When the new Insolvency Law came into force on September 1 2004, the framework for resolving business crises in Spain changed significantly – although the most frequently affected stakeholders (debtors, creditors, employees, judges and advisers) may not be fully aware of the magnitude of the change. The new law provides for the application of a single procedure in the event of insolvency, although the eventual outcome could be recovery or winding-up.
No official English translations of the Insolvency Law are currently available.
The new text seeks to overcome problems caused by archaism, imprecision and a lack of harmonisation. As stated in the preamble to the law, it clearly aims to support the future viability of businesses, as opposed to promoting lengthy and convoluted legal procedures that serve only to aggravate the situation and often leave liquidation as the only solution. Nonetheless, the law also protects creditors by providing a more professional, rapid and secure proceeding (involving specialised judges who deal exclusively with insolvencies, as well as specialised trustees), and new debt preferences that void certain longstanding privileges which are no longer appropriate in Spain’s current business framework.
From a commercial viewpoint, the most relevant changes introduced by the new Insolvency Law, which endorse the objective to secure the future viability of businesses, are as follows:
- A debtor company must now apply for a declaration of insolvency in certain specified circumstances (eg, current or imminent insolvency, nonpayment of taxes or social security contributions for three months). In the event of non-compliance, the directors may incur serious liability, including disqualification from holding office. However, a debtorinitiated proceeding can be advantageous to the company.
- In general, the company’s incumbent management is not prevented from controlling or administering the business, but is supervised by the trustee. This allows individuals with in-depth knowledge of the business to remain in positions of responsibility, as long as there are no circumstances that would necessitate their removal from office, such as fraudulent activity, misappropriation or false accounting. Accordingly, voluntary filings are likely to increase.
- Certain creditors lose priority. For example, the claims of creditors classed as related parties (eg, group companies, shareholders, directors and their relatives, shareholders of group companies) become subordinated debts (loans from shareholders, de facto or de jure directors or other group companies).
- The guarantees of debts secured by real estate may be provisionally suspended during the insolvency process, thus avoiding the division of the debtor’s assets.
- The privileges of tax and social security creditors have been substantially reduced – such debts, in general terms, will be privileged only up to 50 per cent of their amount.
- In certain cases contracts extinguished prior to the declaration of insolvency may be reinstated and valid contracts may be terminated, depending on which solution is of greater benefit to the business.
- Credit and financing of any kind do not mature automatically or accelerate when insolvency is declared. All such clauses contained in the relevant agreements are deemed to have been omitted.
- New financing may be obtained, to be repaid in accordance with the payment and viability plan approved by the creditors.
- Employment relations may be extinguished and altered or suspended, and layoff proceedings may be initiated.
- Timeframes for the completion of insolvency and liquidation processes are shorter.
- In the final provisions of the law, provision is made for the preparation of new laws or the modification of existing ones on the existence and priority of credits in the case of specific executions, or in relation to corporations and limited liability companies.
However, while the new Insolvency Law is much more specific as regards liquidation processes, the viability plan procedure is mentioned just three times and the applicable criteria do not always favour the future viability of the business undergoing the insolvency process. The law states that the approved creditors’ agreement can provide only for a maximum 50 per cent debt waiver and a maximum five-year term of the debt, unless liquidation of the company would have a significant impact on the economy. In addition, the business will be liquidated in case of failure to meet the payment schedule set out in the viability plan. These criteria appear to be excessively restrictive.
1 The Legal Framework And The Effectiveness Of Court Processes/ Legal Remedies
1.1 Describe The Nature And The Effectiveness Of The Following:
(a) Debt recovery remedies where the creditor has no security
Where a claim is unsecured, only the general principle of the debtor’s unlimited liability applies. The claim can be enforced through ordinary declaratory court proceedings as long as the debtor has not been declared insolvent, or by participating as a creditor in the insolvency proceeding if the debtor has been declared insolvent.
An unsecured creditor ranks behind creditors holding general or special privileged claims (ie, secured claims and claims classed as privileged by law), but ahead of all subordinated creditors (see section 7.2).
(b) The enforcement of security
Until a debtor is declared insolvent, the holders of security interests in movable or immovable property (or in other statutory situations where assets are specially subject to payment of a claim) can elect to institute separate enforcement proceedings to recover the debt by disposing of the secured assets, without prejudice to the debtor’s unlimited liability.
However, this right of separate enforcement is affected if an insolvency order is made. With the exception of enforcements on vessels or aircraft, an insolvency order prevents a creditor from enforcing its security until an insolvency agreement has been approved, or unless liquidation does not commence within one year of the date of the insolvency order.
