Bankruptcy Overview 20100820

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INTRODUCTION

The insolvency regime or regimes that may be applicable to aparticular borrower will often be a pivotal issue in work-out orrestructuring transactions, even where the transaction isintended to be out of court.The applicable laws will determine when, for example, the directors' duties might change from

being owed to the shareholders to the general body of credi-tors, and will often determine the point at which insolvencypractitioners can look back at the antecedent transactions in anattempt to unwind them under the applicable insolvency laws.They will also provide the backdrop for any negotiations, asthe constituencies will measure any proposed recovery againstthe possible results from an in-court insolvency proceeding.Furthermore, as more and more cross-border financing trans-actions are being created, understanding the interplay between

multiple insolvency regimes, and how one jurisdiction maygive effect to an insolvency proceeding commenced in anoth-er jurisdiction, will become increasingly important to thenegotiating dynamics in any attempt to craft an out-of-courtresolution to a "stressed" or "distressed" situation.

Owing to internationalisation and the vast differencesbetween insolvency regimes throughout jurisdictions, anoverview of each of the regimes will now be provided for cer-tain key markets throughout Europe and Asia Pacific. TheU.S is taken as a starting point, with a detailed look atChapter 11 and Chapter 15.

1. THE UNITED STATES

CHAPTER 11 OVERVIEW

Introduction to Chapter 11Chapter 11 of the US Bankruptcy Code was created with theintention of making the corporate reorganisation process as

equitable as possible. The main goals of Chapter 11 are to:1) Rehabilitate financially viable businesses preserving

operations and saving jobs2) Ensure equality of distribution of value of the insolvent

company among the insolvent debtors similarly-situatedcreditors

3) Maximise the value of assets and distributions to creditors

4) Provide discharge from indebtedness and a fresh start tothe debtor

5) Provide the debtor with time and ability to restructure bal-ance sheet and business

These goals point out the primary reasons why a Chapter 11case is substantially different from a case under chapter 7. Ina case under chapter 7 the debtors pre-petition managementis replaced by a chapter 7 trustee whose sole purpose is not

the preservation of the debtor as a going concern but ratherthe liquidation of the debtors assets for the highest price andthe distribution of the proceeds of sale in strict conformity with the absolute priority rule. Chapter 7 cases generallyinvolve businesses that have already ceased operations, andthus where there is no going concern value to preserve.

Petitions and Automatic StaysIn the US, a bankruptcy case is commenced by filing a peti-tion, which is a form document listing estimates of thedebtors assets and liabilities and indicating its intention toreorganise (Chapter 11) or liquidate (Chapter 7). Petitionscan be either voluntary or involuntary. As soon as the volun-tary petition is filed, or an order for relief on an involuntarypetition is entered, an automatic stay is in place.

An automatic stay in the US Bankruptcy Code is a nation-

wide injunction which comes into effect automatically andinstantly upon the filing of the petition or entry of the orderfor relief, as the case may be, without regard to affected par-

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Mark Broude, Herv Diogo Amengual, Frank Grell, John Houghton and Jake Redway, Latham & Watkins LLP

This article was first published in The Guide to Distressed Debt and Turnaround Investingby Private Equity International


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ties notice of bankruptcy filing or opportunity to contest theimposition of the stay. The purpose of an automatic stay is to

provide a breathing spell for the Debtor in Possession (DIP),sothat the DIP and other parties in interest have time to work outthe debtors financial problems and negotiate a plan of action. Italso serves as a buffer from creditors,whose actions could other-wise potentially destroy the debtor in the creditors scramble forrelief.

The automatic stay applies to all of the debtors property andcreditors, no matter where they are located. As a practical mat-

ter, it is difficult to enforce the automatic stay (or the USBankruptcy Courts jurisdiction generally) against a creditor thatdoes not do business, or otherwise have a presence, in the US. Where a stay of actions by creditors who have noconnection with the United States is important for a debtor,commencing an additional insolvency proceeding in the appro-priate jurisdiction may be required. In most situations involvingsuch creditors, however, debtors frequently seek some authorityfrom the bankruptcy court to pay foreign creditors (or at least

those with no connection with the United States in the ordinarycourse of their business).

Parties in InterestThe US Bankruptcy Code has a very broad definition of partiesin interest, who are the parties that have a right to be heard ina Chapter 11 case. Generally, any creditor (whether the credi-tors claim is fixed, contingent on a future event, disputed orundisputed) and any stockholder (referred to in the BankruptcyCode as an equity security holder) has a right to be heard bythe bankruptcy court. Nevertheless, individual creditors orshareholders generally will only come to court or negotiate withthe debtor on issues affecting them specifically. The rest of thetime, they will rely on the major players in the case to representthe various constituencies.

The major players in a Chapter 11 case are:

Debtor in Possession (DIP): the debtor itself has fiduciary dutiesto all of its creditors and shareholders. The DIP is supposed totake those actions it believes will maximise the value of the estate

and thereby achieve the greatest return practicable for all con-stituencies within the bounds of the absolute priority rule.

United States Trustee: is an arm of the US Department ofJustice which oversees the conduct of bankruptcy cases. TheUS Trustee is responsible for the administration of mostbankruptcy cases. The US Trustee system was developed toensure that bankruptcy judges were freed from holding anyadministrative responsibilities for the debtor.The US Trusteepossesses standing to be heard as a party of interest andenjoys broad immunity for acts taken in its official capacity.

Chapter 11 Trustee: appointed in cases of major fraud or mis-management. There is no automatic appointment of atrustee in a Chapter 11 case. If appointed, the trustee mayoperate the debtors business during the pending Chapter 11case. Unless a creditor or other party in interest can show thatthere has been fraud, gross mismanagement or other malfea-sance, management will usually remain in place.

Official Committees: it is the norm for a committee of unse-cured creditors to be formed during Chapter 11 cases. Suchcommittees are typically composed of the seven unsecuredcreditors with the largest unsecured claims who are willing toserve. The committee has fiduciary duties to all unsecuredcreditors,but not to the other constituencies in the case. TheUS Trustee may appoint as many additional committees as itdeems appropriate to assure adequate representation of cred-itors or of equity secure holders. In addition, a court may(though this is not f requent) direct the United States Trusteeto appoint an official committee of equity holders or ofanother constituency that the court determines to merit rep-resentation through an official committee. An official com-mittee has broad negotiating powers on behalf of the credi-tor or shareholder body it is appointed to represent. Eachofficial committee is generally empowered to employ, at theexpense of the debtor estate, accountants, lawyers and other

professionals to perform services for the committee. Theseprofessional advisors must meet a stringent standard of dis-interestedness in order to serve on the matter. For instance,

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to meet this standard, the advisor must not be a creditor ofthe debtor, meaning that claims for fees to be paid before a

case is settled would disqualify the advisor from service.

Agent Bank(s)/Steering Committee: a secured bank group thatgenerally does not constitute an official committee. TheAgent bank and a handful of other banks with large stakesin the credit will usually negotiate on behalf of the entiregroup of creditors and, although they cannot bind the entiregroup, they can help build consensus. The bank group rep-resents only the interests of its members; it does not have

any obligations to other creditor constituencies.

Judicial System:The US has two levels of judicial oversightfor Chapter 11 cases, the US Bankruptcy Court and theDistrict Court or Bankruptcy Appellate Panel. TheBankruptcy Judge does not enjoy life tenure once appoint-ed, unlike most federal US judges. The District Court andthe Bankruptcy Appellate Panel provide alternate routesof appeal from bankruptcy courts in many US jurisdic-

tions.

Securities and Exchange Commission: has a nearly unlimited rightto be heard in Chapter 11 cases, but may not appeal any ruling,order or decree entered in the case. This right applies even if thedebtor has no publicly registered securities and is not otherwisesubject to SEC jurisdiction; however, as a practical matter theSEC does not become actively involved in cases where no SECjurisdiction is otherwise implicated.

Property Definition under Chapter 11Under Chapter 11, property of the estate is defined as all legalor equitable interests of the debtor in property as of the com-mencement of the case. This includes property owned by thedebtor, collateral, leased property, property in possession of thedebtor and the debtors property in the possession of a thirdparty, as well as any proceeds, rent or other profits borne from

the debtors property. A debtor can use, sell or lease its propertyin the ordinary course of its business without special courtauthorisation during Chapter 11 proceedings. Any use, sale or

lease out of the ordinary course requires court approval,which issought by motion, usually on at least 20 days notice.

