Spain: The Draft Spanish Insolvency Law

On September 7, 2001, the Spanish Council of Ministries ("Consejo de Ministros") reviewed a report issued by the Ministry of Justice on a draft insolvency law ("Anteproyecto de Ley Concursal") and agreed to forward such draft to the Council of State ("Consejo de Estado") and the General Council of the Judiciary ("Consejo General del Poder Judicial") in order to be reviewed.

The draft insolvency law (hereinafter, the "Draft Insolvency Law") is at a very early stage in the legislative process. Once the Council of State and the General Council of the Judiciary issue their reports, the Draft Insolvency Law will need to be approved by the Spanish Council of Ministries and forwarded to the Spanish Parliament for its review, discussion, amendment and approval. Therefore, provided that the Spanish Council of Ministries forwards the Draft Insolvency Law to Parliament, it is quite likely that its current content will be altered or amended through the legislative process.

Nevertheless, I think it is worthwhile to examine the Draft Insolvency Law at this stage to see where Spain is heading regarding insolvency rules.

Nobody argues about the urgent need to amend the outdated Spanish insolvency rules. The bulk of the current Spanish insolvency regulations are set out in the Commercial Code of 1885, the Suspension of Payments Law of 1922 and some sections of the Comercial Code of 1829. At least, the Spanish Council of Ministries seems to take this new law seriously when it refers to it as a "decisive step" in the process of modernisation of the Spanish justice system, which the two main Spanish political parties have agreed to reform by subscribing the so-called State Agreement for the Reform of Justice ("Pacto de Estado para la Reforma de la Justicia"). Let us hope the Spanish Council of Ministries does not lose interest during the coming months.

The shortfalls of the current Spanish insolvency rules are notorious. Perhaps the current rule that raises most eyebrows among our clients is the open-ended suspect period (the so-called, "retroaction period") in the event of bankruptcy of a Spanish company, coupled with the absolute nullity (without exceptions) of all transactions carried out during such suspect period. I am, therefore, glad to announce that the Draft Insolvency Law does at least foresee an end to these rigid provisions, by setting a time limit of 2 years for the suspect period and by only allowing the nullity of transactions which are detrimental to the debtor’s estate.

I would, nevertheless, like to point out that the purpose of this article is not to analyse the provisions of the Draft Insolvency Law in detail, but merely to summarise what I consider are the main principles and some of the most relevant features of the Draft Insolvency Law.

The Draft Insolvency Law includes in the same law all substantive and procedural rules applicable to insolvency situations, with the sole exception of certain provisions on the creation of the so-called Juzgados de lo Mercantil (hereinafter, "Commercial Courts") which, for constitutional reasons, will be included in an organic law foreseen to be enacted jointly with the insolvency law.¹ This is something that was already foreseen in Civil Procedure Law 1/2000, which came into force early in 2001.

The new insolvency rules will be applicable to both companies and individuals, whether engaged in business or not. This will simplify the current system that provides for different rules depending on whether the insolvent person or entity is engaged in business or not. The Draft Insolvency Law obviously includes some rules that are only applicable to companies, but the insolvency system will be the same for any person or entity becoming insolvent.

The Draft Insolvency Law only foresees one insolvency proceeding: the "concurso", which implies leaving behind the current Spanish insolvency proceedings; mainly, regarding legal persons, the "suspension of payments" and the "bankruptcy" proceedings. The word "concurso" comes from the Latin "concursus", which may be translated into English as "concurrence". This word clearly conveys the idea of concurrence of creditors and, for lack of a better word in English, I believe the word "concurso" should be translated in this context as "insolvency".

The preamble of the Draft Insolvency Law states that this single insolvency proceeding will work due to the flexibility of the new rules, which allow different solutions depending on the circumstances of the debtor: basically, an arrangement or composition with creditors or the liquidation of the debtor’s estate. Another example of this flexibility is the application of fast-track procedural rules to minor insolvencies.

Insolvency proceedings are triggered by the insolvency of the debtor, which is defined as the state in which a debtor falls when it is unable to fulfil its obligations (Article 2.2 of the Draft Insolvency Law). The Draft Insolvency Law is also quite flexible when applying this definition.

