Harmonisation of European Insolvency Law: Operation Patchwork has Commenced, but Where Will it Take Us?

The Commission observes two key problems with the current national insolvency regimes: (i) costly and lengthy insolvency proceedings are leading to low recovery values, and (ii) a low predictability of (the outcome of) insolvency proceedings which leads to high information costs and creates barriers to cross-border insolvency.28 The main drivers for these problems are on the one hand the recurring and extensive differences between national substantive insolvency regimes, and on the other hand that certain jurisdictions are inadequately designed or are missing certain features.29 In particular, the cross-border divergences (i) bring different outcomes across Member States, (ii) result in different degrees of efficiency of insolvency proceedings, (iii) amount to legal uncertainty on the outcomes of insolvency proceedings, and (iv) bring about higher ‘information and learning costs’, especially for cross-border creditors.30

In response to that, and in the Commission’s policy language,31 harmonisation of insolvency is considered to be a ‘key tool for a more efficient functioning of the capital markets in the European Union, including greater access to corporate finance’.32 The Proposal has the objective to ‘contribute to the more efficient allocation of capital in the single market and enhance market integration under the CMU’.33 The Proposal should converge insolvency regimes on those topics that inefficiently allocate capital and negatively impact the capital market.34 More specifically, the Proposal aims to develop more uniform rules in Member States for better value recovery (notably in the fields of transaction avoidance, asset tracing, directors’ duties and pre-pack procedures), more efficient insolvency proceedings (notably with respect to Micro- and Small Enterprises (MSEs) procedures, insolvency triggers and transparency) and efficient and fair distribution of recovered values (notably in the field of creditor committees and – although this is not included in the Proposal – the ranking of claims).35

Existing EU legislation in the field of insolvency law – in particular formed by the EIR 2015 and the Restructuring Directive36 – provides already for harmonisation of particular cross-border insolvency law, as well as ‘pre’ insolvency and ‘post’ insolvency law, but hardly deals with (core) elements of substantive insolvency law.37 Therefore, the Commission considers additional legislation necessary.38

The Commission has opted for a European directive with minimum standards, as the other legal instruments (a regulation and/or a recommendation) were considered less suitable to achieve the desired results. A regulation, on the one hand, would not offer enough flexibility to introduce common standards, given the variety and diversity in legal cultures and legal systems in the Member States. A recommendation, on the other hand, would be too noncommittal, leading to insufficient convergence.39 The Proposal has its legal basis in Article 114 of the Treaty on the Functioning of the European Union (TFEU), which gives the European Parliament and the Council the power to adopt legislation aimed at adapting national legislation affecting the establishment and functioning of the internal market.40 The scope of the Proposal is not restricted to cross-border matters, since the approximation of the various national insolvency regimes also applies to pure domestic situations within the boundaries of Member State. Therefore, and in contrast to the EIR 2015, Article 81 TFEU is not fit to serve as the legal basis in this case.

The Proposal focuses on non-bank corporate insolvency law and, therefore, excludes insolvency proceedings concerning financial institutions, consumers or public bodies (under national law).41 The Proposal broadly covers three themes which it considers ‘targeted’ aspects of insolvency law or ‘targeted’ elements of Member States’ insolvency rules. These themes are: (i) recovery of assets from the insolvent estate, (ii) efficiency of insolvency proceedings, and (iii) predictable and fair distribution of recovered value among creditors.42 The topics within these themes aim to maximise the recovery of value from the insolvent company for creditors, strengthen procedural efficiency and ensure a fair and predictable distribution of values among creditors.43

In the Proposal, after a preamble of 63 recitals and an introductory title (I General provisions with a scope of application and definitions), the Commission has divided the targeted aspects of insolvency law – based on the abovementioned themes – into seven titles (II-VIII), followed by a final title (IX with final provisions). The core of the Proposal (Titles II-VIII), which is discussed in more detail in the following contributions by other authors, includes provisions on: (i) transaction avoidance, (ii) asset tracing, (iii) pre-packs, (iv) directors’ obligation to request the opening of insolvency proceedings, (v) simplified resolution of micro enterprises, (vi) the creditors’ committee, and (vii) measures to increase the transparency of national insolvency rules.

