A significant modernization of French bankruptcy law is on the way. The new law, long awaited by both debtors and creditors, was passed in July and goes into effect on Jan. 1, 2006.

The reform introduces the concept of "conciliation" aimed at rescuing debtors at the first signs of serious financial difficulties and the "rescue" inspired by the U.S. chapter 11 system, which gives the debtor more flexibility and more certainty that their interests will be taken into account than under present law.

Conciliation

The new law introduces a revamped concept of "conciliation" proceedings. These proceedings are open to debtors who are bankrupt within the meaning of French bankruptcy law (i.e., inability to meet due debts with the available assets—a pure balance-sheet test). Such is not the case under the present regime.

However, the debtor must act promptly: only those who are technically bankrupt for 45 days or less may apply for conciliation proceedings. Those who have been bankrupt for longer must start the formal bankruptcy process (see below for changes on the formal process).

"Conciliation" involves contractual and judicial intervention in order to reach an agreement amongst the debtor and his creditors that is both sound and secure. The main advantage of the process is the confidentiality attached to it. The main drawback is the absence of the general stay of execution that is the characteristic of the formal bankruptcy process.

Once an agreement is reached between the debtor and his creditors, the debtor can apply to the court to have the agreement acknowledged by the court so that it acquires the same force as that of a judgment. That process is still confidential in the sense that the judgment that acknowledges the agreement is not made public, but still has the same force between the parties involved.

However, the debtor (and the debtor only) can request to have the agreement ratified ("homologated") by the court. In this case, the agreement becomes public, but a stay of execution is imposed during the whole time the terms of the agreement are enforced by the parties.

Even though only the debtor can apply for the homologation of the agreement, one can easily see the pressure that credit institutions will put on the debtor to have the agreement homologated. The benefit to those creditors of formal, public recognition by the court of the existence and binding nature of the agreement is that those creditors who bring in "fresh" or "new" money to the debtor in distress will rank ahead of prior or later creditors if the debtor ultimately enters a formal bankruptcy process, such as administration or liquidation. The French legislators make it clear that this advantage only benefits those creditors who bring "fresh" or "new" money to the debtor in distress, not merely a conditional promise, loan restructuring or reduction of past debts.

Rescue

Inspired by the U.S. chapter 11 model, the "rescue" (sauvegarde) process allows a stay of execution in order for the debtor to negotiate with its creditors within the framework of two committees: the suppliers and the credit institutions' committees. The novelty is that the process is initiated by the debtor, who retains control of the business. The debtor need not be bankrupt within the meaning of French bankruptcy law, but only show "difficulties which he/she cannot overcome and which may lead to a cessation of payments [the technical test of bankruptcy under French law, i.e., an inability to pay due debts as they fall due]." The negotiation between the debtor and the creditors then leads to a draft plan, which the court will review and approve if the interests of all creditors are preserved.

Unfortunately, the possible layoff of employees was not addressed within the new rescue proceedings. The mechanism in place within the framework of the French administration proceedings (see below), i.e., the possibility for the administrator to apply to the court to authorize mass layoffs that are "urgent, inevitable and indispensable," was not extended to the "rescue" proceedings. This may discourage debtors from applying to the court to be put in "rescue" proceedings.

Other Changes

A. Administration Proceedings: If no rescue is possible or requested, then the first step toward a more traditional process of bankruptcy under French law is the administration proceedings (redressement judiciaire). The administration phase is geared toward assessing whether the business can be continued, whether it must/can be disposed of or if it should be placed into liquidation.

Under the new regime, the plan to sell the bankrupt entity—which represented hitherto the bulk of the work during administration proceedings—was pushed back to the liquidation stage. Nothing prevents the preparation of such plan—and the gathering of offers from potential buyers—during the administration proceedings, but its implementation, namely the sale of the insolvent entity or its assets, will only take place in the liquidation stage.

At the administration stage, the administrator either runs the business or merely assists the directors in running the business, depending on what the court decides.

B. Liquidation Proceedings: The biggest innovation of the new system is to introduce a fast-track liquidation regime that allows debtors to close within a year the liquidation process and to start afresh at the liquidation stage, provided no disqualification orders were made against them.

C. Undue Support: One of the least-understood provisions of French bankruptcy law is the notion of "undue support," which allows credit institutions or creditors that had granted or maintained credit to an insolvent debtor to be liable for some of the debts of the debtor if such conduct was deemed improper by French courts. The new law has introduced a new article in the French Code of Commerce (article L. 650-1), which severely restricts such lender liability now. The new provision only contemplates it in case of fraud, serious inter-meddling with the running of the business of the debtor or if the securities taken are disproportionate in comparison to the support granted.

Conclusion

The new regime offers more possibilities to debtors in distress and more protection for creditors willing to assist in a rescue. It highlights France's modern and realistic approach toward the practical aspects of bankruptcy law. Such an approach was called for, given the competition between the various European bankruptcy systems created by EU Regulation 1346/2000 and its loose concept of "centre of debtor's main interests" that may incite a court not to send a case to a jurisdiction it does not trust or know.