REVISION OF INSOLVENCY LAW - NEW IN INSOLVENCY LAW. BANKRUPTCY LAW 30 YEARS

REVISION OF INSOLVENCY LAW NEW IN INSOLVENCY LAW. BANKRUPTCY LAW 30 YEARS Conference tributed to 70th birthday of prof Paul Varul COLLECTION OF PRESENTATIONS

COLLECTION OF PRESENTATIONS

Prof Stephan Madaus “The protection of secured creditors in plan proceedings” Prof Paul Omar ”Challenging The Orthodoxy of Asset Security and its Role in Insolvency” Prof Chirstoph Paulus “On the Crossroads of Security Interests and Insolvency Law”

FOREWORD

REVISION OF INSOLVENCY LAW – NEW IN INSOLVENCY LAW. BANKRUPTCY LAW 30 YEARS FOREWORD Tartu University organized a conference “Revision of Insolvency Law – New in Insolvency Law. Bankruptcy Law 30 Years” on Dec 8th, 2022. This conference was a tribute to 70th birthday of prof Paul Varul, a grand man of civil law in Tartu University. His contribution to the reform of Estonian laws and development of the Law School of Tartu University is invaluable. The main topic of the conference was modern aspects of insolvency laws in Estonia. The Tartu University had the exceptional opportunity to host alongside renowned Estonian scholars and practitioners prof Christoph Paulus, prof Stephan Madaus and prof Paul Omar.

We would like to thank all the lecturers for incredible content to the event. Being one of the presenters I am pleased to say that the presentations of prof Christoph Paulus, prof Stephan Madaus, prof Paul Omar, prof Paul Varul, Dr. Urmas Volens, Kersti Kerstna­-Vaks, Dr. Annemari Õunpuu and Toomas Saarma were fascinating. The conference was handled on the highest level by energetic coordinators, Peeter Viirsalu and Tarmo Peterson. In the name of Tartu University we would like to thank prof Irene Kull and Aive Suik, who have been at the heart of the event. The conference could not take place without their effort. Last but not least, the conference would not have happened without help from our sponsors. Therefore, we are most grateful to TGS Law Firm, RASK Law Firm, Law Firm COBALT, Law Firm Eipre & Partners, Law Firm Kasak & Lepikson, the Estonian Chamber of Enforcement Agents and Trustees in Bankruptcy, the Academic Society of Estonian Lawyers and Lydia Hotel.

-2-

Unfortunately, the volume of this bulletin is limited. Therefore, Tartu University decided to publish international presentation of prof Stephan Madaus “The protection of secured creditors in plan proceedings”, prof Paul Omar ”Challenging The Orthodoxy of Asset Security and its Role in Insolvency” and prof Chirstoph Paulus “On the Crossroads of Security Interests and Insolvency Law”. These presentation all focused on the rights of secured creditors in insolvency proceeding. We hope that you find these presentations an interesting reading.

We hope that the presentations published in this collection will provide a good overview of the high standard of the conference and will be of broad interest both to those who attended the conference in person and to all others who wish to keep abreast of developments in bankruptcy law.

Sincerest gratitude in the name of the Tartu University

Anto Kasak

-3-

THE PROTECTION OF SECURED CREDITORS IN PLAN PROCEEDINGS Stephan Madaus Secured creditors enjoy privileges regarding the treatment of their rights in insolvency proceedings. They are typically entitled to receive the value of their collateral or retain the collateral on behalf of their claim in an insolvency liquidation. In a restructuring, their position may seem more vulnerable. A restructuring plan is able to affect even a secured claim and may thus limit the creditors’ ability to collect. If the creditor does not agree with such treatment and opposes the restructuring plan, cramdown mechanisms are to be considered by the court. The paper explains the relevant considerations for class formation and the best interest test. The paper does not discuss the ability of restructuring proceedings to stay the enforcement of secured claims until a plan is confirmed.

A. Introduction The 2019 EU Directive on restructuring and insolvency (2019 Directive)1 introduces a preventive restructuring framework to all EU Member States that includes the ability to affect the rights of secured creditors. Their enforcement rights can be stayed for a certain period of time pursuant to Art. 6(2). Their claims can be modified by a restructuring plan including a parallel modification of their security right.

The ability to affect secured credit may be a novelty to some Member States. While the commencement of insolvency proceedings routinely also hindered secured creditors in accessing collateral, the power to permanently modify secured credit in a restructuring or insolvency plan has not yet been generally possible under local insolvency laws. Traditionally, the effects of a composition only extended to unsecured creditors.2 The commonness of secured credit in today’s credit markets prompted the European Commission to recommend the inclusion of secured credit into the scope of a restructuring plan already in 2014.3 It is no surprise, therefore, that the preventive restructuring plan of the 2019 Directive is capable of modifying both secured and unsecured debt if confirmed.

1 Directive (EU) 2019/1023 of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency), OJ L 172, 26.6.2019, p. 18–55.

2 See Bob Wessels and Stephan Madaus, Rescue of Business in Insolvency Law, Instrument of the European Law Institute, Oxford University Press 2020, paras. 591-592.

3 Commission Recommendation of 12 March 2014 on a new approach to business failure and insolvency, OJ L 74, 14.3.2014, p. 65–70, para. 16.

-4-

It is worth mentioning, however, that this new approach has not yet been implemented in all aspects of European insolvency law. The 2015 recast of the European Insolvency Regulation (EIR)4 did not reduce the broad protection offered by Art. 8(1) EIR for rights in rem in assets of the debtor located abroad. A stay or plan implemented in main insolvency proceedings may therefore not hinder secured creditors when enforcing their rights in rem in such assets.5 This protection would also be extended to stays and plan modifications in preventive restructuring proceedings if they are listed in Annex A of the EIR. This paper describes the position of secured creditors in a preventive restructuring plan procedure. It looks at the class formation first before detailing the requirements to pass the best interest of creditors test when faced with creditor opposition. Both requirements are tested by the court in a plan confirmation and thus establish the protection of secured creditors. This paper does not consider other means to avoid a plan confirmation, such as objections concerning the acceptance and legality of a plan or a crossclass cramdown, or any legal conditions for staying the enforcement of security rights in support of plan negotiations.

B. Class Formation Art. 8(1) lit. d of the 2019 Directive requires the plan proponent to describe the classes into which affected parties have been grouped.

The idea to form classes of creditor claims is new to the law of many Member States.6 Traditionally, all unsecured creditors were equally affected by a composition offered by the insolvent debtor (or insolvency practitioner) and voted on the proposal as one group.

As the basic economic interest of this creditor group is rather similar, a majority vote supporting the composition may signal that this offered solution is also fair and equitable against equally treated, yet dissenting minority in this group.

4 Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast), OJ L 141, 5.6.2015, p. 19–72.

5 For a more detailed discussion, see eg Richard Snowden, in: Reinhard Bork/Kristin van Zwieten, Commentary on the European Insolvency Regulation, 2nd ed., Oxford University Press 2022, para.

8.05-8.20 and 8.42-8.49.

6 See Wessels and Madaus (fn. 2) para. 595.

-5-

1. The principles underlying any class formation The need of the modern restructuring practice to involve other creditor groups in the capital structure of a company as well as their equity holders when sharing the burden of a debt restructuring is reflected in a flexible, extended scope of modern restructuring plans. Their ability to modify both secured and unsecured debt (Art. 9(4) of the 2019 Directive) as well as equity rights (Art. 12 of the 2019 Directive) created the need to modify the equal treatment condition and thus the voting mechanism. It was not possible to maintain a rule of equal treatment across all affected parties as this would cause the need to equally modify secured credit and equity rights. Instead, differential treatment was both justified and needed.

The need for a differential treatment leads to the application of the principles of non-discrimination. Any differential treatment of parties by a plan must be justified by a corresponding difference in rights or interest. Where such a difference does not exist (to a significant degree), equal treatment is required. Consequently, parties to a plan may only see their rights being placed in different classes as long as these rights are sufficiently different. At the same time, they may only be put in the same class if their rights or interest are sufficiently common with the other rights in the class.

Art. 9(4) of the 2019 Directive expresses these fundamental rules of class formation in the first sentence.7 It goes on to explain that sufficient differences in interest justifying a position in separate classes is assumed for secured and unsecured credit as well as for workers’ claims and, potentially, for claims of vulnerable creditors such as small suppliers. Art. 8(1) lit. d requires the plan proponent to explain the way in which classes were formed and affected rights assigned to them. The court sanctioning the plan must review the justification of classes pursuant to Art. 10(2) lit. b.

Two additional aspects are worth mentioning.

First, the plan must not necessarily modify the rights of all stakeholders. Even in fully collective insolvency proceedings, the plan proponent may select the groups of stakeholders affected by a restructuring plan while leaving others unimpaired.8 In preventive restructurings, this selection is prominent. Stakeholders which are not affected by a proposed preventive restructuring plan are not even parties to the plan proceedings (while they may be affected by a stay under Art. 6 of the 2019 Directive).

7 See also Recital 44.

8 See eg § 1124 of the US Bankruptcy Code or § 237(2) German Insolvency Code.

-6-

The selection of affected parties requires a justification under non-discrimination principles. In fully collective proceedings, this justification forms part of the class formation process. Not impaired stakeholders are grouped in classes of unimpaired claims or interest.9 In preventive restructuring proceedings, the formation of classes of unimpaired stakeholders is not necessary as long as the plan explains – and justifies – the selection of creditors and shareholders that are impaired. Art. 8(1) lit. e of the 2019 Directive requires exactly such a statement in the plan.

Second, Art. 9(4) subpara. 3 of the 2019 Directive allows Member States to provide that debtors that are SMEs can opt not to treat affected parties in separate classes. This provision seems to allow SME debtors to treat parties with significantly different types of claims and interest equally since the need to treat all rights in one class equally under Art. 10(2) lit. b is not exempted. Taken together, the SME exemption allows small debtors to propose a simplified plan similar to traditional compositions based on the idea that the capital structure of such enterprises is ‘relatively simple’.10 However, any equal treatment of significantly different claims, especially secured and unsecured, can hardly be in line with non-discrimination principles. As a consequence, SME debtors are only able to opt for single class of affected parties if this class is sufficiently coherent, in particular only encompassing unsecured claims even if they are held by both private and public creditors. The selection of affected parties needs to comply with non-discrimination standards and require the SME plan proponent to leave other stakeholders either unimpaired or to create a separate class.

