Michał Barłowski, interviews

Michał Barłowski: A revolution ahead in Polish bankruptcy law

An interview with Michał Barłowski, the partner in charge of the Bankruptcy and Restructuring practices at Wardyński & Partners, about planned amendments to Poland’s Bankruptcy & Rehabilitation Law.

Litigation Portal: Restructuring is an alternative to bankruptcy. So why do we hear so little about effective restructuring and so much about liquidating bankruptcies?

Michał Barłowski: The reasons are many and have various sources. Some businesses still believe that they can manage to the bitter end. This is one of the reasons that the provisions on rehabilitation do not function. This procedure may generally be initiated by a debtor that is still solvent but foresees that it will become insolvent. Another contributing factor may be a lack of awareness of the potential consequences of delay in filing a bankruptcy petition. There are also “staged” bankruptcies, where the debtor is first stripped of its assets, to the detriment of the creditors. Nor should we overlook plain old poor management, which may lead to a loss of liquidity, for example through overinvesting.

Some also blame the law. A scapegoat here may be, for example, the Public Procurement Law. Businesses complain that if the sole criterion for selection of a contractor is price, the competition on the market is so intense that they are practically forced to submit bids that trim their profit margin to the bone. In that case, an increase in prices of services or materials needed to fill the order, or delay in payment for goods and services provided under the contract, may result in the contract becoming unprofitable or even require the contractor to file for bankruptcy.

Others perceive the problem in the Bankruptcy & Rehabilitation Law, particularly the severe definition of insolvency, under which non-payment of just two invoices that are due, payable and undisputed qualifies a business as insolvent.

The Ministry of Justice is developing amendments to the Bankruptcy & Rehabilitation Law. What changes should we expect to see?

Indeed, a team appointed by the ministry drafted the guidelines for amendments to the law and published them in December 2012. If these proposals are enacted, we will face a revolution rather than evolution in the law, if we compare these changes to the most recent “major” amendment of the Bankruptcy & Rehabilitation Law, in 2009.

A new insolvency procedure is to be introduced as an alternative to a liquidating bankruptcy. This would be modelled not on Chapter 11 of the US Bankruptcy Code but on the French procédure de sauvegarde. This is intended to facilitate the process of restructuring of debtors.

Many procedural simplifications are also called for, and—to avoid stigmatising debtors—a division between restructuring proceedings (there would be three different arrangement procedures and one rehabilitation procedure) and bankruptcy proceedings (what are currently known as a liquidating bankruptcy). It was decided not to force secured creditors to participate against their will in any restructuring proceedings. Another new aspect would be the option to defer payment of social insurance obligations or spread the payments out in instalments (but without reducing the principal amount).

Among the more interesting of the proposed changes is the weakening of the definition of insolvency, which apparently was drawn from Poland’s Bankruptcy Law of 1934. Two grounds for insolvency—liquidity and balance sheet—would remain. A business would be found to be insolvent on the basis of liquidity if it has objectively and continually ceased paying its debts as they fall due, and this would be presumed to be the case (in the absence of evidence to the contrary) if there is a delay in paying monetary obligations of over 3 months as of the date of filing of an application to open one of the proceedings. Under the balance-sheet test—oversimplifying for this purpose—it would be assumed that a business (whether a legal person or an organisational unit) is insolvent when the value of its assets is less than the amount of its obligations (in other words, the same test that is currently in place), but such state would have to persist for over 24 months.

The deadline for filing a bankruptcy petition would be extended to one month, as it is well-known from practice that the current 14-day period is unrealistic. Issues concerning the ineffectiveness of transactions conducted to the detriment of the bankruptcy estate (or the rehabilitation estate—a new term) would be tightened by extending ineffectiveness to cover transactions with affiliates within a capital group as well as unilateral acts (e.g. if a contractual penalty is imposed when there is no loss). The provisions concerning the ineffectiveness of contracts with the debtor’s representatives for inflated fees would be changed. A procedure would be introduced for involuntary liquidation of companies with respect to which a bankruptcy petition has been denied because of insufficient funds to cover the costs of the bankruptcy proceeding. There are many changes, and they are needed.

