Bankruptcy of a company involved in a debt restructuring agreement The position of creditors and the steps to be taken by them

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1 Bankruptcy of a company involved in a debt restructuring agreement The position of creditors and the steps to be taken by them 1. A brief overview on debt restructuring agreements Debt restructuring agreements 1 are entered into by: companies facing a temporary and reversible financial crisis; and a number of creditors representing at least 60% of the amount of debts of the company. Such agreements are an increasing popular instrument for companies who are trying to restructure the debts arisen - and the conditions set forth in contracts they concluded - prior to a situation of financial crisis that become very burdensome for the company. Generally, debt restructuring agreements involve a renegotiation of the interest rate, a deferral of the terms of certain payments and the negotiation of new loans (so-called bridge finance ) in order to help the company face the financial crisis, if not a haircut on certain credits. In order to be effective, debt restructuring agreements shall be certified by a financial expert professional and homologated (i.e. approved) by the competent tribunal. It should be noted that sometime - in order to avoid/delay bankruptcy - restructuring companies are prone to accept contractual conditions that they may be unable to fulfill in the future; alternatively, it may happen that such companies are able to fulfill the debts arising from the debt restructuring agreement, but not the other debts that they have to pay. Furthermore, the conditions of the market may vary very rapidly and/or differ from the assumptions of the business plan envisaged by the company. This will lead the conditions of the debt restructuring agreement to become too burdensome for the debtor. In the aforementioned cases problems might arise because, while IBL strictly regulates the pre-homologation phase, it does not provide a clear regulation for the post-homologation stage and, therefore, for the situation of non-fulfillment of the debt restructuring agreement. With this regard we could talk about a gap in IBL, which will be filled by judges on a case-by case basis. In particular, once a company enters into a debt restructuring agreement and is not able to fulfill its obligations, we should address these three main questions: 1) can a creditor, by filing a suitable petition, obtain a declaration of bankruptcy of the company? Who can file this petition? Are all the creditors entitled to request the bankruptcy 1 Regulated by art. 182-bis of the Italian Bankruptcy Law ( IBL ) 1

2 of the company or is this right reserved to the creditors that did not sign the debt restructuring agreement? 2) What is the statute of claw back actions in case of declaration of bankruptcy of a company which entered into a debt restructuring agreement? 3) In the event of a declaration of bankruptcy, would the creditors which entered into the debt restructuring agreement, and those who did not, be repaid by the bankrupt entity? The present advice will try to give some general answers/guidelines in respect of the aforementioned questions. 2. Declaration of bankruptcy of companies which entered into a restructuring agreement As of today, there have been under IBL only two reported cases in which a court has pursuant to the filing of a petition for a declaration of bankruptcy declared bankrupt an entity which entered into a debt restructuring agreement 2. According to Italian courts, the homologation of a debt restructuring agreement does not mean per se that in case of inability to fulfill its obligations the company may not be declared bankrupt. This may happen both in the case of nonfulfillment of the conditions set forth in the debt restructuring agreement and in case the company is not able to face its obligations arising from other legal/contractual sources. As a consequence, both the creditors of the non-fulfilled debt restructuring agreement and the creditors of other non-fulfilled contracts have the right to file a petition asking to the competent court a declaration of bankruptcy of the insolvent company 3. In order to be declared bankrupt, a company must be considered unable to properly and regularly fulfill its obligations (i.e. the company shall be deemed insolvent). Italian bankruptcy law does not set out any fixed criteria on the basis of which a situation of insolvency shall be assessed. The insolvency is therefore usually recognized by Italian courts on the basis of several indicators, such as: the amount of outstanding debt; the existence of enforcement proceedings/attachments over the assets of the company; and substantial debts towards employees in relation to salaries and unpaid social security payments. Italian courts are inclined to deem that a company is insolvent when, following a review of the circumstances referred to above, it appears not only that the company has not just cash-flow difficulties, but that it is in a situation where it has actually lost its structural capability to orderly perform its obligations 4. 2 We are referring to Tribunale di Santa Maria Capua Vetere, 9 ottobre 2013, and Tribunale di Parma, 27 settembre The reason for such a conclusion is that the homologation judgement does not preclude a new declaration of insolvency of the company which entered in the restructuring agreement. It only constitutes an acknowledgement by the judge of the ability of the company to face the crisis without the support of the court. 4 In order to be declared bankrupt, a debtor shall be insolvent and meet certain dimensional requirements. As all the ordinary insolvency proceedings, bankruptcy is submitted to the exclusive jurisdiction of Italian bankruptcy courts. More in detail, in order to be submitted to bankruptcy, article 1 of IBL provides that a company shall jointly meet the following three thresholds: (a) the total assets in the last three financial years prior to the filing of the bankruptcy petition shall be more than 300,000.00, 2

