Negotiating restructuring plans

Draft of 20 September 2018 BEST PRACTICES IN EUROPEAN RESTRUCTURING Contractualised Distress Resolution in the Shadow of the Law LORENZO STANGHELLINI Full Professor of Commercial Law, University of Florence Member of the Group of Experts on restructuring and insolvency law advising the European Commission RIZ MOKAL Barrister, South Square Chambers in London Visiting Professor of Laws, University of Florence Honorary Professor of Laws, University College London CHRISTOPH PAULUS Full Professor of Private Law, Civil Procedure Law, Insolvency Law and Roman Law, HumboldtUniversität zu Berlin Member of the Group of Experts on restructuring and insolvency law advising the European Commission IGNACIO TIRADO Full Professor of Laws, Universidad Autónoma de Madrid Director at the International Insolvency Institute Fellow of the American College of Bankruptcy Secretary General of the International Institute for the Unification of Private Law (UNIDROIT) Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 This is the Final Report of the research project Contractualised distress resolution in the shadow of the law, which has been made possible by the European Commission Grant JUST/2014/JCOO/AG/CIVI/7627 This publication has been produced with the financial support of the Justice Programme of the European Union. The content of this publication is the sole responsibility of the contributors and can in no way be taken to reflect the views of the European Commission Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 TABLE OF CONTENTS CHAPTER I TIMELY IDENTIFYING AND ADDRESSING THE CRISIS 1. On the ‘crisis’ and on triggers for insolvency proceedings and restructurings .............................................. 1 POLICY RECOMMENDATION #1.1 (REQUIREMENTS TO BEGIN RESTRUCTURING PROCEEDINGS) ..................................... 4 2. 3. On the importance of early and effective triggers ................. 4 Recognition of the crisis ........................................................ 6 3.1. What the law can do ...................................................... 6 POLICY RECOMMENDATION #1.2 (EARLY WARNING SYSTEMS) ................................................................................. 11 POLICY RECOMMENDATION #1.3 (DUTY TO DEFINE CRISIS EVENTS) ......................................................................... 11 POLICY RECOMMENDATION #1.4 (ROLE OF MANAGEMENT WITH REGARD TO EARLY WARNING) ................... 11 POLICY RECOMMENDATION #1.5 (AFFORDABLE COUNSELLING FOR MSMES TO PREVENT AND ADDRESS CRISIS) ............................................................... 11 3.2. What the debtor/debtor’s management and hired professionals can do ............................................ 12 GUIDELINE #1.1 (VOLUNTARY EARLY WARNING SYSTEMS) ................................................................................. 13 POLICY RECOMMENDATION #1.6 (BASIC TRAINING ON ACCOUNTING, BUSINESS AND FINANCE) ............................... 13 GUIDELINE #1.2 (ACCESS TO CURRENT AND ACCURATE INFORMATION FOR ADVISORS) ................................. 13 3.3. What the creditors and shareholders can do; the role of financial creditors in particular .................... 14 GUIDELINE #1.3 (BANKS’ ASSESSMENT OF DEBTOR’S FINANCIAL CONDITION) ............................................................. 18 GUIDELINE #1.4 (DISCUSSION OF FINANCIAL CONDITION OF THE DEBTOR ON THE INITIATIVE OF A CREDITOR OR OTHER PARTY) .............................................. 18 4. Incentives to pursue restructuring.......................................... 18 GUIDELINE #1.5 (DEBTOR SHOULD ADDRESS CRISES IN A TIMELY MANNER) .............................................................. 21 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 POLICY RECOMMENDATION #1.7 (INCENTIVES TO PREVENT AND ADDRESS CRISIS)................................................. 21 5. Reduction of disincentives..................................................... 22 POLICY RECOMMENDATION #1.8 (DISINCENTIVES TO CREDITORS’ COOPERATION AND OVERLY HARSH AVOIDANCE REGIMES)............................................................... 24 Annex 1: A restructuring-friendly environment ............................ 24 POLICY RECOMMENDATION #1.9 (RESTRUCTURINGFRIENDLY LEGAL ENVIRONMENT).............................................. 25 Annex 2: Promoting a co-operative approach between debtor and banks ............................................................................ 25 CHAPTER II FAIRNESS 1. 2. Introduction ........................................................................... 27 1.1. Substantive and procedural goals .................................. 27 1.2. Imperfect information and how not to respond to it ................................................................................ 28 1.3. Fairness of process and of outcome .............................. 29 Treatment of equity claims ..................................................... 30 2.1. The ‘debt/equity bargain’ ............................................... 30 2.2. The treatment of equity holders in the absence of the God’s eye view ..................................................... 31 2.2.1. The ‘still solvent’ scenario ................................ 31 2.2.2. The ‘micro, small and medium enterprises’ scenario .......................................... 32 2.2.3. The ‘irrational creditors’ scenario ..................... 33 POLICY RECOMMENDATION #2.1 (CREDITORS’ SUPPORT AS A REQUIREMENT FOR THE CONFIRMATION OF A PLAN)................................................................................ 33 3. Notification and information provision ................................. 33 POLICY RECOMMENDATION #2.2 (NOTICE TO CREDITORS) .............................................................................. 34 4. POLICY RECOMMENDATION #2.3 (ELECTRONIC OR ONLINE NOTICE) ........................................................................ 34 POLICY RECOMMENDATION #2.4 (INDIVIDUAL NOTIFICATION).......................................................................... 34 POLICY RECOMMENDATION #2.5 (ADEQUATE INFORMATION TO BE PROVIDED TO STAKEHOLDERS) ............... 34 Comparator ............................................................................ 35 POLICY RECOMMENDATION #2.6 (NO-PLAN SCENARIO) ....................................................................... 36 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 5. 6. 7. 8. Competing plans .................................................................... 36 POLICY RECOMMENDATION #2.7 (COMPETING PLANS) ...................................................................................... 38 Class constitution ................................................................... 38 POLICY RECOMMENDATION #2.8 (CLASSIFICATION OF STAKEHOLDERS FOR VOTING PURPOSES) ............................... 39 POLICY RECOMMENDATION #2.9 (CLASS FORMATION: COMMONALITY OF INTEREST) ............................... 39 POLICY RECOMMENDATION #2.10 (CLASS FORMATION: RELEVANCE OF LEGAL RIGHTS, NOT PRIVATE INTERESTS) .......................................................... 39 Conduct of meeting ............................................................... 40 POLICY RECOMMENDATION #2.11 (VALUE OF CLAIM FOR VOTING PURPOSES)............................................................. 40 POLICY RECOMMENDATION #2.12 (VOTING PROCEDURES NOT REQUIRING A PHYSICAL MEETING) ................ 40 POLICY RECOMMENDATION #2.13 (PRESUMPTION OF VALIDITY OF STAKEHOLDERS’ MEETING) ................................... 41 Court’s review and confirmation ........................................... 41 POLICY RECOMMENDATION #2.14 (CONDITIONS FOR CONFIRMATION OF A PLAN THAT HAS BEEN APPROVED BY EACH AFFECTED CLASS OF STAKEHOLDERS) ......................... 43 9. POLICY RECOMMENDATION #2.15 (CONDITIONS IMPOSED BY THE COURT)........................................................... 43 Dissenting stakeholder classes............................................... 43 POLICY RECOMMENDATION #2.16 (CONDITIONS FOR CONFIRMATION OF A PLAN THAT HAS NOT BEEN APPROVED BY EACH AFFECTED CLASS OF STAKEHOLDERS) ....................................................................... 45 CHAPTER III THE GOALS, CONTENTS, AND STRUCTURE OF THE PLAN 1. 2. 3. Introduction ........................................................................... 48 POLICY RECOMMENDATION #3.1 (SCOPE OF PLAN) ................... 49 POLICY RECOMMENDATION #3.2 (APPLICABILITY TO CLAIMANT SUBSET)............................................................ 50 The restructuring plan ............................................................ 50 GUIDELINE #3.1 (OPERATIONAL AND FINANCIAL RESTRUCTURING). ............................................................. 51 Possible measure of the restructuring plan ............................ 51 3.1. Measures on the asset side.............................................. 51 3.1.1. Sale of the business ......................................... 51 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 3.1.2. 3.1.3. Sale of non-strategic assets ............................. 52 Changes in workforce ..................................... 52 POLICY RECOMMENDATION #3.3 (SALE OF BUSINESS AS GOING CONCERN). ................................................................ 53 POLICY RECOMMENDATION #3.4 (CHANGES IN WORKFORCE). ........................................................................... 53 GUIDELINE #3.2 (ASSETS-SIDE MEASURES). .............................. 54 3.2. Measures on the liabilities side ..................................... 54 3.2.1. 3.2.2. 3.2.3. 3.2.4. 3.2.5. 3.2.6. 3.2.7. 3.2.8. POLICY Change in the financial terms of credit exposures......................................................... 54 Change in interest rates ................................... 54 Postponement of debt ...................................... 55 Debt write-downs (‘haircuts’) ......................... 55 Treatment of loan covenants ........................... 55 New contributions by shareholders or third parties ..................................................... 56 Exchange of debt for equity ............................ 56 New financing ................................................. 58 RECOMMENDATION #3.5 (ALLOCATION OF NEW FUNDING). ......................................................................... 60 POLICY RECOMMENDATION #3.6 (DEBT-FOR-EQUITY SWAPS). .................................................................................... 60 POLICY RECOMMENDATION #3.7 (PREFERRED EQUITY AND CONVERTIBLE DEBT). ............................................ 60 POLICY RECOMMENDATION #3.8 (NONSUBORDINATION OF LOANS OF CLAIMANTS WHO SWAP 4. DEBT CLAIMS FOR EQUITY). ....................................................... 60 POLICY RECOMMENDATION #3.9 (NEW FINANCING). .............. 61 Valuation issues ..................................................................... 61 4.1. Objectives and uncertainties ........................................... 61 4.2. Techniques...................................................................... 63 4.2.1. 4.2.2. 5. Discounted Cash Flow (DCF) method ............................................................ 63 Market Valuation Methods ............................. 63 GUIDELINE #3.3 (VALUATION METHODS). ................................ 64 The explanatory (or disclosure) statement............................. 64 5.1. Context .......................................................................... 65 5.2. Consequences of failure to implement the restructuring .................................................................. 66 5.3. Overview of existing indebtedness ............................... 67 5.4. Timeline ........................................................................ 67 5.5. Financial projections and feasibility ............................. 67 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 5.6. Valuation and allocation of the value amongst claimants ....................................................................... 69 5.7. Legal pre-conditions for restructuring .......................... 69 5.8. Actions to be taken by affected stakeholders ................ 70 5.9. Objections to proposed plan .......................................... 70 5.10. Fund(s) to address contingencies .................................. 71 5.11. Intercompany claims ..................................................... 71 5.12. Position of directors, senior management and corporate governance .................................................... 71 5.13. Tax issues ...................................................................... 72 5.14. Professional costs associated with plan formulation and approval .............................................. 73 5.15. Jurisdiction .................................................................... 73 GUIDELINE #3.4 (CONTENT OF THE PLAN)................................. 74 POLICY RECOMMENDATION #3.10 (DIRECTOR LIABILITY AND ITS EFFECT ON THE PLAN). ................................. 74 POLICY RECOMMENDATION #3.11 (TAXATION IN RESTRUCTURING). ..................................................................... 74 CHAPTER IV DRAFTING HIGH-QUALITY PLANS AND THE ROLE OF PROFESSIONALS 1. 2. 3. Introduction .......................................................................... 76 The critical role of advisors .................................................. 78 2.1. Professional qualification and experience ..................... 78 GUIDELINE #4.1 (PROFESSIONAL QUALIFICATION AND EXPERIENCE OF THE ADVISORS) ......................................... 79 POLICY RECOMMENDATION #4.1 (PROFESSIONAL QUALIFICATION AND EXPERIENCE OF THE ADVISORS) ................ 80 2.2. Position and independence of advisors .......................... 80 GUIDELINE #4.2. (INDEPENDENCE OF THE ADVISORS) ............. 82 2.3. The advisors’ approach .................................................. 82 GUIDELINE #4.3 (REVIEW OF FINANCIAL AND ECONOMIC DATA) .............................................................. 83 2.4. The issue of costs ........................................................... 84 POLICY RECOMMENDATION #4.2 (COSTS OF ADVISORS) ....................................................................... 85 The peculiarities of restructuring plans ................................. 86 3.1. The peculiarities of restructuring plans vis-àvis ordinary business plans ............................................. 86 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 3.2. Drafting restructuring plans in the shadow of judicial reviewability ...................................................... 87 GUIDELINE #4.4 (FOCUS ON JUDICIAL ............................................................... 89 The restructuring plan............................................................ 89 4.1. The restructuring plan: the past, the present and the future of the business ................................................ 89 REVIEWABILITY) 4. GUIDELINE #4.5 (SUMMARY AND DESCRIPTION OF MAIN ACTIONS) ......................................................................... 90 4.2. The past: explaining the causes of the distress and why they can be overcome ...................................... 90 GUIDELINE #4.6 (TRANSPARENCY REGARDING THE CAUSES OF THE DISTRESS) ......................................................... 91 4.3. The present: valuating assets and liabilities ................... 92 4.4. The future: the business plan and the satisfaction of claims ...................................................... 93 GUIDELINE #4.7 (ASSESSING AND STATING THE ECONOMIC VIABILITY OF THE DISTRESSED BUSINESS) ................ 94 4.5. The focus on cash flow forecasts .................................. 94 5. GUIDELINE #4.8 (PREPARING ACCURATE CASH FLOW FORECASTS) ...................................................................... 95 Dealing with uncertainty ....................................................... 96 5.1. Uncertainty as an unavoidable component ..................... 96 5.2. The time frame of the restructuring plan ....................... 97 GUIDELINE #4.9 (TIME FRAME OF THE PLAN) ............................ 101 5.3. Time frame of the restructuring vs. time frame for paying creditors ........................................................ 101 GUIDELINE #4.10 (REDUCTION OF THE INDEBTEDNESS TO A SUSTAINABLE LEVEL) ............................ 103 5.4. Setting out clear assumptions, forecasts and projections ...................................................................... 104 5.4.1. The case for clarity ......................................... 104 5.4.2. Conditions of the plan..................................... 104 GUIDELINE #4.11 (DISTINCTION BETWEEN CONDITIONS FOR THE SUCCESS OF THE PLAN AND PRECONDITIONS FOR ITS IMPLEMENTATION) .............................. 106 5.5. Governing uncertainty .................................................... 106 5.5.1. Describing the actions to be carried out pursuant to the plan................................... 106 GUIDELINE #4.12 (DESCRIPTION OF ACTS TO BE IMPLEMENTED UNDER THE PLAN) ......................................... 107 5.5.2. Testing for the variation of assumptions..................................................... 107 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 GUIDELINE #4.13 (ASSUMPTIONS AND THE EFFECT OF THEIR VARIATIONS)................................................................... 108 5.6. Deviations from the plan and adjustment mechanisms .................................................................... 108 GUIDELINE #4.14 (DIVERGENCE BETWEEN FORECASTS AND REALITY) .................................................. 109 5.7. Provisions for adverse contingencies ............................. 109 GUIDELINE #4.15 (PROVISIONS FOR ADVERSE CONTINGENCIES) ............................................................... 110 CHAPTER V NEGOTIATING RESTRUCTURING PLANS 1. Negotiations and stay on creditors’ actions ........................... 112 1.1. Negotiations of restructuring plans: the need for good practices ........................................................... 112 1.2. Negotiations and stay on creditors ................................. 113 GUIDELINE #5.1 (REQUESTING A STAY ON CREDITORS) .............................................................................. 115 GUIDELINE #5.2 (PROJECTING CASH FLOWS DURING THE STAY)................................................................................. 116 GUIDELINE #5.3 (AVOIDING A HARMFUL STAY ON CREDITORS) .............................................................................. 116 POLICY RECOMMENDATION #5.1 (STAY ON CREDITORS) ...................................................................... 116 1.3. Negotiations and protection of transactions connected to negotiations ............................................... 116 POLICY #5.2 (PROTECTION AGAINST AVOIDANCE AND UNENFORCEABILITY) .................... 119 1.4. Negotiations and interim financing ................................ 119 GUIDELINE #5.4 (EXISTENCE OF THE CONDITIONS FOR INTERIM FINANCING).................................................... 121 2. RECOMMENDATION Information and cooperation ............................................... 121 2.1. The need for a complete ‘information package’ ........................................................................................ 121 2.2. Disclosure and good faith ............................................... 124 2.3. Cooperation by creditors? .............................................. 126 3. GUIDELINE #5.5 (RELATIONSHIPS WITH CREDITORS DURING NEGOTIATIONS) ..................................................... 127 Dealing with banks and credit servicers ................................ 127 3.1. The special role of banks in corporate restructurings .................................................................. 127 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 3.2. Legal constraints to forbearance and prudential requirements for NPL provisioning ................................ 130 3.2.1. A prudential framework partly inconsistent with the ‘rescue culture’ ............. 130 3.2.2. A cooperative approach between debtors and banks ........................................... 133 GUIDELINE #5.6 (AWARENESS OF THE REGULATORY CONSTRAINTS SPECIFIC TO THE BANKS INVOLVED IN THE RESTRUCTURING. COOPERATIVE APPROACH BETWEEN BANKS AND DEBTORS) ............................................... 134 GUIDELINE #5.7 (INTERNAL FINANCIAL ASSESSMENTS CONDUCTED BY THE BANK ON THE DEBTOR) .......................................................................... 135 3.2.3. 3.2.4. The long road to exiting the classification as non-performing exposures (NPEs) ........................................... 135 A possible abbreviated path ............................ 138 POLICY RECOMMENDATION #5.3 (EXEMPTION FROM THE ONE-YEAR CURE PERIOD AFTER FORBEARANCE) ................ 139 3.2.5. The long road to exiting the forborne status ............................................................... 140 GUIDELINE #5.8 (MINIMUM DURATION OF EXPECTED REGULAR PERFORMANCE UNDER THE PLAN) .............................. 141 3.2.6. 3.2.7. The discouraging effects of provisioning rules on the banks’ participation in restructurings ......................... 142 Conclusion: the need to start negotiations early ............................................ 145 GUIDELINE #5.9 (EARLY START OF RESTRUCTURING NEGOTIATIONS) ................................................................. 146 3.2.8. Banks as important partners of restructuring and the questionable push to sell NPLs that may be successfully restructured. Policy recommendations ............................................ 146 POLICY RECOMMENDATION #5.4 (PRUDENTIAL EFFECTS OF EXPOSURES’ AGEING) ........................................ 149 3.3. Handling coordination and hold-out problems in negotiating with banks ............................................... 150 4. POLICY RECOMMENDATION #5.5 (RESTRUCTURING LIMITED TO FINANCIAL CREDITORS) .......................................... 151 POLICY RECOMMENDATION #5.6 (ADOPTION OF CODES OF CONDUCT BY BANKS) ........................................... 152 3.4. Dealing with credit servicers .......................................... 152 Dealing with other kinds of creditors .................................... 153 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 4.1. Diversification of creditors’ incentives and preferences...................................................................... 153 4.2. Dealing with workers ..................................................... 153 GUIDELINE #5.10 (DEALING WITH WORKERS DURING NEGOTIATIONS) ................................................................. 156 4.3. Dealing with tax authorities ........................................... 157 POLICY RECOMMENDATION #5.7 (EFFECTIVE NEGOTIATION WITH TAX AUTHORITIES) ................................. 158 5. The role of external actors: mediators and independent professionals ..................................................... 159 5.1. Facilitating the negotiation through external actors .............................................................................. 159 5.2. The mediator................................................................... 161 POLICY RECOMMENDATION #5.8 (APPOINTMENT OF AN INSOLVENCY MEDIATOR. DUTY OF CONFIDENTIALITY) ............................................................ 166 6. Consent .................................................................................. 167 6.1. Passivity in negotiations ................................................. 