Hamilton Perspectives Publications

Strong criticism of the rule on relative priority in the EU Restructuring Directive

The European Parliament and Council Directive on a Framework for Preventive Restructuring, a sec­ond chance and mea­sures to make re­struc­tur­ing, in­sol­ven­cy and debt can­cel­la­tion pro­ce­dures more ef­fec­tive and amend­ing Directive 2012/30/EU (the “Restructuring Directive“) are ex­pect­ed to be adopt­ed short­ly. Following adop­tion, the di­rec­tive shall with­in two years be trans­posed in­to the na­tion­al laws of the mem­ber states (or with­in three years if ex­ten­sion is re­quest­ed by a mem­ber state and grant­ed). In Sweden, the Retructuring Directive will en­tail ex­ten­sive leg­isla­tive amend­ments, es­pe­cial­ly in the Act (1996: 764) on cor­po­rate re­or­gan­i­sa­tion.

In re­cent weeks, sev­er­al aca­d­e­mics and prac­ti­tion­ers have strong­ly crit­i­cised the rel­a­tive pri­or­i­ty rule in the lat­est ver­sion of the di­rec­tive text. (See, for ex­am­ple, the ar­ti­cle “The Imminent Distortion of European Insolvency Law: How the European Union Erodes the Basic Fabric of Private Law”). by Allowing ‘Relative Priority’ (RPR) ‘by Roelf Jakob de Weijs, Aaart Jonkers and Maryam Malakotipour at the University of Amsterdam, https://pa­pers.ss­rn.com/sol3/pa­pers.cfm?ab­stract_id=3350375).

The crit­i­cism refers to the pre­req­ui­sites for a court to ap­prove a re­struc­tur­ing plan even though a class of cred­i­tors op­pos­es the plan (cross-class cram-down force). It is prob­a­bly too late to make changes to the di­rec­tive text and the rule of rel­a­tive pri­or­i­ty will there­fore most like­ly re­main in the fi­nal ver­sion.

The pro­posed rule on cross-class cram-down in the Restructuring Directive is in­spired by chap­ter 11 in the US Bankruptcy Act, where there is an ab­solute pri­or­i­ty rule (“APR”) that lim­its the court’s pos­si­bil­i­ties to de­cide on cram-down. An APR is al­so in­clud­ed in the pro­posed Restructuring Directive. However, in the lat­est ver­sion of the di­rec­tive text, Member States have the op­tion to im­ple­ment a rel­a­tive pri­or­i­ty rule; “RPR”). The choice be­tween APR and RPR is a hot is­sue as it is about the bal­ance be­tween the in­ter­ests of the cred­i­tors and share­hold­ers. The APR op­tion is cred­i­tor-friend­ly while the RPR op­tion is share­hold­er-friend­ly.

In short, the APR op­tion means that all class­es of cred­i­tors and share­hold­ers (or oth­er eq­ui­ty hold­ers) must be ranked in the same or­der as in a liq­ui­da­tion, and in a liq­ui­da­tion the share­hold­ers have the low­est rank­ing. Cross-class cram-down of a cer­tain op­pos­ing class of cred­i­tors can, ac­cord­ing to the APR op­tion, be im­ple­ment­ed on­ly if cred­i­tors with low­er rank­ing or share­hold­ers do not re­ceive any val­ue what­so­ev­er ac­cord­ing to the re­struc­tur­ing plan. The APR op­tion means, for ex­am­ple, that the plan can­not be forced through if the plan means that the ex­ist­ing share­hold­ers may re­tain their shares even though all cred­i­tors are not paid in full. Under cur­rent Swedish rules, share­hold­ers are not af­fect­ed by a com­po­si­tion pro­pos­al. The start­ing point ac­cord­ing to the APR op­tion will ac­cord­ing­ly be the op­po­site. If all cred­i­tors can­not re­ceive full pay­ment (100 per cent), the val­ue of the ex­ist­ing shares shall be com­plete­ly erased by pro­vi­sions in the re­struc­tur­ing plan. The ex­ist­ing share­hold­ers will re­ceive val­ue on­ly if the af­fect­ed cred­i­tors ac­cept it.

In short, the RPR op­tion means that it is be pos­si­ble for a court to ap­prove a re­struc­tur­ing plan de­spite that the rank­ing be­tween cred­i­tors and stake­hold­ers is not strict­ly ad­hered to in the plan. According to the RPR op­tion, it is on­ly re­quired that the high­er ranked class re­ceives a greater val­ue than the low­er ranked class re­ceives. This means, for ex­am­ple, that if the val­ue of the as­sets cov­ers 100 per cent of the claims in a cer­tain class of cred­i­tors, it should nev­er­the­less be pos­si­ble for the court to  ap­prove a plan that gives cred­i­tors in that class a pay­ment of on­ly 50 per cent (or oth­er per­cent­age) of the amount of the cred­i­tors’ claims as long as the val­ue re­ceived by a low­er ranked cred­i­tor class or share­hold­ers amounts to a val­ue that is low­er than the val­ue the op­pos­ing high­er ranked class re­ceives. This pos­si­bil­i­ty of trans­fer­ring val­ue from high­er ranked class­es to low­er ranked class­es or share­hold­ers in­creas­es the high­er ranked cred­i­tors’ cred­it risk and can there­fore make it more dif­fi­cult for com­pa­nies to ob­tain bank and sup­pli­er cred­its.

The pos­si­bil­i­ty for mem­ber states to choose be­tween the APR op­tion and the RPR op­tion may lead to com­pe­ti­tion be­tween mem­ber states where some states may want to at­tract in­ter­na­tion­al re­struc­tur­ing pro­ce­dures by choos­ing to im­ple­ment the share­hold­er-friend­ly RPR op­tion, while oth­er states may pre­fer it more cred­i­tor-friend­ly APR op­tion. One idea with the Restructuring Directive was to re­duce com­pe­ti­tion be­tween the mem­ber states’ dif­fer­ent re­struc­tur­ing regimes and fo­rum shop­ping. However, the choice be­tween the APR op­tion and the RPR op­tion can lead to in­creased com­pe­ti­tion and fo­rum shop­ping.