3 Given the above, it is obvious that, when entering into a debt restructuring agreement, debtor companies and creditors in accepting, experts in assessing the suitability of the restructuring plan and the competent courts in homologating them should be very careful in avoiding that the debtors accept conditions that they are not able to fulfill; and in making a correct assessment of the possible evolutions of the market in which the debtor operates. In fact, if we consider that: (iii) the conditions of the markets may change rapidly and therefore the terms of the debt restructuring agreement if made only on the basis of the situation at the time the agreement is signed may become very burdensome in the future; when the company signs the debt restructuring agreement it is obliged to pay all the existing creditors within 120 days from the expiry date of the relevant credit; the company shall pay all the debts it assumes after the signature of the debt restructuring agreement at the relevant expiry dates it is likely to happen that if the company accepts too burdensome conditions it will not be able to fulfill all its obligations. At this stage, if there is a filing for a declaration of bankruptcy of the company, the competent court on a case-by-case basis will address such a request and either declare the company bankrupt or homologate the agreement. Please note that this does not mean that the conditions set forth in the debt restructuring agreement may not be re-negotiated. It is possible that the debtor and the creditors will change such conditions through another agreement. The new debt restructuring agreement will not need to be homologated again if it does not change the terms of payment and the modalities set forth in the previous agreement, otherwise it will be necessary to obtain a new homologation by the competent court The statute of claw back actions Once the company is declared bankrupt, a presiding judge ( giudice delegato ) is nominated and an official receiver ( curatore fallimentare ) is appointed by such judge. The receiver totally replaces the former management of the company and shall liquidate the assets of the company (under the supervision of the judge). Bankruptcy claw back action Among the various duties of the official receiver 6, he shall start claw back actions vìs-a-vìs all the person/entities/companies which benefitted of payments/transfers/acts in the period preceding the declaration of bankruptcy ( suspect period ) and under certain conditions set forth in art. 67 of the IBL. The aforementioned period varies according to the kind of act that the (b) during the three financial years prior to the filing of the bankruptcy petition, the average yearly gross income of the company shall be more than 200,000.00, (c) the amount of the debts (including debts not yet overdue) shall be more than ,00. The proceeding may be commenced upon an application by the company itself (i.e., the board of directors of the company, in this case a "voluntary bankruptcy" takes place), its creditors and/or in some cases the Public Prosecutor (in the last two cases an "involuntary bankruptcy" take place). Please be aware that, when the company becomes insolvent, its directors are under a positive duty to apply for a declaration of company's insolvency. 5 Inter alia, see Tribunale di Terni, 4 july The official receiver shall manage the estate of the bankrupt entity; act against the directors of the company (as well as the controlling people/entities) for their liability related to the insolvency of the company; (iii) refer to criminal courts regarding any element that could point out criminal behaviors of the directors/shareholders etc. 3

4 bankrupt entity performed. The following chart summarizes some transactions/acts which may be set aside and the relevant suspect period and burden of proof: ACTS/TRANSACTIONS/PAYMENTS SUSPECT PERIOD BURDEN OF PROOF 7 - gratuitous transactions 8 - payments of debts expiring on or after the declaration of insolvency 9 - transactions in which the services rendered by the bankrupt or the obligations undertaken by same exceed for more than 1/4 the consideration received by the bankrupt company 10 - two years not applicable because it is assumed that such transactions have been carried out in order to jeopardize the reasons of the creditor - one year the beneficiary should prove that was not aware of the insolvency status of the debtor - payments of outstanding debt made by the bankrupt not in cash or by other usual means of payment 11 - granting of securities over the bankrupt's assets meant at securing pre-existing debts not yet due as of the date of creation of the relevant security 12 - granting of securities over the bankrupt's assets meant at securing due debts 13 - payments of overdue debts - creation of securities over the bankrupt company's assets, granted contemporaneously to the assumption of the relevant debts 14 - six months the beneficiary should prove that was not aware of the insolvency status of the debtor - six months the receiver should prove that the beneficiary was aware of the insolvency status of the debtor Generally speaking, the homologation of a debt restructuring agreement grants a general exemption from claw back actions (in the event the company is 7 Concerning the knowledge of the insolvency status of the debtor. 8 Please see Article 64 IBL. 9 Please see Article 65 IBL. 10 Please see Article 67, 1, No. 1 IBL. 11 Please see Article 67, 1, No. 2 IBL. 12 Please see Article 67, 1, No. 3 IBL. 13 Please see Article 67, 1, No. 4 IBL. 14 Please see Article 67, 2 IBL. 4