If the debtor files the request for the opening of the insolvency proceedings (the so-called voluntary insolvency: "concurso voluntario"), such filing implies the debtor’s acknowledgement of its insolvency situation. In this event (i.e., debtor’s request), it is not necessary for the debtor to actually be insolvent at the time of filing the request; it suffices that the situation of insolvency is "imminent" (Article 2.3 of the Draft Insolvency Law). In other words, the debtor is obliged to file the request for the opening of the insolvency proceedings when it is insolvent, but has the power to request its declaration of insolvency if the insolvency situation is imminent.

Debtors are encouraged to voluntarily file the request for the opening of the insolvency proceedings. As I will explain below, the general rule in these cases will be the intervention (rather than the suspension) of the debtor’s management powers.

However, if the insolvency request is filed by the debtor’s creditors (the so-called necessary insolvency: "concurso necesario"), such request requires the prior occurrence of any of the situations that the Draft Insolvency Law presumes as indicative of the debtor’s insolvency:

• The unsuccessful enforcement of the creditor’s right due to the lack of available attachable assets;
• The general breach of the debtor’s payment obligations;
• The existence of attachments on the debtor’s assets that generally affect the debtor’s net worth;
• The dereliction of the debtor’s directors not leaving any representative with full powers;
• The hurried or uneconomical dereliction or disposal of the debtor’s assets;
• The general breach of some of the following obligations: payment of tax and social security obligations for a term of 12 months (consecutive or not); payment of salaries for the last 6 months, and; payment of rents of all types of leases, of the deferred purchase price or instalments of mortgage loan agreements, relating to the debtor’s business premises, for a term of 6 months.

Creditors are also encouraged to file the request for the opening of the insolvency proceedings. As indicated below, 25% of the non-subordinated claims of the creditor who requests the opening of the insolvency proceedings will be considered a claim with a general privilege (Article 90 of the Draft Insolvency Law).

Once the court declares the insolvency situation, the debtor’s powers to administer its assets are either suspended or subject to the intervention of the court.

The suspension of the debtor’s management powers is the general rule in the event of necessary insolvencies (that is, in insolvencies declared as a result of a creditor’s request). That notwithstanding, the Draft Insolvency Law also grants courts the power to suspend the debtor’s powers to administer its assets when the debtor files the request for the declaration of insolvency or to avoid the suspension of such powers in the necessary insolvencies. This is another example of the flexibility of the Draft Insolvency Law, which is aimed at allowing the court to apply the most adequate measures required by the circumstances of the particular case.

If suspended, the management of the debtor’s affairs is left in the hands of the receivers ("administración judicial"). The receivers are a body composed of a lawyer, an economist and a common creditor; although, in the case of regulated entities (e.g., banks, investment services firms, and insurance companies) the economist is replaced with a representative of the regulator. The appointment of a single receiver is also foreseen for minor insolvencies. If the debtor’s management powers are subject to the intervention of the court, the receivers will also carry out such intervention or supervision.

The debtors’ actions that are contrary to the limitations mentioned above are not null and void, but merely subject to being nullified by the receivers (Article 39.7 of the Draft Insolvency Law).

The declaration of insolvency does not, by itself, interrupt the business or professional activity of the debtor, but the insolvency judge is granted full powers to close its business premises and order the cessation of the business or professional activities if it deems it necessary.

Subject to the suspension or intervention mentioned above, the general rule is that the governing bodies of insolvent companies continue functioning during the development of the insolvency proceedings. The most relevant effect of the declaration of insolvency on companies is perhaps the court’s power to order the attachment of the directors’ and liquidators’ assets if the court believes that there are reasonable grounds that the insolvency will end up being declared as negligent ("culpable") and that the debtor’s assets might not be sufficient to pay all of its debts. This measure applies not only to legally appointed directors and liquidators, but also to de facto directors and liquidators and, not only to the directors and liquidators as at the time of the insolvency request or declaration, but also to any person that has acted as director or liquidator of the company within 2 years from the date the insolvency situation is declared by the court.