167 6.2. Consequences of creditors’ rational apathy in negotiations .................................................................... 168 6.3. Measures to tackle passivity in negotiations .................. 170 POLICY RECOMMENDATION #5.9 (OPINION ON THE RESTRUCTURING PLAN BY AN INDEPENDENT PROFESSIONAL APPOINTED AS EXAMINER) ................................. 170 GUIDELINE #5.11 (OPINION ON THE RESTRUCTURING PLAN BY AN INDEPENDENT PROFESSIONAL APPOINTED ON A VOLUNTARY BASIS) ................................................... 171 6.4. Measures specific to restructuring tools that aim at (or allow) binding dissenting creditors ................ 172 POLICY RECOMMENDATION #5.10 (EXCLUSION OF NON-PARTICIPATING CREDITORS FROM THE CALCULATION OF THE REQUIRED MAJORITIES) ....................... 174 POLICY RECOMMENDATION #5.11 (PROVISIONS MITIGATING THE ADVERSE EFFECTS OF A DEEMED CONSENT RULE) ........................................................................ 174 CHAPTER VI EXAMINING AND CONFIRMING PLANS 1. 2. Introduction ........................................................................... 175 POLICY RECOMMENDATION #6.1 (EXAMINATION AND CONFIRMATION OF THE PLAN) ....................................... 177 Examination ........................................................................... 177 2.1. Voluntary examination ................................................... 178 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 2.2. Mandatory examinations ................................................ 180 POLICY RECOMMENDATION #6.2. (EXAMINATION OF THE PLAN)................................................................................. 184 3. Participation and plan approval ............................................. 185 3.1. Participants in the restructuring procedure ..................... 185 3.2. The vote .......................................................................... 189 POLICY RECOMMENDATION #6.3. (PARTICIPATION AND PLAN APPROVAL) ............................................................... 190 4. Confirmation.......................................................................... 191 4.1. Definition and scope of confirmation .............................. 191 4.2. Pros and cons of judicial or administrative plan confirmation ..................................................................... 192 4.3. Who should confirm the plan? ......................................... 193 4.4. Content and different types of plan confirmation ......................................................................................... 196 4.5. Appeals against the decision to confirm or reject the confirmation of the plan ............................................. 203 POLICY RECOMMENDATION #6.4. (CONFIRMATION OF THE PLAN) .................................................................... 206 CHAPTER VII IMPLEMENTING AND MONITORING PLANS 1. 2. Introduction ........................................................................... 207 Implementing the plan ........................................................... 209 2.1. Responsibility for implementing the plan ...................... 209 2.2. Change in board composition and retention of key employees ................................................................ 210 POLICY RECOMMENDATION #7.1. (PROVISIONS ON CHANGES IN BOARD COMPOSITION) ...................................... 212 2.3. Directors and officers specifically appointed to implement the plan (CRO) ............................................. 212 GUIDELINE #7.1 (APPOINTMENT OF A CRO) ............................. 214 2.4. Appointment of a professional with the task of realising assets ................................................................ 215 GUIDELINE #7.2 (APPOINTMENT OF A PROFESSIONAL TO REALISE ASSETS). .......................................................... 216 POLICY RECOMMENDATION #7.2 (APPOINTMENT OF A PROFESSIONAL TO REALISE ASSETS) ................................... 216 3. Monitoring the implementation of the plan ........................... 216 3.1. The importance of proper monitoring ............................ 216 3.2. Monitors ......................................................................... 217 10 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 GUIDELINE #7.3 (MONITORING IN CASE OF PLANS AFFECTING ONLY CONSENTING CREDITORS) .............................. 219 GUIDELINE #7.4 (MONITORING IN CASE OF PLANS AFFECTING NON-CONSENTING CREDITORS)................................ 219 POLICY RECOMMENDATION #7.3 (MONITORING IN CASE OF PLANS AFFECTING NON-CONSENTING CREDITORS) ...................................................................... 220 4. 3.3. Monitoring devices ......................................................... 220 Reacting to non-implementation ........................................... 221 4.1. Consequences of non-implementation: ‘Zombie plans’ ............................................................... 221 POLICY RECOMMENDATION #7.4 (AMENDING AND CURING THE PLAN DURING IMPLEMENTATION) ....................... 223 4.2. Possible remedies for plans that are not fully implemented ................................................................... 223 POLICY RECOMMENDATION #7.5 (POWER TO INITIATE REMEDIES) ........................................................... 225 CHAPTER VIII SPECIAL CONSIDERATIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES 1. 2. Introduction ........................................................................... 227 1.1. The importance of the topic............................................ 227 1.2. The conclusions of the research concerning MSMEs. .......................................................................... 228 The need to implement a bespoke system for MSMEs. ................................................................................. 231 POLICY RECOMMENDATION #8.1 (SPECIALISED MSME REGIME) ....................................................................... 232 POLICY RECOMMENDATION #8.2 (FINANCIAL CREDITORS’ INCENTIVES) .......................................................... 232 POLICY RECOMMENDATION #8.3 (PUBLIC CREDITORS’ POWERS AND INCENTIVES) .................................... 233 3. The main elements of the reform: a comprehensive approach aimed at introducing a cost-effective, flexible procedure. ................................................................. 233 POLICY RECOMMENDATION #8.4 (PRINCIPLES GUIDING THE SPECIALISED MSME REGIME) ............................. 235 4. The procedural structure ........................................................ 236 4.1. The ‘core’ procedural solutions ...................................... 236 POLICY RECOMMENDATION PROCEDURES OF MSME REGIME) #8.5 (CORE ............................................ 238 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 4.2. The options available to the debtor ................................ 239 4.3. The options available to creditors. ................................. 240 POLICY 5. RECOMMENDATION #8.6 (OPTIONAL MODULES AVAILABLE TO PARTIES) ...................................... 242 Encouraging timely use of the MSME regime. ..................... 242 POLICY RECOMMENDATION #8.7 (TIMELY USE OF THE REGIME) ............................................................................ 246 POLICY RECOMMENDATION #8.8 (ENCOURAGING THE ENTREPRENEUR TO BEHAVE COMPETENTLY AND RESPONSIBLY DURING INSOLVENCY PROCESS) 6. .......................... 246 Measures concerning creditors .............................................. 247 POLICY RECOMMENDATION #8.9 (RESPONDING TO CREDITOR PASSIVITY) .............................................................. 248 APPENDIX GUIDELINES & POLICY RECOMMENDATIONS I. Guidelines ................................................................................... 249 Chapter I ........................................................................................... 249 Chapter II .......................................................................................... 250 Chapter III......................................................................................... 250 Chapter IV ........................................................................................ 251 Chapter V .......................................................................................... 254 Chapter VI ........................................................................................ 257 Chapter VII ....................................................................................... 257 Chapter VIII ...................................................................................... 258 II. Policy Recommendations .......................................................... 258 Chapter I ........................................................................................... 258 Chapter II .......................................................................................... 260 Chapter III......................................................................................... 263 Chapter IV ........................................................................................ 265 Chapter V .......................................................................................... 266 Chapter VI ........................................................................................ 269 Chapter VII ....................................................................................... 271 Chapter VIII ............................................................................. 272 12 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V NEGOTIATING RESTRUCTURING PLANS* SUMMARY: 1. Negotiations and stay on creditors’ actions. – 1.1. Negotiations of restructuring plans: the need for good practices – 1.2. Negotiations and stay on creditors – 1.3. Negotiations and protection of transactions connected to negotiations – 1.4. Negotiations and interim financing – 2. Information and cooperation. – 2.1. The need for a complete ‘information package’ – 2.2. Disclosure and good faith. – 2.3. Cooperation by creditors? – 3. Dealing with banks and credit servicers. – 3.1. The special role of banks in corporate restructurings. – 3.2. Legal constraints to forbearance and prudential requirements for NPL provisioning. – 3.2.1. A prudential framework partly inconsistent with the ‘rescue culture’. – 3.2.2. A cooperative approach between debtors and banks. – 3.2.3. The long road to exiting the classification as non-performing exposures (NPEs). – 3.2.4. A possible abbreviated path. – 3.2.5. The long road to exiting the forborne status. – 3.2.6. The discouraging effects of provisioning rules on the banks’ participation in restructurings. – 3.2.7. Conclusion: the need to start negotiations early. – 3.2.8. Banks as important partners of restructuring and the questionable push to sell NPLs that may be successfully restructured. Policy recommendations. – 3.3. Handling coordination and hold-out problems in negotiating with banks. – 3.4. Dealing with credit servicers. – 4. Dealing with other kinds of creditors. – 4.1. Diversification of creditors’ incentives and preferences. – 4.2. Dealing with workers. – 4.3. Dealing with tax authorities. – 5. The role of external actors: mediators and independent professionals. – 5.1. Facilitating the negotiation through external actors. – 5.2. The mediator. – 6. Consent. – 6.1. Passivity in * Although discussed in depth and shared by all the members of the Co.Di.Re. research team, paragraph 1 is authored by Lorenzo Stanghellini, paragraph 2 is authored by Andrea Zorzi, paragraph 3 is authored by Monica Marcucci and Cristiano Martinez, paragraph 4 is authored by Alessandro Danovi and Patrizia Riva, paragraph 5 is authored by Paola Lucarelli and Ilaria Forestieri, and paragraph 6 is authored by Iacopo Donati. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 112 negotiations. – 6.2. Consequences of creditors’ rational apathy in negotiations. – 6.3. Measures to tackle passivity in negotiations. – 6.4. Measures specific to restructuring tools that aim at (or allow) binding dissenting creditors. 1. Negotiations and stay on creditors’ actions 1.1. Negotiations of restructuring plans: the need for good practices Restructuring plans aim to obtain concessions from the creditors, or some of them, with the goal of making them better off than the available alternatives (usually the insolvency liquidation of the business). The debtor, therefore, must convince them that accepting the plan is both in their best interest as a group, and in the best interest of each affected creditor. This is a difficult task since it implies verifying and sharing complex information on the present situation and agreeing on the likelihood of future scenarios. Negotiations are necessary whenever the plan must be agreed upon through an expression of consent. No sensible creditor would accept a plan without being adequately informed and, possibly, without having negotiated a counterproposal, or one or more amended proposals, that, in the creditor’s view, yield a better outcome. However, negotiations with certain creditors (most commonly the main creditors) are common also in procedures in which the acceptance or rejection of a restructuring plan is done through a vote, which also binds dissenting creditors. In such procedures, it is usually the debtor who submits its proposal, which must meet the applicable standards of disclosure (set by the law and implemented by the court), and stakeholders vote on that proposal.1 Even though in such a setting it is not necessary to envisage a negotiation before the vote, very often the plan put to a vote is the result of a process by which an initial proposal is modified in order to secure the required approval by the requisite majority. 1 Applicable law establishes the required majority and how to count the votes (by value of claims only, or by value and number of claims) and how to consider those who have not voted (dissenting, consenting or simply nonvoting). Some of these issues have been addressed in this Chapter, below. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 113 In some cases, a negotiation phase is necessary for the debtor to choose the right tool to restructure its indebtedness. For instance, the debtor may approach its main creditors with a view to achieving a purely out-of-court restructuring only to realise that this path is not practicable due to the opposition by, and/or the passivity of, some of those creditors, resulting in the non-feasibility of a purely out-of-court solution. This makes the negotiation phase extremely important. It must be noted, however, that there is seldom any written rule – besides general contract law – that states how the debtor and the stakeholders must deal with each other while negotiating a restructuring plan. Is there a duty to share with the other parties all information available (for instance, how much a creditor has provisioned against the claim that the debtor asks to restructure), or just the information that, if missing or misleading, would make a party’s consent invalid? Is there a duty of the creditors to cooperate with the debtor in good faith? The answer to both questions is probably that, unless otherwise provided under the law, each party is entitled to act selfishly (see below, par. 2.3). This just renders more pressing the need for good practices applicable to the negotiations of contractual and quasi-contractual preventive restructurings. 1.2. Negotiations and stay on creditors Negotiating with creditors does not require per se a stay on creditors’ claims. Financial distress, which is the very cause for which the debtor engages in negotiations with its creditors, can have different levels of severity. In fact: (1) financial distress may not be yet so serious as to prevent the debtor from paying its debts as they fall due. In these cases the debtor seeks to tackle future cash-flow tensions in a timely manner. It must be noted, however, that the time before such tensions begin to emerge may well be shortened by the creditors’ reaction to the start of negotiations (banks, for instance, may stop rolling credit lines over). In this case, and until the situation deteriorates, a stay on creditors’ enforcement actions is not necessary if not to prevent the opportunistic behaviour of one or more specific creditors; (2) in other cases, financial distress may prevent the debtor from paying all its current debts, but some creditors (usually, Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 114 financial creditors) have agreed on a ‘standstill’ and/or to interim financing so as to allow the debtor to remain solvent during the negotiations, e.g. by paying suppliers and workers in order to maintain the business as a going concern, with benefits for all the creditors. In this case, a sufficient number of creditors deems it in their own interest to sustain the debtor’s efforts to restructure, and therefore a stay on creditors’ enforcement actions is not necessary; (3) finally, financial distress may be so serious as to prevent the debtor from paying its current debts, an insufficient number of creditors (or no creditor) have agreed on a standstill and no interim financing is available on purely contractual terms. In this case, a stay on creditors’ enforcement actions may be necessary to preserve the business value in the interest of the creditors as a whole and thus sustaining the debtor’s efforts to restructure.2 The difference between the two last situations is that while in case (2) the creditors have reached an interim conclusion that the debtor’s efforts to restructure are worth upholding and are bearing the risk for doing so, in case (3) the creditors have not reached such a conclusion. Therefore, granting a stay on creditors is done on the (not unrealistic, but not obvious) assumption that the creditors have not reached the conclusion that the debtor’s efforts to restructure are worth upholding due to collective action problems and/or transaction and coordination costs, and they would have done so if they were acting as a cohesive and informed group. Requesting (or availing itself of the legal possibility of) a stay on creditors requires responsibility by the debtor, which must be reasonably convinced that by doing so it is preserving value for the creditors and it is not merely worsening the situation. The debtor must also be clearly aware of the cost of the stay, both in terms of limitation of creditors’ rights and in terms of potential losses for all the stakeholders deriving from 2 In this sort of case, the conflict existing between the individual interest of each creditor and the interest of the creditors as a whole is a well-known collective action problem, often labelled as the ‘tragedy of the commons’. It is a well-established view that from the perspective of each individual creditor of an insolvent debtor the most rational course of action would be to act as quickly as possible to grab the firm’s assets (or its equivalent liquidation value) and satisfy its claim, even though this would disrupt the business going concern to the detriment of all the other creditors. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 115 continuing a loss-making business. This is due to the fact that a stay directly impinges on creditors’ legal and contractual rights, limiting them. The level of necessary confidence in the beneficial effect of the stay is directly proportional to the length of the stay: the longer the stay, the higher the confidence should be in the fact that the stay is maximising value for the creditors. As seen above, the issue of the stay on creditors is strictly linked to the issue of interim financing. A debtor may not need a stay if it receives financing specifically aimed at keeping the business solvent. The conditions and effects of such financing will be examined in the next paragraph. Two remarks are necessary: (1) a significant degree of uncertainty is unavoidable, and while keeping the business going is reversible, stopping the business may not be. Therefore, at an initial stage, a stay on creditors may be useful merely to preserve the possibility of maintaining value for the creditors, a possibility that must be verified as soon as possible to avoid an unnecessary destruction of value. Such a verification should be made by someone independent having adequate business expertise, most commonly an external examiner (appointed by the court, by the creditors or by the debtor, provided that the examiner is independent); (2) there might be cases in which, although the business is worth more as a going concern than liquidated, a stay on creditors does not solve the problem, as the short-term cash outflows relating to expenses that must be incurred after the moment when the stay would take effect exceed inflows and no interim financing is reasonably available. In this situation, liquidation is unavoidable. Such cases make the case for timely coping with distress particularly strong. Guideline #5.1 (Requesting a stay on creditors). The debtor should request a stay only when there is a going concern value to preserve. The degree of certainty with regard to the existence of going concern value should be stronger when the requested stay has a long duration, has been extended after a previous request, or when the procedure to lift the stay is burdensome for creditors. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 116 CHAPTER V Guideline #5.2 (Projecting cash flows during the stay). Before requesting a stay, the debtor must draw a cash-flow projection showing in detail what the cash-flow inflows and outflows will be during the period creditors are stayed. Such projection must take into account the likelihood of harsher commercial terms by suppliers (possibly, dealing with the debtor only if paid upfront) and, if available, interim financing. Guideline #5.3 (Avoiding a harmful stay on creditors). If the projected short-term cash outflows exceed inflows and no interim financing is reasonably available, the debtor should abstain from requesting a stay and should quickly resort to the best available option to preserve the business value, either as a going concern or as a gone concern. Policy Recommendation #5.1 (Stay on creditors). The law should provide for a court to have the power, at the debtor's request, to grant a stay on creditors to facilitate restructuring efforts and negotiations. The initial order of the stay, the court's decision not to terminate the stay despite creditors' motions, and any extension of the stay should depend on the assessment that the stay is beneficial to the creditors as a whole. 