by Gabriel Moss QC and Professor Dr. Christoph G. Paulus

THE EUROPEAN INSOLVENCY REGULATION THE CASE FOR URGENT REFORM (An earlier version of this paper was produced for the R3/INSOL EUROPE Conference in London held on 15 July 2005) by Gabriel Moss QC and Professor Dr. Christoph G. Paulus The regulation on insolvency proceedings (EC Regulation 1346/2000) came into force on 31 May 2002. Article 46 provides that no later than 1 June 2012 and every five years thereafter, the Commission shall present to the European Parliament, the Council and the Economic and Social and Committee a report on the application of the Regulation. The report is to be accompanied if need be by proposal for adaptation of the Regulation. Although we are nowhere near 2012, consideration is already being given to possible amendments to the Regulation. Such amendments would require a further Regulation. This may be contrasted with the Article 45 procedure for amending the Annexes by means of a decision on of a qualified majority of the Council, on the initiative of one of its members or on a proposal from the Commission 1. Various possible amendments are being discussed by persons concerned with this subject. We set out below a series of topics that we consider could benefit from discussion and possible amendment. (1) Definition of centre of main interests One of the main functions of the Regulation is the allocation of international jurisdiction to open insolvency proceedings. Article 3(1) deals with international jurisdiction to open main proceedings. That jurisdiction depends upon the place where the centre of the debtor s main interests is situated. This crucial concept of centre of main interests is not defined in the Regulation. This lack of definition may be contrasted with the concept of 1 In fact the Annexes have not so far been amended by this procedure but by the 2003 Act of Accession (of the 10 new countries) and by Council Regulation (EC) No. 603/2005. 1

establishment, which under Article 3(2) is critical to the question of jurisdiction to open territorial proceedings. The concept of establishment is defined in Article 2(h). Some courts have treated Recital (13) of the Regulation as if it were the applicable definition of centre of main interests and the words in the recital should correspond to the place where the debtor conducts the administration of his interest on a regular basis and is therefore ascertainable by third parties as if it were the definition laid down by the Regulation. However, Recital (13) is not designed to provide such a definition. The wording of Recital 13 is taken from the introductory sub-paragraph of paragraph 75 of the Virgos-Schmit Report 2 on the draft Convention which preceded the Regulation. Since the Convention was never finalised, this Report never became official, but is treated as a helpful guide to the interpretation of the Regulation 3, the provisions of which essentially repeat those of the draft Convention. The introductory sub-paragraph of paragraph 75 of the Report was never intended to be a definition of the concept of centre of main interests but simply a generalised introduction to the more detailed explanation in paragraph 75 of what was intended. Paragraph 75, after the introductory remark quoted by recital (13), goes on to explain in more detail the concept of centre of main interests and the different ways in which it applies to corporations and individuals, professionals and others. Even that explanation is brief and does not attempt to lay down a definition. As a result of the lack of any definition, different courts in different countries have approached the question of centre of main interests very differently and have put different emphasis on various features. 2 The text is available in English in Appendix 2 of Moss Fletcher and Isaacs, The EC Regulation on Insolvency Proceedings (Oxford University Press, 2002). 3 For example, Re BRAC Rent-A-Car International Inc [2003] BCC 248; The Salvage Association [2003] BCC 504; Re Daisytek-ISA Ltd and Others [2003] BCC 562; Financial Services Authority v Dobb White and Others [2003] EWHC 3146 (Ch); Re Stojevic 8 Ob 135/04t (Austrian Supreme Court, 17 March 2005). 2