Cash CollateralCash collateral is defined as the cash and cash equivalents inpossession of the estate, including any proceeds, product, off-spring, rents or profits of the estate, but solely to the extent thatsuch cash or equivalents are subject to a valid, perfected securityinterest. A DIP or a Trustee is limited in its use of cash collat-eral. It cannot use cash as collateral unless the secured creditorconsents or the Bankruptcy Court authorises its use on the

grounds that adequate protectionis provided.

The Chapter 11 Claims ProcessThere are two types of claims that can be filed under Chapter11: secured claims and unsecured claims. A secured claim is aclaim by a creditor that is secured by assets of the debtor in theevent of non-payment. An unsecured claim is a claim, the pay-ment of which is not backed by the debtor's collateral or a lienon property of the debtor.

Any claims must be filed by the court-established bar dateandclaimants must file proof of claim asserting their entitlement topayment. The only exception is where the debtor, in its sched-ule of assets and liabilities that it is required to file with thebankruptcy court early in its case, schedules a given creditorsclaim in an amount with which that creditor agrees, and theschedule does not list that claim as contingent, unliquidated ordisputed in that situation the creditor is not required to file aproof of claim (though it may be advisable to file the proof ofclaim even in that circumstance).

Any party in interest has the right to object to any proof ofclaim filed. Usually the bankruptcy court will adjudicatethe validity of the disputed claim, but sometimes it willallow the claim to be litigated in another (non-bankruptcy)court. The other court would determine whether the debtor

is liable on the claim and the amount of the liability,but theclaimant would then have to seek payment through thebankruptcy process.

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Where a debtor has a dispute with a non-debtor and reachesan agreement to resolve that dispute (which may involve liti-

gation claims as well as any other claim that either party assertsagainst the other), then the settlement must be approved bythe bankruptcy court. The standard for approving a settlementis that the settlement must fall anywhere within the range ofreasonableness.

Oversecured creditors are entitled to post-petition interest up tothe value of the collateral whether the security interest was cre-ated by an agreement or by statute. Unsecured or undersecured

creditors claims for unmatured interest (also called post-peti-tion interest) are disallowed under the US Bankruptcy Code.

Certain pre-petition claims are given priority over other claimsaccording to the statue. There are 10 statutory priorities, includ-ing pre-petition wage and employee benefits up to $10,000 peremployee for cases filed after October 17,2005 and up to $4,000per employee for cases filed before that time. In addition, pre-petition tax claims (unless stale) are a priority claim.

In the post-petition phase, administrative expense claims andnecessary costs and expenses for preserving the debtors estateconstitute priority claims. These claims require a transactionwith the estate or a tangible benefit to the estate.

Executory Contracts and Unexpired LeasesA DIP or trustee can reject a contract or a lease upon showingthat rejection is in its business judgment. Rejection does notequate with avoidance or termination of the contract. Instead,rejection constitutes a breach of the contract that relates back tothe date immediately preceding the petition-filing date. Thisallows the debtor to pay the damages for this breach of contract with bankruptcy dollars as an unsecured claim against theestate.

A DIP can also assume the contract, which turns the contract

between the debtor and the contracting party into a contractbetween the bankruptcy estate and the party. The DIP or thetrustee has the right to assume a beneficial contract even

where a default exists, as long as assumption of the defaultedcontract is conditioned upon 1) cure or adequate assurance of

prompt cure; 2) compensation for actual pecuniary damagesfrom default or adequate assurance of prompt compensation;and 3) adequate assurance of future performance under theassumed contract or lease. Some defaults do not count forthese purposes, however. If the DIP or trustee assumes acontract or lease and later breaches the assumed agreement,damages will be assessed as an administrative expense claimbecause the contract is a transaction with the estate.

The Plan ProcessThe goal of a Chapter 11 case is to reorganise the debtor pur-suant to a plan of reorganisation. At the outset of a Chapter11 case, the debtor has the exclusive right to propose a planof reorganisation. That initial exclusivity right lasts for 120days, but may be extended by the court for cause, but notbeyond 18 months in cases filed after October 17, 2005.After expiration of the debtors exclusive period, any party ininterest can file a plan.

Confirming a plan of reorganisation presupposes negotiatingthe plan in good faith with sufficient constituencies to max-imise the chances of successful confirmation. Generally, thedebtor would negotiate plan terms with a representative of itssignificant secured lenders, official committees, exit financingsources (both investors and lenders) and any other entity thathas a unique and critical claim against the debtor. The planmust comply with the Bankruptcy Code requirements forplan content and the proponents must comply with the rulesfor solicitation of votes and confirmation.

Classification: The plan must divide the claims and intereststo be addressed by the plan into classes, and specify thetreatment for each class in conformity with the absolute pri-ority rule (subject to any agreement to the contrary). Theabsolute priority rule dictates that no junior class can receive

distributions until the senior classes have been paid in full. The classes generally include: Secured Claims;Administrative Claims; Priority Prepetition Claims;



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General Unsecured Claims (including trade, nonpriorityemployee claims, contract/lease rejection claims, any defi-

ciency claims); Contractually Subordinated Claims;Statutorily Subordinated Claims (claims for damages arisingout of the purchase or sale of a security); and Equity (includ-ing rights to additional equity).

Disclosure and Solicitation: Any holder of a claim (debt)against or interest (equity) in the debtor who will notreceive everything it would be entitled to under applicablenonbankruptcy law is impaired and therefore entitled to

vote to accept or reject the plan. A plan proponent mayonly solicit votes on a plan if it has provided a court-approved disclosure statement to the parties whose votesare being solicited. A disclosure statement must containadequate information of a kind that will allow a hypo-thetical investor typical of the class being solicited to makean informed judgment about the plan. Normally, a hearingon the adequacy of a disclosure statement is held on amonths notice; the court will set the deadline for ballots on

the plan and date of the confirmation hearing when itapproves the disclosure statement. Generally, a monthsnotice of the confirmation hearing is required, but the timeperiod may be shortened or lengthened depending on thesize and complexity of the case and the number of partiesentitled to vote on the plan.

Plan Acceptance. For a plan to be confirmed, the court mustfind that each class of claims and interests that is entitled tovote has accepted the plan or that the plan can be crammeddown, or confirmed over the objection of a dissenting classof claims. Acceptance by a class of claims requires accept-ance by 2/3 in amount and more than half of claims in theclass that actually vote on the plan. Acceptance by a class ofinterests requires acceptance by holders of 2/3 in amount ofthe interests in the class that actually vote on the plan. Aclass that is not impaired is deemed to accept without a

vote. A class that receives nothing under the plan is deemedto reject the plan without a vote (and must be crammeddown). At least one impaired class of claims (not including

the votes of insiders) must vote to accept the plan, or thecourt cannot confirm the plan.

Other Confirmation Requirements include:(a) plan must be feasible the court must find that confir-mation is not likely to be followed by the need for furtherreorganisation or liquidation;(b) except to the extent that a particular claim holder hasagreed to different (less favourable) treatment of its claim,administrative (post-petition) claims must be paid in cash infull on the effective date (or when they are due);

(c) priority claims must receive over time payments equal tothe value of the allowed amount of the claim (if the class hasaccepted) or (if the class has not accepted) must be paid incash in full on the effective date;(d) priority tax claims must be paid in full within 6 years; and(e) each holder of a claim or interest in an impaired classmust have accepted the plan or will receive (or retain) at leastas much under the plan as it would in a Chapter 7 liquida-tion (the best interests test).

In a cram down, the court may confirm the plan over therejection of one or more classes if the plan (1) does notdiscriminate unfairly with respect to the dissenting class(which in general means that similarly situated classesreceive similar treatment) and (2) is fair and equitable with respect to the dissenting class (which generallyrequires (i) with respect to a class of secured claims, itmust receive distributions with a present value equal to thevalue of its interest in its collateral and (ii) with respect toa class of unsecured creditors that either that class receiveproperty (payments, securities, other assets) with a present value equal to the allowed amount of its claim (or fixedliquidation preference of its interest), or no junior class isreceiving anything under the plan).

Effect of Confirming a Plan

Once a plan is confirmed, it must be consummated,which means that the closing of the transactions called forunder the plan takes place and distributions are made in



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accordance with the plan terms. The date on which theplan is substantially consummated is referred to as the

effective date.