2. Class formation for secured claims Class formation means that legal entitlements or interests are grouped in order to be affected by the plan, not parties. Where a person or legal entity has several claims or rights against the debtor, each of these rights are to be considered individually when the reasons are reviewed why the plan would affect it at all and why the plan would classify it as proposed.

9 See again § 1124 of the US Bankruptcy Code or § 237(2) German Insolvency Code.

10

Recital 45 of the 2019 Directive.

-7-

a) The secured claim and the security right Secured creditors are often in possession of two rights ag5ality of interest’ for class formation,11 such a similarity of interest is certainly present for both the secured claim and the security right. Both legal entitlements may and should be treated equally in the same class. Importantly, voting rights should only be granted in accordance to the common interest.

In jurisdictions where class formation shall primarily reflect different legal entitlements, separate classes for the secured claim and the affected security right seem to be a straightforward concept.12 The identical economic interest must be reflected when voting rights are considered.13 Even more, it may support a construction of such provisions that enables a plan proponent to avoid the creation of separate, parallel classes with identical parties and the same treatment.14 b) Separate classes for different security rights The coherent treatment of the secured claim and the security right when forming classes connects to the question whether different secured claims and their security rights may be collected in the same class. Art. 9(4) of the 2019 Directive seems to indicate that this is possible when explaining that creditors of secured and unsecured claims shall form separate classes. Can there be one class for secured claims and one class for unsecured?

The answer refers back to the need for a sufficient commonality of interest (Art. 9(4) first sentence). Where a note is secured by a guarantee of a third party, all noteholders share a common interest. Their secured claims may be collected in one class. If a bank loan is secured by a mortgage, however, the interest of the bank may differ significantly from the interest of the noteholders regardless of the fact that all of them are secured creditors of the same debtor. Separate classes are required. Similarly, senior and junior lienholders may share the same legal right in the same property of the debtor but their economic interest may be significantly different due to the different expectation in receiving any value. Class formation is case-sensitive.

11

See Art. 9(4) and 10(2) lit. b of the 2019 Directive.

See § 222(1) no. 1 German Insolvency Code and § 9(1) no. 1 German Restructuring Code (StaRUG).

12

See § 237(1) second sentence German Insolvency Code and § 24(3) German Restructuring Code (StaRUG).

13

14

See Jannik Weitbrecht, Mittelbare Planeingriffe in Sicherungsrechte, Nomos 2019, p. 185-207.

-8-

C. The ‘Best Interest of Creditors’ Test The ability of a restructuring plan to impair secured claims creates no concern for secured creditors as long as such an impairment is conditioned to their consent.

The ability to impair rights is indeed connected to the right to vote. Art. 9(2) of the 2019 Directive states that all affected parties must have a right to vote on the adoption of a restructuring plan. The right to vote does not mean, however, that any party voting to reject the plan cannot be bound to the plan nonetheless.

There are two scenarios in which a secured creditor can be bound to a plan against their will. First, the creditor may find their claim in a class with other secured claims who voted to accept the plan with the required majority under the law applicable (dissenting minority scenario). Art. 9(6) of the 2019 Directive authorises a majority vote in a class to bind the dissenting minority. Second, the secured creditor may find sufficient support in their class to have it voting not to accept the plan, but see the rejecting class being bound nonetheless based on the applicable cross-class cramdown provision (cramdown scenario). Art. 11 of the 2019 Directive requires Member States to introduce such a cramdown power.

In both scenarios, the power to bind the dissenting creditor is, amongst other requirements, conditioned by a ‘best interest of creditors’ test.15 1. The definition of the test in Art. 2(1) no. 6 of the 2019 Directive The ability of the law to coercively bind a party to the modification of their rights as proposed in a restructuring plan derives from the idea that a plan is fair also in relation to this creditor if the plan treatment is accepted by a majority of equally positioned and equally treated creditors (dissenting minority scenario) or at least offers a fair distribution of inevitable losses by the standards of the law (cramdown scenario). In both scenarios, it is also commonly accepted that a plan cannot propose to have any creditor receive less value than they would receive in the scenario that would unfold without the plan unless the creditor actually agrees. A plan that offers dissenting creditors more than they would receive in the alternative scenario, however, is deemed to be in “the best interest of all concerned”.16 See Art. 10(2) lit. d. The provision is part of the cramdown requirements as well; see Art. 11(1) lit. a.

The best interest test is also the relevant test under US law, see § 1129(b)(2)(A) of the US Bankruptcy Code.

15

This phrase was first used in § 5103A of the US Bankruptcy Act of 1874 and established the use of the term ‘best interest test’ in US bankruptcy law; see eg Jonathan Hicks, ‘Foxes Guarding the Henhouse: The Modern Best Interests of Creditors Test in Chapter 11 Reorganizations’, 5 Nev. L.J. 820, 822 (2005).

-916

In line with this idea, Art. 2(1) no. 6 of the 2019 Directive defines the best interest test to be satisfied ‘if no dissenting creditor would be worse off under a restructuring plan than such a creditor would be if the normal ranking of liquidation priorities under national law were applied, either in the event of liquidation, whether piecemeal or by sale as a going concern, or in the event of the next-best-alternative scenario if the restructuring plan were not confirmed’.

Recital 49 explains that a court is able to reject a plan ‘where it has been established that it reduces the rights of dissenting creditors or equity holders either to a level below what they could reasonably expect to receive in the event of the liquidation of the debtor’s business, whether by piecemeal liquidation or by a sale as a going concern, depending on the particular circumstances of each debtor, or to a level below what they could reasonably expect in the event of the next-best-alternative scenario where the restructuring plan is not confirmed.’ Similar wording is found in recital 52.

2. The factors to consider A dissenting secured creditor is worse off under the plan if the plan would see him or her worse off.17 There are three aspects to consider.

First, it should be stated that the relevant position for the comparison is not merely a nominal legal position under the plan as of the effective date of the plan. Recital 49 seems to allow for such an understanding of the test when it refers to the level to which the plan “reduces the rights of dissenting creditors”. What is actually meant is not the nominal right to receive value but the value to be actually received under the plan and to compare this expectation with ‘what they could reasonably expect to receive’ in the alternative scenario. This means that a plan may see the secured creditor worse off even though the security right remains unaltered simply due to the fact that the value of the collateral would decrease in the proposed scenario.

Second, the expectation of receiving value on behalf of a secured claim is, in the first step, determined by the value of the collateral.18 Depending on the category of encumbered assets, such a valuation may be technically challenging. The facts underlying the As the best interest test determines whether dissenting parties are worse off under the plan, it is also called ‘worse off’ test; see eg In the matter of Virgin Active Holdings Ltd. [2021] EWHC 1246 (Ch) para. 106.

17

Axel Krohn, Rethinking priority: The dawn of the relative priority rule and the new “best interests of creditors” test in the European Union, Int Insolv Rev 2021 30:75, 86.

18

- 10 -

judgment of the United States Court of Appeals for the Second Circuit in re Sears Holdings Corp. may serve as an illustration.19 The Sears Holdings Corporation and its affiliates operated 687 stores across the US when they filed for bankruptcy in 2018. Some debt obligations were secured by the inventory in these stores. On the petition date, neither the debtors nor their creditors knew whether Sears would be sold or liquidated. The bankruptcy court held a hearing to determine the petition date value of the collateral and heard testimony from valuation experts put on by the debtors and various secured creditors, whose assessments of the collateral’s value varied widely, ranging from $2.46 billion to $3.28 billion – depending on how the experts calculated the revenue one could expect to earn from selling the inventory (at full retail price; a depressed, going-out-of-business or liquidation price; or an orderly company-wide going out of business sale). More on this valuation discussion in a moment. Where the enterprise as a whole is collateral, eg of a floating charge in English restructuring cases, the technical challenges of determining the enterprise value in a hypothetical scenario multiply.20 Third, the expected value to be received on behalf of a secured claim depends on the costs and fees to be subtracted from expected earnings in a collateral sale under the applicable law in the alternative scenario. These costs include overhead fees and legal costs.

They may also comprise any other contribution from earnings based on, for instance, a statutory super-priority claim or administrative expense that is entitle to receive value from a sale of collateral first. Under German law, for instance, the sale of inventory would be organised in the course of insolvency proceedings and allow the insolvency administrator to deduct nine per cent of the distributable earnings before turning over the remaining proceeds to the secured creditor.21

19

See In re Sears Holdings Corp., No. 20-3343 (2d Cir. 2022).

For a detailed discussion, see eg In the matter of Virgin Active Holdings Ltd. [2021] EWHC 1246 (Ch) paras. 133-196.

20

21

See §§ 170, 171 German Insolvency Code.

- 11 -

3. Determining the value of the collateral in the alternative scenario The 2019 Directive does not provide a rule about how to value collateral or the business of the debtor as a whole. Art. 14(1) only explains that a valuation of the debtor’s business in court shall only be mandatory if contested and not be done as a matter of principle.

Art. 14(2) adds that any such valuation in court shall be assigned to ‘properly qualified experts’. This leaves a lot of room for national legislators and case law to fill the gap.

The only substantive guidance is found in Art. 2(1) no. 6 and recitals 49 and 52 of the 2019 Directive. Pursuant to these provisions (cited above), the court needs to compare the expected value to be received under the plan with the expected value the creditor would receive in the hypothetical scenario without the plan. The task to identify this scenario is guided by the statement in Art. 2(1) no. 6 where two basic alternative scenarios are described: (1) the liquidation of the debtor (piecemeal or going concern sale) and a distribution on behalf of the secured claim according to the applicable liquidation priority, or (2) any distribution on behalf of the secured claim ‘in the event of the next-best-alternative scenario’ without the plan. As recitals 49 and 52 further illustrate, these provisions actually contain three scenarios to consider: (1) a piecemeal liquidation; (2) a going-concern sale; (3) any other alternative scenario that is more likely if the plan is not confirmed. This guidance is interesting because one could well argue that the third option necessarily includes all other options if they are the most probable alternative scenario.