The area of greatest conflict has been in relation to groups of companies. This particular subject is dealt with in a negative way in paragraph 76 of the Report. This simply says that no rule is provided for groups of affiliated companies. Each debtor is looked at as a separate legal entity. The position might be affected by the drawing up of a European norm on associated companies. No such norm has so far been drawn up. The most acute conflict in the case law has occurred in the Eurofood case, where the question of the correct approach to the centre of main interests has been referred by the Irish Supreme Court to the European Court of Justice, which held an oral hearing on 12 July 2005. The Irish and Italian courts took radically different approaches to what were essentially the same set of facts. In essence, Eurofood was one of a series of finance subsidiaries set up by the Parmalat Group in order to raise money for the Group. It took advantage of the low tax area in the Dublin Docks in Ireland and was run with the necessary formalities and regulation as an Irish registered company. However, transactions were plainly instigated and controlled from the headquarters of the parent company in Italy. The Irish courts have thought it plain that the centre of main interests is in Ireland. That would accord not only with the place of registration but the place of regulation, auditing etc. The Italian courts considered that the centre of main interests was in Italy where the effective decision making took place. It is possible that the European Court of Justice will give some guidance on this point but it is also quite possible that it will not. The uncertainty arises because it may well not be necessary for the Irish Supreme Court to be able to give its decision on the appeal before it, to know the answer to the question of the correct approach to the centre of main interests. That is because the question of whether the Irish courts should have opened main proceedings may depend, not on where the centre of main interests lay in an objective sense, but whether the Irish courts open proceedings first or the Italian courts open proceedings first 4. If that is correct, then it may not matter, to the 4 This approach is wholly supported by Re Stojecvic, cited above, where the Austrian Supreme Court felt that once a court in one Member State had opened main proceedings on the basis that the centre of 3

resolution of the appeal in Ireland, which of the two courts took the correct approach to the centre of main interests. Accordingly, there is absolutely no certainty that the decision of the European Court of Justice will throw any light on this subject. On the other hand, the existence of such radically different approaches to the same question means that an amendment to the Regulation providing a proper definition for this critical concept is needed as a matter of priority. No question in the Regulation is likely to create more international conflict between Member States than the question relating to the location of the centre of main interests. We would jointly propose the following definition for discussion in the case of individuals:- The centre of a debtor s main interest for the purposes of Article 3(1) shall mean in the case of individuals, the place of habitual residence, except that in the case of professionals it shall be the professional s principal office or principal location from which his profession is conducted Such a definition will not necessarily avoid all disputes, but at least will provide a common text for the courts of the Member States to interpret. Unfortunately, we are unable to agree a common suggested definition for companies and other legal persons. The suggestion of Gabriel Moss QC is: The centre of a debtor s main interests for the purposes of Article 3(1) shall mean, in the case of companies and legal persons, the place of the registered office, except that, where the head office functions of the debtor are carried out in another Member State and that other Member State is ascertainable to prospective creditors as the place where such head office functions are carried main interests was in that Member State, a court in a second Member State could not refuse to recognise the opening on the ground that it thought the centre of main interests was in the second Member State. See also the last sentence of Recital (22). 4

out, it shall mean the Member State where such head office functions are carried out. The suggestion of Professor Dr. Christoph Paulus is : The centre of a debtor s main interests for the purposes of Article 3(1) shall mean, in the case of companies and legal persons, the place of the registered office, or, if shown to be in a different Member State, the place where the debtor conducts the administration of his interests on a regular basis and which is therefore ascertainable by third parties, except for cases where the debtor is part of a group of companies or legal persons which operate as an economic unit ( an economic unit case ). In an economic unit case, the centre of a debtor s main interests for the purposes of Article 3(1) shall mean the place where the head office functions of the debtor are carried out, provided that place is ascertainable by prospective creditors as the place where such head office functions are carried out. (2) Ability to change centre of main interest Recital (4) of the Regulation suggests that one of the aims of the Regulation is to combat forum shopping involving the transfer of assets or judicial proceedings from one Member State to another in order to obtain a more favourable legal position. However, this aim is potentially contradicted by the ability, apparently left open by the Regulation, for a debtor to move his or its centre of main interest precisely by way of forum shopping. It is possible that the courts of the Member States will adopt interpretations of the Regulation which limit the ability to change the centre of main interest at will, if that involves leaving behind unpaid creditors. For example, English domestic law is interpreted in such a way that a person who has carried on business in England is treated as continuing the business for the purposes of bankruptcy jurisdiction until he has made arrangements to settle his business debts: Re A Debtor (No 784 of 1991) [1992] Ch 554; Theophile v Solicitor- General [1950] AC 186 (HL); Moss Fletcher & Isaacs: The EC Regulation on Insolvency Proceedings (OUP 2002) paragraph 8.44. 5

