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The Agreement in the Bankruptcy Procedure

The Agreement with Creditors in the Bankruptcy Procedure

One of the ways to end a bankruptcy procedure is the approval of an agreement with Creditors. It will be necessary to distinguish between advance agreement proposal (PAC) and ordinary agreement procedure. In addition to the majority of creditors, the judge's declaration will be required for approval. Once completed, the bankruptcy procedure may be terminated.

  1. What is the content of the agreement?
    • Peculiarity of alternative contents
  2. What is an Advance Proposal of Agreement? (known as PAC)
    • How does it differ from ordinary processing?
      • Legitimation
      • Deadlines
      • Membership
      • Process
  1. How is the ordinary processing of the agreement done?
    • How is the creditors´ committee established?
    • Which creditors have the right to vote?
    • What majority is required at the creditors’ committee?
    • When is a double majority required?
  2. Is approval by the judge necessary?
    • Who can object?
  3. To whom does the agreement become effective?
  4. What happens if the debtor does not comply with the agreement?
  5. Amendments by the Consolidated Text of the Bankruptcy Law
  6. Conclusions

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Title V Chapter I of the Bankruptcy Law 22/2003 deals with the agreement phase, articles 98 to 141. There are two possibilities to end a bankruptcy procedure, an agreement or the liquidation. In Spain most of the bankruptcy procedures end in liquidation. However, the debtor would benefit more if an agreement were approved. As, this agreement allows the debtor to continue its activities and the bankruptcy procedure to end. It is therefore necessary to understand what an agreement is in this procedure. For that, here is the answer to a number of questions.

  1. What is the content of the agreement?

The agreement between the debtor and its creditors modifies the circumstances of the credits subjected to the Bankruptcy Procedure. This agreement, if fulfilled, is a way of ending a Bankruptcy Procedure. The proposal of the agreement must be written and signed by the debtor or all the creditors who propose it. Moreover, if the commitment to pay a credit is made by a third party, the latter must also sign it.

The agreement must include the removal of a percentage of the credits or a waiting period for its payment. In addition, other types of proposals such as converting these credits into shares may be included. Conversion into another financial product with different characteristics may even be agreed. It is considered possible to include the sale of production units of the debtor. However, this sale will require the acquirer to continue with their activity. This agreement may never result in a change in the credit classification. Apart from this content, in any case the proposal will be accompanied by a detailed payment plan. Also it will be necessary to include a viability plan in a specific case. This is when there are resources linked to the continuity of the debtor´s activity for the fulfillment of the agreement.

It will not be admitted that the effectiveness of the agreement will be conditioned by any factor, except in the case of related bankruptcy procedures. And it may include alternative options to be chosen by the creditors. For example, a creditor will choose between removing a percentage of its credit or waiting a few years for payment.

– Singularity of alternative contents

However, this possibility of choice will not be indefinite. It will have a period of up to one month after the judicial approval of the final agreement. Therefore, in case of lack of election, the agreement will have to explain what will be applied to creditors. In this respect, the Supreme Court Sentence nº750/2011 of October 25th supports this consideration. It establishes that the judge cannot change the creditor’s option by default. In other words, if the creditor does not choose, it will be governed by the provisions of the agreement for lack of choice.

In addition, there may be several alternative contents, that is, different alternatives for various creditors. There may be creditors who opt to wait and others who opt to reduced its credits. As the above-mentioned sentence states, therefore, no majority is required for this election.

  1. What is an Advance Proposal of Agreement? (PAC)

An advance proposal of agreement (APA) is one that is proposed before the start of the agreement phase. It is proposed during the common phase of the bankruptcy procedure. It has one main advantage and that is the speed of its processing. In addition, it will generally give the debtor more control over the agreement.

– What are the differences with the ordinary processing?

Both procedures for the proposal of an agreement have differences in terms of legitimation, deadlines and process. These are explained below.

