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The World Bank

Task Force

Insolvency and Creditor/Debtor Regimes

Law, Justice and Development Week 2014

Subject: Introduction

Commenter Comments

Vijay Tata VT welcomed the participants and introduced the background material available to the TF members, drawing the participants’ attention to the highlighted amendments. These are based on the discussions and written suggestions of the TF members since the last meeting. He briefly presented the three topics in the agenda: i) Secured transactions, ii) Directors’ and Officers’ Accountability, and iii) Treatment of Financial Contracts in Insolvency. He further announced with regard to the secured transactions paper that the comments made will serve as a basis for a further draft that will again – possibly together with specific questions – sent to the TF members. Professor Rodrigo Rodriguez will serve as rapporteur.

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Subject: Secured Transaction

Adolfo Rouillon He started explaining the three documents sent to the TF members that analyze the Principle A on security rights. He clarified that this second document, that reflects some suggestions/comments made during and after the previous year’s meeting, is still a draft that can be modified and improved. He reassured also that we are focusing on the Principles, not the Recommendations. In this regard, he recalled that the scope of the Principles is to assess (and suggest improvement if needed) the creditor debtor rights system mostly in countries where the level of the system’s sophistication is not very high. For this reason he recalled the necessity of maintaining the Principles flexible and not too complicated.

Accordingly, some parts of the draft that was circulated (highlighted in yellow) are essentially a rephrasing exercise of current principles containing important suggestions, but not substantial changes.

Other suggested changes (blue highlights) are substantial changes or additions to the current version of the Principles and should be considered more carefully by the TF members.

He noted that the current principles are 5 and in the proposed changes they will be 8 after a separating exercise. In fact, no new principles will be added to the current version, rather what is suggested is an internal division of the existing principles for purposes of clarity (Example: enforcement of security rights).

He reassured that a list of questions and a summary with proposed changes will be sent out to the TF members shortly.

Subject: Directors’ and Officers’ Accountability

Commenter Comments

Irit Mevorach First she explained that the WB Principles are divided in 4 Parts. A) Legal framework and creditors’ rights. B) Risk management and Corporate workout, C) Legal framework and insolvency, D) implementation: institutional and regulatory frameworks. She further explained the differences between the A Principles and the UNCITRAL Legislative Guide on Secured Transactions.

Directors’ obligations are related to part B of the Standard (specifically, Principle B2). Irit highlighted the fact that the WB Principle B2 is too general, short an outdated compared to the UNCITRAL Legislative Guide on Insolvency Law (“LG”) and should be amended and aligned with part IV of the UNCITRAL LG (“LG IV”). She suggested amending Principle B2 so it does not focus on recklessness and gross negligence, aligning it with LG IV. She further suggested adding sub principles to

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clarify the obligations for official directors and factual directors, liability and remedies and the funding of actions.

Irit Mevorach asked Jenny to update on the work that UNCITRAL is doing in the field of Directors’ obligation in the enterprise group context.

She also noted written comments received:

From Nepal (Bharat Upreti) who noted the need to deal with shareholder liability that have factual control over the entity, an issue that is not addressed in the current version of Principle B2 (as it only refers to directors).

From Prof Pulgar (Spain) who has described in a paper the Spanish approach and showed a degree of convergence among system in this area, a movement from the civil law more rigid approach to a more subtle system as reflected in the new recommendations of the Guide and the proposed revision of Principle B2.

Lucio Ghia: Thanked UNCITRAL for the excellent work done in this field. He considers, however, that some practical issues are underestimated: in particular the practice under which the directors are considered assets of the bankruptcy. In this regard, in several jurisdictions, Italy included, the procedures take a long time and are extremely costly. A stronger balance should therefore be found between the costs and the time to satisfy claims as expressed in the Principles.

Irit Mevorach agreed on the fact that implementation issues are important.

Lorenzo Stanghellini:

He made three comments on the principles.

I) B2.2 -- He asked to clarify the sentence “any other person exercising factual control and performing the function of a director” cited in Principles B2.2, particularly to clarify whether this term included or excluded legal persons.

II) B2.3 - he suggested to reconsider the sentence after the parenthesis “including that the director took reasonable steps to avoid or minimize insolvency” and suggested to refer minimize “the losses” and not “insolvency”. In a lot of jurisdictions to be or not to be insolvent is a legal fact that in incompatible with the possibility to minimize that status.

III) B2.3 - he asked to reconsider/refine the sentence “the law should specify that the remedies for liability found by the court to arise from a breach of the obligations should include payment

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in full to the insolvency estate” as it seems to exclude systems where the compensation is adapted to the degree of responsibility.