1.3. Negotiations and protection of transactions connected to negotiations Regardless of the granting of a stay, the continuation of the business pending negotiations requires that the debtor be able to carry out transactions in the ordinary course of its activity (e.g. paying workers and suppliers) as well as transactions specifically aimed at furthering negotiations (e.g. paying reasonable fees and costs to the advisors). To this purpose, the counterparties to the debtor should be able to rely on the protection of such transactions, if equitable, in the scenario of a subsequent insolvency proceeding following the failure of the restructuring attempt. In certain jurisdictions, this comes from the requirements envisaged for avoidance actions, which Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 117 provide that payments by the debtor made in close timely connection to receiving an equitable consideration (e.g. a certain service or an asset) are not avoidable.3 Whereas in other jurisdictions where such transactions could be voided should the restructuring not succeed,4 it is important for the law to provide an express exemption covering these cases as well. This is important to avoid third parties refraining from dealing with the firm as soon as the distress has come to light, once the firm has started negotiations. No one would rationally assume the risk of the success of the restructuring attempt unless he or she is already exposed to the firm and/or obtains contractual terms remunerating such a risk. As a result, engaging in negotiations would cut most firms out of the market, even if still cash-flow solvent, thereby preventing the continuation of the business during negotiations, making it impossible to obtain the required professional advice, and ultimately determining the non-viability of the restructuring attempt. In light of the above, the law should provide for safe harbours and/or mechanisms allowing third parties to rely on the effects of the transactions carried out during restructuring negotiations. It is advisable for the law to directly set forth exemptions of certain types of transactions that are clearly aimed at making restructuring negotiations possible (e.g. payments of workers and strategic suppliers, reasonable fees and costs in seeking professional advice). The law should also include a provision creating a more general safe harbour (as a result of either the requisites for avoidance actions or an exemption to avoidance) for all other transactions that, while not specifically exempted, are carried out to further negotiations on a restructuring attempt that does not appear prima facie nonviable.5 3 This is the choice made by the German legislature. See sec. 142 InsO. This is the case of Art. 67(2) of the Italian Insolvency Act, providing that equitable transactions occurring six months before the beginning of the insolvency liquidation are declared void if the trustee provides evidence showing that the counterparty was aware (or should have been aware) of the debtor insolvency. 5 An alternative would be to provide that the judicial or administrative authority, upon the debtor’s request, may grant an exemption for any transactions not expressly exempted by the law, if the debtor provides evidence of the fact that the transaction is useful to further negotiations on a restructuring attempt that does not appear prima facie non-viable. However, 4 Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 118 CHAPTER V It is not advisable for the law to make the exemption from avoidance actions and/or unenforceability conditional on the confirmation of the restructuring agreement by the competent judicial or administrative authority. Such a solution, which has been adopted by certain jurisdictions and may be the one chosen by the European legislature,6 only partially neutralises the risk borne by third parties for the success of the restructuring attempt. Indeed, those dealing with the firm during negotiations continue to share the risk, beyond their control, that the restructuring negotiations will be aborted or, in any case, will not lead to a confirmed agreement, while being discharged only of the risk of non-implementation of the restructuring agreement once confirmed.7 The legitimate purpose of allowing the avoidance and/or unenforceability of transactions carried out when there was no reasonable perspective of achieving a restructuring agreement such a solution appears suboptimal, since it might either clog the courts further or (also given the urgency of these decisions) become a rubberstamping of transactions without proper scrutiny, inviting abuse. 6 Pursuant to Art. 17, par. 1 of the proposed Directive on preventive restructuring ‘transactions carried out to further the negotiation of a restructuring plan confirmed by a judicial or administrative authority or closely connected with such negotiations are not declared void, voidable or unenforceable as acts detrimental to the general body of creditors in the context of subsequent insolvency procedures’. It is not clear from the language of such provision whether the transactions ‘closely connected with such negotiations’ may not, in any case, be ‘declared void, voidable or unenforceable’, regardless of confirmation by the judicial or administrative authority. The provision of the Proposed Directive, which appears to subordinate the protection of ‘restructuring related transactions’ to the (later) judicial or administrative confirmation of the restructuring plan (Art. 17), seems inconsistent with the provision on ‘interim financing’ (Art. 16), which does not qualify judicial or administrative confirmation as a condition for granting protection, even though interim financing is just one particular type of restructuring-related transaction. 7 Granting protection to third parties regardless of the plan adoption and confirmation could be, at first glance, perceived as unfair to those creditors that are impaired as a result of the transaction (i.e., those creditors whose recovery would have been higher if the restructuring-related transaction had been avoided). However, should the law allow for the avoidance of such transactions, the third parties suffering an additional risk would either (i) not negotiate with the debtor, since it would be irrational for them not to be remunerated for such additional risk, or (ii) pretend that this additional risk be remunerated, to the result of carrying out transactions that would be regarded as inequitable and, thus, would more likely be voided. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 119 and obtain its confirmation should be pursued otherwise. Invalidating the protection of all transactions reasonably carried out to further a restructuring agreement, which eventually is not reached or confirmed, would be ‘overkill’. The exemption from avoidance and/or unenforceability should be lifted only with respect to those transactions that are deemed fraudulent or in any case carried out in bad faith.8 Policy Recommendation #5.2 (Protection against avoidance and unenforceability). The law should provide protection against the risk of avoidance and/or unenforceability of reasonable transactions carried out during negotiations and aimed at making restructuring negotiations possible, by either providing exemptions or designing the requirements for avoidance and/or unenforceability accordingly. 1.4. Negotiations and interim financing Interim financing helps keep the business solvent while the debtor is negotiating with its creditors. As mentioned, interim financing shares the same goal of the stay, namely preserving value for the creditors, and may be obtained by the debtor independently from a stay or in combination with it. Financing a distressed debtor, however, entails serious risks: (1) the financing may destroy value, giving a hopeless debtor new fuel to burn. Liquidation may then occur with fewer assets left for the creditors and/or more debts to satisfy out of the debtor’s estate; (2) the lender can incur the risks of recovery, as the debtor may not be able to reimburse the financing received and the security, if any, may be declared voidable. Therefore, from the debtor standpoint, interim financing should be sought only when the debtor is confident that it is in 8 The proposed Directive on preventive restructuring already provides that the exemption should concern only transactions that have not been ‘carried out fraudulently or in bad faith’ (Art. 17, par. 1), thereby making the case for removing the provision of the judicial or administrative confirmation of the restructuring agreement as a condition for the protection of the transactions carried out during the negotiations. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 120 the best interests of creditors. Such belief must be strong and founded on data and independent analyses when the amount of the financing is likely to affect the outcome of a liquidation. From the lender standpoint, granting interim financing ordinarily entails a recovery risk. Except for the case when the law reduces or neutralises the lender recovery risk (see below), no sensible creditor, be it a creditor already exposed or an external market player, would grant new financing unless it is reasonably confident the debtor will be repaying it (admittedly, creditors already exposed have a utility function more inclined to granting financing than external creditors). The lender is a market player that does not assess just the debtor’s estate from a static perspective, but also the future prospects of the business once restructured. Hence, when a lender grants interim financing, it strongly signals that the restructuring attempt is worth sustaining. As interim financing may contribute to preserve the business value, the law may help the debtor in obtaining it by reducing the risk borne by the lender. To this purpose, the law may give the grantor of interim financing an exemption from avoidance and liability actions and/or provide for priority to its claim (see e.g. Art. 16 Draft Directive). However, shielding the lender extending interim financing from the recovery risk may yield some undesired results, namely the loss of the above-described signalling value and allowing for the continuation of a business that should instead be ceased, since the restructuring attempt is not viable/credible. These undesired effects are partially tempered by the circumstance that, according to certain general legal principles common to most jurisdictions, measures protecting the lender would not operate when there is evidence that the interim financing has been extended fraudulently or in bad faith.9 9 The Proposed Directive expressly sets forth that ‘new and interim financing shall not be declared void, voidable or unenforceable as an act detrimental to the general body of creditors in the context of subsequent insolvency procedures, unless such transactions have been carried out fraudulently or in bad faith … The grantors of new financing and interim financing in a restructuring process shall be exempted from civil, administrative and criminal liability in the context of the subsequent insolvency of the debtor, unless such financing has been granted fraudulently or in bad faith’ (Art. 16, par. 1 and 3). Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 121 Guideline #5.4 (Existence of the conditions for interim financing). Interim financing should be sought only when the debtor assesses, on the basis of sound data and, if possible, expert advice, that this is in the best interest of creditors, especially to preserve the business’s value. 2. Information and cooperation 2.1. The need for a complete ‘information package’ An issue that has consistently surfaced in the qualitative empirical study is the need for the debtor to present creditors with adequate information in order for them to be able to decide in an informed and timely manner. In general, reliable and updated information is necessary in order to draft a correct plan. Businesses should have adequate reporting systems (see Chapter 1) that are able to allow detection of distress in a timely fashion and provide updated data at a level of granularity that is sufficient to design the plan in a suitably sophisticated manner. However, having the data is not enough. When drafting a restructuring plan, debtors should always be aware that they are addressing creditors and other third parties (advisors, insolvency practitioners, courts, as the case may be) that may not be immediately aware of all the business’s details and the plan’s aspects and implications. Information regarding the business and the plan, therefore, should not only be reliable, updated and complete, but should also be presented in a way that is easily understood and deal with all aspects relevant for the creditors and the other third parties. Completeness of the information package touches upon another key aspect, i.e. the timeliness of creditors’ response. Restructuring plans almost always require consent of at least some creditors as a prerequisite for the plan. However, completeness of the information package, while always being of great importance, becomes pivotal when negotiation occurs outside formalised proceedings. When there are formal proceedings, with set timelines and a moment in which creditors can cast their vote or otherwise express their position, the proceedings themselves solve the issue of timeliness. To the Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 122 contrary, outside of formal proceedings, it is even more important for the debtor to spontaneously adopt a timely and transparent approach from the start, especially with regard to the information they provide to creditors. An issue that is commonly raised is the difficulty for businesses to receive comprehensive and final responses in a reasonable time, especially from banks and other financial creditors. Of course almost any restructuring implies the involvement and participation of institutional creditors, in particular of banks. These difficulties increase (i) when there are several creditors or, in any case, the average value of each claim is not large, which is frequently the case in some jurisdictions (typically, in Italy, Spain, where usually businesses resort to various banks on equal footing also for credit facilities in the ordinary course of business and there is no leading bank, as is instead common elsewhere, e.g. Germany, and there are more micro and small enterprises), and (ii) in times of crisis, when banks are flooded by requests. In this respect, regulatory rules setting requirements for banks on NPLs provisioning may exert a significant influence on the incentives to the lender banks and the debtor during negotiations.10 It should be noticed that timeliness is of the essence not only for the debtor, but for the whole restructuring process. Time plays a crucial role in the reliability and effectiveness of the plan: it is not uncommon that, due to defects and delays in the negotiation process, plans that were drafted taking into account a certain time horizon are no longer current when creditors consent to the plan, because the underlying situation has changed. The implementation of the plan is, of course, immediately affected as well. The availability of high quality, complete and understandably presented information (a) is a prerequisite for the drafting of a good plan and (b) may facilitate obtaining positive, or at least timely, responses by creditors, and in particular by financial creditors. Timely responses from creditors have a positive effect to the extent that they make it possible to: 10 See infra par. 3 for an assessment of the effects of the incentives posed by regulatory rules on NPLs provisioning. It is worth to mention that such incentives would operate by fostering a quick reaction by the bank but, at the same time, creating an incentive for the debtor to slow down negotiations, as time increases its leverage in negotiating with banks. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 123 (1) abandon plans that appear defective or for any reason unfeasible from the beginning, avoiding further costs and detriment to creditors, and facilitating the filing for formal insolvency proceedings; (2) correct and improve the plan, when it is feasible, or at least appears as such theoretically (of course in order to be useful such amendments should be carried out promptly); (3) increase the certainty on the possibility of success of a feasible and well-balanced plan. The exact content of the information package to be provided to creditors and third parties will vary from case to case. However, some basic information should not be missing: § the causes of the crisis, if possible highlighting whether the crisis has a mainly financial origin or not; § the initial situation: all information and data on the debtor must be clearly and objectively outlined. Such data should rely upon some form of professional review; § a summary description of the proposed plan; § a more detailed description of key aspects, with a focus on key elements (such as the minimum amount of debt that needs to be written off or rescheduled, the minimum amount of creditor acceptance, whether the plan envisages the direct continuation of the business, etc.) and risks (including legal risks); § financial information; § prospective financial information, including the assumed cash flow projections; § key assumptions of the plan. A more detailed description of some of the elements of the plan outlined above is contained in Art. 8 of the draft Restructuring Directive. In the negotiation phase, the plan need not be complete and an outline will be enough. However, it is important that the basic information be given from the start so that creditors can immediately form an opinion about the plan. Any delay in this respect may result in postponing the restructuring and, thus, engaging in negotiations when a turnaround is no longer possible, or anyway when the debtor’s conditions have deteriorated. Once negotiations have started, as soon as possible the debtor should: Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 124 (a) prepare information to be disclosed to creditors, especially financial creditors, and related supporting documentation; (b) carry on negotiations in good faith; in return, creditors should promptly and critically evaluate the information received and ask for further information and documents, when needed; (c) define the plan in all its details, fine-tune it and define the proposals to be made to creditors; (d) if the plan includes the business continuing as a going concern, highlight whether standstill agreements or additional financing are necessary for the plan to go forward. Special attention should be given to the reasons why new financing is needed (with regard to the best interests of creditors); (e) highlight possible contributions provided by shareholders or third-party investors (in the form of risk capital or credit facilities) or show the reasons why asking for these contributions is not feasible. In more general terms, the debtor should be able and ready to provide all necessary supporting documents to creditors or other interested parties that may request them. 2.2. Disclosure and good faith When a restructuring plan is needed, the debtor is in distress. This causes the usual relationship between the debtor and its creditors or contractual counterparties to be altered. The extent to which this happens, however, depends primarily on how deep the crisis is. In general, directors have a duty to minimise losses for creditors (and, says Art. 18 of the draft Restructuring Directive, for workers, shareholders and other stakeholders).11 How does this translate into a duty do disclose all relevant information? In other words, can directors, acting in the interest of shareholders (who have appointed them) engage strategically with creditors and fail to disclose information that they are not required to 11 It should be noted that the goal of minimising losses, being referred to stakeholders having very different interests, is only seemingly unitary. Indeed, due to the provision of Art. 18, directors may often be subject to conflicting duties whose importance is not graded by the proposed Directive. In this respect, see the amendments proposed to the draft Directive. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 125 disclose by law? Does negotiation with creditors follow the same pattern of negotiation when the company is not in distress? The answer is probably no. Creditors are captive counterparties to the debtor and are asked to give up something they had bargained for. The debtor is often already breaching the credit contract or may be about to do so; the only issue in a restructuring is how big this breach will be. Creditors have no proper alternative to negotiating, because enforcement of the claim is not an option as a matter of law (when there is a stay and a collective proceeding) or as a matter of fact (the debtor is already underwater). Given that this negotiation is not between parties free to choose their counterparty and is therefore somewhat coercive, and given that there is also a collective action problem when there are many creditors, it is fair to say that an adequate procedure and disclosure are proper tools to mitigate these issues. However, there are some nuances. There is no doubt that the debtor must negotiate in good faith, even more than with ordinary negotiations. Many national laws provide for a similar duty either specifically to restructuring or, more commonly, as a general principle (this is the case, for instance, of Art. 1375 of the Italian Civil Code, Art. 7 of the Spanish Civil Code, or sec. 242 of the German Civil Code). It is not self-evident, however, whether debtors owe a duty of complete candour to creditors – which they certainly would not owe if not in distress. If the equity has not been completely wiped out, directors continue having a duty to maximise shareholder value, whilst not causing further losses to creditors. Therefore, it is arguable that directors do not have to reveal their ‘reserve price’ when bargaining with creditors. But even assuming that equity has been completely wiped out, directors may have a duty not to reveal all circumstances to all creditors, because this could frustrate the optimal overall outcome of the restructuring plan, especially when negotiating without the protection of a stay on creditors’ actions, but not only. Revealing too much information to creditors could cause negotiations to fail due to opportunistic behaviour of some creditors or just due to lack of coordination among them. These cases are likely not to be so frequent. As a general rule, therefore, one can say that debtors have a duty to disclose Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 126 all relevant information to creditors and other interested parties, and to do so in a clear and complete manner. 2.3. Cooperation by creditors? Creditors should negotiate in good faith with the debtor. It is debatable, however, whether creditors have a duty to cooperate also when the law does not provide for coercive instruments. For example, can a creditor behave opportunistically absent a cram-down mechanism? Can a creditor refuse to accept (and sink) a restructuring plan that would make it better off just because it wants to uphold its notoriety as a hard player? Probably, good faith does not mean that creditors should actually cooperate with the debtor. As long as they do not take advantage of a position they may have acquired during negotiations and of information gleaned from the debtor during negotiations and they are not conflicted, creditors should be free to pursue their personal interest, which may differ from a standard definition of what their interest should be (i.e., the interest of an average creditor in the same position). Opportunistic behaviour should probably only be prevented by majority decision coupled, as the case may be, with a best interest of creditors test, and perhaps by specific interventions to make sure that creditor voting (or participation in decisionmaking) is ‘sincere’, i.e. making sure that the creditor has no ‘external’ interests but is acting in its own interest as a creditor of that debtor.12 Apart from these limits, there is a risk that by broadening the scope of good faith and deriving from it a duty to cooperate with the debtor, curbing all forms of dissent from what is a (supposed) average creditor’s best interest, too much discretion is given to courts or to authorities that oversee plans. Instead, 12 It is very difficult to exactly draw a line between legitimate external interests (e.g. for repeated players, such as banks, conveying a message to the market that would maximise the recovery of the entire portfolio, even though impeding the adoption of a viable restructuring plan and thus having a negative effect on the recovery rate in that specific case) and external interest that may not be legitimately pursued to the detriment of other creditors (e.g. willingly pushing the firm into insolvency with the purpose of triggering credit default swaps). Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 127 courts should always defer to a free and unconflicted decision of those whose interests are at stake, even if this entails a suboptimal outcome in the specific case. Guideline #5.5 (Relationships with creditors during negotiations). Especially when the restructuring plan that the debtor plans to submit to creditors requires the creditors’ individual consent, from the outset of negotiations the debtor should provide the creditors involved with adequate and updated information about the crisis and its possible solutions. Information should be provided concerning the causes of the crisis, a description of the plan and its key elements and assumptions, financial information both past and prospective. 3. Dealing with banks and credit servicers 3.1. The special role of banks in corporate restructurings Banks are a special category of creditors. Perhaps with the exception of microbusinesses in some jurisdictions, they often hold a remarkable share of the company’s indebtedness, which makes them a key counterparty in the negotiation of restructuring plans. They may also act as providers of new money, whose decision to financially support a restructuring attempt through interim or ‘new’ (post-confirmation) financing may be crucial for its success and, ultimately, for the survival of the distressed debtor. Banks’ approach to restructuring can therefore deeply influence the outcome of a crisis management strategy. However, decisions of financial creditors in this field are not fully discretionary and debtors need to be aware of the various elements (factual and regulatory) that – given the present regulatory context – may affect banks’ willingness to engage in constructive negotiation for a restructuring plan.13 13 Banks’ ‘specialty’ is primarily rooted in the fact that extending loans is the core business of these entities and an activity subject to regulatory constraints due to its connection with the public interest. As credit exposures incorporate elements of risk, applicable regulations impose on lenders to reflect such risks at balance sheet level (e.g. capital ratios, provisioning) and Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 128 CHAPTER V The banking environment has changed markedly following financial and sovereign crises in the European Union. Concerns have arisen about forbearance policies and the management of non-performing exposures (NPE) across the EU, as the then existing rules on these matters were seen as having prevented banks from timely recognising the impairment of outstanding debt and therefore as having contributed to the huge increase of risky exposures in banks’ balance sheets. In particular, the EU has been enacting a set of new standards and rules to ensure that banks pursue timely strategies in managing non-performing loans (NPLs)14 and derecognise bad loans from their financial statements, mainly for the purpose of coping with the existing NPL burden under an ‘emergency’ prospective – amplified in number and size by the stagnation of the corporate loan market – and preventing a further increase in the amount of deteriorated loans by applying the same emergency approach. In this respect, the most relevant recent changes concern: (i) the introduction of new accounting standards to increase transparency of banks’ financial statements,15 (ii) a convergence across Europe, in part still to be achieved, around the notions of ‘forbearance’ and ‘nonperforming exposures’,16 to adapt their internal organisation to effectively monitor and contain credit risks. This in turn affects the manner in which banks may react when dealing with counterparties in distress. 14 In the ECB language (NPL Guidance and addendum), ‘NPL’ and ‘NPE’ are used interchangeably. 15 In 2014, the International Accounting Standards Board (IASB) published IFRS 9 Financial Instruments, which includes a new standard for loan loss provisioning based on ‘expected credit losses’ (ECL). 16 Definition convergence has been achieved so far for supervisory reporting purposes, pursuant to Commission Implementing Regulation (EU) No 680/2014 of 16 April 2014, laying down implementing technical standards with regard to supervisory reporting of institutions according to Regulation (EU) No. 575/2013 of 26 June 2013 on prudential requirements of institutions (CRR). Convergence, however, is expected to be soon extended to the prudential framework within a package of measures to be adopted to tackle the problem of NPLs in Europe (see Commission communication of 11 October 2017 on completing the Banking Union). In particular, a Commission proposal for a Regulation on amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures – COM(2018) 134 final; from now on, CRR Amending Regulation – provides for the introduction in the CRR of a new definition of NPE, which is largely based on the current framework set forth in Commission implementing Regulation Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 129 (iii) setting out new legislative requirements to ensure the fulfilment of common regulatory provisioning levels for NPLs (i.e. amounts of equity capital that loans – depending on the risk category – are to be backed by).17 In the meantime, EU supervisors have issued guidelines drawn from best practices relating to NPL management to urge banks to monitor their credit exposures in the entire course of their relationship with borrowers, and to adopt prompt measures when signs of distress emerge.18 Finally, the Commission has recently proposed a directive on credit servicers, credit purchasers and the recovery of collateral with the aim of developing a EU secondary market for NPLs and ensuring a more efficient value recovery for secured creditors through accelerated out-of-court enforcement procedures (from now on, Credit Servicers Directive).19 In this changing landscape banks’ willingness to participate in corporate workouts and, more generally, their attitude towards restructuring attempts has been deeply impacted and is expected to change further. This trend is confirmed by national findings. They show that prudential rules on NPLs have become the major driver for banks in evaluating restructuring plans, as (EU) No 680/2014. Provisions will be added in the CRR to define the notion of ‘forbearance measures’ as well as in relation to cases where NPEs subject to forbearance measures shall cease to be classified as NPEs. It is worth noting that, in contrast with ECB Guidance, the CRR Amending Regulation does not deal with legacy NPLs, but it still questionably includes the ‘emergency approach’ under the Guidance to ‘ordinary’ credit management. 17 The proposed CRR Amending Regulation will impose a ‘Pillar 1’ minimum regulatory backstop for the provisioning of NPEs by EU banks – which is meant to apply to all exposures originated after 14 March 2018. Any failure to meet such provisioning floor will trigger deductions from Common Equity Tier 1 (‘CET1’) items. 18 On 20 March 2017 the ECB published its Guidance to banks on nonperforming loans addressed to credit institutions it directly supervises under the Single Supervisory Mechanism (‘significant institutions’). Such Guidance presents ECB’s expectations and best recommendations on dealing with NPLs. In the context of the published requirements, banks should reduce their NPL portfolios by applying uniform standards, thereby improving the management and quality of their assets. An addendum to the Guidance has been published in March 2018 dealing with loss provisioning expectations. For ‘less significant institutions’ some national supervisors (e.g., the Bank of Italy) have adopted or are adopting guidelines consistent with ECB Guidance. 19 Proposal for a directive of the European parliament and of the Council on credit servicers, credit purchasers and the recovery of collateral COM(2018)135 published on 14 March 2018. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 130 CHAPTER V keeping NPLs on their balance sheet is increasingly costly for banks. 3.2. Legal constraints to forbearance requirements for NPL provisioning and prudential 3.2.1. A prudential framework partly inconsistent with the ‘rescue culture’ Intensified regulation on the management of NPLs (notably stricter supervisory guidance and regulatory capital requirements) will likely reduce banks’ leeway to give concessions without an immediate pay-out (i.e. without tangible effects on their balance sheet). In light of the current regulatory landscape it may be expected that banks would be primarily led to consider how to quickly free up their balance sheet from the burden of risky exposures, even though such solutions would not entail the maximisation of the present value of the exposure. The risk of such a sub-optimal outcome is amplified by a high degree of uncertainty about the scope of the envisaged prudential provisions. The rules proposed by the Commission in the draft CRR Amending Regulation are partially inconsistent with the ECB expectations laid down in the 2018 Addendum. Namely, the ECB guidelines apply to the existing credit stock, i.e. those classified as NPE after 1 April 2018, while the parallel provisions of the proposed Regulation will only apply to exposures arising after 14 March 2018. In addition, it is worth recalling that the regulatory framework on NPLs is deeply affected by the fact that it is conceived as an emergency discipline (created in response to an extraordinary situation), whose draconian severity would no longer be justified in an ordinary, post-recession scenario. The fact remains that at this point in time – and regardless of any reservations one may have on the content of the rules and standards at hand – this is the regulatory background operators must deal with and whose implications with respect to preventive restructuring need to be assessed. The attitude of banks in the context of restructuring may be influenced by a number of factors, which are to a great extent beyond the control and even the perception of the debtor. In particular, the behaviour of the bank in restructuring Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 131 negotiations is indeed affected not only by the amount at stake or the nature of the claim (e.g. secured or unsecured), but also by the overall financial situation of the bank, the composition and soundness of its credit portfolio, and the internal NPL strategy it has in place. Pursuant to recent supervisory guidelines, banks are also urged to implement several organisational changes and operational arrangements to achieve a more effective handling of ‘problematic’ exposures (i.e. not only of exposures for which insolvency proceedings or foreclosure proceedings have already been initiated, but also for those that could still be remedied in full or in part through an out-of-court restructuring or other measures). Such organisational changes and operational arrangements exert a remarkable impact on the banks’ approach to restructuring negotiations. For instance, supervisors strongly recommend: § the adoption of NPL strategies and the implementation of operational plans setting out the options for NPL management;20 § the establishment of dedicated NPL workout units, which need to be separated from the loan granting units and would engage with the borrower along the full NPL lifecycle and take on, according to the guidelines, a different focus during each phase of that cycle. This measure would eliminate potential conflicts of interest and the risk of any bias in assessing the best strategy to deal with a problematic exposure, ensure the presence of staff with dedicated expertise and experience, and somewhat standardise the approach to credit management in debtors’ distress scenarios. The other, less direct, consequences of such measure are making the bank-firm relationship more impersonal in case of distress and replacing, to a large extent, soft information with scorings and other risk assessment techniques in assessing and addressing the firm’s distress;21 20 By way of example, ‘hold and forbearance’ approaches might have to be combined with portfolio reductions and changes in the type of exposures (e.g. debt to equity swapping, collateral substitution, foreclosure); moreover, the operational plan might allow only certain activities to be delivered on a segmented portfolio. 21 This approach may be perceived as causing a decrease in the likelihood of debt restructuring compared with cases in which lending units are involved and relationship banking prevails. International experience (like the case of Royal Bank of Scotland, see A. DARR, ‘Internal Contractual Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 132 CHAPTER V § the internal implementation of a number of credit monitoring tools and early warning procedures and indicators (at both portfolio and borrower level) so as to promptly identify signals of client deterioration. Banks are also recommended to develop specific automated alerts at the borrower level to be triggered in case of breach of specific early warning indicators. When such breaches occur, banks should involve the dedicated NPL workout units to assess the financial situation of the borrower and develop customised recovery solutions at a very early stage.22 Of course, the existence of a sophisticated system for managing problematic exposures internal to the banks does not prevent a debtor from taking autonomous initiatives prior to the occurrence of those triggering events (e.g. initial arrears), which would activate the bank NPL workout unit and cause it to take preliminary contacts. Indeed, a debtor might always be aware of other sensitive events unknown to creditors that may affect the soundness of the credit relationship (see Chapter 1), and in such case it should immediately start to plan remedies on its own, possibly with the assistance of financial advisors. However, under the above-mentioned circumstances, a debtor might waste time and resources in devising a plan based upon concessions that its financial creditor would not accept, due to general regulatory/operational constraints, or to idiosyncratic factors such as its own NPL strategy or the results Mechanisms for Addressing Insolvency: a case study of RBS’, available at www.codire.eu) and economic analyses on the effects of separate decisionmaking on debt restructuring and systematic use of scoring techniques show that these practices, on the contrary, can substantially improve financial restructuring of viable companies. See G. MICUCCI, P. ROSSI, ‘Debt Restructuring and the Role of Banks’ Organizational Structure and Lending Technologies’, (2017) 3 J Financ Serv Res 51. 22 It is worth recalling that these supervisory expectations are aimed at promoting efficient and prudent conduct by intermediaries in the management of credit risks; banks’ action or the lack of appropriate initiatives in this respect will be assessed by supervisors and might trigger supervisory actions. They cannot be interpreted, however, as imposing on banks specific duties to inform debtors or to launch any initiative in substitution of inactive debtors. Banks may offer their assistance or require borrowers to engage in finding solutions and are recommended to do so for prudential reasons, but only borrowers are responsible to manage distress, as part of their entrepreneurial activity, and may consequently be held liable towards stakeholders for their lack of prompt action. For their part, banks should avoid any form of interference with the business management of their clients, both in good times and bad. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 133 of internal assessments on the recovery prospects of that segment of exposures or, in some cases, of that specific exposure. 3.2.2. A cooperative approach between debtors and banks As we have pointed out in Chapter 1, it is important to promote a cooperative approach between debtors and banks, which may lead to the early identification of crisis and, therefore, to more value-maximising solutions. Therefore, it is important for the debtor to promptly approach (i.e. with the earliest signs of distress) its financial creditors to verify with them the existing (regulatory or operational) boundaries within which any negotiation would have to take place should the situation get worse. Debtors should be ready to provide – subject to proper confidentiality arrangements – any information that may impact their soundness and that might be useful for a prompt assessment by lenders of the financial situation of the debtor and the possible triggering of early warning mechanisms. In turn, banks should be available and willing to provide any relevant information in this respect. In this vein, banks should share with interested debtors the results of financial assessments, including sectorial analyses, that have been internally conducted in the context of their NPLs management activity, whenever such results may anticipate the evolution of the crisis and may help the debtor in identifying the most effective and feasible remedies. This would be particularly beneficial to MSMEs, whenever it is practically feasible, which might not have in place adequate risk monitoring mechanisms or may not avail themselves of the assistance of qualified financial advisory services. This does not mean that financial creditors should disclose their negotiation strategy in advance before sitting at the bargaining table. However, it would be good practice for lenders to promptly share with the debtor (already in preliminary contacts, whenever feasible) any concern (either deriving from specific supervisory measures or connected to internal NPL policies and operational plans) which would impact on their agreement to certain measures to turn around the firm. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 134 Admittedly, a cooperative approach requires a change of attitude of banks and businesses. The empirical research shows that far-reaching covenants that allow banks a wide discretion (especially for large firms) and fear of pressure to reduce the exposure as a consequence of detecting the first indications of an impending distress (for all firms) cause a widespread tendency of debtors to procrastinate communication with banks.23 This behaviour is understandable, given that, although rare, there have been cases of banks abusing their strong position.24 In parallel with achieving more transparency by debtors banks should be under a duty of good faith not to exploit the information they receive to ameliorate their position at the expense of other creditors, thereby making restructuring more difficult or impossible. Guideline #5.6 (Awareness of the regulatory constraints specific to the banks involved in the restructuring. Cooperative approach between banks and debtors). Debtors should promptly gain awareness of the regulatory considerations their lenders would make from a regulatory point of view, including in connection with elements of their NPL strategy and operational plan that under given circumstances may materially affect their approach to workout. To achieve such awareness, a debtor should promptly approach its lenders and share with them, under appropriate confidentiality arrangements, any relevant information that might adversely affect the soundness of its business or the value of collateral and require, in turn, to be promptly informed, at the outset of any negotiation and to the extent possible, of elements of the lender’s NPL strategy and other general constraints that might influence the willingness of the latter to make concessions, or certain types of concessions, in a given crisis scenario. 23 The results of the qualitative part of the empirical research, published on the website www.codire.eu, go in this direction, especially with respect to Spain. 24 Again, see the qualitative part of the empirical research. Abuse is rarely brought to light, although there are some notable exceptions (see A. DARR, ‘Internal Contractual Mechanisms for Addressing Insolvency: a case study of RBS’, available at www.codire.eu). Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 135 Banks should not exploit the information they receive from debtors to ameliorate their position at the expense of other creditors, thereby making restructuring more difficult or impossible. Guideline #5.7 (Internal financial assessments conducted by the bank on the debtor). Banks should share with interested debtors (upon reasoned request from the debtor and to the extent possible) any results of internal financial assessments, including industry analyses, conducted on the debtor’s situation or on the status of a specific loan segment, which might foster a better understanding by the debtor of the seriousness of the crisis and a reasoned identification of its possible remedies. 3.2.3. The long road to exiting the classification as nonperforming exposures (NPEs) As earlier described, NPLs are also subject to rigid reporting and supervisory expectations aimed at facilitating earlier recognition of actual and potential credit losses as well as ensuring a capital structure that gives adequate coverage to them.25 In general terms, exposures are qualified as nonperforming (NPLs) when: (a) the bank deems them to be unlikely to pay in full without recourse to collateral realisation, regardless of the existence of any past due amount or the number of past due days; 25 Exposures are balance sheet assets that banks must weigh by reference to the underlying risk (typically a credit and counterparty risk) under the applicable regulatory framework. Risk-weighted assets count within capital ratios as the quantitative reference for calculation of the own funds banks must hold, as a minimum, in order to absorb potential losses. For that purpose, banks must classify exposures by reference to their riskiness, i.e. their (un)likeliness to be paid in full at maturity. This is the micro-prudential perspective of each bank. Risky exposures are also periodically reported to supervisors for macro-prudential supervision purposes, i.e. monitoring of systemic risks, if any, to the financial sector as a whole or the real economy. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 136 (b) they have a material past due amount of more than 90 days, where materiality is defined by competent authorities to reflect a reasonable level of risk (currently in Italy 5% of the overall exposure).26-27 Regardless of their performing or non-performing status, exposures may be classified as forborne if the debtor, while experiencing (or about to experience) difficulties in meeting its financial commitments, benefits from concessions (typically made in the form of loan modifications and/or refinancing).28 Banks indeed enjoy a margin of discretion, in certain cases, as to whether exposures that benefitted from concessions should be classified as non-performing loans or (performing) forborne credit.29 26 In accordance with Art. 178(2)(d) of Regulation (EU) No 575/2013 (CRR), the materiality of a past due exposure shall be assessed against a threshold defined by the competent authorities. The conditions according to which a competent authority shall set the threshold referred to in paragraph 2(d) have been further specified in the Commission Delegated Regulation (EU) n. 2018/171 which will be applicable no later than 31 December 2020. This Regulation sets out an absolute and a relative threshold: the past due amount of an exposure is deemed material when both thresholds are breached. The absolute threshold should not be higher than 100 EUR for retail exposures and 500 EUR for non-retail exposures, and the relative threshold can be set at a level lower than or equal to 2.5%. 