The History and the Contemporaneity  of the European Insolvency Law

 

Ilona Schelleová[1] Karel Schelle[2]

 

 

1. INTRODUCTION AND HISTORY

 

The Aim of and Reason behind the European Legal Regulation of Insolvency

 

The continuing European economic and political integration, which actually began at the end of the twentieth century and became more intense at the beginning of the twenty-first century, significantly influences the economic independence of individual EU Member States. These states support a greater openness of their economic system. The sky-rocketing cross-border business activities are at the same time becoming more and more complicated. This is undoubtedly supported by the four basic European principles of freedom – the freedom of movement for goods, people, services and methods of funding – the non-existence of which would mean limitation of the development. This development also results in an increased number of debtors who have property abroad either for diversification of the risk of loss of own values or for their own profit growth. This usually means certain barriers for the creditors, who would like to achieve full satisfaction of their rights from the debtors. The debtor may, especially in the case of his insolvency, try to hide his property from the creditors by transferring it to a foreign country that does not legally recognize insolvency proceeding abroad. On this account, the aim of the international and European legal regulation of insolvency is to react to these situations by ensuring that no debtor’s property remains unaffected by his insolvency, regardless of debtor’s country of origin or his place of residence, as this is the only efficient and proper way of dealing with the cases of insolvency.

 

Both international and European insolvency law recognizes and differentiates between two basic legal principles in this area:

a) the principle of universality: this principle states that it does not matter, where debtor’s property is located, which enables to include debtor’s property located in any country;

 

b) the principle of particularity (territoriality): it has been the main principle over the last years; this principle is based on the national legal regulations of insolvency where each country will exercise full sovereignty in deciding whether the decisions of foreign courts shall be accepted or not.

 

As may be obvious from the differentiation above, the real barrier to the prospect for the international as well as European insolvency law is the typical rule of national courts to obey the principle of particularity (territoriality) – the courts in many countries do not recognize the decisions of foreign institutions or courts as legally binding. The obvious solution to such situations therefore is the attempt of the international institutions at unification of national insolvency regulations according to the uniform international criterion, which guarantees common standards in consideration of the rights of the creditors to satisfaction from debtors’ property. This idea and internationally applied approach of unification of the national insolvency laws are called the Principle of controlled universality.

 

The principle of particularity began to prevail and became an internationally known and acceptable approach to insolvency law only over the past decades. This was caused not only by the intensification of European integration, but also by the overall tendencies towards globalization all over the world, which turn the question of common principles for the insolvency proceedings into a more and more important and urgent topic. Together with the academic and politically multilateral discussions held on the international level, many countries slowly try to transform their national insolvency laws and thus achieve greater cooperation and coordination in this area in accordance with the international principles. Nevertheless, the first and really successful attempt at leaving the legislative and national approach, which still prevailed in most countries in the seventies and eighties of the twentieth century, was the „Bankruptcy Law“ of the USA. This bankruptcy law, issued in year 1978, subsequently served as one of the models for other modern legal regulations of insolvency all over the world.

 

However, the historical development of the legal regulation of insolvency in Europe dates back further than that, long before the foundation of the European Community. Nevertheless, it was only in the twentieth century that the European countries began to make laws and agreements that were accepted also beyond the boundaries of individual countries.

 

The first pioneer in this area was the Scandinavian Agreement, which was entered into at the Nordic Convention in year 1932. This agreement, signed in the same year by Sweden, Norway, Finland and Denmark, was the first international agreement dealing with insolvency and settlement proceedings. It followed from the principle of universality and comprised also some conflicting rules of law that regulated certain specific cases. It came into effect in year 1935.

 

Another pioneer in this development appeared some time later and although its implementation was not to a larger extent successful, it managed to extend regional cooperation to real international cooperation, which significantly contributed to further development of the international insolvency law. The Istanbul Convention (known also as the European Convention on Certain International Aspects of Insolvency), which was signed by 7 countries in Istanbul, was prepared by the Council of Europe on the 5th June 1990. Unfortunately, this convention was ratified only by Cyprus, and therefore has not come into effect yet (, as this would require ratification by at least three countries). A probable reason for this failure is insufficient scope of questions of the insolvency law, which are dealt with in this convention. However, the importance of this convention lies in laying the foundations for multilateral and international unification of the legal regulation of insolvency in Europe.

