Know your place

The European Commission’s Regulation on Insolvency Proceedings has been taken up in a number of cases. Lyndon Norley and Richard East report on how it has been interpreted

Since the European Union (EU) Reg-ulation on Insolvency Proceedings came into effect across Europe on 31 May 2002, there have been a number of interesting judicial decisions interpreting and applying its provisions.

The regulation is directly effective in 24 of the 25 current member states of the EU (it is anticipated that Denmark will shortly pass the parallel domestic legislation necessary to incorporate the regulation into its laws).

Despite its somewhat ambiguous name, the regulation does not replace the national insolvency regimes applicable in each state. It is instead designed as an instrument to mediate between the potentially competing courts of each state in order to determine which country has jurisdiction over the insolvency of a particular debtor. The express purpose of the regulation, as set out in Recital 15, is to designate the state, whose courts may open insolvency proceedings in respect of a debtor.

As a tool for the avoidance of judicial conflict in pursuit of European integration, the regulation does for insolvency proceedings what the Brussels Regulation of 2001 did for non-insolvency civil and commercial contentious proceedings.

Application of the regulation

The regulation does not apply to insurance undertakings or credit institutions, for which categories of debtor the EU has promulgated specific directives. Nor does it contain any express provisions relating to groups of companies, although, as described below, this has not hindered the courts from applying the regulation in such situations.

According to the regulation, the courts that will have principal jurisdiction over an insolvency are the courts of the EU member state in which the debtor’s “centre of main interests” (Comi) is located. The Comi is presumed to be the location of incorporation or registration of the debtor in question. However, this presumption is rebuttable and Recital 13 to the regulation provides that the Comi “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”.

The regulation applies to “collective insolvency proceedings which entail the partial or total investment of a debtor and the appointment of a liquidator”. The categories of insolvency proceedings to which the regulation applies, which can be winding-up or reorganisation proceedings, are listed exhaustively by jurisdiction in Annex A. Notably, out-of-court proceedings and solvent liquidations are generally excluded from the scope of the regulation.

Once the location of the main proceedings has been determined, the law of that state applies exclusively to the debtor’s assets, and in particular governs such matters as the powers of the insolvency practitioner, the conditions for set-off and the terms governing the lodging and verification of claims and the distribution and realisation of assets. However, this rule is subject to some important specific categories of exceptions, notably:

  • Rights in rem, ie security interests. In circumstances where secured assets are situated in another European member state, the enforcement of security is governed by that state’s law.
  • Rights of set-off. The terms of the regulation do not affect the rights of creditors to demand set-off against a debtor where such a set-off is permitted by the law applicable to the debtor’s claim.
  • Employment contracts. The law to apply is that which is applicable to the contract in question.
  • Financial market settlement systems. The law to apply is that applicable to the system in question.
  • Contracts relating to immovable property. The law to apply is that of the member state in which the property in question is situated.

Secondary proceedings

Once main proceedings have been opened in a member state, the only proceedings which may be opened by the courts in another state are “secondary proceedings”. Such proceedings may be opened in any state in which the debtor has an “establishment”, defined in the regulation as “any place of operation where the debtor carries out a non-transitory economic activity with human means and goods”. This generally requires the existence of a branch office or similar, rather than the mere presence of assets.

Secondary proceedings under the regulation may comprise only liquidation or winding-up proceedings and are limited in scope to the realisation of the debtor’s assets within that jurisdiction. Such secondary proceedings are discrete ancillary procedures used in various sets of circumstances, eg where local interests are to be protected, the debtor’s estate is very complex and diverse, or where there are great differences between the legal systems in the secondary jurisdiction and in the jurisdiction in which the main proceedings are taken. To ensure the dominance of the main proceedings, the insolvency practitioner in such proceedings is given the express opportunity to intervene in the secondary proceedings, and even to request a stay of the secondary proceedings if this may benefit the creditors in the main proceedings.

Automatic recognition

One of the principal facets of the regulation is that it provides (in Article 16) that any judgment opening main or secondary proceedings will be recognised automatically in other EU member states without the need for further formalities, unless the regulation provides otherwise (eg rights in rem) or a secondary proceeding has been opened in the jurisdiction in question. There is also a residual public policy exception set out in Article 26 of the regulation that gives a member state the discretion to refuse to recognise proceedings brought in another member state if to do so would be “manifestly contrary” to its public policy. This provision has already been given its first airing in the Eurofood litigation as described below.

Case law on the regulationInitially the regulation was met with a large degree of scepticism, on the basis that it did not expressly seek to deal with the insolvency of corporate groups, instead focusing on the Comi of individual companies. It was perceived that this would result in multiple competing proceedings in different jurisdictions. Concerns were also raised about the unclear definition of “centre of main interests”. These misgivings have been swept away by the body of case law which has emanated from the judicial interpretation of the regulation. Judges, particularly in the UK, have embraced this new tool enthusiastically. Highlights include the Enron Directo, BRAC Rent-a-Car, and Crisscross Telecommunications cases.