27 In certain jurisdictions, NPLs may be subject to additional classifications for national supervisory purposes, e.g. by reference to their riskiness, calculated as a function of both the severity of the debtor situation (distress, crisis, non-viability or insolvency) and the banks’ initiatives, or lack thereof, to overcome such situation. In Italy, for instance, NPLs are divided into the following sub-categories: bad loans; substandard loans and past due loans. All these sub-categories satisfy either of the EBA criteria as described above sub a) and b). 28 By way of example, banks must use the ‘forbearance’ category at least for debtor-friendly amendments to loan agreements or write-offs. They are expected but they are not required to do so when existing concession clauses are triggered to cure or prevent exposures more than 30 days past due or when modifications are made due to actual or potential payments on performing exposures are more than 30 days past due. In Italy, national regulatory provisions envisage that when a pool of banks temporarily ‘freezes’ credit facilities in anticipation of restructuring, this is not per se a forbearance measure. The ‘frozen’ period, however, must be counted as days past due. 29 Some examples may help understand the practical situations banks may face. In particular, as the applicable credit classification is a principlebased standard, it leaves some room for judgement. This typically happens when it is disputable whether certain exposures have the characteristics to be classified as unlikely to pay. In those instances, banks choosing to use the ‘performing forbearance’ category must make sure that their choice does not Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 137 However, with respect to forborne non-performing exposures, consistent with this regulatory framework it would be essential to identify the conditions under which restructured exposures may exit from the non-performing category and enter into the forborne performing category. Only when the conditions for a restructured exposure to exit from the nonperforming category are met will the bank be able to free up resources and reflect the classification change in its balance sheet. The shift of a forborne exposure from non-performing to performing status is neither immediate nor automatic, as it rests on the debtors’ capability to repay, i.e. reinstating a situation where the repayment is sustainable for the borrower. Such an effect depends on whether both (i) the bank deems that no more defaults/impairments exist after one year from the forbearance, and (ii) there is not, following the forbearance measures, any past-due amount or concern regarding the full repayment of the exposure according to the post-forbearance conditions at the end of one year (so called ‘cure period’).30 Achieving the end of the NPL status is therefore a long and difficult path that can adversely affect the willingness of banks to take an active role in restructuring processes. Lenders indeed might refrain from consenting to even profitable (and value maximising) crisis resolution arrangements, as granting a forbearance measure under a rescue plan would not entail – due to the one-year cure period - an immediate benefit in terms of NPLs reduction, which is the fundamental goal that all banks’ NPL strategies must have.31 This is a particularly undesirable instead delay a required loss recognition, nor conceal the actual asset quality deterioration. In other cases of restructuring through concessions, exposures are to be identified as forborne non-performing. Certain restructuring models, however, can lead to different consequences.. For instance, pursuant to Italian prudential rules, in the case of a court-approved business sale to a non-related third party on a going-concern basis, the exposure that is taken up by the transferee is to be reported as performing. 30 This means that the mere expiration of the one-year time period is not sufficient, as other conditions need to be met. As a consequence, the cure period can even be longer than one year. 31 In addition (and more importantly), keeping the non-performing status for one year from forbearance would substantially alter – as discussed below in par. 3.2.6 – the negotiation dynamic in connection with the harsh effects of the exposure’s ageing (i.e., ‘vintage’ according to the terminology used in the ECB documents) on the provisioning requirements currently under development. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 138 outcome in cases where objective elements show that the debtor, despite suffering from temporary difficulties, is still viable and upon restructuring full and timely repayment of the forborne loan would be highly probable. As under these circumstances the underlying risk would go back to normal levels, a mitigation of the classification regime would be essential to prevent the failure of a workable rescue attempt of a troubled debtor.32 3.2.4. A possible abbreviated path A possible way to mitigate the adverse effects of the forbearance classification regime might be that of either shortening the cure period (e.g. to six months) after a wellfounded and credible restructuring measure with concessions made effective, or – alternatively – to provide for the immediate exit of the loan from the NPL category and its shifting into a new status that should signal that concessions have been granted under a feasible and short-term plan. In both options, specific safeguards should be required in order to demonstrate that the debtor is still viable and that the restructured debt is sustainable. In particular, in order to prevent potential misuse of forbearance measures to hide impairments and given the implication of NPL classification for the stability of the financial system, the milder classification regime suggested here should be restricted to concessions granted under restructuring arrangements that have some degree of 32 In 2014, Spanish legislators took a step to incentivise the use of refinancing agreements (collective and homologated) by softening the regulatory framework of banks. Exposures subject to a refinancing agreement could be re-classified as ‘normal risk’ insofar as there were objective elements that made the payment of the amounts owed under the agreement appear probable (see Additional Rule 1 of Royal Legislative Decree 4/2014 and developed by the Bank of Spain in its Regulation (circular) 4/2014, of 18 March 2014). The rule was very ‘generous’ since it expressly stated that in order to assess the increased probability of repayment, the write-downs and additional time to repay had to be taken into consideration. And, more importantly – and also more controversially – the reclassification could be executed from the very moment of formalisation of the refinancing agreement: there was no need to wait a prudential period of implementation to lower the risk in the bank’s balance sheet. The regulation was repealed in January 2018 as it was deemed to not be compliant with the EU rules on exposure classification. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 139 ‘reinforced’ assurance with respect to their ability to reinstate the viability of the business and the ability of the debtor to duly perform. Therefore, the proposal is to reduce or abolish the cure period only in connection with restructuring plans confirmed by the court, in which an independent professional appointed by the court or otherwise designated within the framework of the restructuring procedure has confirmed the financial soundness of the debtor post-confirmation, as well as the future capability of the plan to ensure the timely and full repayment of the debt (in its original or modified amount).33 The option of the automatic exit from the NPL category would be more effective in fostering the participation of banks in restructuring negotiations as it would entail immediate benefits in terms of exposures classification for reporting purposes.34 In addition, this solution would not seem to increase the risks of a late recognition of impairments, provided that appropriate safeguards are established to verify the soundness of the plan and assess the borrower creditworthiness. Indeed, the policy suggestion at hand should be regarded in light of the new supervisory framework on NPL management, and in particular in light of the strict monitoring and assessment requirements discussed earlier, which should allow banks to promptly detect changes in the debtor’s financial conditions during the entire life-cycle of credit exposures and to modify its classification status accordingly. Policy recommendation #5.3. (Exemption from the one-year cure period after forbearance). For the purpose of incentivising banks’ participation in the negotiation of restructuring plans, regulatory provisions or standards 33 It is worth noting that we are not proposing a different instrument than those envisaged by the Directive Proposal, which do not necessarily require an independent expert’s opinion. We believe that the debtor and the creditors should not be deprived of the possibility of a successful restructuring, which is why a plan that, although subject to failure, is sufficiently serious (i.e. is more likely than not to succeed), should be confirmed (see Chapter 4, par. 5.4.2). However, given the relatively high failure rates shown by the empirical research (www.codire.eu), we suggest that exceptions to the one-year cure period should be limited to cases where there is a high probability that the debtor will remain solvent. 34 Further, it would be difficult to identify objective parameters under which deciding that 6 months or any other time reduction would be reasonable. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 140 CHAPTER V for the exit of credit exposures from non-performing status should not apply when concessions are made within the context of a restructuring plan confirmed by the court, in which an independent professional appointed by the court or otherwise designated within the framework of the procedure has confirmed the financial soundness of the debtor post-confirmation, as well as the future capability of the plan to ensure the timely and full repayment of the debt (in its original or modified terms). 3.2.5. The long road to exiting the forborne status Under the current framework the regained performing status of a restructured exposure (after the one-year cure period) does not affect its classification as forborne. Pursuant to the ITS, a performing restructured exposure can be classified as purely performing (i.e. exiting even from the forborne performing status) only when it is deemed performing during an additional probation period of two years, within which regular payments of more than an insignificant aggregate amount of principal or interest were made for at least half of the time, and provided that at the end of the probation period no exposure of the debtor is more than 30 days past due. This rule too may be cumbersome, as during the probation period banks are expected to perform stricter monitoring over the exposures and, in addition, the forborne status has repercussions for asset quality assessments. The monitoring of forborne performing exposures in probation period is very important, not only in order to verify whether requirements for the exit from the category are fulfilled; there may be events that can cause an automatic change in the status of the exposure and bring it back to non-performing. In particular, if a forborne exposure in probation period that has exited non-performing category is subject to additional forbearance measures or is more than 30 days past due, the overall exposures of the debtor have to be classified again as non-performing, thereby nullifying the benefits of the initial restructuring. The length of the probation period, however, does not seem to have discouraging effects – as such – on the participation of banks in restructuring negotiations. It appears to require banks Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 141 to carry out an in-depth and careful assessment of the long-term prospective viability of the debtor, thereby affecting the willingness of the former to consent to a plan that would not provide enough assurance in this respect. Regardless of possible future changes in the treatment of certain types of forborne exposures (along the lines suggested above with respect to the so-called ‘cure period’) debtors should thus be aware that any concession they intend to request has to be conceived having regard, inter alia, to the reporting implications for lenders. This requires, in particular, that restructuring measures be drafted under sound and credible terms, especially with regard to their attitude (in combination with other remedies, if needed) to restore the debtor’s financial soundness and ensure that its ability to regularly perform is maintained in the medium-long term. In particular, current rules imply that a time horizon of at least one year of regular performance (or of ‘no concern’ about the debtor) should be granted, as a minimum, because this is the length of time necessary for the exposure to cease being qualified as nonperforming. Banks, however, would likely pursue a more ambitious goal, i.e. the restoration of a full (not forborne) performing status, for which a three-year time horizon would be the minimum standard. Even this standard might not, indeed, be sufficient, as financial creditors might reasonably expect the debtor to pursue a longer-term viability, so as to avoid – in particular – the risk of using forbearance more than once, as this might be an obstacle to exiting from non-performing status. Guideline #5.8 (Minimum duration of expected regular performance under the plan). When negotiating concessions with banks, debtors should consider the feasibility of the proposed distress resolution actions in light of their predictable effects for lenders in terms of exposure classification and reporting requirements. For this purpose, any restructuring measure proposed by the debtor should be conceived under credible terms and on the basis of a sound assessment as to the ability of the measure to restore and maintain the debtor’s financial soundness and ability to perform in the long run and, in any case, for a time horizon of at least three years. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 142 3.2.6. The discouraging effects of provisioning rules on the banks’ participation in restructurings Based on exposures’ classification and related risk weighting, banks are also required to set aside minimum levels of capital to cover losses caused by loans turning nonperforming in order to meet supervisory expectations. If a bank does not meet the applicable minimum level, deductions from own funds would apply. In this regard, recent supervisory guidelines establish substantially rigid quantitative common levels of provisioning.35 These supervisory expectations have been devised for the purpose of de facto eliminating the degree of discretion that credit institutions still have in determining NPE coverage levels, thereby achieving convergence of provisioning practices among banks. According to recently issued guidelines, the levels of provisioning expected by the supervising authority depend on: (i) whether the loan is collateralised (in full or in part) or otherwise incorporates forms of credit risk mitigation, and (ii) time passed since the exposure has been classified as NPE. In particular, the bank is expected to provide full provisioning coverage for secured exposures (or portions thereof) after seven years from the moment when they became non-performing, and for unsecured exposures (and portions thereof) after two years from the moment when they became non-performing. The provisioning coverage for secured exposures must progressively increase according to ageing (socalled “vintage”, based on the terminology used in the ECB documents), i.e. 40% after three years, 55% after four years, 70% after five years, and 85% after six years (provisioning factors). These supervisory expectations apply to all exposures of significant banks classified as new NPEs since April 2018, 35 A similar approach is followed by the draft CRR Amending Regulation. While the proposed Regulation is aimed at introducing common provisioning requirements applying to all credit institutions established in all EU Member States (as the aforesaid EBA draft guidelines), the ECB Addendum – as noted - specifies the ECB’s (non-binding) supervisory expectations for significant credit institutions directly supervised by the ECB under the Single Supervisory Mechanism. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 143 but the ECB will start monitoring compliance with these requirements only from 2021 onwards.36 It is reasonable to expect that these harsh measures will significantly increase the volume of NPL disposals by banks, as keeping NPLs on their books will ultimately result in a higher cost of capital. Recourse to massive sales – with high depreciation effects – will likely be more severe for credit institutions established in EU Member States suffering from time-consuming and inefficient insolvency and debt recovery regimes.37 What seems to be clear at this stage is that the role and involvement of banks in restructurings is anyway likely to be deeply impacted by the new prudential rules on calendar provisioning. Banks, indeed, would likely be interested in engaging in the negotiation of restructuring plans38 provided that the restructuring process and the implementation of the plan be expected to occur before full provisioning coverage is required (i.e. within two or seven years, respectively, for unsecured and secured exposures after the claim is classified as NPL). After full impairment is made and the bank’s capital is affected so as to absorb the loss, banks might have little incentive to actively participate in negotiations and may be interested in collecting whatever recoverable amount on the impaired exposures is available, being ordinarily more inclined to pursue the easiest ways out, irrespective of whether they may be detrimental to debtors’ chances to recover. 36 The statutory prudential backstop under the proposed Regulation would instead apply to all banks and only to exposures originated after 14 March 2018, and not to prior legacy exposures. 37 Level playing field concerns caused by this divergence in the effects of common provisioning requirements across Europe would be mitigated – in the intention of European institutions - by the impact of other reforms that are being devised to tackle the problem of NPLs. The draft Restructuring Directive, first of all, with its aim to lead to the establishment in all Member States of common preventive rescue measures, should contribute to improve the efficiency of restructuring procedures within the EU. In addition, the performance of collateral foreclosures should considerably benefit from the introduction of out-of-court accelerated enforcement procedures, such as the one envisaged in the proposed Credit Servicers Directive. 38 Unless they have a strong incentive to help the survival of a debtor, in order to maintain a long-term relationship with a strategic client that they consider still viable. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 144 Further, it is worth noting that, even before the moment when the bank is required to ensure full provisioning, the rules on provisioning may significantly alter the incentives for the bank to engage in restructuring negotiations. Taking into account the existing classification regime as described above, unless the plan provides a write off and immediate repayment of the debt, the bank may not have sufficient interest in restructuring (at least with respect to unsecured exposures), to the extent that the end of the one-year probation required to exit the non-performing category could hardly occur before the twoyear term for full provisioning. As a result, a proposed restructuring, as far as unsecured exposures are concerned, is more appealing for the banks from a prudential perspective if it is reached and brought into effect at the latest within one year from the classification of the loan as non-performing. In fact, any forbearance agreed thereafter would not prevent the full provisioning effect at the two-year deadline (as mentioned, the loan may exit the NPE category only after one year of regular payments, or when the debtor – at the end of the year – has otherwise demonstrated its ability to comply). If a restructuring plan cannot be reasonably expected to be adopted and implemented, the bank would likely be mainly interested in an immediate partial payment rather than other concessions (e.g. a rescheduling) that would anyway result in full provisioning. With respect to secured exposures, banks could factor in the effects of partial provisioning from the third to the sixth year of ageing, thereby being more inclined to accept – in principle – sacrifices that already incorporate the percentage of partial provisioning required. Again, however, any forbearance agreement should be reached at the latest one year before the deadline for full provisioning (i.e. within the end of the sixth year of ageing), as after that moment a financial lender might no longer be willing, at least in principle, to grant concessions that would aim at preventing the insolvency liquidation of the debtor without however affecting the NPL status of the exposure (which would remain non-performing until the deadline for full provisioning).39 39 Still, it has to be recognised that for secured exposures a restructuring agreement due to become effective a year before the full provisioning deadline would also not be very appealing for banks, since at that point in time they should have provisioned already 85% of the exposure. