The Characterization of Pre-insolvency Proceedings in Private International Law

Abstract

The decade since the financial crisis has witnessed a proliferation of various ‘light touch’ financial restructuring techniques in the form of so-called pre-insolvency proceedings. These proceedings inhabit a space on the spectrum of insolvency and restructuring law, somewhere between a pure contractual workout, the domain of contract law, and a formal insolvency or rehabilitation proceeding, the domain of insolvency law. While, to date, international insolvency instruments have tended to define insolvency proceedings quite expansively, discussion of the cross-border implications of pre-insolvency proceedings has barely begun. The question is whether pre-insolvency proceedings should qualify as proceedings related to insolvency for the purpose of private international law characterization. The risk is over-inclusivity of cross-border insolvency law, which, where it is based on universality and unity, might defeat contractual expectations. This article argues, however, that we should be slow to exclude pre-insolvency proceedings from cross-border insolvency law: these proceedings are initiated in the zone of insolvency, their effectiveness depends on a statutory mandate and not purely on private ordering, they interact and intersect with formal proceedings, and can benefit from the unique system developed by cross-border insolvency law. We suggest, though, that modified universalism (the leading norm of cross-border insolvency) and international insolvency instruments, should, and are able to, adjust to the peculiarities of pre-insolvency proceedings to address concerns about inclusivity and accommodate pre-insolvency proceedings adequately.

1 Introduction

Insolvency is typically excluded from international instruments harmonizing the private international law of commercial and civil law matters.¹ It is a ‘unique’ sub-system of commercial law, linked to issues of public interest and aiming to promote a fair process taking account of interests of multiple groups of stakeholders, to maximize value, minimize waste, and, enable rescue of viable businesses. Thus, international insolvency law (or ‘cross-border insolvency’) is developing as a sui generis system of private international law for transnational insolvency, which aims to achieve the goals of insolvency in cross-border cases.² Predominantly based on the norm of modified universalism,³ this emerging cross-border insolvency system prescribes efficient levels of centralization of proceedings, recognized and assisted by foreign authorities, to maximize value and enable business rescue, considering all relevant stakeholders wherever located. This special system seeks to transcend domestic private international law rules to provide a harmonized framework for international insolvencies.

The decade since the financial crisis has witnessed, however, a significant shift from bank to capital market financing of large corporate borrowers that has led to profound changes in the market for resolution of corporate financial distress⁴—notably the emergence of ‘light touch’ formal financial (balance sheet) restructuring techniques.⁵ Policymakers, especially in the European Union, have responded to market developments by embarking on an aggressive new phase of corporate rescue oriented legislative endeavour that focuses on so-called pre-insolvency or preventive insolvency proceedings.⁶

This current vogue for pre-insolvency proceedings is the latest phase of a global effort to fashion a comprehensive range of debt resolution tools for use at various stages of what accountants sometimes refer to as the demise curve⁷ of the corporate life cycle. In many systems, until relatively recently, the only viable choice for debtors and creditors were at the extremes: either a private, informal, out-of-court workout—in other words a contract between the debtor and creditors, and the creditors inter se, requiring unanimity among creditors for it to become binding—or a formal liquidation in which creditors, aided by an officeholder (be that a trustee, liquidator, or receiver), take control of and liquidate the assets before dividing the proceeds among themselves.⁸ Recognition, however, has grown of the importance of value maximization at whichever point on the demise curve the formal intervention occurs. As a result, business insolvency systems have evolved to offer a spectrum of possibilities—including formal reorganization or rehabilitation proceedings at intermediate points on the spectrum between the extremes—with some facility to convert from one procedure to another, or to combine various procedures, depending on the circumstances.

Since the Asian financial crisis of the late-1990s, international institutions such as the IMF, the World Bank, and UNCITRAL have actively championed reforms⁹ that provide formal rehabilitation alternatives to a contractual workout or a liquidation, incorporating features such as a stay on creditor enforcement to prevent runs on the assets, and mechanisms for the authorization of post-commencement financing, the proposal, approval and court confirmation of formal plans of reorganization, and the conversion of rehabilitation to liquidation proceedings in the event that the debtor fails to have a plan confirmed.¹⁰ These institutions now regard insolvency systems offering a broader spectrum of informal and formal debt resolution procedures as critical in promoting access to affordable credit and financial stability.¹¹ Chapter 11 of the US Bankruptcy Code has been particularly influential in this process¹² and has been almost elevated to the status of a global template for formal reorganization law,¹³ although international standards have been designed flexibly to accommodate different legal systems at varying stages of economic development.

Pre-insolvency proceedings, at their core, inhabit a space on the spectrum somewhere between a pure contractual workout and a formal insolvency or rehabilitation proceeding. They are restructuring proceedings that corporate debtors can access before they become insolvent with the aim of avoiding insolvency. They entail a surgical debt restructuring and an early intervention at the first signs of distress, concentrating on financial creditors rather than creditors of the operating business, permitting no, or limited, court involvement, avoiding stigma and reputational damage. Such proceedings may preserve value better than later-stage intervention through formal insolvency proceedings that implicate all stakeholders, and almost invariably result in distressed asset sales of one form (liquidation, break up) or another (pre-pack designed to achieve a going concern, or at least a ‘better than liquidation’ outcome).¹⁴ Pre-insolvency proceedings are typically designed for use by debtors whose businesses are profitable, in that operating revenues exceed operating expenses, but whose balance sheets are overleveraged with the consequence that they will not be sufficiently profitable to repay their financial creditors as these creditors’ loans mature. They usually offer the prospect of effective early intervention in situations where contractual workouts are not possible because there is deadlock among creditors, by providing voting mechanisms that enable assenting majorities of creditors to bind dissenting ‘holdout’ creditors to the terms of a restructuring deal.¹⁵

Across the spectrum, insolvency and restructuring law provides a comprehensive and dynamic series of ex post interventions. Viable companies with overleveraged capital structures can access deadlock resolution procedures and thus overcome obstacles to an informal workout.¹⁶ The businesses of companies that are more deeply distressed can be salvaged, and returns to creditors maximized, by means of a sale for the best price reasonably obtainable¹⁷—be that at going concern value, ‘better than liquidation’ value or some point in between. Companies can attempt a restructuring and transition to a formal insolvency or rehabilitation proceeding to implement an asset sale if the restructuring is unsuccessful. Inevitably, though, there is blurriness in domestic legislative offerings—in other words, there are plenty of examples of hybrid proceedings that can function both as pre-insolvency restructuring proceedings and as formal rehabilitation proceedings that insolvent debtors and their creditors can use to salvage value at points further down the demise curve.

As capital structures have come to be dominated by secured credit, urgent questions have arisen about the impact of secured creditor control on the choice between a restructuring or a sale and, where a sale is pursued, the timing of the sale.¹⁸ The primary sorting question—which companies should be restructured and which companies should have their assets sold—thus looms large and justifies a clear analytic distinction of the kind that Sarah Paterson draws between, on the one hand, proceedings aimed at rewriting the bargain between the debtor, its finance creditors and shareholders, and, on the other hand, formal insolvency and rehabilitation proceedings aimed at realizing the assets.¹⁹ But while insolvency and restructuring law deploys a range of different tools—some that pursue a restructuring outcome, some that pursue a sale outcome, some that function as hybrids—altogether these processes nevertheless amount to a comprehensive, unified body of law. That law addresses coordination problems for which private ordering alone does not provide effective solutions, with the goal of maximizing enterprise value across a sliding scale of situations ranging from anticipated to actual distress.