The intention to define three scenarios nonetheless may become visible when we include the second sentence in recital 52 into the consideration. Here, the EU legislator asks Member States ‘to choose one of those thresholds when implementing the best-interest-of-creditors test in national law.’ The idea is to provide options to Member States, which in turn may choose to clearly select the alternative scenario for all cases, for instance by referring solely to a piecemeal liquidation scenario.22 If Member States decide not to follow this advice and instead implement the next-best-alternative-scenario standard, like for instance Germany,23 there is no further guidance about how to identify this scenario.

22

Krohn (fn. 21) 84.

See § 64(1) German Restructuring Code (StaRUG). Also see § 901G(3) UK Companies Act describing the hypothetical counterfactual as the ‘event of the relevant alternative’, which is further clarified in § 901G(4) as ‘whatever the court considers would be most likely to occur in relation to the company if the compromise or arrangement were not sanctioned’.

23

- 12 -

a) Uncertainty about the likely alternative scenario and how to identify it The best interest test originates from insolvency proceedings. The alternative scenario to a plan solution in such proceedings is the default outcome under insolvency law – a liquidation. In cases where the debtor ceased to trade when entering proceedings, a piecemeal liquidation of the remaining assets would unfold. The secured creditor’s position in such a scenario would be determined by the value of the collateral that could be realized in a liquidation sale of the encumbered assets to the amount that the creditor could claim value pursuant to the statutory distribution rules.

If, however, the debtor is still trading when filing for insolvency, many insolvency laws provide assistance in keeping the business alive in order to preserve the going concern and realized a going concern value in a (liquidation) sale of the business as a whole (as an alternative to a plan solution). Accordingly, a modern best interest test must reflect that a going concern value may not only be achievable under a plan but also in an alternative scenario.

The issue that occurs in such a case is uncertainty. When a plan is proposed, voted on and considered by a court for sanctioning, it may be far from certain whether a going concern sale could be achieved if the plan was rejected. In addition, the level of certainty may change over time when a sale is further prepared after a plan was developed and proposed in case the plan does not find support (dual track case).

Again the Sears case may serve as an example.24 On the day of the commencement of Chapter 11 proceedings, neither the debtors nor their creditors knew whether Sears would be sold or liquidated. At the same time, the experts’ assessments of the collateral’s value, the inventory in the stores, varied widely, depending on the scenario in which they were to be sold: at full retail price; a fully depressed, going-out-of-business price (liquidation price); or an orderly company-wide going out of business sale (net orderly liquidation value). The bankruptcy court held that, as of the petition date, two scenarios were ‘realistic’: a going concern sale or a force liquidation of the debtors. The court concluded to accept valuation between the forced liquidation and the full retail price and used the net orderly liquidation value. The secured creditors appealed this decision arguing that, since the debtors did not ultimately liquidate, but instead continued operating many of their stores before selling their business as a going concern, See In re Sears Holdings Corp., No. 20-3343 (2d Cir. 2022). Please note that the decision does not concern a valuation for a best interest test (§ 1129(a)(9) US Bankruptcy Code) but a valuation of collateral affected by a going concern sale (§ 363 US Bankruptcy Code). The case may still serve to illustrate common valuation issues.

24

- 13 -

the valuation should have reflected the full retail value of the inventory. The Court of Appeals argued that a going-concern sale was a best-case-scenario at the petition date when a company-wide liquidation was possible as well, especially because there were no bids for the debtor’s business and because the debtor was prepared to liquidate immediately if necessary.25 It is a matter of the applicable law whether the valuation of the collateral in the (hypothetical) alternative scenario would need to be based on the scenario identified as most likely on the date of the petition. The decision in Sears declined to allow the actual outcome of the case to have significant influence in the identification of the relevant scenario. This conclusion has merits when translated to a best interest test. The requirement that the court needs to identify the alternative scenario based on the expectation of all parties on the petition date prevents hindsight bias and avoids uncertainty for the plan proponent. The design of every plan is based on a scenario analysis that must necessarily reflect the hypothetical development of the case without the plan that is most likely at the time when the plan proposal is finalised by the plan proponent. The relevance of the day of the petition provides the stability needed for such early plan calculations and expectations. Because the petition date and the date of the commencement of bankruptcy proceedings is the same under US law, no further discussion was required in this respect. In a European context, where plan proceedings may not commence immediately, the date of their commencement may serve as the relevant date.

It must be stressed that the decision does not mean that secured creditors may not claim any increase in the value of their collateral, as identified on the date of the petition. The case only illustrates potential difficulties in identifying a relevant scenario for valuations. Once the scenario is identified properly, the value that the secured creditor would receive in it on behalf of their claim is to be valuated. Where asset prices rise in such a hypothetical, the value attributed to the secured claim rises accordingly.26 At this point is seems useful to also stress that it is a matter of the applicable law on insolvency and secured transactions to identify the assets of the debtor that serve as collateral in the relevant alternative scenario. The best interest test of restructuring laws builds in these policy decisions. The extent to which legislators or case law enable floating charges or even fixed charges to attach a class of present and future assets that reflect 25

See In re Sears Holdings Corp., No. 20-3343 (2d Cir. 2022) p. 21-22.

For US law, see Melissa B. Jacoby and Edward J. Janger, Tracing Equity: Realizing and Allocating Value in Chapter 11 96 Texas L Rev 673, 694-695 (2018).

26

- 14 -

the going concern of a business like book debt or inventory may vary.27 A restructuring plan would need to reflect these policy decisions because they define the entitlement floor of these secured creditors in the alternative scenario. Statutory limitations, such as a super-priority for certain claims28 or limits the ability to attach new assets generated after the commencement of proceedings29 but also avoidance rules, may have a significant effect in defining such entitlements.30 b) The expectation of a going concern on the petition day The facts of a case are significantly different if the proceedings commence with the understanding of the parties that there is a going concern in the debtor’s business. This is especially the case in restructuring proceedings as such proceedings solely aim at preserving the going concern and maximising the value in the form of a restructuring surplus. It can also be the case in pre-packaged insolvency proceedings.

The hypothetical counterfactual in restructuring-only preventive proceedings like those described in the 2019 Directive is often far from the typical case inspiring distribution rules and priorities in an insolvency liquidation. Hence it is not convincing to even assume that the alternative scenario without a plan is an insolvency law piecemeal liquidation.

In cases in which neither the debtor nor the creditors wish and expect the business to be liquidated in a piecemeal fashion, but nonetheless fight and partially disagree about the appropriate way to realise and distribute the going concern value amongst stakeholders, the most likely alternative scenario to the proposed plan is another plan,31 sometimes a going concern sale.32 The determination of the alternative scenario should again be made based on the expectations of parties on the date of the commencement of proceedings. The plan does not need to identify the relevant alternative scenario with certainty; See, most prominently, the discussion about how to tell such charges apart under English law in Re Spectrum Plus Ltd; National Westminster Bank plc v Spectrum Plus Ltd and others - [2005] 4 All ER 209.

27

28

See eg §§ 40, 175 UK Insolvency Act.

29

See eg § 91 German Insolvency Act or § 552(a) US Bankruptcy Code.

30

For a brilliant discussion of relevant factors see Jacoby and Janger (fn. 29) 709-721.

See Lorenzo Stanghellini, Riz Mokal, Christoph Paulus and Ignacio Tirado, Best Practices in European Restructuring, Contractualised Distress Resolution in the Shadow of the Law, Wolters Kluwer 2018, p. 44. See also Michael Crystal and Riz Mokal, The Valuation of Distressed Companies: A Conceptual Framework, Int Corp Rescue 2006, 123, 128.

31

See In the matter of Virgin Active Holdings Ltd. [2021] EWHC 1246 (Ch) para. 109-117. Also see Krohn (fn. 21) 84-85.

32

- 15 -

the identification of the most likely hypothetical counterfactual suffices.33 Any court review is a matter of facts and, thus, evidence.

D. Conclusion The protection of secured creditors in plan proceedings, which follow the structure of the 2019 Directive, is strong, but not impervious. Secured claims can be modified in a plan. The rules on class formation provide them with a strong position in negotiations.

The best interest test guarantees them the value of their collateral in a predictable way.

Any additional value cannot be claimed on behalf of a secured claim.34 The way these safeguards are described in the 2019 Directive is far from perfect. Detailed, tailor-made provisions are missing and were left for the Member States to fill in.

This imperfection may well be criticised as a cause for ‘much complication and uncertainty’.35 It reflects a business reality, which is not simple. And it enables the nuances of each case to be adequately reflected. Professional standards will quickly adapt to these new rules.

See In Re DeepOcean 1 UK Limited [2021] EWHC 138 (Ch) para. 29; In the matter of Virgin Active Holdings Ltd. [2021] EWHC 1246 (Ch) para. 106 for the UK version of a best interest test in § 901G Companies Act. 33

Any surplus in value realized by good will and cooperation is to be distributed amongst firm-based claimants, ideally by agreeing on a plan, and cannot be grabbed by asset-based claimants like secured creditors. Secured creditors are not automatically senior creditors for any value in the firm available for distribution; see eg Jacoby and Janger (fn. 29) 709; deviating eg Rolef J. de Weijs, Harmonization of European Insolvency Law: Preventing Insolvency Law from Turning against Creditors by Upholding the Debt–Equity Divide, ECFR 2018, 403, 418. The underlying discussion of a fair value distribution goes beyond the aspect of protection examined in this paper. The question how to share any ‘bankruptcy-created value’ and, even more, the ‘restructuring surplus’ is found in national legislation implementing one of the priority rules offered in Art. 11 of the 2019 Directive. The discussion of these rules deserves a separate paper.

34

Giulia Ballerini, The priorities dilemma in the EU preventive restructuring directive: Absolute or relative priority rule? Int Insolv Rev 2021 30:7, 11. Similar concerns are raised by Krohn (fn. 21) 87 (‘complicated expert battles’).

35

- 16 -

Stephan Madaus

Prof. Dr. Stephan Madaus has held his chair at the Martin Luther University Halle-Wittenberg since April 2014, where he was the head of the Law School from 2016 to 2018. He teaches property law (including secured transactions), insolvency and restructuring law, as well as contract and tort law. Prof. Madaus is a Member of the European Commission’s Expert Group on Restructuring and Insolvency. Her was co-chairing the Academic Committee of the International Insolvency Institute from 2018 to 2021 and currently serves as a member of the board. Prof. Madaus is a Founding Member of the Conference of European Restructuring and Insolvency Law (CERIL).