Confirmation and consummation of a plan results in a dis-charge of all pre-petition claims against the debtor. Thedischarge means that the reorganised debtor is not respon-sible for paying such claims under their original terms;rather it is only responsible for treating the claims inaccordance with the plan: if the plan says the claims getpaid in full, they get paid in full, but if the plan says they

get 10 cents on the dollar in notes or it says they get noth-ing, then that is all the holders of the claims are entitledto receive from the reorganised debtor.

CHAPTER 15 OVERVIEW

Chapter 15 of the US Bankruptcy Code was signed intoUS law on April 20, 2005. It deals with the recognition inUS courts of foreign bankruptcy or insolvency proceedings

and replaces Section 304 of the Bankruptcy Code in casescommenced more than 180 days after the date of enact-ment (October 17, 2005).

Chapter 15 is taken from the Model Law on Cross BorderInsolvency prepared by the United Nations Commissionon International Trade Law. It is principally intended toprovide a coherent procedural framework for co-operating with foreign courts in the management of the UnitedStates assets of a debtor involved in insolvency proceed-ings overseas. An insolvency representative appointed bya foreign court may petition for recognition of the foreignproceeding in a US Bankruptcy Court. Temporary reme-dies are available prior to the approval of the petition.

After the foreign proceeding is recognised, the remediesavailable will depend on whether the US court determines

that the foreign proceeding is a main or a non-main pro-ceeding. If a proceeding is determined to be a main pro-ceeding, the foreign representative will have greater rights

and remedies at his or her disposal. A proceeding is consid-ered a main proceeding if brought where the debtors centre

of main interests lies a location presumed to exist in thecountry in which the debtor is incorporated or registered.

Filing of a Petition EligibilityNew Section 1515 permits a foreign representative, suchas a court-appointed administrator, to seek recognition ofthe foreign proceeding in the US by filing a petition forrecognition. In order to obtain recognition of the foreignproceeding, it must merely be shown that a foreign pro-

ceeding has been commenced and that the petitioner is aforeign representative.

Chapter 15 changes the definitions of foreign proceed-ing and foreign representative as previously interpretedby courts in proceedings under Section 304 of theBankruptcy Code. Although the change to the definitionof foreign representative is not particularly significant,the definition of foreign proceeding is expanded. Under

Section 304, three aspects of the definition of a foreignproceeding were required before ancillary proceedingswere recognised:(1) the foreign proceeding must have been considered as aproceeding;(2) the proceeding must have been conducted for the pur-pose of liquidation, debt adjustment, discharge or reorgan-isation; and(3) the proceeding must have been pending in a foreigncountry where the debtors domicile, residence, principalplace of business or assets were located.

Along with the enactment of Chapter 15, the definition ofForeign Proceedingwas amended in three ways.First section101(23) of the Code was amended to define a foreign proceed-ing as a proceeding in a foreign country, including an interimproceeding,under a law relating to insolvency or adjustment of

debt in which proceeding the assets and affairs of the debtor aresubject to control or supervision by a foreign court. This rep-resents an expansion of the prior definition, which had pro-



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vided that a foreign proceeding means a proceeding,whether judicial or administrative. Courts had interpreted

this to mean that an insolvency or debt restructuring thatwas not supervised by a court did not qualify as a proceed-ing and was therefore not entitled to recognition underSection 304.

Second, section 101(23) of the Bankruptcy Code was amend-ed to require that the foreign proceeding takes place under alaw relating to insolvency or the adjustment of debts. The ref-erence to a relevant insolvency law did not appear in the prior

definition, which instead required that the proceeding was forthe purpose of liquidating an estate, adjusting debts by com-position, extension, or discharge, or effecting a reorganisation.It would appear that, by requiring only a relationship to insol-vency laws, the new definition is broader than the earlier defi-nition with its enumerated purposes.

Third, Section 101(23) of the Code was amended by remov-ing the requirement that the foreign proceeding be com-

menced in a foreign country where the debtors domicile,residence, principal place of business, or principal assets arelocated. The amended definition merely requires that theproceeding be commenced in a foreign country. Even if acourt were to find that the particular jurisdiction was neitherthe debtors domicile nor the location of its principal assets,it would not preclude recognition of a foreign proceeding.However, it would affect the determination as to whetherthe foreign proceeding should be considered a foreign mainproceeding or a foreign non-main proceeding, as well asother rights and remedies.

Finally, Section 101(24) of the Bankruptcy Code wasamended to elaborate on the definition of a foreign repre-sentative, without significantly changing the substance ofthe definition. Therefore, it is now made clear that a foreignrepresentative is an individual authorised in a foreign pro-

ceeding to administer the reorganisation or the liquidationof the debtors assets or to act as a representative of such for-eign proceeding.

In addition, the evidentiary requirements for recognition offoreign proceedings have been simplified. New Section 1516

provides that a certified copy of the decision commencing theforeign proceeding indicating on its face that such proceed-ing is a foreign proceeding and that the representative is aforeign representative allows the court to presume that suchassertions are true.

Effects of Filing - Temporary Remedies AvailableA representative of a foreign proceeding will be able to obtainremedies more immediately under Chapter 15 than under

Section 304. Under new Section 1519(a), temporary reme-dies are available upon application by the foreign representa-tive until the petition for recognition of the foreign proceed-ing has been decided by the court, so long as such remediesare urgently needed to protect the assets of the debtor or theinterests of the creditors Under Section 1519(a)(1), theseprovisional remedies can include:(1) staying of execution against the debtors assets;(2) entrusting the debtors United States assets to the foreign

representative;(3) suspension of the right to transfer assets of the debtor;(4) provision for examination of witnesses and collection ofinformation concerning assets and liabilities; and(5) the granting of additional relief excluding relief related toavoidance actions.

All of these remedies were available under former Section304, either directly in the statute or as a result of case law.However, Section 1519 makes these remedies availableupon request before the petition is approved, whether ornot the underlying application for recognition is contro-verted. Thus, Chapter 15 provides for provisional reme-dies that the representative of a foreign proceeding canrequest based simply upon the filing of a petition forrecognition.

Section 1506 permits the court to deny relief if it would bemanifestly contrary to the public policy of the UnitedStates. The ability of the court to grant or terminate



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relief is also modified by Section 1522(a), which requiresthat the court ensure that the interests of the creditors

and other interested entities, including the debtor, are suf-ficiently protected.

Effects of Recognition Remedies Available in anyProceedingIf a foreign proceeding is recognised by the US BankruptcyCourt, any temporary remedy granted pursuant to proposedSection 1519 is automatically extended under new Section1521. In addition, the court may stay the commencement or

continuation of any action concerning the debtors assets,rights,obligations or liabilities. As with temporary relief availableunder Section 1519, the court is empowered to grant addition-al relief . These powers are not without limits,however. Section1521 provides for specific limitations on available relief. Forexample,under Section 1521(d),the regulatory or police actionsof a governmental unit may not be stayed and Section 1521(f)provides that the set-off of specified financial transactions can-not be stayed.

The remedies available to the foreign representative also excludethe avoidance of transfers at the time of commencement in gen-eral and the avoidance of preferential and fraudulent transfers inparticular. In order to obtain a remedy on such grounds,the for-eign representative would be required to commence a fullChapter 11 case, which he/she is empowered to do pursuant toSection 1511.

The nature of the further remedies available to the representa-tive of a foreign proceeding will vary depending on whether thecourt finds the foreign proceeding to be a main or non-main for-eign proceeding. Although remedies under Section 1521 aregenerally available in the case of any recognised foreign proceed-ing,in granting permanent relief,Chapter 15 draws a distinctionbetween main and non-main proceedings.

Section 1502(4) defines a foreign main proceeding as a pro-ceeding in country where the debtor has the centre of its maininterests, and Section 1516 states that, in the absence of evi-

dence to the contrary, the location of the debtors registeredoffice is the centre of its main interests. It is not clear how this

presumption will be applied in the context of an organisationwith multiple registered offices,but courts may be persuaded torely on interpretations of the same phrase found in theEuropean Unions Regulation on Cross-Border Insolvencies(the EU Reg.). In the end, the determination may come downto a factual inquiry which leaves some potential for conflictingresults. For example, in the 2003 Daisytek case, a UnitedKingdom judge ruled that the debtors centre of main interestswas in the United Kingdom despite the fact that the companys

German subsidiaries had their registered offices in Germany.

