Blog Post

New EU insolvency rules could underpin business rescue in the COVID-19 aftermath

Corporate bankruptcies are set to rise in the context of COVID-19. EU countries should speed up adoption of recent insolvency reforms and, in addition, offer consistent treatment to restructuring finance.

By: Date: March 24, 2021 Topic: Banking and capital markets

One of the less-remarked consequences of the COVID-19 crisis, the associated lockdowns and the unprecedented collapse in demand experienced by some companies, has been a dramatic fall in business defaults and insolvencies. In a normal year, just under 200,000 insolvency proceedings are initiated in Europe, based on private sector figures (there are inherent problems in comparing national notifications). But with the onset of the COVID-19 recession, EU countries suspended regular insolvency law enforcement (an end-2020 European Commission survey showed the extent of this). Meanwhile, fiscal measures, including furlough schemes and tax deferrals, and credit support schemes, including loan moratoria and publicly-guaranteed credit, seem to have been effective in buffering the shock to corporate liquidity.

Suspensions of insolvency enforcement were initially justified. Widespread insolvencies would have resulted in labour market chaos, while loan defaults would have brought collateral to markets at fire-sale prices. But ultimately insolvency rules will again apply with full force in all EU countries. A pickup in insolvency filings by companies that are either illiquid or insolvent based on existing legal definitions seems inevitable, meaning courts will be faced with a backlog of cases. But if EU countries can move more quickly to implement a 2019 EU directive that introduced some insolvency reforms, the outcomes might be more efficient than would have been the case only a few years ago.

Priorities in corporate restructuring

The purpose of insolvency proceedings is to coordinate between competing creditor interests and either impose a reorganisation, in which creditors loose part of their claims and the company emerges largely intact, or a liquidation of the company. On the whole, European insolvency regimes have been biased towards liquidation, rather than restructuring of still-viable enterprises. Proceedings have tended to be lengthy and costly, yielding hard-to-predict outcomes. A November 2020 European Banking Authority (EBA) survey underlined the costs and time required, and the limited recovery values in liquidation.

The EBA estimates are based on data up to the end of 2018 – a time of relatively strong growth. This means the estimates are unlikely to be a good guide to the coming years, when insolvencies will spike. Experience from Chapter 11 proceedings in the US suggests that bankruptcy proceedings are more costly if the ability of courts to restructure firms is constrained. Moreover, such cases are more likely to end in the liquidation, rather than reorganisation, even if the enterprise is in principle viable on the basis of a financial restructuring.

‘Forum shopping’ after Brexit

In the recovery from the COVID-19 crisis, solutions to insolvency negotiated by lenders and enterprises out-of-court, or with limited involvement of the courts, will become particularly important. In 2019, the EU adopted a directive on preventive restructuring (EU 2019/1023) – which now looks like particularly fortuitous timing. The deadline for the directive’s transposition is July 2021, though all but three member states have requested an extension of this deadline. As implementation would open up restructuring options which will be sorely needed in the recovery, national administrations should not lose more time.

One innovation in the directive is the concept of ‘debtor in possession’: business owners and their managers who have accessed preventive restructuring procedures may remain in control while the restructuring solution is worked out, given some safeguards for creditors. Stays on enforcement should allow negotiations to take place as creditors and suppliers are obliged to allow normal business to continue. Also, classes of creditors must be defined with separate voting rights, and restructuring plans can in principle be approved by a majority of classes of creditors or even by a single class. This so-called ‘cram down’ represents a major innovation in many EU countries. With some exceptions, the ‘absolute priority rule’ will apply, offering senior creditor classes settlement ahead of all more junior classes.

The directive has already led to notable reforms in some countries. In both Germany and the Netherlands, new insolvency laws became effective in January 2021. The Dutch law copied significant elements from both the United Kingdom, and the US Chapter 11 proceedings.

However, these transpositions of the directive also show that it will not iron out all of the long-standing differences between national insolvency regimes. Local preferences in dealing with insolvency can still be reflected under the directive. For instance, under the Dutch law, shareholders, trade unions and works councils can also initiate restructurings, which would then be supervised by a restructuring professional. Also, states can deviate from the absolute priority rule, and give additional rights to shareholders and workforce representatives in a cram down.

Within the EU, a restructuring ruling by a court in one jurisdiction must be recognised by all other member states. Thus larger companies could use the restructuring law in whatever member state is most suitable to their situation and where courts accept the case. Up to 2020, UK courts regularly offered larger companies convenient, if costly, pre-insolvency procedures, which were open to any borrower who could demonstrate some connection to English law.

Such legal services will likely be another casualty of Brexit, as the UK-EU Trade and Cooperation Agreement does not cover cross-border recognition. The UK has requested to accede to the Lugano Convention, under which its civil law rulings would be recognised, though time is quickly running out for the EU to accept this request ahead of a deadline in early April. It is likely other EU jurisdictions can play a similar role, and several EU capitals, such as Paris, are already styling themselves as new European centres for resolving insolvency cases.  Rulings will need to be flexible and predictable and there will also need to be sufficient capacity in local legal services.

