Cooperation in areas not directly addressed under the EU Regulation 1346/2000, differences between common law and civil jurisdictions

The aim of this paper is to consider how the growing trend of cooperation among insolvency practitioners and courts in the EU can be developed to address the shortcomings of EU Regulation 1346/2000 on cross border insolvency proceedings and how further initiative by member states can address some remaining difficulties.

The EU Insolvency Regulation is designed to enable international insolvencies to be dealt with in an orderly manner. Absent this regulation, proceedings in respect of multinational companies would be more difficult to coordinate. However the Regulation, which had a troubled legislative passage, is a rather flawed instrument, as implemented, which has given rise to a number of teething troubles, relating in particular to the interpretation of the Regulation and in relation to its application to groups of companies and at times tension between the common law and civil law jurisdictions. The insolvency profession has always shown genius in finding ways round practical problems, such as by the use of prepackaged proceedings, out of court restructuring and protocols and they have been driving the developments in the implementation of the Regulation in impressive fashion, such that practical means for the resolution of what have been significant sticking points is emerging, and we have a greater spirit of harmonious cooperation between the civil and common law jurisdictions which is likely to gather apace in light of the current economic climate.

This climate is of course the recent collapse of the sub prime market in the US, the nervous financial market and the consequent ramifications for borrowers and lenders in other countries, for example in the UK Northern Rock, the fifth largest lender which experienced a run as customers with savings accounts lost confidence in the bank. It is also highly significant that financing arrangements in the EU are far more complex they were a few years ago, since banks increasingly have repackaged and syndicated debt in the form of bonds. This has resulted in more funds becoming available to firms. Much of the recent private equity takeover activity for example has been financed by borrowing. However it has also meant that the range of stakeholders in insolvency proceedings is far greater than was previously the case. The different manner in which funds are being held, and a possible loss of appetite by the market, may lead to a squeeze that will necessitate greater use of reorganisation procedures, which provide companies with protection for a limited period of time while they work out solutions to their difficulties, but they may also make reorganisations more difficult. It is therefore unfortunate that the law on paper is lagging behind the law in practive.

The problems of international insolvencies will be familiar to many. High profile insolvencies will involve branches and subsidiaries in many countries. An orderly scheme for handling international cases is needed because insolvency laws are not identical. Although the starting point is equal treatment of creditors under the par condicio creditorum principle, in practice the substantive entitlements of creditors to payment are far from equal, since they reflect in many instances policy decisions about the entitlements of particular creditors, in particular employees. No uniform approach is taken so that some will be paid a higher dividend in one country than in another so it can make a very real difference which jurisdiction is chosen for insolvency proceedings. Differences also arise in the entitlements of secured creditors, relating to the scope and validity of charges, reservation of title clauses and trusts. Transaction avoidance laws vary, so that a transaction may be voidable in one member state but not another. The impact of insolvency on contractual arrangements differs: in some jurisdictions, such as the UK, a contracting party can exercise contractual rights to terminate a contract upon the insolvency of the other contracting party; in other countries the debtor is protected. Other differences may arise from entitlements in e.g. tort law. For example in a recent US and UK case, involving the company Federal Mogul the company faced significant tort liabilities, jurisdictions with a track record of close cooperation, a dispute arose regarding future tort claimants whose illness had not yet manifested itself. Differences arose as to what amount, if any, such creditors would be entitled to and although such claims would be recognised in the US they would not in the UK.[1]

EU Regulation

So that international insolvencies can be dealt with in an orderly manner the EU regulation on insolvency proceedings was introduced in 2000 after a long and protracted legislative process that began in the early 1960s. It compliments the Brussels Convention of September 27, 1968 on jurisdiction and enforcement of judgments in civil and commercial matters. It is purely a conflict of laws measure, since it does not harmonise the substantive laws of the member states on insolvency law. It provides rules regarding jurisdiction, choice of law and recognition of judgments for both companies and individuals, although proceedings concerning insurance undertakings, credit institutions and some investment undertakings are excluded.

Regarding jurisdiction, it adopts a procedural division between main and secondary proceedings. Main proceedings are to be opened in the state where the company has its centre of main interests. There is a rebuttable presumption that the COMI is the place where the company has its registered office.[2] Recital 13 of the Regulation, which provides that the COMI is the place where the debtor conducts the administration of its interests on a regular basis and is therefore ascertainable by third parties. Secondary proceedings may be opened in a jurisdiction where the debtor has an establishment, however such proceedings can only be liquidation proceedings and they relate only to assets in the member state where they are opened. A company will have an establishment in any jurisdiction where it carries out a non-transitory economic activity with human means and goods: Reg. 1346/2000, Art. 2(h).

