Corporate Debt Resolution in particular in the context of the Winding-up Procedure - No deterioration of the creditors' position

Legal insight

April 2021

George Kefalas, LL.M. (mult.), Μ.Sc.

(republished from Capital.gr)

Summary: The principle of no deterioration in the position of creditors is expressed in many legislative texts and pervades insolvency law as a whole. Compliance with this principle is a prerequisite both in the context of the out-of-court mechanism and of reorganisation, and in practice it is also a necessary condition for reaching a settlement agreement with credit institutions or debt management companies. The correct application of this principle is therefore of paramount importance in all cases where the need to settle a company's debts arises.

1. Introduction

After the outbreak of the economic crisis in Greece, there have been many cases of companies and individuals who have tried to achieve a settlement of their debts, especially with credit institutions or debt management companies, the so-called funds (or servicers). The relevant institutional framework has been specified by establishing specific principles that must be observed so that the credit institution, but also the State or the Social Security institutions, can consent to such a settlement. The new bankruptcy code (Law 4738/2020 - Debt Settlement and Second Chance) repeats the basic principles already reflected in the previous bankruptcy code, the previous law on the out-of-court mechanism (Law 4469/2017) and Article 65 of Law No. 4472/2017 on the liability of representatives of the State and credit institutions from loan and debt restructuring operations. Prominent among these principles is the "principle of non-deterioration of the position of creditors". Compliance with this principle is a basic precondition for the conclusion of a reorganisation agreement, but also for any agreement on the settlement of debts to the State or the banks in general. 

2. The principle of no deterioration in the position of creditors

The principle of non-deterioration of creditors' position means that a creditor cannot be placed in a worse position than he would have been in if he had initiated enforcement proceedings and, especially in the case of reorganisation, than he would have been in if the debtor had been bankrupt. In simpler terms, the arrangement means that the creditor cannot receive less than he would have received if the debtor had gone bankrupt. This assessment takes into account not only the amounts that the creditor would recover in each case (in the arrangement or in bankruptcy), but also the time and manner of recovery. 

This principle applies in principle only to non-consenting creditors. On the contrary, consenting creditors can agree to receive even smaller amounts under the reorganisation agreement than they would have received in the event of the debtor's bankruptcy. However, this is not the case with regard to the claims of the State, which can only consent if this principle is fulfilled. 

Prior to Law no. 4738/2020, the same could be said with regard to credit institutions, as the (now repealed) Art. 3 of Law No. 4472/2017, stipulated that an employee of a credit institution is liable for civil and criminal liability if he or she signs a restructuring agreement, without fulfilling the principle of not worsening the position of creditors. Following the repeal of the above article, it seems that credit institutions can consent to a restructuring agreement even if their position worsens, if they expect other benefits, e.g. long-term good cooperation with the debtor. 

In order to establish whether or not this principle has been violated, a comparison should be made between the amount that the creditor would receive in the event of bankruptcy and the amount he would receive from the implementation of the reorganisation agreement. The following is a step-by-step analysis:

3. The first part of the relationship. The first part is the amount that the creditor will recover in the event of bankruptcy.

i) Preparation of a list of the debtor's assets. In the context of reorganisation, the compilation of a list of the debtor's assets is part of the minimum content of the expert's report. 

ii) Calculation of the value of the forcible liquidation of the debtor's assets. According to the instructions of the Special Secretariat for Private Debt Management (S.S.D.I.M.), the value of the forcible liquidation will be reflected in an appraiser's report and, in the absence of such a report, the value of real estate will be derived from the ENFIA certificate and of movable assets from their book value (e.g. (e.g. equipment) and, in the case of movable property that is not accounted for, from the declaration of the debtor, who will have to provide relevant evidence of value if requested. 

iii) Reduction of the value of a forced liquidation to present value: The forcible liquidation value is what the asset will yield at the time of the auction. Conducting the auction in the context of bankruptcy (but also outside bankruptcy) requires a certain period of time to elapse. According to the EIFID guidelines, the maximum period required for liquidation in bankruptcy is, depending on the type of each asset, 5 years. This value should therefore be discounted to the present on the basis of a discount rate. The discount rate used is the debtor's weighted average cost of funding as derived from the proposed resolution agreement. As an indication, for January 2021 the weighted average cost of funding according to the Bank of Greece was 4.63%, but a lower rate may be agreed by the parties.

