The EU Insolvency Regulation (1346/2000) came into effect on May 31 2002

The EU Insolvency Regulation

Mark Hyde, Partner, Adrian Cohen, Partner
Clifford Chance LLP

Stephen J Taylor, Leader, Business Recovery Services, Eurozone Countries
PricewaterhouseCoopers

The EU Insolvency Regulation (1346/2000) came into effect on May 31 2002. It applies to all EU member states except Denmark (now including the 10 European countries that joined the European Union on May 1 2004). As a regulation, it is automatically law in the relevant member states, overriding where necessary any conflicting provisions in national laws.

The regulation does not provide uniform substantive law provisions for members of the European Union. The primary function of the regulation is to codify the manner in which a member state determines whether it has jurisdiction to open insolvency proceedings. In addition, the regulation seeks to impose a uniform approach to the choice of governing law. Once these factors have been determined, the procedural rules of the relevant member state will generally apply.

In practice, the regulation has proved to be unsuccessful in these aims. This is primarily because the local courts across Europe have interpreted the regulation quite differently. Broadly speaking, the English courts have taken a flexible and practical approach, seeking to use the regulation to the fullest extent possible to determine whether and when the English courts have jurisdiction. In contrast, the courts in many of the member states in which civil law systems prevail have taken a much more restrictive view and have used the regulation only to the extent that it plainly does not conflict with the national law of the state.

The regulation also provides for the automatic recognition of individual member state insolvency proceedings within the European Union, although in practice this recognition is not automatic and requires some effort on the part of the practitioner.

Scope

The regulation applies to collective insolvency proceedings which entail the partial or total divestment of a debtor and the appointment of a liquidator. These are listed in the annexes to the regulation. The regulation was recently amended to update these annexes and to account for the accession of new member states. The annexes were updated on April 14 2005 to take account of developments in insolvency procedures available in the member states.

The regulation extends primarily to corporates and other individuals within the member states, including various corporate entities such as trading companies, special purpose vehicles and group treasury companies. The regulation applies only to entities that have their centre of main interests within an EU member state, including those whose place of incorporation may be outside of the European Union, but whose centre of main interests is within a member state.

The regulation does not apply to entities with a centre of main interests outside of the European Union. The extent to which insolvency proceedings from outside of the European Union are recognised will depend on the domestic legislation and practice of each particular member state.

The regulation does not apply to banks, credit institutions, insurance companies, investment undertakings holding funds or securities for third parties, or collective investment schemes. These are dealt with by two separate European directives which are beyond the scope of this chapter.

Jurisdiction

The applicable jurisdiction for insolvency proceedings, as provided by the regulation, is the court of the member state where the debtor’s centre of main interests is located. In the case of a company or other legal person, in the absence of proof to the contrary, there is a rebuttable presumption that this is where the registered office of the company is located. It is the rebutting of this presumption that has proved to be the key to the effective use of the regulation, but also its most controversial aspect.

The regulation provides for separate branch proceedings or ‘territorial’/’secondary’ proceedings in certain restricted circumstances in countries other than the state in which the centre of main interests is located. The courts of member states have jurisdiction to open insolvency proceedings against the debtor only where the debtor is established within the territory of that other member state. Unlike the main proceedings, which (in the absence of secondary proceedings) have effect throughout the European Union (other than Denmark), the secondary proceedings are restricted to the assets of the debtor situated in that specific member state and are limited to winding-up procedures. In practice, the absence of clear guidelines to meet the standards of civil law proceedings has created many problems and resulted in very high legal costs. It is fair to say that a secondary proceeding will often result in more inefficiencies, more delays in concluding the process and a worse outcome for both creditors and employees.

Choice of law

The regulation imposes a unified code for choice of law rules which, in conjunction with the mandatory regime of jurisdiction rules, aims to enable those who have dealings with a debtor whose centre of main interests is within the European Union to identify with greater certainty the substantive legal provisions by which their rights will be determined in the event of the debtor’s insolvency. The general rule is that the law applicable to the insolvency proceedings and its effects shall be that of the member state within the territory in which such proceedings are opened. So unless secondary or territorial proceedings are initiated, the law of the state of the centre of main interests is likely to dominate.

The regulation recognises that there will be cases where strict adherence to the general rule will interfere with the rules under which transactions are carried out in other member states, and therefore the general rule is subject to a number of exceptions and carve-outs.

These exceptions include the following:

• rights ‘in rem’, including rights of security (to include holders of floating security over a fluctuating pool of assets);

• rights of setoff permitted by the law applicable to the insolvent debtor’s claim;

• rights under a reservation of title clause;

• contracts relating to immovable property;

• rules of payment systems and financial markets; and

• contracts of employment.

No definition of ‘centre of main interests’

There has been much commentary on the lack of clarity and guidance available in respect of the regulation. This is most apparent in the absence of any clear definition of ‘centre of main interests’. What the regulation does say in relation to centre of main interests is limited to the following:

• "The centre of main interests should correspond to the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties" (Paragraph 13 of the preamble to the regulation); and

• "In the case of a company or legal person, the place of the registered office shall be presumed to be the centre of its main interests in the absence of any proof to the contrary" (Article 3(1) of the regulation).