There is, however, no guarantee that the Regulation will be interpreted in this way. There are certainly examples in the current case law of individual debtors who have claimed to have moved their centre of main interests easily and swiftly from countries where they have incurred liabilities to sunnier countries where they have none 5. To prevent this kind of forum shopping, there is an urgent need for an amendment clarifying or amending the Regulation to deal with this type of case. We suggest the following provision for consideration: For the purposes of Article 3(1), a Member State may treat itself as the location of the centre of a debtor s main interests ( the deemed location of the debtor s centre of main interests ) if:- (1) At any time during the previous five years that Member State undoubtedly contained the centre of the debtor s main interests and (2) the debtor has moved its centre of main interest to another Member State or a State which is not a Member State and (3) the debtor has left unpaid liabilities in the Member State which used to contain the centre of his main interests. Main proceedings opened in the deemed location of the debtor s centre of main interests shall be recognised by other Member States under this Regulation as if the centre of main interests were located in that Member State. Where no main proceedings have yet been opened in the deemed location of a debtor s centre of main interests, if a court in the Member State which contains the centre of main interests of the debtor receives a request to open main proceedings in respect of the debtor, it shall consider whether it is in the best interests of the general body of creditors to open such proceedings or to adjourn the hearing to see whether main proceedings are opened in the deemed centre of main interests. 5 See for example Shierson v Vlieland-Boddy [2004] EWHC 2752 (England to Spain, affirmed on this point by the Court of Appeal in England on 27 July 2005, [2005] EWCA 974); Re Staubitz-Schreiber, BGH, decision of 27 th Nov., 2003, ZIP (= Zeitschrift fuer Wirtschaftsrecht) 2004, 94 (preliminary issue pending before the ECJ for the Reference (OJ) see http://curia.eu.int/jurisp/cgi- 6

(3) The race to the court The Eurofood case illustrates the possibility under the Regulation of an unseemly competition between different Member States to open insolvency proceedings first. In the Eurofood case this is connected with radically different interpretations of the undefined critical criteria for the centre of main interests. However, even if that concept is to be defined, differences of view, or possibly differences in the evidence available to each court, can still lead to different results. It will therefore remain important to reduce incentives to national courts to rush to open proceedings first. The problem is complicated by the fact that some procedures covered by the Regulation do not involve any significant time span between the request and the opening, whereas others do. Thus in the Eurofood case, assuming that the filing of the petition and the appointment of a provisional liquidator in Ireland did not constitute an opening, there is under Irish (and UK and German) procedure a significant gap between the request by the filing of a petition and the opening by the making of a winding up order, since the hearing for the making of the winding up order cannot take place before certain steps, such as advertising to give notice to creditors generally, have taken place 6. (We are assuming that any domestic law relation back to the date of the petition in Irish or UK law does not affect the analysis of the allocation of international jurisdiction). By contrast in Italy, the ministerial decree appointing a special administrator can be followed quite quickly by an urgent application and an urgent declaration of insolvency by the court. In England, administration orders can be obtained a short period after the petition is filed, because there is no need to advertise or give extensive notice of the petition. bin/form.pl?lang=de&submit=suchen&alldocs=alldocs&docj=docj&docop=docop&docor=docor&doc jo=docjo&numaff=&datefs=&datefe=&nomusuel=&domaine=&mots=insolvenz&resmax=100). 6 In Philipp Holzmann AG (Amtsgericht Frankfurt-am-Main) a temporary administrator was appointed by the court on the request of four Management Board Members on 21 March 2002 to take control of the assets and business but insolvency proceedings were only opened on 1 st June 2002. In Germany, there is often a three month gap connected with obtaining monies, as a result of the insolvency, from the Federal Labor Bureau. 7