The choice of law provisions under the regulation are that the law of the state where the proceedings were opened (the lex concursus) governs the opening of proceedings, their conduct and closure. However some matters are addressed differently under Arts 5-15 e.g. the validity and extent of rights in rem are determined according to the lex situs.

Significantly, Article 16 of the Regulation provides that the opening of proceedings in a member state having jurisdiction shall be recognized in all other member states from the time when it becomes effective in the jurisdiction that opened the proceedings. Therefore the timing of opening of proceedings can be exceedingly important, in particular since the member states may only refuse to recognise proceedings opened in another member state in extremely limited circumstances, namely where they are manifestly contrary to public policy, according to Article 26. In a disputed case, the first to open proceedings will normally prevail therefore.

Problems

There are two key shortcomings of the regulation which necessitate the growing spirit of cooperation. One is from the perspective of clarity; the other is from the perspective of practicality. The first is the lack of adequate guidance regarding the COMI. The presumption is that it is the place where the registered office is, which has the advantage that it can be ascertained by somebody wanting to know where the registered office is. However many companies are incorporated in a particular jurisdiction for reasons of tax, or regulatory reasons, and carry on their business activities elsewhere.[3] In such circumstances the presumption can be rebutted but the criteria for doing so are not set out and can give rise to differences of opinion. Where jurisdiction turns on the subjective interpretation of judges as to where the COMI lies the laws becomes unpredictable. This has given rise to jurisdictional disputes, which in more recent times have given way to greater liaison between insolvency practitioners and the courts.

The second problem is the lack of provision for consolidated and coordinated proceedings for corporate groups. The Regulation provides rules relating to jurisdiction and choice of law but is designed for application to one company at a time, in relation to its branches and establishments, with main and secondary proceedings, with mandatory cooperation and coordination between the office holders.[4] In this context a consolidated approach to reorganisation is envisaged, since it is not possible to open secondary reorganisation proceedings. If the company is to be reorganised this will be done under the main proceedings alone, encompassing the branches unless liquidation proceedings are opened. However, in the event of a corporate group becoming insolvent, each subsidiary and parent company must prima facie be dealt with separately, since they each have separate legal personality.

This omission of specific provision for dealing with the insolvencies of group companies in a consolidated and coordinated manner was deliberate. The legislative process for the regulation was protracted, as noted, and the addition of provisions for group companies was a bridge too far which could be left for a later date. This is apparent from the Virgos Scmidt Report, which was actually prepared in connection with an earlier Convention that never came into force (its passage required unanimity and the UK declined to vote in favour for unrelated political reasons) however it is used as guidance in the interpretation of the Regulation. It makes it clear that the omission of groups was deliberate.

This omission was, however, potentially problematic since corporate groups dominate international business.[5] Several significant problems can arise if no consolidated approach is taken to insolvent groups.[6] One significant problem is that assets may be devalued if each company in the group is treated separately, for example if an asset owned by one subsidiary would only achieve its full value if sold together with property owned by another subsidiary.[7] For example Robert van Galen gives the example of the KPNQwest nv group, which owned cables, including one which ran in a ring through Germany, France, Belgium and the Netherlands. The portion of the ring in each of these countries was owned by a subsidiary registered in that country. Therefore a coordinated approach was required to achieve the sale of the ring. However the group disintegrated with a consequent loss of value.[8]

If no consolidated approach is taken, main proceedings could potentially be opened in each member state in respect of subsidiaries and, in many cases, multiple main proceedings involving sub divisions of the company.[9] These problems are particularly difficult in significant groups. Enron had over 3000 subsidiaries all over the world.[10] Parmalat had subsidiaries throughout Europe and the Americas. The difficulties of investigating fraudulent activities within the group would be magnified in the event that a coordinated approach was not taken.

Initially it seemed as if there would be a schism in approach between common law and civil law jurisdictions, or more specifically a difference between countries with a codified framework to their laws and ones without. The English judge Lord Peter Millett has described that ‘A judge in a codified system will tend to say:

“Show me where it says I can do it”; and a judge in an uncodified system will say: “Show me why I can’t do it”.[11] This approach in uncodified systems can lead to pragmatism in filling in the gaps in what legislation there is: gaps in the legislation give an entitlement to the judiciary to act. Moreover the common law countries have not tended to subscribe to a territorial view of insolvency proceedings.[12] Civil law judges, in contrast, may be more included not to act unless there is direct provision to enable it.

English case law

In line with this pragmatic approach the English courts quickly developed a line of case law adopting a practical approach to the resolution of the difficulties of corporate groups, firstly in 2002 in ReEnron Directo[13]where the COMI of a Spanish registered company was found to be in England, inter alia on the basis that the headquarters functions of the company were carried out in England, although no reasoned judgment was given. The approach in this case became termed the ‘mind of management’ approach.

