BY: BERNARD FEUGÈRE

This article is a continuation of the article that appeared in the previous publication of Avrio Info analyzing the law of July 26, 2005, which significantly modifies the law of judicial insolvency procedures in France.

This article is a continuation of the article that appeared in the previous publication of Avrio Info analyzing the law of July 26, 2005, which significantly modifies the law of judicial insolvency procedures in France.

The safeguard procedure is a major innovation of the new law in that it allows managers to request that is applied even if the company is not in a state of insolvency, the objective being the formulation of a plan for payment of creditors over several years.  The legislature’s purpose was to encourage the manager to act as soon as difficulties arise in order to increase the chances of his company’s recovery.

The requirements for the law’s application are set forth in article L 620-1 of the Commercial Code: « The debtor must provide documentation of difficulties that he is unable to overcome, which are of such an extent as to lead him to insolvency. »

However, the application of a safeguard procedure will, in a sense, result in a form of insolvency since it prohibits the payment of pre-existing claims. Hence, relationships with suppliers might deteriorate; it is thus important to foresee this injurious consequence and assess the drawbacks before initiating the procedure.

Since the company is not in a state of insolvency, the manager may request an ad hoc mandate before initiating a safeguard procedure. That is a possibility to be envisioned, because, with an ad hoc mandate, negotiations can be entered into with the suppliers and agreements can be taken to prepare for a safeguard plan. Of course, all of these procedures have a cost that must be evaluated before any decision is taken, to make sure that the company can bear it.  It would be illogical to initiate a procedure to save the company that would result in emptying its treasury.

For implementation of the procedure, an application must be filed with the Clerk’s Office of the Court, in which must be stated the reality and nature of the difficulties, and the reasons why the debtor is unable to overcome them. Finally, it must demonstrate that a state of insolvency does not yet exist.

Attention must be paid to the fact that if, during the course of the procedure, the Court finds a state of insolvency, it may convert it into a judicial administration or liquidation (articles L 640-5 and R 621-5 of the Commercial Code).

Hence, in light of that contingency, it is imperative to thoroughly analyze the company’s situation and future before selecting a procedure. A bad choice may result in the company’s downfall and in a judgment against its manager.

Merchants, traders, craftsmen, farmers, legal entities and professions have access to this procedure. From the opening to the end of the procedure, the employees are heard. The Court appoints a bankruptcy judge and asks the employees present, members of the works council and employee representatives to appoint a representative. For companies that do not have a works council or representatives, the Court asks the employees present to elect a representative.  The Court appoints a judicial administrator and a judicial representative. The appointment of an administrator is not required if the company’s turnover is less than 3 million euros and if the company has less than twenty employees.  The procedure is then called “simplified” in contrast to the general procedure (article L 621-4, paragraph 4, and article R 621-11 of the Commercial Code).

The administrator’s role consists of supervising or assisting the debtor. Article L 622-1 of the Commercial Code provides in its first paragraph « Administration of the company is carried out by its manager».

In a judicial administration procedure, the administrator, pursuant to article L 631-12 of the Commercial Code, assists in the administration or carries it out alone. Therefore, the safeguard procedure protects the manager against the risk of loosing his powers, except, of course, for good cause; refer to article L 626-4 of the Commercial Code.

If the difficulties that existed at the opening of the procedure disappear, the Court, upon the debtor’s request, may end the procedure (article L 622-11 of the Commercial Code).

Since it was up to the debtor to place his company under this procedure, if the reasons for it no longer exist, it is logical that he can decide to end it.

A- The creditors – a new priority right (article L 622-17)

For creditors which, after the judgment opening the safeguard, became such for the purposes of the procedure, or for having provided services to the debtor in the context of the latter’s business, the law provides that their claims be paid on the agreed due dates.  Otherwise, they are given a priority right by which they will be paid before any other claims, except for:

-         the priority right of employees;

-         legal costs;

-         and cash contributions during the course of an approved conciliation procedure.

The approved conciliation procedure grants the same priority rights.

These new creditors are thus given a new priority right, but article L 622-17 specifies that they must be paid on the agreed due dates.  Therefore, in default of payment, they may pursue the collection of their claims notwithstanding the current procedure.  Their action is not paralyzed by the fact that individual legal actions are stopped. That is obvious, since the company is not in a state of insolvency – the sine qua non of it having the benefit of the safeguard procedure. The company must therefore make its payments on the due dates; otherwise, the state of insolvency would be declared, and conversion of the procedure into a judicial administration, even liquidation, would be required.

Let us note that this article L 622-17 of the Commercial Code applies in a judicial administration procedure (in accordance with article L 631-14 of the Commercial Code).

The creditor must declare its claim; otherwise, it loses its priority right.  Paragraph 4 of article L 622-17 of the Commercial Code states « Outstanding claims lose the priority right conferred thereon by this article if they have not been declared to the judicial representative or the administrator, if one is appointed, or, when these officials have ceased to exercise their functions, to the commissioner for execution of the plan or the liquidator, within one year from the end of the period of  judicial supervision ».