(c) Corporate bankruptcy/ liquidation processes
The Insolvency Law establishes a single type of insolvency proceeding which aims both to protect the debtor’s assets from premature or disorganised enforcement and to ensure that all creditors are treated equally in the collection of their claims.
The insolvency proceeding can be instituted by the debtor itself or by any of its creditors, or by the members of the debtor company if they are personally liable for its debts.
(d) Formal corporate rescue processes
There is only one type of debt recovery proceeding in Spain. The commencement of insolvency proceedings stays all other judicial debt recovery proceedings and other extrajudicial enforcement measures applicable in certain cases, such as notarial foreclosure.
The key aim of protecting the company as a productive unit of social interest is reflected mainly by the prohibition against separate enforcement proceedings in the statutory liquidation guidelines. Among other things, these provide for the preparation of a liquidation plan that envisages the single sale en bloc of any or all of the debtor’s establishments, operations or other units producing goods and services.
(e) Informal corporate rescue processes
There are no specific informal corporate restructuring processes that go beyond the usual contractual remedies in business practice (eg, debt refinancing, deferral and guarantee, assignment of the claim or debt to a third party).
1.2 What Are The Formal Processes To Effect A Liquidation Of The Company’s Assets?
Liquidation may be commenced at the request of the debtor or the creditors, or even at the initiative of the judge, depending on the circumstances. It may be carried out on the basis of a liquidation plan which is drawn up by the insolvency administrators, or by following certain supplementary rules, such as transferring en bloc and by public auction all establishments, businesses and productive units of the debtor.
1.3 What Is The Effect On Debt Collection And The Enforcement Of Security Of:
(a) An adjudication of corporate bankruptcy/liquidation?
An insolvency order automatically unites all debt recovery proceedings against the debtor. Declaratory and enforcement proceedings instituted individually by creditors are barred, as is the individual payment of debts to creditors outside the insolvency proceeding. Claims are ranked by priority as subordinated claims, ordinary claims and privileged claims (general privileged and special privileged).
The effects of the enforcement of secured claims are described in section 1.1(b). The insolvency receivers can also pay secured creditors at any time out of assets generally available to the creditors, without having to realise the assets on which the claims are specifically secured.
(b) The commencement of a formal corporate rescue process?
The new Insolvency Law marks a shift away from the traditional dual insolvency model, which involved on the one hand proceedings for general enforcement (bankruptcy), and on the other proceedings to protect the debtor’s assets or the viability of the business (previously, Chapter 11- type insolvency). The new single insolvency proceeding successively accomplishes the twin goals of preservation and enforcement.
(c) The initiation of an informal corporate rescue process?
See section 1.1(e).
1.4 Are Insolvency Procedures Started In Another Jurisdiction In Respect Of A Corporation Incorporated In Your Jurisdiction Recognised?
Where insolvency proceedings are commenced in another EU member state, any resolutions issued by the competent courts of that member state will be automatically recognised in Spain from the time they become effective in that member state.
However, where insolvency proceedings are commenced in a jurisdiction which is not an EU member state, the recognition of resolutions is automatic only if an applicable international convention expressly so provides. In most cases it is thus necessary to initiate a special exequatur procedure to obtain recognition of the foreign resolution in Spain. This requires:
- reciprocity between Spain and the state in which the resolution was issued; and
- that the resolution be definitive, issued in collective proceedings based on the debtor’s insolvency and not be issued by default.
1.5 In What Circumstances Would The Directors Or Officers Of A Company In Financial Difficulties Face Potential Personal Liability For Continuing To Trade?
Whether the directors of a troubled company will face personal liability ultimately depends on whether the company is unable to fulfil its obligations on a regular basis. In such case the company is deemed insolvent and liability will extend to its legal representatives, directors or liquidators (de facto or de jure) if they contributed to or exacerbated the company’s insolvency. Aside from this general principle, the new law identifies certain cases in which there is a non-rebuttable presumption of personal liability – for example, where the company has breached its obligation to keep accounts, or has concealed some or all of its assets.
Under the Insolvency Law, company directors or representatives will also be found personally liable where they have breached their obligation to seek a declaration of insolvency within two months of the date on which they became aware or should have become aware of the insolvency. Such liability is also presumed – in the absence of proof to the contrary – where a company that is bound by accounting obligations failed to draw up the financial statements, or to deposit the approved financial statements with the Corporate Registry, in any of the three financial years prior to the declaration of insolvency.