At present, priorities in relation to the opening of main proceedings depend on the order of opening. Once an opening of a main proceeding occurs in one Member State, then subject to the special exception in Article 26 on the grounds of public policy, each other Member State is required to recognise the prior opening under Article 16 and the following Articles 7. This contrasts with the position in the jurisdiction regulation where in a race to the court it is the order of filing that is significant. The difficulty with priority depending on the order of opening is that it potentially distorts procedures in Member States where there is normally a substantial gap between the request and the opening. If there is a rival request in some other Member State, each state will have an incentive to rush through to the stage of opening first. 8 It seems to us that such an unseemly competition can be avoided by an amendment whereby, if the court in one Member State becomes aware of a request to open a proceeding within the Regulation in another Member State, it should adjourn any subsequent request addressed to it to await the outcome of the first request in time. We would accept that this still leaves open the risk of a race to submit a request. However, any race to lodge a request would seem to be less damaging than a race to open: the court receiving the first request would have time to consider the case carefully and if possible to communicate with or seek information from the other jurisdiction. It also seems to us that whenever there are outstanding requests in more than one Member State to open proceedings, the courts should if possible communicate with each other to ensure that each court has a full appreciation of the true facts and if, even after such appreciation, each court still considers that it has jurisdiction to open main proceedings, the courts could try to ascertain which opening would be in the greater interests of the general body of creditors of the debtor. The respective advantages and disadvantages of 7 See for example Klempka v ISA Daisytek SA [2003] BCC 984 (Court of Appeal of Versailles) Re Stojecvic (supra). 8

opening a main proceeding in each Member State could be ascertained by means of experts appointed by each court with a view to agreeing the outcome. If the courts are still unable to agree, the matter could be put to a court or expert in a neutral Member State. (4) Court to court communications As anticipated under the previous heading, the operation of the Regulation could benefit from court to court communications in relation to requests or insolvency proceedings and their co-ordination. Such communications are common between the US and Canada and one such communication has taken place between the US and the UK in the Cenargo case. Moreover, court-tocourt communication is now expressly provided for in respect of cross-border cases in the new Chapter 15 of the US Bankruptcy Code by section 1525(b). It is appreciated that civil law judges may find it more difficult than their common law counterparts to take part in such communications. However, if the text of the Regulation authorised and regulated such communication, this would give civil law judges a firm basis on which to operate. The Regulation itself could cross-refer to an existing text, namely the guidelines on court to court communications in cross frontier insolvency cases adopted by the American Law Institute on 16 May 2000 and the International Insolvency Institute on 10 June 2001. This text is already available in English and other major European languages 9 and could be translated into the remaining languages of the Regulation. It is important to note that the purpose of court to court communication would not be in order to hold joint hearings or to make joint decision. The purpose of such communications would be to prevent or solve misunderstandings, avoid, as far as possible, any conflicts between the jurisdictions and to co-ordinate different proceedings, if such exist, in a satisfactory way. 8 As it happened in the case of AG Mönchengladbach ZIP 2004, 1064. 9 At http://www.iiiglobal.org/international/guidelines.html 9

It is appreciated that court to court communications within 25 countries, given the very different languages and legal systems, may present practical difficulties even if it is expressly supported by the text of the Regulation. Accordingly, the Regulation could provide, as an alternative to direct communication, the appointment by the relevant courts of experts who could communicate with each other and report back to their respective courts. This would have a similar effect to direct communication. (5) Central register of insolvency proceedings It is a very real weakness of the Regulation that it does not provide for any central system of registering and recording insolvency proceedings opened in accordance with the Regulation. We appreciate that it may be too big a task initially to register every insolvency proceeding within the 25 countries. However, it would be a major step forward if registration were required by the Regulation in a central register of all proceedings opened in respect of companies or legal persons whose registered office was in another Member State. This ought to be a manageable number. In an ideal world such registration would also extend to individuals who have habitual residences in another Member State. However, the notion of habitual residence is clearly less certain than the location of a registered office for a legal person. The current situation creates a very real likelihood that there will be cases where a second purportedly main proceeding is opened in ignorance of the opening of a main proceeding elsewhere. This occurred in the case of an individual, Mr Stojevic, in a case which has recently reached the Austrian Supreme Court. Although the Austrian Courts held that the English prior opening of bankruptcy proceedings had to be recognised in Austria, they could not as part of the appeal set aside the purported main proceedings on the appeal because there had been no application to set aside the purported Austrian main proceeding or to treat it as a secondary proceeding. This resulted in a completely anomalous situation. A similar anomalous situation could occur in the case of a company or legal person. 10