With little guidance in the regulation itself, it has therefore been left to the local courts to decide how the regulation should be interpreted on this point. Unsurprisingly, the approach taken by local courts in the various European jurisdictions has not been consistent.

Local spin on ‘centre of main interests’

England and Wales

The English courts have exercised their jurisdiction under the regulation a number of times. An example of this was provided by a July 2002 decision of Justice Lightman in the case of Enron Directo SA. Although the company in this case was incorporated in Spain, the English court was able to exercise its jurisdiction over the company, finding that its headquarters were located and all financial and economic decisions made in London; therefore, for the purposes of the regulation, its centre of main interests was in London.

Similarly, in the case of Re BRAC Rent-a-Car-International Inc the English court exercised its jurisdiction in making an administration order in respect of a Delaware incorporated company. It found that the company never traded in the United States and all of its operations were conducted in England. This shows the wide-ranging impact of the regulation, which may apply to entities that have been incorporated outside of the European Union but have their centre of main interests in a member state. The judge considered that to limit the effect of the regulation to entities incorporated within a member state would prevent it from achieving its purpose and leave it open to avoidance.

The BRAC decision was endorsed in Ci4net.com, the first contested English case under the regulation initiated by a creditor and opposed by the company. The creditor asserted that the centre of main interests was in England notwithstanding the fact that the companies in question were registered in the United States and Jersey. One of the most significant factors identified by the court was the importance of creditors being certain in the knowledge of where they can pursue assets and that place having some element of permanence. The court was persuaded that even though the companies were registered elsewhere, correspondence and representations made to their most substantial creditor all pointed to the companies having their principal executive offices in England.

Similarly, the findings in BRAC were also considered in the case of Re Aim Underwriting Agencies (Ireland) Limited. This case related to an Irish incorporated company, although its centre of main interests was held to be in England since it was wholly controlled and managed from England by its parent company. The Irish company had no employees and its only known creditor was its parent.

In 2005 the BRAC decision was given statutory form. The Insolvency Act 1986 (Amendment) Regulations 2005 amended the definition of ‘company’ for company voluntary arrangements and administrations, to include companies not incorporated in European Economic Area member states but which have their centre of main interests in a member state (other than Denmark).

The vexed question of what determines the centre of main interests was the subject of a further case in England on November 26 2004. Shierson v Vlieland-Boddy focused on issues relating to the centre of main interests in respect of an individual debtor. The court in this case held that the relevant date for determining where a debtor’s centre of main interests is situated is the time of the opening of the main proceedings. In this case it was the date of hearing of the bankruptcy petition, not the date of the presentation of the petition or the date on which the debt was incurred. The judge noted that the regulation does not forbid a change in the centre of main interests and that creditors are always at risk of such a change. Therefore, creditors cannot have any certainty in knowing what insolvency law will apply, unless the centre of main interests has not changed. The centre of main interests is a factual matter to be determined by the court at the relevant time.

One English case deserves significant comment in this regard: In re Daisytek-ISA Limited. In this case the English court made administration orders in respect of German companies and a French company. The importance of the decision lies in the manner in which the regulation has extended the jurisdiction of the English court.

The real significance of Daisytek lies in the consideration given to the centre of main interests issue. The judge noted that the identification of the centre of main interests required the court to consider the scale and importance of the company’s interests administered at a particular place, and then consider the same factors in relation to any other place where it may be regarded as having its centre of main interests. The judge in Daisytek also afforded great weight to the centre of main interests being ascertainable by third parties and referred to the Virgos-Schmit Report (a commentary on the draft European Convention on Insolvency, the predecessor to the EU Insolvency Regulation), which explained the rationale for the rule. (However, in the Shierson case, the judge commented that the regulation has not given creditors the certainty suggested in the Virgos-Schmit Report, since the risk of a change in the centre of main interests is always present.) In Daisytek, as the company was a trading company, the judge identified that its most important group of creditors were its financiers and trade creditors. Significant factors considered were as follows:

• The business was funded by a factoring company which was an English subsidiary of the Royal Bank of Scotland;

• Seventy per cent of the goods supplied to the German subsidiaries were supplied under contracts entered into by one of the main English subsidiaries in the group; and

• In comparing the administrative functions carried out in the respective jurisdictions, the judge found that a greater proportion of those functions were carried out in England than in either Germany or France.