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 145 3.2.7. Conclusion: the need to start negotiations early The current classification regime and the recommended operational practices for the management of NPLs, coupled with the severe provisioning regime, seem clearly oriented to convey the message that problematic loans should be addressed at a very early stage and trigger prompt action by banks in their own interest. Indeed, any negotiation, to be usefully undertaken by a debtor, should start before the exposure enters the NPL category, i.e. as soon as tensions emerge. After that moment, room for concessions by banks would be in fact considerably limited. However, in general terms, imposing a rapid full provisioning of NPLs will likely induce banks to pursue shortterm solutions that may be detrimental to debtors’ chances to recover, which in turn may prove inefficient for the system as a whole. Furthermore, due to the described prudential rules, in certain cases a debtor could have incentives to engage in strategic delay, since the bank could be deemed more inclined to grant concessions after the classification of the loan as nonperforming, under the threat of full provisioning. However, on the one hand, this might be true, as highlighted above, only to the extent that the delay would not affect the possibility to adopt and implement (at least with respect to the bank claim) a credible restructuring plan within the one-year period required to enable the exposure to exit from the non-performing category before full provisioning is required. On the other hand, debtors should consider that because of legal constraints banks might implement an ‘exit strategy’ by selling the NPL to third parties, as soon as they deem a timely and satisfactory restructuring unfeasible. In such a case, the purchaser, a new contractual counterparty, would sit at the bargaining table with the debtor. Also, the aforesaid incentives for banks might be less significant in respect of loans secured by collateral under the form of movable or immovable assets benefitting from ‘accelerated extrajudicial collateral enforcement’ (AECE), which could be envisaged in the proposed Credit Servicers Directive currently under discussion. Indeed, secured financial lenders that have included an AECE clause in their credit agreements could decide to activate that clause rather than participate in negotiations with the debtor. The current text of Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 146 CHAPTER V the draft Directive clarifies that the AECE cannot be activated if a preventive restructuring proceeding has been initiated and a stay of actions has been granted. However, this would not prevent lenders from activating the AECE despite pending negotiation of an out-of-court workout, thereby hindering a debtor’s attempt to restructure. Any workout strategy including financial creditors that could avail themselves of that special enforcement clause should therefore consider that it would be hard to obtain their consent unless they are granted recovery of the full market value of the collateral as quick as in an extrajudicial enforcement. Guideline #5.9 (Early start of restructuring negotiations). Negotiations of restructuring plans should start as soon as the first signals of distress emerge and, if possible, before credit exposures are classified as nonperforming. The plan should be designed so as to ensure that any concession is agreed and brought into effect no later than one year before the moment when the bank is expected to ensure full provisioning. 3.2.8. Banks as important partners of restructuring and the questionable push to sell NPLs that may be successfully restructured. Policy recommendations The introduction of stricter provisioning requirements, as noted, will give incentives to banks to sell NPLs more frequently to reduce the costs of handling problematic exposures. This outcome may be justified in the short term, as long as the aforesaid emergency approach is necessary to solve the problem of the extraordinary NPL volume in banks’ balance sheets. However, continuing to abide by such an approach in the future with respect to NPL management in the context of ordinary bank operations would be questionable from a policy point of view. The research shows that turnaround specialists see the continuation of the banking relationships of the distressed firms as very important, both for the firm-specific information they possess and for their ability to maintain and extend credit, supporting the business during the Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 147 implementation of the plan.40 Transferring the credit agreement to credit servicers may be neutral if the most efficient strategy is the pure recovery of the loan, but may imperil otherwise possible restructurings that still require active banking partners. In theory, banks might still play a role in all cases in which discussions with debtors start at very initial stages of distress, i.e. when, in light of the framework described above prompt action by the banks could prevent the deterioration of a credit exposure and its entry into the NPL category. In these situations (which might occur, essentially, in the first 90 days of past due, and only if banks do not already deem the exposures to be unlikely to pay), the banks’ approach should aim at supporting the debtor in restoring the long-term viability of the business rather than granting concessions on a purely bilateral debtorcreditor relationship, let alone increasing their protection (collateral/guarantees). To achieve this in the short time span above, however, might be difficult when the distressed debtor has a large and complex structure and has to deal with a multitude of lenders. Under those circumstances coordination might be extremely problematic and costly and a prompt sale to professional credit purchasers might again be a more efficient solution. In this regulatory framework, banks might then be forced to simply deem unrealistic the perspective of a timely restructuring, and just refuse to engage in (prospective or actual) negotiations. This would pave the way for credit servicers as the main actors of restructuring, which is probably not a welcome consequence given that they are less equipped to serve exposures (e.g. through interim financing or simply with the rollover of existing credit lines) that, while problematic, might still undergo a positive evolution. The unintended result would be that fewer firms would be able to overcome a temporary situation of financial distress, and more would become insolvent even if that could have been avoided. 40 The risk that the loan transfer to credit servicers may force the transition to the status of ‘bad loan’ of UTPs that may be restructured is strongly perceived by Italian professionals interviewed, and was highlighted by one of the speakers (Stefano Romanengo, turnaround manager) at the Rome Conference of 27 June 2018 in which the research was presented to Italian stakeholders. See P. CARRIÈRE, ‘Il prevedibile impatto per il sistema finanziario e imprenditoriale italiano della proposta di direttiva sullo sviluppo dei mercati secondari di NPL’, (April 2018) available at www.dirittobancario.it. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 148 As stated, to prevent such an outcome, which among other things would distort the very role of banks as institutional credit providers and professional risk-takers, a milder regime for provisioning should be considered. For instance, and especially if no exceptions were introduced to the one-year cure period after forbearance (at least in cases, as suggested above, of courtconfirmed, well-founded restructuring plans),41 not only a longer time span should be defined before which full provisioning is required, but such an effect should take place when there is no reasonable prospect to recover any amount from the loan. Along the same lines, quantitative levels of provisioning should not be set rigidly in correspondence with ageing, regardless of the real financial situation of the debtor and its recovery prospects. Ageing itself should be adapted to the fact that the debt has been restructured. Therefore, after any forbearance taken in connection with a restructuring, the ageing for the exposure that has been restructured, be it in the original or modified amount, should be suspended, and should be resumed only if the exposure is still non-performing at the end of a reasonable period needed to carry out a successful turnaround. Regulators could establish, for instance, that the ageing should be resumed if the exposure is still non-performing after three years, which in common practice is considered a time span after which a plan, if successful, is able to restore the viability of the business. Such time is considerably longer than the one-year minimum cure period provided by the EBA ITS, which, however, is not the only condition to be satisfied to exit the NPL-forbearance category, but there are other necessary conditions to be met,42 that in practice could make the cure 41 In any case, the cure period would continue to apply with respect to any other forbearance measures, e.g. to restructuring measures agreed in an out-of-court workout. 42 According to the EBA ITS, when forbearance measures are extended to non-performing exposures, the exposures may be considered to have ceased being non-performing only when all the following conditions are met: (a) the extension of forbearance does not lead to the recognition of impairment or default; (b) one year has passed since the forbearance measures were extended; (c) there is not, following the forbearance measures, any past-due amount or concerns regarding the full repayment of the exposure according to Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 149 period for these exposures even longer. Furthermore, the applicable provisioning factors should be calibrated around the real recovery prospects of the exposure, considering also the collateral recovery value in case of secured exposures, as identified by banks under the special monitoring tools for NPLs that they are required to have in place pursuant to supervision guidance. Indeed, rather than adding bank risks on top of the ordinary counterparty risk that they take and duly factor in at the moment of the initial granting of credit, the new supervisory standards on NPL management (as laid down in the ECB guidance and in national level provisions for less significant banks) should be emphasised and properly implemented so as to make sure that the expected in-depth assessments, monitoring techniques and alert mechanisms under the newly introduced supervisory standards are properly employed by banks to detect the slightest changes in risk levels during the entire life cycle of the credit relationship. Policy Recommendation #5.4 (Prudential effects of exposures’ ageing). Provisioning requirements should be calibrated around the real level of risks underlying credit exposures, as continuously verified and assessed by banks on the basis of reliable and objective parameters. After any forbearance measure taken in connection with a restructuring plan under which payment of the original or modified amount is envisaged, ageing counting should be suspended once the forbearance measure is granted and should be resumed only if the exposure is still non-performing at the end of a reasonable period needed to carry out a successful turnaround (e.g., after three years). In any case, full provisioning should be required only if and to the extent that risk assessments pursuant to the post forbearance conditions. The absence of concerns has to be determined after an analysis of the debtor’s financial situation. Concerns may be considered as no longer existing when the debtor has paid, via its regular payments in accordance with the post-forbearance conditions, a total equal to the amount that was previously past due (if there were past-due amounts) or that has been written-off (if there were no past-due amounts) under the forbearance measures or the debtor has otherwise demonstrated its ability to comply with the post-forbearance conditions. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 150 objective and reliable parameters show that no residual prospect of recovery within a reasonable time exists. 3.3. Handling coordination and hold-out problems in negotiating with banks The intense regulation to which banks are subject and the specific requirements they have to fulfil in managing distressed debt substantially differentiate the position of banks from that of other creditors. Financial creditors tend to share in most cases similar constraints and, at least in broad terms, similar interests. In light of the above, legislators may consider regulating restructuring procedures or measures specifically devised for financial creditors or, at least, permitting the restriction of the group of affected creditors exclusively to financial creditors.43 These restructuring agreements – commonly negotiated out of court and limited to financial creditors as to their effects44 – should be aimed at overcoming a situation of liquidity distress and preventing insolvency while protecting all the involved parties from claw-back actions for the case of subsequent insolvency proceedings.45 However, although financial creditors tend to have aligned interests, there may be circumstances where certain creditors oppose a restructuring pursuing the best interests of the creditors as a whole, either holding out opportunistically or on the basis of different economic interests and constraints.46 This 43 This is the case of the UK scheme of arrangement that, even though not specifically devised to deal with financial creditors (and, indeed, not even a restructuring procedure from a formal standpoint), may be used to push through a restructuring affecting only certain categories of creditors, including financial creditors. 44 See the Italian accordo di ristrutturazione con intermediari finanziari and the Spanish acuerdo de refinanciación homologado. 45 As shown by empirical evidence in all jurisdictions involved, financial creditors are usually more inclined to agree on a restructuring than the other type of creditors. 46 For instance, different lenders may have a different relationship with the debtor (some may have an interest in continuing doing business with the debtor in the future, others may have a short-term interest to recover their claim). They may also find themselves under a different level of pressure to resolve a problematic loan due to certain features of their credit portfolio or their exposure to the specific corporate sector in which the debtor operates. In Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 151 sort of misalignment is obviously more likely when there is a high number of banks involved in the restructuring process. Indeed, the existence of different interests and constraints may hinder financial creditors’ coordination and may give rise to hold-out issues capable of compromising the restructuring process. For this reason, it is important to have legal mechanisms in place whereby an agreement can be reached with a defined majority of financial creditors and made binding over dissenting or non-participating lenders, subject to fair and reasonable terms and conditions. In addition, in order to facilitate negotiations with banks (and, actually, also negotiation among banks) on a restructuring, banks should be encouraged to agree on codes of conduct or common procedural protocols (somehow inspired by the so-called London Approach). This would bind banks to a set of procedural rules to foster cooperation, such as: § appointing a steering committee to facilitate the dialogue among banks in view of pre-defined objectives and abiding to scheduled deadlines; § basing discussions on reliable information to be verified by an independent expert; § ascribing a duty of fairness to the other banks involved (e.g. not selling claims to a purchaser that the bank knows would impede restructuring, and/or requiring the purchaser to continue participating in coordination committees established by the banks and take a cooperative approach with the banks’ coordinator). Policy Recommendation #5.5 (Restructuring limited to financial creditors). The law should provide for restructuring procedures or measures producing effects exclusively on financial creditors, without affecting nonconsenting non-financial creditors. addition, if any of the financial creditors have credit protection – credit insurance or credit default swaps – their interest may conflict with the rest of the group, and they may have incentives to force the restructuring into a form that triggers their rights against hedge counterparties or even push the debtor into formal insolvency. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 152 CHAPTER V Policy Recommendation #5.6 (Adoption of codes of conduct by banks). Banks should be encouraged to adopt codes of conduct to foster coordination among lenders, independent verification of information and fairness during negotiations. 3.4. Dealing with credit servicers EU institutions are basing the strategy to address the problem of NPLs on, among other things, encouraging the development of efficient secondary markets for those loans. In this vein, the proposed Credit Servicers Directive provides for a common set of rules regulating specialised credit purchasers that will be authorised to operate within the EU. Their plausible more active presence in the market for distressed debt is expected to further change the scenario in which restructuring negotiations can take place. On the one hand, professional NPL funds and investors might have a more speculative and less cooperative approach vis-à-vis debtors during restructuring negotiations; on the other hand, however, these specialised actors could be better positioned to support the debtor in a crisis situation compared to banks. For sure, credit servicers could act with more flexibility than banks, as they do not face the same regulatory constraints. In addition, by investing in ‘single name’ corporate NPLs with the goal of gaining control over the restructuring process, they may improve the likelihood of a successful turnaround. Private funds are also better equipped than commercial banks (due also to less intrusive regulatory constraints on share ownership) to invest in shares allocated under debt-equity swaps as they are more likely to be committed to overhauling the companies concerned. However, having banks totally replaced by professional credit purchasers in managing restructurings does not appear to be – as indicated above – a desirable outcome. A more balanced approach, one which sees a NPL handled by the entity (bank or credit servicer) that in each specific case is most able to recover value from it, seems advisable. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 153 4. Dealing with other kinds of creditors 4.1. Diversification of creditors’ incentives and preferences As mentioned above while discussing the duty to act in good faith (par. 2.3), creditors may have very different incentives and preferences. The traditional view that creditors as a whole are driven by the goal of maximising the present value of their claim is a simplification, indeed very useful but still not conveying the wide array of utility functions of creditors. For example, it is apparent that banks are motivated by the goal of maximising their entire portfolio of distressed loans rather than maximising recovery with respect to a specific case of business distress. As a result, banks may sometimes take positions that are ineffective from the perspective of a certain restructuring deal but are regarded by the bank as efficient with a view at maximising the present value of the distressed portfolio as a whole (e.g. sink a restructuring to convey to the players in the market a certain internal policy that is deemed suitable to allow a higher recovery from an aggregate standpoint). Further, workers may be inclined to accept solutions that are not providing them the best possible recovery if they allow the continuation of the business. In this vein, the possible examples of legitimate creditors’ interests diverging from the apparently inflexible purpose of maximising the present value of claims are countless. As a result of such diversity of incentives and preferences of creditors, the debtor should assume a different approach in conducting negotiations over the restructuring plan according to the different kinds of creditors. 4.2. Dealing with workers In any crisis, effectively negotiating with workers is very important for the success of the restructuring attempt due to their particular role and position. On the one hand, workers are generally strongly in favour of restructuring since its success is often essential to allow them Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 154 to retain their jobs. 47 They could consider in their best interest to support a plan, although this be unfavourable vis-à-vis the alternative scenario of formal liquidation from a recovery standpoint, whenever the adoption of the plan allows them to retain their jobs (especially since several jurisdictions, including Italy and Spain, grant to workers’ claims priority on the business estate).48 Workers would inevitably factor into their decisions the risk of losing their jobs and the likelihood of finding a suitable alternative workplace. Furthermore, particularly in small and medium firms, workers may also have personal bonds to the entrepreneur that discourage them from turning down the restructuring proposal. On the other hand, workers are virtually always ‘suppliers’ of strategic inputs in view of the continuation of the business, therefore making their consent to the restructuring extremely important. In other words, the successful implementation of the restructuring strongly depends on retaining key employees, who incidentally are those employees that are more likely to dissent to the restructuring plan since they probably have other alternatives to reaching a deal with the entrepreneur. It should also be noted that negotiations with workers are usually regulated under the law more heavily than with respect to other categories of creditors. The most relevant trait is that such negotiations in many jurisdictions cannot normally take place on an individual basis, but rather must be conducted on a collective basis, involving, for example, trade unions.49 47 The cooperative (and resigned) behaviour that employees show during restructuring negotiations has been unanimously emphasised during the interviews conducted in Spain. See the Spanish National Findings available at www.codire.eu. 48 The priority granted to workers’ claims is well-grounded on both social and economic arguments (such as the fact that workers are not free to diversify their investment). 49 In Italy, trade unions are involved in negotiations whenever future claims would be affected by the restructuring. Instead, when the restructuring would only affect workers’ individual claims that are already existing, trade unions are entitled to negotiate on behalf of the workers only when so designated by the interested workers. In Germany trade unions play no formal role in restructuring negotiations with workers, whenever a works council (Betriebsrat) exists. The explanation lies on the circumstance that the works council in practice usually consists (also) of unionists, and they turn to the trade union for representation and advice. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 155 In order to effectively negotiate with workers, the debtor should focus on offering attractive incentives that can dissuade the most skilled employees from accepting alternative work offers. This is important to neutralise, or at least reduce, the risk for adverse selection, which would lead the firm to retain only less qualified or less productive workers once the restructuring plan has been adopted, thereby significantly undermining its chance of survival. Such a risk is particularly strong with respect to businesses heavily relying on highly specialised skills. In these businesses the real intangible assets are the workers’ know-how and capabilities. This is the reason why, paradoxically, when the firm is in distress and restructuring negotiations are started, implementing an effective incentive scheme is crucial. With a view to retaining the best employees, it is also very important to conduct negotiations in a transparent and fair manner so as to preserve the value of trust in the relationship between the debtor and its employees. As noted in Chapter 3, the restructuring plan may envisage the reduction of the workforce, which could be temporary or permanent. This is often a very important measure for achieving a turnaround of the business: deferring industrial corrective actions, such as not addressing redundancies, may result in a further round of negotiations, or even in the non-viability of the business. This may be a very delicate issue, and when informing the workers about the fact that the plan envisages such a measure the debtor should reflect very carefully on the best communication strategy.50 The reduction of the workforce may take place either by incentivising the voluntary resignations of certain employees (most commonly through offering a certain amount of money as compensation or an alternative job)51 or by unilaterally dismissing certain workers.52 In this latter case, most 50 In the interviews conducted in Germany, several experts recommended being as open as possible with employees and sharing plans regarding redundancies as soon as possible. 