Promotion of group restructuring and cross-entity liability arrangements

ABSTRACT

Modern enterprises often operate as interconnected groups of companies. This is facilitated by various cross-entity liability arrangements, which aim at risk mitigation and control, and may contribute to the reduced agency cost of debt. However, they pierce limited liability (cross-guarantees) or impose correlation between the fates of separate entities (intercompany cross-defaults and ipso facto clauses). They can promote group exposure and disincentivise debtors from taking early actions to avoid insolvency. This paper explores the tools that are embraced to address these problems to achieve group restructuring. They include restrictions of cross-entity ipso facto clauses and extension of enforcement stays to group entities. I examine the ex ante and ex post effects of group liability arrangements, make a comparative overview of national law responses and suggest recommendations to find a balanced approach to cross-entity liability arrangements, enhance the existing legal regimes and form the basis for future reforms of insolvency laws.

KEYWORDS:

• Group restructuring
• intragroup liability arrangements
• cross-guarantees
• ipso facto clauses
• enforcement stay

Acknowledgements

I wish to thank Prof. em. Bob Wessels, Prof. Matthias Haentjens, Prof. Reinout Vriesendorp, the anonymous referee and the editor Prof. Luca Enriques for helpful comments and suggestions. All errors and omissions are the author’s own.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Hansmann and Kraakman refer to these doctrines as ‘defensive asset partitioning’ (protecting personal assets from company’s shareholders) and ‘affirmative asset partitioning’ (shielding company’s assets from creditors of its shareholders and managers). See Henry Hansmann, Reinier Kraakman, ‘The Essential Role of Organizational Law’ (2000) 110(3) Yale L.J. 387.

2 Richard Squire, ‘Shareholder Opportunism in a World of Risky Debt’ (2010) 123 Harv. L. Rev. 1151, 1213, noting that intragroup guarantee arrangements are extremely prevalent. Jack F. Williams, ‘The Fallacies of Contemporary Fraudulent Transfer Models as Applied to Intercorporate Guaranties: Fraudulent Transfer Law as a Fuzzy System’ (1994) 15(5) Cardozo L. Rev. 1403, 1404, noting that guarantees by companies related to a corporate borrower constitute ‘a common element of many financial transactions’. See also Richard Squire, ‘Strategic Liability in the Corporate Group’ (2011) 78 U Chi L Rev 605, 615, referring to the Posner’s theory of explaining entity partitions by the desire to reduce monitoring costs and simplify risk assessment by creditors, but questioning its persuasiveness in light of the widespread use of cross-guarantees that transmit credit risk across subsidiary boundaries.

3 Phillip Blumberg, ‘Intragroup (Upstream, Cross-Stream, and Downstream) Guaranties under the Uniform Fraudulent Transfer Act’ (1987) 9 Cardozo L. Rev. 685, 687, noting that intra-group guarantees protect creditors from ‘possible intragroup manipulation.’

4 William H. Widen, ‘Corporate Form and Substantive Consolidation’ (2007) 75 Geo. Wash. L. Rev. 237, 265, noting that ‘intercompany guarantees create a type of substantive consolidation by contract.’ Arguably, this ‘contractual substantive consolidation’ benefits only a creditor with a guarantee, making it closer to a veil piercing.

5 Due to additional protection in insolvency, a guaranteed creditor can be compared to a creditor with in rem security rights. Such a creditor oftentimes chooses liquidation, while unsecured creditors usually prefer reorganisation, as they are likely to get little or nothing in liquidation. Henry T.C. Hu, Jay L. Westbrook, ‘Abolition of the corporate duty to creditors’ (2007) 107 Colum. L. Rev. 1321, 1353.

6 Directive (EU) 2019/1023 of the European Parliament and of the Council 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).

7 ibid Recitals 1, 2, 22.

8 ibid Recital 22.

9 ibid Recital 15.

10 ibid Recital 24.

11 11 U.S. Code Title 11.

12 Corporate Insolvency and Governance Act 2020.

13 Wet homologatie onderhands akkoord. For unofficial English translation of the WHOA and related documents, see <https://www.debrauw.com/insightsandopinions/draft-bill-continuity-companies-act-ii-wcoii/> accessed 26 April 2021. The WHOA is in force since 1 January 2021.

14 Gesetz zur Fortentwicklung des Sanierungs- und Insolvenzrechts, Bundesgesetzblatt Jahrgang 2020, Teil I, Nr. 66, ausgegeben zu Bonn am 29. Dezember 2020. The StaRUG is in force since 1 January 2021.

15 Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018). The IRDA is in force since 30 July 2020.

16 It was noted that Chapter 11 deserves a prominent place in ‘the pantheon of extraordinary laws that have shaped the American economy and society and then echoed throughout the world.’ Elizabeth Warren, Jay L. Westbrook, ‘The Success of Chapter 11: A Challenge to the Critics’ (2009) 107(4) Mich. L. Rev. 603, 604.

17 A third-party release leads to a release – total or partial discharge or amendment – of claims against third parties (e.g. co-obligors, guarantors and collateral providers) in the insolvency or restructuring proceeding of the principal debtor. In some cases, a third-party release may also be used to release the obligations of the primary debtor in a scheme concerning a non-primary debtor (e.g. guarantor). See In the matter of Nordic Aviation Capital Designated Activity Company [2020 No. 162 COS.]. Third-party releases are available in the UK, Singapore, Australia, Ireland, the Netherlands (WHOA) and Germany (StaRUG).

