STUDIES ON SPANISH-PHILIPPINE PRIVATE LAW
Papers of the Private Law of the Philippines and Spain International Scientific Congress

BANKRUPTCY: AN AGREMENT WITH CREDITORS

Maria Nieves Jimenez Lopez
 Research Fellow of Procedural Law at the University of Malaga

Abstract:

This exposition has as a main objective to analyze the different possibilities currently establish in the insolvency law to solve the insolvency proceeding through agreements with creditors, within or outside the process, because this is, in fact, the only way to finish the process successfully. For this reason, in recent years, the insolvency law has changed its own nature, increasingly leveraging this solution to insolvency situations. So, we analyze also the most significant reforms that in this direction have been made. Finally, we will discuss the situation of the natural person in insolvency and the advances that have been made in this area, as well as the improvements we have left to do.

Key Words: arrangements with creditors, early proposal composition, refinancing agreement, out of court payment agreement, natural person insolvency

• Introduction

Currently, Insolvency Law is one of the most important areas of law, as it is a matter deeply related to national and international economic situation, due to the forced insolvency law relationship with the economy. In fact, the undeniable economic crisis, social and financial we are living in a time, has led to reflection on the current economic structure which has led to many changes occurring in recent years for this field of law, because, though it may seem ironic, insolvency law is in crisis, also internationally, because today all states have reconsidered their own structure and insolvency process model that seems to not respond effectively in the economic and social times convulsed in which we live, to that for which, however, was designed.

Thus, we find that in recent times all states mired or infected with this crisis, have reformed their insolvency system looking for an improvement that allows to respond to the needs and current economic conditions. Also in the Spanish State have been carried out these reforms, being, in our case, very important and necessary reforms, while Spanish Insolvency Law was greatly lagging behind other legislation, European and Anglo-American, who had been developing and gradually adapted to the current situation.

            In this sense, the real revolution in this area occurred in 2003, when is enacted our new Insolvency Act. This law supposed undoubtedly a change in the mindset of the legislature regarding the insolvency matters, producing a radical change in the structure, consideration, principles, and in general, the pillars on which the Insolvency law is based.

However, despite its good intentions, the fact is that this law is born with some deficiencies that are soon to become apparent and have been trying to overcome by partial reforms. Indeed, since the entry/come into force of this Act in 2004, there have been several modification on it.

Nevertheless, this new Insolvency Act means a substantial change in all aspects of the Spanish Insolvency Law, beginning with the very name of the law as Insolvency Act, a term that has been applauded from all sectors to understand that is a return to classical Spanish terminology. But this term go beyond a simple historical reference. This term underlies one of the true and most important innovations of this law: to set the insolvency procedural unity, being that the distinction between proceedings for traders, bankruptcy procedure and receivership, and not traders, creditor insolvency procedure and the discharge of debts and stay of payment procedure, disappears.

Furthermore, the use of this term instead of bankruptcy that historically denote a punitive nature and that are used in other legislation, emphasizes the procedural nature of the act and highlights its new objectives.

In this sense, we can say that this law is born with four well-defined objectives:
           

• To modernize Insolvency Law,
• To achieve the satisfaction of creditors
• To promote the continuity of the businesses
• To provide greater flexibility, agility and transparency to the insolvency proceedings

So, we devote some reflections here to analyze whether these objectives are being met.

• The arrangements with creditors within the Insolvency Proceeding

Although at the beginning of this exposition we have said that the new insolvency law is a major change in Spanish economic scene, the fact is that basically, the main purpose of Insolvency law still gets the satisfaction of the rights of creditors. And it is important not to forget this point, because that will mark the regulation and the evolution that has taken this matter in Spain.

However, in spite of this objective, it is true that the new regulation wish to satisfy creditors trying, at the same time, to encourage the continuity of the business. But this goal appears in the new legislation as a secondary objective, being that the idea is to get the satisfaction of creditors but trying as far as possible, to promote the continuity of business. But for getting that, it is vital to have the effective possibility to make agreements with creditors.