A foreign non-main proceeding is defined in Section 1502(5) asa proceeding pending in a country where the debtor has anestablishment. Section 1502(2) goes on to define an establish-ment as any place of operations where the debtor carries out anon-transitory economic activity, similar to the definition ofthe term establishment used in the EU Reg.

To the extent that the US Bankruptcy Court determines that aforeign proceeding is non-main, the relief granted under Section1521 would be subject to the requirement that the court is sat-isfied that the relief relates to assets that, under the law of theUnited States, should be administered in the foreign non-mainproceeding or concerns information required in that proceed-ing. Furthermore, the determination that the foreign proceed-ing is main or non-main is also relevant to the extent that theforeign representative seeks to commence a full Chapter 11 casein order to avoid preferential or fraudulent transfers. The for-eign representative of a foreign proceeding (main or non-main)would have standing to commence a full Chapter 11 case pur-suant to Section 1511, but is entitled to commence a voluntarycase only if the foreign proceeding is main. If the foreign pro-ceeding is non-main, the representative would only be able tocommence an involuntary case.

Effects of Recognition Automatic Remedies in Main Proceedings The representative of a foreign proceeding is afforded moreremedies under new Chapter 15. Under new Section 1520,



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recognition of a foreign main proceeding triggers certain auto-matic remedies. In particular, recognition of a foreign

proceeding will trigger the automatic stay of Section 362. This would mean that no judicial proceeding against theforeign debtor can be commenced or continued in the USto the extent that the cause of action arose before the com-mencement of the ancillary case under Chapter 15.Section 362 would also prevent enforcement of judg-ments, liens and set-offs obtained before the commence-ment of the case, as well as other acts to obtain control ofthe property of the debtors estate.

It should be noted that Section 1520(4)(b) explicitly permitsthe commencement of an individual action or proceeding ina foreign country to the extent necessary to preserve a claimagainst the debtor. Thus,creditors of a foreign debtor wouldretain a limited right to proceed against the company in the jurisdiction where the foreign proceeding is pending andelsewhere. The date of effectiveness of the automatic stay islikely to be the date of recognition of the foreign proceeding

(excluding any period of interim relief). Therefore, actionsthat were or could have been commenced prior to the filingof the petition for recognition of the foreign proceeding willbe stayed, and the date of commencement of the foreign pro-ceeding itself will not be pertinent to the application of theautomatic stay.

Section 1520 also provides certain other automatic remediesand protections. First, the foreign representative in a foreign

proceeding would have the ability to use,sell or lease the cashcollateral (including cash equivalents) of the foreign debtorupon notice and hearing or upon consent of the secured partypursuant to Section 363 of the Code. Second, pursuant toSection 549, a foreign representative would also be able toavoid transfers of property of the estate occurring post-recognition. Third, pursuant to Section 552, any propertyacquired by the foreign debtor (that is within the territorial

jurisdiction of the United States) would be free from anysecurity interests that existed before the commencement ofthe ancillary case.

Next follows an overview of insolvency laws outside the USand review of major markets.

2. EUROPE

CENTRE OF MAIN INTEREST

On May 31, 2002, the EU Regulation on InsolvencyProceedings (the EU Regulation) came into force in allEU jurisdictions except Denmark. Its aim was to intro-duce uniform conflict of laws rules for insolvency pro-

ceedings and connected judgments. In broad terms, theEU Regulation provides that the main insolvency pro-ceedings are to be opened in the EU Member State wherethe debtor has its centre of main interests (COMI).Main proceedings have universal scope and encompass allof the debtors assets and affect all creditors, whereverlocated.

COMI has become the main judicial focus in the applica-

tion of the EU Regulation. The Regulation states that itis presumed to be the companys place of incorporationand should be ascertainable by third parties. The EURegulation was intended to avoid forum shopping but it isapparent from judicial interpretation that the courts areprepared to apply main proceedings to groups of compa-nies, even when these are not incorporated within the EU.

Once main proceedings are opened in one EU state, sec-

ondary proceedings may be opened in another.Secondary proceedings may be opened in any state wherethe debtor has an establishment, i.e., the place wheredebtor carries out a non-transitory economic activity withhuman means and goods. These proceedings can only beliquidation or winding up proceedings and are limited torealisation of the debtors assets within that jurisdiction.

Given the universal effect of opening main proceedings,in many cases this has resulted in a race to the courts toopen main proceedings. If a judge can be convinced at an



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ex parte hearing that the COMI of a company is in yourcountry, then you can establish main proceedings that

take precedence everywhere in the EU.

3. UNITED KINGDOM

Introduction The Enterprise Act of 2002In the UK, the restructuring process was brought marginal-ly closer to that of the Chapter 11 process in the USthrough the enactment of the Enterprise Act of 2002. Theprincipal effect of the Enterprise Act is the elimination of

the ability of a holder of a floating charge created afterSeptember 15, 2003 to appoint an administrative receiver,whose duties run solely to the charge holder, or to disposeof an insolvent companys assets subject to the charge forthe benefit of the charge holder. Instead, the charge holder will be required to commence an administration byappointing an administrator whose duties will run to allcreditors.

Directors DutiesThe directors of a UK company have substantially greaterflexibility than their counterparts in countries such asFrance and Germany to allow an insolvent UK company toattempt to achieve an out-of-court restructuring. There isno absolute deadline by which the directors of an insolventUK company are required to cause the company to com-mence an insolvency proceeding. A director who allows acompany to continue trading operating outside of any

insolvency proceeding when he or she knows, or shouldknow, that there is no prospect of avoiding an insolvent liq-uidation, risks personal liability for the companys debtsincurred at that time and thereafter under the theory ofwrongful trading.

The director can escape such liability by demonstrating thathe or she took every reasonable step that should have beentaken under the circumstances to avoid or minimise loss tocreditors. In addition, continuing support from a compa-nys creditor group whilst a restructuring is being effected

may entitle directors to conclude there is a reasonableprospect of avoiding an insolvent liquidation. Moreover,

there is no criminal liability for wrongful trading in the UK,although the offending director may be disqualified fromacting as a director or other manager of a company for aperiod of time. This flexibility provides a better opportuni-ty for achieving out-of-court restructurings than is oftenprovided elsewhere in Europe.

UK Procedures GenerallyIn addition to liquidation (of which there are three kinds),

there are basically two kinds of formal insolvency proceedingscommonly used for UK companies. One of these, the admin-istrative receivership, will become less common over time andwill eventually disappear entirely as a result of the aforemen-tioned Enterprise Act provision (but for certain limited excep-tions in the capital markets and structured finance contexts).An administrative receiver appointed by the floating chargeholder completely displaces management, but it can andoften does temporarily continue the operations of a com-

pany. However, an administrative receivership cannot beused to effectuate a restructuring. Instead, the administrativereceiver will simply sell the assets of the company as soon asreasonably possible as part of a going concern if feasible,piecemeal if not for the benefit of the charge holder.

AdministrationThe closest parallel to a Chapter 11 proceeding in the UK isadministration. As a result of the Enterprise Act, administra-

tion is becoming the major corporate bankruptcy procedure inthe UK. An administration may be commenced in-court orout-of-court. The company, its directors or a creditor, includ-ing a secured creditor, may apply to the court for the appoint-ment of an administrator if the company is insolvent or likelyto become insolvent. The company, its directors or the hold-er of a floating charge on all or substantially all of the compa-nys assets may also appoint an administrator out-of-court.

If the appointment of an administrator is sought by a partyother than the floating charge holder, whether in-court or



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out-of-court, the floating charge holder is entitled to advancenotice and is given the ability to appoint its own choice asadministrator. However, the duties of the administrator willrun to all creditors, unlike those of an administrative receiver,which run exclusively to the appointing charge holder. Underlaw, the administrator must be a licensed insolvency practi-tioner, most of whom come from the large accounting firms.

Once appointed, the administrator basically displaces thecompanys directors and assumes broad executive authorityand powers. Significantly, the Enterprise Act did not provide

for the retention in an administration of the insolvent com-panys management (i.e., for a DIP). Under a court approvedprotocol, it is possible that the administrator may leave muchof the day-to-day management decisions to existing manage-ment under the administrators supervision; however, theadministrator retains the ultimate executive authority. The administrator is charged with attempting to realise asquickly, efficiently and reasonably as possible, the followinggoals in order of priority:

1) the rescue of the company (or of its operations) as a goingconcern,2) the achievement of a better realisation on the companysassets than would be obtained in a liquidation, and3) if 1 or 2 is not reasonably practical, the realisation on assetsfor the benefit of secured or preferential creditors.

