Qualification of Insolvency

Insolvency proceeding can be qualified as either “tortious” or “accidental”. Insolvency proceeding can be qualified as such when an agreement is approved which, owing to the amount of the settlement and the length of time that must elapse before payment to creditors, proves to be particularly detrimental to creditors, or if the company is in liquidation.

If the insolvency proceeding is qualified as tortious (for instance, where the company has filed false documents) the individuals who managed the company may be disqualified from administering assets for a period of 15 years and declared to be personally liable for those debts which cannot be paid from the debtor’s assets.

COMMENT

In any event, in order to initiate insolvency proceedings in Spain, the debtor must be currently or imminently insolvent. If it is a creditor that initiates the proceedings, the debtor must be currently insolvent. If insolvency is not even imminent, agreements to restructure the company cannot take place within the scope of insolvency proceedings, and, consequently may be rescinded within a period of 2 years if they are considered to be detrimental to the debtor.

C AUTOMATIC STAY/MORATORIUM Chapter 11 - US Bankruptcy Code

Immediately upon the filing of a bankruptcy petition, the “automatic stay” stays all litigation and prevents the enforcement of judgments and of security without leave of the court.64 _{This includes}

staying the continuation of any existing actions that were commenced before the filing.

A party who takes any action in violation of the automatic stay risks contempt of court actions and penalties. Also, any act done in contravention of the stay is retroactively made void or voidable by the court. The stay is effective during the entire time the case is pending, but creditors and other parties may make motions to lift or modify the stay.65

Unified Insolvency Proceedings, Spain

One consequence of the declaration of insolvency is the stay on any individual action instigated by a creditor against the assets of the company. Such a stay is not absolute since it does not affect lawsuits in progress in civil or labour courts at the time insolvency is declared. Such proceedings will continue until the judgment or award becomes final and binding. The stay does not affect administrative or criminal proceedings which may have a significant impact on the debtor’s assets, even if these are filed after insolvency has been declared. However, executory proceedings, including administrative or fiscal procedures for compulsory collection, will be suspended if in progress, with the exception of those agreed upon prior to the declaration of insolvency, and they may not be initiated once insolvency has been declared.

One of the most important innovations of the Insolvency Act is the special treatment given to the enforcement of security on the debtor’s assets (e.g. pledges, mortgages). For a maximum period of one year following the insolvency declaration, there is a suspension on the enforcement of these security rights. This period will terminate earlier if, (a) a settlement agreement is agreed or (b) the company is placed into liquidation.

COMMENT

The stay of insolvency proceedings in Spain does not aim to give the insolvent company “breathing space”, but aims to ensure a fair distribution of the insolvent’s estate and to avoid a premature sale of assets that may disrupt the progress of the insolvency proceedings or impede solutions which may be in the best interest of the insolvent company and its creditors as a whole.

64 _{Bankruptcy Code paragraph 362(a)} 65 _{Bankruptcy Code paragraph 362(d)}

D LIFTING THE STAY Chapter 11 - US Bankruptcy Code

Generally, an affected party can apply to court at any time after the filing of a bankruptcy petition for relief from the automatic stay. The court may terminate the stay, modify it or subject it to conditions.66

The court may lift the stay for cause, but is generally reluctant to do so during the initial stages of a Chapter 11 case because of the general presumption that a debtor should be given a chance to reorganize and prepare a plan.

Motions to lift or modify the stay are based on the following:

1. a court may lift or modify the stay upon a showing of “cause”, which includes the lack of adequate protection of an interest in property; or

2. with respect to property securing a lien, (i) the stay will be lifted if the debtor company does not have equity in such property and (ii) such property is not necessary to an effective reorganization. There are also special rules for single asset real estate cases and Chapter 11 debtors who are individuals. Also, the automatic stay may not stay in effect when applied to certain protected creditors, such as certain aircraft lessors and lenders and vessel lessors and mortgagees. In this context, a lack of adequate protection focuses on whether the creditor is being injured by continuation of the stay due to, among other things, a deterioration in value of its collateral or consumption of collateral by the company. To counter this potentially negative impact of the stay, a debtor company must provide adequate protection, which may take the form of:

1. periodic cash payments to cover any depreciation during the stay; or

2. additional or replacement liens or substitute security to the extent of any deterioration in value, and other relief that will amount to an ‘indubitable equivalent’, a flexibly interpreted concept.67

Unified Insolvency Proceedings, Spain

The stay cannot be lifted but, as discussed above, the suspension of actions against the debtor is in no way absolute. Please refer to the section headed Moratorium for further details on the stay and permitted proceedings.

COMMENT

The creditors in insolvency proceedings in Spain do not have special rights to lift the stay, as this would not be in line with the purpose of the proceedings, which is to ensure a fair distribution of the insolvent’s estate and to avoid a premature sale of assets

that may disrupt the progress of the insolvency proceedings or impede solutions which may be in the best interest of the insolvent company and its creditors as a whole.