  • Legitimation

In the case of an APA, only the debtor can file it according to Article 104 LC. On the other hand, in the ordinary processing creditors could also file it. Ordinary processing is the name given to that proposal of agreement that is made once the agreement phase has begun. The creditors who can present the proposal in this phase must represent one fifth of the total liabilities. This proportion of one fifth will not be calculated on the number of creditors, but on the total debts. Then, the percentage of each credit in relation to total debts shall be taken into account.

However, there will be a limitation on the debtor’s right to propose an APA. He could not submit such a proposal if he applies for liquidation. He couldn’t also if he has incurred into the following prohibitions. The debtor has been definitively convicted for corporate offences. The debtor has not submitted its annual accounts for the last three years.

  • Deadlines

The deadline for submitting the APA ends with the expiration of the deadline for the communication of credits. The time frame begins when the debtor applies for the voluntary bankruptcy procedure or when the necessary one is declared. The debtor may, however, submit this advance proposal together with the application for voluntary bankruptcy procedure. The expiration of the communication of credits occurs one month after the declaration of the bankruptcy procedure by the judge.

However, the time limit for the ordinary processing of the agreement is different; it is regulated in Article 113. It ends when the objections to the inventory and the list of creditors are completed. There is a particularity in the time limit for creditors. They may submit proposals of an agreement up to 40 days before the creditors’ committee takes place.

  • Accessions

The APA will have to contain creditor accessions. Such accessions must be from privileged or ordinary creditors representing one-fifth of the liabilities submitted by the debtor. Therefore, accessions are mandatory in that percentage to admit the advance proposal. However, there is one exception in the case of voluntary bankruptcy procedure. When the proposal is submitted with the application for bankruptcy procedure, accessions must represent one tenth of the liabilities. In the ordinary processing, creditors may also adhere, even though the accessions are not required for its admission. The accessions will be made by appearing in front of the judicial secretary or by public instrument. Furthermore, they will be pure and simple, i.e. there will be no modifications to them.

According to Article 108 accessions may be revoked only in the case of an APA. All this must be done before the expiry of the period for objecting to the inventory and the list of creditors.

  • Process

As we have seen, both proposals are made in different phases. This leads to differences in their processes. Thus, for example, an advance proposal can be submitted again at the arrangement phase. It will even be allowed to be modified for its approval by the creditors’ committee. This committee is one of the main differences between the two proposals; as such committee is required in the ordinary processing. But they also have similarities such as the need for the evaluation of the proposal by the Receivership.

  1. How is the ordinary processing of the agreement done?

The ordinary processing of the agreement requires the convening and holding of the creditors committee. At this meeting, the creditors will vote and agree on whether or not to approve the proposed agreement. In this process, the creditors are allowed to adhere to the agreement until the list of attendees is closed. In the written procedure of the agreement, the accessions will be presented until the second month after the order that states this processing. This processing will take place when there are more than 300 creditors.

– How is the creditors’ committee established?

The creditors committee will also take place when an APA that was rejected is proposed, whether or not it is modified. The bankruptcy judge will issue an order convening the creditors committee and the beginning of the agreement phase. This will be done fifteen days after the end of the objections to the inventory and the list of creditors.

The meeting will be held in the second or third month from the date of the judge´s order. It will be in the second month when an amended advance proposal of agreement is submitted. On the contrary, it will be held in the third month in the remaining cases. This date will be established in the order convening the committee. In addition, a specific place and time will also be fixed.

The creditors’ committee will be chaired either by the judge or, exceptionally, by the Receivership. It will be validly constituted if creditors representing half of the ordinary credits of the bankruptcy procedure are present. If this half of the ordinary credits is not present it could be constituted with another percentage. This percentage is 50% of the liabilities between ordinary and privileged credits. Creditors of subordinated credits will never be counted for this purpose.

The debtor and the Receivership are obliged to attend the meeting. If the Receivership does not attend, according to Article 117 LC, it will lose its salary. In addition, all creditors on the attendance list may attend. For the constitution of the committee some creditor would be considered present even if they are not. Those creditors are the ones who have signed and adhered to the proposals, counting as part of the necessary 50%. Therefore, if their vote is not contrary in the committee, it will be understood as in favor of the agreement.

