A critical element to the success of any restructuring process - which can take place within pre-insolvency or insolvency proceedings - is having sufficient time, which depends, in large part, upon the debtor’s liquidity. Even though restructuring processes are often planned and prepared for weeks or months in advance with a view to conserving sufficient cash to effect the restructuring, this is sometimes not enough, and additional liquidity, known as post-petition financing, is then required. That being said, debtors often struggle to find new financing once restructuring proceedings [1] commence. Incentives are therefore needed to give debtors access to cash, to convince lenders to finance distressed companies and to ensure that they will not be in the same position as other creditors should the restructuring deteriorate into a liquidation. Financing a distressed company is risky per se for lenders; as a consequence, they may not commit without additional and special safeguards in line with the characteristics of the restructuring market.
The US legal system was a pioneer in addressing this issue with the inclusion of so-called debtor-in-possession (“DIP ”) financing provisions in the US Bankruptcy Code in 1978, which has allowed for an elaborate system of financing, giving a safe harbour for emergency money lenders and initiating what is now a very lucrative and competitive market. Some jurisdictions on the other side of the Atlantic, in particular France and Italy, adopted this concept but in an uncoordinated manner. That is changing following the introduction by the Directive [2] of a harmonized system of post-petition financing. The Directive states that EU Member States must ensure that post-petition financing is adequately encouraged and protected, and has set out specific rules for this purpose. In particular, post-petition financing shall not be declared void, voidable or unenforceable in subsequent insolvency proceedings and EU Member States may also grant post-petition financing lenders the right to receive payment with priority in such proceedings.
The Directive is intended to set out minimum standards that must be adopted by all EU Member States. However, the Directive provides EU Member States with multiple options, which has led to variations in the way these rules have been integrated throughout the EU. The purpose of this article is to outline the different ways these rules have been implemented, particularly in France, Germany, Italy [3] and the Netherlands.
Post-petition financing is a valuable tool for stakeholders in the restructuring market. However, it requires substantive incentivisation rules to flourish effectively as well as procedural rules to frame and secure the granting and the allocation of such financing, while protecting the interests of other creditors and parties in interest.
Post-petition financing: a valuable tool for stakeholders of the restructuring market
Post-petition financing is primarily intended to allow for a debtor to operate and restructure, but, as we shall see, it can also be a beneficial device for all stakeholders in the restructuring market, in particular for pre-petition lenders and new lenders seeking an entry point into a distressed situation.
From the debtor’s perspective, as set out in the Directive, the purpose of post-petition financing has two components: first, the short-term need for cash to secure the continued operations of the business during the restructuring process (“interim financing”) and, following that, the more stable funds needed to finance the implementation of the restructuring proposals [4] (“new financing”). Interim financing usually takes the form of short-term working capital facilities, allowing the debtor to continue its business while working through the details of a subsequent restructuring. New financing is more often provided through long-term instruments and constitutes a facet of the restructuring solution that notably helps to enhance the future sustainability of restructuring proposals.
The granting of additional funds by lenders directly serves the debtor’s interests because it signals to stakeholders a willingness to continue to support the company and confidence in the debtor’s business prospects where the debtor expects to reorganize. For example, empirical evidence has shown that companies that file for bankruptcy in the US under Chapter 11 and obtain and benefit from DIP financing are more likely to recover from a distressed situation and will have a shorter restructuring process than debtors that did not obtain DIP financing [5].
The providers of post-petition financing are also key. The characteristics of such financing may attract sophisticated lenders, such as hedge funds and private equity funds, which often seek to improve the operating performances of debtors they are investing in [6]. The existence of a post-petition financing system may also be a great benefit to finance providers. As identified in the US practice, lenders’ interests can be split into at least three approaches. First, the defensive approach refers to pre-petition lenders who provide DIP funding as a way to secure their position and protect the value of their existing loans by preventing other lenders from providing DIP financing and obtaining liens senior to their pre-petition liens. Second, the offensive approach refers to new lenders, usually hedge and private equity funds, who are generally driven by the prospect of gaining control over the restructuring process and/or the debtor’s business by also acting as the “stalking horse” bidder for the debtor’s assets, also known as loan-to-own strategies [7]. Third, but less frequently, by lenders who do not fall within the prior categories, but rather who provide “pure” DIP financing for profit and expect to be repaid in full during the course of the restructuring process case usually from a sale of the debtor’s assets or, in some cases, exit financing, in the form of debt or equity investments, upon emergence from bankruptcy.
Regardless of the lender's profile, the attractiveness of post-petition financing also has to do with its intrinsic features. Debtwire data from 2017 to 2020 shows that almost 50% of DIP financing instruments have an interest rate over 9% and that they often provide DIP lenders with a range of fees, averaging about 5% of the loan amount [8]. However, the US experience also tells us that this attractiveness has created a very competitive market particularly among pure DIP lenders, bringing in new actors and slowly driving down, or moderating, prices.