The effects of the insolvency declaration on creditors generally are particularly relevant, especially on secured creditors. The Draft Insolvency Law declares a stay of all foreclosure proceedings of unsecured creditors ("acciones ejecutivas") against the debtor’s assets, so their claims may concur with the claims of the remaining unsecured creditors.

Perhaps the most interesting change to the current insolvency rules will be the treatment to the effects of the insolvency declaration on foreclosure proceedings commenced by secured creditors. Article 55 of the Draft Insolvency Law foresees a stay of such proceedings for a term of up to 12 months from the date of the insolvency declaration. The reason for this stay – as explained in the preamble of the Draft Insolvency Law – is to avoid that the foreclosure of the debtor’s assets by the secured creditors hinders solutions which may end up being in the best interest of the debtor and the remaining creditors. This will be the case because secured creditors will be given the opportunity – but will not be obliged -- to join the remaining creditors in the negotiation of a composition agreement ("convenio") with the debtor.

Furthermore, the Draft Insolvency Law seems to support alternatives to the foreclosure of security interests during the insolvency proceedings: for instance, the sale of the asset with the survival of the security interest and the subrogation of the purchaser in the debtor’s obligations under the secured facility. This is seen in the preamble of the Draft Insolvency Law as an alternative that would avoid the detrimental effects that the foreclosure of the security interest could have on the interest of the persons involved in the insolvency proceedings.

The treatment of the effects of the insolvency declaration on the debtor’s contractual relationships is also new. The general rule is that contracts will continue in full force and effect notwithstanding the debtor’s insolvency declaration. However, the insolvency judge may declare the termination of specific contracts if it considers them to be detrimental to the debtor’s estate or even the continued full force and effect of contracts that otherwise could be terminated by the counterparty due to the debtor’s default. In line with this, another interesting feature of the Draft Insolvency Law is the non-admissibility of the insolvency declaration as a contractual termination event. Unless expressly allowed by a particular legal provision, such clauses will be deemed not to be included in the contract.

As I anticipated above, the Draft Insolvency Law provides for a new treatment of transactions carried out by the debtor during the period immediately prior to such declaration. The current retroaction system – which is described as "disturbing" by the preamble of the Draft Insolvency Law – is replaced by specific reinstatement actions ("acciones de reintegración") aimed at setting aside transactions which are detrimental to the debtor’s estate. In certain cases the Draft Insolvency Law presumes certain detrimental acts and, in others, such harm will need to be proved by the receivers or by the creditor filing the relevant action.

Pursuant to Articles 70 and 71 of the Draft Insolvency Law, the receivers will be entitled to request the nullity of acts detrimental to the debtor’s estate which are carried out by the debtor within the term of 2 years prior to the declaration of insolvency, whether there was fraudulent intent or not. The harm to the debtor’s estate is presumed in the following events:

• Transfers of assets without consideration.
• Transfers of assets to persons specially connected to the debtor. The following persons are considered to be specially connected to debtors which are legal persons: (i) partners who have unlimited liability for the debtor’s debts; and (ii) partners or shareholders of listed companies with a stake of at least 5% or of unlisted companies with a stake of at least 10%, provided that said partners or shareholders are in any of the situations foreseen in Article 42 of the Code of Commerce.²
• Creation of security interests in relation to pre-existing obligations or new obligations that replace pre-existing obligations (i.e., the creation of a mortgage to secure an outstanding loan or the mortgage refinancing of an outstanding loan).
• Payment or other means of termination of obligations which maturity date would otherwise fall after the declaration of insolvency.

In any other cases, the harm to the debtor’s estate will need to be evidenced in order to set the transactions aside.

The general rule is that reinstatement actions must be brought by the receivers, although the debtor’s creditor will also be entitled to bring these actions if they previously request the receivers to do so in writing, their request is justified and the receivers do not file the action within 2 months from the date they are requested in writing.

It must be noted that the above system of reinstatement actions within the 2 year suspect period works without prejudice to any other action or claim that could be brought forward pursuant to Spanish law (Article 70.4 of the Draft Insolvency Law). For instance, the fraudulent conveyance action ("acción pauliana") foreseen in Articles 1111 and 1291.3 of the Civil Code, which may be exercised within 4 years from the date of the fraudulent act. These additional actions must also be brought forward and heard by the Commercial Court handling the insolvency proceedings.