As a starting point, we consider it, least to say, quite remarkable and in some respects certainly problematic that a legislative proposal that deals with the harmonisation of substantive insolvency law does not define the core concept of insolvency. The need for a definition in the process of harmonisation was already identified by the High Level Forum as one of the core elements on which harmonisation should focus.44 All possible practical and political difficulties aside, the absence of such a definition seems a major limitation in achieving the stated harmonisation goals. Without a definition, it is left to the Member States to interpret this concept as they see fit during the implementation which might impede achieving predictability and uniformity. This is likely to result in definitions which might negatively affect the appetite of investors and creditors for cross-border investment, hamper the single market and thereby infringe on the objectives of the Proposal.

Not only does the Proposal lack a definition of ‘insolvency’, similarly, the Proposal is also missing another core definition, namely ‘insolvency proceeding’.45 In doing so, it remains unclear when avoidance actions will be justified, as the Proposal links the possibility to declare avoidance actions void to the opening of ‘insolvency proceedings’ (Title II). The same can be said with respect to the directors’ duty to file for the opening of insolvency proceedings (Title V), the establishment of creditors’ committees (Title VII) and the measures for enhancing transparency of national insolvency laws in view of the obligations for the Member States to create national factsheets on certain elements of national law on insolvency proceedings (Title VIII). Therefore, with this approach, core topics are potentially not harmonised.46

In this context, reference should be made to the Restructuring Directive in which several key concepts such as ‘likelihood of insolvency’ were also left undefined.47 Consequently, this has not only led to much academic debate but also to a great variety – i.e., limited harmonisation – in the varied national implementations of the Restructuring Directive.

In addition, and contrary to the genesis of the EIR 2015 and the Restructuring Directive, the Proposal does not consider an all-encompassing and well-defined subject of insolvency and/or restructuring law. Rather, the Proposal is a kaleidoscope comprising several different and quite incoherent topics that are proposed for harmonisation. The Proposal is not only diverse content-wise, but the different provisions also have wide-ranging standards for harmonisation. The provisions of some of the topics seem quite detailed while others are hardly developed. Parts of the Proposal clearly introduce minimum harmonisation standards, as is the case with the ‘additional grounds’ that Member States may introduce for avoidance actions if it leads to greater protection of the interests of joint creditors,48 and with the directors’ duty to timely request the opening of insolvency proceedings.49 However, (most of the) other topics are regulated in quite detail with less flexibility for Member States. Consequently, Member States will be restricted in choosing the way how to implement the Proposal upon its adoption. This result is remarkable since, as noted earlier, harmonisation of substantive insolvency law has so far been seen as problematic.50

At the same time, it should be noted that the Commission initially, in addition to harmonisation of the aforementioned topics, considered a more ambitious and far-reaching harmonisation of insolvency law.51 From that perspective, the Commission has taken a cautious approach to the Proposal. The ranking of claims, for example, was considered essential to achieve a CMU in earlier stages,52 but the option to introduce a comprehensive harmonisation of the ranking of claims was discarded as potentially problematic from a subsidiarity perspective and was also considered politically non-feasible. The disparate starting position of Member States regarding the ranking of claims, also because of its embeddedness with other parts of the national legal regimes and legal traditions would make harmonisation infeasible.53

The Commission is treading new territory with the proposal for substantive harmonisation of insolvency law. These proposals need to pass the subsidiarity and proportionality test, also when the envisaged harmonisation is limited to specific aspects only.54 This follows from the fact that insolvency law is an area where the EU has no exclusive competence.55 A careful consideration of the feasibility of the Proposal is all the more so important, as several Member States have shown reluctance for EU actions in this area.56

The subsidiarity test requires that any action by the EU in an area where it has no exclusive competence, is only allowed ‘if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at a regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.’57 The Commission submits that the ‘different starting points, legal traditions and policy preferences’ in the Member States with regard to their insolvency regimes are unlikely to result in an effective convergence of those insolvency systems.58 Furthermore, as the Commission states: ‘The harmonisation of national insolvency laws can lead to a more homogenous functioning of the EU capital markets, reducing market fragmentation and ensuring better access to corporate financing. Action at the EU level is better placed to substantially reduce the fragmentation of national insolvency regimes and ensure convergence of targeted elements of Member States’ insolvency rules to an extent that would facilitate cross-border investment across all Member States. Action at the EU level would also ensure a level playing field and reduce the risk of distortions to cross-border investment decisions caused by actual differences in insolvency regimes and a lack of information about these differences.’59

