How the “coronacrisis” is causing insolvency and financial difficulty and the law does not (yet) address this

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09.04.2020 – Authors: Alina Radu, Valentin Voinescu, Stefan Ionescu, Catalina Dan

Let’s think of the typical company on the market which is now experiencing both a drop in liquidity and in demand, and is faced with multiple challenges in the supply chain.

Insolvency

The company in question may be formally in insolvency, according to legal definitions. This includes both actual and imminent insolvency. Law no. 85/2014 regarding the insolvency prevention and insolvency procedures (“Insolvency Law”), provides that a debtor is presumed by law to be insolvent if it does not pay its debt (an outstanding debt of at least RON 40,000) within 60 days as of the maturity date (we can call this “actual insolvency”). On the other hand, the insolvency of a debtor is imminent when there is evidence that the debtor will not be able to pay the debt at maturity, due to lack of available funds (we’ll call this “imminent insolvency”).

Therefore, the main difference between the two types of insolvency is the fact that an imminent insolvency does not require an outstanding debt, but rather proof that at the maturity date the debtor does not have enough funds to meet his obligations.

The procedure may be initiated upon the request of either: (i) the debtor which is insolvent or in a state of imminent insolvency; or (ii) any creditor which has a certain, liquid, due and payable claim out-standing for more than 60 days. In both cases, the outstanding debt must be of at least RON 40,000 (approximately EUR 8,000).

A debtor is obliged to file for insolvency within 30 days as of the date the company becomes insolvent. However, it is important to note that pursuant to the Insolvency Law, should a debtor be involved, in good faith, in out-of-court negotiations at the end of the 30 days period, he must file an insolvency claim with the relevant court only within 5 days after the negotiations have failed.

Failure to file such claim within 6 months after the expiration of terms mentioned above is a criminal offense for the debtor’s directors. On the other hand, if insolvency is imminent rather than actual, the debtor does not have a legal obligation to file for insolvency (but is entitled to do so).

As the coronavirus outbreak already takes its toll on the economy, there are several companies that may find themselves in an insolvency scenario. Therefore, the question that raises is: are there any effective approaches available?

Among the measures taken by the Decree No. 195/2020 on the declaration of the state of emergency on the territory of Romania (the “Decree”) it is important to highlight that:

  • enforcement activities have not been restricted by the Decree insofar as they do not pose a threat to the sanitary measures taken by the National Committee for Emergency Situations[1];
  • for the duration of the state of emergency, the statute of limitations is suspended; and
  • all litigation is suspended, save for matters that are deemed urgent.

The legal deadlines provided under the Insolvency Law with respect to filing for insolvency are not affected by the provisions of the Decree. Therefore, debtors that fulfil the conditions required by the Insolvency Law are then still bound by the obligation to file a claim. Similarly, in the event all legal requirements are fulfilled, a creditor may still file a claim with the relevant court and the insolvency procedure can be opened.

However, given that all litigation is suspended during the 30 days period of the state of emergency, are the courts of law going to resolve any insolvency claims?

Since the Decree only provides that litigation is not suspended for urgent matters, on the 24th of March the Superior Council of Magistracy has issued a decision (the “SCM Decision”) further detailing the claims that are going to be resolved throughout the state of emergency period. According to the SCM Decision, only claims based on article 66 (11) of the Insolvency Law are specifically deemed urgent and, at a first glance, it may seem that claims with regard to opening the insolvency procedure are not.

The same SCM Decision provides that the county court may resolve as well claims of exceptional nature, which are considered to be of special urgency, even though they are not expressly stated in the SCM Decision. Thus, a court of law shall determine on a case-by-case basis if the insolvency claim submitted by a debtor meets the urgency standard required by SCM Decision and the Decree.

Moreover, taking into consideration that enforcement proceedings related matters are expressly stated among the matters that are deemed urgent, it is obvious that throughout the state of emergency, companies can still be subject to proceedings against them.

As a consequence of the above-mentioned, in the near future, we may witness a great deal of situations such as companies filing insolvency claims one against another – on one hand companies throughout the supply chain and on the other, as a result of loans granted between companies. Even though the Romanian Government has taken measures whereby debtors can request to postpone their reimbursement obligations under the financing granted by banks (please see our extended article on the Government Emergency Ordinance no. 37/2020 (the “GEO 37/2020”) addressing bank debt here – this includes regular updates on the competing legislation adopted by Parliament and in the final stages of the legislative procedure), there still is an issue with regard to companies that do not fulfill the conditions provided in the GEO 37/2020, as well as with the debt incurred between companies themselves.

Given the impact of the coronavirus pandemic on the economy and on the companies’ financial situation, the state must have a firm stance with regard to the applicability of the insolvency legislation. However, there are no clear guidelines or legal provisions with respect to the approaches to be taken by affected companies, leaving entrepreneurs to fight alone with the unknown, giving them almost no chance against the financial crisis approaching.