It is also relevant that the Draft Insolvency Law expressly acknowledges that third parties who acquired debtors’ assets affected by reinstatement actions will benefit from the protection afforded by the application of the good faith principle and, in particular, by public registries. Of particular importance is the acknowledgement of the protection afforded by public registries (e.g., the Land Registry) to third parties acting in good faith. Under the current system, a third party purchaser acting in good faith does not benefit from the protection of the Property Registry if the land or building had been previously sold by a bankrupt company to its vendor during the suspect period (i.e., the retroaction period). This unfair and unjustified result, which derives from the absolute voidness of all transactions carried out during the retroaction period, will be corrected with the Draft Insolvency Law.

Insolvency proceedings will be handled by new Commercial Courts, called "Juzgados de lo Mercantil", which the Organic Law for the Insolvency Reform will create. Among them, the Commercial Court within the territory where the centre of a debtor's main interests is situated shall have jurisdiction to handle the insolvency proceedings. This is in line with Article 3 of the Council regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings, which will come into effect on May 31, 2002. If the debtor has its corporate domicile in Spain and the centre of the debtor’s main interests does not coincide with its corporate domicile, the creditor filing the request for insolvency will be entitled to elect the Commercial Court of the territory of any of them.

In the event of companies, it is presumed that the centre of its main interests coincides with its corporate domicile but, in order to avoid forum shopping, Article 9.1 of the Draft Insolvency Law ignores any changes to the corporate domicile within the term of six months prior to the filing of the request for the insolvency declaration.

The preamble of the Draft Insolvency Law also states that the Organic Law for the Insolvency Reform will grant the Commercial Court jurisdiction over the insolvency proceedings with full and exclusive jurisdiction over any matter that could affect the debtor’s estate, including labour matters.

The Draft Insolvency Law grants Commercial Courts wide discretionary powers to exercise their duties. For instance, Commercial Courts will be entitled to take preservation measures before the declaration of insolvency or the appointment of the receivers; will be able to make public the debtor’s insolvency declaration and any other measures in the interest of third parties in the manner they consider appropriate; and will be entitled to adjust the effects of the insolvency declaration depending on the circumstances of the debtor, the creditors and the debtor’s contracts.

The ranking of claims is one of the most relevant innovations of the Draft Insolvency Law. The current privileges and preferences are greatly reduced in the Draft Insolvency Law. The preamble of the Draft Insolvency Law states that "the principle of equal treatment of creditors must be the general rule in insolvency situations and its exceptions must be very limited and always justified".

Creditors’ claims are ranked as privileged, ordinary and subordinated (Article 88.1 of the Draft Insolvency Law). Privileged claims are, in turn, ranked as claims with a special privilege, if they affect specific assets of the debtor’s estate, and claims with a general privilege, if they affect all of the debtor’s estate (Article 88.2 of the Draft Insolvency Law).

The following claims are considered claims with a special privilege (Article 89 of the Draft Insolvency Law):

• Claims secured with mortgages over moveable or immovable assets ("hipotecas mobiliarias e inmobiliarias") and pledges without delivery of the pledged asset ("prendas sin desplazamiento") in relation to the specific assets subject to the mortgage or pledge;
• Claims secured with rights in rem over the rental income or other proceeds of specific immovable assets ("anticresis");
• Claims secured with construction liens ("creditos refaccionarios") in respect of specific immovable assets;
• Claims arising out of financial leasing agreements or purchase agreements of moveable or immovable assets, in favor of the lessors or vendors and, if applicable, the lenders, in respect of the assets let or sold with reservation of title, prohibition to sell or termination events for default in payment;
• Claims secured with a pledge over dematerialised securities ("valores representados mediante anotaciones en cuenta") in respect of such dematerialised securities; and
• Claims secured with pledges formalised in a public document, in respect of the assets subject to the pledge; in the case of pledges of receivables, it is sufficient that the creation of the pledge may be evidenced through a reliable document ("documento fehaciente"): that is, either a public document or a private document that fulfils the requirements of Article 1127 of the Civil Code (for instance, a private document that has been filed with the public authorities).