 

Another guideline for achieving the common goal in the area of cross-border insolvency law, besides the European development of the international insolvency law, was provided by acts of international institutions, such as the UNCITRAL – the United Nations Commission on International Trade Law. UNCITRAL started to prepare the model of insolvency law at the beginning of the nineties and the „Model Law on Cross-Border Insolvency with Guide to Enactment“ was adopted by the middle of the year 1997. “This model law is designed to assist States to equip their insolvency laws with a modern, harmonized and fair framework to address more effectively instances of cross-border insolvency.“ One of the advantages of this model law was the fact that it respects the differences between national legal regulations of insolvency on the one hand, and offers some solutions on the other hand. Proceedings according to this model law in one country do not have to have a direct influence on another foreign country, but rather rely on the authority of UNCITRAL. One expects its principles that have been incorporated into this model law to be generally accepted by foreign countries as the whole. Some countries actually have already accepted this model law and modified their legislation accordingly; among these countries are Mexico, Japan, Great Britain, USA, Poland and others.

 

The newly developing institutions of the EU also tried to draft and adopt similar regulations on insolvency on the basis of the last-mentioned attempts, such as the EC Directive on insolvency proceedings. However, this specific draft of a subsidiary agreement dealing with unification of the insolvency proceedings within the EU was prepared too early before the adoption of the Treaty of Amsterdam (from year 1997) and has never been signed. On the other hand, it served as the basis for the well-known Council regulation (EC) No. 1346/2000, which was prepared after the extension of the powers of the European Community by the Treaty of Amsterdam.

 

 

2. GENERAL EUROPEAN LEGAL REGULATION OF INSOLVENCY TODAY

 

Before the present European legal regulation of insolvency can be discussed in more detail, it is necessary to mention those articles of the EU Treaty that enabled adoption of such a regulation. The following articles of the Treaty establishing the European Community are concerned:

-          Article 10 – on fulfilment of the obligations arising out of this Treaty

-          Article 249 – on general application of the Regulations and Directives, binding, as regards the result that shall be achieved.

The general European insolvency law is primarily based on Regulations. “A regulation is a legislative act of the European Union that has general application. It shall be binding in its entirety and directly applicable in all Member States”.

  There are the following EU Regulations that deal with the insolvency law:

-          EC Regulation No. 1346/2000

-          EC Regulation No. 603/2005.

The legal regulation of insolvency proceedings in the EU is on the other hand based primarily on Directives. “A directive is a legislative act of the European Union. It shall be binding, as to the result to be achieved, upon each Member State to which it is addressed, but shall leave to the national authorities the choice of form and methods. A Directive differs from Regulations, which alone are at the same time implementing and do not require any implementation measures.”

There are the following main EU Directives concerning some specific questions of the insolvency law:

-          Directive No. 2001/17/EC

-          Directive No. 2001/24/EC

There may also exist some other Directives dealing with specific issues concerning the European insolvency law, yet these Directives regulate some very specific questions of the insolvency proceedings, such as the questions concerning insurance companies.

 

 

3. EC REGULATION NO. 1346/2000

 

General Introduction to the Regulation

 

The Regulation No. 1346/2000 on insolvency proceedings, which came into effect on the 31st May 2002, like many important and crucial legal regulations, did not originate overnight; the preparation of this Regulation lasted almost forty years. It has 47 Articles and contains the framework for cross-border insolvency within the European Union after the 31st May 2002. The Regulation according to the protocol of the Treaty of Amsterdam applies to all Member States of the EU except Denmark, including countries that joined the EU on the 1st May 2004. Like most modern international legal regulations dealing with insolvency, this Regulation is based on the principle of controlled universality. Most EU Member States thus still, irrespective of the fact that the Regulation, as an EU regulation, shall be binding in its entirety

 and implicitly applicable in all Member States, have to modify their national insolvency law within a very short term, so as to be fully compatible with this Regulation and capable of putting this objective into practice. There may consequently arise some problems, which have to be dealt with in most Member States, in order to make the Regulation fit correctly into their national legal frames. Some EU Member States have already, as a reaction to these problems and their diversity, modified their legislation, nevertheless some other Member States are still at the stage of consideration. The following rules that are determined by the Regulation are nevertheless applied directly:

    1. international jurisdiction of the court in the Member State that is supposed to open the insolvency proceedings,
    2. acknowledgement of these proceedings in other Member States,
    3. provisions on the election of law,
    4. the power of the liquidator (trustee in bankruptcy) to operate also in another Member State.