Then, the Insolvency Act tries not only to allow, but also to encourage such agreements taking the following measures:

• The possibility of submitting an early proposal of composition

This is one of the most important additions made by this Insolvency Act, in relation to the measures that have been taken to facilitate the resolution of the insolvency proceeding through the arrangements with creditors. It is entitled to request only the debtor himself, unlike what happens in an ordinary proposal of composition in which are also legitimated creditors, provided they meet certain requirements. The proposal can be submitted to the Court by the debtor as from the petition fro voluntary insolvency or as from declaration of compulsory insolvency and, in both cases, until expiry of the term to lodge claims.

In order for a proposal to be admitted to consideration, it must be accompanied by adhesions by creditors of any kind whose claims exceeded one fifth of the liabilities presented by the debtor, but when the proposal is submitted at the same time that the voluntary insolvency petition it shall suffice for the adhesions to amount to one tenth to the same liabilities.
Submitted the proposal, the Court shall resolve on its admission. When the early proposal of composition has been submitted with the petition for voluntary insolvency or prior to this judicial declaration the Court shall resolve on its admission in the actual order declaring the insolvency proceeding open. In other cases, the Court shall resolve by reasoned order on its admission to proceedings within the three days following that of submission of the early proposal of composition.

Once the early composition proposal has been admitted to consideration, must be notified it to the insolvency administrator for evaluating its content according to the payment scheme. If the evaluation is favourable, it shall be attached to the insolvency administrator report. But if the valuation is unfavourable, it shall be submitted to the Court in the shorter possible time which may make admission of the early proposal ineffective. From admission to consideration of the early proposal of composition and until expiry the term to challenge the inventory and list of creditors, any creditor may declare his adhesion to the proposal.

Expired the term to challenge the inventory and list of creditors, or the term to revoke the adhesions, the Court Clerk shall verify whether the adhesion presented reach the legally required majority, in which case he shall proclaim the result, and after that the Court shall hand a ruling of approval. This ruling shall put the end to the common phase on the insolvency procedure without opening the ordinary composition or the winding-up phase.

In other cases, if the approval of the composition is not appropriate, the Court shall require the debtor without delay to declare whether he maintains the early composition proposal for submission thereof to creditors’ meeting or whether we wish to petition for winding-up, handing then a order opening the composition or the winding-up phase, as appropriate.

• The composition phase as the normal solution to the insolvency proceeding

Once the common phase has ended without an early proposal of composition approval or maintained, the second phase of the insolvency proceeding is opened, and its can be resolve by a composition with the creditor o with a winding-up phase. In this sense, the preamble of the own Insolvency Act takes into consideration the composition phase as the normal solution to the insolvency proceeding, although we can not forget that there is more than possible solution through winding-up.But it can be seen as the legislator considers the winding-up phase as a secondary alternative by which can be solve the insolvency proceeding.

However, the fact is that the winding-up phase has the same opportunities to rise as a solution to the insolvency proceeding, being that, firstly, it can be requested by  the debtor at any time during the process, but also because when it is nor possible to end by a composition, it is necessary the winding –up phase, and this indeed is not always possible.

Regarding to the legal nature of the composition, that has been widely discussed by our the legal doctrine and in our jurisprudence, but in general, it could be said that the composition should be seen as a bilateral legal act that requires court approval for its completion.

The proposal of composition can be submitted by the insolvency debtor that even he can to maintains the early composition proposal in case that it had been presented but not approved, but also by the creditors whose claims are recorded in the insolvency proceedings and that exceeded, jointly or individually, one fifth of the total liabilities recorded on the definitive list of creditors. Submitted the proposals, the Court shall admit to consideration if they fulfil the conditions established in the Insolvency Act, ordering, at the same time, to serve notice of the proposal to the insolvency administrator so that he may issue in writing an evaluation of the content. Submitted the evaluation and until to the moment of closing the list of attendees at the meeting, adhesions by creditors to the proposal of compositions shall be admitted.