Once an administrator is appointed, a broad automatic stayon creditor enforcement actions will come into effect. Once

a notice of intention to appoint an administrator is given toqualifying floating charge holders, an interim stay is effectiveuntil such times as the administrator is actually appointed,affording immediate protection for the company.

An administration will proceed with minimal court involve-ment. In particular, the administrator has the power to sell thecompanys business without court review of the sale process orcourt approval of the sale. The administrator is empowered tosell the companys assets free and clear of the interests of acharge holder but has a duty to account to the charge holder for

the value of the collateral sold. More than 50 percent in value ofthe creditors must be present in person or by proxy at the initialmeeting of creditors and must approve the administrators pro-posal for dealing with the company, and this requirement leadsto extensive consultation between the administrator and thecreditors beforehand. While a creditors committee may beformed, it will have no ongoing power to control the adminis-trator or the direction of the administration other than indirect-ly through its power to approve the administrators fees (whichcan also be approved by the court). A reorganisation ends 12months after it is commenced unless it is extended by the con-

sent of the creditors or by the court.

Administration ExitWhile restructurings can be, and occasionally are, accomplishedin an administration through a company voluntary arrange-ment or scheme of arrangement, the more likely outcome byfar will be either the going-concern sale on a relatively acceler-ated basis or the piecemeal liquidation of the debtors assets.Within administrations, these sales and liquidations are com-

mon, and restructurings uncommon, for several reasons. Tobegin with, if the administrator can meet the first two goals ofan administration by selling the assets of the company as agoing-concern at a price in excess of liquidation values,then thatwill be the safest, and therefore preferred, course for the admin-istrator to take in most cases, regardless of the fact that certaincreditors might prefer that the administrator attempt a restruc-turing. Moreover, an administrator who attempts to achieve arestructuring will be faced with numerous practical problems.

The automatic stay or moratorium does not prevent non-debtorparties from exercising their right to contractual set-off. Unlikein the US and certain other countries, the administrator lacksthe ability to assume,or to assume and assign, an executory con-tract if the non-debtor party has the contractual right to termi-nate the contract (including as a result of the commencement ofthe administration) or to withhold its consent to the assignmentof the contract. Similarly, the administrator does not have theright to reject unprofitable or otherwise burdensome executorycontracts. A moratorium or administration itself does not pre-



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vent the termination of contracts, as often administration isdeemed to be an event of default and so an administrator mayhave to negotiate with important suppliers/ customers to enablehim to continue trading.

No Direct Equivalent to DIP Financing; but PriorityLending PossibleMoreover, neither the Enterprise Act nor prior existing UKlaw makes any specific provision for the US-style DIPlending. While lending to a company in administration istheoretically possible, the lender will be provided with

nothing like the protections and security a DIP lenderwould enjoy in Chapter 11. The new loans will be subjectto fixed charges and receivable assignments (factoring). While the administrator is empowered to grant the newlender liens on unencumbered assets, he or she has no abil-ity to provide the lender with the benefit of a priming lienover a fixed charge, and the administrators ability to obtaincourt approval to override existing negative pledges withoutthe consent of the pledge is limited. The new loans will

enjoy priority over existing floating charges if the adminis-trator accepts personal liability for the loans; however, theadministrator will generally be reluctant to accept such lia-bility, and even if he or she accepts such liability, the newloans, except to the extent secured by unencumbered assets,will share priority with other contractual obligations of thecompany incurred during the administration.

As a result, US DIP-style lending will be impossible, except

perhaps in the occasional case where the debtor has substan-tial unencumbered assets that are free of a negative pledge.While it is not uncommon for the existing lender or lendinggroup to continue to finance a company in administration,such financing is purely defensive and generally done solelyfor the purpose of preserving going-concern value pending asale of the assets by the administrator as a going concern.

Schemes of Arrangement and CVAsNotwithstanding these limitations, in-court restructurings,including debt-for-equity swaps, are possible in the UK

through company voluntary arrangements (CVAs) orschemes of arrangement (Schemes). A CVA is a restructur-ing arrangement between a company and its creditors pur-suant to which the creditors agree to accept discounted pay-ments on their claims, which can be made over time, as analternative to receiving less than they would likely receive ina liquidation. While a CVA can be implemented out-ofcourt, a CVA is typically effectuated as part of an administra-tion because a CVA does not provide for a moratorium oncreditor enforcement actions (except for very small compa-nies). Like an administration, a CVA has the advantage of

requiring minimal court involvement. If creditors holding atleast 50 percent in value of all creditor claims, and 75 percentor more in value of the claims of creditors actually voting (inperson or by proxy) at a meeting held for the purpose of vot-ing on the proposed CVA, vote in favour of the proposedCVA, then the CVA is binding on all creditors who receivednotice. Court approval of a CVA is not required. However,the utility of the CVA is limited by the fact that it cannotbind secured creditors without their consent.

A Scheme is also a statutory compromise between a companyand its creditors, and like a CVA can be combined with anadministration. Unlike CVAs, however, Schemes are court-intensive procedures which are more difficult and expensive toimplement. Also unlike in a CVA, where all creditors vote aspart of a single class, creditors in a Scheme will vote in sepa-rate classes of creditors holding common interests. If a major-ity in number of creditors holding 75 percent or more in value

in a class of creditors agree to support a Scheme, then onceapproved by the court the Scheme becomes binding on allcreditors of that class, regardless of whether or not they hadnotice of the Scheme. However, like a CVA, a Scheme can-not be used to bind secured creditors without their consent.

Formerly, Schemes had an advantage over CVAs in that CVAscould not be used to bind creditors who did not have notice ofthe meeting at which the vote on the CVA was held. However,due to a change in the law made effective as of January 1,2003,a CVA approved by the requisite creditor vote will also be



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binding on all creditors who did not receive notice, althoughsuch creditors will have the right to challenge the CVA incourt within 28 days of becoming aware that the meeting hastaken place. Given the relative advantages and disadvantagesbetween CVAs and Schemes, the trend is towards using CVAsmore and Schemes less.

Out of Court Restructurings now Becoming the NormAs a result of the many practical difficulties involved in tryingto achieve an in-court restructuring in the UK,consensual out-of-court restructurings, are the preferred approach whenever

practical. This preference is supported by the general under-standing that the commencement of an administration may bedestructive of value, particularly in certain industries such astelecom. Notwithstanding the difficulties in effectuating arestructuring in the UK through an in-court process, a largeand active market has developed in the UK for the tradingof both senior loans and bonds. Buyers in this market includehedge funds and other distressed debt traders, many of whichare US-based and including those who purchase distressed

debt with an eye to potentially acquiring equity in debt-for-equity restructurings. These different holders are typicallyrepresented on both bank group steering committees and adhoc bondholder committees in large restructurings.

4. FRANCE

IntroductionThe successful work-out or restructuring of loans and other

debts owed by a French company is largely dependent uponhow quickly the parties recognise the problem and howquickly they can achieve a consensual resolution prior to thecommencement of formal insolvency proceedings. Severalfactors make both quick identification of the need for arestructuring and prompt implementation of the restructuringimperative.

Under French law, a company must file for bankruptcy reliefwithin 45 days of it first becoming insolvent on a cash flowbasis (i.e., upon it becoming unable to meet its debts, as they

become due, with its available assets) or its management sub-jects itself to civil sanctions. Upon a company's insolvency, anycreditor, the commercial court or the public prosecutor mayalso properly commence an involuntary bankruptcy proceed-ing against it. In addition, as from 1 January 1,2006, compa-nies experiencing difficulties which they cannot overcome andwhich lead to their becoming insolvent on a cash-flow basisare entitled (but not required) to commence certain voluntarybankruptcy proceedings known as safeguard proceedings.Thebankruptcy court may look back up to 18 months prior to thedate on which it opens the bankruptcy proceedings to deter-

mine, if such is the case, at what date during that period thecompany became insolvent.