Initiatives such as the EU’s Directive on Preventive Restructuring Frameworks (‘the Directive’)²⁰ are concerned with harmonization of domestic laws. But as many large restructurings transcend national boundaries, the purpose of our article is to consider the treatment of pre-insolvency proceedings in private international law. While, to date, cross-border insolvency instruments have tended to define insolvency proceedings quite expansively, discussion of the cross-border implications of pre-insolvency proceedings—and, in particular, the normative case for treating them under the same umbrella of formal insolvency proceedings in private international law—is only just beginning.²¹

This article first maps the contours of pre-insolvency proceedings (Sect. 2) and reviews how insolvency and pre-insolvency proceedings are treated in current cross-border insolvency law (Sect. 3). It then seeks to contribute to the normative discussion. Section 4 considers whether pre-insolvency proceedings should (or should continue to) be characterized as related to insolvency and be governed by the leading specialized cross-border insolvency instruments and by the norm of modified universalism. The risk is over-inclusivity of cross-border insolvency law, which, where it is based on universality and unity, might defeat contractual expectations. Thus, the alternative is to treat pre-insolvency proceedings as ‘contract like’ for the purpose of private international law characterization. However, we advance reasons why, in our view, we should be slow to exclude pre-insolvency proceedings from cross-border insolvency law. At stake in the normative debate is the availability (or otherwise) of the tools and norms of cross-border insolvency law—foreign recognition, expansive foreign court relief, and international cooperation, coordination, and communication between courts and other actors (aspects of the overarching norm of modified universalism)—to assist and protect pre-insolvency proceedings overseas. At a conceptual level, we doubt whether legislatively mandated or ‘state-supplied’²² deadlock resolution mechanisms, can properly be analogized for private international law purposes to consensual contract modifications. At a practical level, foreign court recognition, relief, and cooperation provide a necessary antidote to overseas manoeuvres by holdout creditors and are mechanisms that accommodate hybridity while also disfavouring procedural fragmentation. However, we do not see the ‘contract’ or ‘insolvency’ question as purely binary. Instead, we proceed to argue in Sect. 5 that cross-border insolvency law’s dominant norm—modified universalism—is sufficiently flexible that it can evolve to accommodate the peculiarities of pre-insolvency proceedings successfully. Accordingly, while we suggest that cross-border insolvency law needs to be flexible, we see no compelling reason to change the current course or reinvent the wheel.

2 Pre-insolvency Proceedings: Mapping the Contours

This section identifies the main features and characteristics of pre-insolvency proceedings. It mainly draws on the influential chapter 11 of the US Bankruptcy Code and on the Directive. It contends that pre-insolvency proceedings have certain core characteristics but that, rather than necessarily standing alone, they may nest within broader, hybrid, multi-purpose proceedings—something akin to a matryoshka doll where a smaller figure nests inside a larger figure. This pliable nature of pre-insolvency proceedings has important implications for the decision how to treat these proceedings in international cases.

The aim of the Directive is ‘to establish a common EU-wide framework to ensure effective restructuring, second chance and efficient procedures both at national and cross-border level’.²³ The Directive builds on an earlier Recommendation that invited member states to introduce ‘effective pre-insolvency procedures to help viable debtors to restructure and thus avoid insolvency’.²⁴ From these pronouncements we can discern the first three core characteristics of pre-insolvency proceedings. First, they are formal in the sense that their effectiveness depends on a statutory mandate and not purely on private ordering. Second, they are primarily debt restructuring proceedings rather than proceedings for realizing assets and distributing proceeds, albeit, asset disposal may be contemplated as part of the restructuring.²⁵ Third, they are proceedings that are available to debtor firms before they are factually insolvent—in other words, before their financial condition has deteriorated so deeply that they meet the statutory predicates (insolvency on a cash-flow and/or balance sheet basis)—that are thresholds to entry into formal insolvency or rehabilitation proceedings in many legal systems.²⁶ A fourth core characteristic that relates to the third is that pre-insolvency proceedings may be debtor-in-possession proceedings—entry into the proceedings might not result in the replacement of the debtor’s incumbent management by an officeholder such as an administrator or a liquidator. Thus, there is a positive incentive for managers to use pre-insolvency proceedings with this characteristic to address anticipated difficulties at an early stage because they will not lose control by doing so.²⁷ Taking these four core characteristics as a whole, it is apt to describe pre-insolvency proceedings as ‘a legal framework that allows firms to readjust their capital structure well before they are in fact insolvent’.²⁸

Pre-insolvency proceedings are thus designed to provide economically viable firms with a formal mechanism through which they can deleverage their balance sheets by renegotiating and concluding a new deal with their principal financial creditors on more favourable terms. The deal may involve one or more of a variety of refinancing techniques such as extended loan maturities (meaning that debt can be repaid later), reduced interest payments, reduced payments of principal indebtedness (commonly referred to as debt write-downs or ‘haircuts’) or agreements to exchange debt for equity (which have the combined effect of reducing principal indebtedness and reducing debt service costs in return for creditors sharing future ‘upside’ with owners).²⁹ When distress is on the horizon, it makes sense for firms to try to renegotiate with their financial creditors before the debt matures or accelerates because contractual events of default in the finance documents are triggered.

The renegotiation has traditionally taken the form of an out-of-court workout³⁰ in which the parties agree by contract to modify the terms of the existing debt or exchange it for fresh, less expensive, obligations. But workouts require unanimous consent or, where there is a collective action clause in the inter-creditor agreement that forms part of the original financing package, the consent of a prescribed super-majority of creditors. As such, while they can be successful, they are prone to holdout problems—creditors blocking the deal and using leverage to extract additional benefits for themselves—and ‘free rider’ problems—creditors who decline to participate, so that they are not bound by the workout terms, and yet who enjoy the prospect of full payment because concessions made by other creditors improve the debtor’s financial health.³¹ The market has devised partial solutions, such as collective action clauses, exit consents, and consent fees, that go some way to addressing these coordination problems.³² However, to ensure that holdout and free rider problems can be overcome decisively, formal restructuring alternatives are required to protect the debtor against the disruptive threat of premature enforcement³³ and to bind all creditors, including dissenters, to the terms of the restructuring deal. Pre-insolvency proceedings therefore mirror workouts in important respects. They provide a framework that facilitates ‘structured bargaining’³⁴ over new financing terms between the debtor’s managers and creditors prior to insolvency. They also permit, through a combination of deadlock resolution voting mechanisms and formal confirmation by a court or administrative authority, the imposition of majority-approved restructuring deals on dissenting or non-participating minorities in a manner that overcomes the potential obstacles to a successful workout.

Chapter 11 of the United States Bankruptcy Code has been influential in the development of pre-insolvency proceedings globally.³⁵ While, it is natural to think of chapter 11 as an insolvency proceeding, it was designed to promote restructuring by encouraging firm managers to negotiate and confirm a plan of reorganization under bankruptcy court oversight³⁶ within the shelter provided by a statutory moratorium—the automatic stay.³⁷ Firms filing voluntarily can access chapter 11—a debtor-in-possession proceeding³⁸—without having to establish that they are factually insolvent.³⁹ Managers control the direction of the case subject to bankruptcy court oversight and other institutional constraints. For example, the debtor-in-possession has a 120-day exclusivity period during which it—and it alone—can file a draft plan of reorganization,⁴⁰ and it remains free to continue running the business in the ordinary course without the need for court approval of its day-to-day operations.⁴¹

Moreover, chapter 11 contains elaborate mechanisms for deadlock resolution pursuant to which a plan of reorganization can be imposed on dissenting stakeholders through a mechanism known as ‘whole class cramdown’ as long as at least one impaired class votes in favour⁴² and the plan meets various statutory requirements, including requirements that the plan is feasible,⁴³ does not unfairly discriminate, and is fair and equitable in its treatment of dissenting classes. The court’s confirmation of the plan is the source of its legally binding effects. It operates to discharge the firm’s pre-bankruptcy obligations and replace them with new obligations under the plan.⁴⁴

On paper, then, the chapter 11 model blends debtor-in-possession and low-barrier-to-entry features. It is designed to encourage early and easy access. It provides a statutory moratorium, plan voting, and confirmation mechanisms aimed at curbing opportunistic creditor behavior. As originally conceived, it is biased towards restructuring rather than asset sales,⁴⁵ and includes safeguards designed to protect dissenting minorities in the plan voting and confirmation process, and to balance the interests of creditors who would prefer to crystallize their loss rather than wait for their money.⁴⁶

In truth, chapter 11 is a hybrid of a pre-insolvency restructuring proceeding and a formal rehabilitation procedure. Indeed, as financial markets have changed over time,⁴⁷ and as practice has evolved in response, chapter 11 has come to function as a multi-purpose ‘one-stop’ shop. As well as wholesale reorganizations implicating all stakeholders (finance creditors, trade creditors, tort creditors) that may incorporate operational restructuring (i.e. changes to the business model) and extensive refinancing—chapter 11’s original raison d’etre—it comfortably accommodates pre-packaged or pre-arranged financial restructurings, approximating to workouts.⁴⁸ This type of ‘skinny’ restructuring, which is more limited in scope than a wholesale reorganization, affects only the finance creditors and often leaves the trade creditors of the operating business untouched. Skinny restructurings are close analogues to the kind of balance sheet restructurings that can be consummated in the UK, for example, through creditors’ schemes of arrangement.⁴⁹ Indeed, skinny restructuring is the main territory of pre-insolvency proceedings in practice.

