European Law on Cross-border Insolvencies Status of French Practice After the E.U. Regulation

European Law on Cross-border Insolvencies Status of French Practice After the E.U. Regulation

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The EC Regulation1 on insolvency (Regulation) went into effect in May 2002 in all E.U. member states except for Denmark. The rules contained in the Regulation will have a significant impact on French practice in cross-border insolvency cases, especially in that the courts may have jurisdiction to open a main insolvency proceeding against a legal entity domiciled in the European Union.

The Regulation has already changed French practice in light of a recent ruling rendered by the Versailles Court of Appeal on Sept. 4, 2003, which has highlighted certain difficulties in the interpretation of the Regulation and has opened the door to a risk of forum-shopping across European member states.

At the same time, the pre-draft bill of the French Ministry of Justice currently under discussion would create a new type of settlement directly inspired from the U.S. chapter 11 procedure in order to prevent court-regulated insolvencies. This pre-draft bill is perhaps only a first step toward rendering French insolvency laws less dramatic for investors and creditors and, consequently, improving their flexibility vis-à-vis international companies that will be in a position to either choose the jurisdiction in which to locate their European headquarters or, alternatively, delocalize management decisions across the various E.U. member states.

Choice of Forum Under the Regulation

The Regulation applies directly to insolvency proceedings opened after May 31, 2002. It applies, broadly speaking, to (1) both natural and legal persons and (2) collective insolvency proceedings that entail the partial or total divestment of a debtor and the appointment of a liquidator (thus, both winding-up and reorganization proceedings). In France, these proceedings are the "redressement judiciaire avec nomination d'un administrateur judiciaire" and the "liquidation judiciaire."

The main purpose of the Regulation is to improve the efficiency and effectiveness of insolvency proceedings by providing a framework within which the different insolvency regimes existing in the various member states can operate and interact. Where the Regulation applies, it determines the jurisdiction in which insolvency proceedings can be initiated and, subject to certain exceptions, the law that will govern.

The following two types of insolvency proceedings are envisaged by the Regulations:

"Main" proceedings are aimed at encompassing all the debtor's assets, without the need of any publication or formal act of recognition in the other member states. For example, the debtor shall, in principle and subject to certain exceptions (e.g., rights in rem), be shielded from creditors' actions in all E.U. member states simultaneously with the opening of the main proceedings in any given member state. However, the effect of the main proceedings in another member state shall stop as soon as a secondary proceeding is opened in that other member state against the same debtor, in which case the assets located in that other member state shall be subject to the secondary proceedings. Consequently, there can only be one main proceeding set within the European Union (by contrast, several "secondary proceedings," as defined below, can be opened at the same time), and the office-holder appointed in the main proceeding must also be recognized and able to exercise its powers in the other member states where a secondary proceeding has been opened.

"Secondary" proceedings are limited to the debtor's assets located in the member states where said proceedings were opened (territorial proceedings). Secondary proceedings must, in principle, be a winding-up proceeding if opened after the opening of main proceedings; by contrast, if the opening of secondary proceedings takes place after that of main proceedings, it shall not necessarily consist of winding-up proceedings.

Different rules apply depending on whether the opening of secondary proceedings takes place before or after the opening of main proceedings.

The Regulation provides also the means necessary to coordinate these different proceedings, such as:

  • The legal effects of the main proceedings opened in a member state must be recognized across the European Union.
  • The law applicable to insolvency proceedings and their effects shall in principle be that of the member state within the territory of which such main proceedings have been opened.

The issue of determining jurisdiction appears as the critical one, an issue to be resolved by each national court before which the case is heard (on the basis of the latter court's own national laws).

In making this determination, courts of the member state within the territory of which the center of a debtor's main interests is situated shall have jurisdiction to open (main) insolvency proceedings. In the case of a company or legal person, the place of the registered office shall be presumed to be the center of its main interests in the absence of proof of the contrary.

Interpretation difficulties may of course arise in the case of a truly global company where management decisions may be taken in a number of different jurisdictions (even online) or where the management is not structured on a vertical model, and consequently, conflicts of jurisdictions appear unavoidable. The decision by a court of a given member state to take jurisdiction is open to challenge by interested parties in that member state only. The appeals courts of the various member states shall thus have the duty to unify the applicability of the Regulation on that issue. French courts must (1) indicate in their judgments the criteria used to justify their jurisdiction (i.e., existence of an establishment or localization of the center of the debtor's main interests in their jurisdiction) and (2) evoke the jurisdiction issue early on during the pleadings in order to ensure due process.