18 INSOL International, ‘INSOL Special Report, Restructuring Cross-border Groups: Key Considerations Around Foreign Tax and Finance-driven SPVs’ (June 2020). See also Katharina Pistor, The Code of Capital: How the Law Creates Wealth and Inequality (Princeton University Press 2019) 51, describing how the integrated nature of Lehman Brothers’ financial arrangements (intercompany guarantees and centralized cash management) contributed to the failure of the group entities, ‘notwithstanding the corporate legal shields that had separated them.’

19 See e.g. §43 German Insolvency Code (Insolvenzordnung, InsO), Article 61 Bankruptcy Act (Italy).

20 Richard Squire, ‘Distress-triggered liabilities and agency costs of debt’ in Barry E. Adler (ed), Research Handbook on Corporate Bankruptcy Law (Edward Elgar Publishing 2020) 125, describing distress-triggered liabilities as ‘contingent obligations of a corporate debtor that tend to be triggered by the debtor’s own financial distress.’ A guarantee issued by one group entity on the debt of another group entity is, according to Squire, also an example of distress-triggered liability. For the purposes of this paper, cross-guarantees and other arrangements granting a creditor access to estates of separate entities and arising from the same obligation are put into a separate category of cross-entity liability arrangements.

21 Anthony J. Casey, ‘The New Corporate Web: Tailored Entity Partitions and Creditors’ Selective Enforcement’ (2015) 124 Yale L.J. 2680, 2689.

22 Richard Squire, ‘Limits to Group Structures and Asset Partitioning in Insolvency: Suppressing Value and Selective Perforation by Means of Guarantees’ in NACIIL Report, The 800-Pound Gorilla. Limits to Group Structures and Asset Partitioning in Insolvency (Eleven International Publishing 2019) 13.

23 Avery W. Katz, ‘An Economic Analysis of the Guarantee Contract’ (1999) 66 U Chi L Rev 47, 73-74. Henry Hansmann and Richard Squire, ‘External and Internal Asset Partitioning: Corporations and Their Subsidiaries’ in Jeffrey N. Gordon and Wolf-Georg Ringe (eds), The Oxford Handbook of Corporate Law and Governance (OUP 2018) 264.

24 Michael C. Jensen and William H. Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ (1976) 3 JFE 305.

25 John Armour. Antonia Menezes, Mahesh Uttamchandani, Kristin van Zwieten, ‘How do creditor rights matter for debt finance? A review of empirical evidence’ in Frederique Dahan (ed), Research Handbook on Secured Financing of Commercial transactions (Edward Elgar Publishing 2015) 3-25, more generally confirming that from an ex ante perspective, better protection of creditors’ rights is associated with lower cost of credit and improved recoveries.

26 Squire, Strategic Liability in the Corporate Group (n 2) 608.

27 Squire (n 22) 14. Squire also claims that the ‘costs of enforcing intragroup guarantees at the expense of the guarantor’s general creditors usually outweigh the economic benefits.’ See Squire (n 20) 126.

28 Squire, Strategic Liability in the Corporate Group (n 2) 605, pointing out that creation of subsidiaries and overuse of guarantees undermines transparency, complicates bankruptcy proceedings and introduces other distortions. Jay L. Westbrook, ‘Transparency in Corporate Groups, Brooklyn Journal of Corporate’ (2018) 13 Brook. J. Corp. Fin. & Com. L. 33, 34, arguing that the ‘very structure of a modern corporate group can make it the engine of injustice and fraud’ and proposing as a solution a regime ‘in which transparency is required with regard to the structure of a corporate group and the activities of each of its members.’

29 Non-adjusting creditors are those creditors which do not adjust the size and terms of their claims to anticipate the future developments and the security interests encumbering the borrower’s assets. Among such creditors are tort creditors, tax and regulatory claims, as well as voluntary creditors with few incentives or possibilities to bargain for security (e.g. due to a small size of claims or high transaction costs of negotiations). See Lucian Bebchuk and Jesse M. Fried, ‘The Uneasy Case for the Priority of Secured Claims in Bankruptcy’ (1996) 105 Yale L.J. 857, 864; Luca Enriques and Martin Gelter, ‘How the Old World Encountered the New One: Regulatory Competition and Cooperation in European Corporate and Bankruptcy Law’ (2007) 81(3) Tul. L. Rev. 577, 583.

30 Squire, Strategic Liability in the Corporate Group (n 2) 617, arguing that in the absence of intragroup guarantees ‘major lenders would pressure group managers to keep better records for each constituent entity, or to pare away extraneous subsidiary boundaries.’

31 Aurelio Gurrea-Martínez, ‘Insolvency Law in Emerging Markets’ (2020) 3/2020 Ibero-American Institute for Law and Finance <https://ssrn.com/abstract=3606395> accessed 26 April 2021.

32 David Hahn, ‘The Roles of Acceleration’ (2010) 8 DePaul Bus. & Com. L.J. 229, 231.

33 Philip Wood, Principles of Insolvency Law (2nd edn, Sweet & Maxwell 2007) 16-025. Wood argues at para. 16-026 that the ‘freeze or stay on self-help termination is unquestionably one of the most draconian and controversial of all the stays, because of the massive impact on transactions.’

34 Michael J. Di Gennaro and Harley J. Goldstein, ‘Can Ipso Facto Clauses Resolve the Discharge Debate? An Economic Approach to Novated Fraud Debt in Bankruptcy’ (2003) 1(3) DePaul Bus. & Com. L.J. 417, 435, noting that an ipso facto clause ‘serves as a sweeping in terrorem clause designed to deter certain misbehavior, imposing a cost on a debtor who resorts to bankruptcy - therefore making activities that increase the likelihood of bankruptcy more costly.’ Jackson refutes this argument by pointing out that the actual cost may be borne by unsecured creditors and not the debtor. He concludes that ‘bankruptcy law is justified in ignoring [ipso facto clauses] because they may be destructive of the collective weal in bankruptcy.’ See also Thomas H. Jackson, The Logic and Limits of Bankruptcy Law (Beard Books 2001) 42-43.