 

The general aims of the Regulation, besides directly applicable rules, which have been demonstrated above, shall primarily enable a more efficient and effective execution of cross-border insolvency proceedings, provide a unified framework for the coordination of provisions that are to be made with respect to the property of the debtor, and last but not least, they should also to eliminate the debtors‘ “forum shopping“ (intentional choice of court of any country).

 

The Framework for Insolvency Proceedings according to the EU Regulation on Insolvency

 

Article 1 of the Regulation defines the scope of powers of the Regulation. It is according to this article necessary for direct application of the Regulation to fulfil four cumulative conditions concerning the insolvency proceedings:

 

a) Only one set of main collective proceedings is permitted, which means that all relevant creditors may demand satisfaction only by means of these proceedings or by means of secondary insolvency proceedings that have been opened pursuant to these main proceedings, because individual suits will be precluded;

 

b) the proceedings concerning debtor’s insolvency have to be based only on „debtor’s insolvency“ and not on any other reasons. The test of insolvency itself is entrenched in the legislation of the Member State that instigates the main proceedings;

 

c) the proceedings concerning total or partial loss of debtor’s entitlement to the property have to result in his total or partial loss. Partial loss of debtor’s entitlement to the property, concerning debtor’s assets or his power of administering these assets, is sufficient. The possible legal character of this loss, depending on the relevant national legislation, does not have any influence on the application of the Regulation on relevant proceedings;

 

d) The proceedings concerning appointment of the liquidator should result in the liquidator being appointed. This requirement is a logical consequence of the previous condition. One can generally say that the transfer of rights to another person, namely the liquidator, takes place always in the case of any insolvency proceedings to achieve debtor’s loss of entitlement. This transfer involves the power of administering or disposition concerning all or part of debtor’s assets and limitations upon debtor’s powers by means of intervention and control of debtor’s action.

 

 

Scope of Application of the Regulation

 

The conception of the Regulation differentiates between three types of rules: procedural, substantive and collision rules. Procedural rules represent a concrete management policy. Substantive rules are rights and obligations that apply to persons whom they refer to. Collision rules are those, which the Regulation focuses on, because they help to decide in which country, and according to which law, the insolvency shall be enforced and what effect it will have on the material level of the law.           

 

The Regulation provides for two basic types of insolvency proceedings: main proceedings of universal scope and local proceedings of territorial scope. Both types of insolvency proceedings are described in more detail in individual chapters of the Regulation and will be outlined below.

 

The key point of the Chapter 1 is the jurisdiction and relevant law. Article 3 of the Regulation confers the jurisdiction to open the main insolvency proceedings. Member States are free to designate the national courts that may open insolvency proceedings. These insolvency proceedings should be recognised and effective in all other Member States without further formalities or obstructions. This Chapter further defines the term “centre of main interests”. It stands for the court of the Member State located in the Member State where the debtor has his “centre of main interests“ and that has jurisdiction to open the main insolvency proceedings. Debtor’s “centre of main interests” shall analogously be his place of the registered office.

 

Chapter 2 of the Regulation focuses on the recognition of insolvency proceedings. It makes use of the universality principle for the main proceedings opened according to the Article 3, which affect all the debtor’s assets and technically involve all his creditors. The Regulation guarantees this universality by setting up a system of mandatory and automatic recognition in all Member States.

 

This principle basically implies recognition of the main proceedings and its consequences in all Member States, where these assets or creditors are located. In other words, this practically means that the opening of main proceedings produces the same effect in other Member States as under the law of the state where the proceedings are opened. This actually provides solution to the key point mentioned in the Introduction to this paper – countries that did not want to accept the decisions of foreign institutions no longer have either the possibility or right to do so, because Chapter 2 of the Regulation puts them under explicit obligation to accept this. The Chapter furthermore deals with the appointment and recognition of the liquidator and with his powers in all Member States. This is one of the crucial effects of the Regulation, because the appointed liquidator is irrespective of the Member State where the proceedings are opened capable of executing his powers equally in all Member States.