  • Which creditors have the right to vote?

The debtor may submit one proposal and the creditors another. If so, proposals will be voted in the order of the amount of the credits that have signed them. It should be borne in mind that if one proposal is approved, the others will not be assessed. Given this circumstance, it is necessary to know who will be able to vote at the committee. Thus, subordinate creditors will not be able to vote in any case. Especially related persons to the debtor, who have acquired credits after the declaration of bankruptcy procedure, won´t vote.

There is a peculiarity for the privileged ones. The law requires the mere approval by the creditors of ordinary credits. However, the privileged creditors may vote in favor of the agreement at the committee.

  • What is the majority required at the creditors’ committee?

As mentioned above, the relevant creditors for the vote are the creditors of ordinary credits. Therefore, it is mandatory the majority of these creditors.

Two scenarios must be distinguished. First, the one with removals equal to or less than 50% of the credits or waiting up to five years. This also includes only the conversion of debt into participative loans up to five years. Second, the one with removals greater than 50% or waits between five and ten years. In this case, more options are included such as the conversion of debt into shares or participative loans up to ten years.

In the first scenario, approval is required from creditors representing 50% of the ordinary liabilities. While in the second scenario creditors are required to represent 65% of the ordinary liabilities. However, since privileged creditors can also vote, the rule clarifies this majority. Article 124.2 states that for these percentages, privileged creditors voting in favor are included in ordinary liabilities.

Finally, it must be understood that when the majority is obtained the effects of the agreement are extended. That is to say, the modifications will be applied to the ordinary creditors who have not voted in favor and to the subordinate creditors.

– When is a double majority necessary?

According to case law and Article 125, there are cases in which a double majority is necessary

Firstly, when the proposed agreement entails new obligations for the creditors, they must approve it. Secondly, if a special treatment is established for some creditors, the rest will have to approve it by a majority. So, those creditors not affected by the special treatment must approve by a majority that the others will be affected. In an Order of the Provincial Court of Cadiz on February 25th 2020, it is clarified that these majorities will be for both types of proposals. Therefore, it will be applied in APAs as well as in the ordinary processing of agreement.

The requirement for this double majority is due a breach on the principle of par conditio creditorum. By this principle there will be equal treatment of creditors who have credits of the same nature. However, this special treatment, as stated in the previous Order, is sometimes necessary to approve the agreement. There could be creditors who have more power over the debtor. That could be when the supply of goods by the creditor to the debtor is necessary to continue his activity.

Two provisions stated in two Orders of the Commercial Court of Madrid No. 1 are also relevant. First, that this special treatment must be specified in the proposal, for its proper approval. It must be explained what this treatment consists of directly. This first one was issued on March 16th, 2006. Second, the vote of the creditor with several types of credits and only one affected will not be counted. So this creditor could not vote for the double majority. Due to he has one credit affected by the special treatment and another one that is not. This was issued on November 16th, 2005.

  1. Is approval by the judge required?

Once the committee is over, the judicial secretary, who participates in it, will submit the minutes to the judge for approval. Even though there is no creditors committee in the APA, this judicial approval of the agreement is always required.

  • Who can object?

Firstly, SAP 346/2011 of La Coruña, states that oppositions may be made even if there weren’t objections to the processing. There will be a deadline for opposing to such approval. This will be ten days from the date the approval is given. The Receivership and some creditors may oppose it. The creditors who did not attend the meeting could oppose to its approval. They could also oppose the ones illegitimately deprived of their vote or who voted against it.

The right to oppose will be different in the case of an advance proposal of agreement or written procedure. In such cases, those who did not adhere to the proposal may oppose it.

If an individual creditor or jointly with others holds 5% of the ordinary credits they may also object. In this case, however, the reason must be that it is objectively not feasible for the debtor to comply with the agreement. As was seen, creditors are entitled to submit a proposal for an agreement. Therefore, to avoid the agreement´s approval by the creditors without taking into account the debtor, the latter may object. He can also oppose on the grounds that compliance is not feasible.