E CONTROL

Chapter 11 - US Bankruptcy Code

In Chapter 11, whether voluntary or involuntary, there is a presumption that control remains with the debtor’s management through the concept of “debtor in possession” (“DIP”) (subject to certain safeguards regarding disposal of assets outside the ordinary course of business). This is based on the proposition that utilizing existing management provides the most economical and efficient means to reorganize under the oversight of the bankruptcy court, and creditors’ committees. Significantly, many companies hire special financial advisors or turnaround management consultants to assist them in their restructuring. Often, the creditors, especially the secured creditors, will condition their cooperation on the hiring of such an expert or chief restructuring officer. Such consultants or specialists nevertheless remains responsible to the board of the company, the bankruptcy court and the creditors. Often, they will already be in place as part of the negotiations leading up to bankruptcy. Although there is a Bankruptcy Code provision to appoint a trustee, such an appointment is rare and only happens where there is some suspicion of misfeasance/fraud/wrongdoing/risk to assets, or because it is in the interests of creditors.

As soon as is practicable after the order for relief, the United States Trustee (a government official with a duty to protect all creditors) appoints a creditors’ committee, usually made up of the seven largest unsecured creditors willing to serve.68 _{The supervisory role and powers of the committee are}

more extensive than in some jurisdictions, and they can incur the expense of attorneys and other advisors with court approval. Such expenses are funded out of the estate of the debtor.69 _{The United}

States Trustee may also appoint other committees as needed (e.g. a Tort Claimants Committee, a Bondholders Committee, etc.). Although the creditors’ committee may employ advisers and may be remunerated from the bankruptcy estate, in smaller cases there may be insufficient financial incentive for there to be a committee formed. This negates the potentially important role the committee has in Chapter 11 proceedings.

When there is a debtor in possession, interested parties may request the appointment of an Examiner to investigate the debtor’s affairs. Although it is mandatory to grant such request where the debtor has unsecured, liquidated debts in excess of $5 million, the bankruptcy court may limit the scope of the Examiner’s investigation to guard against a “fishing expedition”.

Unified Insolvency Proceedings, Spain

The declaration of insolvency does not in itself have any impact on the continuity of the business activities of the company. In the case of voluntary insolvency, the directors of the company will usually continue to manage and operate the business of the insolvent company. In the case of involuntary insolvency, the management of the company will be taken over by the receivers. However, the court can modify the above rules, at its discretion, and, in exceptional circumstances, at the receiver’s request, the court may order the closure of the company’s offices and the cessation or suspension, partially or wholly of commercial activity.

If a company is placed into liquidation, the debtor’s control over its assets is suspended and its business and assets are taken over and managed by receivers.

In exceptional circumstances where there is a possibility that the insolvency proceedings will be declared as “tortious” and the assets of the company are insufficient to satisfy creditor claims in full,

68 _{Bankruptcy Code paragraph 1102-1103} 69 _{Bankruptcy Code paragraph 1103(a)}

the court may order that certain assets of the directors of the insolvent company are seized as a precautionary interim measure. As mentioned above, if an insolvency proceeding is qualified as “tortious”, the directors of the company could be declared to be personally liable for those debts which cannot be paid in full from the debtor’s assets.

COMMENT

Although in Spanish proceedings the debtor retains control over the management of the company, its decisions must be orientated

towards the preservation of its assets. Therefore, certain limitations are imposed on the debtor, who may not transfer assets without the authorisation of the court, nor may the debtor carry out any activity that does not correspond to its corporate business or that is not in keeping with normal market conditions.

F CONTRACTS Chapter 11 - US Bankruptcy Code

The debtor or trustee may assume a contract or lease even it if contains a clause that provides for termination in the event of insolvency, provided the debtor cures any default, and, if the debtor had been in default, provides adequate assurance of future performance by itself or its assignee. Alternatively, the debtor may reject any such lease or executory contract, giving rise to breach as of immediately prior to the petition filing, leaving the non-debtor party to such lease or contract with a pre-petition claim for breach. Certain unsecured claims, such as those of landlords and executives, are limited by the Bankruptcy Code.

The trustee or the debtor in possession has the valuable ability to extract value from favourable contracts by assuming and then assigning these contracts regardless of whether the contracts themselves prohibit or condition such assignment.

Special rules and exceptions place limitations on a debtor’s ability to assume or reject certain kinds of contracts, including collective bargaining agreements and intellectual property agreements.

Unified Insolvency Proceedings, Spain

In principle, the declaration of insolvency does not affect the validity of those contracts that contain mutual obligations and have not yet been performed. Contractual clauses allowing for termination in the event of insolvency are void, although a creditor can make an application to court for the termination of such contracts if the company is in default of its obligations and liabilities pursuant to the contract. Even if there is a valid reason for termination of a contract, the court can order the enforcement of the contract if it is in the best interest of the debtor and its general body of creditors as a whole. In addition, the debtor (or, if applicable, the receivers) are entitled to seek an order from the court to terminate a contract (even if no breach has occurred) if it is in the best interest of the relevant insolvency proceedings.