His research interests are in dealing with debt burdens and consequently focus on insolvency and restructuring law, with a special focus on the comparative analysis of relevant regulatory approaches in jurisdictions worldwide as well as in the soft law of international organizations. Together with Prof. Bob Wessels (Leiden University), he headed the ”European Law Institute’s Project on Rescue of Business in Insolvency Law” from 2013 to 2017 (OUP 2020). He was a member of the research team that evaluated the 2012 insolvency law reform (“ESUG”) for the German Ministry of Justice in 2017/2018.

- 17 -

As a member of an international research team, he helped to develop the ”Modular Approach for MSME Insolvencies” (OUP 2018) and to described a potential model law for “Financial Institutions in Distress: Recovery, Resolution, Recognition” (OUP 2023). f 2002–2010: Assistant Professor at University of Rostock. f 2008–2009: Visiting Scholar at Stanford Law School, Stanford, Ca., U.S.A. f 2010–2011: Associate Professor, Chair for European and International Company Law (Prof. Dr. Horst Eidenmüller, LL.M.) at Ludwig-Maximilians-Universität München. f 2012: Associate Professor, Chair for International and Comparative Law at Regensburg University. f 2012–2014: Full Professor, Chair for Civil Procedure and Insolvency Law at Regensburg University. f Since 2014: Full Professor, Chair for Civil Procedure and Insolvency Law at Martin-Luther-University Halle-Wittenberg f Member of the International Insolvency Institute (Co-Chair of their Academic Committee 2018–2021; Board Member since 2019), INSOL Europe’s Academic Wing, and the Conference of European Restructuring and Insolvency Law (CERIL) f Co-editor of the Law Journal „Neue Zeitschrift für das Recht der Insolvenz und Sanierung (NZI)“ f Co-editor of the Münchener Kommentar Insolvenzordnung (Volumes 1–4) and StaRUG

- 18 -

CHALLENGING THE ORTHODOXY OF ASSET SECURITY AND ITS ROLE IN INSOLVENCY Paul Omar

Introduction Lending orthodoxy holds that asset-security is a permissible way a creditor to gain extra protection. Thus, in insolvency, it is readily accepted as an exception to the pari passu principle, along with privileges/preferences, the only issue being whether encumbered assets are treated within or outside the insolvency estate. The international bodies active in the field, including the World Bank, also readily accept this position. However, could things be done differently? Is there a different construct applicable to the lending contract that would avoid the need for security and how effective could it be? If not, could enforcement and recovery of collateral be mitigated in some way as to promote the objectives of today: rescue and rehabilitation of the debtor and protection of the debtor’s family?

Asset Security: The Conventional View Security is the lynch-pin of the commercial arrangement. The development of security in order to protect the creditor’s interest is often related to the underlying varieties of property that exist and to how legal systems make available arrangements by which interests in property or their equivalent are given to creditors so as to enable the choice of whether to reclaim the indebtedness due represented in the form of a physical asset or a sum of money of corresponding value. This provides greater certainty than would the mere enforcement of a claim in personam against the debtor and is often used as an adjunct to or instead of this type of claim. The use of security serves to promote the security-holding creditor to a better position in relation to claims over the debtor’s assets than would be the position of other creditors. This is a particular concern in insolvency when the value of the underlying assets is unlikely to be sufficient to meet all claims against the debtor and the creditor doted with security is thus allowed to obtain enforcement of its rights over assets in priority to other creditors. Although the view has been expressed that the granting of security is not wholly efficient and may lead to a misallocation

- 19 -

of resources,1 the general consensus is that security serves to ‘enhance the probability of repayment’.2 Thus, the underlying basis on which most reforms in security law are undertaken is the assumption that a good security regime increases the likelihood of credit at low interest rates and costs, thus serving to benefit those who are able to take advantage of it to obtain credit and thus capital for economic activities.3 The role of asset security in the funding of business is essential where debt finance is one of the few options for businesses intending to expand. While creditors would prefer, obviously, to have the sums lent repaid, the availability of a “Plan B” that palliates the risks of non-performance or insolvency, in theory also reducing the cost of access to credit, has long been attractive for lenders. For that reason, the mediaeval strictures of the pari passu principle have been avoided, almost from the outset, for creditors, consensual security being one of the avenues recognised at law for the mitigation of the doctrine, the other usually being preferences, the latter normally of statutory origin or creation.

The importance attached to security as a tool for the support of lending, especially for developing countries, is seen in its reflection in key international texts.4 In the World Bank Principles for Effective Insolvency and Creditor/Debtor Regimes,5 for example, the creditor’s ability to bargain for the transfer of security rights enabling enforcement over the debtor’s property is the “simplest [and] most effective means” of ensuring the principle of prompt payment. It is certainly more effective, they say, than would be the prospect of insolvency proceedings with attendant procedural complexity and delays.6 The desire to enable direct enforcement by the creditor may explain the popularity at common law, historically, of institutions like receivership, granting direct access to the debtor’s property (and later the entirety of their business), as a method for circumventing See J. Hudson, ‘The Case against Secured Lending’ (1995) 15(1) International Review of Law and Economics 47.

1

See E-M. Kieninger, ‘Introduction: Security Rights in Movable Property within the Common Market and the Approach of the Study’, Chapter 1 in E-M. Kieninger (ed), Security Rights in Movable Property in European Private Law (2004, CUP, Cambridge), 7.

2

3

Ibid., 8.

The role of asset security in insolvency proceedings is recognised in many modern texts, including Principle 7 of the G22 Key Principles and Features of Effective Insolvency Regimes 1998, Principle 3 of the World Bank Principles and Guidelines for Effective Insolvency and Creditor Rights Systems 2001, Principle 9 of the Principles of European Insolvency Law 2003, Recommendations 3-4, 50-51, 88, 100, 188-189 of the UNCITRAL Legislative Guide on Insolvency Law 2004 and Principles A1-A5 of the World Bank-IMF Joint Initiative on Creditor Rights and Insolvency Standards 2005.

4

5

See the 8 Principles in Part A of the text (2015 Revision).

6

Executive Summary, World Bank Principles, at 5.

- 20 -

recourse to more formal (and usually collective) proceedings. It might also explain the concern, even within formal proceedings, with preserving the creditor’s rights by segregating or exempting secured assets, as many systems in fact do, thus creating two pools of assets, which may be termed “general” and “encumbered”, the latter normally only being available to the creditor in whose favour the security has been created. In an environment where liquidation is the norm, such separate pools cause few problems, although rules need to be made for what happens if assets in the “encumbered” pool are insufficient to meet the value of the security: will the creditor be able to claim against assets in the “general” pool and on what basis, i.e. is the secured status preserved? Different systems answer these problems in slightly different ways. Where rescue procedures are available, segregating assets may be inefficient and counter-productive in the case of a sale of the business as a going concern and many systems, but not all, favour a form of reintegration of the otherwise segregated assets, subject to continued respect for the creditor’s priority.

Why the Need for Security?

Reasons to like Security It confers greater protection for lenders and gives priority to lenders over and above all other types of privileges and interests. In the common law, knowing that there are two systems: the common law itself and equity, both of which were able to create forms of security, necessitates a decision as to the relative priority between different forms of security (the usual rule being that legal security is better than equitable) and, within each type, between different security instruments (often on the basis of creation and/or registration, if required). This is so that creditors know that the security that is anticipated and certain is the security that is going to be enforced. There is also the possibility of carving out, which may be available depending on the jurisdiction in which participants in the security process find themselves. Some systems say that the secured creditor can simply take the collateral away and deal with it, while others prefer to integrate the collateral within the single insolvency (estate), albeit still respecting the secured creditor’s priority. In most cases, though, there will be two pools of assets, one of secured collateral, one of general assets, the former devoted to the secured creditor’s interests, the latter to all other creditors. Creditors like security because of the opportunity of over-securing against loans, so, especially where the collateral may be worth significantly more than the sums advanced. This ensures that there is always a cushion for the creditor and that, if the collateral diminishes in value, it is the debtor that takes the first cut and not the creditor.

- 21 -

Another reason for creditors to like security is its origin, which probably go as far back as Roman Law and the development of the “real right”, also known as the “accessory right” or the “in rem” right”, and the fact it confers access to the object (the res) as an alternative to the repayment of the loan (a position that is replicated in the may systems that owe their inheritance, in whole or in part, to Roman Law). This makes sense, especially where the object is an asset purchased with the moneys advanced, such as a house.

Where the object is no longer available, some systems will offer the possibility of obtaining the cash equivalent, still protected by the priority, an advantage to relying simply on the promise in the loan instrument to repay (an “in personam right”, or “personal right”). In the common law system, there is also the possibility to trace an asset into third-party hands, so that if the collateral has been disposed of, the secured creditor or insolvency practitioner (on behalf of the secured creditor or general body of creditors) can trace the asset with view to recovering it. Incidentally, though the rules of tracing are complex, both UNCITRAL and the European Commission (in its Insolvency III Project) are considering work on an asset tracing framework to encourage the development of the necessary tools to enable it to happen. Undoubtedly, this will be a new area of development for practitioners to come.

Reasons not to like Security There are a few reasons here too. The issue of efficiency has been noted above.7 Costs are a major issue. Everything that is chargeable to the collateral and the security is imputed to the debtor. The debtor pays for every action the creditor takes in respect of that security. This can lead to unwarranted costs, over which the debtor has no control. There is also the potential loss of priority for some secured creditors. If, say, the secured creditor has an equitable charge in the common law system, the floating charge (a charge over a collection of assets) being an example par excellence of an equitable charge, having been created by the courts of Equity, then the creation of a legal charge, at any time (even subsequently to the equitable one) will cause the equitable charge to lose priority over the asset(s) “abstracted” from the collection. There is also the possibility of subordination, a statutory example of which is section 176A, Insolvency Act 1986 (UK), which carves out a part of the funds otherwise subject to a floating charge, so as to distribute these funds to the unsecured creditors. This is, of course, also subject to the usual rule that fees and expenses (costs of the court process and any asset-dealing etc.) are payable in priority to all creditors. This could be described as statutory manipulation of the order of priority.

7

See above note 1.