35 Yeon-Koo Che and Alan Schwartz, ‘Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance’ (1999) 15(2) J.L. Econ. & Org. 441.

36 The guarantee does not make the creditor risk disappear, but it shifts the risk of monitoring to a guarantor. See Katz (n 23) 59, arguing that guarantees ‘help protect creditors against some of the risks of debtor misbehavior or insolvency by shifting those risks to guarantors.’ However, the ability of insider guarantors to efficiently perform the monitoring function may be questioned due to the close bonds between the main debtor and the guarantor in a group context. This is especially true for upstream guarantees, provided by subsidiaries with insufficient information on the group performance (information asymmetry) or the ability to monitor or influence the corporate parent. See Aart Jonkers, Insider guarantees in corporate finance: An economic analysis of Dutch, US and German law (PhD thesis 2020) 267, noting that guarantees in corporate finance typically shift the risk ‘to inferior risk-bearers and inferior monitors, whereas the guaranteed creditors are often expert risk-bearers and expert monitors.’ A similar problem of the reduced incentives to monitor the debtor by a sophisticated lender has been emphasised with respect to the provision of collateral. See Michael Manove, A. Jorge Padilla and Marco Pagano, ‘Collateral versus Project Screening: A Model of Lazy Banks’ (2001) 32(4) RAND J. Econ. 726.

37 Creditor opportunism is understood in broad terms as the pursuit of economic self-interest by a creditor even if such behaviour provokes negative side-effects on third parties. For discussion of the negative effects of creditor opportunism on economically efficient restructuring, see David Ehmke, ‘Publicly Offered Debt in the Shadow of Insolvency’ (2015) 16 EBOR 63. On the problem of holdouts and tragedy of anticommons in insolvency and restructuring, see Rolef J. de Weijs, ‘Harmonisation of European Insolvency Law and the Need to Tackle Two Common Problems: Common Pool and Anticommons’ (2012) 21(2) Int. Insolv. Rev. 67.

38 Bob Wessels and Stephan Madaus, Instrument of the European Law Institute – Rescue of Business in Insolvency Law (2017) 395, noting that ‘any restructuring is doomed if the commencement of proceedings may prompt financial creditors to accelerate the repayment of credit or licensors and lessors to terminate contracts.’

39 Aart Jonkers, ‘Selective Perforation by Means of Guarantees: Dutch Law’ in NACIIL Report, The 800-Pound Gorilla. Limits to Group Structures and Asset Partitioning in Insolvency (Eleven International Publishing 2019) 75, arguing that ‘intergroup guarantees can be seen as promises to the lender to make preferential payments, especially on the eve of bankruptcy.’ An insider-guarantor can also put pressure on the borrower to pay the guaranteed creditor, indirectly profiting from such payment by limiting its exposure under the guarantee. The benefit is, however, indirect, as the payment goes to a non-insider creditor. Jason Gordon and Robert J. Landry III, ‘The Risk-Shifting Effect of Business Bankruptcy: A Statutory Solution to Provide Additional Protections for Personal Guarantors of Debts by Closely-Held Business Ventures’ (2015) 32(1) Emory Bankr. Dev. J. 67, 76, whereby the benefit of the guarantor is termed a ‘phantom benefit’.

40 Kenneth M. Ayotte and Edward R. Morrison, ‘Creditor Control and Conflict in Chapter 11’ (2009) 1(2) J. Legal Analysis 511. See also Jay Westbrook, ‘The Control of Wealth in Bankruptcy’ (2004) 82(4) Tex. L. Rev. 795.

41 Frederick Tung, ‘Leveraging in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance’ (2009) 57 UCLA L. Rev. 115, 168, arguing that the full protection against insolvency risks induces the lender to refuse to renegotiate and that such a creditor could be worse than indifferent to a workout, as in some cases it ‘would gain most by affirmatively sabotaging any workout effort and causing the debtor to fail.’ Tung discusses a situation where a creditor purchases a credit default swap, which fully insures it against the risk of the borrower’s non-payment. Horst Eidenmüller, ‘Comparative Corporate Insolvency Law’ in Jeffrey N. Gordon and Wolf-Georg Ringe (eds), The Oxford Handbook of Corporate Law and Governance (OUP 2018) 1019, emphasizing that not all creditors are alike and that ‘[f]ully secured creditors may press for premature liquidation even in cases where the company is not economically distressed.’

42 The ever-increasing control by secured creditors over the insolvency process has been particularly emphasised in the US literature. See Douglas J. Baird and Robert K. Rasmussen, ‘The End of Bankruptcy’ (2002) 55 SLR 751; David A. Skeel, ‘Creditors’ Ball: The New Corporate Governance in Chapter 11’ (2003) 152(2) U. Pa. L. Rev. 917, 918, noting that ‘[w]hereas the debtor and its managers seemed to dominate bankruptcy only a few decades ago, Chapter 11 now has a distinctly creditor-oriented cast.’ See Robert Rasmussen, ‘The end of bankruptcy revisited’ in Barry E. Adler (ed), Research Handbook on Corporate Bankruptcy Law (Edward Elgar Publishing 2020) 42, mentioning among the factors strengthening the position of secured creditors in insolvency: 1998 amendments to Article 9 UCC, making it easier to obtain a blanket security interest in all debtor’s assets; debtor-in-possession financing and the use of far-reaching lending covenants, giving a senior lender control over debtor’s access to cash in its accounts.