The meeting shall be held on the day and at the time set in the summoning notice. The Court Clerk shall explain the proposal or proposals admitted to consideration that bare submitted for discussion stating their origin, and when appropriate, the amount and ranking of the claims held by those who have submitted them. Explained the proposals, it shall be the moment for the discussion. In this sense, discussion and voting shall first take place on the proposal submitted by the insolvent debtor. If it is not accepted, the meeting shall proceed likewise with those submitted by the creditors, successively and in order from greater to lesser, in terms of the total claims held by those signing them. Once a proposal has been accepted, discussion of the remaining ones shall not proceed.

Accepted the composition, the Court Clerk shall submit the minutes to the Court and shall submit the composition accepted for approval thereof. However, the insolvency administrator, the creditors who have not attended to the meeting, those who had been illegitimately deprived of their vote thereat and those who have vote against the proposal of composition accepted by the majority shall be actively legitimated to formulate an opposition. Respecting to the insolvency debtor, may oppose or submit to open the winding-up phase, but only in case that he has not formulated the proposal of composition accepted by the meeting nor has given his approval. 

Once the term of opposition has elapsed without any opposition being raised, the Court shall hand down a ruling approving the composition accepted by the meeting. In other case, being raised any opposition, this shall be raised through the channels of an insolvency procedural plea and resolve by a ruling that shall approve o reject the composition accepted.

Approved the composition by the Court and ceased all the effects of the declaration opening the insolvency proceeding, the insolvency debtor shall report to the Court on the fulfilment thereof on a six months bases, and when he deems the composition to be completely fulfilled he shall deliver to the Court the report with the relevant evidences and shall petition for the judicial declaration of fulfilment. If the Court deems the competition to have been fulfilled it shall declare so by order.

However, any creditor who deems the composition to be breached with regard to matters affecting him may petition to Court to have that infringement declared. The petition shall be processed as an insolvency procedural plea and it shall resolve with a ruling by the Court. If this ruling declare the infringement of the composition by the debtor shall give rise to the termination thereof and the winding-up phase shall be opened.
In other case, once the order declaring the fulfilment is final and the term for actions to declare infringement has expired, or when appropriate, those lodged are rejected by final judicial resolution, the Court shall hand down and order of conclusion of the insolvency proceedings.

But, the most contentious issue regarding to the composition is above the content that it can be have. In this sense, it has been criticized that the Insolvency Act has limited and restricted in excess the private autonomy of the debtor and its creditors. Under the Insolvency Act, the proposal of composition must contain propositions for discharge of debts or stay of payment or both. With regard to ordinary claims, the proposals for discharge of debts may not exceed half the amount of each one of them, nor those of stay of payment five years from the judicial resolution approving the composition becoming final. Exceptionally, in the case of the insolvency proceedings affecting businesses whose activity may have a special transcendence for the economy, as long as a feasibility plan submitted so provides, the insolvency Court may, at a party’s request, authorise, giving the reasons, those limits being exceeded.

The proposed composition may also contain alternative proposals for all creditors, or for those of one or several classes, including offers for conversion of claims into shares, stakes or corporate quotas, or into participation loans. The proposed composition may also include disposal proposals, either of the set of assets and rights of the insolvent debtor assigned to his business or professional activity, or of certain productive units, to a specific natural or legal person. The proposals must include undertaking by the acquirer to continue the business or professional activity inherent to the productive units affected and to pay the claims to the creditors, under the provisions set forth in the composition proposed. In these cases, the legal representatives of the workers shall be heard.

But under no circumstances whatsoever may the proposal consist of assignment of assets and rights of the creditors in payment or for payment of their credits, or any other means of general winding up of the insolvent debtor’s estate to settle his debts, nor alteration of the classification of claims established by the law, nor the amount of these set in the proceedings, without prejudice to the acquittals that may be agreed and the possibility of merger, split or general assignment of assets and liabilities of the insolvent debtor that is a legal person.

