The impact of the UNCITRAL Model Law on Cross-Border Insolvency and the European Insolvency Regulation on distressed M&A transactions
January 2014 | SPECIAL REPORT: DISTRESSED M&A AND INVESTING
Financier Worldwide Magazine
In this era of globalisation, the onset of insolvency for a corporate enterprise often results in the commencement of multiple proceedings in different countries, governed by distinct legal regimes. The participants in a distressed M&A transaction involving a multinational business therefore need to carefully consider issues such as which laws and procedures will apply to the transaction, which person or entity has the legal authority to sell the debtor’s assets, and whether any third party may assert a claim to those assets. To appreciate these issues, consider the markedly different insolvency sale processes in the United States – under Section 363 of the US Bankruptcy Code, which generally requires a competitive bidding process, and the United Kingdom – typically done through a ‘pre-pack’ sale arranged in private and concluded by a third party administrator.
Fortunately, the burgeoning field of cross-border insolvency law has generated two key instruments, the UNCITRAL Model Law on Cross-Border Insolvency and the European Insolvency Regulation, which provide valuable assistance and guidance in navigating the waters of cross-border distressed transactions.
The UNCITRAL Model Law on Cross-Border Insolvency
The UNCITRAL Model Law on Cross-Border Insolvency (the ‘Model Law’), adopted by the United Nations Commission on International Trade Law in 1997, is designed to assist countries in equipping their insolvency laws with a modern framework for handling cross-border insolvency proceedings. The Model Law does not attempt to unify the substantive insolvency laws of different countries, but rather focuses on encouraging cooperation and coordination between jurisdictions. Legislation based on the Model Law has been enacted in 20 countries, including the United States (in Chapter 15 of the US Bankruptcy Code), Great Britain, Canada, Japan and Australia.
A central feature of the Model Law is a streamlined procedure for the representative of a debtor in a foreign insolvency proceeding – referred to as a ‘foreign representative’ – to obtain recognition of the foreign proceeding and apply for relief from domestic courts in aid of that proceeding. Among the relief available under the Model Law, in Article 21, is the entrustment to the foreign representative of the assets located in the enacting country, thereby giving the foreign representative the power to control the disposition of those assets. Entrustment relief under the Model Law, therefore, enables the foreign representative to orchestrate a coordinated sale of the debtor’s assets where those assets are located across multiple jurisdictions. Article 21 also empowers the domestic court to allow the foreign representative to distribute the proceeds of the asset sale in the foreign proceeding, provided the court is satisfied that the interests of local creditors are adequately protected.
A complimentary provision of the Model Law is the requirement in Article 25 that domestic courts cooperate “to the maximum extent possible” with foreign courts and representatives. In the case of a cross-border asset sale, the cooperation mandate of the Model Law would promote, for example, the institution of one set of sale procedures to govern the transaction, which procedures are approved or given effect by the various courts having jurisdiction over the assets to be sold.
The cross-border proceedings of Destinator Technologies, Inc. and WellPoint Systems, Inc., both headquartered in Canada, highlight the use of the Model Law to achieve a streamlined and efficient global sale process. In each of those cases, the Canadian court overseeing the main proceedings approved sale and bidding procedures for the sale of the company’s worldwide assets, and the US bankruptcy court overseeing the ancillary proceedings under Chapter 15 subsequently recognised and gave effect to those sale procedures (which were consistent with the requirements for a Section 363 sale in a US Chapter 11 proceeding). The coordination and cooperation between the Canadian and US courts allowed the respective sale processes to conclude in approximately two months in the case of Destinator Technologies, and approximately three months in the case of WellPoint Systems, from the commencement of the insolvency proceedings.
The parties to distressed cross-border sales must be mindful of the implications of Article 20 of the Model Law, which provides for certain automatic relief where the foreign proceeding is recognised as a ‘foreign main proceeding’ – a proceeding pending where the debtor has its centre of main interests (COMI). Under Article 20, the transfer of the debtor’s assets located in the enacting country is suspended and made subject to that country’s insolvency law. Thus, in a proceeding under Chapter 15 in the US, the sale of the debtor’s US assets is governed by Section 363 of the Bankruptcy Code. In a recent case, In re Elpida Memory, Inc., 2012 WL 6090194 (Bankr. D. Del. Nov. 20, 2012), a Delaware Bankruptcy Court ruled that although the sale of a Japanese debtor’s assets (including certain US patent rights) had been approved by the Japanese court overseeing the main insolvency proceedings, the US Bankruptcy Court was required to independently review and approve, under US Section 363 standards, that aspect of the transaction involving US assets. The Elpida case underscores that parties to a distressed cross-border sale must consider whether the transaction will require the review and approval of more than one court, possibly under different standards.