However, investing in a distressed company is risky by nature and lenders can be reluctant to step in. That is the rationale behind post-petition financing regimes, namely, the need to legally incentivize lenders.
Momentum based on the introduction of incentivization tools…
In some jurisdictions, the financing of distressed companies takes a more market-based approach that is characterized by the non-interference of the law. The decision to invest is left to lenders and their objective assessment of the debtor’s situation. No rules are provided to incentivize lenders to finance distressed debtors.
In the UK, pre-insolvency financing also takes this market-based approach. Post-insolvency, lenders who provide funding to the company acting through the appointed insolvency practitioners will benefit from a higher priority when it comes to the distribution of recoveries than unsecured lenders. However, there has been no real equivalent to the DIP financing structure seen in the US or the new post-petition financing structures that are being developed by EU Member States in compliance with the Directive.
The Directive has chosen a more prescriptive path based on a framework of legal rules designed to incentivize lenders and is directly inspired by the US system.
Lending to a distressed debtor can be a more risky proposition than lending to a non-distressed company, and lenders will want to be protected against the risks to the extent possible. The pinnacle of the prescriptive system is the priority incentive, which basically entitles post-petition lenders to receive payment of their claims with priority in the ongoing restructuring process and in the context of subsequent insolvency proceedings. In situations where there are no available unencumbered assets, legal priority is a valuable incentive to attract lenders.
However, the Directive leaves it open to EU Member States to choose whether or not to grant post-petition lenders with priority over pre-petition debt. This priority by operation of law already exists in the US, French and Italian post-petition systems. However, the effectiveness of that priority depends on the actual ranking given to the claim in case of subsequent insolvency proceedings.
- The US system provides compelling rules with a priority that entitles post-petition lenders to be paid ahead of all other creditors holding secured and administrative priority claims, subject to certain restrictions and requirements to protect such other creditors [9].
- French law grants a “privilège” to post-petition financing that gives post-petition claims a certain level of priority over other pre-existing secured claims but remains subordinated to and ranked behind certain wage claims. This ranking will benefit both interim and new financing [10] and neither will be subject to the terms of the restructuring plan.
- In Italy, the IBL already provides that any post-petition financing shall be repaid with priority over other creditors in the context of any potential subsequent bankruptcy, in any case, taking into consideration the priority rules provided by law.
- It should be noted that the Netherlands and Germany decided not to provide post-petition lenders with priority over existing lenders (although in practice when forming classes ordinary creditors may be treated unequally under certain circumstances, which means post-petition financing could also be favoured).
Many jurisdictions have a concept of “claw-back” or transaction avoidance claims, where transactions entered into by the debtor within a certain period before its insolvency (known as the look-back period) can be challenged and set aside (although the length of the look-back period and the point at which the debtor is judged to be insolvent differ – sometimes significantly – between EU Member States). However, a legal system where post-petition financing can be challenged under transaction avoidance provisions could jeopardise the availability of financing to distressed debtors. More generally, ex-post control can be rather problematic because post-petition financing is by essence raised on an urgent basis and in situations where it is sometimes difficult to anticipate or assess the impact of its granting. The retrospective assessment of an ex post control, such as the “claw-back” or transaction avoidance actions, can therefore be inappropriate to address concerns about post-petition financing.
To protect against this risk of challenge, the Directive requires EU Member States to ensure that, in case of a subsequent insolvency of the debtor, post-petition financing will be protected against claw-back actions and that the post-petition lenders will not incur any liability on the ground that such financing is detrimental to other creditors. France, Germany, Italy and the Netherlands have already integrated such protective frameworks. However, safeguarding mechanisms under German law do not completely exclude claw-back or lender liability risks so that accompanying mitigating measures are recommended.
Although not contemplated by the Directive, post-petition lenders may also benefit from protection against the effect of a cram-down in subsequent restructuring proceedings.
- In France and Italy for instance, no write-off or delay can be imposed on a lender’s post-petition claims without the consent of that lender.
- In the Netherlands and Germany, there is no particular legal framework providing for protection against the effect of such a cram-down.
However, post-petition financing systems cannot disrupt the priority of claims or disapply rules on transaction avoidance or liability without also providing for a framework to mitigate and counterbalance the concessions aimed at promoting the financing of distressed debtors.
… that requires procedural rules to frame and secure the granting and the allocation of such financing
As set out above, post-petition financing stands at the crossroads of multiple, sometimes competing, interests that require safeguards. The US practice has shown that court involvement on an ex ante basis, i.e., at the start of the bankruptcy process, and, in almost all cases, well prior to the debtor proposing a Chapter 11 plan, is key to managing the competing interests inherent in all Chapter 11 cases. In addition, the US system provides for court approval of DIP financing on an interim basis, shortly after the bankruptcy filing, and then on a final basis, about 21 days after the interim DIP financing order has been entered.
