Brexit & Insolvency

There are very few parts of the economy where the effects of ‘Brexit’ won’t be felt. The UK’s insolvency and restructuring regime isn’t one of them.

While the basic building blocks of the UK’s regime are likely to remain mostly untouched, leaving the EU will affect other laws that govern insolvency practitioners’ work and, most importantly, depending on the deal negotiated, could alter their ability to work effectively on cross-border cases.

Leaving the EU may throw up new barriers to insolvency practitioners as they seek to return money to creditors and combat fraud by hunting for assets on the continent. Such barriers would also cast a shadow over the UK’s position as a centre for international restructuring and insolvency work. Both outcomes would hurt jobs, growth, inward investment, and productivity.

It’s hard to overstate how important the ability to work quickly and easily in Europe is for the UK’s insolvency and restructuring profession. In an October 2015 survey of R3 members, about half of the survey respondents said their firm’s cases involved working elsewhere in the EU; almost one-in-ten said that almost all of their firm’s cases involved EU cross-border work.

How exactly the UK’s insolvency and restructuring regime is affected by Brexit depends on the timetable and deal the UK government is able to come up with. What is clear is that the government has a lot of hard work on its hands to make sure the UK’s world class insolvency and restructuring regime continues to work as effectively as it does at the moment.

The UK’s Insolvency Act

At a very basic level, the UK’s insolvency and restructuring regime is largely independent from Brussels and leaving the EU won’t necessarily change what our insolvency regime ‘looks’ like.

Purely domestic cases are likely to be unaffected. Liquidation, administration, bankruptcy or Debt Relief Orders were all designed in the UK to work in the UK. There is no one, comprehensive EU insolvency procedure. The UK regime works very differently to regimes elsewhere in Europe. Whereas places like France or Germany have insolvency regimes which are driven by the courts and lawyers, the UK’s formal insolvency regime primarily features ‘office holders’: accountants who have an additional special qualification licensing them to act autonomously to make decisions about what to do with insolvent companies or the assets of insolvent individuals (government official receivers fulfil a similar function).

Why Brexit will matter is because the insolvency rules don’t exist in isolation. Even the 1986 Insolvency Act, the building block of our insolvency regime, contains some nods to Europe.

Other UK legislation

There are two distinct issues. The first is that, as well as complying with the Insolvency Act, office holders have to comply with other legislation, too. Employment laws, for example, dictate how an office holder treats employees at an insolvent company, including how employees should be notified of any redundancies. Tax and property laws have an impact on insolvency procedures, too. All these areas of the law are influenced by EU legislation.

The extent to which the UK government retains these European laws post-Brexit remains to be seen. If the government decides to drop some of these European rules, that will change how UK office holders go about their business. In some cases, this could be positive for the UK insolvency regime: a conflict between UK insolvency law and European employment law, for example, makes it difficult for office holders to comply with both sets of legislation at the same time. This creates confusion for office holders and employees, and can put creditor returns at risk; it’s a problem which has been a bugbear for the insolvency and restructuring profession for quite some time.

Mutual recognition

The second ‘Brexit’ issue for the insolvency regime is the impact leaving the EU will have on the enforceability of the UK insolvency regime across the Channel (and in Ireland). This is decidedly more consequential: whereas the first issue concerns what office holders are required to do, the second issue is about being able to fulfil these requirements. Achieving a good Brexit deal here is the insolvency profession’s primary concern.

The problem is recognition. Under the European Regulation on Insolvency Proceedings (‘the Insolvency Regulation’), insolvency proceedings in one EU Member State are automatically recognised in all the others (except Denmark). The Insolvency Regulation also helps decide the jurisdiction in which proceedings take place when an insolvent company or individual has their ‘centre of main interest’ in Europe.

Automatic recognition is particularly important because it means UK office holders can quickly and easily retrieve an insolvent company or individual’s assets if they are in other European countries: the insolvency procedure and the office holder’s powers are recognised across Europe regardless of where the insolvency procedure is taking place. Without automatic recognition, UK office holders may have to go through a lengthy court process to get their hands on any non-UK assets. They might have to apply to have their powers recognised on a country-by-country and case-by-case basis, or they might have to start new insolvency proceedings from scratch in whichever country the assets are in.

A lack of automatic recognition would mean fewer returns to creditors: either retrieving the assets is unaffordable in the first place, or the added costs of achieving recognition will be deducted from what assets can be retrieved. Worse, applying for recognition in the courts is no guarantee of actually gaining that recognition. Unsuccessful recognition attempts would mean more legal costs, but no recovered assets to pay for them.

Automatic recognition and co-operation between member states provides clarity and predictability in cross-border work, reduces costs and help maximise value for creditors. European rules have also helped the UK establish itself as a leading centre of insolvency and restructuring expertise, and have helped attract investment and businesses.

It is very important then that the government adds preserving the benefits provided by the Insolvency Regulation to its ‘Brexit to-do list’. Failure to do so will make cross-border insolvency and restructuring harder to deal with from the UK, risking growth and investment, productivity and jobs. It will increase creditors’ costs, reduce creditor returns, and may also increase the cost of borrowing. And it will make it harder for the UK insolvency and restructuring profession to combat fraud by restricting their ability to retrieve assets located elsewhere in Europe.

In short, the end of the Insolvency Regulation would be a real setback for the UK’s insolvency regime.