 

Chapter 3 deals primarily with the “secondary insolvency proceedings”. The framework of this Regulation follows from the main insolvency proceedings in the Member State where the proceedings are opened, and where the debtor has his “centre of main interests“, yet it permits the opening of secondary proceedings in other Member States, if the debtor has any place of operation there. Chapter 3 of the Regulation deals with this matter in more detail. Secondary proceedings may serve two main purposes: firstly, they protect the creditors (usually local creditors) against the main proceedings and secondly, they help the main proceedings and support them. The opening of secondary proceedings may be demanded by the liquidator in the main proceedings or by another person who is duly authorized by the local law. It is worthy of notice that one of the crucial provisions dealing with secondary proceedings emphasises the obligation primarily for the liquidators to cooperate and communicate all necessary information. This may not necessarily be the case between the courts, due to the fact that there are certain problematic issues concerning cross-border insolvency. The Regulation thus follows the principle that various liquidators have to cooperate closely, especially by exchanging sufficient amount of key information. The main insolvency proceedings and secondary insolvency proceedings together may not contribute to effective realization of total assets, unless there is an effective coordination of all collateral and mutually dependant proceedings.

 

Chapter 4 of the Regulation deals with particularities of information for the creditors and with their claims. In short, each creditor, no matter where within the EU he has a seat, is entitled to set up their claims with respect to debtor’s assets in any set of insolvency proceedings that has not been closed yet.

 

Chapter 5, which is the last chapter of the Regulation, contains final and transitional provisions.

 

 

4. INFLUENCE OF THE CURRENT EU REGULATION ON INSOLVENCY ON THE LEGAL SYSTEMS IN THE EU MEMBER STATES

The Council Regulation (EC) No. 1346/2000 of 20th May 2000 on insolvency proceedings came into effect as late as on the 31st May 2002. The European Union thus introduced a legal frame for solving cross-border insolvency proceedings. However the Regulation is limited by its scope, which can be simply explained by diverse background of the legal systems of individual Member States.

                                                                              

The main reason lies in non-existence of a unified system of rights of retention (of deposits, guarantees) in Europe and in great diversity of the national insolvency laws with respect to the criterion of priority that shall be granted to various categories of creditors. In fact, the basic elements of the framework for insolvency law of each country still vary greatly. The same applies also to national legislations that have been revised in the last decade, e.g. in France and Belgium and – in year 1999 – in Germany and Italy. England and Scotland have already significantly revised their insolvency laws; Spain and Poland shall revise them this year, while a radical revision is already in progress in the Netherlands. Nevertheless, some Member States (such as Denmark, England, Italy, the Netherlands or Scotland) keep modifying the diversity of insolvency proceedings, which are often entrenched in several different national acts and regulations, whereas other European countries (such as Germany or France) have only one (complex) solution. Let us have a look at one figure as an illustration of this diversity: The EU Regulation on insolvency nowadays coordinates 54 types of proceedings. However, there is another difference in the scope of application of the insolvency law. For example in France and Belgium, the insolvency law applies only to debtors with commercial or professional activities, whereas in England, Germany or the Netherlands it applies basically to all types of debtors; with the exception of the last two countries mentioned, which again treat insolvency of banks and insurance companies (or some other financial intermediaries) very differently.

 

There are about twenty verdicts under this Regulation that were reached in Europe only in the first year since the Regulation on insolvency came into effect. It seems that the Regulation brought about interesting decisions especially in Great Britain, Germany, and the Netherlands. These decisions have pointed to the two main streams of problems in the area of legal regulation of insolvency and the insolvency legislation.

 

The first of them concerns the area that was excluded from the scope of Article 1, section 1 of the European Regulation on insolvency; namely insolvency proceedings concerning financial intermediaries, such as insurance companies, credit institutions, investment companies holding funds or securities for third parties and collective investment companies. The exclusion of these subjects has not been specified expressly in the Regulation, but only by means of other tools and regulations of the acquis communnautaire.