But as well as a range of restructuring outcomes, chapter 11 can also be used to accomplish court-approved sales that are functionally equivalent to various formal insolvency proceedings, for example, the UK administration sale.⁵⁰ Here too, there are several possibilities. The court can approve a sale as part of a confirmed plan,⁵¹ or, prior to plan confirmation under section 363 of the Bankruptcy Code, in which case the sale is conjoined with a so-called liquidating plan, which becomes a vehicle for distributing the sale proceeds.⁵² More controversially, debtors-in-possession, invariably at the behest of their senior creditors,⁵³ have pushed the envelope of the section 363 power to carry out quick going concern whole-of-firm sales without any kind of accompanying plan process. In these cases, after the sale, the debtor will either convert to a liquidation or simply get the chapter 11 case dismissed.⁵⁴ Critics object that section 363 whole-of-firm sales, which courts review on a deferential business judgment standard, do an end run around chapter 11’s plan protections for dissenting creditors and dissenting classes.⁵⁵ Be that as it may, chapter 11 is at root a pre-insolvency proceeding—it has the four core characteristics we identified earlier⁵⁶—although in practice, it is a hybrid restructuring and insolvency proceeding through which debtors and creditors can engineer a range of outcomes (skinny financial restructurings, wholesale reorganizations, asset sales followed by a distribution).

Chapter 11, through its debtor-in-possession (DIP) financing provisions,⁵⁷ also provides a platform for the investment of new money in the firm to ensure continuity while a plan is negotiated. Subject to court approval, these provisions permit the firm to grant new lenders priming liens that confer priority on the new lender over existing lienholders. As such, the Bankruptcy Code establishes a backstop framework for resolving inter-creditor issues relating to the terms on which senior creditors will provide ongoing liquidity to the firm’s operating business. In practice, the DIP financing provisions create governance leverage through which DIP lenders can control the course of the case.⁵⁸ But for our purposes, they underscore the point that chapter 11 has always been much more than just a voting mechanism to accomplish a skinny restructuring before the debtor begins its descent down the demise curve. The Bankruptcy Code’s elaborate provisions preventing ipso facto termination of contracts and empowering the debtor-in-possession to assume or reject its executory contracts and leases further illustrate chapter 11’s breadth and hybridity.⁵⁹

In setting a base line for minimum harmonization, the EU’s emerging conception of pre-insolvency proceedings draws on chapter 11’s model.⁶⁰ Thus, the focus on so-called pre-insolvency proceedings, in the form of processes akin to chapter 11, is becoming significantly widespread, although these are unlikely to emerge as a one-size-fits-all or a single uniform template for restructuring. The Directive’s base line model possesses the core characteristics identified at the beginning of this section. It would require member states to ensure that, ‘where there is a likelihood of insolvency, debtors in financial difficulty have access to an effective preventive restructuring framework that enables them to restructure their debts or business’.⁶¹ Thus, factual insolvency is not a pre-condition to access (third characteristic)⁶² and restructuring, rather than liquidation of assets and distribution of proceeds among creditors, is the outcome contemplated (second characteristic). The EU model is formal (first characteristic) in that it contains rules on plan contents, class formation, valuation, and voting, and requires member states to ensure that restructuring plans which affect the interests of dissenting parties, or which provide for new financing, can only become binding if they are confirmed by a judicial or administrative authority.⁶³ The fourth characteristic—debtor-in-possession—is also a default feature.⁶⁴ However, the Directive does also contemplate partial DIP models in which officeholders may—and in some situations must—be appointed to oversee the case.⁶⁵

The proceedings contemplated by the Directive bear some resemblance to chapter 11 but are far from identical to it. For example, chapter 11’s automatic stay and DIP financing provisions are significantly watered down and, some of the proposed standards, such as the ‘likelihood of insolvency’ access standard, retain, as one would expect, a distinctly European character that reflects compromises among the EU institutions and the member states.⁶⁶ The directive seeks to minimize court involvement in the interests of efficiency and cost-effectiveness⁶⁷ and arguably, therefore, provides the basis for a suite of cheaper European alternatives to the American system in which the institutional role of the court and of creditors’ committees comes with a considerable price tag. Formal court sanction is therefore a feature of the EU model, but the role of the court is expected to be more ‘light touch’.

In summary, at its core a pre-insolvency proceeding is a form of voting mechanism by which a debtor can seek to avoid insolvency by imposing a debt (usually balance sheet) restructuring on holdout creditors. Yet, while chapter 11-like processes can be deployed as pre-insolvency proceedings in the manner just described, they are really hybrid restructuring and insolvency proceedings that debtors (whether already insolvent or in anticipation of insolvency) can use to reallocate or realize firm value in various ways, which, for simplicity, we have characterized as skinny restructurings, wholesale reorganizations and sales. Insofar as it approximates to a ‘chapter 11-lite’ model, the Directive would create the legal foundation for the continued emergence of a range of European restructuring proceedings with considerable variance in design and detail⁶⁸ and potential also for hybridity. This point is important because hybridity presents considerable challenges of characterization from a private international law perspective.

3 The Treatment of Pre-insolvency Proceedings in Current Cross-Border Insolvency Law

3.1 Legal Framework

The current global framework for coordinating cross-border insolvencies is still patchy in situations where it relies on a transnational web of domestic private international laws. But considerable progress has been made towards harmonization of the private international law of insolvency mainly through two instruments: the EU Insolvency Regulation (recast) (‘EIR’)⁶⁹ and the UNCITRAL Model Law on Cross-Border Insolvency Law (‘Model Law’).⁷⁰ Domestic versions of the Model Law have been enacted by 46 jurisdictions to date,⁷¹ including key jurisdictions with large financial markets such as the United States,⁷² the United Kingdom,⁷³ and Singapore.⁷⁴ These two instruments seek to avoid a costly multiplicity of proceedings and promote centralized, coordinated, and therefore value-maximizing, resolution of cross-border cases.

The EIR harmonizes rules on jurisdiction, applicable law, recognition and international effect of insolvency proceedings and insolvency-related judgments throughout the EU. The Model Law creates a framework for international recognition and relief of eligible proceedings.⁷⁵ Its aim is to promote harmonization through unilateral country adoptions of the transnational system as well as shared interaction and practice among enacting states over time.⁷⁶

The norm animating both instruments is modified universalism. Modified universalism’s core tenet is a centralizing principle which gives primacy to a ‘main’ proceeding conducted in the jurisdiction where the debtor has its ‘home country’ and places courts in other jurisdictions in a supporting role. Under modified universalism, the ‘main’ proceedings’ court is the hub of the wheel and other courts assist the ‘main’ proceeding so as to centralize the administration of the debtor’s estate as far as possible.⁷⁷ Modified universalism holds that courts should strive to achieve ‘unity’ (a single forum) and ‘universality’ (a single applicable insolvency law) when it is the most efficient approach, and take a global perspective, with the aim of creating market symmetry between the cross-border insolvency system and transnational commercial reality.⁷⁸ But modified universalism acknowledges that a fully universalist system—a single, unitary, worldwide proceeding administered in all cases from the debtor’s ‘home’ jurisdiction, under ‘home’ law—does not always fit the enterprise structure and its geographical spread, and does not take account of differences in jurisdictions’ capacity and level of adherence to minimum standards regarding insolvency.⁷⁹ The EU and global instruments (by which we mean the various instruments promulgated by UNCITRAL, primarily the Model Law)⁸⁰ that generally accord with modified universalism reflect a realistic approach to the administration of cross-border insolvency. At the core of the EIR and the Model Law is the notion of a debtor’s COMI (centre of main interests) where the main proceedings should be opened (under the EIR) or that should be recognized as the main proceedings (under the Model Law). Additional ‘secondary’ proceedings may be opened, however, under the EU system or ‘non-main’ proceedings may be recognized under the Model Law. The instruments also provide certain safeguards that reflect the persistence of national legal orderings, in particular a standard public policy ground for denial of recognition and/or relief.⁸¹

In practice, the cross-border insolvency instruments streamline the basis on which the effects of a proceeding in the debtor’s ‘home’ jurisdiction can be extended beyond that jurisdiction. This way, assets in other jurisdictions can be protected from individual enforcement and marshalled, and restructuring plans approved by the ‘home’ court can be globally enforced. As well as creating a framework of private international law rules for insolvency, the instruments also promote a wider culture of international cooperation by establishing extensive duties of cooperation and communication between courts and between practitioners.⁸²

3.2 Proceedings Eligible for Assistance and Cooperation Under Cross-Border Insolvency Law: Definitions and Predicates

The threshold question is: what proceedings fall within the scope of the current cross-border insolvency instruments? In other words, how do these instruments separate the proverbial sheep (eligible proceedings) from the proverbial goats (ineligible proceedings)? We consider the position under the Model Law and the EIR in turn.