Directors Duties and Lender LiabilityThe borrower's directors and managers can all incur liabili-ty if the borrower is allowed to continue transacting busi-ness once it has become insolvent on a cash flow basis, with-out (i) filing for bankruptcy within the prescribed 45 dayperiod or (ii) requesting the opening of conciliation proceed-

ings (see below). The managers and directors would thensubject themselves to civil liability, including liability forsome or all of the company's debts, a prohibition againstmanaging, directing or controlling any other company for amaximum of fifteen years, and a prohibition, for a maximumof five years, of holding any public office.

A bank which knowingly continues to lend to an insolventFrench company, thereby creating or contributing to the

illusion that the insolvent company is credit-worthy, sub- jects itself to potential liability if such continued lendingwere to be deemed to be a fraud of third party rights, ifthe bank were deemed to have actively participated in theborrower's management or if the security interests takento secure the lending were deemed to be disproportionate.

Formal Processes Three forms of formal bankruptcy proceedings exist inFrance:1) the safeguard, the objective of which is to help in the



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reorganisation of the company in order to, in the follow-ing order:a. allow the company to continue trading,b. preserve employment,c. settle the company's liabilities;2) the judicial reorganisation, the objectives of which areto, in the following order:a. allow the company to continue trading,b. preserve employment,c. settle the company's liabilities; and3) the judicial liquidation, the objective of which is the

termination of the business or the realization of the com-pany's estate by one or more sales.

The company requests, and the bankruptcy court determines,at the outset of the case, which proceeding shall be opened.A safeguard can subsequently be converted into a judicialreorganization or a judicial liquidation and a judicial reorgan-ization can subsequently be converted into a judicial liquida-tion. Once a bankruptcy case is opened, a broad automatic

stay will be imposed and a presiding judge will be appointed.A judicial administrator, in reorganisation cases, and a judi-cial liquidator, in liquidation cases, will also be appointed. The bankruptcy court will decide whether the judicialadministrator, who is charged with preserving the debtor'sbusiness will supervise, assist (the most common scenario) orcompletely replace (except in a safeguard where the adminis-trator may not replace management) the debtor's existingmanagement. The judicial liquidator, on the other hand, has

powers the effect of which is that he essentially replaces thedebtor's management.

If judicial reorganisation or judicial liquidation proceed-ings are opened,a number of agreements entered into by cred-

itors with the debtor may be voided. If any of the abovethree bankruptcy proceedings are opened, creditors wouldbe exposed to liability in the event of either (i) fraud, (ii)clear participation in the management of the debtor or ifthe guarantees taken as security for financing granted bythem are disproportionate.

Limited Creditor RightsThe rights and role of creditors in a French bankruptcy pro-ceedings differ from those of creditors in a Chapter 11 casein the US. With the exception of committees of EU

licensed credit institutions and of major suppliers (i.e. thosewhose claim on the company is at least equal to five per centof all of the company's liabilities to its suppliers1) that aremandatory in larger companies and may be authorized bythe bankruptcy judge in others at the request of the debtoror the judicial administrator, there are no creditors commit-tees, the judicial administrator has no specific duties tocreditors, and creditors can neither propose nor vote on anyplan of reorganisation. A bankruptcy official will be

appointed in respect of creditor claims, but his role is essen-tially to consult with the debtor and the judicial administra-tor and to communicate with individual creditors withrespect to determining the allowance of pre-bankruptcyclaims.

On the other hand, the presiding judge in a French bank-ruptcy has extremely broad powers, both judicially and inthe administration of the debtors business, as compared to

a bankruptcy judge in the United States; he must, for exam-ple, approve any decision to terminate employees. One ofthe principal responsibilities of the judicial administrator isto submit a report to the court containing a recommenda-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. Creditorsthat 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 consultedindividually (see the section entitled "No "Cramdown Equivalent").


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1) that the restructured business be continued by the debtor,either with no change in ownership or with the issuance ofadditional shares,2) that the business be sold as a going concern, in whole orin part, or3) that the business be liquidated pursuant to a judicial liq-uidation.

However, the bankruptcy court is not bound by the judicialadministrator's recommendation in making the decision asto the debtors fate among the above possibilities.

Likely Exit from French Insolvency Process While a restructuring or reorganisation is possible underformal bankruptcy proceedings, the likely outcome, until 1January 2006 when the safeguard proceedings first becameavailable, for a French company that became the subject ofa bankruptcy case was either the going-concern sale orpiecemeal liquidation of its assets. It was generally believedthat in excess of 90 percent of French corporate bankrupt-

cies ended in such a sale or liquidation rather than in a suc-cessful restructuring of the debtor.

Sales and liquidations were common, and restructuringsthrough bankruptcy proceedings uncommon, for severalreasons. To begin with, until 1 January of this year, a com-pany could not legally commence a bankruptcy proceedinguntil it was already insolvent on a cash flow basis. As aresult, a financially distressed but not yet insolvent compa-

ny was precluded from using reorganisation proactively toeffectuate a restructuring that would enable it to avoidinsolvency. In addition, a judicial reorganisation could notlast longer than 20 months, not necessarily a great deal oftime for a large, complex organisation to develop a plan ofreorganisation.

No DIP EquivalentUS-style offensive or fresh DIP lending is generallyimpractical because such loans granted in bankruptcy pro-ceedings rank junior in right of payment to certain employ-

ee claims and to administrative claims and rank onlyparipassuwith certain other claims and because negative pledgesmay not be overridden without the pledgees consent.

No Cramdown Equivalent: Hinders Debt for Equity ExitMoreover, nothing like cram down exists in a judicialreorganisation. The absence of such a mechanism means that itis impossible both to subject existing shareholders to a debt-for-equity swaprestructuring against their will and to compel cred-itors to accept any treatment of their claims less favourable thanpayment in full of the face amount of their claims over a period

which does not exceed 10 years (subject to the developmentsabove relating to creditors members of one of the two creditorcommittees). Accordingly, while a company in a safeguard or ajudicial reorganisation can be rescued by a plan of reorganisa-tion that provides the company with new capital via the issuanceof new equity interests (with the consent of the existing equityholders) or debt, safeguard or judicial reorganisation provide noeffective way to de-leverage a companys debt structure or tocancel its out of the money equity interests.

Limited Opportunities for Distressed Investors?These limitations,coupled with the fact that creditors could notpropose or even vote on a plan of reorganisation (which wasmodified by the introduction of credit committees for EUlicensed credit institutions and major suppliers as of 1 January ofthis year, see above developments), meant that no secondarymarket developed for the trading of bonds or loans to be used byparties, such as hedge funds, interested in acquiring distressed

debt as a means to acquiring a controlling equity interest in acompany through a bankruptcy reorganisation. The develop-ment of such a secondary market was also impeded by prohibi-tions and limitations imposed by French law on the ability ofinstitutions other than French banks or European banks hold-ing the so-called European Passport to acquire debts owed byFrench companies that are not yet due and payable.

Out of Court SolutionsGiven the limited utility of French insolvency proceedings ineffectuating restructurings, consensual restructurings negoti-



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ated privately between a company, its equity holders and itscreditors out-of-court and prior to the companys insolvencywere, and are likely to remain, commonly regarded as thebest solution for a financially distressed company for whicha restructuring is feasible. French law also provides for twocourt-assisted, to a lesser or greater extent, proceedings(the mandat ad hocand the conciliation) designed to help acompany achieve a consensual restructuring and therebyavoid bankruptcy. Both of these proceedings are conduct-ed on a confidential basis and feature the appointment bythe court of an insolvency professional to assist the compa-

ny in its attempt to reach a consensual restructuring.

The mandat ad hocproceedings can only take place in theabsence of the subject companys insolvency, and the con-ciliation can only take place if the company has not beeninsolvent for more than 45 days, again emphasizing theimportance of quickly identifying the need for, and pro-ceeding to implement, a restructuring.

Both the mandat ad hocand the conciliation are confiden-tial and require that the debtor request that the commer-cial court appoint a professional, a mandataire ad hocor aconciliateurdepending on the proceeding, to help the com-pany find a consensual restructuring (the mandataire adhoc or the conciliateur are generally chosen among thelicensed administrateurs judiciaries). Once this profession-al is appointed, the restructuring is consensual, eventhough, in a conciliation, the court may impose a two year

moratorium and a reduction of their contractual interestto the then prevailing French "legal interest rate" on dis-senting creditors that would not agree on a consensualrestructuring.