43 Di Gennaro and Goldstein (n 34) 441, describing that a creditor, protected by an ipso-facto clause, may be incentivized to force insolvency whenever the current market conditions make it beneficial, even if this is not in the collective interest.

44 Wee Meng Seng, ‘The Singapore Story of Injecting US Chapter 11 into the Commonwealth Scheme’ (2018) 15 ECFR 553.

45 Ignacio Tirado, ‘Scheming against the Schemes: A New Framework to Deal with Business Financial Distress in Spain’ (2018) 15 ECFR 516.

46 Emilie Ghio, ‘Transposing the preventive restructuring directive 2019 into French insolvency law: Rethinking the role of the judge and rebalancing creditors’ rights’ (2021) 30(1) Int. Insolv. Rev. 54.

47 For discussion of recent insolvency law reforms in a number of European jurisdictions, see David Ehmke et al., ‘The European Union preventive restructuring framework: A hole in one?’ (2019) 28 Int. Insolv. Rev. 184.

48 Restructuring Directive, Recital 2.

49 Lorenzo Stanghellini et al. (eds), Best Practices in European Restructuring: Contractualised Distress Resolution in the Shadow of the Law (Wolters Kluwer 2018) 5, noting that ‘restructuring and insolvency professionals unanimously consider late reaction to a crisis to be the single most important reason for businesses becoming unsustainable and heading towards liquidation.’ Wessels and Madaus (n 38) Recommendation 1.21, stressing the importance of supporting ‘early warning mechanisms that detect a deteriorating business development and signal the respective urgency to act.’

50 Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast).

51 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms.

52 UNCITRAL Model Law on Enterprise Group Insolvency (2019). The MLEGI compliments the UNCITRAL Model Law on Cross-Border Insolvency (1997) and targets group insolvencies to encourage and enable coordinated responses to financial distress. For that purpose, it offers a wide range of special tools, including designation of a ‘planning proceeding’, which is led by a ‘group representative’ in order to develop a ‘group insolvency solution’. The latter is designed in a flexible way to reflect ‘a proposal or set of proposals developed in a planning proceeding for the reorganization, sale or liquidation of some or all of the assets and operations of one or more enterprise group members.’ MLEGI, Article 2(f). For discussion of the MLEGI, see Irit Mevorach, ‘A Fresh View on the Hard/Soft Law Divide: Implications for International Insolvency of Enterprise Groups’ (2019) 40(3) Mich. J. Int. Law 505.

53 InsO, § 3a, 269d-269i.

54 Codice della crisi d’impresa e dell’insolvenza in attuazione della legge 19 ottobre 2017, n. 155, Art. 284.

55 Ley Concursal, Artículo 25.

56 LOI n° 2015-990 du 6 août 2015 pour la croissance, l'activité et l'égalité des chances économiques, adding Article L. 721-8 to the Code of Commerce.

57 Restructuring Directive, Article 7(5).

58 ibid Article 6.

59 ibid Recitals 40 and 41.

60 ibid Recital 32.

61 Fabrice Robert-Tissot, ‘The Effects of a Reorganization on (Executory) Contracts: A Comparative Law and Policy Study [United States, France, Germany and Switzerland]’, III Bronze Medal Winner Paper (2012) 24, <https://www.iiiglobal.org/node/1557> accessed 26 April 2021, finding that the enforcement of ipso facto clauses could be inefficient ‘for it would only advantage the non-debtor, but cause significant losses for the other creditors.’

62 A few narrow exceptions covered the supply of utilities such as gas, water and electricity (Section 233 Insolvency Act 1986) and the supply of ‘essential’ goods and services (Section 233A Insolvency Act 1986)

63 Belmont Park Investments Pty Ltd v. BNY Corporate Trustee Services Ltd Butters v. BBC Worldwide Ltd [2011] UKSC 38.

64 The anti-deprivation rule asserts that ‘there cannot be a valid contract that a man’s property shall remain his until his bankruptcy, and on the happening of that event shall go over to someone else, and be taken away from his creditors.’ Ex parte Jay, In re Harrison (1880) 14 Ch D 19, at 26 (Cotton LJ).

65 Belmont Park (n 63) 106.

66 Felicity Toube and Joanne Rumley, ‘A Brave New World? Should the UK Ban Ipso Facto Clauses in Non-Executory Contracts?’ (2018) 31(3) Insolvency Intelligence 78. Louise Gullifer and Jeniffer Payne, Corporate Finance Law: Principles and Policy (3^rd edn, Hart Publishing 2020) 111, noting that ‘the principle is of limited application.’

67 Belmont Park (n 63) 104.

68 Bob Wessels and Stephan Madaus (eds), Rescue of Business in Europe. A European Law Institute Instrument (OUP 2020) 208. Goode critically evaluates the English approach and convincingly argues that a contractual right may in practice constitute a valuable asset, whose termination can diminish the assets available to creditors, ‘so that in form and in substance the termination operates as forfeiture.’ Roy Goode, Principles of Corporate Insolvency Law (4^th edn, Sweet & Maxwell 2011) 222.

69 For a detailed historical account, see Vern Countryman, ‘Executory Contracts in Bankruptcy: Part II’ (1974) 58 Minn. L. Rev. 479.

