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European Pre-Insolvency Proceedings

A primer for investors in distressed credits

Recent draft-legislation in the European Union may significantly impact investors in distressed European credits. In order to promote investment in the European market, the European Commission issued a proposed directive on November 22, 2016 (COM(2016) 723), which is intended to harmonize the restructuring and insolvency regimes of EU member states by implementing regulations for pre-insolvency proceedings. The proposed legislation is currently being reviewed by the European Parliament and European Council. This review process could take up to two years. If approved, all EU member states would have an additional two years after adoption to bring their legal systems into compliance with the directive.

All EU member states currently have laws governing formal insolvency proceedings. However, many states lack regulations that govern the restructuring process at the pre-insolvency stage. In those states, attempts to effect out-of-court restructuring plans are often obstructed by holdout creditors seeking to obtain preferential treatment. Under current laws in many states, a creditor may block adoption of an out-of-court restructuring plan, even where a majority of other creditors support the plan. In those instances, the only way to effectuate the restructuring plan is to pay off the holdout creditor or apply for a formal insolvency proceeding in which an opposing minority can be overruled. Both options are often unpalatable because the debtor is usually short on cash and prefers to avoid a formal insolvency proceeding, including the potentially negative effects on the debtor’s reputation and business. Additionally, a formal insolvency proceeding must involve all of the debtor’s creditors, even if only certain of the debtor’s financial liabilities require restructuring. The draft legislation seeks to resolve the issue of holdout creditors in pre-insolvency negotiations, thereby creating a more sensible and efficient path for debtors to restructure their debts.

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