The absence of insolvency implied by the existence of amandat ad hocreduces, for participating creditors, the risk:(a) that their agreements with the debtor be subsequentlyvoided, and(b) that they incur a liability for having provided credit tothe debtor as it provides them with a good faith argument

that, to their knowledge, the debtor was in good standing,albeit experiencing financial difficulties.

The conciliation proceeding (procdure de conciliation) is theonly proceeding that provides post conciliation lenders orsuppliers providing new money or new goods/services neces-sary for the continued operation and the survival of the busi-ness a priority right of payment if the conciliation agreementis approved by the commercial court in a public judgment.

Pursuant to this priority right of payment such new

money/goods/services are paid before any claims born priorto the opening of the conciliation proceedings and, in theevent that a safeguard, judicial reorganisation or judicial liq-uidations proceedings are subsequently opened, prior to anyclaim subject to such proceedings, with the exception of cer-tain employee claims and the administrative expenses relat-ing to such proceedings. In addition, if the commercial courtapproves the conciliation agreement, the agreements made inthese proceedings are no longer exposed to the risk of being

voided if subsequent bankruptcy proceedings are opened andthe risk that creditors party to such agreements incur a liabil-ity for having provided credit to the debtor is removed, savemanifest fraud in both cases.

5. GERMANY

IntroductionRecent developments in German law have brought the

German bankruptcy process somewhat closer to theChapter 11 process in the US and make a restructuringeffectuated through an in-court insolvency proceeding moreof a possibility in Germany than in, for example, France.

Nevertheless, out-of-court restructurings, where possible,are still the preferred approach. Once again, certain factorsmake both the prompt identification of the need for arestructuring and the prompt implementation of the restruc-turing, in each case before the company becomes insolvent,very important.


47A O i f Gl b l I l R i


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Directors 'Duties and Lender LiabilityUnder German law, the managing director of a company isrequired to file a petition for the commencement of insolven-cy proceedings without undue delay, but no later than threeweeks, after the company has become insolvent on either a cashflow or balance sheet basis. Moreover, the full three-week peri-od may only be utilised if the directors are making a legitimateeffort to achieve an out-of-court restructuring. In case of aninsolvency on a cash flow basis, the only way that this three-week period can be extended is if all of the creditors explicitlyagree to an extension of the dates on which payments to them

are due; this is not necessarily possible in an insolvency on a bal-ance sheet basis.

A creditor can also file a petition for the commencement of aninvoluntary bankruptcy proceeding against a German company.However, in doing so, the creditor needs to establish not only itsclaim, but also the debtors inability to satisfy such claim whendue. This most often requires attempts to enforce the claim which in turn requires a judgement on the existence of such

claim. Therefore, creditors filings are rarely seen in Germany.Moreover, banks mostly do not take that ultimate step againsttheir clients for reputational, but also liability issues as a wrong-ful creditors filing could make the creditor liable for damagescaused by that (which may be severe). Instead creditors mostlyremindmanagement of their duties if they want to achieve a fil-ing.

A managing director of an insolvent company who fails to file a

petition for the commencement of an insolvency proceedingwithin the required time period will be subject to personal civilliability for such things as the companys social security pay-ments, withholding tax obligations and value added tax obliga-tions and to criminal liability, including imprisonment. An unse-cured lender who obtains collateral security from a borrower thatis insolvent or where insolvency (on a cash flow basis) is immi-nent might subject itself not only to avoidance of the security asa preference but (admittedly only under special circumstances)also to potential criminal prosecution for requesting and accept-ing preferential treatment.

Moreover, a new loan extended by an existing lender inits borrowers crisis might be found to be extended inviolation of good morals, causing not only any security to beinvalidated, but also putting the lender at risk of being liableto third party creditors who have relied on the borrowerscontinued existence. To avoid such lender liability, beforeextending credit to an existing borrower in distress, lendersseek (mostly third party) opinions on the merits of such bor-rowers restructuring plan.

The Effect of Filing in Germany

The filing of an insolvency proceeding in Germany com-mences a "provisional administration" period, mostly lastingthree months, in which a provisional administrator isappointed by the presiding court to secure the debtor's assets,to analyze the debtor's economic situation and continuing viability and to make a recommendation to the presidingcourt as to whether an insolvency proceeding should be for-mally opened. The administrator will usually be a lawyerfrom a firm specializing in insolvency practice. During this

provisional administration period, the debtor is protected bya moratorium on creditor enforcement actions and thedebtor's management will usually remain in place; however,management's acts will typically need to be approved by theprovisional administrator. If an out-of-court restructuringcan be achieved during this provisional administration peri-od, the formal opening of the insolvency proceeding can bemooted.

At the end of the provisional administration period the pro-visional administrator will recommend that the court eitherformally open the insolvency proceeding or drop the case. Ifthe case is dropped, individual creditors will be free toenforce their rights and the debtors assets. A court will onlyformally open an insolvency proceeding if it finds that thedebtor is insolvent and if it is satisfied that the debtor hassufficient unencumbered assets to provide for the payment ofthe costs of the proceeding. The stated objective of anyGerman insolvency proceeding is the maximum realisationon the companys assets for the benefit of the creditors.




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Debtor in Possession PossibleA company may request that its management continue in placeunder the supervision of a creditors trustee during the penden-cy of the insolvency proceeding. This request will be grant-ed by the court unless the court determines that such self-management will unduly delay the proceedings or otherwisedisadvantage the creditors, but if the insolvency proceedingresulted from an involuntary filing by a creditor, the consentof that creditor will also be required.

The Role of Creditors

An administrator in a German insolvency proceeding willperform his or her duties with very little court supervision.On the other hand, creditors have a significant role to play.Creditors, for example, can replace the court-appointedadministrator with their own choice for administrator at themandatory first meeting of the creditors following the formalopening of the insolvency proceeding. While a creditorscommittee is not mandatory, one is regularly appointed inlarger cases. Such creditors committee has the power to

decide on the most significant actions by the insolvencyadministrator such as sale of relevant assets or starting orcontinuing major lawsuits. The creditors committee decidesby simple majority of heads, it is appointed by a majority votein the creditors meeting (determined on the amounts ofclaims, not on the number of creditors). If a restructuringplan is proposed in the insolvency proceeding, creditors willbe able to vote on whether that plan should be adopted, andwhile creditors cannot generally give binding instructions to

the administrator, they can collectively instruct the adminis-trator to propose a restructuring plan.

Restructuring PlansThe new German insolvency law, adopted in 1999, providesthe opportunity to propose a restructuring plan, a corporaterehabilitation alternative to the two traditional outcomes of aGerman bankruptcy: the sale of the companys assets as agoing concern and the piecemeal liquidation of the compa-nys assets. A company seeking to take advantage of this newability to do an in-court restructuring can now file for bank-

ruptcy relief upon a showing that its cash flow insolvency isimminent rather than actual.The continued operations of thebusiness may be financed by loans enjoying a priority of rightin repayment over pre-petition unsecured claims, and suchloans may even be secured by unencumbered assets. Therestructuring plan can be proposed by the company, theadministrator or by the administrator acting on the instruc-tions of the creditors. A pre-packaged restructuring plan iseven possible. Theoretically, restructuring plans are unlimit-ed in scope. In addition to providing for the companys con-tinuing existence, a restructuring plan can, for example, pro-

vide for a reduction in the debtors indebtedness, for the saleof the companys assets, in whole or in part, and for the ter-mination of unprofitable activities.

If a restructuring plan is proposed, creditors will be organisedinto groups (such as trade creditors, bank creditors andsecured creditors) for the purpose of voting on whether therestructuring plan should be approved. A simple majority innumber of holders and of the total amount of claims in a

creditor group is sufficient to constitute the approval of thatgroup. The restructuring plan must also be approved by thecourt. A cram downis possible, as the court can approve theplan over the rejection of a creditor group if a majority of thegroups have accepted the plan and if the court is satisfied thatthe dissenting creditors will receive at least as much underthe plan than they would in a liquidation.

Since 2002, in-court restructurings have become more com-

mon in Germany. Nevertheless, as an insolvency proceedingin Germany is still more likely to end with the going concernsale or piecemeal liquidation of the debtor's assets than witha restructuring, in-court restructurings are still generally nei-ther the debtors nor the creditors first choice.