70 In a number of cases, courts, guided by considerations of equity and public interest, barred the enforcement of ipso facto clauses in order to prevent the forfeiture. See e.g. Queens Blvd. Wine and Liquor Corp. v. Blum, 503 F.2d 202 (1974), holding that a court may deny enforcement of a bankruptcy forfeiture clause on equitable grounds, where contract termination would be ‘grossly inequitable and contrary to the salutary purpose of Chapter XI.’ See also Weaver v. Hutson, 459 F.2d 741 (4th Cir. 1972). These cases remain controversial.

71 11 U.S.C. § 365(e).

72 Susan Block-Lieb, ‘Fishing in Muddy Waters: Clarifying the Common Pool Analogy as Applied to the Standard for Commencement of a Bankruptcy Case’ (1993) 42 Am. U. L. Rev. 337, 424, highlighting that the goal of debtor’s financial rehabilitation was distinct from that of increasing distributions to creditors. See also Report of the Committee on the Judiciary together with Separate Supplemental, and Separate Additional Views, H.R. Rep. No. 95-595 (1977) 348, explaining that the goal of § 365(e)(1) is to restrict the application of clauses that frequently hamper rehabilitation efforts.

73 The list of such jurisdictions is provided in the Annex 1. For a country-by-country overview of the treatment of executory contracts and ipso-facto clauses in insolvency, see Jason Chuah and Eugenio Vaccari (eds), Executory Contracts in Insolvency Law: A Global Guide (Edward Elgar Publishing 2019).

74 UNCITRAL Legislative Guide on Insolvency Law, Part one and two, 2004, Ch. II, para. 118. EBRD Core Principles of an Effective Insolvency System, September 2020, Principle 11. FSB Key Attributes of Effective Resolution Regimes for Financial Institutions, 2014, I-Annex 5: Temporary stay on early termination rights.

75 For example, the limitation of ipso facto clauses in the UK covers only contracts for the supply of goods and services. See Insolvency Act 1986, Section 233B. Australian law introduces more than 60 exclusions from the rule against ipso facto clauses, many of which cover common commercial contracts. See Christopher Symes and Jason Harris, ‘Be Careful What You Wish For! Evaluating the Ipso Facto Reforms’ Oxford Business Law Blog (13 September 2019) <https://www.law.ox.ac.uk/business-law-blog/blog/2019/09/be-careful-what-you-wish-evaluating-ipso-facto-reforms> accessed 26 April 2021. The WHOA uses the all-encompassing language ‘commitments and obligations to the debtor’, indicating broad coverage of the prohibition. See WHOA, Article 373(3). As to the material scope, in the USA the rule on ipso facto clauses extends to all cases under Chapter 11. In Singapore ipso facto restrictions apply to specified proceedings, which do not include winding up or receivership. In the Netherlands the limitations are arguably applicable only in the context of the preparation and confirmation of extrajudicial restructuring plans.

76 For example, in Europe groups of companies have become the prevailing form of large-sized enterprises. See Report of the Reflection Group on the Future of EU Company Law, 5 April 2011, p. 59. There are also more than one million SMEs in Europe which have subsidiaries or joint ventures abroad. See Commission Staff Working Paper, Impact Assessment Accompanying the Proposal for a Directive, 22 November 2016, SWD(2016) 357 final, p. 35.

77 UNCITRAL Legislative Guide on Insolvency Law, Part three, 2010, Ch. I, para. 10.

78 Lehman Bros. Special Fin. Inc. v. BNY Corporate Tr. Serv. Ltd. (In re Lehman Bros. Holdings Inc.), 422 B.R. 407 (Bankr. S.D.N.Y.2010).

79 The validity of flip clauses under US law remains disputable, though. In a number of later cases, courts have come to the opposite conclusion, holding that such clauses do not amount to prohibited ipso facto clauses. See Lehman Bros. Special Fin., Inc. v. Bank of America NA, 553 B.R. 476 (Bankr. S.D.N.Y 2016), aff’d 2018 WL 1322225 (S.D.N.Y. March 14, 2018). Lehman Brothers Special Financing Inc. v. Branch Banking and Trust Company, No. 18-1079 (2d Cir. August 11, 2020).

80 Perpetual Trustee Company Limited & another v. BNY Corporate Trustee Services Ltd & another [2009] EWCA Civ 1160, holding that the ‘effect of the “flip” provisions was thus not to divest LBSF [the debtor] of monies, property, or debts, currently vested in it, and to revest them in the Noteholders, nor even to divest LBSF of the benefit of the security rights granted to it. It was merely to change the order of priorities in which the rights were to be exercised in relation to the proceeds of sale of the collateral in the event of a default.’ Confirmed in Belmont Park (n 63). For the analysis and the explanation of the complex facts and the underlying transactions, see Sarah Worthington, ‘Good Faith, Flawed Assets and the Emasculation of the UK Anti-Deprivation Rule’ (2012) 75(1) Mod. L. Rev. 112; Hugh Collins, ‘Flipping Wreck: Lex Mercatoria on the Shoals of Ius Cogens’ in Stefan Grundmann, Florian Möslein, and Karl Riesenhuber (eds), Contract Governance: Dimensions in Law and Interdisciplinary Research (OUP 2015) 395.

81 Lehman Bros. Special Fin. Inc. (n 78).

82 ibid.

83 JPMorgan Chase Bank, N.A. v. Charter Communications Operating, LLC (In re Charter Communications), 419 B.R. 221 (Bankr. S.D.N.Y.2009). In this case the lender argued that only clauses tied to bankruptcy of the debtor (and not its affiliates) were unenforceable. The court disagreed and concluded that the lender shall remain bound by the original terms of the loan agreement. Read further Douglas G. Baird and Anthony J. Casey, ‘No Exit? Withdrawal Rights and the Law of Corporate Reorganizations’ (2013) 113 Colum. L. Rev. 1.