 

The second stream of problems may be connected with the limited geographic reach of the EU Regulation on insolvency. Although there is a widespread belief in most European countries that the EU Regulation on insolvency represents a giant step forward towards creating an approvable framework for facilitating the interaction and synchronization of various insolvency systems in the whole European Community, the principal drawback actually is the limited territorial scope of the Regulation. In the introductory part (item 14) of the Regulation is simply stated: “This Regulation applies only to proceedings where the centre of the debtor's main interests is located in the Community.“ As a result of this, the Regulation cannot be applied, if the centre of the debtor's main interests is located outside the area of the Member State; such as in Norway, Switzerland, Turkey, the CIS or the USA. Into the framework of the Regulation on insolvency does not fit either a debtor who only has his “place of work” there.

 

The Czech Republic has been bound by the European Regulation on insolvency since it joined the EU in May 2004. The recent insolvency regulation of the Czech Republic – Act No. 328/1991 Coll., on Bankruptcy and Settlements – is by various experts considered to be one of the worst insolvency regulations in the whole Europe, even despite the fact that it has undergone numerous direct and indirect revisions. The main reasons for criticism are:

a) insufficient protection of the creditors

b) „automatic“ winding-up of a company

c) too general provisions and interpretation

d) long duration of the proceedings.

 

A new law on insolvency was adopted as a result of this criticism – the Act No. 182/2006 Coll. on insolvency and settlements (or the new „ Insolvency Law“). This law has been in force since the 9th May 2006. It is a completely new regulation, (i.e. not another confused revision), which is elaborated in more detail and is more connected with the Regulation (EC) No. 1346/2000 in force. It might be considered to belong among modern regulations on insolvency, because this recodification is based on modern European regulations on insolvency. As a result of this, the insolvency proceedings according to this law include both European and international elements. Its effects are directly connected with the applicable Regulation (EC) No. 1346/2000 and with the relevant national regulation of the EU Member State, as required by the relevant EU law.

 

This law seems to be a good step forward, but there still remains the question, whether it will really bring some significant changes to the Czech insolvency proceedings practice. Unfortunately, it seems that the principle of the problems with Czech insolvency proceedings practice is connected not only with poor quality of the current laws, but probably also with many other critical and eventual problems, which will be explained in the following paragraphs of this paper.

 

If we want to sum up the effects of the legal regulation of insolvency since year 2003, we shall point out to a very important period in the development of international insolvency law, especially within the region of Europe. The main legislative development can be observed in the legal systems of Germany and Spain, as well as of Austria; out of the new EU Member States or Accession States can be mentioned Poland and Romania. A majority of these legislative developmental modifications, except for the German and Austrian ones, recognize the model law of UNCITRAL and specifically coordinate their approaches to codification of international insolvency law regulations. The main driving force within the context of the EU that led to creation of the EU Regulation on insolvency was the idea that insolvency of companies, the activities of which have bigger and bigger cross-border impacts, significantly affects proper operation of the domestic market. This invoked the need for a European Community Regulation that would focus on necessary coordination of activities concerning assets of an insolvent debtor. The followed EU principle is not restricted only to the EU territory, but could partly be detected also in other regions worldwide. However, only time will tell, what the real assets of synchronization of the provisions concerning cross-border insolvencies, which include also interests of countries - non-member states, are.

 

5. DIFFERENTIAL ANALYSIS OF INSOLVENCY REGULATIONS AMONG SELECTED EU MEMBER STATES

Before we start performing the differential analysis of insolvency regulations among selected EU Member States, it is first necessary to determine the main indicators, which may be used to assess, or even better to measure, the efficiency and quality of the insolvency regulations. One of the factors that might reflect the quality of these regulations definitely is the duration of legal action, in this specific case – duration of an average set of insolvency proceedings.

 

There are at least three main factors that may exercise an influence on the insolvency proceedings: legislation, judicial process and corruption.

 

The legislative situation in the Czech Republic is by no means very positive. „The legislative environment in the Czech Republic for supporting the rights of creditors and recovery of debts is generally considered as unsatisfactory.“ Until recently, the situation was similar also in Slovakia, which had almost identical insolvency law. The adoption of new legislation, which took place about a year ago, may not have such a considerable effect, nevertheless one can still expect bigger chances in the future. Besides that “the non-existence of explicit procedural rules including mandatory deadlines make room for arbitrariness, cause an excessive prolongation of the proceedings, and postpone the decision-making.“ It can be said that this statement still holds true for the Czech Republic, where the old insolvency law is still in force, although the newly adopted Insolvency Law, which shall come into effect on 1st July 2007, contains for example mandatory deadlines. Ireland, on the other hand, has a modern Insolvency Law, which ensures effective judicial process by observance of all deadlines.