While DIP-style lending is a theoretical possibility, aGerman debtor lacks the ability to provide a DIP lender witha priming lienwith priority over pre-petition secured inter-ests, cannot override negative pledges without the pledgeesconsent (which however only results in a breach of such neg-




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ative pledges without the DIP loan or the security grantedfor it being affected) and cannot borrow money without theconsent of the creditors assembly or the creditorscommittee.As a result, in practice the financing necessary to enable adebtor to attempt to propose a restructuring only comes fromexisting creditors who support such attempt.

Limited MoratoriumAlthough there is a continuing moratorium on certain creditoractions during the pendency of an insolvency proceeding, oncethe formal proceeding has been commenced there are significant

exceptions to this moratorium; for example, creditors with realestate security can foreclose on their collateral and factors canproceed to collect receivables assigned to them.

No Debt for Equity Exit Without Shareholder ConsentFinally, a restructuring plan cannot be used to achieve a debt-for-equity swap restructuring without the consent of thecompanys existing shareholders (although this impedimentcan sometimes be overcome via an auction of the debtors

shares if the shares are pledged to a lender with such lenderbidding its claims in the auction, and thereby acquiring theshares itself). It should be noted that debt-for-equity swaptransactions with German corporate entities are subject torestrictions under mandatory German company law, inparticular, the issuance of new shares in consideration of arelease of debt requires an audit of the company by anindependent auditor appointed by the competent court,which must evidence that the (released) claim of the cred-

itor is fully valuable and enforceable, before new shares areissued and the nominal capital of the corporation isincreased accordingly. Thus, the creditor needs to makesure that the value of the claims to be contributed is notover-estimated.

The Distressed Investing Market in GermanyGrowingly, a secondary market develops in Germany forthe trading of bonds and loans that can be used by parties,such as hedge funds, interested in acquiring distresseddebt as a means to acquiring a controlling interest in a

company through a bankruptcy restructuring. The devel-opment of such a secondary market has been delayed forsome time by the fact that German banks do not normal-ly sell their loans to third parties because of the close his-torical relationships between German banks and theirborrowers, and bank secrecy, confidentiality and data pro-tection issues that would likely arise if the loan was soldwithout the borrowers consent. This has changed as solu-tions were found to cope with bank secrecy, confidentiali-ty and data protection issues.

Consensual restructurings negotiated privately between a com-pany, its equity holders and its creditors out-of-court and priorto the company's insolvency are commonly regarded as the bestsolution for a financially distressed company for which a restruc-turing is feasible. Due to heightened concerns about lender lia-bility, however, German banks in recent years have becomesomewhat less likely than in times past to participate in restruc-turings that involve additional funding obligations and the tak-ing of equity and more likely to enforce their security (which

opens the door for foreign institutions to step in as new lenders).

6. EAST ASIA

Most jurisdictions in East Asia present challenges to the reali-sation of value from troubled enterprises different than those inEurope and the United States. Although each jurisdiction hasits own particularities, there are a number of common attrib-utes.

Despite the variety of social systems and economies, theregenerally is a preference for out-of-court consensual solu-tions. Governments are reluctant to support foreign credi-tors use of domestic courts to enforce claims against domes-tic obligors. Domestic creditors in East Asia prefer tradi-tional solutions.

Large business groups in East Asia enjoy considerable politi-cal influence. If government support is not available onacceptable terms, governments are likely to suggest bro-kered solutions, sometimes involving combinations withother, healthier domestic groups.




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There is little transparency. Public companies usually are con-trolled by families or groups which use cross-holdings tomaintain effective control with the public float reflecting onlya minority interest. Related party transactions can mean thecontrol over the key asset such as land or inputs are main-tained indirectly by the principal shareholders and revenuesdiverted by marketing or distribution channels controlled bythe ultimate majority shareholders.

Domestic banks and finance companies may act on the basis ofmore than purely commercial considerations either to impedeor support solutions offered by foreign creditors.

Domestic insolvency statutes often are of little practical signif-icance. Black letter statute can be important but selectiveenforcement often is the pertinent aspect.

China has a relatively new and untested body of insolvencylaw.Reflecting Chinas move towards a market-based economyand its tendency to adopt reforms only after a number of iso-lated test caseshave demonstrated the implications, China isconsciously experimenting. In the right social and political

context, China has permitted foreign expertise to participateand commercial discipline to prevail. In other contexts, onlystate mandated solutions have been permitted.

Although concepts like an automatic stay and DIP financ-ing can be discussed, they have little practical meaning in thecurrent context. Even when relatively sophisticated approach-es to Non Performing Loans and asset recovery models havebeen adopted, the political realities have set in leading to effec-

tive deadlocks.

In contrast, Indonesia has had insolvency legislation since theDutch colonial period. Although it is invoked occasionally forminor domestic cases, the number of cases involving cross-border claims can be counted on one hand. Except one case inwhich the Bakrie Group chose to adopt a form of pre-pack-aged solution, foreign creditors have generally been blockedon procedural or other grounds. Courts are widely perceived

as corrupt and ineffective. As a result, obligors have little needfor an automatic stay and consensualsolutions are the rule.

Malaysia and Taiwan present examples of court systemsthat can work and legislation which can permit of quicksolutions on bases readily recognisable to Anglo-American and continental European creditors. Again,however, the political context can be decisive. If the gov-ernment considers a court solution appropriate, the courtscan be quick and effective. Otherwise, a consensual solu-tion may be encouraged.

Two recent cross-border insolvencies demonstrate therealities which can be fairly typical in the region.

Asia Pulp and Paper is the largest emerging market insol-vency. A parent private limited company incorporated inSingapore issued registered bonds and privately placedbonds in the Asia, North America and European capitalmarkets on the strength of substantial Indonesian andChinese sub-holding company and operating companyrevenues. Such Indonesian and Chinese entities alsoincurred substantial indebtedness. Singapore declined to

accept jurisdiction over any insolvency proceeding on thebasis that most assets were located in Indonesia andChina. This view was adopted notwithstanding the diver-sion from commonly controlled Singapore listed publiccompanies of amounts equal to more than one billionUnited States dollars. Left to Chinese and Indonesiancourts for their remedies, creditors have accepted or areaccepting a traditional solution which leaves the share-holders in control of the group.

In contrast, the Swiss cement conglomerate, Holcim, suc-ceeded in acquiring control of one of Indonesias largestpublic cement producers on an out-of-court basis on termsnegotiated with that companys creditors and principalshareholders. Having revealed that approximately twohundred fifty million United States dollars carried on thebooks of PT Semen Cibinong as cash did not, in fact, rep-resent cash, the principal shareholders apparently deter-

mined that their negotiations either with the IndonesianBank Restructuring Agency in respect of other outstand-




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ing obligations would benefit from a sale a portion of theproceeds of which would be paid to that agency. Havingacquired strategic stakes in the debt of PT Semen Cibinong

on the secondary market,Holcim was able to negotiate termsultimately acceptable to all parties for both the restructuringof the companys debt and the acquisition of a controllingstake in its equity.

IN SUMMARY

As many restructurings now touch upon more than one

market, it is no longer sufficient to just have the knowledgeof insolvency laws in one jurisdiction. In particular, as wehave just explained, the differences in global insolvency lawsare boundless which leads to widespread confusion, withmost companies having subsidiaries and investors spreadthroughout the globe. It is hoped that this overview providessome clarity into the differentiators of just some of the keymarkets and to the legal meaning of insolvency. I

Herv Diogo AmengualHerv 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 GrellFrank 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 prof ile restruc-

turings as Eurotunnel, Gate Gourmet, Jarvis and British Energy. He is recog-

nised as an expert in his practice by Legal 500, Chambers and IFLR 1000.

Mark Broude

Mark Broude has extensive experience in business reorganization, creditors rights,

representation of unsecured creditors committees and bank finance working. Mr.

Broude also represents bondholders and debtors, including the Trump hotels and

casinos. Mr. Broude is representing the Official Committee of Unsecured

Creditors in the bankruptcy cases of Delphi, Inc. He is recognized as an expert in

his practice by Chambers.

Jake Redway

Jake Redway acted for the creditors committees in restructuring the obligations of

the Republic of Colombia as well as the principal shareholders of several

Indonesian banks in reaching settlements with the Indonesian Bank

Restructuring Agency. Jake also acted for Holcim Ltd in the acquisition and

restructuring of PT Semen Cibinong.

An Overview of Global Insolvency Regimes

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