84 Lehman Bros. Special Fin. Inc. (n 78).

85 For the analysis of different ‘prototypes’ of group structures, based on the degree of integration and control, see Irit Mevorach, Insolvency within Multinational Enterprise Groups (OUP 2009), Chapter V.

86 Insolvency Act 1986, sec. 233B(3).

87 Bankruptcy and Insolvency Act, sec. 65.1.

88 IRDA, sec. 440(1).

89 ibid, sec. 440(3).

90 Corporations Act 2001, sec. 415D(1)(f).

91 Aharon Barak, Purposive Interpretation of Law (Princeton University Press 2005) 28, explaining purposive interpretation in the following way: ‘The interpreter does not deal with form alone, because divorced from its substance, form has no vitality. The interpreter does not deal with substance alone, because divorced from form, the substance cannot be actualized. The interpreter works with the form of the text, guided by its substance.’

92 11 U.S. Code Title 11, § 365(e), referring to ‘the commencement of a case under this title.’

93 Commercial Code, Article L. 622-13, referring to ‘the commencement of safeguard proceedings.’

94 WHOA, Article 373(3), referring to ‘acts that are directly related and reasonably necessary to the implementation of the plan.’

95 Insolvency Act (Austria), § 25b(2), referring to ‘the event of the opening of insolvency proceedings.’

96 Restructuring Directive, Article 7(5). Notably, the original Proposal used a more restrictive language and covered clauses operating ‘solely by reason of the debtor’s entry into restructuring negotiations.’

97 For the discussion of resolution tools and their effects on contracts entered into by the failing institution, see Francisco J. Garcimartín Alférez and Sara Sánchez Fernández, ‘Resolution and contracts’ in Matthias Haentjens and Bob Wessels (eds), Research Handbook on Cross-Border Bank Resolution (Edward Elgar Publishing 2019) 201.

98 BRRD, Article 68(3).

99 Basel Committee on Banking Supervision (BCBS), Report on intra-group support measures (2012) 4, noting that intra-group exposures/transactions and support measures have the potential to adversely affect the solvency, liquidity and profitability of individual entities within a group. See also BCBS, International Organization of Securities Commissions (IOSCO) and International Association of Insurance Supervisors (IAIS), Intra-Group Transactions and Exposures Principles (1999), listing various types of intra-group transactions and exposures.

100 BRRD, Article 2(1)(31).

101 BRRD, Article 2(1)(26).

102 David A. Skeel, ‘The new synthesis of bank regulation and bankruptcy in the Dodd-Frank era’ in Barry E. Adler (ed), Research Handbook on Corporate Bankruptcy Law (Edward Elgar Publishing 2020) 86.

103 One such initiative is headed by the International Swaps and Derivatives Association (ISDA). ISDA developed a number of Stay Protocols. For example, ISDA 2014 Resolution Stay Protocol provides that adhering parties agree not to exercise certain cross-default and early termination rights if an affiliate of a counterparty becomes subject to certain insolvency regimes, such as the US Bankruptcy Code or receivership under the FDI Act. ISDA 2014 Protocol was subsequently replaced by ISDA 2015 Universal Protocol, but the approach to cross-defaults has not substantially changed. The main idea behind addressing default rights pursuant to ISDA Protocols is that ‘a failure of one part of a SIFI should not necessarily lead to defaults and close-outs of derivatives and repos sitting in affiliates of the SIFI, if the affiliate is still performing on its obligations.’ Stephanie Massman, ‘ISDA Resolution Stay Protocol: A Brief Overview’ Harvard Law School Bankruptcy Roundtable (10 February 2015) <https://blogs.harvard.edu/bankruptcyroundtable/2015/02/10/isda-protocol-a-brief-overview/> accessed 26 April 2021.

104 Restructuring Directive, Article 6. Irit Mevorach and Adrian Walters, ‘The Characterization of Pre-insolvency Proceedings in Private International Law’ (2020) 21 EBOR 855, 863, noting that Chapter 11 ‘was designed to promote restructuring by encouraging firm managers to negotiate and confirm a plan of reorganization […] within the shelter provided by a statutory moratorium – the automatic stay.’

105 UNCITRAL Legislative Guide on Insolvency Law, Part three, 2010, Ch. II, para. 40.

106 Restructuring Directive, Articles 6 and 7.

107 ibid Recital 32.

108 11 U.S. Code § 362.

109 Credit Alliance Corp. v. Williams, 851 F.2d 119 (4^th Circ. 1988); In re S.I Acquisition, Inc., 817 F.2d 1142, 1147 (5th Cir.1987); In re Supermercado Gamboa, 68 B.R. 230, 232 (Bankr.D.P.R.1986); Reliant Energy Servs., Inc. v. Enron Canada Corp., 349 F.3d 816, 825 (5th Cir.2003).

110 11 U.S. Code § 362(a)(6).

111 The legal basis for extending a stay to non-debtor parties is not obvious. Some courts base their decisions on § 105(a) of the US Bankruptcy Code (In re Calpine Corp., 365 B.R. 401 (S.D.N.Y. 2007). Other courts rely on § 362(a), even though it does not explicitly provide for such an extension (Queenie Ltd. v. Nygard International, 321 F.3d 282, 287 (2d Cir. 2003).