The decision of the first court to open the main proceedings should be recognized immediately in the other member states without those states having the power to scrutinize the first court's decision. This automatic recognition is based on the principle of mutual trust among the various member states. No further formality is in theory required. Certain very limited exceptions apply to this automatic recognition principle, mainly based on the "manifest contrariety" with public policy of the other member states.

With respect to the recognition and enforceability of judgments, it is worth noting that the Regulation provides for a simplified recognition process (as compared to the conditions set forth traditionally by French case law). Despite the principles contained in the Regulation, there is a degree of uncertainty as to the manner in which French courts will review foreign judgments rendered in the framework of the Regulation.

Traditional Practice of French Courts in Cross-border Cases

There is no specific body of French law that regulates cross-border insolvencies. Rather, pragmatic solutions have been found by French courts on the basis of general principles of international private law.

Under French international private law, as in the case of the Regulation, the solution to the conflict of laws derives from the solution that will be adopted in respect of the conflict of jurisdictions. Consequently, once a French court takes jurisdiction, French law will automatically apply (subject to certain limitations and exceptions) and determine, for example, all restrictions to creditors' rights.

The attitude of French courts toward insolvency cases having certain cross-border elements in them is dramatically changed by the Regulation. Indeed, priority must be given to the verification of their own competence on the basis of the principles contained in the Regulation. The judgment whereby a French court would decide to open proceedings against a given debtor will necessarily contain a decision on its own competence.

In French practice, the nationality of the debtor or that of the debtor's management is not a significant criterion. Instead, French courts have jurisdiction (1) when debtors have the seat of their enterprises (the main center of their interests) located in France; (2) when there exists the presence in France of an "establishment" of certain assets; and (3) when purely pragmatic reasons exist with the sole objective of allowing French creditors to succeed in recovery actions otherwise impossible.

Most of these grounds are not compatible with the provisions of the Regulation when the latter applies in a cross-border case. Certain conflicts may exist between insolvency proceedings opened in France against a debtor on the basis of the above criteria, and insolvency proceedings opened abroad against the same debtor (when, for example, the foreign judgment has not been recognized yet in France). Since French law applies to an insolvency case opened in France, the effect of the French proceedings may easily have extraterritorial effects (1) on the basis of the "universal effect" of the French insolvency case, wherever the assets of the debtor are actually located, and (2) through specific mechanisms contained in the French Commercial Code that may bring, in certain cases, the non-French shareholders or managers of the French debtor within the reach of French courts, either by allowing French courts to officially open a new insolvency proceeding against them personally or by holding said shareholders or managers, or any of them, as jointly or severally liable for the payment of any excess liabilities outstanding of the French debtor.


It is likely that the trend of forum and law shopping when applied to insolvency cases will become even stronger when the E.U. Regulation on the European Company becomes effective in October 2004.

The opening of insolvency proceedings in a foreign jurisdiction is not enough to prevent a French court from opening separate proceedings in France against the same debtor unless the foreign judgment benefits from recognition in France pursuant to §509 of the Civil Procedure Code, in which case French courts are precluded from doing so. The recognition of a foreign judgment in France takes the form of a decision of the court of first instance; once recognized, the foreign judgment will be fully effective in France against the French assets of the debtor; the French Court of First Instance will still exercise certain scrutiny of the foreign judgment further to certain criteria set forth by the French Supreme Court (e.g., due process, compatibility with French International Public Order, executory and res judicata status) without the possibility to review its merits. Even without the benefit of a formal recognition, a foreign judgment might have certain (but very limited) effect on the French territory. Unless proceedings are opened or the foreign judgment is recognized, in France the debtor will still be considered as in bonis and thus shall keep full possession of its assets in France (e.g., no recovery measure may take place against the debtor's assets in the French territory).

These principles shall continue to be of assistance to French courts, especially in each case where the Regulation does not apply, such as instances like the opening of insolvency proceedings in France against (1) the local subsidiary of a U.S. parent company, (2) a French company having a subsidiary, an establishment or certain immovable assets in the United States, (3) a local subsidiary of a group of companies whose headquarters is located in another E.U. member state or (4) a debtor established outside of the European Union but having an establishment or assets in France.

The Regulation in Practice: The Versailles Appeals Court Ruling of Sept. 4, 2003

The main effect of the ruling was to prohibit a French court (i.e., the Pontoise Commercial Court) from opening insolvency proceedings against a French legal entity incorporated in Pontoise (SAS ISA Daisytek) and, conversely, to recognize the jurisdiction of the Leeds High Court of Justice on that same French entity. In fact, the Leeds High Court took jurisdiction not only on the U.K. parent company (Daisytek-Isa) but also on the various subsidiaries of the group located in other E.U. member states (13 altogether) against each of which it opened main proceedings under the Regulation. The legal basis used in support of the U.K. administration order (as confirmed later on by the Ruling) was that the center of main interests of SAS ISA Daisytek was located in the United Kingdom and not in France, since that company, although incorporated and domiciled in France, was in reality managed directly from the group head office located in Bradford.

