New European directive on insolvency

The Official Journal of the European Union published on 26 June 2019 Directive (EU) 2019/1023 on preventive restructuring frameworks, discharge of debt and disqualifications, signed on 20 June. The rule aims to allow viable companies in financial difficulty to restructure in time, avoiding bankruptcy, and to give honest entrepreneurs who fail a second chance. It will enter into force twenty days after its publication.

Member states will have to transpose it into their law by 17 July 2021 at the latest, although they may request a one-year extension. It is one of the most significant European reforms of insolvency law, and its stated aim is to reduce obstacles to the proper functioning of the internal market, including the great disparity of procedures and the costs of cross-border insolvencies.

What the directive provides

The directive is built around three blocks. The first requires states to offer early-warning tools, so that companies can detect problems in time, and preventive restructuring frameworks in which the debtor keeps control of its business, with the possibility of temporarily suspending its creditors’ individual enforcement actions while it negotiates a plan.

That plan is adopted by classes of creditors, and can bind those who reject it under certain conditions, provided safeguards are respected. It also protects new financing and interim financing provided to sustain the business during the restructuring. The second block, discharge of debt for entrepreneurs, and the third, the efficiency of procedures, complete the rule.

A second chance

The directive requires that honest insolvent entrepreneurs have access to a full discharge of their debts within a maximum of three years, with justified exceptions. It seeks to ensure that business failure is not a lifelong burden and that someone who has closed a project can start again, something studies place among the factors that favour the creation of companies.

In Spain there are already figures along those lines, such as refinancing agreements and the second-chance mechanism introduced in 2015, but the directive will require a review of their scope and conditions. The changes will arrive with transposition, which will probably be one of the important reforms of Spanish insolvency law.

What to do now

Although transposition is some way off, the directive reinforces a practical idea: the sooner a problem is detected, the more options there are. A company should watch indicators such as cash-flow strains, delays in payments or collections, accumulated losses or dependence on a few customers, and have a procedure for acting when they trigger. Directors must know their duties when there is a risk of insolvency.

In Spain, already today, insolvency obliges a request for insolvency proceedings within a set period, and losses that reduce equity below half of share capital are a ground for dissolution. An adviser can help design an early-warning system and assess, before it is too late, the refinancing or restructuring alternatives. This note is general information. Finally, keeping the accounts up to date and cash forecasts realistic is the best basis for any early warning: without reliable figures in good time, neither the entrepreneur nor their advisers or creditors can judge whether a difficulty is temporary or structural. When the situation is already tense, it is wise to speak early with the main creditors, banks and key suppliers: an open negotiation, backed by documents, before defaults occur, leaves more room for solutions than a conversation forced by a deadline.

Getting ahead of financial difficulties usually costs less than managing them once they have broken out.

This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.