New Insolvency Law takes effect
Dear clients and cooperation partners,
On 1 November 2010, the new Insolvency Law took effect: many have already reacted to it as somewhat revolutionary. Although previous vital changes in the insolvency field were made hardly two years ago, the financial and economic crisis has highlighted several problems and drawbacks in the insolvency procedure. Insolvency proceedings were expensive and long drawn-out for both legal entities and physical persons, while creditors’ rights were often violated. At the same time, the restructuring process (LPP – Legal Protection Process) was successful only in a few cases. The new law is expected to lead to easier access to insolvency and restructuring procedures, help raise the efficiency of the insolvency practitioner’s work, considerably quicken the procedure for selling the debtor’s assets and liquidation. The most important provisions of the new law as distinct from the previous one appear below.
Regional head of the Restructuring & Insolvency Team
- WHAT’S NEW FOR LEGAL ENTITIES INITIATING INSOLVENCY PROCEEDINGS?
- RESTRUCTURING UNDER THE NEW INSOLVENCY LAW
- INSOLVENCY OF PRIVATE INDIVIDUALS
1. WHAT’S NEW FOR LEGAL ENTITIES INITIATING INSOLVENCY PROCEEDINGS?
We will briefly outline several essential changes to insolvency proceedings introduced by the new Insolvency Law. The minimum default debt allowing limited liability companies and joint stock companies to apply for insolvency has been raised to LVL 3,000 (approx EUR 4,270). The new law retains the debtor’s warning obligation, ie, the debtor is given three weeks either to pay off the debt or raise reasoned objections against the payment obligation.
To expedite the process, in future the courts will apply only the so-called “liquidity or cash flow test” and check on the existence of the debt and default (assessing the debtor’s cash flow and capability to meet obligations due). The law lifts the previous “balance sheet test” that made the courts assess whether assets exceed obligations, which meant that initiating insolvency proceedings could sometimes be significantly deferred. When applying the liquidity test, the issue as to when the debtor’s board members have to apply for insolvency is just as vital. Perhaps they might hope for a three-week period of preferential treatment after obligations fall due or at least after receiving the warning notice. Unfortunately, the law is not clear on this point, and it remains to be seen how the court tackles the issue.
The law will now allow creditors to withdraw an insolvency application, for instance, where the debtor has repaid the debt. This provision might create a risk of using insolvency proceedings as a method of debt recovery. However, the law contains two novel aspects that might deter this kind of misuse. Firstly, the person filing the bankruptcy application must pay a deposit of two minimum monthly salaries (at present LVL 360 or approx EUR 512). Although the deposit is repaid if the creditor withdraws the application, the risk is that the debtor will not pay and it may later turn out that the debtor has no possessions to cover the expense of insolvency proceedings. Consequently, the creditor would lose not only the principal debt but also the deposit paid. Secondly, a petitioning creditor will have to repay amounts received from the debtor during the last three months to avoid insolvency on the basis of that creditor’s application.
Finally, insolvency proceedings will be speeded up by the new provisions. These shorten to one month the period for a creditor’s application and significantly restrict the area of authority of the creditors’ meeting. However, the creditors’ meeting can dismiss the insolvency administrator in future.
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2. RESTRUCTURING UNDER THE NEW INSOLVENCY LAW
The new Insolvency Law will bring many novelties in restructuring or so called legal protection proceedings (LPP) and out-of-court legal protection proceedings (OLPP).
Firstly, practical solutions to economic problems will become more important than compliance with formalistic requirements. For example, a debtor is now required to submit a forecast regarding income, as well as cash flow projection. Hopefully, as a result of the new Insolvency Law, LLP and OLPP plans will provide a well reasoned and detailed answer to the most important question for all creditors – what will the debtor do to increase its profit and to restore its solvency?
Secondly, the maximum term of LPP and OLPP will be four years (on elapse of the initial two years the term will be extendable). In practice this increases the possibility of successful restructuring, because in many cases only two years is a too short a term for restoration of solvency.
Thirdly, new regulation of LPP and OLPP will give a debtor and its creditors a chance to choose an administrator. Previously this was possible only in OLPP and was considered one of the advantages of OLPP. Since the remuneration of the administrator will be set on the basis of an agreement between the parties, an incentive is created for administrators to perform duties diligently and to facilitate successful resolution of a debtor’s financial problems.
Fourthly, the legislator has tried to find a balance between the interests of secured and unsecured creditors. From now on the most important decisions in LPP and OLPP (such as approval of the LPP or OLPP plan and choice of administrator) requires approval by both two thirds of secured creditors and half of unsecured creditors. Involvement of all creditors in decision making is a positive trend, because in most cases the viability of a plan depends on the support of major creditors. In addition, the myth that involvement of secured creditors will eliminate any possibility to undergo LPP or OLPP is unfounded. In most cases the secured creditors have resources to assess the viability of a plan and to provide useful guidance. According to statistics, plans approved by secured creditors are more successful than those approved by unsecured creditors only.
Finally, another important development in restructuring is the possibility for a company to undergo OLPP after it is declared insolvent. Currently it is not clear whether this solution will be more successful than those that existed previously (reorganisation and settlement within insolvency proceedings) and whether this will help in revival of the Latvian economy.
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3. INSOLVENCY OF PRIVATE INDIVIDUALS
The insolvency process for private individuals, which caused extensive discussion during this summer, has undergone many changes. The legislator has tried to give a “second chance” to more debtors who are acting in good faith. Primarily this is evident in the shorter duration and lower costs of the insolvency process.
The new law introduces a new precondition for the insolvency process – during the last six months the private individual concerned must have been a taxpayer in Latvia. The insolvency process is divided into two stages – bankruptcy and procedure for settlement of liabilities. During the first stage – bankruptcy – the administrator sells the private individual’s assets. Sale of assets might last six months (previously, sale might occur throughout the insolvency process of a private individual). During the procedure for settlement of liabilities a private person’s liabilities are settled in part or in full according to a special plan. The term of the procedure depends on the amount of settled debt. The whole insolvency process of a private individual might now last up to four years, which is less than under the previous law.
The administrator and creditors – mainly banks – and which previously had little chance to influence insolvency processes – have been given larger rights. For instance, creditors may file a claim with the administrator or the court if there are constraints on the insolvency process; additionally, creditors can dismiss the administrator. With regard to the costs of the insolvency process, there is no monthly remuneration for the administrator, whose remuneration is calculated on the amount of assets sold that are owned by the bankrupt individual. The new insolvency process has become similar to the insolvency process for legal entities. For example, creditors must file a claim at their own discretion instead of a private individual who previously included these claims in a special plan; there are creditors’ meetings and a chance to challenge transactions performed by a private individual. It should be noted that the previous Insolvency Law will apply to private individuals’ insolvency processes declared before the new Insolvency Law is effective, although an insolvent private individual may require that the procedure for settlement of liabilities is implemented under new law.