3.2.1 The Model Law

The Model Law applies—and therefore its benefits become available—predominantly where a foreign court or foreign representative seeks assistance in the enacting state in connection with a ‘foreign proceeding’.⁸³ A proceeding must be a ‘foreign proceeding’ to qualify for recognition.⁸⁴ Article 2(b) defines ‘foreign proceeding’ as:

[A] collective judicial or administrative proceeding in a foreign State, including an interim proceeding, pursuant to a law relating to insolvency in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation.

The definition is intended to be expansive⁸⁵ and to encompass proceedings involving debtors that are in severe financial distress or insolvent, including proceedings accessible to debtors ‘that are or will be generally unable to pay their debts as they mature’.⁸⁶ In principle, then, the Model Law can accommodate proceedings across the spectrum, including preventive and hybrid proceedings, and apply to them the sui generis private international law system of insolvency based on modified universalism.

The commentary in the Model Law’s Guide to Enactment on each of the predicates—‘collective’, ‘law relating to insolvency’, ‘debtor’s assets and affairs subject to the control or supervision of a court’, ‘liquidation or reorganization’ purpose—supports a broad, inclusive reading.⁸⁷ The requirement for ‘collectivity’ rules out de facto collection proceedings that enable individual creditors or groups of creditors to enforce their claims, such as a receivership instigated by a secured creditor.⁸⁸ But proceedings are not necessarily ruled out because they leave a class of creditors’ rights unaffected:

A proceeding should not be considered to fail the test of collectivity purely because a class of creditors’ rights is unaffected by it. An example would be insolvency proceedings that exclude encumbered assets from the insolvency estate, leaving those assets unaffected by the commencement of the proceedings and allowing secured creditors to pursue their rights outside of the insolvency law […].⁸⁹

In practice, ‘collectivity’ apparently would also not rule out skinny restructurings that address balance sheet liabilities while leaving the claims of operating creditors untouched on the argument that the restructuring affects, and affords due process rights, to all creditors included within its scope.⁹⁰ A proceeding is not ruled out merely because it is conducted under a law that is not designated as an insolvency law or does not contain rules relating exclusively to insolvency.⁹¹ Function carries more weight than form. Thus, for example, a company law proceeding, like a UK scheme of arrangement, which can be used for solvent and distressed/insolvent restructurings may still be a ‘proceeding […] pursuant to a law relating to insolvency’ under Article 2(a) of the Model Law.⁹² While the debtor’s assets and affairs must be subject to the control or supervision of a court,⁹³ control or supervision may be potential rather than actual and need not be exercised directly.⁹⁴ A proceeding administered by an insolvency practitioner would still qualify as long as the insolvency practitioner is subject to court supervision.⁹⁵ DIP and partial DIP proceedings, in which the debtor retains control over its assets subject to court oversight, are intended to qualify.⁹⁶ The ‘liquidation or reorganization’ predicate is also prima facie broad enough to include proceedings that lead to one or more of a range of outcomes—break-up sales, going concern sales, wholesale restructurings, and skinny restructurings involving balance-sheet ‘reorganization’⁹⁷—and therefore brings multi-purpose hybrid proceedings inside the tent.

3.2.2 The EIR

In its original version, the EIR, and the lapsed draft EU Convention on which it was based,⁹⁸ applied to ‘collective insolvency proceedings which entail the partial or total divestment of a debtor and the appointment of a liquidator’.⁹⁹ This narrow definition, which required proceedings to be based on the debtor’s insolvency and not on other grounds,¹⁰⁰ reflected the liquidation and management displacement biases of European insolvency systems that were prevalent 30 years ago. The updated scope of the recast Regulation is broader and captures the institutionalization of rescue within European insolvency systems in the intervening years, while also foreshadowing the EU’s preventive restructuring initiative.¹⁰¹ Article 1(1) of the EIR, insofar as relevant to our present discussion, now reads as follows:

This Regulation shall apply to public collective proceedings, including interim proceedings, which are based on laws relating to insolvency and in which, for the purpose of rescue, adjustment of debt, reorganization or liquidation:

• (a) a debtor is totally or partially divested of its assets and an insolvency practitioner is appointed;

• (b) the assets and affairs of a debtor are subject to control or supervision by a court; or

• (c) a temporary stay of individual enforcement proceedings is granted by a court or by operation of law, in order to allow for negotiations between the debtor and its creditors, provided that the proceedings in which the stay is granted provide for suitable measures to protect the general body of creditors, and, where no agreement is reached, are preliminary to one of the proceedings referred to in point (a) or (b).

Where the proceedings referred to in this paragraph may be commenced in situations where there is only a likelihood of insolvency, their purpose shall be to avoid the debtor’s insolvency or the cessation of the debtor’s business activities.

Under the influence of the Model Law definition of ‘foreign proceeding’, aspects of which are apparent in the opening language of Article 1(1), the recast Regulation’s scope is wide enough to encompass pre-insolvency, debtor-in-possession style proceedings as well as more traditional insolvency or rescue proceedings for which insolvency is a pre-condition.¹⁰² Moreover, skinny restructurings affecting only some creditors are explicitly brought within the Regulation’s scope.¹⁰³ On the flipside, as is also the case with the Model Law, out-of-court workouts are ‘out’: they are not ‘public’¹⁰⁴ and do not involve court supervision or control.

But despite cross-fertilization, the EIR and Model Law differ in important respects. First, while Article 1(1) sets parameters, it is not dispositive. In the interests of legal certainty, the proceedings within the scope of the EIR are listed for each member state in Annex A, a practice that originated with the draft Bankruptcy Convention.¹⁰⁵ The Court of Justice of the European Union has ruled that Annex A determines exhaustively whether or not a national proceeding qualifies: if it’s on the list, it’s ‘in’ even where there are doubts about whether it meets the Article 1(1) criteria¹⁰⁶; if it’s not on the list, it’s ‘out’.¹⁰⁷ To update the Annex, countries must notify the Commission of changes to domestic law and request the amendment of Annex A so that it accurately reflects national notifications. On receiving such a request, the Commission reviews it and proposes a regulation to replace Annex A with an updated list. Thus, the Regulation has the character of an ‘opt in’ instrument in terms of the proceedings covered. If member states choose not to notify a particular proceeding, it will not be in Annex A and will therefore be outside the Regulation’s scope.

Second, the Regulation attaches a formalistic meaning to ‘law relating to insolvency’. Recital (16) expressly rules out proceedings ‘based on general company law not designed exclusively for insolvency situations’. Thus, a multi-purpose Companies Act proceeding that can function as a pre-insolvency or insolvency proceeding, albeit non-exclusively, is ‘out’. This goes some way to explaining why UK schemes of arrangement are outside the scope of the EIR¹⁰⁸ despite routinely being recognized as eligible foreign proceedings by US courts under chapter 15 of the Bankruptcy Code, the US enactment of the Model Law.¹⁰⁹

4 Pre-insolvency Proceedings in Private International Law: Contract or Insolvency?

We saw in Sect. 3 that the trajectory of cross-border insolvency law as reflected in the key international instruments has generally kept track with the evolution of insolvency and restructuring law. If we leave aside the difference between the Model Law and the EIR concerning ‘law relating to insolvency’, the only resolution tools decisively beyond the pale are out-of-court workouts and creditor-initiated individual collection mechanisms. We can argue about whether ‘light touch’ preventive restructuring proceedings having the characteristics outlined in Sect. 2 are sufficiently public,¹¹⁰ sufficiently collective (where they affect only a narrow tranche of creditors), and sufficiently court supervised, but we suggest that the prevailing inclination of the law is towards inclusivity.