In the above cases the company directors or representatives may be ordered to return all property or rights which they may have improperly obtained from the company’s assets, in order to compensate the loss and damage caused. If the debtor company must ultimately be liquidated, the judge may oblige the directors or legal representatives personally to pay the creditors any outstanding portions of their claims that they have been unable to recover.
2 What Are The Advantages And Disadvantages Of Triggering A Formal Procedure?
The legal duty to file a petition for insolvency must be fulfilled within two months of the date on which the debtor has notice, or should have notice, of its actual or imminent insolvency.
In theory, triggering a formal restructuring procedure is the best way to protect the rights of both debtor and creditors, as the law does not provide for an informal alternative to insolvency proceedings.
The debtor’s property may be safeguarded more effectively through a formal insolvency process, not only because this might prevent loss of control of the business and maintain effective management, but also because it allows for an agreement to be reached on the continuation of the business. The debtor’s actions will always be carried out under the control of the courtappointed supervisory representatives, unless its powers are held in abeyance by court order.
On the other hand, the law does not leave the creditors unprotected: it provides them with recourse to recover their debts within an organised framework that gives due consideration to the principle of equal treatment between creditors.
Insolvency status also has a protective effect in relation to the debtor’s contractual relationships, and any contractual provision for the termination of a contract merely on the grounds that an insolvency order has been made will be void.
However, the risk of the debtor’s activities being negatively affected by the adverse publicity of a formal filing for restructuring should not be ignored, particularly where maintaining public confidence is an important factor that affects the continuity of activities.
As regards control of the debtor, and depending on the circumstances, the new legislation distinguishes between:
- voluntary intervention requested by the debtor, which maintains control of the business under the supervision of court representatives; and
- compulsory administration requested by a creditor, where the debtor loses control of the business to court-appointed administrators or trustees.
There are exceptions in both cases. In principle, the process is voluntary unless certain circumstances make the implementation of compulsory administration necessary.
Insolvency proceedings do not, per se, modify the substantive rules governing the debtor’s labour relationships, but they do offer possibilities for greater flexibility in reorganisation by permitting agreements that amend the terms of employment and barring individual lawsuits by employees against the debtor.
3 What Are The Practical Options For Outof- Court Restructuring?
The new legislation contains no provisions on informal restructuring agreements. However, this does not imply that informal, extra-judicial restructuring procedures cannot be carried out in Spain.
Informal restructuring processes may be carried out only if the debtor is still solvent, as insolvency proceedings must be commenced if the debtor’s liabilities exceed its assets. Otherwise, liability may be incurred both by the debtor and by its directors (de facto or de jure).
However, the new legislation specifies a number of circumstances in which all actions of the debtor in the two years preceding the declaration of insolvency may be extinguished if they are deemed detrimental to the insolvency estate, irrespective of the existence of fraudulent intent. Examples include:
- the payment or extinguishment of obligations that would have matured after the date on which insolvency is declared; and
- the creation of new real property guarantees to cover pre-existing obligations or any new obligations that may replace them.
Such circumstances generally arise during informal or out-of-court restructuring processes. Therefore, should the debtor be declared insolvent in the two years following the date on which the restructuring process is implemented, the rescission of the restructuring agreement might be ordered, in which case the creditors will lose any additional guarantees obtained in order to extend the debt maturity period, grant a reduction or offer additional financing.
In the event of an informal restructuring process, all typical measures provided under Spanish corporate law are available (eg, mergers, takeovers or spin-offs of companies, reorganisation of assets and liabilities, collective layoff procedures).
4 Effect On Management
What is the effect on the management of a company of:
(a) An adjudication of corporate bankruptcy/liquidation?
(b) The commencement of a formal corporate rescue process?
(c) The initiation of an informal corporate rescue process?
The most important risk involved in managing a company is the liability the directors may incur. This liability is expanded considerably by the new Insolvency Law (see section 1.5). Under the new law, personal liability applies both to the directors and liquidators of legal entities (de facto and de jure), and to those who held such positions in the two years prior to the date of the declaration of insolvency.
However, such liability will be incurred only:
- where the so-called ‘qualification section’ has been pursued (ie, where the company has been cleared of civil liability);
- as a result of the commencement of liquidation; and
- where the court has declared that the insolvency was fault-based.
Personal liability will be incurred by those directors whose conduct gave rise to or worsened the state of insolvency.
5 Parties In Interest/Key Players
In the case of a formal restructuring, the new Insolvency Law provides that one of the three members of the judicial administration should be an ordinary creditor. Accountants/lawyers and other advisers constitute the remaining two members of the judicial administration (one auditor or equivalent and one lawyer).