112 Reliant Energy Services, Inc. v. Enron Can. Corp., 349 F.3d 816, 825 (5th Cir. 2003).

113 Ritchie Capital Management, L.L.C. v. Jeffries, 653 F.3d 755 (8th Cir. 2011).

114 In re Union Trust Philadelphia, LLC, 460 B.R. 644 (E.D. Pa. 2011); In re Hart, 530 B.R. 293 (Bankr. E.D. Pa. 2015); In re Saxby’s Coffee Worldwide, LLC, 440 B.R. 369 (Bankr. E.D. Pa. 2009).

115 In re Caesars Entertainment Operating Co., Inc., 561 B.R. 441, 76 Collier Bankr. Cas. 2d (MB) 746 (Bankr. N.D. Ill. 2016).

116 ibid.

117 Shlomo Maza, ‘Enjoying Third Party Litigation under §362’ (2017) 26 Norton J. Bankr. L. & Prac. (online version).

118 This practice is facilitated by the ‘affiliate-filing rule’ of 28 U.S. Code § 1408 and Rule 1015(b) of the Federal Rules of Bankruptcy Procedure. The affiliate-filing rule promotes reorganisation of an entire business enterprise as may be necessary. Another reason for group filings may be the general unavailability of such remedy as a third-party release in the USA. See Dorothy Coco, ‘Third-Party Bankruptcy Releases: An Analysis of Consent Through the Lenses of Due Process and Contract Law’ (2019) 88 Fordham L. Rev. 231.

119 For example, in State Bank of India vs. V. Ramakrishnan and Ors. (14.08.2018 - SC), interpreting section 14 of the Insolvency and Bankruptcy Code 2016, the Supreme Court of India clarified that the insolvency moratorium did not extend to a guarantor. See also §89 InsO, seeking protection of debtor’s insolvency estate.

120 See also the StaRUG, §49(3), which permits the extension of a stay of actions arising from intra-group liability arrangements to protect guarantors and collateral providers.

121 For an evaluation of Singapore reforms, see Gerald McCormack and Wai Yee Wan, ‘Transplanting Chapter 11 of the US Bankruptcy Code into Singapore’s restructuring and insolvency laws: opportunities and challenges’ (2019) 19 JCLS 69.

122 Prior to the 2017 reforms, the case law on the issue was not settled. For example, in Pacific Andes Resources Development Ltd [2016] SGHC 210, the court opined that ‘a scheme of arrangement is territorial in nature and therefore the protective relief that s 210(10) offers to facilitate a scheme ought to also be territorial.’

123 Singapore Companies Act, sec. 211C (repealed by the IRDA).

124 IRDA, sec. 65(1).

125 IRDA, sec. 65(2).

126 On the nature and extraterritorial application of a stay, see Manoj Pillay Sandrasegara, Sim Kwan Kiat, ‘Report on Singapore’ in Corporate Restructuring and Insolvency in Asia 2020, ABLI Legal Convergence Series (2020) 614.

127 In interpreting sec. 211B(1) of the Companies Act (now replaced by sec. 64 of the IRDA), which provides for an automatic stay, the court in Re IM Skaugen SE held that when applying for a stay, the debtor needs to provide evidence of support from company’s creditors of the restructuring. It stressed that in a group restructuring context, the ‘court cannot ignore and indeed must pay heed to the overall support of the creditors for the group restructuring efforts.’ Re IM Skaugen SE [2018] SGHC 259 at para. 63.

128 For background, see Committee to Strengthen Singapore as an International Centre for Debt Restructuring, Report of the Committee (20 April 2016) <https://www.mlaw.gov.sg/news/public-consultations/public-consultation-on-the-report-of-the-committee-to-strengthen> (accessed 26 April 2021).

129 Explanatory Memorandum to the Draft Act on Court Confirmation of Extrajudicial Restructuring Plans.

130 WHOA, Article 376(2).

131 WHOA, Article 376(4).

132 The definition of a ‘group’ is given in the Dutch Civil Code (Article 2:24b). A group ‘is an economic unit in which legal persons […] are organizationally interconnected. Group companies are legal persons and commercial partnerships interconnected to each other in one group.’ The existence of economic unity and organisational interconnectedness are therefore the main characteristics of a corporate group under Dutch law. They highlight interdependence of group entities, importance of group synergies and (typically) centralized management.

133 WHOA, Article 372(1). See Michael Veder and Adrián Thery, ‘The release of third party guarantees in pre-insolvency restructuring plans’ in Dennis Faber et al. (eds), Trust and Good Faith across Borders, Liber Amicorum Prof. Dr. S.C.J.J. Kortmann (Wolters Kluwer 2017).

134 WHOA, Article 370(1).

135 Reinout Vriesendorp and Wies van Kesteren, ‘De WHOA en de rechter: een leidraad’ (2019) 36 Tijdschrift voor Insolventierecht 277.

136 The jurisdiction over legal entities for the purposes of the WHOA may be established either on the basis of the centre of main interests (COMI) as defined in the EIR Recast, or by virtue of a sufficient nexus with the Netherlands.

137 WHOA, Article 384(3).

138 WHOA, Article 372(3).

139 Reinhard Bork, Principles of Cross-Border Insolvency Law (Intersentia 2018) 143.

140 Ewan McKendrick, Contract Law: Text, Cases, and Materials (6^th edn, OUP 2014) 13. Freedom of contract is, of course, not absolute and there are many exceptions imposed to protect weaker parties, ensure competition and fairness. See Michael J. Trebilcock, The Limits of Freedom of Contract (Harvard University Press 1997). Roger Brownsword, Contract Law. Themes for the Twenty-first Century (2nd edn, OUP 2006) Chapter 3. Paul S. Davies, Magda Raczynska (eds), Contents of Commercial Contracts: Terms Affecting Freedoms (Hart Publishing 2020). See also Richard A. Epstein, ‘Contracts Small and Contracts Large: Contract Law through the Lens of Laissez-Faire’ in F.H. Buckley, The Fall and Rise of Freedom of Contract (Duke University Press 1999) 28, distinguishing three interrelated concepts: security of exchange, sanctity of contract and freedom of contract.