This trend towards inclusivity raises normative questions. Is cross-border insolvency law over-inclusive? Should the tools of cross-border insolvency law be available to universalize the effects of a domestic pre-insolvency proceeding on foot in the jurisdiction of the debtor’s COMI? Should we redraw the boundaries and make cross-border insolvency law less inclusive? Is it necessary, or at the very least desirable, for pre-insolvency proceedings to receive international recognition, assistance and cooperation on much the same terms as insolvency proceedings?

4.1 The ‘Full Collectivity’ Theory

It can be argued that the touchstone for universal applicability under cross-border insolvency law should be whether a proceeding is ‘fully’ collective. On one influential view, a proceeding is only fully collective where it deals with all creditors to resolve a common pool problem by restricting individual rights of enforcement either procedurally, by means of a stay, or substantively by modifying creditor entitlements.¹¹¹ It follows from this view that insolvency law should only be permitted to override the legitimate expectations of creditors, including expectations as regards the anticipated forum for, and law applicable to, the resolution of their claims, where the proceeding is fully collective.¹¹² This full collectivity theory is primarily concerned to protect the private autonomy of contract creditors, expressed through forum selection and governing law clauses, from unjustified encroachment by the COMI jurisdiction’s insolvency law.¹¹³ In short, under the full collectivity theory, unless the proceeding purports to deal procedurally or substantively with a situation of general default—that is, one that in some way addresses the claims of all creditors long term (finance) or short/medium term (operating)—they should be excluded. Thus, the US chapter 11 proceeding would be included because it imposes a wide stay and allows ‘forced modifications of creditors’ entitlements’,¹¹⁴ but the UK scheme of arrangement or the French procédure de financière sauvegarde accélérée would be excluded, as these proceedings can be characterized as ‘not fully collective’, because their goal is restricted to accomplishing ‘an early financial restructuring of portions of creditors’ claims’.¹¹⁵ One important implication of full collectivity is that pre-insolvency proceedings designed to promote skinny financial restructuring should be treated as a species of de facto private resolution and the logic of contractual workouts should still prevail.

4.2 The ‘Separate Domains/Separate Normative Foundations’ Theory

Another way to address the trend towards over inclusiveness is to sever more sharply insolvency proceedings from restructuring proceedings and treat insolvency law and restructuring law as separate domains with separate functions and distinctive normative foundations.¹¹⁶ According to this ‘separate domains’ theory, the domain of insolvency law is asset realization proceedings that respond to a common pool problem whereas the domain of restructuring law is court-assisted agreements among stakeholders about future entitlements to future revenue streams. The former protects assets from a destructive enforcement race and provides instead for collective enforcement of claims against an insufficient pool of assets and distribution on liquidation principles. The latter involves a new bargain between the debtor and creditors about future revenues.¹¹⁷ Under this theory, a legal framework that supports structured bargaining over future value differs from a collective liquidation and distribution of assets because it responds to an anti-commons problem rather than a common pool problem.¹¹⁸ Accordingly, restructuring law ought properly to be based on contract and company law principles—with the law supplying deadlock resolution procedures to overcome the problem of holdout vetoes standing in the way of the new bargain—rather than on the distributive norms of liquidation law.

The separate domains theory does more than merely address the policy dilemma of cross-border characterization. It aims more widely to decouple restructuring law from liquidation principles (including the absolute priority rule) and ground it on the expectations of stakeholders outside of insolvency.¹¹⁹ We have much sympathy with the idea that the methodology for determining whether entitlements to future value in a restructuring have been allocated fairly and equitably should not be wedded to counterfactual liquidation outcomes.¹²⁰ However, we are concerned that the separate domains theory would carve out restructuring proceedings, including skinny restructurings and restructuring aspects of hybrid proceedings,¹²¹ from the scope of cross-border insolvency law, leaving the cross-border issues to be resolved by ordinary private international law.

4.3 In Defence of the Emergent Status Quo

We worry about under-inclusiveness for several reasons. First, insolvency and restructuring law may be best seen as a unified body of law—and a unified jurisdiction—which responds to various kinds of collective action problem with the goal of preserving and maximizing value. Against this backdrop, any move to exclude pre-insolvency proceedings from cross-border insolvency law runs into two problems: (1) restructuring cases higher up the demise curve will arise where debtors will need cross-border assistance and cooperation under existing cross-border insolvency instruments to accomplish desirable outcomes; and (2) the legal response to situations of distress that have multinational elements will become fragmented according to the point on the demise curve where the intervention takes place or depending on the manner of the intervention.

The main case against inclusiveness in cross-border cases is that insolvency law and its related jurisdiction has no business overriding the private autonomy of contract debtors in restructuring contexts involving ‘contractualized’ or semi-contractual debt resolution. The objection is that the universal extension (and thus rigid over-reaching) of the COMI court’s law and jurisdiction harms the legitimate expectations of creditors who contracted for some other governing law and pre-selected some other forum for resolution of their (debtor-creditor and inter-creditor) disputes.¹²²

However, in skinny restructurings, the creditors are invariably sophisticated multinational parties whose expectations will be shaped as much by prevailing trends in the restructuring market as by contract. It will hardly come as any surprise to such creditors that a debtor in a state of pre-insolvency distress may seek to restructure in a venue conducive to achieving a favourable restructuring outcome in as efficient a manner as possible. To be sure, there may be concerns about abusive forum shopping—including the ability of debtors to migrate their COMIs and so displace privately agreed governing law and dispute resolution mechanisms with an ‘alien’ COMI state restructuring regime—but the reality is that it is difficult to achieve a successful restructuring without a sizeable majority of the debtor’s finance creditors on board. Those creditor majorities that are already onside with the restructuring effort invariably select (or influence the selection of) the restructuring venue¹²³ and expect to do so.

In truth, then, the concern about the COMI court/law defeating creditor expectations distils down to a concern about appropriate counter-majoritarian minority protections for potential holdouts that dislike the majority’s chosen mechanism for breaking any deadlock and the terms of the proposed deal. Minority protection, of course, is important. However, if expectations—as we would contend—are shaped organically by practice in debt markets, it is difficult to understand why the contractual expectations of the minority, represented by venue and governing law clauses in the finance documents, should be automatically dispositive if the majority wishes to modify the contract in a restructuring regime of its choice when distress arises.¹²⁴ Further, skinny restructurings that require formal mechanisms to break deadlocks or bind in unknown creditors do have externalities that affect not only the finance creditors. A successful restructuring will nip a crisis in the bud and help to ensure that established relationships between the debtor and its operating creditors continue to flourish.

Second, cross-border insolvency law’s dominant norm, modified universalism, can provide scaffolding for ensuring creditors are treated fairly in foreign jurisdictions, including through the safeguards it provides such as the public policy standard or the notion of ‘adequate protection’.¹²⁵ We take this discussion up further in Sect. 5, but for now we note as well that modified universalism is a flexible norm that can be developed to accommodate the peculiarities of pre-insolvency proceedings and thus address concerns about over-inclusivity, within the ambit of cross-border insolvency law.

Third, attempts to sever restructuring law (which responds to likelihood of insolvency) and insolvency law (which responds to factual insolvency) might do more harm than good. If we conceive of problems of financial distress as being on a curve—the demise curve—or, without much variation, on a downward spiral, and we accept the proposition that early intervention higher up the curve may often be more desirable than later intervention lower down the curve, insolvency and restructuring law are on a continuum. We know that it is notoriously difficult to prove that a debtor is ‘insolvent’ or ‘likely insolvent’ or ‘viable’ at any given moment in time because distress is fluid rather than static. Thus, laws deploy various techniques and proxies for judicial determination that streamline access into formal proceedings—in English law, tools such as the statutory demand¹²⁶ or formal declarations in notice of appointments.¹²⁷ The ‘viable business in need of restructuring’ may without intervention deteriorate into the ‘non-viable’ business that ought to be liquidated. Decisions to restructure rather than liquidate (or vice versa) in response to financial distress are governance decisions that confront debtors, creditors, and sometimes courts, on this continuum. The questions that these decisions raise are interwoven: restructuring involves a distribution (or redistribution) of value among stakeholders just as much as liquidation, albeit the methodology (court-based valuation of the debtor’s future revenue streams versus market sale) is different.¹²⁸ And, sometimes, because of hybridity, the ‘restructure or liquidate’ question is conflated within a single proceeding or through a combination of formal proceedings—for example, in English law, a scheme or company voluntary arrangement exit (restructuring) from administration (a proceeding used more often than not to pursue a ‘better than liquidation’ asset sale). ‘Restructure or liquidate’ is a governance question that is also directed at how best to maximize value for creditors at the point of intervention. Insolvency proceedings address collective action problems that would harm creditors collectively from maximizing value lower down the demise curve. Pre-insolvency (restructuring) proceedings, too, address holdout and free rider problems¹²⁹ that harm a value-maximizing restructuring higher up the demise curve which may have positive spillover effects (preservation of employment, preservation of long-term supply chain relationships with operating creditors).¹³⁰ Similarly, concerns that managers (or substantial creditors) will take wrong decisions—abusively attempting a restructuring of a non-viable debtor that ought to be liquidated or liquidating a viable debtor that ought to be restructured—are all part of the same continuum.¹³¹ Insolvency and restructuring law is, therefore, a unified body of law that maps onto the continuum, rather than two discrete bodies of law. One thing bleeds into the other. A debtor that has a likelihood of insolvency risks breaching loan covenants or triggering events of default and moving swiftly from ‘pre-insolvency’ to full-blown crisis. Rigid framings that distinguish pre-insolvency (restructuring) proceedings from insolvency proceedings lose sight of this fluidity.