- 22 -

Creditors often also want “to have their cake and eat it”, the case of Re Spectrum Plus8 being an illustration in point. In this case, the creditors attempted to create an instrument that would provide a floating charge over the moveables, i.e., the debts while they were unpaid, and then, once the debts had been paid and deposited in the hands of the debtor, to serve as a fixed charge over the proceeds in the bank account, a type of Quistclose trust.9 Eventually, the courts said no to this practice, requiring creditors to elect security types or to provide for different security for different species of assets, but which reputedly generated enormous cost (allegedly a quite considerable sum) for the number of contracts that needed to be rewritten and practices needing to be altered in the wake of the decision. Loss of priority is indeed a concern for secured creditors. The ineffectuality of the “negative pledge” clause, by which debtors promise not to create any subsequent security, particularly security that might have a higher status than any existing security (the example of an after-created legal charge enjoying higher status than any equitable charge is just such a possibility), is well known, no real consolation being forthcoming to say that the creditor can sue for the breach of the promise when priority has been lost.

There is also the de jure merger of asset pools, where the secured asset is retained by the insolvency practitioner with the consent of the court, as in the French system. A de facto merger of pools is also a possibility, as in the Quistclose case referred to above, where a weak form of security led to the payment of collateralised debt into the debtor’s bank account, which merged the funds into the debtor’s working capital and undermined the effectiveness of the security, as the creditor took the risk of enforcement over an account whose contents might already have been dissipated (this eventually led to the practice of using dedicated bank accounts for debt-collection). Referring back to the possibility of tracing, a difficult thing to do anyway, but where mergers of pools have happened or assets substituted by their value (i.e., where the asset is no longer available in its original type/form, but in a new form), tracing becomes even more complex and there are limits as to how far the law will permit you to “follow” the asset and/or its value. The more hands the property passes through, the less the law is willing to act.

8

Re Spectrum Plus [2005] UKHL 41.

9

Barclays Bank Ltd v Quistclose Investments Ltd [1968] UKHL 4.

- 23 -

In fact, provisions conferring immunity on “innocent” acquirors of assets exist.10 In such an event, the creditor will have to go back to the debtor to assert what is no longer a secured, but general, claim.

The biggest reason, however, not to like security, is that it clearly breaches the pari passu (lit. equal steps) principle, referred to occasionally as the pars condicio creditorum (the equal condition/status of creditors). Is this an urban myth as principles go, or is it simply a reflection of a principle to be attained? Even in the early days of the development of bankruptcy processes in Italy in the 13th century, pari passu was already being eroded through being negotiated away through contract with those creditors who succeeded in establishing claims before the tribunals and courts for special treatment being able to take more away from proceedings, while local laws sometimes intervened to accord privileged status to some and thus priority in the distribution of proceeds. As an aside, security itself, a form of contractual re-bargaining recognised through law, is often confused with privilege, which originates in the law. But both security and privileges (also preferential claims) serve to further diminish the pool available to creditors unable to promote themselves by any means. If pari passu ever existed, it no longer does so (or if it does, then ineffectively), especially considering the range of priorities in modern texts.

Path-Dependency: Some Thoughts to explain the Prevalence of Security When discussing law reform, the idea of path-dependency is often adverted to, particularly in emerging and developing economies with a colonial past. Though alternative sources of inspiration may be suggested by experts called into help with reform initiatives, oftentimes, a preference is expressed for the law or legal system with which the jurisdiction is familiar through the historic connexion, because this law/system appears to work in the context in which it is found. Moreover, reforms which take place in the influencing system are often seen by the influenced as good reforms to emulate, for a variety of legal, economic, social or other reasons. The choice is thus made, not for the law of the coloniser, but for the efficiency and effectiveness that law appears to represent and which could be usefully transposed. In a path-dependency model peculiar to security, security has always been seen as good, effective and, further, “consecrated” by being seen as part Section 104(2), Law of Property Act 1925 (England and Wales), provides that the title of a third-party to whom land has been conveyed (by the mortgagee or its agent) is unimpeachable. The same may be true where the debtor effects the sale and the third-party has no notice of the breach of contract this constitutes. The same can apply to moveables that have been stolen and sold to an “innocent” third party: section 21(2), Sale of Goods Act 1979 (UK).

10

- 24 -

of an ancient model, being derived from Roman Law, the summum of ancient law. Thus, the security model is to be desired and its application in modern systems derived from Roman(-inspired) origins wanted.

This view is undoubtedly boosted by the view of the international institutions active in the lending and law reform sectors. For them, the presence of an effective security regime constitutes prime access to finance. With the addition of a registration system, by which transactions with certain forms of collateral are better managed, this access is enhanced. The progressive accretion of novel types of assets to the register further enables the commoditisation of collateral, as has happened in many jurisdictions with the creation of asset-specific registers (first immoveables, then moveables, specific or general) or with the creation of non-asset specific security subject to registration. The move to a single register for all forms of security is also reflective of this staged development.

It may be true that, as economic analyses have shown, when changes are made to the collateral/security regime, there is a certain amount of improvement in the underlying access to lending. Is this, however, solely due to improvements to the security framework or to the often general raft of reforms of which security can be a part? However, the basis on which data is collected and analysed has been the subject of dispute. The Doing Business report, long held up by the World Bank as a model of how to best measure the parameters of success for any particular economy, came under closer and more adverse scrutiny, not just by emerging and developing countries on certain continents, but also by the developed.11 Even the United Kingdom is said to have succumbed to the lure of the report by timing the reforms in the Corporate Insolvency and Governance Act 2020 to be able to influence the outcomes of the exercise. Although the Doing Business framework has been replaced by B-Ready system, data is not yet available to indicate whether it is any better at reflecting the impact of change.

It is true, nonetheless, that reforms to asset security are so prevalent, perhaps (in part) due to the phenomenon of path-dependency. This may well be true if the scope of reforms initiated (and funded) by the various international institutions, in partnership with the countries involved and/or third-party funders and interest groups, is examined and enumerated. Many of the reform projects focus on general civil and commercial justice, while, within commercial justice and commercial law topics more broadly, the For a criticism of the methodology of the Doing Business Report, see Gerard McCormack, ‘Why ‘Doing Business’ with the World Bank May Be Bad for You’ (2018) 19(3) European Business Organization Law Review 649.

11

- 25 -

focus has tended to be on insolvency and restructuring (including that of financial and other key institutions), corporate governance and asset-security with perhaps a nod to structural issues, such as the training of judges and the support for court frameworks and staff and, more generally, capacity building and knowledge transfer, albeit often as an afterthought in many of these projects. Concern over consumers, access to finance, financial education and exclusion have been late, but welcome, additions to this list of imperatives.

What is noticeable, in this regard, is the competition that exists in the reform field between institutions and competing methodologies, in which certain approaches are promoted. These include the US approach in Article 9 of the Uniform Commercial Code and the concept of a single form of security for most major types of collateral, the French approach, which has found favour in the OHADA group of countries through the adoption of Uniform Laws inspired by the models prevailing in France, and the common law approach, which enables legal and equitable variants within a seemingly more flexible matrix. All these approaches are circulating in the reform pool, within which all these approaches compete for an audience. It is not for this author to say whether there is one model that is particularly better or more appropriate at achieving particular outcomes. It is sufficient to note that the competition exists and influences the way in which reforms are perceived, in large part due to the importance attached to asset security frameworks, whether on their own or as part of a larger picture of economic and commercial legal reform.12

Do “Alternative” Strategies and/or Adjustments Exist?

The question here is whether it is possible to get away from using asset security or needing to embed traditional views of asset security as part of the commercial/insolvency legal framework. In this regard, creditors have always been creative. They have mostly been able to write off bad debts against tax. They may on occasion obtain tax breaks, often if the phenomenon of default is particularly prevalent in an economy. Excepting the situation where non-performing loans on a lender’s balance sheet carry the risk of infringing stability rules, for which may central banks require special provision to be made, the lender carrying a debt at risk of default is probably capable of managing the incidence of risk for itself. In that light, managing the probability of this risk often prompts banks to adjust the interest rate in lending agreements, this rate often also deSee, by this author, ‘Updating the Framework for Asset Security in France: The Reforms of 2006’ (2007) 2 JCompL 189, 198-199, for French perspectives on the competition.

12

- 26 -

pendent on the quantity and quality of collateral being supplied. Moreover, circumventing the principle of limited liability and the “inconvenience” of the separate legal entity principle, the personal guarantee from corporate directors and officers has long been an established feature of lending. Of course, it should be noted that such guarantees are just another form of security: the promise to surrender collateral in the event of the failure of the principal obligor to pay.

One big caveat, however, is that these alternatives are not seen as true alternatives/adjustments. Again, secured creditors want to have their cake and to eat it! So, these alternatives are really extra measures to be deployed, mostly, in addition to conventional in rem security. Nonetheless, some types of adjustments to the contract can be seen to function to limit the impact of security and the ability of the creditor to recover. In the case of subordination, for example in the case of project-specific security to which priority is accorded for a limited time or purpose, thus necessitating lenders to accept a temporary change of priority for the duration of this secondary lending, this type of status change is seen as an acceptable feature of project-lending and lenders readily accept its imperative. Delays to enforcement and/or recovery, particular examples having been seen in recent pandemic conditions and also as a result of the war in Ukraine, but which can be instituted at any time, can also serve to adjust creditors’ expectations by making access to the courts, the opening of proceedings and the enforcement of claims more difficult.

Lastly, there can also be restrictions on the types of collateral that can be made available for security. The Roman institution of the pactum commissorium (commissary agreement), by which the debtor could pre-agree to the transfer of collateral in favour of a creditor in the event of default, was later abolished by the pactum Marcianum (Marcian’s agreement),13 which was in turn subsumed into the modern laws of many states, including France and Italy. The modern operation of the pactum Marcianum often features a prohibition on the collateralisation of a principal residence or its use for certain types of lending. Alternatively, access to this collateral by creditors during the enforcement process may be limited. In this light, it is of interest that some of the individual states in the US offer what is known as the “homestead exemption”, under which primary residences are immune, albeit in some places only up to a certain value, from enforcement of debt.

The example of Jersey can also be cited, where Article 12 of its Bankruptcy (Désastre) Law 1990 postpones access by the creditor for such time as the home is required for the needs of the debtor’s spouse and/or dependents. The security remains as security, albeit Reputedly named after the Praetor who offered it as a remedy to parties unfairly impacted by a pactum commissorium.

