Putting the pre-pack into practice: A ray of light at the end of the tunnel?
The WCO I Amending Act aims to help companies with activities serving societal interests when they face financial distress. But does it create an adequate framework to solve the current issues concerning the pre-pack?
As the COVID-19 crisis has shown, financial distress can happen to any company. Society is best served by sound mechanisms to resolve financial distress while minimising the downsides for all related parties. This includes the pre-pack, which has emerged as a mechanism in Dutch insolvency practice from 2012 onwards. The pre-pack promotes restructuring by means of a pre-negotiated sale of a company as a going concern, executed following the bankruptcy petition. To revive the Continuity of Enterprises Act I (Wet Continuïteit Ondernemingen I, WCO I) – which provides a legal basis for this practice – the draft WCO I Amending Act was proposed on 25 May 2021. This new draft bill (wetsontwerp) amends the scope of the WCO I and provides a helping hand only to companies with activities serving societal interests in financial distress.
Legislating the pre-pack in Dutch bankruptcy law
In addition to the framework for extra-judicial plans (onderhands akkoord buiten faillissement, WHOA), the Dutch Bankruptcy Act (Faillissementswet) provides to two types of corporate bankruptcy proceedings: the suspension of payments (surseance van betaling) and the bankruptcy proceeding (faillissement). The pre-pack is a method that has been developed in legal practice and can be qualified under the latter category. It aims to prepare for formal insolvency in a relatively calm manner so there is a better chance that a company’s viable parts can be sold to the highest bidder, with limited disruption to the company itself. In the case of a pre-pack, the company can continue to operate as a going concern, so that financial and operational damage can be limited as much as possible, while preparations are made to sell the company as a going concern in bankruptcy.
The WCO I introduces a statutory basis to appoint a preliminary bankruptcy trustee and a preliminary supervisory judge at the request of the debtor, prior to the commencement of the bankruptcy proceeding. If the situation arises that the company goes bankrupt, the court will formally appoint these persons as trustee and supervisory judge. The WCO I is currently in the last stage of parliamentary approval and aims to create a statutory basis for the pre-pack.
The pre-pack has been the subject of extensive discussion. One aspect that is often criticised is its lack of transparency since the appointment of the preliminary trustee and preliminary supervisory judge are not published in the central insolvency register. For suppliers and customers of the company, it may therefore be unknown whether a company has started a pre-pack.
A bumpy ride for the WCO I: CJEU in Smallsteps and Heiploeg
The WCO I is currently pending at the Dutch Senate (Eerste Kamer) of the Dutch Parliament. The process of handling the bill has been delayed due to Dutch courts referring preliminary questions to the Court of Justice of the European Union (CJEU) on the cases Smallsteps and Heiploeg.
Trade Unions had raised objections to the pre-pack used in the Smallsteps case, which used an exception of the Transfer of Undertakings Directive, as implemented in Dutch law, allowing the debtor to dismiss employees in a bankruptcy proceeding. In Smallsteps, the CJEU ruled that the Dutch pre-pack did not meet all requirements. Although it was considered a bankruptcy proceeding, it was not used for the purpose of liquidation, nor was their adequate supervision by a competent public authority.
In 2020, the Dutch Supreme Court posed preliminary questions in the Heiploeg case, effectively re-submitting the question which was dealt with in FNV/Smallsteps, but in a broader scope. The Heiploeg case is still pending at the CJEU. However, as a result of the legal uncertainty about the position of the pre-pack, it is hardly used these days.
The Amending Act as the solution for companies with activities serving societal interests
Bankruptcies bring many negative effects and this is even more so in the case of companies with activities serving societal interests. This became all too obvious with the bankruptcies of the hospitals MC Slotervaart and MC IJsselmeer in 2018. The Dutch Bankruptcy Act at the time proved to be inadequate to deal with the reality of a hospital bankruptcy. External reports recommended that a pre-pack should be available to make the necessary preparations silently before commencing a bankruptcy proceeding.
To promote a more controlled resolution of bankruptcies of all debtors with societal interests, a draft WCO I Amending Act was submitted for public consultation in May 2021. It should enable adoption of the pending WCO I, to provide a legal basis for the pre-pack. However, the scope of the proposed legislation is restricted: it would only cover companies with activities serving societal interests and would only facilitate a controlled liquidation. A silent preparatory phase – also for the purpose of liquidation – should enable the (preliminary) trustee to give adequate consideration to the societal interests involved. How sensible this may seem, the legislature has omitted to define what qualifies as companies with activities serving societal interests.
The Dutch legislature has chosen to introduce ‘companies with activities serving societal interests’ as an open norm. This creates legal uncertainty as to which companies fall within the scope of the Amending Act. The explanatory memorandum to the Amending Act provides a non-exhaustive list that includes companies in the healthcare sector, educational institutions, energy suppliers, waste processing companies and internet and telephone companies. In addition, it may also concern organisations of public interest as referred to in the Dutch Audit Firms (Supervision) Act (Wta). Furthermore, the legislature’s proposal to restrict the pre-pack to controlled liquidations is confusing. The explanatory memorandum takes a turn and points out that a transfer of a company’s activities may still be explored if this will limit the damage (to society). To provide legal certainty, the Dutch legislature must clarify the scope of WCO I Amending Act.
The legislative process of the WCO I has been subject to much discussion and delay. Legal uncertainties have inhibited the use of pre-packs in recent years. The intention of the Amending Act is that if companies with activities serving societal interests go bankrupt, these companies must first undergo a mandatory pre-pack phase to guarantee a controlled liquidation. Despite the good intentions, the draft Amending Act does not deliver on its promise. Whereas it aims to answer valid concerns raised in light of prior bankruptcies of hospitals, it does not provide an adequate framework to solve the current issues. As it stands, a great deal of legal uncertainty with the pre-pack remains, and therefore does not bring the desired light at the end of the tunnel for the Dutch pre-pack practice.