The Imminent Distortion of European Insolvency Law: How the European Union Erodes the Basic Fabric of Private Law by Allowing ‘Relative Priority’ (RPR)

Abstract

Last-minute the mandatory inclusion of the most important measure of creditor protection, the Absolute Priority Rule (APR), was removed from the draft EU Directive on Preventive Restructuring Frameworks and Second Chance without coherent explanation. It would now suffice for Member States to introduce a so-called ‘Relative Priority Rule’ (RPR).

The APR is a rule of creditor protection that stands on firm academic ground. In the recent Jevic case, the US Supreme court called the APR "quite appropriately, bankruptcy's most important and famous rule” and “the cornerstone of reorganization practice and theory.” The proposed RPR risks turning a rule of creditor protection into a vehicle for opportunistic behavior that threatens the basic fabric of private law.

The now proposed RPR can probably traced back to a concept of Relative Priority that has been widely discussed in the US, but does the exact opposite to the US idea. RPR as proposed by some in the US upholds the right of senior creditors to be paid before junior creditors and of junior creditors to be paid before shareholders. US RPR only differs from APR in the time at which the rights are assessed. EU RPR however disrespects priority rights altogether. In as far as the EU was indeed persuaded by discussions in the US, the proposal implements the wrong rule.

There is also very little to like about EU RPR. Next to threatening the basic fabric of private law by disrespecting bargained for priority rules without clear justification, EU RPR subsidizes the overleveraging of companies and incentivizes orchestrating insolvency, by granting shareholders value that based on normal private law rules belongs to creditors. Subsidizing overleverage is something the EU is actually trying to prevent with other measures. Even if doing away with creditor protection would be deemed appropriate, EU RPR is too vague to apply in practice. Negotiating under EU RPR can be compared to playing tennis without a net.

It seems that the idea behind EU RPR was to create more flexibility, also to support Small and Medium Enterprises (SME’s). The outcome of EU RPR will however be that it will allow for transfers of wealth from creditors to shareholders, which is likely to be damaging to the economy and to further undercut the position of specifically SME’s.

Keywords: Insolvency Law, Reorganization, Absolute Priority Rule (APR), Relative Priority Rule (RPR), Restructuring, Creditor protection, Preventive Restructuring Frameworks, European Private Law, Cross-class cram-down, Corporate bankruptcy

JEL Classification: K2, K22, K33