13

- 27 -

not enforceable till such time as the period or purpose for retaining the home has expired. This measure can be understood in light of the relative paucity of available housing on the island and the family-oriented policy of its courts, unlike the situation which exists in the UK, where such priority is limited.14 Nonetheless, even in relation to such adjustments that exist, it is invariably the case that creditors will price these costs into the contracts and that the debtor will end up inexorably bearing the burden of those price-adjustments.

Do Real Alternatives exist?

The question then becomes: are there any genuine alternative strategies or models that can enable us to depart from these time-hallowed asset-security frameworks and structures? Are there any forms of cooperation outside the traditional framework that can exist between creditor and debtor that can secure funding? This may involve having to reconceptualise Ownership: no more meum et tuum, the separation into what is mine and what is yours. We may need to move away from this strict model towards a model of shared ownership and a new way of repartition of risks. Here, consideration may be given to the alternatives shown as possible by the Islamic finance model, one of a number of models worth close investigation. While proponents of the use of Islamic finance mostly come from countries whose religion and culture is inspired by Islamic models, it might be surprising to see that the UK is a major jurisdiction in many aspects of Islamic finance. According to a 2021 report from The City UK,15 an industry-led body representing financial and related services based in the UK, the UK is the leading Western jurisdiction involved in Islamic finance, with UK-based assets totalling USD 7.5 billion (2021 figures) amounting to 85% of total assets held in Europe (Turkey excluded), even more than the US (c. USD 636 million).16 The UK is also a Western leader in Islamic FinTech, due in part to a strong regulatory environment, a pool of talented professionals and a growing customer base (both within and outside the UK), not to mention favourable tax and policy environments. In fact, the London Stock Exchange is a global hub for sukuk (sharia-compliant bonds) listings, amounting to over USD 50 billion and is the world’s fifth largest provider of Islamic financial education.

See, by this author, ‘Security over Co-Owned Property and the Creditor’s Paramount Status in Recovery Proceedings’ [2006] 70 Conv 157.

14

CityUK Press Release (24 November 2022), available at: <https://www.thecityuk.com/news/theuk-remains-the-leading-western-hub-for-islamic-finance/>. The report itself may be viewed at: <https://www.thecityuk.com/media/1tbbofqr/islamic-finance-global-trends-and-the-uk-market. pdf>.

15

These figures are dwarfed, of course, by the global value of Islamic banking assets, estimated at USD 2.8 trillion (2021 figures) and likely to grow to exceed USD 4 trillion by 2026.

16

- 28 -

The motivation for the UK financial sector to be active in the Islamic finance is not necessarily cultural, despite the large ethnic population in the country. It has more to do with the desire to make profit and to provide services to clients operating in jurisdictions where the use of Islamic finance is either mandated or constitutes a distinct advantage. This, many UK-based financial lenders and legal service providers are readily involved in the structuring of finance according to Islamic models. The model itself is interesting because (placet Stephan Madaus) it reintroduces risk to the creditor. This is noteworthy, since, in most cases, having security is about the avoidance of risk. The creditor is enabled to over-secure, assert title to deal with the collateral, separate it into a different asset pool and to state: “This is mine!” The Islamic finance model, however, appears to be based on a shared investment and/or risk.

The musharakah (joint investment) contract, for example, sees creditor and debtor pool value into a joint purchase of an asset. In Malaysia, where Islamic banking and finance has a certain vintage,17 such purchases may be made of all manner of assets, ranging from consumer goods to property for housing. Int his model, there is a progressive transfer of ownership between debtor and creditor: as the debt is repaid, the debtor acquires more of a share and control of the property. This is not so strange for English law, due to the presence of the trust, invented, allegedly, in the 13th century or earlier to protect the property of those away fighting for the King, such as in the Crusades, and provide contingency plans bearing in mind the risks attendant on such ventures, death and disease being foremost amongst them. The idea of trust is to secure a trusted person to become the factual owner, but to hold the land for a purpose(s) dictated by the transferor, usually to perform services occasioned by land tenure and to look after the transferor’s family. The trust model is very close to the Islamic institution of the waqf (pl. awqaf) (which may be translated as “endowment”), which often involves a charitable purpose, akin to many trusts. The kinship between trust and waqf models is uncertain, but the similarities have prompted the suggestion that the later model, that of the trust, is borrowed,18 perhaps through the prism of conflict and cultural connections engendered through contact between scholars interested in each other’s worlds. This may well be an example of the early influence of Islamic law on the West, which can be seen, not just in the possible influence on trust law, but, within land law, on the development of the “equity of redemption” concept that credits the debtor with the value of repayments and The Islamic Banking Act 1983 was the first law in Malaysia to mandate licensing and regulation requirements for Islamic banks in the country.

17

See Monica Gaudiosi, ‘The Influence of the Islamic Law of Waqf on the Development of the Trust in England: the Case of Merton College’ (1988) 136(4) University of Pennsylvania Law Review 1231.

18

- 29 -

also the doctrine of “clogs and fetters” that prevent the use of contractual clauses seeking to undermine the debtor’s ability to recover property once paid for.

In the modern world, set against the background of the clamour for more clients and profits, the musharakah system appears to work. So too, its close kin, the murabaha, which is an agreement as to cost and markup, allowing for the sharing of profits resulting from an investment. Thus, as the value of the underlying asset increases, so there is a progressive distribution of the enhanced value to both debtor and creditor alike. However, a diminution in value would also be similarly distributed, unlike the asset security regime where the debtor bears the loss of value, first in the “cushion” occasioned by the debtor’s own equity, then in the ability for the creditor to bring an action on the personal covenant to recover any deficit after liquidation of the asset. This may be where we have to reintroduce to creditors the idea that losses may be a part of the general plan and that asset acquisition occurs through a form of cooperation. Thus, it should not be just the debtor who loses out in an investment goes sour. As has been said (placet Tarmo Peetersen): “It is about people, not just bricks!” Creditors would have no one to lend to if there were not people willing to borrow (whether we mean individuals/consumers or business entities whose entrepreneurs need seed and/or expansion capital).

There are, of course, problems in Islamic finance models too, chiefly in the need to secure an opinion on sharia-law compliance, which will also involve the need to ensure that the murabaha and, indeed, all Islamic finance models and structures work subject to the avoidance of riba’ (usurious or excessive interest) and any other vitiating factors under Islamic law.19 Moreover, many similar issues to those impacting conventional security require resolution: who controls the asset; how to evidence progressive transfer of interests/ownership; who bears the loss in the event of investment failure; and whether we attach liability for any investment decisions that go awry. Nonetheless, the Islamic finance model is a model that, due to its regular use in the modern age, constitutes a possibility for adaptation, always assuming that issues of the differences in culture and legal thought are possible to resolve.

The Way Forward In the end, the real question may be whether conventional security is here to stay. Is the prevalence of the model, its antiquity and its garnering of devotees an assurance of peIt should be noted that there is not a single Islamic law, but four ancient schools (madhahib) of jurisprudence in Sunni Islam, to which must be added the Shia schools of thought. There is inevitably the possibility of conflict of opinion between schools.

19

- 30 -

rennity? Is there truly “nothing new under the sun”?20 However, it is not the case that the current model always works: there is no harmonised treatment of security or priorities, thus creating comparative advantages and the possibility of “forum-shopping”, both for debtors seeking less costly credit and security and for creditors looking for a better Plan B to enforce over the collateral. This process incidentally also helps tie security types and their availability to sources of credit, hence the preference globally for US or common law models (such as the UK and Singapore) which accompany lending arrangements sourced on those very markets. Thus, the flavour of security that we end up employing will be directly related to our economic interest. Moreover, the implicit preference, adverted to earlier, in terms of law reform, for options related to common membership of a legal family and/or tradition also give favour to the above models and that in the civil law, to which the most recent OHADA reforms lend witness. Thus, going forward, would the option be to harmonise the concept (and types) of security?

In this context, although most Western European legal systems (and those deriving from them) boast an inheritance from Roman law and its insistence on classifying security into real and personal, also incidentally determining whether the security constituted a real right to the property or simply a privileged claim, the gulf in modern days between the civil law and common-law perspectives seems too wide to bridge. In the way the latter has moved to the creation of an intermediate class of interests (based on equitable principles) and the availability of security over classes or collections of assets, the differences are palpable.21 Furthermore, the prohibition on European Union competence in the matter of real property,22 on which real security rests, could pose an obstacle to the holistic treatment of all forms of security for the purposes of any harmonisation. Even addressing the issue of priority has been a contentious exercise for the recent work in 2021-2022 by the European Commission Group of Experts in Restructuring and Insolvency, the consensus eventually emerging that this was not an area ripe for progression (or even, in the view of some, capable of harmonisation), particularly in light of the many other topics competing for attention.

An alternative way, however, to deal with this difficulty might be to explore how the personal property security interest framework, a development originating in North Ame20

Ecclesiastes Ch 1, Vs 9 (King James’ Version).

Curiously, the Mauritian Civil Code manages to accommodate both classic civil law forms of security and, in Book III, Title XVIII, Chapter X, sûretés flottantes (floating security, i.e. the floating charge).

21

22

Article 345, TFEU (Old Article 295, EC Treaty).

- 31 -

rica, could have application, given it has been adopted by some mixed legal systems, such as Jersey.23 However, this might be a step too far for jurisdictions in which lending practices have revolved around the availability of certain models of security, while the transition to new models might be, arguably, costly in terms of altering not just contract clauses, but also behaviour and expectations. However, in favour of harmonisation, it is easy to see the attractiveness of the unitary security device in Article 9 of the American Uniform Commercial Code in the way that it functions for security in movables,24 when compared to the disperse security regime in France and generally in civil law jurisdictions. This is particularly so in light of the expansion of the model across the world and its adoption or influence on changes in a number of jurisdictions, including Australia, New Zealand and many of the Canadian provinces.25 It is also clear to see the influence of this model in the Jersey law as well as the re-drafting of provisions within other security regimes.26 The implicit recognition of the model in the European Bank of Reconstruction and Development’s Model Law on Secured Transactions 1994, on which subsequent reforms in some Eastern European countries have been based, as well as on the United Nations Convention on the Assignment of Receivables in International Trade 2001 and the UNIDROIT Convention on International Interests in Mobile Equipment (or Cape Town Convention) 2001 has appeared to signal moves towards the acceptance of this model as reflective of an international standard.27 As such, the problem for civil law jurisdictions, which have not generally embraced this model, is how they are perceived to perform in comparison with those that have. This is a position that some say was reflected in the World Bank’s annual survey called Doing Business, where, measured against key performance indicators, civil law jurisdictions were generally perceived as doing less well than their common law counterparts.