However this approach was not without its critics and gave rise to judicial friction that was evident in the Daisytek proceedings.[14] In this case an English court placed subsidiaries registered in England, France and Germany in administration, after the parent company in the group had entered Chapter 11 proceedings in the US. In making these orders McGonigal J considered that it was necessary to weigh up the scale and importance of the interests administered in each jurisdiction that was a COMI candidate, including the jurisdiction of the registered office. We can see here perhaps some difference from the line of interpretation taken by the civil law courts, since the venue of jurisdiction is balanced as one candidate to be the COMI, as opposed to taking the registered office as the starting point. Importance was attached to where third parties dealing with the company would consider that its main administration was conducted. In finding that the French registered subsidiary had its centre of main interests in the UK the court noted many factors, including that administrative functions in relation to the subsidiary were carried out in the UK and that the subsidiary was funded primarily by a UK bank and was issued with most of its supplies from the UK. Therefore creditors would have known that England was where the important functions in relation to the company were carried out. Similar findings were made in relation to the German registered subsidiaries. Since the English proceedings were opened as main proceedings the courts in other member states subject to the Regulation were required to recognize the proceedings.

This case was greeted with disbelief by the Tribunal de Commerce of Cergy-Pontoise and the criticism that the court had mistaken a subsidiary for a branch. This court opened main proceedings, contrary to the scheme set out under the Regulation, which only permitted secondary proceedings to be opened. The decision was subsequently reversed by the Court of Appeal of Versailles and later the highest appeal court. Public policy arguments under Art 26 and human rights arguments under the European Convention on Human Rights Article 6 were invoked before the French appeal court without success. There was a similar skirmish in Germany, where parallel main proceedings had been opened as the Amtsgericht Dusseldorf initially refused to recognise the UK proceedings, an approach which was clearly contrary to the Regulation. The delay caused by the resolution of this dispute meant that the German subsidiary could not be included in a sale of the group’s business, which led to lost jobs, increased costs and a delayed realisation of the company’s assets.[15]

This line of case law was misconceived. It was considered that the Anglo Saxon approach to insolvencies was being illegitimately exported in imperialist fashion. It may also have been perceived as a hangover from the ‘long arm’ jurisdiction employed by the English courts at common law, where the IA 1986, s221 permits the winding up of unregistered companies, including companies registered abroad, exercisable if there is a reasonable prospect of benefit to the applicant and the court is able to exercise jurisdiction over one or more persons,[16] even if the company has no assets in the UK. It was also considered that the UK laws gave them an advantage over continental systems in the speed with which proceedings could be opened, enabling them to win any race to open proceedings. However these were misconceptions, as it was the pragmatism of IPs and the courts in line with the common law ethos which led this approach. The mind of management tag was also unfortunate, since it gave the impression of intellectual activities only, which could not be easily ascertained by those dealing with the company. In fact the approach went beyond that, as it was clearly evident in the Daisytek case that many factors had been taken into account, including the expectations of creditors.

For example in Re Crisscross Telecommunications,[17] concerning a group with subsidiaries incorporated in a variety of EU member states and also in Switzerland. The COMI of each of the subsidiaries was found to be in England. It was noted that board meetings were predominantly held in England; that management, administration, accounting and other functions were carried out almost exclusively by employees based in England; but also that, although contracts were made with customers outside England they normally dealt with English employees and the suppliers were instructed to send invoices to England. Again, therefore, account was taken of the perceptions of those who would have dealt with the company.

The line of case law continued in a more judicially harmonious manner in Re MG Rover[18] where England was held to be the centre of main interests of SAS Rover France. The order was made on the basis of evidence that the day to day operations; management of employees; finances and marketing were carried out in England. In order to address some of the differences between English administration orders and orders in other member states the court made some modifications to the order. This decision was recognised by the French Commercial Court in Nanterre, on the basis that the presumption that the COMI was in France had been rebutted, and that creditors would have known that the centre of main interests of the company was in England, on the basis that MG Rover was recognised worldwide as an English company. The French court considered that there was no public policy objection to the opening of the proceedings in England, since the protection of French employees had been addressed by the administrators, who had assured the employees that they would receive the same level of payments as they would have done if secondary proceedings were opened in France. This decision was upheld on appeal, following a challenge by the Public Prosecutor. The Court of Appeal indicated that secondary proceedings should only be opened in France if the applicant for such proceedings could demonstrate that they would have a useful purpose. On the facts the opening of secondary proceedings was considered not to be necessary as it would not enhance the protection of local interests or the realisation of the company’s assets.