Fourth, given that conditions of distress are fluid and are on a continuum, restructuring cases can arise where debtors will need cross-border assistance and cooperation under existing cross-border insolvency instruments—or new instruments that may be adopted in the future¹³²—to reach a successful outcome. Take, for example, the case of a freestanding UK scheme of arrangement (that is a scheme not combined with some other proceeding) by a debtor on the cusp of a covenant breach that would be a tipping point between ‘likely insolvency’ and ‘insolvency’. What if a dissenting activist hedge fund creditor seeks to leverage its position by threatening or initiating involuntary insolvency or collection proceedings in another country where the debtor has assets?¹³³ In that case, cross-border insolvency instruments such as the Model Law offer the prospect of a stay in that country that would prevent the creditor from blowing up the restructuring.¹³⁴ Cross-border insolvency instruments also provide mechanisms for exporting the effects of restructuring plans so that they will bind dissenting and unknown creditors wherever they are situated—again to prevent holdouts from disrupting the outcome. At the moment, there is considerable uncertainty surrounding the treatment of restructuring plans under ordinary commercial conflicts of law rules.¹³⁵ And while the decision of the UK Supreme Court in Rubin v. Eurofinance SA¹³⁶ reminds us that cross-border insolvency has a long way to go before all local courts will enforce foreign restructuring plans on a universalist theory,¹³⁷ UNCITRAL has already taken steps to create a regime for recognition and enforcement of ‘insolvency-related judgments’ designed to plug the gap.¹³⁸ As things stand, then, cross-border insolvency law is better placed to serve cross-border restructuring efforts.¹³⁹ For practical purposes, it has a first mover advantage.

Let us concede some ground for the moment and admit the possibility of a taxonomy that applies commercial conflicts rules to solvent restructuring proceedings and cross-border insolvency law rules to insolvency proceedings.¹⁴⁰ This would accommodate normative positions that would object to the use of an ‘insolvency’ characterization where a debtor is not yet factually insolvent because individual enforcement rights are not yet triggered (debts have neither matured nor accelerated under the terms of the debt contract) and there is, as yet, no general default.¹⁴¹ But to overcome current uncertainties, we would need to design a robust international architecture of commercial conflict rules with tailored jurisdictional rules, mechanisms for cross-border injunctive or anti-suit relief to prevent holdouts from blowing up restructurings in foreign jurisdictions,¹⁴² and tailored rules on the recognition and enforcement of restructuring plans that deal with their special characteristics.¹⁴³ We would also still need a test to manage the borderline between ‘solvency’ and ‘insolvency’ that would be hard to craft in a way that accommodates the fluidity of financial distress (e.g. ‘likely insolvent’ debtors at risk of covenant breach).

Fifth, if we posit discrete private international law regimes for statutory contract modification mechanisms and insolvency proceedings with different rules of jurisdiction and recognition, we run into problems of hybridity that, in turn, risk unhelpful fragmentation of jurisdiction in cross-border restructuring. To illustrate, let us consider three types of hybridity. One arises from multi-purpose proceedings, like chapter 11, in which several outcomes—skinny restructuring, wholesale restructuring, or liquidating sale—can be accomplished in the same proceeding. We introduced this type—call it ‘outcome’ hybridity—already in Sect. 2. A second arises where more than one domestic law proceeding is combined to achieve a resolution—call it ‘combination’ hybridity—for example, in English law, where a scheme or company voluntary arrangement (CVA) may be sheltered within an administration. A third arises where a proceeding can be accessed by solvent or insolvent entities for restructuring. Here, the proceeding may have a single restructuring purpose, but it is accessible to debtors across a range of financial states. UK schemes of arrangement are the obvious example. Call this third type ‘financial status’ hybridity.

Outcome and financial status hybrids pose a ‘generic versus functional’ characterization problem. Recall that under the full collectivity theory,¹⁴⁴ chapter 11 proceedings are ruled ‘in’ because of the automatic stay and the capacity for a chapter 11 debtor to force modifications on all creditors, while skinny restructurings through a scheme or procédure de financière sauvegarde accélérée are ‘out’. And yet, a prepackaged chapter 11 plan that impairs only the finance creditors is functionally the same as a skinny restructuring through a scheme.¹⁴⁵ If we characterize chapter 11s generically on the basis that chapter 11 is capable of functioning as a fully collective proceeding, then prepackaged 11s are ‘in’. If we characterize chapter 11s functionally on the basis of the actual outcome pursued, then prepackaged 11s should be ‘out’.¹⁴⁶ A functional approach is needed to make a model based on full collectivity work properly, but a functional approach introduces fact sensitivity into what is supposed to be a streamlined process. Faced with an application for recognition, courts would have to sort between skinny restructuring 11s and wholesale 11s. A generic approach along the lines of the EIR annexes is preferable because it allows for easy sorting (11s are generically ‘in’ whatever their outcome) and creates strong lines of precedent (i.e. once courts recognize proceeding X under the law of country Y as an insolvency proceeding, there is a reasonable assurance that they will treat that proceeding as eligible for recognition without having to engage in a fact sensitive inquiry).¹⁴⁷ An outcome hybrid, like a chapter 11, raises the same issue in a different way for a model based on the separate domains theory that uncouples debt restructuring from insolvency law¹⁴⁸: pursuit of a worldwide sale outcome (‘in’); pursuit of a restructuring outcome—skinny or otherwise—(‘out’). Financial status hybrids pose less of a problem for this model as it would exclude all restructurings whether solvent or insolvent. But the full collectivity model distinguishes between proceedings that address a common pool problem and those that do not. By that measure, a financial restructuring via a scheme of all the debts in an insolvent company¹⁴⁹ that only has financial assets and debts should be ‘in’.¹⁵⁰

‘Combination’ hybrids pose a different sort of problem: a problem of fragmentation. Consider first the example of a restructuring plan sheltered behind a stay—exactly the kind of procedure that the Directive contemplates.¹⁵¹ A comprehensive stay that extends to secured creditors is indicative of an insolvency proceeding but a skinny restructuring would be treated as not fully collective according to the full collectivity model and as restructuring rather than insolvency according to the separate domains model. A seamless resolution making use of a combination of procedures would be broken into its constituent parts for purposes of private international law. Worldwide recognition of the stay proceeding would turn on cross-border insolvency law rules. Worldwide recognition of the restructuring proceeding would turn on ordinary commercial conflicts’ rules.

Another example of the problem posed by combination hybrids is where a debtor combines a stay-cum-sale proceeding with a restructuring proceeding to achieve a disguised restructuring.¹⁵² The controversial case of Bluebrook¹⁵³ is illustrative. In Bluebrook a group of debtors proposed schemes of arrangement with its senior lenders that involved a pre-packaged sale of its operating business to a Newco entity sheltered within an administration proceeding. Under this scheme-cum-administration, senior creditors were to receive part of the sale proceeds and were offered equity in the new entity in return for releasing the balance of their claims. Junior creditors offered nothing in the scheme were left with worthless claims against Oldco, an outcome justified on the basis that the junior creditors had no economic interest in the group because the value of the group’s assets was less than the value of the senior debt. The restructuring was skinny not wholesale—only finance creditors were affected—and the end result was functionally identical to a whole class cramdown.¹⁵⁴ By combining the administration stay with a scheme exit, the debtor achieved a result under English law that could have been achieved more straightforwardly in chapter 11. Perhaps, then, a full collectivity model would treat the composite as an insolvency proceeding. However, the point is not free from doubt because it may regard skinny restructurings (the scheme portion in Bluebrook) as ‘not fully collective’.¹⁵⁵ The separate domains model would treat the administration as an insolvency proceeding and the scheme as a restructuring proceeding. Thus, were it to be necessary for the debtor (1) to prevent disruption of the sale by seeking foreign recognition of the administration and a worldwide stay and (2) to seek foreign recognition of the effect of the scheme, different rules would apply to (1) and (2).