Nonetheless, the debate over harmonisation and its desirability may be ceding ground

23

In the Security Interests (Jersey) Law 2012.

See Harry Sigman, ‘Security in Movables in the United States – Uniform Commercial Code Article 9: A Basis for Comparison’, Chapter 3 in Kieninger (ed) (above note 2).

24

See Ron Cuming, ‘The Internationalization of Secured Financing Law: the Spreading Influence of the Concepts UCC, Article 9 and its Progeny’, Chapter 22 in Ross Cranston (ed), Making Commercial Law: Essays in Honour of Roy Goode (1997, OUP, Oxford).

25

See Sjef Van Erp, “Globalisation or Isolation in New Dutch Property Law? The New Civil Code of the Netherlands and the New Civil Codes of the Netherlands Antilles and Aruba Compared” (2003) 7(5) EJCL, section 3, copy available at: <www.ejcl.org/75/art75-2.html>.

26

27

Sigman (above note 24), 54.

- 32 -

to a different approach, that seen in the Financial Collateral Directive,28 which seeks to immunise financial collateral from the consequences of the application of domestic insolvency law rules. As such, this approach, which is the norm for arrangements in favour of regulated lenders, may well come to influence the lending dynamic entirely, including through influencing the terms of contracts for lending and the treatment of collateral in all other situations. This would incidentally remove the need for consideration for underlying harmonisation, given that such arrangements, whether involving financial collateral or not, would effectively lead to the segregation of such assets from insolvency.

This still leaves the question of asset integration open, particularly where this may constitute the sine qua non for rescue and which would otherwise lead to tying indissolubly the fate of rescue to the views of the secured lender. Whether this is in all circumstances desirable remains an open question.

Summary The above debate is rich, but does not resolve the question of whether the asset security environment will ever change. However, assets and property rights do change from time to time, as witness the rise in intangible property and its commodification for modern business. The value in such rights and in processes (such as the one-click methodology) may be difficult to ascertain, but needs nonetheless to be taken into account in valuing businesses and their property. It is fortunate, perhaps, that these assets were susceptible to the development of security rights only a little distinct from traditional ones, and the ability of legal systems to adapt made their acceptance smoother. However, the appearance of new assets will not always permit the extension of existing security. New assets may need new models, as the subjection of crypto-assets (including currency), blockchain technological processes and new ways of holding value to the current property and security dynamic illustrates by its very problematic nature, needing to decide on the nature of the asset, unlike any other hitherto, before determining whether the current security regime can encompass it (to this, many would say no). This will undoubtedly require reassessment of the security environment. Perhaps, while we are at this work, we could also review the participation and risk-taking elements of this process to better redistribute the burden between debtors and creditors.

27 March 2023 (revised 19 October 2023)

28

Directive 2002/47/EC. - 33 -

Paul Omar

Paul Omar is an academic lawyer working in the British HE sector and serving also as Consultant to a number of international bodies active in the insolvency and restructuring fields. Paul has worked in mainstream British academia for 25 years, principally at Sussex University and also in Wales and the East Midlands. At present, he is a Senior Lecturer in Land Law at De Montfort University Leicester. He has also had visiting appointments at the University of Pretoria, University College London and the Jersey Institute of Law, St. Helier. His research interests encompass insolvency, corporate and property law and he has published over 230 articles, books, chapters and edited collections.

Paul has served as Secretary of the INSOL Europe Academic Forum and as a member of the Steering Committee of the INSOL International Academic Group, the INSOL Europe Joint Academic-Practitioner Project on Cooperation and Communications, the Academic Advisory Group on the INSOL International Diploma Project, the Course Committee of the INSOL International Global Insolvency Practice Course and, more

- 34 -

recently, as a member of the European Commission’s Experts Group on Restructuring and Insolvency, which helped inform the drafting of the Preventive Restructuring Directive 2019.

Paul is at present a Consultant to the European Bank of Reconstruction and Development working on projects in Armenia, Serbia and elsewhere, mostly in the field of professional and judicial training. He is also advising BIICL on a project drafting company, partnership and insolvency model laws for CARICOM. He is external adviser to the Indian Graduate Diploma in Insolvency course and also the Technical Research Coordinator for INSOL Europe.

- 35 -

ON THE CROSSROADS OF SECURITY INTERESTS AND INSOLVENCY LAW Christoph G. Paulus

A. Introduction Writing this contribution in deference to my dear colleague and friend, Prof. Paul Varul, I do this on the common ground that both of us are academics. To be sure, Paul’s knowledge and practice reaches far beyond the academic agenda thanks to his eminent career, which brought him in touch with so many fields and areas of legal life, which seem to be non-existent when looking at this life solely from an academic text book’s perspective. It is therefore a bit presumptuous when I present here an increasingly important instrument of global relevance which is rarely if ever found in these academic writings.

I do hope, nevertheless, that Paul will recognize the intent and the good-will on which the following description is based, and be it a mere presentation without too much of a deeper discussion of particular issues.

Starting point of most academic teaching is – for very understandable and for very justified reasons – to present the distinct fields of law in distinct classes and in distinct text books. Accordingly, the class on the law of security interests will touch on the national rules and will possibly also cover the international environment. Similarly, the class on insolvency law will address the national insolvency law and will possibly include lessons from the European Insolvency Regulation and the autonomous international law. Tertium non datur, i.e. these are the two spheres which usually are presented to the students.

Needless to point out that with this dichotomy the future practitioner is by far not equipped with everything what needs to be known for understanding, let alone for being successful in legal practice. Usually, soft law or even no law is rarely taught at universities as maybe the best approach to dealing with a particular case or getting a deal through. The contractualisation of wide parts of the daily economic life and its implication of displacing law of property and procedural law is all too often unnoticed in academic teaching as are particular developments in certain areas of law.

- 36 -

Paradigmatic for the latter is the Cape Town Convention1 which can be seen as a step in an ongoing development towards a global lex mercatoria. This is precisely what shall be addressed here and what might constitute a tertium in the abovementioned sense. It is neither national nor international law; it is something beyond the categorization of nation or inter-nations.

B. Some general observations on the Cape Town Convention When talking about the Cape Town Convention, it appears advisable for a better understanding of its concept and structure to put it into the broader context of the founders’ basic conception. It was drafted under the auspices of the International Institute for the Unification of Private Law (UNIDROIT) which is – in its own characterisation – “an independent intergovernmental Organisation … Its purpose is to study needs and methods for modernising, harmonising and co-ordinating private and in particular commercial law as between States and groups of States and to formulate uniform law instruments, principles and rules to achieve those objectives.”2 Its former president together with the present president have published a book 3 which is to be understood as a strong plea for the benefits of a lex mercatoria. Roughly half of the book is devoted to the historical development of this particular legal phenomenon whereby trade associations such as the Hanse play an essential rule. Therefore, addressing this in Tartu as a member town of this association is more than appropriate, since all those merchants carried, as it were, their own law in their knapsack with them – no matter whether they acted in Bergen/Norway, in Amsterdam/Netherlands, in Lübeck/Germany, or in Tartu.

The two Italian authors then, in the second half of the book, describe the present time and ups and downs regarding self-regulation of economic actors. Their plea for the advantages of a lex mercatoria is further to be put in context with UNIDROIT’s other highly successful instrument, the UNIDROIT Principles of International Commercial

Convention on International Interests in Mobile Equipment from 2001, available at: https://www. unidroit.org/instruments/security-interests/cape-town-convention/.

1

2

Taken from the website: https://www.unidroit.org/about-unidroit/.

Alberto Mazzoni / Maria Chiara Malaguti, Diritto del Commercio internazionale – fondamenti e prospettive, 2019 (in German: Die Architektur des internationalen Wirtschaftsrechts – Grundlagen und Ausblicke, 2021).

3

- 37 -

Contracts4 which have so far already gathered a considerable amount of case law from more or less all over the world and which is with some justification to be understood as a pillar of a modern appearance of a lex mercatoria.

When we now turn to the structure of the Cape Town Convention we see the Convention as a kind of umbrella legislation which describes as its purpose „to ensure that interests in (equipment of high value) are recognised and protected universally“. It does so by regulating a number of issues – primarily the establishment of a security interest and the requirements necessary for international effectiveness, i.e. primarily compliance with certain form requirements plus registration, artt. 7, 16 ff. of the Convention.

Most importantly it foresees specifications for certain types of equipment by means of Protocols. The Convention, thus, is something like a general part to which the Protocols constitute special parts. At the time of the drafting of the Convention, in 2001), three protocols were already envisaged dealing with equipment regarding aircraft, rails, and space. These industries have in common that they are dealing with highly mobile goods which as such create automatically an enormous challenge for any legal treatment. Given the huge and almost dramatic differences under and in both security law and private international law rules, it might easily happen that the engines of a plane which are under all practical circumstances most certainly collateral of a security agreement change their status as collateral several times on a flight from – let’s say – Talinn to Tokyo – depending on which jurisdiction the plane is flying over.

Thus, in order to provide a security interest that is not dependent on the actual location of the collateral and transcends, as it were, the limitations of national boundaries the Convention was throughout hailed as an enormous step forward. However, it should be borne in mind that the advantages of this instruments most certainly awake voraciousness among other industries. After all, art. 51 of the Convention envisages explicitly the possible set-up of further Protocols. And it is needless to point out that the playing field and the interests of multinational enterprises is bound to collide with the realities of a fragmented legal world.5 Accordingly, the most recent protocol from 2021 on equipment regarding mining, agriculture and construction (MAC) industries addresses collateral Available at: https://www.unidroit.org/wp-content/uploads/2021/06/Unidroit-Principles-2016-­ English-bl.pdf. On them, see above all Bonell, The Unidroit Principles and Transnational Law, Unif.