B- The creditors – Declaration of claims (articles L 622-24 and R 622-21 of the Commercial Code)

1/ Claims born prior to the opening of the procedure

All creditors other than employees must declare their claims to the judicial representative within two months of publication of the judgment of opening in the BODACC. The deadline for foreigners is four months. Otherwise, the creditor will receive the dividends specified in the plan. Under the previous legislation, the claims were extinguished; this is a substantial modification.   

2/ Claims born subsequent to the opening of the procedure

These are claims born subsequently, but which are not within the purview of article L 622-17 set forth hereinabove, as they do not have priority. These subsequent claims, without having priority, must be declared for all sums overdue and not yet matured on the basis of a valuation, within two months of publication of the opening in the BODACC; and, if the contract was concluded subsequent to the judgment, the declaration must also be made for all sums overdue and not yet matured on the basis of a valuation within two months, but not, of course, from the judgment, but from the date of the most recent unpaid instalment.

Employees

As in a judicial administration procedure, the safeguard provides for the appointment of a representative of the employees, who may, in particular, use the means of recourse defined by article 661.1 of the Civil Code, with his assignment specified by articles L 625-1, -2, - 4, L 642-2, L 654-17 and L 662-3.

But it should be noted that he may file a complaint for damages in civil proceedings in the event of an infraction, particularly bankruptcy.  He may also request publication of the proceedings after the opening of the procedure at the first hearing.

AGS (Salary coverage insurance)

This insurance plan covers the payment of salaries unpaid at the time of the opening of the procedure, and the legal allowances for termination of employment contracts due during the course of the administration and liquidation procedures.  Regarding the safeguard procedure, the insurance plan is completely different.  Since the company is not in a state of insolvency, it is logical to think that the AGS does not have to advance the funds, unless, as stated by the legal provisions, the judicial representative justifies a serious need for funds. But then, that would come down to revealing a state of insolvency, and hence would result in the opening by the Court of a judicial administration procedure, or even liquidation.

The consequences of this provision are significant, because, contrary to a judicial administration, the company may not reconstitute its cash by not paying the salaries due at the time of the filing for bankruptcy. These funds are indeed indispensable, since credit with suppliers will very substantially be reduced, if not eliminated.  Therefore, once again, the legal provisions clearly explain the legislature’s intention – i.e. a safeguard procedure must be initiated only on the obvious condition that one is not in a state of insolvency, and that one has foreseen cash difficulties but does not yet suffer therefrom.  It is understandable that an error of analysis regarding a company’s situation can be fatal.

Layoff

The safeguard procedure does not afford the right of a simplified layoff of employees as exists in the context of a judicial administration or liquidation, except in the event of a sale of a business branch, pursuant to article L 626-1 of the Commercial Code.

Consequently, there is no additional exception; the provisions of the labour code must apply.  A more complicated and longer layoff procedure will result, which must, of course, be prepared as early as possible, because the effects of a layoff – a reduction of expenses -- may not benefit the cash position immediately.

Creditors Committee

This committee is an innovation inspired by American law.  It applies in a safeguard procedure as well as in a judicial administration procedure.

It is mandatory for companies that have more than 150 employees on the date of application for opening of the procedure, and whose turnover before taxes on the date of closure of the procedure exceeds 20 million euros.

For other companies, the debtor or the administrator may ask the bankruptcy judge for the authorization to create committees.  The law provides for two committees, one of which is for banks and the other for the main suppliers of goods and services. It is to be noted that institutional creditors and employees, as well as territorial public authorities and their institutions are excluded from these committees.   

The administrator invites the Committees to a meeting within thirty days of the judgment opening the procedure, with the debtor submitting its proposals within two months following the creation of these committees (a period that is renewable once by the bankruptcy judge).

Each committee decides by a majority of its members representing at least two-thirds of the amount of claims of all of the committee’s members. The plan is adopted only if the two Committees so decide. The plan may provide for debt forgiveness, which is tax deductible. Article 182 of the law has amended article 39 of the Tax Code in that sense.

However, the powers of these committees are quite limited as the decision goes to the Court if they reject the debtor’s plan.  The Court may also reject the plan that is proposed, and decide on another plan. In addition, if the debtor does not present its proposal within the specified time limit, the decision goes to the Court pursuant to ordinary law. Therefore, if, the debtor feels that the negotiations with the creditor are not successful, in order to avoid a negative decision of the committees, it may not submit proposals enabling it to return to the Court without having to provide the committees’ opinion.

Nonfulfilment of the plan

Once the plan is approved, it must be complied with; but that does not resolve everything, as the company may again face difficulties. If such is the case, a creditor, a bankruptcy judge or the public prosecutor may submit the matter to the Court, or the Court may ex officio assume jurisdiction in that regard. The legal provisions state that it « may » order cancellation of the plan, which means that it is not obligated to do so.

