[Case law for Wessels Insolvency Law, Vol. VIII, Legal Moratorium] Deze week wordt met de bureauredactie van uitgever Kluwer de laatste hand gelegd aan
[Case law for Wessels Insolvency Law, Vol. VI, Composition, Private Arrangements] Deze week gaat de kopij van Wessels Insolventierecht VI voor drukken zodat de bewerking van Het Akkoord februari/maart in de winkel ligt. Literatuur en rechtspraak tot november 2006 heb ik kunnen verwerken. Voor een opgave van deze rechtspraak, zie bijgaand document.
[Manuscript of Wessels Insolvency Law, Vol. II (Consequences of Insolvency, Part 1) forwarded to publisher] Deze week stuur ik de kopij naar Kluwer voor Wessels Insolventierecht III, het deel waarin de pauliana, verrekening en de zekerheidsrecht de hoofdmoot vormen. Bij vlotte verwerking zal het boek in april kunnen verschijnen. De jurisprudentie tot eind december 2006 is verwerkt. Zie voor een overzicht bijgaand document.Rechtspraak III.pdf
On Wednesday, March 7, 2018, in the USA, the Senate Judiciary Subcommittee on Oversight, Agency Action, Federal Rights and Federal Courts will be holding a hearing onder the title ‘Small Business Bankruptcy: Assessing the System’. For the American Bankruptcy Institute (ABI) Robert Keach, co-chair of the ABI Chapter 11 Reform Commission, will testify on the Commission’s Small and Medium-Sized Enterprise (SME) case recommendations published by the end of 2014. For more information about the hearing, please go to https://www.judiciary.senate.gov/meetings/small-business-bankruptcy-assessing-the-system. For the part in the ABI Chapter 11 Reform Commission’s report related to the Commissions’s SME recommendations, see https://abiworld.app.box.com/s/uzc6yo7dr8lt1g2m4uxs.
At the request of ABI, Rolef de Weijs (now an insolvency law professor at University of Amsterdam) and I (emeritus University of Leiden) and a large group of global (non-US) comparative experts, have commented upon the Reform Commission’s recommendations. See http://leidenlawblog.nl/articles/american-bankruptcy-institute-report-recommends-structural-reform-of-chapte. De Weijs and my views have been published (in English) as: Bob Wessels and Rolef de Weijs, Proposed Recommendations for the Reform of Chapter 11 U.S. Bankruptcy Code, in: Ondernemingsrecht 2015/37, aflevering 2015-06, mei 2015, pp. 210-221. For a draft version of the text see http://www.bobwessels.nl/blog/2015-04-doc7-article-on-reform-of-chapter-11/. The international reports and our recommendations have been published in book form also, see B. Wessels and R.J. de Weijs (Eds.), International Contribution to the Reform of Chapter 11 U.S. Bankruptcy Code. European and International Insolvency Law Studies 2, The Hague: Eleven International Publishing 2015 (ISBN 978 94 6236 606 0)
Below, taken from our ‘Proposed recommendations’ article of 2015, is the part that we devoted to SME’s and the short conclusion on the full report (I recall some 400 pages) (note that the order of the footnotes has been changed).
5. Small and medium-sized enterprise cases
36. Chapter VII of the Report contains a specific section with recommendations on Small and Medium-Sized Enterprise (SME) Cases. It kicks off with a definition of a SME, develops so-called SME Principles, provides for a system of oversight of SME Cases, and recommends on the timing of a plan, its content and the confirmation process. A federal bankruptcy system that effectively and efficiently rehabilitates distressed small and middle-market companies has been seen by the Commission as essential, but research of literature and many testimonies suggests exactly the opposite: that the current system does not work for SMEs, is it is cost-prohibitive and ineffective for many companies. The Commission seeks to reduce the cost of bankruptcy, to provide more effective tools for navigating the chapter 11 bankruptcy process, to allow the families and founders who own these companies an opportunity to retain that ownership interest after the bankruptcy is completed, and to maximize value for all stakeholders. The Commission’s proposal would automatically apply to nonpublic companies that file for bankruptcy with assets or liabilities of less than $10 million. The SME-framework is optional. Nonpublic companies with assets or liabilities between $10 million and $50 million also could seek court approval to qualify for the small and medium-size enterprises framework. It is important to understand that the SME proposal would be available for around 85% of the companies which are now in chapter 11. We here discuss the recommendations on oversight (§5.1) and (§5.2) the introduction of an equity retention plan.
5.1. Oversight in SME cases
37. The approach as to oversight is different in SME than in large cases. It is recalled that the overwhelming majority in number of cases under Chapter 11 would qualify as SME. The system for oversight in large cases takes as a starting point the debtor in possession and active creditor involvement. In small cases, it will often not be worth the creditors’ effort to get involved.