On I) Irit Mevorach clarified that B2.2 would include legal persons. On II) she agreed on rephrasing (“the extent of insolvency”). On III) she mentioned that liability should indeed correlate with the loss- as provided in B2.3.

Ignacio Tirado Principle B2 accommodates very well a lot of systems but not all systems. In particular the Principles under discussion might be a problem in the systems with bad corporate governance. For example where there is criminal liability in filing late. The problem is that the new principle seems to link the liability just to the damage costs as a result of the delay in filing.

Irit Mevorach disagreed with the point raised by Ignacio Tirado in the sense that the Principle as redrafted is now aligned with LG IV that took a particular approach, more in line with common law wrongful trading regimes. But it does not exclude criminal or other bases for liability.

Christopher Redmond

Commenting on principle B2.1, he observed that if there is agreement that rescue is beneficial, the directors should be able to decide between the two options (rescue or liquidation). Therefore, the business judgment rule should be included in Principle B2.1, especially in light of subsequent litigation. There is a serious danger that restructuring is neglected in favor of liquidation to avoid possible questioning of business judgment decisions made.

Irit Mevorach explained that if we go further then what is stated by the principle B there is a risk to go beyond what the LG IV prescribes. This might cause a problem because the WB principles should stick to what is stated in the UNCITRAL LG but not go beyond it, highlighting also that the business judgment rule is contained in the commentary to the LG Recommendations.

Prof. Pulgar She raised the concern that not all the consequences and options are considered in this principle, referring as an example to the power of the directors to propose debt to equity swaps.

Irit Mevorach replied that the WB principles have to be sufficiently general and they cannot incorporate all specific options.

Sam Bufford He raised the point that “Imminent or unavoidable insolvency” mentioned in the standard is recognized by the international experts to be too late for restructuring. The point should be anticipated before

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reaching these points, as recognized in the new French and German laws adopted recently. He further highlighted the difficulties in determining or assessing many elements of a responsibility claim, for instance “causation”.

Irit Mevorach replied that the current text intends to cover the situation before actual insolvency. As to the further remarks, she acknowledged the practical difficulties of certain elements of a responsibility claim and the fact that the role of the judge may be indeed difficult.

Janice Sarra She said she is not concerned about judicial requirements as the other members of the TF appear to be. However, in her opinion, the preamble in obligations and remedies seems to be disconnected from the following recommendations. Obligations and Defences are mixed together in the text. She suggested revisiting the structure in order to obtain a more harmonized piece and less disconnected standards.

Irit Mevorach agree with the point raised by Janice about some overlapping between recommendations in B2.3 and the obligations in B2.1 but that this is a result of following the UNCITRAL recommendations and ensuring consistency.

Leif Clark

i) He clarified that the Principle and the Legislative Guide serve different functions. The WB Principles are used to assess a legal system, through conducting a ROSC based on investigating an existing system. Differently, the LG is an instrument useful when a policymaker is in a process of writing a law (that should later withstand a ROSC assessment). For this reason, he believed that in the exercise of incorporating the LG recommendations into the WB Principles we should be more flexible and use a slightly different approach and wording. In particular, in B2.1 he proposed to be more “granular” and more sensitive. ii) The second point he raised referred to recommendation LG Rec. 266 (In order to deter behaviour of the kind leading to liability under LG Rec. 259, the law relating to insolvency may include remedies additional to the payment of the compensation provided in LG Rec. 262), which is not picked up in the WB principles. Irit Mevorach stated that the points raised by Leif are linked with the points raised by Ignacio Tirado (missing reference to additional penalties and criminal legislation). In light of that she suggested adding some provisions in a foot note regarding additional measures (as is mentioned in LG Rec. 266). Regarding the point about being more

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granular, she explained that this would make the principle even vaguer and would raise further concern of the sort pointed out by Sam Bufford.

Robin Phelan i) He is becoming more and more convinced that the trend toward “sale as a going concern” on microbusiness is the more efficient way to reallocate assets. This should be kept in mind while we are doing this exercise of incorporating the LG into the WB principles/standards. ii) The judgement business test should be contained, but it must be clear that it is impossible to pre-determine as it will always depend on the situation. iii) Finally, he agreed with Sam Bufford on the fact that “imminent” is a too late moment for restructuring: “you can’t go back too far” and it’s impossible to foresee insolvency. But he mentioned that this is captured in the LG and the principle, and that it is a fact that the role of the judge is difficult but this is the nature of this standard.