Finally, the judge may oppose the approval of the agreement ex officio. If the judge considers that some precept of the law has been violated, he will refuse to approve the agreement. This non-compliance may concern the content of the agreement, or the form or contents of the accessions or the committee.

In cases where the opposition prevails because it has not been resolved, there will be no judicial approval. Therefore, if there are no more proposals, the liquidation phase will be opened.

  1. Who is covered by the effectiveness of the agreement?

The agreement will be effective from the day it is approved by the judge in sentence. From it the effects of the declaration of the bankruptcy procedure will end. In fact, the Receivership will be ceased and will have to report to the judge.

The approved agreement will automatically affect all the ordinary and subordinate creditors with credits prior to the declaration. It will affect even those credits that have not been recognized. For the subordinate creditors the waiting period will start from the fulfillment of the agreement with regard to the ordinary creditors. Thus, if an ordinary creditor has waited five years, the five-year waiting period for the subordinate will begin after that. The Madrid Provincial Court in its Order 296/2014 establishes a nuance for creditors with special privilege. For these, the agreement will apply to the part of their credit not covered by the enforcement of the guarantee. For that proportion the credit will be ordinary.

The privileged creditors will be bound in two cases. Individually if they had voted in favor or adhered to the proposal. Or even by becoming bound once the agreement has been judicially approved but before the declaration of compliance. Jointly, they will be bound if certain majorities of the privileged creditors concur. For the majorities we have the previous two scenarios. Thus, in the first scenario, a majority of 60% of the privileged creditors will be required. On the contrary, in the second scenario it will be necessary to have a majority of 75% of them. For creditors with special privilege it will not be computed on the total of the privileged debts. It will be computed according to the amount of guarantees accepted over the total guarantees granted.

  1. What happens if the debtor breaches the agreement?

After court approval, a declaration of compliance is also required by the bankruptcy judge. This will be done after the debtor confirms his compliance with reports to the judge.

However, sometimes the debtor will not comply with the agreement. He won’t when its powers of disposal have been limited, but he has not complied with these limitations. A declaration of non-compliance is required to make such non-compliance effective for the purposes of the bankruptcy procedure. This declaration must be requested by any creditor as established in Article 140. However, the courts establish nuances to this legal standing. Since the agreement does not affect credits against the insolvency estate, those creditors will not be entitled to claim. This fact is established by the Provincial Court of Zaragoza in its ruling 621/2012. Likewise, a creditor with a special privilege who is not affected by the agreement will not have legal standing either. This is established by the Sentence of the Provincial Court of Las Palmas of January 23th 2008. To claim creditors will have from the time of default to two months after the order of compliance.

The declaration of non-compliance will result in the termination of the agreement. For creditors with special privileges, this declaration will allow separate enforcement of their guarantee credits. Once the two-month period has elapsed, no application for default may be made. Therefore, the bankruptcy procedure will be concluded with a resolution issued for this purpose by the judge.

  1. Amendments by the Consolidated Text of the Bankruptcy Law

Finally, it should be noted that on May 5th the Consolidated Text of the Bankruptcy Law was approved. This will come into force on September 1st 2020. This text introduces some modifications to the agreements. The most relevant ones should be highlighted. The first is that it aims to unify the procedure between the two types of proposals. It introduces that the Receivership should issue a report on the viability of the debtor complying with the agreement. Finally, the maximum waiting period of 10 years is eliminated.

  1. Conclusions

The debtor should notice what stage of the bankruptcy procedure he is at in order to know which proposal to submit. He should then be aware that a majority of creditors is required to approve the agreement. The purpose of agreements is to ensure the continuity of the debtor’s business. Therefore, the debtor must take extreme precautions to comply with all the necessary procedural requirements. If the debtor, once all the procedural requirements have been met, executes what has been agreed, it will avoid liquidation.

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