Although I regard the proposed changes favourably, there are areas in which I sense a shortage of new approaches. In my view, creditors will still have too few legal instruments to exercise influence over the course of the proceedings (issues such as selection of the bankruptcy trustee and the competencies of the creditors’ committee, not to mention an influence over the type of procedure to be conducted). In an economic sense, it is the creditors who should be calling the shots in the proceeding, because the restructuring will determine the conditions and the amount for repayment of “their” money. The creditors should thus have an influence not only on the conditions of the arrangement by voting on the plan (here I take a positive view of the idea that only active creditors should vote on the plan), but they should also have an influence on what happens during the course of the proceeding, i.e. who manages the debtor’s enterprise and how. This is what determines whether value will be created in the enterprise and whether performance of the plan will ultimately be feasible. I would be in favour of an approach under which the worse the debtor’s situation, the greater influence creditors have on what happens with the debtor’s assets, at the expense of the debtor’s rights. The court should guard the interests of all of the parties by examining whether the proposed plan represents a compromise which would unjustifiably prejudice the interests of any of the parties, or violates the law or public policy. Discipline should also be imposed on the parties so that they bring the restructuring procedure to a close as quickly as possible.

In turn, in a liquidating bankruptcy, the procedure should be designed, with few exceptions, to most effectively distribute the debtor’s assets, unless the creditors determine that it is in their interest to continue operating the enterprise for a certain period. This is what happened, for example, in some of the proceedings concerning the assets of Lehman Brothers, where due to the unfavourable economic environment (fire sale prices for assets), the creditors preferred (indirectly) to keep the assets under management for some time in order to liquidate them when the market was better.

Of course it should be borne in mind that this is an oversimplified picture which does not take into account, for example, the conflict between the interests of various creditors (priority vs. non-priority, old vs. new, creditors who are insiders or affiliates, financial creditors vs. trade creditors, and so on), which are often hard to reconcile.

Also notable is the broad discretion which the drafters of the law plan to provide debtors, counting on their ingenuity in selecting one of the four available restructuring procedures. I have my doubts whether businesses will be in a position to make the right choices. Suffice it to say that under current law, companies file bankruptcy petitions late, 80% of those are for liquidating bankruptcies, and the rehabilitation procedure is not working.

All four of the restructuring procedures would be available to both solvent and insolvent debtors. I am concerned that this could lead to discrepancies between the letter of the law and the practice. This is the case now under the balance-sheet test for insolvency. (If a company takes out loans to launch its business, it may be deemed insolvent from the very start and thus should immediately file a bankruptcy petition.)

A sine qua non for opening restructuring proceedings would be the debtor’s guarantee that obligations arising after opening of the proceeding would be paid. Although the rule that the plan covers only obligations that arose before opening of restructuring proceedings is part of the canon of every arrangement procedure, in the case of severe insolvency, when it will take time to sell off non-essential assets, restructure employment and make changes in the product line and distribution system, it will probably not be possible to guarantee that obligations arising after opening of the proceedings will be paid.

As I understand it, the “guarantee” of payment of such obligations should occur at the stage of issuance of the order opening the restructuring proceeding. Thus if the petition to open the proceeding is filed by an insolvent debtor (and all four restructuring procedures would be available also to such debtors), it appears that in practice the only debtors that will be able to take advantage of these procedures are those that are only mildly insolvent or those that are paying their debts on a current basis but do not have funds to pay off long-term obligations, such as loans.

This situation should be examined on the basis of the proposed new, relaxed definition of insolvency, which emphasises the loss of the ability to satisfy monetary obligations, i.e. an objective and long-term inability to satisfy such obligations. In my view, this means that merely suspending the duty to satisfy monetary obligations that arose before opening of the restructuring proceeding will not be sufficient to guarantee payment of new obligations arising after the proceeding is opened.

The practice will probably move toward making a rational economic assessment of the debtor’s projected cash flow for the first few weeks after opening of the proceeding. If the debtor’s asset position and relations with its own debtors demonstrate a likelihood of meeting current obligations, or opening the proceeding would enable the debtor to obtain new financing, such proceedings would be opened.

Such petitions would be considered by experienced judges from the regional courts (rather than district court judges as is now the case). The debtor should be required to submit a statement at the stage of filing of the petition to open restructuring proceedings that it has liquid funds available to satisfy the obligations that will arise after opening of the proceeding or will have such funds in hand for several weeks after opening of the proceeding or until new financing is obtained.

When should we expect the new regulations to be ready?

I understand that it was originally expected that the time required to draft the actual regulations based on the guidelines already presented would be short, but it is hard to predict how fast the bill would work its way through the legislative process or, once enacted, how long it would be before the new regulations enter into force. I should also mention that many EU member states have already amended their insolvency regulations.