If we do not want such consequences, the law must state that, and it does not. The simple fact that creditors will agree to postpone is not sufficient, as in the context of such crisis, it is important that there are clear and simple guidelines/legal provisions to be followed.

Financial difficulty

Assuming the company in question is not formally insolvent, it may still risk an abrupt downturn because of covenants which start to be “broken” in its financing and/or as a result of either maintaining payments or performance of obligations throughout the supply chain in very onerous terms.

This, notably, includes fiscal obligations which have not been removed, albeit some measures have been taken.

The  Government Emergency Ordinance no. 29 of 18 March 2020 (“GEO 29/2020”) provides certain fiscal measures. However, there is still a great deal of concern with regard to the approach of the fiscal authorities in the aftermath of the coronavirus pandemic.

While they are postponed during the state of emergency period, we note that they still exist and they are going to be due at another point in the future, without really resolving the financial crisis the companies are going to experience.

Furthermore, this may trigger events of default under certain financing agreements, as the respective company will find itself with unpaid fiscal debt.

Therefore, even though companies may still survive this downturn and not become insolvent, they may still find themselves in financial difficulty.

The Insolvency Law provides that companies in financial difficulty may resort to a formal procedure setting out an arrangement with the creditors (concordat preventiv). A company is considered to be in financial difficulty when even though it is capable to fulfil its current payment obligations, it does not have long-term funds and/or it has a high degree of indebtedness which cannot be covered by the resources generated through its operational activity/financial activity.

Based on such arrangement, a debtor may be able to stay the proceedings initiated by creditors against it without formally entering into the insolvency procedure. However, it must be taken into consideration that this process implies the intervention of a court[2]. Consequently, given the provisions of the Decree, it certainly is difficult for a company to obtain such a court decision in the current climate.

Following the SCM decision, enforcement proceedings related matters (such as suspension of enforcement proceedings, challenges to enforcement, orders of enforcement) are deemed urgent and therefore litigation is not suspended[3]. However, preventive action, such as a creditor arrangement (concordat preventiv), do not seem to be viewed as urgent. Therefore, a court of law cannot rule with respect to matters such as the approval of such arrangement (in Romanian omologarea concordatului preventiv) or the stay of enforcement proceedings against the debtor granted prior to the approval of the arrangement. Consequently, companies have every chance to see proceedings initiated against them, without an effective possibility of entering into the formal arrangement (concordat preventiv) provided by the Insolvency Law, in order to prevent other serious financial consequences.

Consequently, it may even seem that preventive restructuring is not encouraged as debtors are left to see their financial situation deteriorate to the point they can file for insolvency.

We can agree that the  Insolvency Law, in its current form, does not take into account economic downturns caused by a state of emergency situation, giving companies no alternatives when it comes to obtaining an out-of-court stay of the enforcement proceedings.

But can that company do something about it? The current situation is not clear.

Conclusion

Our analysis indicates there is no legal protection for companies (and indirectly for banks) against a “pile-up” of debt of various kinds, various claims and formal defaults under various contracts.

The idea of “stopping the clock” for 3-6 months obviously is not followed by current legislative measures.

A very simple solution would be to make the preventive procedure far simpler between banks and companies, out-of-court, and more accessible and preventive for this period, ensuring both companies that they will not be facing a disaster and also assuring banks that by adhering to such arrangements they are not “punished” by the regulator and are effectively maximizing return on the long term.

If a company agrees with financial creditors (banks) to standstill and not incur penalties for 3 months, it would be logical that no other creditor should be able to enforce against that company or for the company to incur penalties. But that is not the law right now.

Whether or not such initiatives will happen in the near future, companies and banks need to be mindful and take measures to organize dialogue within a framework of cooperation.

Even if we assume that liquidity measures will be perfect, it is still a reality that business in itself is being heavily impacted (simply less value is created in the economy due to reduced demand and supply) and restructuring will be needed.

For even more details regarding this issue, check out our article:

In addition, please see our guide entitled:

And also:


[1] Since the Decree: (i) enforcement of debts towards the state budget have been halted by EGO 29/2020 (unless these were already confirmed by court decision in criminal cases) for a period ending 30 days after the end of the state of emergency; (ii) evacuation and direct enforcement measures (such as physically removing goods to their rightful owner) have been halted by the Enforcement Officers National Union; and (iii) while public auctions sales have not been explicitly restricted – organising them is problematic given the ban on public gatherings of any more than 3 people.

[2] Of course, companies may also reach out-of-court arrangements with creditors, but unless a company can effectively “round up” all its creditors and get them on board, those creditors which are not party to the arrangements can still take enforcement or insolvency action. Furthermore, it is likely that even those who are party to out-of-court arrangement could still successfully take action – however they will face the risk of contract breach and damages towards the debtor company.

[3] The current form of the law adopted by Parliament which is not yet in force at the date of this writing includes provisions on suspension of enforcement proceedings, the full scope of which is yet unclear. This is an area constantly under development which we will continue to monitor.

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