Fragmentation has jurisdictional implications. The application of different rules to different pieces of a combination hybrid could mean that different courts (the insolvency-home court and the court selected by contract) would have jurisdiction over those different pieces. Similarly, in countries that maintain an institutional separation between bankruptcy and commercial courts, debtors might well need to seek the assistance of a bankruptcy court with respect to the ‘insolvency’ piece and a commercial court with respect to the ‘restructuring’ piece.¹⁵⁶ This would be an unfortunate way to deal with problems of distress that are on a single continuum. It would make the coordination of cross-border cases more difficult and costlier and potentially allocate cases (or portions of cases) to generalist courts that lack the focused expertise of bankruptcy courts. Cross-border cases in which stakeholders wish to pursue a financial and operational restructuring involving both asset disposals and a confirmed plan would be harder to accomplish.

For all these reasons, a single legal and institutional framework of transnational law that treats insolvency and restructuring law as a unified body of law (call it ‘the law of transnational distress’) and that covers the entire continuum may be the preferred approach. Although the current international framework of cross-border insolvency law undoubtedly has gaps,¹⁵⁷ it is the best model we have for streamlining coordination and scrutiny in cross-border cases. Carving some or all pre-insolvency proceedings out of this framework might increase rather than reduce the uncertainty on the fluid borderline between ‘solvency’ and ‘insolvency’, and potentially increase coordination costs because of the risk of fragmentation.

5 Modified Universalism and Pre-insolvency Proceedings

While earlier in Sect. 3 we described modified universalism in absolute terms, the truth is that modified universalism has been understood in different ways and, notwithstanding its dominance, the nature of modified universalism is still somewhat amorphous and contested.¹⁵⁸ Modified universalism is often viewed as some form of compromise between universalism and territorialism,¹⁵⁹ or as an interim solution until the ideal of pure universalism can be achieved.¹⁶⁰ It has been dubbed a ‘thread’, a ‘term’, or a ‘trend’.¹⁶¹ Nonetheless, it can be observed that modified universalism is evolving as a norm in its own right.¹⁶² It is not so much a compromise as a realistic, and thus flexible, approach, that can accommodate different business structures, different types of proceeding, different market sizes, different levels of market integration, and new or emerging trends in the field of insolvency.¹⁶³ Modified universalism aims to achieve the goals of insolvency, on a cross-border level, namely to promote a fair and indeed the most efficient solution, considering the positions of all relevant stakeholders wherever located.¹⁶⁴ It seeks to enable global solutions to multinational default with efficient levels of centralization of insolvency proceedings.¹⁶⁵ It is becoming a prevalent norm, increasingly followed by countries, institutions tasked with implementation of international instruments and international policy makers.

Moreover, modified universalism may be emerging as customary international law (CIL).¹⁶⁶ CIL is a recognized legal source that can fill gaps in international instruments and influence existing instruments. It arises from the general and consistent practice of states, where that practice is based on a belief in the conformity of the practice with international law. Once CIL has become pervasive enough, countries are bound by it regardless of whether they have codified the laws domestically or through treaties. CIL is also responsive to emerging trends in practice. Modified universalism is already quite dominant, and it is also flexible and thus akin to CIL. It can finally transform into CIL to become part of the international insolvency legal order if we no longer aspire to implement pure universalism but instead focus the effort on specifying the modified universalist norm and improving its coverage and reach. Because of its flexibility and wide applicability (as a default system that does not require active adoption), CIL, alongside the further development of instruments such as the Model Law, can also to some extent overcome territorialist biases that still prevail in real-world decision making.¹⁶⁷

Modified universalism is more advanced in some aspects than it is in others. For example, the norms concerning enterprise groups or regarding banks (in cross-border insolvency/resolution) are at an emergent stage.¹⁶⁸ Indeed, so is the modified universalist norm as it applies to pre-insolvency proceedings. Modified universalism is, however, pliable and can react to new trends in the market, and the evolution of preventive procedures is one such notable movement. The modified universalist norm is also influenced by developments of international instruments, in the form of soft or hard law (and vice versa, the norm influences the instruments).¹⁶⁹

As explained in Sect. 3, both the EIR and the Model Law (the key regional/international instruments of cross-border insolvency) have, to some extent, already adapted to the trend towards pre-insolvency proceedings, which in turn contributes to the development of modified universalism. This response to the pre-insolvency trend in the instruments is, however, not necessarily complete. There is room for further consideration of the type of cross-border solutions that should be employed in such cases. Issues for further consideration flow from the discussion of core features of pre-insolvency proceedings discussed earlier. We briefly indicate below some aspects of cross-border pre-insolvency proceedings that may require flexible accommodation by the modified universalism norm and the instruments linked to it, though we do not suggest that this exposition represents a complete list.

In terms of jurisdiction and the mirroring recognition rule, it was noted in Sect. 3 that modified universalism has largely focused on the notion of the debtor ‘home country’, which has been developed into the COMI rule in the regional and international instruments. In the typical formal insolvency cases, which involve operational reorganization or liquidation, centralization of a cross-border insolvency process will most efficiently take place at the COMI. ‘Forum shopping’ to other places should be closely scrutinized to ensure that relocations are not pursued for the wrong reasons,¹⁷⁰ and that creditors are on board and the relocation does not contradict their expectations.¹⁷¹ In cross-border pre-insolvency proceedings, however, and especially in skinny restructurings, the jurisdiction/recognition rule may be more relaxed at least in the way it is applied in practice. It may be less important to concentrate the proceedings in the place of key operational decisions, and more important to look for a jurisdiction that can effectively implement a restructuring, namely a forum that provides a proceeding exhibiting the core features of pre-insolvency measures discussed earlier. The home of the restructuring, therefore, may not necessarily be at the COMI,¹⁷² strictly speaking in the sense of where operational decisions were ascertainably made before the need for pre-insolvency proceedings arose.

As explained in Sect. 2, a key aim of pre-insolvency proceedings is to resolve deadlocks and hold-outs. On the international level, this aim can be extended to resolving ‘jurisdiction deadlocks’ and ‘jurisdiction holdouts’, where the debtor or relevant creditors attempt to initiate a pre-insolvency proceeding in a place where such a proceeding is available and is likely to provide an effective outcome. Concerns regarding creditors’ expectations are also generally less acute.¹⁷³ Subject to safeguards, ordinarily such attempts should be permitted. The presumption should be in favour of the relocation, which may be understood as ‘forum choice’ (ex post when the debtor is approaching insolvency) in such cases. Furthermore, a full relocation of the COMI may not be required for ascertaining jurisdiction (under the EIR system) and for recognition of the pre-insolvency proceeding as the main proceeding (under the Model Law regime), especially where in the (original) COMI forum a restructuring mechanism is not available.¹⁷⁴

The reality is that many countries have not yet caught up with global restructuring trends. The case of Ocean Rig provides a good example.¹⁷⁵ In this case, a group of companies were COMI’d in a country that had no pre-insolvency proceeding (Marshall Islands). The group’s members therefore relocated their COMI and initiated debt restructuring proceedings in the Cayman Islands. The Cayman Islands court appointed joint provisional liquidators to promote schemes of arrangement for the companies. The provisional liquidators then sought recognition of the proceedings in the United States under the Model Law (chapter 15 of the US Bankruptcy Code). Notwithstanding objections, the Bankruptcy Court granted interim relief enabling the provisional liquidators to set up and procure creditor acceptance and court approval of Cayman schemes and subsequently recognized the Cayman proceedings based, in part, on a finding that the debtors’ relocation was legitimate in circumstances where the Cayman Islands, unlike the Marshall Islands has a well-established system for debt restructuring.¹⁷⁶ The Bankruptcy Court then went on to enforce the Cayman schemes of arrangement by means of a permanent injunction¹⁷⁷—currently the standard approach in the US for giving effect to foreign restructurings.¹⁷⁸

The EIR rule on jurisdiction is already quite flexible because it does not prohibit debtors from moving their COMIs when insolvency is approaching. The EIR places modest limits on forum shopping providing only that if the registered office of the company was moved within 3 months before the request for opening of insolvency proceedings, the presumption that the COMI is at the registered office will not apply.¹⁷⁹ The Model Law does not prohibit forum shopping either. The Guide to Enactment is clear that the debtor’s COMI may move prior to the commencement of proceedings ‘in some instances in close proximity to commencement […].’¹⁸⁰ However, in such circumstances, the Guide states that it is desirable that the receiving court considers more carefully the factors relevant to determining COMI and takes ‘account of the debtor’s circumstances more broadly’.¹⁸¹ In this respect, the Guide notes in particular that ‘the test that the centre of main interests is readily ascertainable by third parties may be harder to meet if the move of the centre of main interests occurs in close proximity to the opening of proceedings’.¹⁸² We argue that a shift or a choice of forum to pursue a restructuring, where it is done for the benefit of the creditors as a whole because the new forum provides appropriate tools not available in the original jurisdiction, should be accepted and recognized following careful assessment of the circumstances and reasons for the move consistent with the Guide to Enactment.