The new law avoids all reference to practitioners under the former Spanish insolvency regime (eg, receiver, commissioner, depository and trustees), which are replaced by a judicial administration. The aim is to form a body of dedicated professionals with broad experience in insolvency and restructuring processes. The following members comprise the judicial administration in insolvency proceedings:
- a lawyer with at least five years’ actual professional experience;
- a registered auditor, economist or accountant with at least five years’ actual professional experience; and
- an ordinary unsecured creditor.
By way of exception to the above:
- if the ordinary unsecured creditor is a corporate entity, it must appoint and delegate its functions to a registered auditor, economist or accountant with at least five years’ actual professional experience;
- in the case of the insolvency of an entity with securities traded on an official exchange, or of an investment services firm, the National Securities and Exchange Commission must be appointed judicial administrator instead of the auditor, economist or accountant;
- in the case of the insolvency of a banking entity, the Deposit Guarantee Fund must be appointed judicial administrator instead of the creditor, while in the case of an insurance company’s insolvency the Insurance Companies Liquidation Commission will take on this responsibility; and
- where the debtor has liabilities of less than €1 million, the judicial administration may be formed by a single member, who must be an auditor, economist or accountant with at least five years’ experience.
The creditors’ assembly no longer plays a relevant role, as was the case under the former legislation. Other than the possibility of acting as a member of the judicial administration, the new law merely allows the creditors’ assembly to approve the plan proposed by the judge.
6 What Financial Information Is Available To Creditors?
Formal restructuring: For a formal restructuring, the information required by the new law is as follows (without differentiating between bankruptcy and suspension of payments, as the new law governs a single insolvency procedure):
- annual accounts for the last three years and the latest management accounts;
- a list of real property and titles of ownership;
- a nominal list of all creditors;
- a report explaining the causes of the insolvency and the means available to the debtor to meet its liabilities;
- for limited liability companies, certification of the resolution adopted by the board of directors authorising the filing of the insolvency petition;
- a declaration relating to branches, agencies or representative offices;
- the books of accounts (statutory books of account, annual accounts, journal and minute book);
- a general and special power of attorney in favour of lawyers and legal representatives;
- the debtor’s incorporation deed, if appropriate; and
- returns relating to the tax on professional and business activities.
The balance sheet should include a valued description of the debtor’s real and movable property, materials and goods, credits and rights of any kind (real assets), as well as all outstanding debts and obligations (liabilities).
In addition to the documentation required above, and when protection is requested by the debtor, the law provides that a report will be required on the debtor’s financial and legal history and the activities in which it has engaged in the previous three years.
If the debtor is a legal entity, it must indicate in the report the identities of all shareholders or partners of which it is aware, the directors or liquidators and, if appropriate, the statutory auditor. If it forms part of a group of companies, it must list the entities forming the group. If the debtor has securities listed on an official stock exchange, it must also provide the consolidated annual accounts and directors’ reports for the previous three years and the statutory audit reports issued on these accounts. Conversely, there is no provision regarding submission of the certification of the resolution adopted by the board of directors for public limited companies, as required under current regulations.
At the conclusion of the initial phase of the judicial administration, if the business is considered viable, the creditors will receive a restructuring plan which includes the viability plan and the proposed restructuring terms.
Out-of-court restructuring agreements: Although out-of-court restructurings are not specifically contemplated in the law, the documentation to be provided by the debtor in such cases is typically as follows:
- an analysis of the debtor’s historical trends and current financial situation;
- projections of the debtor’s long-term viability, including short-term cash flows and cash needs; and
- financial and operational restructuring plans demonstrating the debtor’s viability. The content of these plans may vary according to the circumstances.
7 Common Questions
7.1 Funding And The Priority Given To New Money
(a) If an insolvent corporation requires urgent working capital funding, what difficulties are likely to be encountered in the provision of such funding?
If judicial insolvency proceedings have not commenced, the company remains free to seek financing to remedy its financial situation. If the company subsequently enters into an insolvency proceeding, the financial institution will be a creditor for the amount of the principal and interest, although interest that accrued before the declaration of insolvency will qualify as a subordinated debt (see section 7.2). Following the declaration of insolvency, the accrual of interest is suspended, except in the case of financing secured by mortgage or pledge. If the insolvent corporation obtains financing from another company belonging to the same corporate group, that debt will be classified as a subordinated debt.
(b) Are lenders providing new money, or debtor-in-possession financing, given any statutory priority?