Alternatives to the Regulation

The government has a number of options it could pursue. The ‘simple’ way of maintaining the status quo would be negotiate the continued application of the Insolvency Regulation to the UK and UK insolvency proceedings as part of any Brexit deal, although this may come at a price.

In the event of a ‘hard’ Brexit, with no continued UK membership of the Single Market and European regulations, there is already one fall-back option in place: the UNCITRAL Model Law on Insolvency (a UN initiative implemented in the UK through the 2006 Cross-Border Insolvency Regulations).

Like the Insolvency Regulation, UNCITRAL provides a route for recognition for office holders’ powers and insolvency proceedings; unlike the Insolvency Regulation, recognition is not automatic (a court application is required) and its reach in Europe is far from universal. Apart from the UK, Greece, Poland, Romania, and Slovenia are the only other EU Member States to have implemented it (although adoption is much more widespread outside of Europe). So, while lawyers from, say, Italy or Spain will have a relatively easy route for applying for recognition in the UK (under the CBIR), UK office holders will only have a similarly easy path to recognition in a handful of EU countries. Unless the government can convince the remaining 23 EU Member States to sign up, UNCITRAL would be a poor swap for the Insolvency Regulation; even if the the rest of Europe signs up, it would not be a like-for-like replacement.

Without the Insolvency Regulation or a Europe-wide adoption of UNCITRAL, the government would have to sign treaties with individual Member States or leave UK office holders to try their luck in European courts on a case-by-case basis. Insolvency Regulation holdout Denmark, for example, has treaties with its Nordic neighbours to ensure the mutual recognition of insolvency proceedings.

While bilateral recognition deals may be politically more achievable than access to the Insolvency Regulation, such deals may not be as universal in reach or consistency and will create a patchwork of regulations for the insolvency and restructuring profession to navigate. This would be costly and is likely to add delays to insolvency proceedings.

Schemes of Arrangement

The recognition issues don’t end there.

A vital part of the UK’s insolvency and restructuring landscape, but outside the scope of the UK’s insolvency legislation and the Insolvency Regulation, are ‘Schemes of Arrangement’ (these are dealt with in the 2006 Companies Act). Schemes are court-sanctioned arrangements used in financial restructurings for large companies and there has been a growing trend of schemes being used to restructure companies incorporated outside of the UK.

Brexit won’t change the English court’s ability to sanction a European company’s Scheme, but it might change the courts’ approach.

As an EU Member State, the UK is also covered by the Judgments Regulation, which, similarly to the Insolvency Regulation, covers mutual recognition and jurisdictional issues. The English Courts have chosen not to express definitive views on whether the Judgments Regulation affords automatic recognition for judgments in relation to Schemes across Europe. But reliance on the Judgments Regulation, together with local law experts’ opinions, often forms part of the submissions to court regarding recognition when seeking the English Court’s approval for a scheme.

Given the fact that the Judgments Regulation is not relied upon for Schemes for non-UK companies, Schemes will continue to be available, although the focus for international recognition will be more firmly placed on local law opinions and principles of private international law. Any potential gaps could be filled by legal conventions such as the 2007 Lugano Convention, which more or less mirrors the Judgments Regulation, and has been signed by the EU, Switzerland, Iceland, and Norway. Another alternative is the Hague Convention.

The EU Insolvency Framework

When we said that the EU does not have much of a direct impact on how UK insolvency procedures work, it would have been more accurate to have concluded that sentence with ‘yet’.

Recently, the European Commission has been consulting on putting together a European insolvency framework, which would introduce some limited common principles for insolvency rules and procedures across the continent. The UK’s insolvency regime already meets or exceeds what has been proposed in many instances, but any Directive based on the consultation will likely require changes across the EU’s insolvency regimes. The length of a bankruptcy term could be made the same across Europe, for example (it’s currently one year in the UK but longer elsewhere). And while there was independent pressure for the introduction of a business rescue moratorium (from us, for example), the government’s decision to propose one earlier this summer was undoubtedly influenced by the Commission’s recommendation that Member States should do so.

Now that the UK has voted to leave the EU, it’s not clear whether these changes will actually be introduced here. As far as EU membership goes, the UK now seems to be in an awkward halfway house: not necessarily signed up to the EU’s future, but not out of it either and still subject to EU legislation for the time being.

A European Directive is expected on the 26th of October this year, well before any Article 50 submission by the UK. But it’s also impossible to ignore the fact that such a submission is likely to be made in the next couple of years, and may come before the deadline for compliance with the Directive, which is expected to be at some point in 2018.

A lot depends on when the UK makes an Article 50 submission, or at least on when the UK sets out its Brexit timetable. Things will also depend on the future relationship with the EU that the UK government envisages.

Given this is the first time a Member State has left the EU (Greenland excepted), everything is very much a work in progress.

One other thing worth noting is that, from anecdotal evidence, with the UK having voted to leave the EU, the UK’s influence on EU law-making has been significantly reduced. So, as the Commission puts its finishing touches to the Directive over the summer, UK voices will have little say over its final shape.

What next?

A good ‘Brexit’ deal for the UK’s insolvency and restructuring regime is possible and it is vital that the government secures one. Hopefully, any post-Brexit agreement on insolvency and restructuring issues will look very similar to the status quo ante. R3 will make sure the insolvency profession’s voice is heard by the government.

Without a good deal, the government will jeopardise creditor returns, jobs, growth, productivity, the cost of borrowing, the UK’s reputation as an international restructuring centre, and the insolvency and restructuring profession’s ability to combat fraud.

There’s a lot, to put it mildly, at stake.