Funding enterprises in restructuring

Encouraging the continued involvement of owners and their managers during restructuring is sensible as it has been shown to result in higher rates of business rescues, though of course creditor rights need to be protected. But during this ‘debtor-in-possession’ phase the business will require continued access to finance, for instance in the form of working capital to keep essential operations going. In the UK and US, dedicated funds have developed, as banks will not normally lend fresh funds to borrowers who are already visibly in distress. In the EU capital market, such funds neither have the required scale, nor is there a consistent treatment of creditors’ rights.

Creditors who provide new financing to a borrower already in restructuring proceedings will look for a senior position in the creditor hierarchy, ranking even ahead of existing secured creditors. They would then be effectively exempt from any debt relief subsequently granted to the borrower, as this would only affect more junior pre-existing lenders. Only some EU countries have so far offered this protection (among them France, Italy and Spain). In further insolvency reform, member states should aim for more uniform treatment across the EU.

Apart from equity-type finance to address the solvency shortfall, continued credit funding will also be needed to allow businesses to undergo the crucial restructuring phase. Rapid adoption of the directive and consistent protection of creditor rights is now needed in corporate sector restructuring.

Recommended citation:

Lehmann, A. (2021) ‘New EU insolvency rules could underpin business rescue in the COVID-19 aftermath’, Bruegel Blog, 24 March

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article Download PDF More on this topic

Working Paper

The effect of COVID certificates on vaccine uptake, public health, and the economy

An analysis of the incentive effects of COVID certificates on vaccine uptake, health outcomes and the economy.

By: Miquel Oliu-Barton, Bary Pradelski, Nicolas Woloszko, Lionel Guetta-Jeanrenaud, Philippe Aghion, Patrick Artus, Arnaud Fontanet, Philippe Martin and Guntram B. Wolff Topic: Digital economy and innovation Date: January 17, 2022
Read article More on this topic

External Publication

Europe must come together to confront Omicron

Statement published in the renowned British Medical Journal (BMJ) to address the wave of the Omicron variant of SARS-CoV-2.

By: Miquel Oliu-Barton, Guntram B. Wolff and Group of authors Topic: Global economy and trade Date: January 13, 2022
Read article More on this topic

Blog Post

European governance

What will be the impact of Europe’s next round of COVID-19 restrictions?

As COVID-19 cases surge, the choice of restrictions, and the details of their implementation, can have a major influence on the degree to which business is impacted.

By: J. Scott Marcus and Lionel Guetta-Jeanrenaud Topic: European governance Date: December 23, 2021
Read article More by this author



Last but not the least

An overview of economic policy and beyond in 2021.

By: The Sound of Economics Topic: European governance, Global economy and trade Date: December 22, 2021
Read article

Blog Post

European governanceInclusive growth

12 Charts for 21

A selection of charts from Bruegel’s weekly newsletter, analysis of the year and what it meant for the economy in Europe and the world.

By: Hèctor Badenes, Henry Naylor, Giuseppe Porcaro and Yuyun Zhan Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: December 21, 2021
Read article Download PDF More on this topic More by this author

Working Paper

mRNA vaccines: a lucky shot?

How can the background of mRNA technology development help us understand how public vaccine research and development policy can be improved to generate the full global social benefits from breakthrough novel vaccine technologies?

By: Reinhilde Veugelers Topic: Digital economy and innovation Date: December 13, 2021
Read article More on this topic More by this author

External Publication

Country case studies on resolving problem loans in Europe: Crises, policies and institutions

Contribution to 'Nonperforming Loans in Asia and Europe—Causes, Impacts, and Resolution Strategies' published by the Asia Development Bank.

By: Alexander Lehmann Topic: Banking and capital markets Date: December 3, 2021
Read about event More on this topic

Past Event

Past Event

Fiscal policy and rules after the pandemic

What are the possibilities for shaping the new fiscal policy?

Speakers: Zsolt Darvas, Maria Demertzis, Michel Heijdra and Katja Lautar Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 24, 2021
Read article More by this author

Blog Post

Fiscal arithmetic and risk of sovereign insolvency

The record-high debt levels in advanced economies increase the risk of sovereign insolvency. Governments should start fiscal consolidation soon in an environment of low nominal and real interest rates and post-COVID growth.

By: Marek Dabrowski Topic: Global economy and trade, Macroeconomic policy Date: November 18, 2021
Read article More on this topic More by this author




How did Europe respond to the pandemic?

By: The Sound of Economics Topic: European governance Date: November 17, 2021
Read about event More on this topic

Past Event

Past Event

Phasing out COVID-19 emergency support programmes: effects on productivity and financial stability

How can European countries phase out the COVID-19 support measures without having a negative impact on productivity and financial stability?

Speakers: Eric Bartelsman, Maria Demertzis, Peter Grasmann and Laurie Mayers Topic: Macroeconomic policy Date: November 9, 2021
Read article Download PDF

Policy Contribution

European governance

COVID-19 financial aid and productivity: has support been well spent?

While support schemes during the pandemic were not targeted at protecting ‘good’ firms, financial support mostly went to those with the capacity to survive and succeed. Labour schemes have been effective in protecting employment.

By: Carlo Altomonte, Maria Demertzis, Lionel Fontagné and Steffen Müller Topic: European governance, Macroeconomic policy Date: November 4, 2021
Load more posts