The following claims are considered claims with a general privilege (Article 90 of the Draft Insolvency Law):

• Claims in respect of salaries accrued for a term of up to 6 months prior to the declaration of insolvency;
• Claims for professional services or the assignment of intellectual property rights accrued for a term of 6 months prior to the declaration of insolvency;
• Claims due to the debtor’s tort liability ("responsabilidad civil extracontractual");
• Claims relating to severance payments accrued for a term of up to 6 months prior to the declaration of insolvency;
• Tax and social security claims without a special privilege; this privilege is limited to 50% of the debtor’s total liabilities; and
• 25% of the non-subordinated claims of the creditor who requested the opening of the insolvency proceedings.

Finally, the following are considered subordinated claims (Article 91 of the Draft Insolvency Law):

• Claims which are not notified to the receivers or which are notified late, but which are nonetheless included in the list of claims by the receivers or by the Commercial Court;
• Claims which are contractually subordinated to the remaining claims;
• Claims in respect of interest (whether ordinary or default interest), save for interest accrued in respect of mortgage or pledge loan facilities up to the amount secured therein;
• Claims in respect of penalties or monetary sanctions;
• Claims of persons especially connected with the debtor; and
• Claims arising out of fraudulent transactions which are declared null and void during the insolvency proceeding.

The insolvency proceedings may end up either with the liquidation of the debtor’s estate ("liquidación") or an arrangement or composition agreement with the debtor’s creditors ("convenio").

The composition is considered to be the normal solution to the insolvency proceedings in the preamble of the Draft Insolvency Law. The Draft Insolvency Law includes certain provisions to provide this solution. Among such provisions, it is worth noting the possibility of the debtor to propose an early composition proposal ("propuesta anticipada de convenio") at the time of filing the insolvency request or, in the case of insolvency proceedings initiated by the creditors, up to the expiry date to notify claims, provided in both cases that the composition proposal is backed by ordinary or privileged creditors with claims representing at least 20% of the debtor’s liabilities (Articles 103 and 105 of the Draft Insolvency Law). Debtors who fall within any of the categories listed in Article 104 of the Draft Insolvency Law cannot however file an early composition proposal (for instance, debtors who have not deposited their annual accounts during the last 3 years).

The idea behind these provisions is to allow the approval of a composition with creditors as soon as possible, saving thus the time and expense of following the whole insolvency proceedings. In any event, even if the early composition proposal is not approved, the Draft Insolvency Law foresees the opening of the standard composition phase once the term to challenge the list of assets and claims expires.

Creditors representing at least 20% of the debtor’s liabilities will also be allowed to make composition proposals up to 40 days before the date of the creditors meeting, and the remaining creditors will be entitled to adhere to such proposals up until the date the list of attending creditors is completed.

The Draft Insolvency Law is flexible with regard to the content of such proposals, but does not allow proposals to pay less than 50% of ordinary claims or proposals to delay payment more than 5 years.

The general rule is that creditors representing at least 50% of the ordinary claims must approve a composition proposal. However, in the event the composition proposals foresees the payment in full of ordinary creditors within less than 3 years or the immediate payment of ordinary claims with a discount of less than 20%, it will be sufficient that the composition proposal is approved by "relative" majority (i.e., by more votes in favor than against). In any event, the composition proposal must also be approved by the Commercial Court.

The Draft Insolvency Law grants debtors the right to opt for liquidation, as an alternative to the composition agreement, but it also imposes on debtors the obligation to request the liquidation when it becomes clear that the debtor will not be able to fulfil the terms of the composition agreement. When creditors request the insolvency declaration, the liquidation is always the second alternative.

The liquidation implies the distribution of the debtor’s assets among its creditors. In the case of debtors who are legal persons, the request for liquidation also implies the winding-up declaration (if it has not already been declared) and the resignation of its directors and liquidators.

Even in the case of liquidation, the Draft Insolvency Law encourages the continuation of businesses or productive units, by supporting the possibility of its sale as a whole, unless the sale of individual assets proves to be the best alternative for creditors. The Draft Insolvency Law sets a time limit of one year to complete the liquidation, and foresees the replacement of the receivers and the non-payment of their fees if the liquidation phase exceeds such time limit.