Wisit-Wisitoria at He remembered to be careful on not going beyond what the LG recommends for the topic under discussion. He stressed the importance that the Uncitral LG and the WB Standards are precisely on the same page. Inconsistencies might cause problems to implementing states.

Irit Mevorach - Summary of the session on Directors’ and Officers’ accountability

She suggested to incorporate two comments/suggested amendments as soon as possible since the LG guide (and its Part IV) are already published : i) Changes the language in B2.3 to include ‘the extent of’

insolvency. ii) Add the footnote clarifying that the liability does not preclude

additional measures, in line with the LG Rec. 266

Adolfo Rouillon With regard to Irit’s proposal on ii) he suggested to keep “at the minimum” and relocate it in the correct place in the text such as “At the minimum the law should provide….”

Leif Clark He disagreed with Adolfo’s suggestion because “at the minimum” would imply that more would be better; it would be better to be more specific on the “business judgement rule” – it is important to save active directors in case of restructuring.

Irit Mevorach Agreed, to keep the previous suggestion to just add a footnote in regarding not precluding other remedies, in line with LG IV Rec. 266.

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Gordon Johnson Considered that some important questions remained unanswered: treatment director in debtor-in-possession situations? Treatment of de facto directors? Treatment of groups?

Vijay Tata He suggested introducing a footnote that explicitly takes into account the role of directors in regimes which provide for debtor-in-possession arrangements. He said that the footnote should better absorb the restructuring scenario and background. Irit Mevorach recalls that Principle B 2.2 does include many of those concepts and the LG IV will further expand particularly on the treatment of groups (Jenny will elaborate on the new project on the group context) and therefore at this stage no further amendments are required. She reminds that we merely align the Principle with LG IV. The issue of the inclusion of legal entity was already discussed above..

Jenny Clift She explained the work of UNCITRAL in view of extending Recommendations 255 and 256 to the groups and she mentioned that a draft should be published and publicly available shortly.

Gregor Baer Inquired about the further schedule and proceeding. Irit Mevorach suggested and TF members agreed, that the final draft will be established on the basis of this discussion (the circulated draft together with the two proposed amendments), as well as any subsequent written comments on the draft circulated after this session.

Subject: Financial Contracts

Commenter Comments

Irit Mevorach She introduced the World Bank Principles C, in particular C10 on Contracts, and she explained the most recent developments, in particular in UNCITRAL Working Group V (“WG V”), where this subject was considered important but at this stage there was lack of resources to pursue it. As a consequence, focus shifted to the World Bank Principles/Standards. She raised the awareness that more work needs to be done in this area because the standards are not up to date. She briefly introduced the rule, the exceptions and the exception to the exceptions.

Edward Janger She introduced the World Bank Principles C, in particular C10 on Contracts, and she explained the most recent developments, in particular in UNCITRAL Working Group V (“WG V”), where this subject was, however, not prioritized considered important but at this stage there was lack of resources to pursue it. As a consequence, focus shifted to the World Bank Principles/Standards. She raised the awareness that more work needs to be done in this area because the standards are not up to date.

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She briefly introduced the rule, the exceptions and the exception to the exceptions.

Robin Phelan With the help of some examples, he made a point on avoidance transactions, to conclude that some specific avoidance provisions contained in the said sections (especially in the US legislation) are much too wide in scope, applicable even to transactions that have nothing to do with financial contracts in the strict sense.

Monica Marcucci Made general comments to the background paper: she thinks that what is emerging from the discussion is the fact that the framework is continuously evolving and there is an international need of increasing the knowledge and the awareness about the treatment of financial contracts. The international framework should be consistent and harmonized.

Irit Mevorach She shared with the TF members written comments received from 1) Professor Gacimartin (UNIDROIT): sent a general remark and

some specific queries. In his general remark he noted that ‘it is essential to clearly identify the substantive policy- if any- that may justify the safe harbours. The commentary to the UNIDROIT Principles tries to summarize the long discussions we had in UNIDROIT on this point… If, however, this policy has been reconsidered in the context of resolution of financial institutions, ie precisely where those risks become more accentuated, it is difficult to understand why it should not be also reconsidered for other cases where those risks are no so relevant.’

2) Bharat Upreti (Nepal): noted that the discussion paper highlights the need for updating the ICR Standards; that there was a need to update the ICR Financial contracts standard in light of what has already been done at FSB and UNIDROIT. In particular, it was suggested that the scope of the special provisions be limited to cases where at least one party is a bank or financial institution or a public authority.