38. In the recommendations for SME the bankruptcy court is rather active, applying realistic deadlines and timely communications among stakeholders in a way tailored to the specific needs of a case. The need for the appointment of a creditors’ committee in every case is eliminated: there is often no appetite to be appointed, it may work ineffective, is time consuming and costly, as the debtor must pay for committee expenses in the Chapter 11 case. The court can also appoint – on its own motion or upon the request of the debtor or another stakeholder – a neutral third party to assist the company in the process (see § 2.1.2 above). He could assist the debtor negotiate with creditors, develop a plan of reorganization or analyze the company’s basic financial or operational issues.
39. One could therefore summarize the approach of checks and balances as a system of communicating vessels. Starting point of Chapter 11 is the debtor in possession. The basic model presumes creditor involvement as the most important check. However, if the creditors do not get involved, the debtor is not left to its own devices and vices. In such a case, creditor involvement is replaced by court oversight, with the possibility of appointing an estate neutral.
5.2. Absolute priority rule and SME equity retention plan
40. Above in § 4.3 the Absolute Priority Rule has already been discussed in relation to the new value exceptions. It has been explained that its usual shorthand version of the APR not allowing any distributions to lower ranking stakeholder until higher ranking creditors have been paid in full, is insufficiently clear. The APR is a protection against cram down.
41. In practice, the APR does make it very difficult for the shareholders to retain an equity stake in the company as long as creditors are not paid in full. In case shareholders are interchangeable, this does not immediately causes problems, as long as there is new value exception. However, if the old shareholders are somehow instrumental to the success of the company, this becomes problematic. If the value of the company is closely related to the persons of the shareholders, who are possibly also the managers of the company, it becomes difficult to reorganize the company without their continued involvement. This becomes problematic if a reorganization procedure would completely wipe them out (with reference to ‘equity is wiped out first’). The need for an exception to the APR in SME cases is summarized in the following rhetorical question in a written statement, also quoted by the Commission: ‘Inclusion of limited exclusivity and the implementation of the absolute priority rule in the bankruptcy regime make the most sense with respect to large public entities whose creditors and equity holders made informed investment decisions and understood their risk and relative priorities. I am not sure that the considerations are the same with respect to smaller businesses. Should entrepreneurs and families who are involved in the day to day operations of their businesses be provided some level of protection not available to holders of securities in public companies?’
42. The Commission has sought to find a balance between providing a continued equity stake for the old shareholders and a protection of creditors facing a write off of their claims in violation of the absolute priority rule. The recommendations taken together lead to an SME Equity Retention Plan. The requirements are to be understood as allowing for a cram down of a class of dissenting creditor, while the old equity holders retain part of the equity. The requirements for allowing an Equity Retention Plan are the following: (i) The prepetition equity security holders will continue to support the debtor’s successful emergence from chapter 11 by remaining involved, on a basis reasonably comparable to their prepetition involvement, in the ongoing operations of the reorganized debtor; and (ii) the reorganized debtor will pay to the holders of unsecured claims, no less often than annually, its excess cash flow calculated in a manner reasonable in relation to the company’s operating cash flow for each of the three full fiscal years following the effective date of the chapter 11 plan.
43. The working of the SME equity retention plan is quite elaborate and will be of interest for both insolvency and corporate lawyers. It provides that the old shareholders retain 100 percent of the common stock and are entitled to receive 15 percent of any dividends. At the same time the unpaid creditors receive 100 percent of a class of preferred stock and are entitled to receive 85 percent of dividends. This is however a temporary situation and therefore not the end. The creditors’ preferred interests mature after four years at which time their interests convert into 85 percent of the common stock. At that moment there is a new status quo in which the old equity holders have 15 percent of the shares and the old creditors are the majority shareholder with 85 percent of the shares. Any old shareholder can prevent this conversion after four years, by ensuring repayment of the creditors’ original claims in full.
44. Taken together, we wonder whether this would provide sufficient stimulus for equity holders to continue to work for the rescue and reorganisation of the company. From a Dutch perspective one feels that there is not much equity left for the old shareholder. At first glance, the outcome looks like old shareholders are only entitled to 15 percent of the profits and 15 percent of the shares. This is also not how the working of the Equity Retention Plan should be understood. The Commission believes that the proposed structure will provide appropriate incentives and protections, basically giving prepetition shareholders four years after confirmation to repay the prepetition unsecured creditors in full. If the old shareholders succeed, all issued preferred shares are redeemed. However, if the old shareholders fail, after four years, they are diluted to having only 15 percent.
45. Remarkably enough in the report no mention is made of a slide clause, e.g. that if the company manages to pay up to 90 percent, that for example the creditors only get 30 percent of the company. The equity retention plan is set up in such a way that it will likely be only attractive if the company files in a timely manner, which is of course the preferred course of action. However, if the problems have already grown to large proportions, the equity retention plan would seem to provide little incentive if there is not a realistic projection of repaying the outstanding debts. In practice, a solution should be possible in which creditors discharge parts of the debt, bringing it back to manageable proportion so that these can be repaid over the course of four years. Here again it should be borne in mind, that the Absolute Priority Rule is less absolute than its name suggests. Parties can negotiate differently and agree on the equity holders to retain a larger stake or to negotiate a different plan and repayment scheme all together. The absolute priority rule only prevents a cram down over a dissenting class if the parties cannot reach the required majorities. Therefore, the SME Equity Retention Plan only provides the possibility to force a plan upon a dissenting class of creditors even if the shareholders hold on to a portion of the shares which would otherwise not be possible.