• The arrangements with the creditors as an effective alternative to the insolvency proceedings

Although the regulation we just have expose in relation to the empowerment of agreements between the insolvency debtor and his creditors, the fact is that once initiated insolvency proceedings, the continuity of the business remained difficult. A significant lack of the Insolvency Act in this regard is then manifested: the insolvent situation should try to be resolved before entering in a insolvency proceedings. Thus arises successive legal reforms in this direction, trying, not only to make the insolvency process ends by arrangement with creditors but also, to avoid that the insolvency proceedings begin encouraging that these agreements with creditors are made before.

Thus, one of the most important changes was the introduction of what was called pre-insolvency. This term alludes to the possibility introduced by the Insolvency Act according to which the insolvent debtor who has a duty to petition for a declaration opening the insolvency proceeding, could try to reach agreement with its creditors to avoid that proceeding, and in this case, this duty shall be suspended. That is, if the insolvency debtor reports to the Court that negotiations with creditors have been initiated, his duty to petition for a declaration opening the insolvency proceeding shall be suspended for a time.

These negotiations may consist in to get a refinancing agreement, the necessary creditors’ adhesions for approval the early proposal of composition or to come to an out of court payment agreement.
Regarding with to the refinancing agreements, recent reforms have quite an impact on this possibility. On one hand, these agreements have received what has been called a shield against a possible reintegration action, in so far as the law declares this agreements irrevocable when they mean a significant expansion of the credit available or a modification or termination of the debtor’s duties, and just in case that it has a feasibility plan submitted that allows the continuity of the businesses in the short and medium term. Also the agreements have to be came before the declaration opening the insolvency proceeding and some more requirements and formalities.
And on the other hand, these reforms have even introduced the possibility of getting a judicial approve of these agreements provided it they meet certain requirements. This possibility has been introduced in order to be able to extend and apply the effects of these agreements to those creditors who had not signed them, or had shown their displeasure with the refinancing agreement or whose credits are not secured claims.
With these reforms, the insolvency law has tried to promote that the creditors of a person in a delicate economic situation confer him the possibility of refinancing their debts to avoid an insolvency situation and an insolvency proceeding.
In relation to the out of court payment agreements, are entered in the Insolvency Act as an alternative to the proceeding. Such agreements may be requested by the debtor to the Registrar or the Notary. The request shall be made by an application form and it has been included an inventory of cash and liquid assets available, the assets and rights held by him and expected regular income. Furthermore, it has been also accompanied by a list of creditors.
Submitted the application form, the registrar or notary shall admitted the petition if it meets the requirements and he appoints an insolvency mediator who has to verify the existence and the amount of loans and who convene the debtor and creditors on the list submitted by the debtor to a meeting. Prior to the meeting, the insolvency mediator shall send to creditors, with the consent of the debtor, a proposal for payment agreement. This proposal shall include a payment plan detailing the resources provided for compliance and a viability plan and also it shall contain a proposal to regulate the compliance with the new obligations. However, creditors may submit alternative proposals or proposals for amendments.
If an agreement is eventually reached, it must be formalized in a public deed and the Registrar or the Notary must notify the end of the procedure to the Court that had jurisdiction to its insolvency proceeding. But in case that it is not possible an agreement, the insolvency mediator shall petition to the Court for a declaration opening the insolvency proceeding, and the Court shall order it immediately.
The most important idea in relation to these out of court payment arrangements is that, once the procedure begins, the debtor may continue with his employment, business or professional activity, but shall refrain from any act of administration and disposition in excess of acts or own operations of its activity. In addition, during the negotiation period of the out of court payment agreement and regarding credits potentially affected by it, the accrual of interests shall be suspended.
However, with the latest amendments in this sense, the possibility to begin a pre-insolvency phase, means, not only to try to avoid the insolvency proceeding and gain time so important in these cases, but also that this method has been configured as an authentic method of protection to the insolvent debtor from its creditors, being that as an important new effect is introduced: the insolvency creditors may not file a petition for a compulsory insolvency proceeding against the debtor that is in a pre-insolvency phase.
Furthermore, the prohibition of commencement of judicial executions on goods that are necessary for the continuity of the insolvency debtor’s the business and the suspension on executions that are in force is also introduced, in the same line of protection to the insolvent debtor, while it is at this stage, although with some exceptions.
Therefore, these changes have been assessed very positively, since they are an effective protection of the debtor who is trying to avoid reaching a insolvency situation.