51 It is quite common practice in Germany, mostly in the case of large insolvency cases, to incentivise voluntary resignation by certain employees offering another workplace at a different firm (often found by the debtor itself, with or without public subsidies). This gives the transferred employees an opportunity to qualify for, and look for, other jobs without being formally unemployed and while receiving a remuneration, although often reduced. 52 In certain cases, the reduction of the workforce may take place without reducing the number of employees, rather reducing the number of Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 156 CHAPTER V jurisdictions require the debtor to conduct a negotiation with the trade unions or other collective bodies representing workers’ interests. When engaging in this sort of negotiation, the debtor should be adequately informed on the existing social safety nets, such as long or short-term public redundancy schemes, ordinary unemployment benefits and early retirement. Indeed, the debtor’s proposals should be structured in such a way as to increase the chance of approval, in light of the possible effects of the existing social safety net. In light of all the above, it is worth considering that in certain cases workers, in their capacity as creditors of the firm, might be interested in filing for insolvency. When no perspective of retaining their jobs is available (either because of an envisaged reduction of the workforce or the apparent nonviability of the business), benefitting from a safety net is an attractive option (e.g. for workers close to retirement), the workers have no claims left unpaid (or such claims enjoy priority that would in any case lead to full satisfaction), and/or there is a strong conflict between the entrepreneur and the workers, pushing the firm to insolvency liquidation may be an option for the workers. Although this is not very common and may sound theoretical, the number of involuntary petitions filed by employees have significantly increased in Italy over the recent years.53 Guideline #5.10 (Dealing with workers during negotiations). The debtor should devote particular attention to dealing with workers during restructuring negotiations, possibly providing incentive mechanisms and, in any case, dealing with them in a transparent way with a view to preserving or gaining their trust. working hours for all or some employees. The research conducted in Spain shows that this solution is quite common and, in many cases, deemed superior by those involved, since it does not entail redundancies and is ‘gentler’ (although in several cases it eventually proves to be insufficient). 53 The reasons underlying this trend are not easily understood, although it might be assumed that it is partially due to a greater number of firms that, in a context of diffuse economic crisis, are unsuitable for a turnaround, and thus the restructuring attempt is seen by the workers as being frivolous. Another reason could be that if the employer is declared insolvent, the social security pays the employees the last six months of salary plus any deferred compensation that is still due (approximately one month of salary for each year of work with the same employer). Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 157 4.3. Dealing with tax authorities Dealing with tax authorities has become increasingly important in light of the huge amount of tax claims that many troubled firms have accrued. This phenomenon is particularly severe in those jurisdictions where tax authorities are quite slow in recognising and enforcing tax claims. Indeed, such a delay creates an incentive for distressed firms to withhold payments to the tax authorities to deal with the cash-flow tension (at least in the short term, before the slow but inevitable reactions of the tax authorities).54 Where tax claims enjoy a strong priority, such as in Italy, the passive approach of tax authorities is well justified from their perspective. A delay in reacting to the debtor withholding tax duties does not affect recovery, since the distressed firm’s estate is devoted primarily to the satisfaction of tax claims, whereas monitoring actions entails a cost (even though such cost would be quite neglectable for tax authorities, since tax authorities are anyway required to monitor all taxpayers to curb tax evasion). However, the undesired effect is building up a significant stock of unfulfilled tax claims that become relevant when the firm engages in restructuring negotiations. Although there might be concerns on the efficiency of the policy choice of granting priority to tax claims, such choice, where it is made, is related to a diffuse and deeply-rooted understanding of public interests as prevailing over private interests, which goes well beyond the issue of business restructuring. In any case, even though with a stronger or weaker position according to the existence or otherwise of a priority for tax claims in the applicable legal framework, tax authorities should be involved in restructuring negotiations. With a view to not preventing efficient restructuring, the legislature should provide for the possibility for tax authorities to reduce or waive claims, if this would allow maximising the long-term interest of the tax authority (which is not limited to maximising the present value of existing claims, but includes also keeping in business a firm 54 The results coming from the empirical research in Spain show that the most common trigger leading distressed MSMEs to seek for specific advice in insolvency is the occurrence of a seizure in favour of tax authorities (see the National Findings for Spain, available at www.codire.eu). Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 158 that would generate other revenues by continuing to operate).55 It might be the case to require that an independent party examine the situation and concur with the assessment of the tax authority(ies) willing to reduce or waive the claims. In order to facilitate the negotiation of the restructuring plan and make it effective, it would be advisable to provide that the decision on the restructuring proposal be taken by few, ideally only one, entities that are competent for all tax claims.56 Such rule would allow having only a single counterparty, facilitating the procedure. Even when the claim may indeed be waived, there should be safe harbours for tax authority employees agreeing on a write off or a rescheduling. Policy Recommendation #5.7 (Effective negotiation with tax authorities). The debtor should be able to negotiate the restructuring with the least possible number of tax authorities, possibly just one, the negotiation should be aimed at maximising the interest of tax authorities as a whole in the long term. The responsible employees of tax authorities should be able to make an objective decision on whether reducing or waiving certain tax claims would pursue the above-mentioned goal. To this purpose, responsible employees should be made exempt from any risks, possibly upon receiving confirmation of their assessment by an independent professional. 55 As mentioned, during restructuring negotiations tax authorities should base their decisions on maximising their long-term interests (which is the position that tax authorities should adopt considering that there are, by definition, repeated players). It would not be appropriate for tax authorities to pursue a more general public interest (e.g. preserving jobs, supporting the economy of less-developed areas), even when this would conflict with the economic interest of tax authorities. Indeed, tax authorities lack the democratic legitimacy and technical standing to make this sort of decision (i.e. how to employ public funds in the public interest), which would be better made through more transparent decisions affecting everyone instead of decisions taken on a case-by-case basis that could raise issues of unlawful discrimination. 56 Identifying one or few decision makers for all tax authorities, although advisable, may not be feasible in certain jurisdictions because of impediments related to their constitutional order or to other national characteristics. For instance, this would be the case of Germany, which has a federal system that would not make possible to concentrate the power to decide on the restructuring in one or few decision makers in all cases. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 159 5. The role of external actors: mediators and independent professionals 5.1. Facilitating the negotiation through external actors The negotiation between the debtor and its creditors may be facilitated by involving external actors, such as independent professionals examining the plan and/or mediators assisting the parties in the negotiations. These two types of figures play significantly different roles in the context of restructuring negotiations. As a result, their respective qualifications and, especially, their attitudes to negotiations should be different. As will be more extensively discussed in Chapter 6, the professional entrusted with the task of examining the restructuring plan is required to provide an independent assessment on the best interests for creditors of what the debtor has proposed in the plan. This assessment entails the following evaluations: (i) whether the plan is feasible in the terms described by the debtor and, thus, whether it would eventually lead to its expected results, and (ii) whether the plan allows for a better outcome than the one creditors could expect in the context of the most likely alternative scenario should the plan not be approved (this being either an ordinary or insolvency liquidation, or the continuation of the business without any deleveraging, but instead excluding the scenario of a merely hypothetical further restructuring plan).57 As a prerequisite of the first evaluation, the independent professional is also required to ascertain that the plan is based on reliable and accurate data by checking assets and liabilities of the business or, where so provided by the law, certifying the data under her or his own responsibility. In short, the role of the independent professional is to reduce the information asymmetry between the debtor and creditors and provide creditors with guidance on whether it is in their best interest to support, or rather to oppose, the restructuring plan. The role of the examiner is particularly important when a significant number of creditors lacks the required competences to assess the proposed plan and/or, due to the size of their claims, lacks 57 For more on the best interest of creditors test, see Chapter 2. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 160 adequate incentives to perform such an assessment. The empirical evidence gathered in this study clearly shows that independent professionals’ opinions exercise a significant influence on creditors, who are noticeably more inclined to approve the proposed plan when a favourable opinion has been issued.58 The mediator is entrusted with a very different task. His or her tasks will be discussed in par. 5.2 below. However, it is worth noting that the mediator has a far deeper involvement in the negotiations than the examiner. The mediator’s main undertaking is to facilitate the reaching of an agreement between the debtor and its creditors based on the terms and contents of the restructuring plan. To effectively carry out such an endeavour the mediator must be granted full access to all information, including the information that the debtor and the creditors wish to keep confidential. In order to make it possible for the parties to reveal such information to the mediator, it is pivotal to grant him or her a strong, broad professional privilege, similar to attorney-client privilege. In light of the above, the role of the independent professional and the role of the mediator should not be coupled into one single person, otherwise either the examiner would lack the required independence, or the mediator would be ineffective due to the foreseeable resistance of the parties, particularly the debtor, to openly share all relevant information. The coupling of the two roles may be considered only in the case of micro and small enterprises, where the increase in cost of retaining two different professionals involved may outweigh the resulting benefit. 58 However, it is quite interesting to note that the right to require an independent expert report on the feasibility and viability of a restructuring agreement (which is given both to the debtor and to the creditors under the Spanish Insolvency Act, art. 71 bis.4) is seldom used (see the National Findings for Spain, available at www.codire.eu). In Germany, banks often require an independent expert evaluation of an existing plan or, in the first place, an independent expert drafting the plan before committing to a restructuring – no least as a protection against liability and avoidance. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 161 5.2. The mediator Negotiating a plan could be challenging due to the involvement of different stakeholders that often have competing interests, thus making their coordination difficult. Furthermore, the parties’ emotional reaction to the firm’s distress, especially for MSMEs where on average the parties are less sophisticated, makes them act selfishly instead of cooperating, thereby causing delays and expensive litigation (this is a quite wellknown collective action problem). The more time that is spent in building trust during the negotiation phase, the better the chances are that participants will reach an agreement on an effective and fair solution. In this regard, the appointment of an independent professional with skills and substantial expertise in facilitating interaction among multiple parties is strongly beneficial. Consequently, over the past years certain jurisdictions have introduced rules that allow debtors to seek the appointment of a mediator both in pre-insolvency situations and after the commencement of insolvency proceedings. Mediation is well established in the United States, where a mediator is often involved to facilitate plan negotiations (e.g. in the practice of the Chapter 11 proceedings). American bankruptcy judges can even mandate mediation (and any party can ask the judge to make such an order) to resolve contested disputes and claim objections that can hamper insolvency proceedings.59 A different approach has been adopted by those European countries that have enacted rules on mediation in the context of business restructuring. In Europe, the intervention of a mediator is regarded as limited to pre-insolvency procedures and for the purpose of helping the parties to reach an agreement on the terms of the restructuring.60 Moreover, the appointment of a mediator, or a conciliator, is deemed mainly useful in the 59 On the US experience, see, L.A. BERKOFF et al., ‘Bankruptcy Mediation’, (2016) American Bankruptcy Institute. 60 Insolvency mediation is spreading across the world as demonstrated in recent comparative studies, see L.C. PIÑEIRO, K.F. GOMEZ (eds.), ‘Comparative and International Perspectives on Mediation in Insolvency Matters: An Overview’, (2017) TDM 4, Special Issue; B. WESSELS, S. MADAUS, ‘Instrument of the European Law Institute - Rescue of Business in Insolvency Law’, (2017) p. 127-131, available at: ssrn.com/abstract=3032309. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 162 context of out-of-court restructurings.61 However, it should be noted that in-court restructurings would also benefit from mediation: negotiations are common in those procedures and the appointment of a mediator could be helpful to speed up the process by coordinating creditors in voting on the restructuring proposal. Qualitative interviews conducted with professionals advising debtors and creditors show that the parties very seldom choose to involve professionals with specific skills and expertise in facilitating restructuring negotiations. This is mostly due to a widespread unawareness amongst those involved in restructuring negotiations about what exactly a mediation procedure is and how it works and, above all, the beneficial effects determined by the presence of the mediator in this context.62 Furthermore, legal provisions mandating the appointment of a mediator in the context of business restructuring are quite uncommon in Europe.63 Only in isolated cases, as in the Spanish out-of-court payment agreement (acuerdo extrajudicial de pagos), the law explicitly designates a mediation process to restructure small business (MSMEs) and 61 The use of mediation to facilitate plan negotiation finds clear endorsement in the European Commission Recommendation, see recital 17 and Section II B (2014/135/EU) and in the draft Restructuring Directive, which introduces two new insolvency professionals in the context of insolvency and business restructurings: a mediator and a supervisor, see recital 18 and Art. 5 of the draft Restructuring Directive (COM/2016/723 final). Mediation is also echoed in World Bank Principle B4 (Informal Workout Procedures), that encourages the involvement of a mediator in the pre-insolvency, informal workout period. See the World Bank ‘Principles for Effective Insolvency and Creditor Rights Systems’, (2016), available at: documents.worldbank.org/curated/en/518861467086038847/Principles-foreffective-insolvency-and-creditor-and-debtor-regimes. 62 The idea of having a mediator involved to facilitate negotiations between the debtor and the creditors still meets considerable constraints in the culture of the entire business community. To a large extent, the prevention of insolvency is still perceived as a matter for courts and judicial procedures. Besides, professionals, who should be adequately informed on the opportunities associated with the appointment of a mediator, rarely advise the parties to appoint one. 63 The 2014 Commission’s Recommendation, recital 32, only provides that: (a) the mediator functions consist in assisting the parties in reaching a compromise on a restructuring plan; (b) a mediator may be appointed ex officio or on request by the debtor or creditors where the parties cannot manage the negotiations by themselves. Most Members States have not yet enacted national rules purported to fulfil the 2014 Commission’s Recommendation with respect to the appointment of a mediator. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 163 identifies the specific requirements to act as a mediador concursal (who is often an expert in turnaround, insolvency or related aspects) as well as the tasks that are entrusted to him or her.64 The appointment of the mediator should be made by the judge,65 taking into account suggestions coming from the debtor or other parties having an interest in the restructuring. The professional appointed as an insolvency mediator must have the ordinary professional qualifications required to act as a mediator,66 possibly in addition to specific competences in insolvency law and related expertise. In fact, the mediator may be required also to advise the parties concerning the choice of the measures to be included in the plan.67 In other terms, the mediator should have specific mediation skills (e.g. listening and communication skills, ability to gain the trust of the parties 64 Insolvency mediation was established in Spain in 2013 by the Spanish Insolvency Act (Ley 14/2013, de 27 de septiembre, de apoyo a los emprendedores y su internacionalización) arts. 231 et seq. Later, Spanish Royal Decree-Law 1/2015 enacted on 27 February, called the second opportunity Law, introduced some amendments both in the ‘out of court payment agreement’ (Acuerdo Extrajudicial de Pagos) regulation, as well as in the mediator role. 65 The judicial appointment of the mediator should not always be mandatory, being decided on a case-by-case basis according to the specific circumstances. See Art. 9 of the 2014 European Commission Recommendation and Art. 2 of the draft Restructuring Directive. 66 See the European Mediation Directive 2008/52/EC of the European Parliament and of the Council of 21 May 2008, which provides that the mediator must have specific training and be insured to cover the civil liability derived from his or her activities. Member States are left free to decide on the professional requirements and other regulations applicable to mediators’ training, although more requirements are likely to be introduced as a result of the revision of the same Directive that is currently underway. 67 In order to facilitate the activity of the parties devising a plan, the mediator’s role often goes beyond resolving disputes and facilitating communication among the parties. Indeed, the mediator should also engage in several technical activities such as: (i) checking the existence and amount of the credits; (ii) preparing a payment plan and, where appropriate, a business viability plan; and (iii) coordinating creditors’ meetings to discuss and settle the agreement proposal. Those activities are typically addressed by the mediador concursal in Spain, see C.S. MOTILLA, ‘The Insolvency Mediation in the Spanish Law’, in L.C. Piñeiro, K.F. Gómez, ‘Comparative and International Perspectives on Mediation in Insolvency Matters: An Overview’, (2017) TDM 4, Special Issue, 5. Also in Belgium out-of-court restructurings often involve a company mediator to assist parties in the preparation of the restructuring plan, see Art. 13, Law on the Continuity of Enterprises of 31. January 2009 (Loi relative à la continuité des enterprises). Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 164 to make them more confident in sharing private information), which should be preferably combined with those competences typical of insolvency lawyers and other advisors involved in the restructuring process.68 The appointment of a mediator may be advisable in light of the importance of a complete information package and of cooperation between the parties (see par. 2) coupled with the following considerations: (a) mediation responds better to the specific private nature of negotiations; (b) when mediation occurs at an early stage, the mediator can aid the parties in identifying the causes of the distress and becoming more receptive to making concessions in the context of the negotiations (one of the most common techniques to achieve this latter result is raising questions about the circumstances that have complicated relationships between the creditors and their debtor); (c) the involvement of a mediator at an early stage of the business distress reduces costs by allowing for a more timely selection of the appropriate tool, thereby avoiding the destruction of value associated with delays; (d) the mediator facilitates adequate sharing of preliminary information between the parties before they begin to discuss the substance of the plan; (e) while managing negotiations the mediator often resorts to specific trust-building strategies to help parties to move closer to the mediator and together; (f) business relationships are preserved and they could even grow.69 The mediator encourages the parties to find their own solutions to the business distress by asking questions that could help identify the issues that form barriers to negotiations and, possibly, making suggestions or asking whether the parties have considered certain possible solutions that would facilitate the advancement of the negotiations. To this purpose, the mediator would organise an initial conference that permits the parties to share their views on the issues that are to be negotiated. Later separate meetings (caucus) will be useful to establish a common 68 In those jurisdictions where mediation in insolvency does exist (e.g. Spain, Belgium, France) the mediator is usually a professional with specific knowledge and skills in facilitating negotiations, combined with substantial expertise in restructurings. 