The proportionality test requires that any measure proposed by the EU will not exceed what is necessary to achieve the objective of the Treaty on the European Union (TEU) and the TFEU.60 The legislative basis is Article 114 TFEU, which also determines the general objective of the Proposal, namely the establishment and functioning of the internal market. The Commission argues that the Proposal is set to contribute to the proper functioning of the internal market, in particular by taking away barriers to the free movement of capital and freedom of establishment. The Proposal is also held to be proportional because it contains only minimum harmonisation requirements and is focused on specific, targeted areas of substantive insolvency law.61

Since the Commission has adopted a ‘patchwork approach’, our view is that an analysis of whether the Proposal is in line with the principles of subsidiarity and proportionality is to be decided for each topic separately. In particular, to what extent is a more homogenous functioning of the capital markets and cross-border investments facilitated by the detailed regulation of the winding-up of microenterprises (Title IV) and creditors’ committees (Title VII)? Especially, the requirement of proportionality may be considered at odds with the rather extensive and detailed provisions dealing with avoidance actions (Title II; Article 4-12), but also pre-packs (Title IV; Article 19-35), winding-up of microenterprises (Title VI; Article 38-57) and creditors’ committees (Title VII; Article 58-67).

The Dutch Ministry of Justice and Security has prepared a ‘Fiche’ in preparation for the discussion of the Proposal in the Council.62 This document entails, in principle, broad support by the Dutch government for strengthening the internal market and the capital market, but shows a certain reluctance63 – especially concerning the pre-pack, directors’ duties to file for the opening of insolvency proceedings, the winding-up of micro-enterprises and the creditors’ committee – because of possible damage to the current efficient Dutch insolvency practice, mostly due to the elaborated details of the Proposal and its burdensome effects on the judiciary.64 As a result, according to the Dutch government, the Proposal in parts ‘[…] goes further than necessary to achieve this objective’.65

In the Impact Assessment of some 240 pages, the Commission elaborates on the background and envisaged impact of the Proposal. It draws on economic and legal academic research, multiple studies that were commissioned and the results of (public) consultations with various stakeholders. It provides a foundation for the ambitions laid down by the Commission with the Proposal. Still, the Proposal raises questions.66 For instance, on its scope (what is and what isn’t proposed for harmonisation), but also to what extent the patchwork of topics presented in the Proposal will be able to positively influence cross-border investments. For anyone well-versed in European insolvency laws, it will be clear that harmonisation certainly has the potential to reduce some of the existing divergences and bring more legal certainty. However, both the suggested (negative) impact of the defined problems on cross-border investment as well as the (positive) effects of the Proposal on those investments remain difficult to assess. It is unclear, for example, whether the alleged ‘home bias’, meaning that large variations in insolvency systems would encourage forum shopping-abuse and therefore negatively impact cross-border investment,67 is a common problem. In addition, the stated relationship between the elements of the Proposal and cross-border investment is based on assumptions suggested by several survey responses.68 Surveys alone cannot give insight into the effects of different measures. This methodological caveat is acknowledged in the impact assessment but not addressed.69

The patchwork approach itself imposes a significant limitation to achieving the objectives of the Proposal. There is limited coherence between the respective topics covered by the Proposal. Furthermore, achieving the objectives with harmonisation is hampered when key concepts are left outside the scope of the Proposal, such as introducing an EU-wide definition of insolvency or insolvency proceeding and a comprehensive harmonisation of the ranking of claims, even though the latter was considered as highly ambitious.70

Due to the lack of coherence in the topics of the Proposal and the difficulties that brings to assess the impact of the Proposal as a whole, it remains unclear whether and to what extent the different topics will contribute to reach the Commission’s objectives. Therefore, we encourage Member States to provide further evidence for the (alleged) impact that certain topics of the Proposal have or are expected to have in their jurisdiction. Not only would this make the suggested provisions more effective, it will also provide Member States with a better justification to amend their substantive insolvency laws. It must be noted that this is already the case for some topics proposed for harmonisation, in particular, because they find their origin in a detailed EU-wide study of domestic laws, as is the case with the provisions on avoidance actions.71 Our suggestion here also builds on prior research arguing for a broader understanding of the concept of harmonisation which should not be perceived merely as a top-down approach. As Ghio et al pointed out (italics in original): ‘the EU must acknowledge the role played by existing domestic rules and practices in the top-down harmonisation process, for its own sake, as it will result in decreased resistance to the EU measure.’72