Once insolvency proceedings have commenced, additional financing may be obtained for certain purposes, such as to implement the viability plan which may be submitted by the debtor as an alternative to liquidation. However, the new financing taken out by the insolvent debtor will have the status of ‘créditos contra la masa’ – a term in Spanish law similar to, but more extensive than, trade debts – with the exception of corporate group debts.
7.2 Ranking Of Creditors
In what order are creditors paid in a corporate bankruptcy/liquidation?
Within the body of creditors, claims are classified as privileged, ordinary and subordinate.
Privileged claims include the following, in descending order:
- claims with special privilege – that is, those secured by certain assets or rights (eg, mortgage, pledge) – which will be paid charged to those assets and rights; and
- claims with a general privilege, which will be paid using the surplus assets of the bankruptcy estate after the claims that constitute créditos contra la masa and claims with special privilege have been paid. Claims with a general privilege rank as follows and are paid in the following order:
- labour claims;
- tax claims;
- social security claims (up to 50 per cent of their amount);
- tortious civil liability claims; and
- claims of the insolvency petitioner (up to a quarter of their amount).
Ordinary claims are paid after those listed above.
Subordinate claims are paid last, in the following order:
- claims that were reported late or inappropriately;
- claims stipulated as subordinate under an agreement;
- claims for interest of any kind;
- claims for fines and other economic penalties;
- claims of related persons (eg, directors); and
- claims of persons that have been found to have acted in bad faith in a challenge to an insolvency proceeding.
Claims that constitute créditos contra la masa will be paid before other claims included in the insolvency proceeding are settled and on their respective due dates, regardless of the stage of the proceeding, but without disturbing those assets to be used to pay claims with special privilege. These include expenses incurred in processing the proceedings and expenses that are basically necessary for the debtor to continue its business.
7.3 Avoidance Of Antecedent Transactions
Are there any legal provisions that might operate to invalidate the creation of security, the disposal of an asset or the payment of a creditor by a company in financial difficulties?
The Insolvency Law provides that any acts performed by the debtor in the two years prior to the date of the insolvency order which are detrimental to its assets can be rescinded. This is considered to be the case where acts of disposition were performed for no consideration and obligations that had not yet matured were paid. A rebuttable presumption of detriment exists where acts of disposition are performed for consideration in favour of persons who are specially related to the debtor, or where security interests are created for pre-existing obligations. If rescission is ordered, the assets delivered and acts performed under the contract in question will be restored, together with associated benefits and any interest that has accrued.
What is the position of both unsecured and secured creditors that vote against, do not agree with or do not consent to either a formal or informal rescue plan?
When an agreement is reached as part of the judicial proceedings, all ordinary and subordinate creditors are bound by its provisions – which might include a debt reduction, a debt deferral or both – even if those creditors voted against the agreement, or in any way opposed it. However, dissenting creditors will retain their rights of action against persons who are jointly and severally bound with the debtor, and against its sureties and guarantors.
In contrast, privileged creditors will be bound by the agreement only if they voted in its favour (they can also adhere to it during the period between its approval and the judicial declaration confirming that the debtor has observed the agreement).
Finally, where the debtor reaches agreement with its creditors outside judicial proceedings (eg, with an unofficial committee of creditors), all creditors – whether privileged or otherwise – that have not voted in favour of the informal agreement retain their rights of action against the debtor.
7.5 Creditor Protection
What actions can creditors take if they are not satisfied with the conduct of either a formal rescue procedure or a corporate bankruptcy/liquidation?
The most significant powers that a dissatisfied creditor enjoys within a formal rescue procedure include the following:
- the power to challenge a decision of the insolvency receivers by demanding that they include the creditor’s claim in the list of claims, specifying the exact amount in the appropriate category;
- the power to challenge a decision adopted on the debtor’s inventory;
- the power to object, on formal or material grounds, to an agreement that has been approved in order to ensure the debtor’s viability; and
- the power to seek a court declaration that the debtor has infringed the agreement.
The most significant powers that a dissatisfied creditor enjoys within a corporate bankruptcy/ liquidation procedure include the following:
- the power to request the court to commence liquidation of the debtor on the grounds that no agreement has been presented, the agreement approved by the creditors has been rejected by the court or the agreement finally approved by the court has been declared void;
- the power to make observations or proposals to modify the liquidation plan;
- the power to request the court to remove from office any insolvency administrators who have unjustifiably delayed liquidation for over a year; and
- upon the commencement of the qualification stage (see section 4), the power to allege what the creditor considers necessary in order to qualify the insolvency as fault-based.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.