3) Tim Schnabel (US): Referring to section III(c) of the discussion paper, in particular the language at page 10 point 3(2)(e) (definition of qualifying financial market participant), he noted that contrary to what is said in the paper (which only mentions financial institution or central bank as qualifying financial markets participants), actually any systemically-important corporation or other entity also fits within the definition provided in the UNIDROIT principles

Edward Janger He commented on Tim Schnabel’s point on language at page 10 point (e) on the definition of qualifying financial market participant. He explained that the key point about UNIDROIT principles is that they limit their scope, as a minimum standard, to financial contracts where one

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of the parties is a qualifying financial market participant. The paper refers to those as a financial institutions and central banks. Tim Schnabel is referring to point (e) that also includes a corporation or other entity that, according to the criteria determined by the implementing State, is authorized or supervised participant to the implementing State’s markets in contracts giving rise to eligible obligations. He thought that what is called institution that acts as financial institution were left out of the definition. He agreed that the paper should have said “is a financial institution and other similarly regulated bodies or central banks”. He thanks Tim Schnabel for having clarified the language in the paper.

Irit Mevorach She noted additional specific written queries sent by Prof Garcimartín, and asked Prof Janger to address them: He asked for more specificity regarding the “short stay” (and some potential inaccuracies in this respect in several points in the paper); clarification regarding insulation of close-out netting from avoidance; clarification regarding what UNIDROIT is suggesting in Principle 8 regarding resolution regimes and on the issue of collateral sale.

Edward Janger He commented on Garcimartín’s points (regarding the stay, and the UNIDROIT reference to the resolution regime), saying that Garcimartin’s notes do not contradict what is in the paper but they indeed provide the opportunity to clarify the language utilized in the paper. Ted explained that in the banks insolvency regime we have a short stay (two days or less) that applies to close out netting and collaterals, as also mentioned by UNIDROIT in Principle 8, unless the contract has been transferred to another qualified financial institution (in which case there is no termination and the suspension becomes permanent). Technically this is a stay. The longer “stay” Garcimartin is concerned about is not really a stay but rather simply what happens when a contract goes to another institution.

Edward Janger Regarding the comments made on page 9, 3rd bullets of the paper (Garcimartín query) he further explained that the fact that you allow close out netting to operate does not prejudice the question of possible later avoidance, and that Garcimartin points about UNIDROIT approach to avoidance reinforces the points made in the discussion paper.

Edward Janger On the queries made in pp 11 and 12 of the paper, he clarified - that indeed as Garcimartin noted, UNIDROIT Principle 8 talks about the stay under the bank resolution regime. – and regarding collateral sale, that UNIDROIT addresses re-hypothecation where property rights in the collateral are replaced by contractual rights to obtain equivalent collateral or value thereof, while the paper discussed collateral in the proper sense.

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Irit Mevorach Invited the TF members to discussed the question noted in the paper- “should the current provisions on the treatment of financial contracts be revised or not”?

Vijay Tata In light of Irit’s intervention, he also asked the TF members to focus on what is the concern at the moment: the possible inconsistency between international standards in a very specific and important area. We have a set of principles at the Bank that are not consistent with the international best practice. It is crucial to harmonize this area.

Luis Mejan He shared Vijay’s concerns, thereby highlighting the fact that we are facing two different regimes with different purposes. 1) the general insolvency regime is trying to maximize the value in order to reorganize or liquidate the company providing the best return to creditors 2) on the other side when we talk about financial institutions, there are other purposes to consider (other than only to reorganize the financial institution), i.e.: the resolution system of financial institutions aims to prevent the damage caused by a systemic risk. The point is that while we are updating the standards in this field we should keep in mind these distinctions.

Christopher Paulus He suggested keeping in mind the larger issue of equality of treatment of creditors and the privileges. Moral hazard issues are heavily involved when it comes to exceptions to that principle of equitable treatment, and their consequences should also be evaluated from a general economic standpoint and considering the lessons of the Lehman Brothers case.

M. Knox In his view the discussion paper focuses on transfer as a model of resolution (p. 8f., US Model and Key Attributes), but there are also other models like Bail-in (write-off equity) that should be kept in mind.

Chris Redmond He raised the point that this TF might not have the expertise to address those issued related to the systemic risks of financial institution i.e. of the scope of such provisions. We should wait until the FSB takes a deep look into those issues and then address these issues in the insolvency context.

Marguerite Zauberman

She commented that the TF cannot spare to address the scope issue. As the short stay addressed in the paper (the “two-days stay”), an important condition of the KA is not taken over (main obligation to have been satisfied). Finally she made a point that the paper is US oriented, as in Europe the “financial contracts” definition is not controversial: it always involves at least one financial institution.