The court also has the power to reinstate certain contracts which have been lawfully terminated. The contracts which are typically reinstated include credit agreements, deferred purchase agreements and forfeiture by reason of the insolvent debtor being in breach of the terms of its lease.

In relation to employment contracts, following a declaration of insolvency, the court has special jurisdiction to issue orders in relation to employment contracts which would otherwise be made by the labour courts.

COMMENT

In relation to Spanish proceedings, the right of the debtor (or that of the receivers, if applicable) to rescind and reinstate contracts is orientated to favour the continuity of the commercial activities of the insolvent debtor for the duration of the relevant insolvency proceeding, and, although it favours the restructure of the debtor, this is not the fundamental aim of the law.

G PROPOSALS TO CREDITORS Chapter 11 - US Bankruptcy Code

For the first 120 days after the order for relief, only the debtor (if there is no trustee) may propose reorganization plans. The debtor also has an exclusive right for 180 days after the order for relief in which to solicit acceptances from impaired creditors and shareholders. The court may extend or reduce the exclusivity period for cause, but in no case more than 18 months following the Chapter 11 order for relief date. After the end of this period, the creditors’ committee or any individual creditor can propose its own reorganization plan.

Before solicitation of approval for the plan, the debtor or trustee must prepare a disclosure statement and have it approved by the court as containing adequate information70 _{to allow a reasonable}

hypothetical creditor to be able to consider the plan.

At least 25 days’ notice of the hearing to consider the disclosure statement must be given to creditors.71 _{If the court approves the statement, it will also fix voting procedures and set a}

confirmation hearing date on at least 25 days’ notice to creditors. As a practical matter, once a plan is timely filed, exclusivity is likely to be extended. This is more likely if the disclosure statement has been approved and the plan has been sent out for vote.

Chapter 11 requires creditors to be designated into classes and for each class whose rights have been impaired to vote in favour by a majority in number and two-thirds in amount of those actually voting72

. The minority is bound by the class vote, provided that the plan provided to each creditor is at least what it would have received in a liquidation of the debtor. This is the “best interest” test.

The classification of creditors is based upon the premise that claims that are substantially similar should be classified together. It is well established that secured creditors holding liens with different priorities on the same collateral are to be separately classified. As a general rule, unsecured creditors are classified in one class. There may, however, be reasons why certain unsecured creditors should be treated differently. Some variation in plan treatment, as among creditors having a pari passu right against the debtor, is permitted, provided that such difference does not “unfairly discriminate” against a class of creditors. Generally, the classification scheme is part of the debtor’s plan proposal. There has been litigation regarding classification, primarily involving the deficiency claim of a secured creditor.

Confirmation of a Chapter 11 plan requires that there be cash to pay administrative expenses and most priority claims, and to make the cash payments provided for in the plan.

Only those creditors and shareholders who are going to have their rights impaired (modified) by the plan can vote. Once the voting has taken place, the court will consider whether or not to confirm the plan in the light of the votes. If there is a dissenting class of claims and at least one class of impaired claims that has accepted the plan, the plan proponent may nevertheless request confirmation of the plan if the plan conforms to the “absolute priority” rule and is “fair and equitable” with respect to the dissenting class and all junior classes of claims and interests. When the court confirms a plan in such a case, it is known as a “cramdown”.

With respect to a class of unsecured creditors, a plan is fair and equitable only if (i) such class receives full value for its claims or (ii) no class that is more junior receives or retains any value.

70 _{Bankruptcy Code paragraph 1125(a)(1)} 71 _{BR 2002 (b)}

Hence, absent full satisfaction of a class of dissenting unsecured claims, there can be no value distributed or retained by any more junior claim or interest. A no vote by a class of unsecured creditors usually means wiping out equity.

Once the plan is confirmed, it binds all creditors and the property vests in the debtor company clear of all prepetition claims (and subject to any of the terms of the plan73_{). Where a debtor is unable to}

confirm a plan, the Chapter 11 case may be dismissed or converted to a Chapter 7 case.74

Unified Insolvency Proceedings, Spain

The intention of the Insolvency Act is to facilitate the approval of a settlement agreement between the insolvent debtor and its creditors. A settlement proposal can be filed with the Commercial Court by the debtor in the following circumstances:

1. during the initial stage of the proceedings, between the petition for insolvency filed by the debtor or declaration of insolvency at a creditor’s request, and the final date for creditors to give notice of their claims; or

2. at any time between the final date given for creditors to give notice of their claims and that given to contest the receivers’ report (please refer to the section on Procedure – The Common Phase); or

3. at a time between the commencement of the Settlement Phase (which takes place after approval by the court of the receivers’ report) and 40 days prior to the date set for the creditors’ meeting.

Within the periods described in paragraphs 2 and 3 above, a settlement proposal can also be filed by the creditors who in aggregate represent one fifth of the company’s liabilities if the debtor has not requested liquidation, or a proposal for settlement has not previously been approved.