The Directive allows EU Member States to choose whether or not to provide that post-petition financing rules should only apply to new financing if a restructuring plan has been confirmed by the court and to interim financing that has been subject to ex ante control. This optional court involvement is in line with the underlying objective of the Directive to limit the intervention of judicial authorities and to provide for flexible procedures.
However, the value of such an ex ante control seems considerable since it provides certainty to post-petition financing transactions, providing certainty to the debtor and the post-petition lenders and avoiding the uncertainties associated with an ex post control. For legal systems that provide for court approval, the criteria on which such court approval is grounded is what really matters.
To begin with, the use of funds needs to be controlled to ensure that the financing is used for appropriate purposes, such as financing the restructuring process and/or the restructuring proposals and not misused by the debtor (e.g., to improperly favour a stakeholder). While the Directive addresses that concern by narrowing the definition of interim financing [11], the absence of mandatory ex ante control could materially weaken the effectiveness of such provision.
- Subject to an ex ante control, the French, the Dutch and the German systems translated that need by providing that interim financing shall be authorized by the competent court and granted within the limits necessary for the continuation of the debtor’s business during the restructuring process.
- In Germany, however, interim financing only qualifies as such and benefits from a certain level of protection if the financing was taken out during the pending restructuring proceeding (i.e., after the notification of the restructuring case to the court).
- According to the Italian system, interim financing shall be authorized by the competent court and granted only for the sole purpose to pursue the creditors' best interests [12], or ensure the continuation of debtors’ going concerns [13]. The Italian system provides also for pre-petition bridge financing, that shall be specifically granted for the sole purpose to allow the debtor to access to the restructuring proceeding. Such bridge financing shall be authorized, upon the debtor's request, by the competent court.
These criteria can also be used to manage the competing interests of post-petition lenders, debtors and other creditors that can arise with respect to post-petition financing practices that favour and incentivize lenders such as cross-collateralisation [14]; waivers and releases [15]; and, roll-up [16] by pre-petition lenders, which are common in US bankruptcy cases subject to certain court controls [17].
- In contrast, France has decided to prevent such transactions by setting out that new financing cannot be approved if it benefits directly or indirectly pre-petition claims.
- In the Netherlands, recent case law confirms that post-petition collateral cannot be protected against claw-back actions to the extent it secures pre-petition financing.
- Although it is not explicitly stipulated, under German law post-petition financing and the corresponding collateral are only protected from later claw-back actions if the financing qualifies as a new financing (i.e., not a deferral or prolongation) and the collateral does not secure pre-petition financing.
- In Italy, interim financing should be granted only in order to fulfil the purposes provided by law and cannot be used, in any case, to repay pre-petition claims. However, under specific conditions, the debtor can ask the court to authorize the repayment of certain pre-petition claims vis-à-vis suppliers and other strategic creditors, if the relevant goods and services are deemed necessary for the going concern by the independent expert.
As stated, controls are useful to balance the competing interests found in restructuring proceedings. One such control in the US practice is the involvement of creditors’ committees, which are appointed by the US Trustee’s Office, an arm of the US Department of Justice, which has an oversight role in US bankruptcy cases. The creditors’ committee is usually involved in the negotiation of certain key terms of the post-petition financing. This occurs most often after the debtor has obtained interim approval of a portion of the DIP financing facility and prior to the hearing to consider approval on a final basis. The creditors’ committee has standing to be heard in all matters and, therefore, is well-positioned to protect the interests of pre-existing unsecured creditors. The US Trustee’s Office also advocates on behalf of stakeholders, in particular unsecured creditors prior to the appointment of a creditors’ committee. The French granting process of post-petition financing does not provide for an express approval of pre-existing lenders, but such lenders will be interested through their involvement in the negotiations of the restructuring proposals. In Italy, the creditors' committee is only established in bankruptcy and composition with creditors proceedings but, in the context of the latter, post-petition financing has only to be approved by the competent court and not also by the creditors' committee. This demonstrates the need and effectiveness of a counterbalanced system, with the need for a timely and effective granting process – again, timing is key in any restructuring process.
The balance of interests is therefore a sensitive aspect of a post-petition financing system. While it may be discussed that the Directive did not push far enough on certain aspects of post-petition financing, such as the priority incentive or the control framework, it is undeniable that the initiative must be applauded. Post-petition financing serves the interests of all stakeholders of restructuring markets and the framework offered by the Directive gives a very promising ground for the development of such market in our jurisdictions. Whether each jurisdiction seeks to develop anything equivalent to the US remains to be seen.
Authored by Astrid Zourli, Maxime Vaillant-Theodat, Pierantonio Musso, Dylan Goedegebuure, Susann Brackman, David Simonds, Chris Bryant and Jennifer Lee.
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