risks for investors, who will have to consider their investments in light of possible business failures and the resulting exposure to monetary losses.

On December 7, 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. The proposal is now undergoing legislative procedure.

Divergent rights of avoidance

A key point of the directive is the EU-wide introduction of the avoidance of legal acts that are detrimental to all creditors. The current differences in member states' avoidance regulations highlight the necessity of a minimum level of harmonisation of insolvency regulations in Europe.

For example, satisfaction through compulsory enforcement can be contested in Germany, France, Portugal, Poland and Sweden. Satisfaction, however, cannot be contested in England, the Netherlands, Spain, Malta, the Czech Republic or Slovakia. The requirements for the facts of the case also differ considerably. The time limit for avoidance varies greatly from state to state. The period for avoidance with intent is one year in Slovenia, ten years in Croatia and Germany, whereas there is no time limit in England, Portugal, Denmark and Finland.

Therefore, in cross-border insolvencies, it is not uncommon for situations to arise in which the legal act in question is voidable under the law of the state in which insolvency proceedings were opened, but not under the law of the other member state involved. According to Article 16 of the EU Insolvency Regulation, the opposing party can then prove that a legal act is governed by the law of a member state – other than the member state in which the proceedings were opened – that deems this act unavoidable. These cross-border cases make it difficult to correctly assess the legal situation and the prospects of success of a lawsuit. Thus, Title II of the draft directive contains minimum harmonisation provisions aimed at protecting the insolvency estate against the illegitimate removal of assets conducted prior to the opening of insolvency proceedings.

Content of Title II – Avoidance actions

Chapter I – General provisions regarding avoidance actions

Article 4 and Article 5 of the draft lay down the general provisions for voidness, voidability or unenforceability of legal acts that are detrimental to the general body of creditors. Article 4, the general prerequisite for avoidance actions, articulates that member states must ensure that legal acts, which have been passed prior to the opening of insolvency proceedings to the detriment of the general body of creditors, can be declared void under the conditions laid down in Chapter 2 of this Title, meaning the following Articles 6 to 12. According to Article 5, member states may introduce or maintain rules that ensure a higher level of protection of creditors, for instance, by providing for more avoidance grounds. This is crucial for states whose avoidance rights are more extensive, as well as the creditors who rely on their protection. The draft aims at providing a common basic standard of protection.

Chapter II – Specific conditions for avoidance actions

Article 6 (1) states that legal acts benefitting a creditor or a group of creditors by satisfaction, collateralisation or in any other way can be declared void if they come into force within three months prior to the submission of the request for the opening of insolvency proceedings, or after such a request. Article 6 (2) extends the parameters for the case of a congruent cover in which case the conditions of Article 6 (1) need to be satisfied and the creditors must be aware of the debtor's financial situation or the opening of insolvency proceedings. Under Article 6 (3), member states must ensure that certain legal acts cannot be declared void.

Article 7 addresses legal acts against no consideration or manifestly inadequate consideration. For these legal acts, the deadline for avoidance actions is extended to one year before the application to open insolvency proceedings. The Article expressly excludes donations and gifts of symbolic value.

For legal acts by which the debtor acts intentionally detrimental to creditors, Article 8 states that the acts are voidable under the conditions that they came into force four years prior to the insolvency application and that the other party knew or should have known of the detrimental intent to the creditors.

Chapter III – Consequences of avoidance actions

The general consequences of the avoidance actions are summarised under Article 9, which also deals with the protection of the insolvency estate and insolvency creditors. In particular, the compensation of the contested legal act to the insolvency estate, the limitation period (three years from the opening of proceedings), the assignment of claims and offsetting against the estate are addressed.

Article 10 addresses the rights of the party, which originally benefitted from the legal act that has been declared void, and their compensation or refund.

The liability of third parties as well as their heir or universal successor is ensured through Article 11. Individual successors are liable if they acquired the asset against no or a manifestly inadequate consideration or knew of the circumstances on which the avoidance action is based.

As Article 12 clarifies, provisions of this Title will not affect Articles 17 and 18 of Directive (EU) 2019/1023. These concern the protection for new financing and interim financing as well as other transactions in connection with the restructuring of European companies.

Outlook

Member states are now in intensive negotiations over the EU Commission's draft Harmonisation Directive. As with many European legislative processes that aim to harmonise different legal systems, the difficulty lies in finding a "common denominator" since some member states find it difficult to move away from their firmly established principles of insolvency law.

There is little doubt, however, that the Commission's proposal will be adopted although its exact form remains to be seen and it is possible that proposal will not be adopted until after the European elections in June 2024.

Since the current directive is only a partial harmonisation, further attempts by the EU Commission to harmonise topics that are still largely excluded in the Harmonisation Directive can be expected in the near future. This applies in particular to the definition of the grounds for opening proceedings.

For more information on insolvency avoidance actions in the EU directive, contact your CMS client partner or these 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.

To read all the articles, please click here.