• Conclusions

As can be seen, the change that has occurred in the Spanish Insolvency Law since 2003 can be described as "radical". In this sense, we understand that we have change our mind because before this date, the insolvency proceeding could be described  as a process of punitive nature whose main objective was to liquidate the debtor's assets to satisfy the claims of creditors, but since this date, we can say that the insolvency law try to protect the debtor who is immersed in that situation and although the purpose of it is still the effective satisfaction of creditors' claims, also a second goal to achieve as far as possible, is the continuity of the business.

In this sense, to get that second goal, increasingly important, the insolvency law has focused on strengthening the agreements with creditors as the real effective solution to the insolvency situation.

Because, although initially negotiating climate within the own insolvency process was favored by the possibility of submit an early proposal of composition with the application of insolvency proceeding and configuring the phase of agreements as  preferential to the liquidation one in insolvency proceedings which remains only as applicable in cases where no agreement is reached achieved between debtor and creditors, it soon becomes clear that this measures are insufficient to satisfactorily resolve situations of insolvency, whereas, despite favoring the possibility agreements, the fact of having to initiate a insolvency proceeding itself and having to wait for the expiry of the procedure leave this possibility as an ineffective solution, since in insolvency agility and speed of reaction is an important note, and these agreements reached, in most cases late, so the good intentions of the law setting the arrangement phase as principal, remaining in that, just good intentions.

That is why, aware of this problem, are introduced over the years, successive reforms aimed not only to further boost the resolution of the insolvency proceeding through agreements with creditors, but also, the most important, try to anticipate the insolvency situation.

That is why they are introduced in the insolvency law, as we have seen, other pre-insolvency techniques that treat rightly prevent that persons in economic difficulties starts a insolvency proceeding. These mechanisms, such as refinancing agreements and the out of court payment agreements, represent a real alternative to insolvency proceedings, and in a way tremendously effective: they are faster, less expensive, and more flexible and agile.

Indeed, the fact is that the successive reforms that have been undertaken in this legal parcel, will all aimed at reforming these ideas. The legislator has understood that the insolvency law has a mission within the legal framework that goes beyond serving as a channel for the fulfillment of obligations. The insolvency law is now rediscovered as a tremendously effective in combat situations of economic crises instrument. In fact, we can say that an agile, strong and well configured insolvency law is a defense mechanism not only, but also protective, highly effective to stop the effects of crisis in the financial sector.

We can therefore praise the change of legislative mentality that has occurred in our country, but we must remember that insolvency law is alive and must be constantly adapt to the state of the financial markets, and in this sense, then it must be borne in mind it is a legal parcel must be in constant change and revision. In addition, it is also true that there is still much to do. Despite these reforms, it is certain that insolvency law is still encountering great difficulties, weaknesses and shortcomings in implementation. But the change of mentality to which we have referred provides a reliable foundation to reach achieve the main goal: to set an effective insolvency law.

• Last reflection: about the non-traders insolvency proceeding

We said at the beginning of this exposition that one of the new elements in the Insolvency Act 2003, is that the application of the principle described above: the principle of Unit, led to the elimination of the distinction between traders and non-traders, so the insolvency law can be applied to any type debtor, whether natural or legal person, leaving only excluding agencies and entities of public law. This effectively represents a novelty in our legislation which, prior to the reform, could find up to four different procedures, depending on the characteristics of the insolvency debtor. However, this development has caused, and despite the many reforms, more disadvantages than facilities.

Nobody is aware that the insolvency situations of a non-trader person have absolutely different characteristics from a trader person. Normally, in these cases, we can see people who usually have a single good value, a property which normally is mortgaged; over-indebtedness caused by the latest economic situations in which it was not difficult to get funding, and in many cases, moreover, to complete the scene, with the addition of a situation of unemployment and lack of obtaining income from such person or the family unit itself.