Having studied the Commission’s output, our first general conclusion is that the Report reflects an enormous wealth of materials, insights and observations, leading to one of the most comprehensive studies of its kind. Our second general conclusion relates to the method chosen by the Commission, including advisory committees and public hearings. Having chosen this path it ensures that ‘all’ experts, professions and stakeholders have been able to express their experiences and view. The draw back of such an approach is that it – by its nature – may lead to recommendations in which a middle way is suggested in an effort to combine different positions and ideas. In all, the Commission does not present what it originally intended: a comprehensive chapter 11 reform, starting from scratch and re-inventing the statute. Our third general conclusion is that the Commission was ready for recommending sweeping reforms, coming from the commonly held view that the chapter 11 process has become to slow and too costly to provide small and medium sized enterprises any meaningful way of reorganising successfully. Many of the suggestions respond to this view and have led the Commission to conclude – as many regulators in the insolvency area would confirm – that a ‘one-size fits all’ approach does not work. In its handling of this structural reform, however, the Commission remains ambivalent, by recommending a renewed structure for chapter 11 cases as the main core for a renewed chapter 11, whilst around 85% of the present cases are seen as the exception and dealt with in some ten percent of the entire report.
We view the following as the most principled recommendations that are of the most relevance for legislatures and policy makers drawing inspiration from Chapter 11. First of all, the introduction of the estate neutral as a supplement to the debtor in possession model (discussed in § 2.1.2). The estate neutral is by its very nature flexible and has no pre-ordained task. The estate neutral can be seen as a remedy to overcome a case specific problem related to leaving the debtor in possession, gearing its specific task to the case at hand, without removing the debtor and thereby the benefits of the DIP model all together. In addition, we view as valuable the introduction of significant restrictions on 363 sales, selling all or nearly of the assets. Restrictions deal both with timing (discussed in § 2.2) and creditor involvement (discussed in § 4.1). First, a general moratorium on 363 sales of 60 days is introduced, with a limited exception for the true melting ice cube cases. Secondly, creditor involvement and participation is increased. The main idea hereof is that transparency of available information and the level of protection should be basically the same under accepting a plan and effectuating a 363 sale. As a third conclusion we feel a workable break trough to the close to a dead-lock position between secured and unsecured creditors has been proposed with the recommendation to increasing pay out to unsecured creditors by giving ‘the immediate out of the money creditors’ an entitlement to the value of a so called redemption option (discussed in § 4.2). The introduction of the redemption option value does not apply to SMEs. Finally, from the selection of topics we commented upon, a conceptual novel recommendation is the introduction of an Equity Retention Plan for SMEs (discussed in § 5.2). The plan seeks to strike a balance between protecting the statutory order of distributions which would normally prevent a distribution to shareholders on the one hand and providing an incentive to shareholders necessary for the successful reorganisation of the company to remain involved on the other. This recommendation thereby provides an exception to the Absolute Priority rule, which usually has as an effect of wiping shareholders out in case of insolvency. This last recommendation is from a company law perspective probably the most interesting one.
For over 30 years Chapter 11 U.S. Bankruptcy Code has been seen as an icon for legislative changes in insolvency law all over the world. It remains to be seen whether the Commission’s recommendations will function as the same beacon of light.
 Written statement made by R. Mikels, Nov., 3, 2012, TMA Field Hearing Before the ABI Commission to Study the Reform of Chapter 11, see Report, at 299.
 For another fair and equitable solution to creditors and equity holders both, see Stephan Madaus, ‘Reconsidering the Shareholder’s Role in Corporate Reorganisations under Insolvency Law’, in: 22 International Insolvency Review 2013, 106 et seq.
 Report, at 297.
 Report, at. 297 and 301.
 Report, at. 297.
 Report, at. 297.
 Report, at 302.
 We also feel that for non-US restructuring and insolvency professionals the Report serves as a very good introduction to the key issues of Chapter 11.
On my website, in the category ‘Current projects’, mention is made of the project for the ‘American Law Institute’ (ALI), in conjunction with International Insolvency Institute. During the start of this project (‘Principles for Cooperation in International Insolvency Cases’) Ian Fletcher and I gave presentations to an interested audience, at Columbia Law School, New York City, June 14, 2006. My lecture, called: ‘Perspectives on a Principles-based Approach to Transnational Insolvency’, deals mainly with pros and cons of using soft law in international insolvency law. It also contains a taxonomy on topics to address. As I have referred to this lecture in one of my fortcoming articles, written for the event of end March 2007 in Brussels concerning 'Twohundred Years Belgian Commercial Code', it is made available.