As many SFNet members know, a strong work-out culture, in which lenders and their financially distressed borrowers use out-of-court workouts (OCWs") as a less costly and more efficient alternative to  formal bankruptcy proceedings, is a well-established feature of the U.S. lending environment. 

However, OCWs are not nearly as prevalent in many other countries.   The laws of many countries discourage OCWs by requiring directors of a distressed company to initiate a formal bankruptcy proceeding for the company upon becoming aware of the company's insolvency, and in some countries directors can even be criminally liable for failing to do so. 

In recent years, there has been an increasing recognition in many countries of the value of OCWs.  Moreover, many countries have recently adopted laws and regulations that insulate directors of distressed companies from liability for failing to place their companies in bankruptcy immediately and that provide a legal environment that recognizes and promotes OCWs.  

Consistent with this trend, the Financial Stability Board ("FSB") embarked on a project to evaluate OCWs as a tool to help financially distressed companies.  FSB is an international body that monitors the global financial system and makes recommendations designed to promote international stability.   FSB's members are the Ministers of Finance, Governors of Central Banks and other major economic and regulatory officials of 24 countries, as well as senior officials of other international organizations.[1]    

One of the ways in which FSB seeks to promote financial stability is by conducting "thematic peer reviews" on specific topics.  FSB is currently conducting a thematic peer review of the use of OCWs, and has invited comments from interested stakeholders concerning the use of OCWs in their respective jurisdictions.  Although one focus of the peer review is the value of OCWs as a tool for responding to the exceptionally high volume of distressed companies owing to the COVID-19 pandemic, the peer review is also examining the value of OCWs in general. 

On August 9, 2021, SFNet submitted its comments to FSB.  The letter was the result of a  joint effort by SFNet's Co-General Counsel (Jonathan Helfat and Bobbi Accord Noland), various members of SFNet's International Finance and Development Committee (in particular the Chairs of the Committee's task forces on Advocacy (Pat Trammel) and Monitoring Legal Developments (Teun Struycken) and various SFNet personnel.

            This article summarizes SFNet's comments to FSB.  The full text of SFNet's comments is available here. 

            SFNet's letter begins by identifying and discussing three categories of OCWs that enjoy widespread acceptance in the United States:

• Sales of distressed businesses, in which a negotiated sale of the business is facilitated by an investment banker or other professional, and often supported by a court order transferring the assets of the business to a purchaser free and clear of liens and encumbrances;
• Debt for equity swaps, in which various classes of creditors of a distressed company will exchange their debt for a combination of debt and equity; and
• Forbearance agreements, in which key creditors of a distressed company will agree to forbear from exercising remedies against the company pending the fulfillment of various reporting, financial and business conditions and milestones.

SFNet's letter also identified various other ways in which countries other than the United States are promoting alternatives to a more formal and traditional reorganization proceeding:

• Pluriformity, a procedure available in the Netherlands for the enforcement of a pledge of the equity in the holding company for a distressed business;
• Modification or temporary suspension of rules imposing civil or criminal liability on directors of distressed companies for allowing the companies to continue conducting business while insolvent; and
• "Living Wills" for companies, which embody contingency plans to be employed if the companies encounter financial difficulty.

The letter then discussed ways in which governments in various counties have specifically addressed business failures prompted by the COVID-19 pandemic, including: loans or grants to companies; delays in paying tax liabilities or employee-related claims; relaxation of potential criticism of regulated lenders, by the governmental bodies that regulate them, for taking a more lenient approach to their borrowers; and the imposition of moratoria on the initiation of insolvency proceedings and the enforcement of remedies against debtor companies.

            SFNet's comments then discussed, and emphasized, the importance of U.S.-style asset-based lending as a tool to help distressed companies navigate and survive during difficult economic times.

            The letter concluded with a number of important messages based on the U.S. experience.  The first message is that fostering a legal environment that encourages OCWs increases the likelihood that domestic businesses will survive in troubled economic times.  The second lesson is that OCWs have better outcomes, and offer the most comprehensive relief, in countries that have adopted a modern secured transactions regime (such as that envisioned by the UNCITRAL Model Law of Secured Transactions, in the development of which SFNet had the privilege to participate).

SFNet's participation in the FSB peer review process is part of SFNet's growing role in advocating on cross-border issues of importance to SFNet's members, with the long-term goal of helping its members accommodate the increasing cross-border financing needs of their borrowers.  

SFNet will keep you informed of future developments in this and other cross-border advocacy initiatives.