L.R. 2000, 199 ff.; idem, The Unidroit Principles of International Commercial Contracts – Towards a New Lex Mercatoria?, Int’l Bus.L.J. 1997, 145 ff.; Baron, Do the Unidroit Principles of International Commercial Contracts Form a New Lex Mercatoria?, 15 Arbitr. Int’l 1999, 115 ff.

4

On this, see Paulus, Multinational Enterprises and National Insolvency Laws: Lobbying for Special Privileges, European Business Law Review (EBLR) 2018, 393 ff.

5

- 38 -

which is far less mobile in its nature than those from the previous three protocols. This is where the call for attention is to be raised. Since as we will see in the following part of this paper, the advantages of a Protocol are tempting for any industry. But as always in private law, what is given to one market participant has to be taken away from some other actor.

C. Cross Roads with Insolvency Law Like all security interests, those under the Convention serve the purpose to protect the secured party from losses in case of its debtor’s default. This is where we come to the crossroad of Convention and insolvency law. Pursuant to artt. 30, 29 of the Convention the effect of a valid international security interest is a super priority in an insolvency proceeding of the debtor. This is what the abovementioned teaching of national insolvency law probably never and international insolvency law hardly ever will address when teaching the systems. Since there is all of a sudden – out of the blue, as it were – a security interest which ignores all other existing legislative ranking orders. Accordingly, either other secured creditors or, in the end, the unsecured creditors will have less estate left for their proportional satisfaction.

But let’s have a closer look to the relevant rules in the Convention. Its art. 30 provides: 1. In insolvency proceedings against the debtor an international interest is effective if prior to the commencement of the insolvency proceedings that interest was registered in conformity with this Convention.

2. Nothing in this Article impairs the effectiveness of an international interest in the insolvency proceedings where that interest is effective under the applicable law.

3. Nothing in this Article affects: (a) any rules of law applicable in insolvency proceedings relating to the avoidance of a transaction as a preference or a transfer in fraud of creditors; or (b) any rules of procedure relating to the enforcement of rights to property which is under the control or supervision of the insolvency administrator.

In art. 29 we find a specification what is to be understood as effective: 1. A registered interest has priority over any other interest subsequently registered and over an unregistered interest.

2. The priority of the first-mentioned interest under the preceding paragraph applies: - 39 -

(a) even if the first-mentioned interest was acquired or registered with actual knowledge of the other interest; and (b) even as regards value given by the holder of the first-mentioned interest with such knowledge.

....

These rules form the basis for the said super priority which is effective in all those states on this globe which have signed the Convention.6 Details shall not be addressed here as the main purpose of this paper is just to raise awareness. But it is informative what art. 8 of the Convention prescribes with regard to the remedies of a chargee: 1. In the event of default as provided in Article 11, the chargee may, to the extent that the chargor has at any time so agreed and subject to any declaration that may be made by a Contracting State under Article 54, exercise any one or more of the following remedies: (a) take possession or control of any object charged to it; (b) sell or grant a lease of any such object; (c) collect or receive any income or profits arising from the management or use of any such object.

2. The chargee may alternatively apply for a court order authorising or directing any of the acts referred to in the preceding paragraph. …

These remedies are further specified, for instance, in the most recent MAC protocol. In its art. X the following rule is to be found: 3. Upon the occurrence of an insolvency-related event, the insolvency administrator or the debtor, as applicable, shall, subject to paragraph 7, give possession of the equipment to the creditor not later than the earlier of: (a) the end of the waiting period; and (b) the date on which the creditor would be entitled to possession of the equipment if this Article did not apply. ...

5. Unless and until the creditor is given the opportunity to take possession under paragraph 3: For the Convention’s sphere of application cf. art. 3 of the Convention which makes applicability dependent on the debtor being situated in a Contracting State. For the list of these states, see https:// www.unidroit.org/instruments/security-interests/cape-town-convention/states-parties/; i.e. 84 states plus the EU as a regional economic integration organisation.

6

- 40 -

(a) the insolvency administrator or the debtor, as applicable, shall preserve the equipment and maintain it and its value in accordance with the agreement; and (b) the creditor shall be entitled to apply for any other forms of interim relief available under the applicable law. ....

And in art. VIII: 1. In addition to the remedies specified in Chapter III of the Convention, the creditor may, to the extent that the debtor has at any time so agreed and in the circumstances specified in that Chapter, procure the export and physical transfer of equipment from the territory in which it is situated.

2. The creditor shall not exercise the remedies specified in the preceding paragraph without the prior consent in writing of the holder of any registered interest ranking in priority to that of the creditor. ...

This shall suffice as a proof for the existence of a tertium beyond and besides the national and international law. Though powerful in its sphere of applicability, the Cape Town Convention has found surprisingly little attention in the legal writings directed towards academic teaching. To be sure, this observation is not meant as a reproach or rebuke for failure of academic literature. As a matter of fact, it is impossible in sight of the mere mass of legal rules and institutions to keep track when the main thrust of a book is to introduce students into the art of lawyering (ars aequi et boni). But it might be advisable to always add that there is much more going on in a practicing lawyer’s every-day work than what can be covered on any textbook.

D. Impact on European Insolvency Regulation and other instruments A final word might be added with regard to the aforementioned crossroads between a valid international security interest and insolvency law when in a particular cross-border insolvency case art. 8 of the European Insolvency Regulation is to be taken into account. It is well known that pursuant to this norm, rights in rem are exempt – not affected – from the applicability of the lex concursus when and if at the time of the opening of the proceeding the collateral is situated in another member state than the opening state. Should any such asset be an equipment pursuant to any Protocol under the Cape Town Convention and should it be subject to a valid international security interest pursuant to the Convention, the legal consequence of art. 8 European Insolvency Regulation has to be corrected: It is replaced by the Convention’s remedies – quite a remarkable consequence.

- 41 -

E. Conclusion As indicated in the beginning of this paper: its goal is a humble one. All what it wants is to present a rather unknown instrument in order to raise awareness about at least two things: (1) Depending on the cases, to be sure, there are possibly many more additional rules to be observed in the “insolvency game” than traditionally assumed and expected when being equipped with university knowledge alone. (2) Commercial actors tend to be innovative when searching for ways around the standard set of legal impediments. By creating a lex mercatoria or by lobby work they might be successful in achieving benefits which are below the radar of academic attention and scrutiny.7 The latter observation leads to the other far-reaching question of what might be the preferable approach: to let the industries develop their own law or to have the constitutional legislative drafting the rules? In other words, what speaks to the benefit of a lex mercatoria and what against it? When looking to historical experiences in both centuries-long periods and most recent years the right answer might not be a clear decision in favour of the one side or the other. Particularly the experience after the last financial crisis in the wake of the break-down of the Lehman Bank in the US teaches that depending on the particular circumstances of one case or one period, the pendulum might swing from one side to the other: Whereas “before Lehman” the prevalent motto seems to have been that as little state-involvement as possible would be good for any economic development it is now “after Lehman”; here the opposite is true.

What would be indispensable for the general acceptance of any lex mercatoria, however, is a responsible and fair rule setting. This is not precisely the same what present day lobby work all over the globe is propagating. All too often is what those lobby groups are pushing for far too one-sided and unbalanced to stand good in any fairness test.

What is needed, therefore, is the development of a culture of an even, transparent and responsible rule setting. When such an attitude could be taken as a given at the persons involved in the rule setting process, it would become much easier to speak in favour of a lex mercatoria.

7

Cf. supra footnote 5.

- 42 -

Christoph G. Paulus

Christoph G. Paulus was a professor of law at the Humboldt-Universität zu Berlin/Germany. He was acting there from 1994 to 2019 – holding a chair for Civil Law, Civil Procedure Law, Insolvency Law and ancient Roman Law. Before that, he was teaching, inter alia, at the universities of Heidelberg and of Saarland/Saarbrücken. He studied law at the University of Munich and has done his LL.M. at the University of California in Berkeley. Being an expert primarily in insolvency law, Prof. Paulus has worked several times as a consultant of both the International Monetary Fund and the World Bank in Washington DC. Moreover, from 2006 through 2011, he served as an adviser of the German delegation on the UNCITRAL insolvency law sessions.

He has lectured worldwide and has held guest professorships at various universities.

In addition, he is a member of various international institutions such as the American College of Bankruptcy and the International Insolvency Institute. Since 2019 he is an Associate Member of South Square, London, and a Counsel with White & Case, Berlin.

- 43 -

f 2009–2016: Director of the Institute of Interdisciplinary Restructureing (iir) f 2008–2010: Dean of the Law Faculty of the Humboldt-Universität zu Berlin f 2004–2008: Dean for international programs at the faculty of law at the Humboldt-Universität zu Berlin f since 1994: Full Professor for Civil Law, Procedure, Insolvency Law and ancient Legal History, Humboldt-Universität zu Berlin f 1992–1994: Associate Professor for Civil Law and Procedure, University of Augsburg f 1990–1993: Interim Professor for Civil Law and Procedural Law at the Universities of Berlin (Technische Universität), Heidelberg, Saarbrücken

f 2021: Member of the EU Commission’s group of experts on restructuring and insolvency law for the creation of minimum standards for the harmonization of restructuring and insolvency law f 2016: Member of the EU Commission’s Group of experts to prepare a Preventive Restructuring Framework f 2006 to 2011: Advisor to the German delegation during the UNCITRAL meetings in New York and Vienna (development of group insolvency law) f 2006: Advisor to the World Bank in Washington D.C. (Advice on insolvency issues; preparation of a contribution on “odious debts” for the World Bank) f since 2005: Advisor to the International Monetary Fund (IMF) in Washington, D.C. (Review of the insolvency laws of several transition countries) f 2002: Advisor to the International Monetary Fund (IMF) in Washington, D.C. (Insolvency Proceedings for States = SDRM) f 2002, 2001: Insolvency law consultant on behalf of the German Society for Technical Cooperation (GTZ) for the editing of the Yugoslav and Moldovan insolvency laws f 1998, 1999: Advisor to the International Monetary Fund (IMF) in Washington, D.C. (Basic Principles and Legislative Guidelines for Insolvency Proceedings)

- 44 -

UNIVERSITY OF TARTU SCHOOL OF LAW

Address: Näituse 20, 50409 Tartu, Estonia oi@ut.ee oigus.ut.ee/en