A flexible application of rules on jurisdiction/recognition can also be conducive to group cross-border restructurings. New provisions in the EIR¹⁸³ and the UNCITRAL Model Law on Enterprise Groups¹⁸⁴ allow some flexibility regarding plans for enterprise groups in distress. Such plans may be developed in a ‘coordination proceedings’ (under the EIR) which may be ‘requested before any court having jurisdiction over the insolvency proceedings of a member of the group’,¹⁸⁵ or (pursuant to the UNCITRAL instrument) in a ‘planning proceedings’ which is a main proceedings commenced in respect of a group member and in which other members participate.¹⁸⁶ Under the UNCITRAL Model Law on Enterprise Groups, it will also be possible to avoid opening additional main proceedings in the forums where group members had their COMIs.¹⁸⁷ These new concepts should be applied, we argue, sufficiently broadly, especially in the context of restructurings.

The pre-insolvency forum should also govern the proceeding based primarily on its laws and procedures, and this should be recognized internationally, even in the face of objections.¹⁸⁸ Yet, this primary rule of deference to the law of the main forum may not be absolute and the regime may design specific ‘carve outs’.¹⁸⁹ Even when a restructuring is usefully centralized, it should be possible to open additional processes pursuant to domestic law where it is efficient or otherwise appropriate to do so—such an approach will comply with the tenets of modified universalism. Additionally, if the restructuring is not in the original COMI forum (because there was a COMI migration), local laws other than the law of the main forum should be taken into account.¹⁹⁰ International insolvency objectives may also justify giving effect to local protections because of recognized public policies or the need to protect certain parties, including when they actually relied on the local law and can demonstrate that the application of the home country law would contradict their legitimate expectations.¹⁹¹ But a centralized process, even when taking place in parallel to additional local processes or accommodating certain local rights, may rely on the procedures and tools available in the main restructuring forum and a full importation of the procedures of local regimes may not be necessary.¹⁹²

Indeed, the choice of law (or ‘applicable law’) norm is generally in a more developing stage compared to the jurisdiction norm of modified universalism. The Model Law does not explicitly address the choice of law problem, nor do the newer instruments developed by UNCITRAL on the enforcement of insolvency-related judgments and the insolvency of enterprise groups.¹⁹³ This gap should be addressed to make the cross-border insolvency framework more complete, and in the course of such deliberations, the implications on pre-insolvency proceedings should be considered. The EIR, on the other hand, already contemplates detailed rules on applicable law, but in future revisions of these rules (alongside the other key provisions on jurisdiction and recognition), more attention can be given to how the rules apply to pre-insolvency proceedings.

The norm regarding relief that should be provided by foreign courts to main proceedings, and its application in instruments, may also require accommodation. Under the Model Law, for example, the key relief granted to foreign main proceedings is a stay of individual actions and execution against the debtors’ assets.¹⁹⁴ This relief is automatic and denying it is allowed only on the basis of the public policy exception.¹⁹⁵ We noted in Sect. 2, however, that while an automatic stay is a core component of a chapter 11 case, it is an optional measure in other pre-insolvency proceedings, including those contemplated by the Directive. Relief in cross-border insolvency, in particular under the Model Law, which largely relies on relief requests by foreign representatives, may develop to address more accurately the needs of pre-insolvency proceedings with international elements. In a restructuring context, recognition of foreign main proceedings may be sought, for example, to extend their binding effects to stakeholders in other jurisdictions. On the other hand, a procedural stay of proceedings and executions, which is currently granted automatically under the Model Law when proceedings are recognized as foreign main proceedings, may not always be required as some restructurings may be negotiated successfully without a need formally to stop creditors’ enforcement.

Safeguards in instruments, primarily the public policy exception to recognition and relief (available in both the EIR and the UNCITRAL instruments), or the notion of ‘adequate protection’ mentioned earlier in Sect. 4, may require additional specification,¹⁹⁶ so that they can be applied appropriately in a restructuring context. Importantly, modified universalism and instruments that subscribe to the norm may develop to clarify applicable international standards of fairness in restructuring, which if not followed might result in denial of recognition and of cross-border effects. Notions of fairness in restructuring are still developing alongside the evolution of various preventive procedures.¹⁹⁷ Instruments such as the Directive and related comparative studies begin to contemplate what fairness may require at the various steps in a restructuring process,¹⁹⁸ and thus contribute to the emergence of clearer international standards in this area. Indeed, within integrated regions, such as the EU, greater harmonization of pre-insolvency proceedings (which may result from the Directive’s implementation) is conducive to the effective application of the EU cross-border insolvency system, based on mutual trust and automatic recognition. Internationally, with lesser harmonization and a more complicated and fluctuating system of trust, the notion of public policy (or adequate protection) may have a more important role, even though the aspiration is to limit its use.

The norm of modified universalism and the instruments governing cross-border insolvency may continue to evolve in the future to accommodate the peculiarities of pre-insolvency proceedings, as experience of handling such processes accumulates. Additional issues to consider in this respect may include, for example, the precise role of the court as guardian of procedural or substantive rights of creditors in various types of pre-insolvency proceedings, in a cross-border context. What we wish to emphasize at this stage is that this flexibility of the modified universalist norm allows it to address the concerns regarding over-inclusivity and alleged lack of nuance of cross-border insolvency law. We can refine and develop the way the norm and the cross-border insolvency instruments apply in different restructuring processes without depriving pre-insolvency proceedings of the benefits of cross-border insolvency law as a sui generis system of private international law.

6 Conclusion

The popularity of pre-insolvency proceedings of the types that are nowadays on the rise internationally may continue, or other ways to address companies’ financial distress may emerge in the future. Yet, so long as proceedings sit on the spectrum between the pure contractual and the fully formal and possess certain core characteristics of ‘state-supplied’ processes aimed at avoiding insolvency, there is merit in including them within a unified law of transnational distress for private international law purposes. Building on the existing foundations of international insolvency law is also prudent for we do not yet know what the next wave of restructurings in Europe will look like.

Along the spectrum, proceedings may not be classified neatly within pre-defined boxes and may represent hybrids that can function both as classic pre-insolvency restructuring proceedings and as formal rehabilitation processes. In the so-called twilight zone when debtors are approaching insolvency, insolvency laws, therefore, increasingly attempt to assist firms and their stakeholders by providing incentives and mechanisms for value maximization, at whichever point on the demise curve the intervention occurs. Cross-border insolvency law as a special system of private international law, governed by the overarching norm of modified universalism, can make these mechanisms work better globally, by minimising coordination and other process costs through a centralized resolution that properly takes into account the interests of all stakeholders involved.

The leading cross-border insolvency instruments, the Model Law and the EIR, which generally follow modified universalism, have responded to the global restructuring trend by favouring the inclusion of debt restructuring proceedings within their scope. Concerns about over-inclusivity of these instruments are, however, important. But as the debate continues, the benefits that cross-border insolvency can provide to pre-insolvency proceedings should not be overlooked. Instead of excluding pre-insolvency proceedings from cross-border insolvency law’s scope, we argue that it is preferable to consider how to accommodate the instruments and their underlying (modified universalist) norm so that they serve pre-insolvency proceedings properly. Being a flexible norm, modified universalism can adjust its rules to respond to changing market conditions and to new types of proceedings.