 

Another significant factor that influences the efficiency of insolvency proceedings is the judicial process. This is probably the main reason for the ineffectiveness of insolvency proceedings in the Czech Republic, as well as in Slovakia, which manifests itself in the long-windedness of the process. Both legal systems distinguish magistrates in bankruptcy, who are a part of regional courts and deal only with commercial matters. However, these they may deal with commercial matters also in some other regions. “Most judges are overburdened with cases and the number of arrears keeps rising, because the judges are unable to close cases as quickly as they open new ones.“ The process is thus protracted and lasts 9 years on an average. Nevertheless, this is the problem not only of bankruptcy proceedings, but also of all proceedings concerning business matters in general. “Approximately one third of trade disputes lay at courts for more than 5 years.“ This may be explained by the number of commercial cases that suddenly appeared after the change of regime in year 1989, as well as by the high number of less important or fundamental cases. There is, according to the words of the Ministry of Justice, a lack of judges, particularly in some regions (e.g. Northern Moravia), but the processes are slow also in regions that are expected to have enough judges. Ironically, the less judges are statistically available per one inhabitant, the more effective the judicial process appears to be (e.g. the Czech Republic has 3 645 inhabitants per one judge, Slovakia 4 607 inhabitants per one judge and Ireland approximately 50 000 inhabitants per one judge!). It is therefore highly probable that the judges either do not work efficiently enough, or are forced to do also someone else’s job, i.e. they spend more time on dealing with paperwork than on judicature. Excessive is especially the amount of paperwork in courts, which therefore are desperately in need of new office workers. This is another significant difference between the Czech Republic and Slovakia on the one hand, and Ireland on the other hand. The procedural part of the lawsuit itself in Ireland is also quicker and more efficient.

 

The last significant factor that influences the insolvency proceedings is corruption. Corruption undoubtedly remains an important factor, which may influence any lawsuit. According to Transparency International is corruption a fundamental problem both in the Czech Republic and in Slovakia. The Corruption Perception Index (CPI) for year 2005 in both countries was 4.3, which means that they occupy the 47th position in the world, or in other words, have the worst result in the European Union (a level of CPI below 5 represents according to TI a serious problem). Although the CPI in the Czech Republic and in Slovakia is the same, the Czech Republic is in a worse situation than Slovakia. Slovakia achieves an improvement caused by a reform of the whole judicial system, whereas the Czech Republic is in the period of stagnation and status quo. By way of contrast, the CPI in Ireland is 7.4 and this figure will generally remain above 6.9 in the long-term.

 

6. CONCLUSION

The existence of the new „Insolvency Law“ of the Czech Republic is the best example of how integration of the Czech Republic into the established order of the European Union can bring a positive effect also in the legal sphere, nevertheless, the main aim of this new legal regulation remains the growth in economic benefit for the country itself. Positive effect therefore again cannot be fully realized, unless relevant reforms are performed in a complex way. As results from the performed analyses, the changes in insolvency legislation have only partial effect, if they are not accompanied by adequate support, i.e. by the desirable drop in the total level of corruption or of the ineffectiveness of the management in public offices, and by an improvement in the general economic development of the whole society. At the same time, if we take a look at this issue from the European point of view, the issue of cross-border insolvency already is being dealt with on the European level, and thus the global equivalent seems to be highly desirable. If this further step is not taken, then the malevolent debtors will make use of any opportunity, concerning circumstances and possibility of prediction, to abuse the ineffectiveness resulting from cross-border cases, which are hardly regulated nowadays. The EU Regulation on insolvency should thus be another good example for a global equivalent, towards which the European legal regulation of insolvency certainly is heading.

 

 

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[1] JUDr. Ilona Schelleová, Dr., Faculty of Law of Masaryk University, Brno, Czech Republic

 

[2] Doc. JUDr. Karel Schelle, CSc., Faculty of Law of Masaryk University, Brno, Czech Republic