That being said, the application of Section 363 in a Chapter 15 case opens up a valuable opportunity for distressed asset purchasers. It allows a buyer of the US assets of a multinational debtor to obtain the unique benefits of a Section 363 sale process – including the ability to acquire the assets free and clear of liens, claims and encumbrances – without the attendant burden and expense of a plenary Chapter 11 proceeding.
The European Insolvency Regulation
The European Insolvency Regulation (Council Regulation (EC) No. 1346/2000 of 29 May 2000 on insolvency proceedings) (the ‘Insolvency Regulation’) took effect in May 2002. The objective of the Insolvency Regulation was to establish common rules on cross-border insolvency proceedings throughout the European Union, and it applies to all member states except Denmark. The regulation has direct effect, meaning that no secondary national legislation is needed for its implementation.
The Insolvency Regulation seeks to harmonise the rules on cross-border insolvency proceedings. It provides that main insolvency proceedings may only be commenced in the member state where the debtor’s COMI is located, and addresses whether and how secondary proceedings can be commenced in other member states. Territorial proceedings may also be initiated prior to the commencement of main proceedings.
The Insolvency Regulation establishes a legal framework for the insolvency office-holder appointed in the main proceeding to pursue a coordinated sale of the debtor’s assets located across Europe. The regulation provides, via Article 16, for the automatic recognition of an order for the opening of proceedings and for the recognition of the appointed office-holder. Article 18 allows an office-holder to exercise his or her powers in other jurisdictions provided he/she complies with local laws. The law of the jurisdiction where main proceedings are opened will then generally apply in the countries that are subject to the Insolvency Regulation, including in relation to the sale of assets (although secured creditors will usually be able to rely on the law governing their security if different).
The Insolvency Regulation also provides for cooperation and coordination between office-holders in different jurisdictions. To a large degree, office-holders in secondary (including territorial) proceedings must defer to the proposals of the office-holder in the main proceedings for dealing with the debtor’s assets, but there may be negotiations and compromise in this regard. Two European restructurings are illustrative of this. In the 2007 restructuring of MG Rover, the company’s intellectual property rights were largely held by a Dutch subsidiary, but the administrators in the UK main proceedings were initially unaware of this. The UK administrators had to reach an agreement with the Dutch liquidator for the sale of the assets in the UK, together with the intellectual property rights in the Netherlands, to the Chinese purchaser of the business. In the recent restructuring of the Nortel Networks group, the UK administrators obtained a request from the English High Court addressed to courts of the other European jurisdictions where Nortel had operations, asking to be notified of any application for the commencement of secondary proceedings and for the administrators to be allowed to appear at any court hearings.
Office-holders have the right to dispose of the debtor’s assets over which they have control. If there are secondary proceedings then the office-holder in those proceedings is obliged to cooperate with the office-holder in the main proceedings (Article 31) and to account for the funds he or she collects if there is any dispute over to which proceedings they should accrue. If creditors acquire assets outside a member state, they must account for them to the office-holder (Article 20).
Purchasers of assets of a debtor in proceedings governed by the Insolvency Regulation need to consider the validity of the appointment of an office-holder and might review any security allowing for the appointment of that office-holder. They will also wish to review the nature of the asset being sold and whether it is subject to any security. Moreover, if the sale is being conducted in the UK through a pre-pack transaction, purchasers should be aware that, although administrators are obliged to comply with a code of conduct in relation to the sale, the sale process may be later challenged by an aggrieved creditor.
In summation, it behoves those involved in distressed M&A transactions with a cross-border element to understand the impact of the Insolvency Regulation and legislation based on the Model Law (such as Chapter 15 in the US) on such transactions. By providing a legal mechanism to carry out a single, coordinated sale process where the debtor’s assets are dispersed among different countries, these international instruments offer a roadmap for pursuing cross-border distressed transactions in an efficient and more predictable manner.
Daniel Saval and Patrick Elliot are partners at Brown Rudnick LLP. Mr Saval can be contacted on +1 (212) 209 4905 or by email: firstname.lastname@example.org. Mr Elliot can be contacted on +44 (0)20 7851 6053 or by email: email@example.com.
© Financier Worldwide
Daniel Saval and Patrick Elliot
Brown Rudnick LLP