69 In order to realise the latter goal, the mediator’s contribution should consist in: (1) letting the parties craft creative solutions that might, for instance, increase debtors’ resilience to business crises; (2) encouraging the parties to communicate effectively. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 165 ground for cooperation with respect to specific issues and to open the channel for the transmission of information necessary for effectively conducting the negotiations over the restructuring plan. While managing meetings, the mediator often resorts to specific brainstorming strategies and activities with the intent of increasing trust. Among others, the most important mediator skill consists precisely in constructing a consistent set of information provided by the group of stakeholders involved in negotiations.70 Indeed, the parties will often share their sensitive data with the mediator, who becomes the vehicle of communication between the different groups and the ‘guardian’ of information. Therefore, the entire mediation process should be covered by confidentiality so as to keep the process private and preserve a sense of trust and substantive fairness between all the parties involved (e.g. confidentiality is one of the significant features of the French mandat ad hoc and conciliation procedures),71 whereas the Spanish mediador concursal does not enjoy such a strong confidentiality duty.72 The issue of confidentiality is indeed crucial. Drafting a correct plan requires reliable and updated information. An issue that was commonly raised by professionals assisting debtors and creditors is the difficulty in quickly creating a comprehensive set of information. Debtors and creditors, especially at the first stage of negotiations, refrain from sharing 70 This means that not all data transferred by the parties to the mediator will be immediately and directly reported to the other parties. Indeed, confidentiality of this information is protected by the mediator and will only be used with the consent of the interested party when (s)he realises – thanks to the contribution of the mediator – that it is reasonable to trust in the other partners. Trust is closely linked with the possibility of building a complete set of data, which represents the basis for a plan that maximises the satisfaction of all the parties involved. 71 See Art. D611-5 of the French Code de commerce. 72 A limitation to the mediator’s duty of confidentiality was adopted in the revised version of the Spanish extrajudicial settlement of payments, providing that the confidentiality duty is overcome in case mediation fails and the mediator takes the role of insolvency practitioner in the ‘consecutive insolvency proceedings’ (Art. 242.2-2ª of the Spanish Insolvency Act). This limited confidentiality of the insolvency mediator is perceived as problematic, See C.S. MOTILLA, ‘The Insolvency Mediation in the Spanish Law’, in L.C. Piñeiro, K.F. Gómez (eds.), ‘Comparative and International Perspectives on Mediation in Insolvency Matters: An Overview’, (2017) TDM 4, Special Issue, 5. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 166 CHAPTER V private information that is necessary to find an agreement on a restructuring plan since they are concerned with the risk that any statement or concession made during the negotiation process can then be used to their detriment. In this regard, the involvement of a mediator may be most beneficial: the mediator could facilitate the adequate sharing of information between the group of stakeholders, organising separate meetings with each party (i.e. debtor, creditors, or other third parties) and acquiring information with the reassurance of full confidentiality. The mediator should then obtain express authorisation from the interested party to disclose the information deemed necessary with a view to rapidly getting to a restructuring agreement (it is important to note that such information, being necessary to reach an agreement, most certainly would have been eventually disclosed by the relevant party). Besides the information that arises from or in connection with the mediation process, in certain cases the mere circumstance of the occurrence of a mediation process should also be treated as privileged. Policy Recommendation #5.8 (Appointment of an insolvency mediator. Duty of confidentiality). Whenever the law mandates or allows the appointment of a mediator, the latter should have those qualifications and skills specifically required to act as a mediator, in addition to being competent in restructuring and insolvency matters. In order to facilitate the gathering of adequate information at an early stage thereby avoiding delays, the parties should be able to share all information with the mediator relying on a strict duty of confidentiality. If the mediator deems that certain information would better be shared among the parties in order to advance negotiations, (s)he should require the party revealing the relevant information to waive the confidentiality. If no waiver is expressly granted, the mediator must not disclose the information under any circumstance. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 167 6. Consent 6.1. Passivity in negotiations The creditors’ decision not to participate in the restructuring negotiations may be commonly ascribed to one of the following situations: (i) the inactive creditor has examined all the circumstances and assessed that staying inactive is a value-maximising strategy (e.g. when the creditor may rely on the fact that a restructuring plan not envisaging a cram down would likely be adopted notwithstanding the lack of that creditor’s consent); (ii) due to the size of the claim and the absence of any other interest (e.g. for employees, keeping their jobs; for suppliers relying on the business relationship with the distressed company, keeping this latter in business), the inactive creditor may find it costlier to actively participate in the negotiations – thereby investing resources and time – than accepting the outcome of the negotiations whatever this may be. The behaviour described first is motivated by opportunistic yet informed considerations by the creditor and is considered a case of so-called ‘free riding’. This strategy is unavailable when the restructuring is carried out through tools that bind dissenting or non-participating creditors (in other words, whenever some form of cram down is available). Therefore, when the debtor could opt for a procedure or measure envisaging a cram down, the debtor has a tool that it may use, or simply threaten to use, to pose a limit on creditors’ ‘free riding’. In light of the nature of the phenomenon that has just been described, passivity in negotiations ascribable to opportunistic considerations can effectively be dealt with by providing procedures and measures envisaging cram-down mechanisms (see Chapter 2). The behaviour described second is commonly labelled ‘rational apathy’. It may occur in the context both of consensual and of compulsory restructurings, when certain creditors do not have an incentive to engage in negotiations. Indeed, from the perspective of an individual creditor having a small stake in the distressed company’s turnaround, there are no, or few, incentives to actively take part in the negotiations or to cast its vote on the plan. The cost of seeking professional advice and/or investing time in understanding and assessing the situation may well outweigh the cost of bearing the risk, and possibly Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 168 suffering the cost, of a disadvantageous solution to the business distress (e.g. an insolvency liquidation of the company when a turnaround was possible; a restructuring allocating relatively more value to other creditors). In the paragraphs below, the focus is on this second type of creditors’ passivity. 6.2. Consequences of creditors’ rational apathy in negotiations Although inactivity appears to be a rational behaviour for an individual creditor having a small stake in the distressed company, this conduct severely affects the efficiency of the business restructuring process. The negative effects of creditors’ passivity in negotiations are different according to the compulsory or voluntary nature of the restructuring tool at issue (i.e. providing or not any form of intra- and/or cross-class cram down). In the case of a compulsory restructuring tool, if the creditors’ inactivity is deemed under the law as a consent or a dissent, creditors’ passivity may respectively open the door to inefficient plans, which would be deemed approved notwithstanding only a minority of creditors actually casting a vote and making it virtually impossible for dissenting creditors to prevail, or, to the contrary, prevent efficient business turnarounds, although in the best ‘collective’ interests of creditors.73 The third option to the strict alternative between deemed consent and deemed dissent is to count towards the majority required to adopt the plan only those creditors that 73 The results of our empirical research show that the deemed consent rule in force in Italy until July 2015 for the in-court restructuring agreement (concordato preventivo) allowed for a certain number of abuses perpetrated to the detriment of creditors. On the other hand, after the deemed consent mechanism was repealed and replaced with a deemed dissent rule (and other limiting measures were adopted), the Italian system has faced a sharp decline in the number of in-court restructuring agreements (concordato preventivo), which is reasonable to assume that resulted in the winding up of a certain number of viable companies that, just a few years before, would have been saved. The repeal of the deemed consent rule has also translated into a lower rate of creditor consents to out-of-court restructuring agreements (accordo di ristrutturazione dei debiti), evidencing the nexus between creditors’ opportunistic behaviour and the threat of the recourse to compulsory restructuring tools. See the Italian national findings available at www.codire.eu. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 169 have actually cast a vote. This would sterilise the influence of passive creditors, making their inactivity irrelevant (see par. 6.4, below). In the case of fully consensual restructurings, the effects of creditors’ passivity are twofold: (i) since the non-participating creditors are not bound by the terms of the restructuring, their inactivity has the effect of putting the burden of the business restructuring on a smaller group of stakeholders that are therefore required to bear a greater sacrifice. As a result, there is less space to strike a deal between the debtor and the creditors participating in the process, thereby making it sometimes more convenient for active creditors to go through an insolvency liquidation (although inefficient from a collective perspective) rather than supporting a restructuring. Indeed, when such a deal is entered into by a limited number of creditors bearing the entire cost of the reorganisation, it is statistically more likely that the restructuring plan – while assessed as being feasible by the court – may eventually not be successfully implemented.74 A possible explanation is that due to the reduced bargaining space, the safety buffers provided by the plan may often be significantly shrunk; (ii) there may be significant and unpredictable deviations from the pari passu principle (e.g. claimants having the same ranking may enjoy very different recovery rates due to the possibility or not of relying on the fact that other creditors will consent to the restructuring agreement and bear the cost thereof). This would make it difficult for lenders to quantify ex ante their loss given default (LGD) of the debtor. It is anecdotally well known that uncertainty is a cost for investors and, in this specific respect, such an uncertainty increases the interest rate required by lenders to the detriment of the entire economy. 74 This has been clearly evidenced by the results of the empirical research conducted in Italy on out-of-court restructuring agreements (accordi di ristrutturazione dei debiti), which are fully consensual restructuring tools. Indeed, the greater the share of indebtedness held by the creditors consenting to the agreement, the more the possibility of the restructuring plan to be confirmed by the court. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 CHAPTER V 170 6.3. Measures to tackle passivity in negotiations Tackling rational apathy requires that the information to creditors be provided in the clearest possible way and made easily accessible for creditors substantially at no cost (see also supra par. 2). In this vein, the information package that is made available to creditors should be complete and accessible also digitally, without providing any burdensome procedures that may discourage creditors, if not required with a view to protecting relevant interests (such as, for instance, the confidentiality of certain data regarding the debtor’s business). Also, an incentive to small creditors to take a stance in the process may come from the provision of an examination phase of the restructuring plan (see Chapter 6, where the possible features of such procedural phase and the relevant costs and benefits are analysed). The independent examiner, when there is any, should clearly and concisely express his or her opinion on the advantage of the restructuring plan for the company’s creditors, avoiding precautionary formulas set in place to soften his or her position that may raise uncertainties among creditors.75 Policy Recommendation #5.9 (Opinion on the restructuring plan by an independent professional appointed as examiner). The law should provide that when an independent professional is appointed as examiner to assess the viability of a restructuring plan, the examiner’s opinion should (a) concisely and clearly 75 The empirical research showed very different attitudes of the examiners across jurisdictions. In Spain, professionals appointed as examiners most commonly express a negative opinion on the restructuring plan, sharing concerns of the fact that the plan is compliant with the creditors’ best interest. The prominent professionals interviewed ascribed this to the threat for the professional of incurring civil liability should the plan not be fully implemented. To the contrary, in Italy court-appointed examiners most commonly (86% of cases) express a positive opinion of in-court restructuring agreements (concordati preventivi). It is worth noting that only 4% of those plans that have been positively evaluated by the examiner are then rejected by creditors, thereby providing evidence of the influence of the examiner’s opinion on creditors’ votes. The above-mentioned data draw attention to the importance of setting adequate incentives for examiners, so as to ensure that their evaluation is as objective as possible, see Chapter 6. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 171 express whether the restructuring plan is in the creditors’ best interest; (b) be made promptly and easily available to all creditors; (c) avoid any disclaimer or other expression having the effect of making it equivocal. Guideline #5.11 (Opinion on the restructuring plan by an independent professional appointed on a voluntary basis). When an independent professional is appointed on a voluntary basis by interested parties to assess the viability of a restructuring plan, the independent professional’s opinion should (a) concisely and clearly express whether the restructuring plan is in the creditors’ best interest; (b) be made promptly and easily available to all creditors; (c) avoid any disclaimer or other expression having the effect of making it equivocal. Besides reducing the cost borne by creditors for getting informed, tackling passivity in negotiations requires also facilitating the process for creditors to express their consent or dissent on the proposed restructuring plan. The procedures that creditors are required to fulfil to cast their vote on a plan, or consent to a restructuring agreement, should be streamlined as much as possible. Proxy voting and virtual meetings should always be allowed (see Chapter 2). The law may also envisage active measures to contrast creditors’ passivity in restructuring negotiations in the form of penalties or rewards for creditors based on their timely and active participation in negotiations. Such type of measures, especially when they operate through a penalty imposed on inactive creditors (e.g. making their priority ineffective), are applicable only to sophisticated creditors, particularly banks and other financial creditors. It would be unfair to penalise inactive creditors that do not engage in negotiations due to the absolute lack of the required tools, as may be the case for small suppliers.76 Therefore, these sort of 76 Although outside of the scope of this research, it may be worth mentioning the mechanism provided in the Kazakhstan insolvency framework. When the debtor informs the banks and other financial lenders about its distress, these have a short period of time (about 10 days) to accept Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 172 CHAPTER V measures most often tackle opportunistic passivity (see above), rather than rational apathy. 6.4. Measures specific to restructuring tools that aim at (or allow) binding dissenting creditors As mentioned, with respect to creditors not casting a vote on the restructuring proposal, in theory there are three possible rules: (i) a ‘deemed consent’ rule, which favours the adoption of the restructuring plan at the risk of allowing some restructurings that are not efficient and, in case of a high passivity rate, making it virtually impossible for dissenting creditors to have the proposal turned down; (ii) a ‘deemed dissent’ rule, which instead could result in the rejection of efficient plans due not to the dissent of the creditors, but merely to their rational apathy that, under the law, is considered tantamount to a negative vote; (iii) a rule that states that only votes that are actually cast are counted. In general terms, this latter rule seems the most effective one. It does not excessively favour one outcome over the other and responds to a common idea of democracy, which requires that the opinion of those that decide to express it prevails. From a more reasoned standpoint, the third rule listed above would allow the outcome (adoption or rejection) to prevail that is deemed best by those creditors that, in light of the specific circumstances, have decided not to stay passive. Although this may be only a subset of the creditors of the distressed firm, it is reasonable to assume – in a context where no deemed dissent or consent rule exists – that the determination taken by the majority of the creditors actually participating in the voting is a good proxy of the determination that would have been taken by all creditors. As a second-best solution, it is worth noting that a deemed consent rule is preferable to a deemed dissent rule. Of the two types of negative consequences resulting from the application the debtor’s invitation to start discussions on a possible restructuring plan. Should a bank or a financial lender remain inactive notwithstanding the debtor’s communication, the priority of their claims, if any, becomes ineffective in the possible subsequent insolvency. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 NEGOTIATING RESTRUCTURING PLANS 173 of these rules, the threat of having some inefficient restructuring plans approved by creditors is less severe than the risk of preventing firms from pursuing efficient restructuring. Indeed, while the first consequence may well be handled otherwise, particularly through the role of court confirmation,77 the second consequence is final and results in the permanent destruction of value. In certain cases, such as for micro and small enterprises, the deemed consent rule may even be superior to a rule requiring that only votes cast be counted. In that case, basically all creditors have claims of small value and it is reasonable to expect that very few creditors would have an incentive to actively participate in the restructuring negotiations. As a result, the outcome of the restructuring proposal may often be determined by a very limited number of creditors, whose active participation could be grounded on interests other than those they legitimately hold as creditors of that firm. (See Chapter 8.) When the law opts for a deemed consent rule, the following provisions could mitigate the effects of its application: (i) strengthening judicial or administrative scrutiny with respect to those cases where the restructuring plan would not be deemed approved but for the application of the deemed consent rule; (ii) allowing proxy voting and reducing the cost of soliciting proxies; in this respect, the rules and customary practices in place for shareholders’ proxy voting could be taken as a significant model;78 (iii) clearly informing creditors, in a direct and concise way, that the lack of a vote on the proposal would be tantamount to consenting to it. 77 Indeed, in several jurisdictions the court is already entrusted with the task of assessing plan feasibility and, under certain conditions, also whether it is in the creditors’ interest (see Chapter 6). In sum, an implicit consent rule would result solely in a larger number of cases subject to court evaluation. 78 In theory, creditors bringing a challenge against the restructuring plan that proves ultimately successful could be given a priority claim towards the distressed business for the reasonable and proper expenditures incurred in order to solicit proxies, subject to the scrutiny of the court when duly challenged. In practice, this may prove difficult to introduce in many Member States. Electronic copy available at: https://ssrn.com/abstract=3271790 Draft of 20 September 2018 174 CHAPTER V Policy Recommendation #5.10 (Exclusion of nonparticipating creditors from the calculation of the required majorities). The majorities required for the adoption of a restructuring plan should be determined without taking into account those creditors that, although duly informed, have not voted on the restructuring proposal. Policy Recommendation #5.11 (Provisions mitigating the adverse effects of a deemed consent rule). When abstentions of creditors are deemed consent, the law should provide for a more thorough judicial or administrative scrutiny of restructuring plans that would not have been adopted but for the application of the deemed consent rule. Electronic copy available at: https://ssrn.com/abstract=3271790