France

The French company in the Daisytek group, which had been the subject of an administration order in England, was then placed into separate main proceedings by a French court in Cergy-Pontoise. This was on the basis that the English court erred in asserting jurisdiction based on the company’s centre of main interests being in England. It was argued that the English court had ignored the general principles of corporate identity in relation to group companies where, in the absence of any special factors, each company in the group should be treated as a separate legal entity, and further, that the regulation does not regulate group insolvency situations. Save for the location of the company’s registered office, there is little in the judgment to assert that the centre of main interests ought to be in France. The Court of Appeal of Versailles confirmed that the sole factor determining jurisdiction of the main proceedings under the regulation is the centre of main interests of the debtor. The English court was first to assert jurisdiction as to the centre of main interests of the debtor. The challenges made by the French administrator based on failure to file or serve the administration proceedings on the French subsidiary, or that the English administration order violated human rights and French public policy, were rejected. The Court of Appeal of Versailles found that there were no formalities for recognition which were required to be fulfilled. Nor was there any need to serve the French subsidiary with the English court documents, as it was the French subsidiary that had petitioned the English court. Furthermore, there was no violation of the French administrator’s right to be heard as he was appointed subsequently and, in any event, contrary to the provisions of the regulation.

The appeal judgment focuses on the technicalities of the regulation and the fact that they were ignored by the court in Cergy-Pontoise. The judgment does not go beyond the fact that the French court never had to consider the issues of centre of main interests, since the English court, being the court first seized, had already decided the issue and the regulation provides that, in the absence of a breach of public policy, the order of the court creating a main proceeding is to be recognised automatically. That decision pursuant to the provisions of the regulation was binding on the French court.

Germany

Notwithstanding the fact that on May 16 2003 the Leeds High Court opened main proceedings against three German companies in the Daisytek group – an intermediate holding (PAR Beteiligungs GmbH) and its two operative subsidiaries (ISA Deutschland GmbH and Supplies Team GmbH) – the German courts were also approached to open insolvency proceedings. The local court in Düsseldorf opened secondary proceedings in the case of the intermediate holding and ‘competing’ German main proceedings against both German operating subsidiaries, hence disregarding the prior decision taken by the Leeds High Court to open English main proceedings.

The decision of the Düsseldorf court to open competing main proceedings in the case of the two German subsidiaries was, in essence, based on the assumption that the decision of the English court constituted a violation of public policy. It was argued that the applicant was not an appointed director of the respective debtors, nor had sufficient proxy so that the principle of due process of law was allegedly violated.

Both decisions of the Düsseldorf court of July 10 2003 to open competing German main proceedings were appealed by the joint English administrators appointed in the English main proceedings. Based on decisions of the German appellate court, on March 12 2004 and April 7 2004 the Düsseldorf court ordered the close of the German main proceedings it had opened in July 2003 and the opening of secondary proceedings. The rationale for the court orders was that one of the German directors of Supplies Team GmbH and of ISA Deutschland GmbH granted ‘oral’ proxies to the applicant (the group’s chief operating officer) to file on behalf of Supplies Team GmbH and ISA Deutschland GmbH in England. As a result, the Düsseldorf court could no longer uphold the view that the English court’s decision constituted a violation of public policy.

The problem that Daisytek illustrates is that even when the decisions of the English court were accepted on appeal both in France and in Germany, the confusion and lack of clarity in the interregnum led to very significant inefficiencies in the process. It can only be hoped that following the considerable publicity that the cases have received, the courts will be much more aware of the regulation and the need to avoid unnecessary conflicts of jurisdiction.

Any disagreement between member states as to where the centre of main interests is located is ultimately to be resolved by the European Court of Justice (ECJ).

Reference to the European Court of Justice

The first significant reference has now been made to the ECJ in respect of the Irish incorporated subsidiary of the Parmalat group, Eurofood IFSC. In relation to that company, the different interpretation of where the centre of main interests was situated led to two different courts asserting that the centre of main interests for Eurofood was in their respective jurisdictions. The Irish court considered that Eurofood’s centre of main interests was in Ireland, based on the following:

• Eurofood was incorporated in Ireland and subject to the fiscal and regulatory controls there;

• It was alleged that the day-to-day administration was carried out in Ireland, where the company’s accounts were also maintained;

• The company’s board meeting took place in Ireland; and

• The creditors’ perception was that the centre of main interests was in Ireland.

The Italian courts asserted that the centre of main interests was in Italy, based on the following:

• The company was merely a conduit for the financial policy of the Italian parent;

• Its exclusive point of reference was to the Italian parent;

• Its operating office was in Italy; and

• The central management function was carried out in Italy.

At present, achieving certainty in instances where there are competing court decisions is possible only by way of a referral to the ECJ. This is a lengthy and expensive exercise. However, the recent reference in the Eurofood insolvency will hopefully provide the ECJ with the opportunity to provide some general guidance as to the necessary factors to be taken into account in exercising jurisdiction and in considering where an entity’s centre of main interests is located.

Enthusiasm of courts to assert jurisdiction

The early English jurisprudential activism is now being followed in Italy and elsewhere. Discrepancies in the interpretation of the regulation (in respect of extending a member state court’s jurisdiction) may in some circumstances result in forum shopping, something the regulation was designed to prevent. On a positive note, there are prospects of using the regulation in pan-European restructurings to enable the consolidation of the administration of group insolvencies and thereby enable a coordinated approach to restructuring of businesses.