(6) Website for judgments Since the entry into force of the Regulation, there has been a steady stream of significant decisions by courts in the Member States. Although there are helpful unofficial collections of such decisions, there is no official collection of case law precedents and the Member States have widely different modes of reporting such judgments. In order to achieve a harmonious interpretation of the provisions of the Regulation throughout the 25 Member States, it is important for courts in the Member States and practitioners to have access to the key judgments. This should obviously be achieved by an official website on which such judgments are posted. (7) Group insolvencies As mentioned above, paragraph 76 of the Virgos-Schmit report points out that no rule is provided for groups of affiliated companies. This is a significant weakness of the Regulation. It is true that all the Member States accept the strict separation of different legal persons, especially in the context of insolvency proceedings. However, such separation is often unrealistic in the light of modern trading conditions. Trading in modern global businesses often takes place across or without full regard to separate legal personalities of different companies. For example, some global businesses trade in divisions which cut across different legal entities. The problem is particularly acute in the case of reorganisation proceedings. Unfortunately, the Regulation, perhaps because it largely reproduces a Convention negotiated over many years and largely prior to the vigorous recent movement of Member States in favour of reorganisation, adheres to the old-fashioned approach of ignoring group structures. 11

Where companies have been run together in a group, it may well be beneficial for at least reorganisation and if possible insolvency proceedings to recognise and give effect to the existence of the group or to the real mode in which the group business has been conducted, if it had cut across different legal personalities. Thus, in the United States, not only can the insolvency proceedings for different companies in a group be dealt with together for administrative convenience, the assets and liabilities can be treated together by way of substantive consolidation in appropriate cases. Accordingly, it would be beneficial if the Regulation were to recognise the modern realities of business and make special provision for situations of groups of companies which were involved in the same business. Such provisions could involve the ability of one Member State, if appropriate, to open main proceedings for all the companies in the group if the business of the group was run as a single entity or without due respect to the separate legal personalities of each company. It is likely that if the proposed definition of centre of main interests referred to above were adopted, that the centre of main interests for all the companies in a group administered from a common central location would be at that location. This would enable main proceedings to be opened at that location for all the companies without any special further provision in the Regulation. However, in some cases, the place of the centre of main interests of each company in a group may be subject to factual or other controversy. It would be better, therefore, if it is established that relevant companies belong to a group and that the reconstruction, rescue or insolvency proceedings would more beneficially be conducted for the group as a whole, using either administrative or substantive consolidation, this option should be available to the Member State which has the centre of main interests of the top company in the group. However, where other Member States had opened main proceedings first in relation to a group company, an amendment to the Regulation could provide 12

that the liquidator of a parent company could apply to a court which has opened main proceedings in respect of a subsidiary to convert those main proceedings into secondary proceedings and to agree to the opening of main proceedings in the Member State where the parent has its centre of main interests. Such a process would be assisted by the ability to have court to court communications as suggested above. (8) The Amendment Process At present, changes other than to the Annexes require an amending Regulation. It has been the experience of many Member States that insolvency law is a fast moving subject which requires the ability to reform and develop the law relatively rapidly. It would therefore be beneficial if the Regulation could be amended by streamline procedure such as that available under Article 45 for the amendment of annexes. This would ensure that the European Union keeps the Regulation up to date and that the aspects of insolvency law covered by it develop sufficiently rapidly in the future to meet new challenges. The five yearly cycle laid down by Article 46 is probably too leisurely for modern conditions. The Regulation should ideally be kept under constant review and a committee of experts could be set up for that purpose with a view to it reporting to the Commission, the European Parliament and the Council. Alternatively, reports could be made on an annual basis, referring to the developments during the previous year. (9) An Obstacle To Rescues One of the weaknesses of the Regulation which reflects its failure, perhaps for reasons suggested above, to give full effect to the current emphasis in Member States on rescue and reorganisation, is the requirement in Article 3(3) that any secondary proceedings must be winding up proceedings. 13

The unfortunate potential consequences of this restriction are referred to in paragraph 8.68 of Moss Fletcher and Isaacs (op cit) and a bad case could help to discredit the Regulation. 10 There is no valid reason for this restriction and the apparent rationale for it a desire to give the liquidator in the main proceeding control is adequately catered for by existing provisions such as Article 33 and following, which would require little amendment if this restriction were removed. The present rule also creates an undesirable incentive to parties wishing to open territorial rescue proceedings to rush to court open such proceedings prior to the opening of main proceedings in another Member State. 2005 Gabriel Moss QC and Professor Dr Christoph Paulus 10 See also Paulus, Europäische Insolvenzverordnung, Art. 3 (commentary forthcoming fall 2005). 14