Ignacio Tirado He responded to Chris Redmonds’ earlier comments emphasizing that this TF is the right place to debate these issues, not the FSB alone.

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He further referred to Garcimartín’s written comments in this context mentioned earlier.

Gordon Johnson Provided background and mentioned that the Principles were left general to accommodate the systems that were not so sophisticated. The focus now should be narrower. He did not agree with the point to have or not a financial institution as counterpart when the only important point is the presence or not of a systemic risk. The existence of a ISDA contract might be a better criterion. If it exists, it is there as a result of business conduct in the market. Only the situation where the two parties are not financial institutions should be excluded.

Dominique D’Allaire Considering the purposes of the ICR Principles, we must remember that they are used to assess countries where the economic situation is constantly evolving. He believed that it is important to adapt the ICR principles to the international framework. So, regarding the first question in the slide he surely replies YES. However he believed also that, because of the mentioned ICR purposes we shouldn’t address too many issues, and leave that to other more specialized institutions (UNCITRAL, FSB).

Christopher Paulus He disagreed with Chris Redmond’s point on not having the expertise to address these important issues – in his view we do have the expertise.

Musamba Isaac Isanga

He explained what powers of the Central bank in Uganda has in respect of distressed financial institutions (all powers). Often the bank is more eager to sell quickly than to restructure. He recalled, that from a standpoint of a developing country, the situation should be avoided that a country follows the UNCITRAL LG but then “fails” in the ROSC assessment simply because both standards are contradictory or incompatible.

Irit Mevorach

She clarified that we are not revisiting the work done by others (FSB/UNIDROIT). It is more about learning from these experiences and aligning our principles with that work, not about questioning it. She also stressed that these institutions (FSB/UNIDROIT) have done their work and proposed Principles and Key Attributes. It is now for the insolvency experts to work on ensuring that the insolvency standards are up to date, consistent with the other developments and best practice.

Vijay Tata He clarified the point that the international framework needs to work in all jurisdictions. We need to harmonize all the international best practices. The WB principles should not represent an impediment to this harmonization.

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M. Knox On the point of the equality of creditors, he recalled that this equality is relativized anyway (referring to the legal situation in the US, where many privileges and subordinations exist). Funding form transactional creditors should be differentiated. Those that do not have a funding expectation should bear less loss than transactional creditors.

Carlos-Altieri Found that consistency was important but: can we define these agreements? Is it not impossible as they constantly evolve? Wouldn’t we have to legislate every day?

Chris Redmond Recalled that te carve-out basis is “systemic issues” – and it is not up to this group (but FSB) to define what the systemic issues are. The “carve outs” have to be well-defined first. The insolvency issues that this TF may deal with should focus on non-systemic issues.

Leif Clark In his view, WB Principles are here for WB when it makes its ROSC. What we say is very broadly “have a safe harbour” – but they are out of date. We cannot wait for UNCITRAL to revise its principles. The Lehman case has showed that “safe harbours” as they are have been counter-productive. Robin Phelan has showed only some examples. And the WB should at least not promote this behaviour, and this is what it does currently with the Principles as they stand now. Again: there must be are very good reason for any preferential treatment. He strongly stressed the need to revise the WB principles.

Edward Janger

He summarized the session’s reactions to the comments/actions items.

There is consensus on:

- There are inconsistencies between the existing ICR standards and the emerging best practices.

- The WB principles/Standards should not be inconsistent with UNIDROIT Principles.

- Alignment with FSB KA should also not be “outlawed” by ICR Principles.

Regarding overstepping others expertise:

- It is very clear that the TF cannot come out with a set of rules and establish best practices. However, we cannot stay in the way of states applying best practices that is not harmonized or updated.

In order to make this exercise concrete we may focus on the following substantial points and try to achieve the maximum level of consistency, taking into account evolving views and experiences He noted that we may look at aspects of LG Rec. 106 and R 107 (scope and “broadness”, consistency with UNIDROIT/FSB), Rec. 104 und R105 (issue about parties involved), Rec. 101 – 103 (should be expanded to include FSB

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Standards and reference to the bank resolution regime applicable – at least this should be taken into account in the context of our work).

Irit Mevorach Summarized the next steps:

- Consistency is required and we should amend the principles, essentially along the lines of Edward Janger’s summary.

- We will work (with experts) on redrafting the Principle - We will circulate a redraft of the Principle with the suggested

changes, - A further TF meeting may be convened to discuss the redrafted

Principle.

Final remarks express their support for a revision of the Principles in the sense of limiting their scope (Carlos Mejorada even suggested abolishing all exceptions).