5 declared bankrupt) for acts carried out, guarantees granted and payments made in execution of the debt restructuring agreement 15. This exemption has been granted by the Italian law-maker in order to reassure the creditors of a company in financial crisis that they will not be subject to the risk of claw-backs if they conclude transactions with the company during the period of crisis. It is not however clear if this exemption involves only the creditors that entered into the debt restructuring agreement or also the other creditors of the company existing when the debt restructuring agreement was signed. With this regard, various opinions emerged: while part of the scholars affirm that the payments made to creditors that are not part of the debt restructuring agreement are functional to the restructuring of the company, and are therefore free from the risk of claw-back actions, others still think that the IBL affords the exemption only to creditors who entered in the restructuring agreement. Even though the first opinion seems preferable and more compliant with the aim of IBL (that is to help the company in crisis and therefore to encourage creditors to reach an arrangement with this company in a certainty situation) we cannot exclude that a court may reach the second conclusion since this case does not appear to have been tested yet. Ordinary claw back action (so-called actio pauliana) In addition to the claw-back actions regulated by IBL, the acts/payments/guarantees made by the bankrupt entity could also be declared ineffective pursuant to the filing of an actio pauliana (i.e. the ordinary claw back action regulated by the Italian Civil Code 16 for the case of payments made by a debtor in order to defraud its creditors). In order to be successful in this action, the official receiver shall prove that (iii) the act was performed in order to create a prejudice to the creditors; the act was performed no more than 5 years prior to the declaration of bankruptcy; and the entity which received the payment was aware of the prejudice that such payment created to the other creditors. The exemption from claw-backs in case of payments/acts/guarantees performed in accordance to a debt restructuring agreement applies also to actio pauliana. 4. The repayment of the creditors during the bankruptcy The official receiver shall satisfy the creditors of the bankrupt entity with the proceeds deriving from the liquidation of the assets. These payments shall be performed strictly in compliance with the ranking set forth by article 111 IBL: 1) costs and expenses of the bankruptcy procedure and other credits indicated by the law (i.e. super-priority claims crediti prededucibili ); 2) preferential/secured claims related to certain assets (i.e. priority claims crediti privilegiati ); 15 Additionally, the debt restructuring agreement grants a 60 days automatic stay of interim, urgent and enforcement claims on the debtors assets. 16 Please refer to art of the Civil Code. 5

6 3) unsecured credits, to be paid proportionally to the amount of all admitted claims (i.e. unsecured claims crediti chirografari ). With regard to the credits arising from a debt restructuring agreement, please note that, in principle, they will be satisfied according to their position in the ranking. Anyway, IBL makes an exception for the creditors who granted loans (i.e. bridge finance ) to the company in financial crisis, in order to help it in restructuring its financial position. In fact, according to article 182- quater and 182-quinquies IBL all the loans granted to the company: in function (i.e. prior to the agreement but in order to allow its homologation); or in execution (i.e. set forth in the agreement) of the debt restructuring agreement are considered super priority claims and will therefore be satisfied prior to all other credits in the event the company should be declared bankrupt. 5. Steps to be taken Companies involved in transactions with a corporation for which a petition of bankruptcy has been filed should promptly appoint a lawyer, with considerable experience in matters related to bankruptcy law and in the business in respect of which the credit towards the insolvent entity arise. If a company received payments by the bankrupt entity, its lawyers should promptly carry out an analysis of the risk of claw-backs and be ready to answer to the requests/petitions of the official receiver. If a company did not receive payments by the bankrupt entity, its lawyers should promptly prepare all the relevant documentation in order to be admitted as creditor of the bankrupt entity by the official receiver and participate in the proceeds of the sales. Naples, 6 November 2014 Studio Legale Lauro This report has been drafted by Giovanni Zarra LL.M. and reviewed by Francesco S. Lauro. 6