iv) Deduction of the costs of the procedure. According to the Hellenic Financial Markets Authority's guidelines, the costs of the proceedings cannot exceed 5% of the value of the asset. 

v) Calculation of the amount that the creditor concerned would recover in the event of bankruptcy: Now that the present value of each of the debtor's assets has been determined and the costs of the proceedings have been deducted, it is necessary to calculate what amount each creditor would recover from each asset. At this point, the classification rules set out in the Code of Civil Procedure and the Bankruptcy Code will apply. Under these rules, a creditor with a security interest in the asset (mortgage, mortgage lien or pledge) will receive 65%, a creditor with a general privilege (including the State and Social Security institutions) will receive 25%, while the other creditors will receive the remaining 10%, in equal shares, i.e. each according to the amount of their claim. If there are no general preferences, the implicitly secured creditors will receive 90% of the value of the asset, while the unsecured creditors will receive 10%, and if there are no implicitly secured creditors, the general preferences will receive 2/3 and the unsecured creditors 1/3.

It should be noted that for the application of the principle of no deterioration of the creditors' position, the property of any guarantors is not taken into account, since, according to para. 3 of Article 60 of Law No. 4738/2020, the creditor's claims against the guarantors remain unchanged, unless the creditor expressly agrees to limit them. However, if, exceptionally, the creditor agrees to limit the guarantee, he will require, in order to consent, to receive at least as much as he would have received from the liquidation not only of the debtor's property but also of the guarantor. 

For example, suppose a company has the following assets:

Assume that the company's creditors are the following:

From the auction of each asset, creditors would receive the following amounts in present value terms:

4. The second part of the relationship. The amount that the creditor will recover if the reorganisation agreement is confirmed. 

i) The reorganization agreement shall agree between the consenting creditors and the debtor on the amount and method of repayment of each creditor, whether consenting or not. It is this amount that must be compared with the amount that the creditor would receive in the forced liquidation scenario and if the former is superior to the latter, the principle of no deterioration of the creditors' position is fulfilled. 

ii) In the case where the resolution agreement does not provide for a one-off repayment of the creditor, then the amount received by the creditor over time should, accordingly, be reduced to a present value, similarly based on a discount rate defined by the relevant guidelines of the Hellenic Central Bank as the weighted average cost of funding as derived from the agreement. 

iii) The present value of the total amount received by the creditor from the implementation of the resolution agreement will be compared with the present value of the amount recovered by the creditor from the involuntary liquidation procedure to determine whether or not the principle of no deterioration in the position of creditors is complied with.  

Thus, let us assume in the above example that under the reorganisation agreement it was stipulated that the creditors would receive the following amounts in equal monthly instalments over a period of five years:

In the above example, the principle of non-deterioration of the creditors' position is fulfilled for all creditors, since, as can be seen from the above table, each of them will receive under the agreement a higher amount in present value terms than the amount they would have received in the event of a forced liquidation in bankruptcy. 

5. The application of the principle to debt arrangements outside the reorganisation procedure

As mentioned above, the same principle of no deterioration of the creditors' position must be fulfilled in the context of the new out-of-court mechanism, while in practice it is also a principle in any arrangement agreement with a credit institution, even at bilateral level. In this respect, the first part of the relationship will take into account the amount that the creditor would recover in the event of enforcement against the debtor and not in the event of the debtor's bankruptcy. 

In these circumstances, the decisive factor is, on the one hand, the amount of the debt and, on the other hand, the time when the enforcement proceedings are concluded by the auction. 

6. Instead of an epilogue

The principle of non-aggression is the fundamental principle in any arrangement agreement with credit institutions. Even after the repeal of Article 65 par. 3 of Law no. 4472/2017, credit institutions require that this principle be respected in order to proceed with any arrangement. Besides, the new procedure of the out-of-court mechanism is also moving in this direction, where the issuance of a relevant Ministerial Decision specifying how this principle will be applied for the seized creditors is foreseen. Therefore, in the context of the negotiation, the correct application of this principle and the objections that the debtor can legally raise in the liquidation procedure (appeals against payment orders, seizure reports, etc.) will play a key role. Any refusal by a credit institution to agree to an arrangement, despite the fact that this principle is fulfilled, will provide the debtor with a further argument to demonstrate the bank's abusive behaviour in a future dispute.