Less than two months later, the Pontoise Commercial Court did open a "redressement judiciaire" under French law against SAS ISA Daisytek on the basis of the place where that company had its registered office (i.e., Pontoise). This French proceeding was ultimately dismissed on the basis that a company that is already subject to main insolvency proceedings opened validly abroad (Leeds) pursuant to the Regulation can no longer be subject to main insolvency proceedings in another jurisdiction (Pontoise), even if the latter is the one normally competent on the basis of the place where that company has its registered office.

Assuming that factual evidence did support the conclusion that Daisytek France's center of main interests was indeed located in Bradford, the ruling was a correct interpretation of the relevant provisions of the Regulation.

Difficulties in the Practical Implementation of the Regulation

Despite the fact that the ruling does recognize the preeminence for legal entities of the real corporate seat over the registered seat or place of incorporation, the interpretation made by the Leeds High Court demonstrates that the terms of the center of the debtor's main interest can receive a very broad interpretation, depending on the objective sought by the relevant jurisdictions: whether to preserve the economic unity of a group of companies considered as a whole, allow creditors of each subsidiary to participate in the recovery process more actively than what it would be the case under the various jurisdictions where the subsidiaries are incorporated, or other objectives. However, the interpretation given by the Leeds High Court can give rise to certain difficulties.

A first set of difficulties comes from the fact that the provisions contained in the Regulation are aimed at guiding the various initiatives of foreign office-holders on debtors' assets located in other member states. They are not targeted at dealing with groups of companies or with various legal entities that are subject to different laws. The results achieved by the ruling led practitioners to formulate the following main observations:

  • Most of the practitioners took for granted that the Regulation could only apply to branches and not to subsidiaries of international groups of companies.
  • The Leeds High Court has opened insolvency proceedings against SAS ISA Daisytek on the basis of criteria contained in the (U.K.) Insolvency Act of 1986 and not on the basis of criteria contained in French insolvency law.
  • The recognition of the ruling in France has the effect of prohibiting the Pontoise Commercial Court from seeking to extend a bankruptcy of SAS ISA Daisytek to its U.K. parent or to its management if the conditions set forth by the French law and the French Supreme Court to do so were to be met (e.g., confusion of both companies' assets, fictitious character of the French subsidiary etc.).

The second set of difficulties is more indirect. The effect of the ruling might stimulate the appetite for forum shopping or even for "law shopping" among the various member states. To go back to the case at hand, it is quite clear that the recognition of the U.K. proceedings against SAS ISA Daisytek shall give, in principle, all its effect to English law, which is the applicable law pursuant to the Regulation, for all matters related to the opening, conduct and closure of the main proceedings, to the exclusion of French law, except in limited matters. We can thus fairly assume that in other circumstances, shareholders, managers and creditors of distressed companies will have a tendency to seek the opening of an insolvency case in the jurisdiction that will be the most favorable to their respective and specific interests. All the more, as of the initial stage of structuring the management of a European group of companies, there might be a trend to attempt to delocalize as much as possible management decisions in the member state whose insolvency laws will be the most favorable should the group face cash-flow difficulties at some point in the future.

The third set of difficulties is more radical: If the nationality of a company depends ultimately on the place where its effective seat is located, there is a risk that all the legal rules traditionally applicable to a legal entity established in a given member state (including the choice of the law applicable to its existence and dissolution) could be disregarded upon the opening of insolvency proceedings against it.

Conclusion

The ruling can be seen either as (1) a correct application of certain provisions contained in the Regulation allowing a court to use a reality test to determine the localization of the center of a debtor's main interests or (2) the confirmation of possible dangers, including the risks of forum and/or law shopping toward the member state whose insolvency laws would be more favorable to specific interests. It is likely that the trend of forum and law shopping when applied to insolvency cases will become even stronger when the E.U. Regulation on the European Company becomes effective in October 2004.

The latter position is certainly opposite to what the Regulation intended to achieve. On the contrary, Recitals (4) makes clear 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 favorable legal position." This being said, the alternative route when a group of companies is facing insolvency in various jurisdictions would be to secure a very close coordination among the various office-holders appointed by local jurisdictions in order to find global and coherent solutions to severe cash-flow problems.


Footnotes

1 O.J. L 160/1 of June 30, 2000. Return to article

Journal Date: 
Thursday, April 1, 2004