With this perspective, the fact is that insolvency law, neither the old nor the new or renovated one, stands as no feasible solution to these situations of insolvency. Firstly, the complexity of this process exceeds the needs of a natural person insolvency situation that, as we say, is often characterized by no many creditors, and even fewer goods, in addition with the existence of a mortgage in most cases. But also because shown especially in these cases, as particularly unwieldy and excessively expensive to be undertaken by an individual debtor.

For these reasons, recently, some important reforms related precisely with the non-traders insolvency proceeding have taken place. In this regard, one of the most important news is that natural persons will be able to use these extra-procedural mechanisms to reach an agreement with creditors. This possibility, prohibited at first, is now open for individual debtors.

However, the main problem facing these debtors was quite another. When it comes to the insolvency preceding of a legal person, except in cases of culpable contest, terminated the proceeding and the winding-up phase, whether creditors had been fully or partially satisfied, the legal person is extinguished. This assumes that claims not satisfied in the process fail to never pay. However, this mechanism did not exist for individual debtors who remained responsible for unsatisfied debts in the insolvency process for all its life.

This situation changed with the reform of 2013, from which the possibility that individual debtors can also see that the outstanding claims after completion of a insolvency process is regulated remain extinguished. However, this regulation had two serious problems of practical application: the first is that although it applied to individual debtor, they should develop a business or professional economic activity, so it did not apply to all individuals, just to individual traders, being outside the scope of application the natural person, the non-trader person who have commented previously.

But also, and secondly, this law appeared to be more ambitious than it really was, because required as a prerequisite to apply this exemption that in the insolvency proceeding all claims against the estate and the preferential claims, special and general, had been satisfied, and even if there were no prior attempt mediated an out of court payment agreement, at least the 25% of the ordinary claims, which actually occurs in a small percentage of proceedings. Therefore, this attempt to articulate what is named as fresh start for the individual debtor was simply reduced to good intentions.

Trying to solve, once again, these deficiencies in the insolvency legislation, there was barely a couple of months the last reform in this respect. This new reform really introduces an authentic fresh star of the natural and non-trader person. The exemption system has two pillars: the debtor must be in good faith and its assets must be liquidated previously (or that the Court orders the conclusion due to insufficiency of the aggregate assets).

However, to apply this mechanism, continuous being required as a prerequisite to apply this exemption that in the insolvency proceeding all claims against the estate and the preferential claims, special and general, had been satisfied, and even if there were no prior attempt mediated an out of court payment agreement, at least the 25% of the ordinary claims, although it also provides for the possibility that it can be applied even if it has not been possible if the debtor is subject to a payment plan for the next five years. Thus, the debtor may be temporarily relieved of all claims except the public ones and for right to be supported, against the estate and those who enjoy a general privilege.

For the final release of debts, the debtor must satisfy in that period not exempt claims or make a substantial effort for it, understood as having intended to deliver, at least half of the income received during the period which did not have the consideration of non-forfeitable assets. Therefore, in the circumstances of the case may declare the final exemption from unsatisfied liabilities of the debtor but had not completed in full the payment plan but had made this substantial effort.

Now, it can be said that has been introduced in Spain the real possibility of a fresh star for the natural and non-trader insolvency debtor, which has been warmly welcomed by the doctrine, courts and society in general.

However, we want to raise two issues in this regard. The first is that it continues to use the insolvency process to try to solve the problem of insolvency of natural persons, despite having shown that it is not suitable or designed for this purpose.

In this regard, note that all our neighboring countries (Italy, France, Germany, United Kingdom, etc.) provide for different procedures depending on the insolvency debtor, and they all have a special process adapted to the insolvency of a natural and non-trader debtor. And the second is that, despite the supposed benefit to debtors the possibility of being exempted from their debts, no one seems to have arisen as the markets will react and financial systems to this new concession, because certainly entities financial will react, I understand that minimizing lending and financing, which in turn will impact on the financial and economic system of the country.

Any case, it is soon to know what is going to happens in this sense, so we have to wait how it is received this reform by the financial sector.