The regulation was intended to combat the incidence of forum shopping within the EU – indeed, Recital 4 to the regulation states that it “is necessary for the proper functioning of the internal market to avoid incentives for the parties to transfer assets or judicial proceedings from one member state to another, seeking to obtain a more favourable legal position (forum shopping)”. It appears from the case law to date that the operation of the regulation may in fact have significantly assisted such forum shopping.

The Eurofood case is one of the most recent, and perhaps the most important, developments in the judicial interpretation and application of the regulation. It concerns an Irish subsidiary of the Parmalat group of companies. In January 2004, a provisional liquidator was appointed to Eurofood in Ireland without reference being made to the regulation. However, in February 2004 the Italian courts, in reliance both on general principles of Italian insolvency law and on the finding that the company’s Comi was in fact located in Italy (because, for example, the ‘executive’ directors were based in Italy and Eurofood had no real presence in Ireland) opened ‘main proceedings’ in Italy and placed Eurofood into the Italian equivalent of administration. Crucially, the Italian court did not consider whether the appointment of the provisional liquidator in Ireland precluded it from opening main proceedings in respect of Eurofood.

Unsurprisingly, the Irish court, when this matter was brought before it again in March 2004, did not agree that the appointment of a provisional liquidator in Ireland was irrelevant to the question of the opening of main proceedings. It held that, by making the appointment order in respect of the company in January 2004, it had opened main proceedings prior to the Italian court, and therefore that it had jurisdiction.

To justify this finding, the Irish court made reference to the fact that the registered office of the company was located in Ireland, that the company was subject to Irish fiscal and regulatory provisions, that third-party creditors would consider the company to be located in Ireland, and indeed that there were no other factors to suggest that the Comi was located anywhere else other than Ireland.

The Irish court of first instance held further that it was implicitly entitled to review the decision of the Italian court to open main proceedings (as the Italian court did not have the jurisdiction to do so); and that in any event, it could refuse to recognise the Italian proceedings on the authority of Article 26 of the regulation on the basis that the company’s creditors had not been given any notice of the Italian hearing, and the Irish provisional liquidator had been given one only working day’s notice, resulting in a breach of those parties’ rights to a fair hearing under the European Convention on Human Rights.

Upon appeal by the Parmalat administrator Enrico Bondi, the Irish Supreme Court has sensibly decided to refer certain questions to the European Court of Justice (ECJ) before giving its definitive ruling. In summary, these questions are as follows:

  • Does the appointment of a provisional liquidator constitute the opening of main proceedings for the purposes of the regulation?
  • What factors are relevant in the determination of the location of a debtor’s Comi?
  • What are the parameters of operation of the public policy exception set out in Article 26?

The decision of the ECJ is keenly awaited, as this ruling will constitute the first piece of definitive guidance on the meaning of Comi. However, the ECJ has refused an application to ‘fast-track’ its decision, hence judgment will be delayed for between 12 and 18 months. It is noteworthy that the Commission has recently decided to commission a review into the practical effects of the regulation. The fact that this review has been commissioned at a much earlier stage than was anticipated indicates both the level of uncertainty surrounding the regulation and the level of importance given to it. In the meantime, the uncertainty will continue, with perhaps a paralysing effect in some cases.

The future of the regulation

It seems likely that the ruling of the ECJ in the Eurofood litigation on the regulation will mirror its recent decision in respect of the operation of the Brussels Regulation in the twin cases of Erich Gasser GmbH v MISAT and Turner v Grovit. In this decision, the ECJ upheld the right of a domestic court in the EU member state that first considers a matter to determine the extent of its own jurisdiction pursuant to the Brussels Regulation without any interference (either at the time or subsequently) from any other domestic court in another member state, even if the parties have agreed expressly that the latter court is the sole forum for the resolution of disputes between the parties.

In its decision in Gasser and Turner, the ECJ effectively recognised that, in order for such pan-European mediation instruments to work, it was an essential prerequisite that any court that considers a matter should defer to the finding of the court that first considered the matter, even if the decision of such court is manifestly incorrect and even if one or more of the parties have acted in bad faith.

An equivalent finding, upholding the jurisdiction of the Irish court, is likely in the Eurofood litigation. As Recital 22 to the regulation makes clear: “The decision of the first court to open proceedings should be recognised in the other member states without those member states having the power to scrutinise the court’s decision.” In order for the regulation to work effectively as a mechanism to avoid the duplication of proceedings, it is imperative that the decision of the first court that has determined that it can open main proceedings be respected.

The practical result of all this will be that debtors who wish to avail themselves of the insolvency proceedings in a particular jurisdiction should ensure that they are quick to make an application to the courts in that jurisdiction, and that there are credible arguments that their Comi is located in such jurisdiction.

The regulation has proved to be a very interesting piece of legislation that is likely to have considerable influence on European insolvency proceedings in the future. Whether your view is that the regulation has been used tactically or abused, it has undeniably provided greater flexibility (and with it uncertainty) to all professional advisers in the insolvency and restructuring arena.

Lyndon Norley and Richard East are partners at Kirkland & Ellis in London. They were assited in this article by associate Graham Lane