The Draft Insolvency Law includes conflict of law rules that are inspired by Council Regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings. Therefore, international jurisdiction to oversee the insolvency proceedings of debtors with assets in different jurisdictions is based on where the centre of a debtor’s main interests is located. The insolvency proceedings initiated in that jurisdiction will be considered as the principal proceedings, without prejudice to the commencement of other insolvency proceedings in other countries where the debtor may have assets.

In this context, the netting provision is particularly interesting. Pursuant to Article 205 of the Draft Insolvency Law "[t]he declaration of the insolvency will not affect a creditor’s right to net its claim when the law governing the reciprocal claim allows it in insolvency situations". This seems to imply that, in the event of insolvency of a Spanish debtor, the netting provision of an ISDA Master agreement subject to English law will be applied pursuant to English law even if the outstanding derivative transactions at the time of the insolvency would not benefit from the netting protection provisions under Spanish law. For example, the netting protection provisions included in the Tenth Additional Provision of the Securities Market Law do not currently cover commodity derivatives and, consequently, the ISDA netting provision subject to English law is not applicable in the event of insolvency of a Spanish counterpart. It appears, however, that, under the new law, commodity derivatives will benefit from the netting provision of an ISDA Master agreement subject to English law.

Article 209 of the Draft Insolvency Law is also interesting. It states that reinstatement actions pursuant to the new law will not be accepted if the person who benefits from the detrimental act proves that such act is subject to the law of a State under which it could not be challenged at all. This provision seems to imply that a detrimental act subject to a foreign law (for instance, the fraudulent disposal of assets subject to an English law purchase agreement) will not be capable of being challenged before a Spanish insolvency court if such detrimental disposal could not be challenged at all under English law. Therefore, if such disposal could not be challenged at all under English law (for instance, because the suspect period under English law is shorter), such disposal will not be able to be challenged in Spain either. I am not, however, convinced that this provision will avoid the challenge of a fraudulent disposal subject to English law on the basis of the fraudulent conveyance rules of the Civil Code. Article 209 refers to "reinstatement actions pursuant to this law" and, as mentioned above, Article 70.4 of the Draft Insolvency Law implies that creditors will be entitled to challenge acts detrimental to the debtor’s estate using other legal remedies available under Spanish law (e.g., fraudulent conveyance rules under Articles 1111 and 1291.3 of the Civil Code).

In clear contradiction with the intention to include all insolvency substantive and procedural rules in the same law (which is stated to be one of the main principles of the Draft Insolvency Law in its preamble), the Third Additional Provision of the Draft Insolvency Law foresees that (i) some insolvency rules enacted during the last few years to overcome the shortfalls of the current insolvency rules in some particularly sensitive activities (see some examples below), and (ii) the rules applicable to credit entities, investment services firms and insurance companies, will be considered "special legislation" and, consequently, their content will prevail over the content of new regulations.

Some examples of "special insolvency rules" are (i) Article 15 of Law 2/1981, on the Regulation of the Mortgage Market; (ii) the Tenth and the Twelfth Additional Provisions of Law 37/1998 on the reform of the Securities Market Law; and (iii) the Third Additional Provision of the Law on Risk-Capital Entities. All of such provisions exclude the transactions they refer to (the issue of mortgage participations, financial derivatives, repos and buy-sell back transactions and certain factoring transactions) from the strict application of the current effects of the bankruptcy declaration during the suspect period (absolute voidness). The drafting of all of such rules is quite similar; basically, the relevant transactions entered into during the suspect period may only be challenged if the plaintiff can prove the existence of fraudulent intent.

1. This comment is based on the drafting of the preamble of the Draft Insolvency Law. I have not yet had access to the draft organic law on this matter.
2. Pursuant to Article 42 of the Code of Commerce, the partner or shareholder must either (i) own the majority of the voting rights; (ii) have the right to appoint or replace the majority of the members of the Board of Directors; (iii) may exercise, due to voting pools or arrangements, the majority of the voting rights; (iv) has appointed with its own voting rights the majority of the members of the Board of Directors.