Two scenarios can be envisioned:

1/ In the course of execution of the plan, the company is again in a state of insolvency. In that event, the Court cancels the plan, and orders judicial liquidation.

2/ The company does not comply with the due dates of payment as specified by the plan, but is not in a state of insolvency. The Court may then decide not to order judicial liquidation. That may lead us to think that a failure to comply with the due dates of payment results being in a state of insolvency, which is true.  But the legislation must be construed with reference to the fact that the plan not only specifies the financial commitments, the non-compliance of which would obviously show a state of insolvency, but also includes provisions dealing with labour, economics, restructuring and other matters. Consequently, if these commitments are not satisfied, the Court may decide not to order judicial liquidation and give the company another chance.

What are the advantages of a safeguard procedure?

In addition to affording an opportunity to take early action without being in a state of insolvency -- which is the principal advantage as it permits the company to avoid serious difficulties -- let us note other obvious advantages of this procedure:

-                                 Surety – article L 626-11 :

« All parties are bound to the provisions of a plan that is approved by the judgment. Except for legal entities, jointly liable persons and persons who granted an autonomous surety or guarantee may invoke it. »

-                                 Remuneration of the manager :

In a judicial administration procedure, the bankruptcy judge determines the manager’s remuneration.  In practice, his remuneration is often substantially reduced, which is justified by the fact that the company must save money, and it is logical that the manager personally participates in it. But this reduction often has very serious consequences, because a manager who is no longer able to pay his taxes or his credit instalments when due, can very rapidly be put into a situation where he is close to losing everything, and consequently is unable, at least psychologically, to manage the company at the time when he is needed most for its recovery.  

In a safeguard procedure, the manager alone decides on the maintenance of his remuneration if his company is registered in his personal name. If the company has the corporate legal form, corporation law applies and the board of directors or a meeting of shareholders approves the remuneration. But the situation is not so simple, because he still must adapt his remuneration to his company’s situation and, thus, take the initiative of reducing it in many cases. Otherwise, he would, at the very least, commit a serious mistake of management, even a misappropriation of assets for excessive remuneration. But he can at least prove his good intention by reducing it reasonably, in such a way that he is not personally put in a very difficult financial situation.

The manager remains in control of his business, as stated in article L 622-1of the Commercial Code

The administrator is there only to supervise or assist.

No order of bankruptcy and no prohibition of management can be rendered against the manager; he does not risk any personal sanctions.  This provision seems to be obvious since the company is not in a state of insolvency.

Disadvantages of this procedure

The major disadvantage, which the legislature cannot put aside, lies in the fact that it is a procedure and not the result of simple amicable agreements; therefore, it is necessarily followed by a publication. And also, the credit with suppliers becomes compromised, and the liquidities are reduced.

In fact, it is an interesting course of action that may effectively rescue companies, as it is no longer necessary to await a state of insolvency; but it requires a thorough analysis of the company at a financial as well as legal level, because an error of diagnosis may abruptly lead to judicial administration or, even worse, judicial liquidation.

With the law of July 26, 2005, the chartered accountant truly becomes an expert whose role is increased, and that is a good provision because there is no doubt that a company, however small, cannot operate without a chartered accountant, who is the principal professional able to advise the head of the company and help him avoid imprudent adjustments or errors of management, particularly the making of premature investments. Let us not object to the cost of a chartered accountant’s services; it is proportional to the company’s size, and an adverse tax judgment or managerial mistake would have much more serious consequences.

Articles L 621-1, L 623-2, L 631-7 and L 641-11 of the Commercial Code render the provisions of the above article L 623-2 applicable in matters of safeguard, judicial administration and liquidation. Article L 623-2 provides : «the bankruptcy judge may, notwithstanding any contrary legal or regulatory provision, obtain from the auditors, chartered accounts, staff members or representatives, employees, public administrations and agencies, contingency and social security agencies, credit institutions and departments in charge of centralizing banking risks and defaults of payments, information of such a nature as to provide him with accurate elements regarding the debtor’s economic, financial, labour and property situation».

The insolvency procedure thus dispels the professional secrecy to which a chartered accountant is bound, but for the purpose of saving the company and giving the accountant the true role of an expert, since he is required to provide « accurate information regarding the debtor’s economic, financial, labour and property situation.»

Lawyers have constantly advised heads of companies to act rapidly before real difficulties arise, but the spectre of the Court has always been disquieting; will it change? In addition, the publication, which is indispensable for the procedure, damages the company. That is why the conciliation procedure without approval is preferred -- even more so since one can benefit from this procedure without being in a state of insolvency, or being in such a state for less than 45 days; but the times for payment of debts are shorter.

A variety of approaches creates difficulty in choosing that which is most appropriate, since the future must be prepared as a function of the figures and the various areas of law.

Bernard FEUGÈRE

Partner, LEXAND, Paris

(http://www.lexand.eu)

http://www.lexand.eu/