141 Ramesh convincingly highlighted the self-reinforcing nature of the ‘legitimate expectations’ argument. He noted that ‘creditors’ expectation that their investment will be undisturbed in a group insolvency is to some extent a mere reflection of the orthodoxy of separate legal personality.’ He continued by underlining that more frequent incursions into the separate legal personality doctrine could further weaken the argument of legitimate expectations, used to justify separate (atomistical) treatment of group entities in insolvency. See Kannan Ramesh, ‘Synthesising Synthetics: Lessons learnt from Collins & Aikman’ 2nd Annual GRR Live New York (26 September 2018).

142 The issue of contractual freedom and its boundaries in insolvency is the subject of a continuous academic debate. See Steven L. Schwarcz, ‘Rethinking Freedom of Contract: A Bankruptcy Paradigm’ (1999) 77 (3) Tex. L. Rev. 515, arguing that the fundamental policies underlying the US Bankruptcy Code, such as equality of distribution among creditors and debtor rehabilitation should in certain cases be able to limit contractual freedom. Jay L. Westbrook, ‘Commercial Law and the Public Interest’ (2015) 4 Penn. St. J.L. & Int’l Aff. 445, underlining the importance of protecting public interest in insolvency proceedings and concluding that the latter cannot be ensured when solely relying on creditors’ contracting.

143 Mevorach and Walters (n 104) 856, describing insolvency law as a unique sub-system of commercial law ‘aiming to promote a fair process taking account of interests of multiple groups of stakeholders, to maximize value, minimize waste, and, enable rescue of viable businesses.’

144 UNCITRAL Legislative Guide on Insolvency Law, Part one and two, 2004, Ch. I, para. 5.

145 Lydia Tsioli, ‘Evaluating the Policy Effectiveness of the Directive on Restructuring and Insolvency: a Question of the Framework’s Scope?’ in Jennifer L. L. Gant (ed), Harmonisation of Insolvency and Restructuring Laws in the EU, Papers from the INSOL Europe Academic Forum Annual Conference Copenhagen, Denmark (INSOL Europe 2020) 36. See also Matthias Kahl, ‘Economic Distress, Financial Distress, and Dynamic Liquidation’ (2002) 57(1) J. Finance 135, 141, arguing that ‘[v]iable firms should be continued because their continuation value is higher than their liquidation value.’

146 The viability test may take different forms and can be applied at different stages of the process. For example, in the USA, viability is not checked at the start of Chapter 11, but it surfaces in norms on involuntary conversion and dismissal (11 U.S.C. § 1112) and relief from the stay (11 U.S.C. § 362). In the UK, as a part of a new moratorium procedure, a monitor should at the outset assess and state that it is likely that the moratorium would result in the rescue of company as a going concern. See Insolvency Act 1986, Part A1, A(1)(e).

147 Horst Eidenmüller, ‘Contracting for a European Insolvency Regime’ (2017) 18 EBOR 273, 288, emphasizing the filtering function of insolvency law, which should be available ‘to restructure only viable firms and liquidate the non-viable ones.’ Eidenmüller also notes that the ‘economic costs resulting from this mistake [letting non-viable firms to restructure] are surely not trivial.’

148 Restructuring Directive, Article 4(3).

149 Chuah and Vaccari (n 73) para. 1.43.

150 Ronald M. Dworkin, ‘The Model of Rules’ (1967) 35 U Chi L Rev 14, 27.

151 Bork (n 139) para. 1.33.

152 Jay L. Westbrook, ‘A Functional Analysis of Executory Contracts’ (1989) 74 Minn. L. Rev. 227, 228, writing that insolvency ‘is that volume of the law that might have been written by Lewis Carroll, every conventional legal principle refracted through the prism of insolvency.’

153 The concept of a group member ‘likely to be a necessary and integral participant’ in the resolution of enterprise group’s (or a part of the enterprise group’s) financial difficulties, has been introduced in the MLEGI. Thus, a planning proceeding – one of the major innovations of the MLEGI – can only be opened with respect to an entity that satisfies the requirement of being a ‘necessary and integral participant’ in a group solution. MLEGI, Article 2(g)(ii). The Guide to the MLEGI in para. 46 explains that it should be apparent that the sought restructuring could not be developed and implemented without involvement of that particular group entity. This characterisation can be instrumental in determining whether a group entity should have access to an extended stay, as suggested in this paper.

154 See In re Metromedia Fiber Network, Inc., 21 July 2005, 416 F.3d 136 (2nd Cir. 2005). This case concerned a related concept of a third-party release. The court warned that ‘a nondebtor release is a device that lends itself to abuse. […] In form, it is a release; in effect, it may operate as a bankruptcy discharge arranged without a filing and without the safeguards of the Code.’ While the extension of a stay does not go as far to discharge the debt, it can have important consequences for a guaranteed creditor.

155 Thomas H. Jackson, ‘Bankruptcy, Non-Bankruptcy Entitlements, and the Creditors’ Bargain’ (1982) 91 Yale L.J. 857, 862. Harry Rajak, Insolvency Law: Theory and Practice (Sweet & Maxwell 1993) 86.

156 The relevant provisions invalidating ipso facto clauses were adopted gradually. Adrienne Ho, ‘The Treatment of Ipso Facto Clauses in Canada’ (2015) 61 McGill L.J. 139.