The joint working session of the Banking and of the Insolvency Committees on “The Funding of Insolvency” highlighted the worldwide convergence in what is now a distinctive sector of the financing industry. Dr Shinjiro Takagi, of MORGAN LEWIS & BOCKIUS first provided a multijurisdictional update on the development of pre-insolvency remedies and the worldwide convergence for the preference of the maintenance of the insolvent but otherwise economically sound business as an on-going entity as a means of improving the outcome for all stakeholders. This requires funding and incentives for funders by way of new money privilege. Mr Oliver Gayner, of IMF BENTHAMS presented third party litigation funding, particularly for insolvent businesses, which has now spread worldwide and gained recognition in arbitration proceedings. Mr Chul Man Kim, of YULCHON, presented the very recent changes to rehabilitation procedures in Korea, reflecting the convergence of legal systems around the techniques of Debtor In Possession funding as well as the promotion of prepackaged solutions by governments and legislators. Isabelle Smith Monnerville, of SMITH D’ORIA, closed the session with a presentation of non-bank funding for insolvent businesses in particular by customers (continuation agreements) or creditors (debt-equity swaps) which are also found in many jurisdictions.

1. NON BANK INSOLVENCY FUNDING
IPBA AUCKLAND 2017

2. Summary
• Stating the obvious: the first source of funding of the insolvent business is the result of the
automatic stay of proceedings and execution
• Customer funding : continuation agreements, renegotiation of contracts
• Equity funding and cram-downs
• Public funding
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3. Stating the obvious
The first source of funding of the insolvent business is the result of the automatic stay of
proceedings and execution.
The financing requirement is reduced and the debtor in possession or the insolvency
practitioner have breathing space for working on turn around and reorganization solutions
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4. CUSTOMER FUNDING – CONTINUATIONAGREEMENTS
Customers may acutely need that the insolvent business continues to ensure that orders already placed are delivered and
so that it can continue to place additional orders until it has established a replacement source
This applies particularly to:
- “just in time” mass production where any failure to supply goods leads to a costly production standstill
- Special productions of equipment or supplies in turnkey operations where the general contractor (or any n+1 supplier)
incurs penalties for non delivery or delay in delivery
• The nature and complexity of the production process entails that these customers cannot simply and in the short term
transfer the production which they have placed with the insolvent business to a different supplier. The balancing of the
production process (including the test and certification phase) and the development of moulds with which the
products for these customers are cast usually requires months of preparation and collaboration with the customer
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5. CUSTOMER FUNDING – RENEGOTIATION OF AGREEMENTS
Conversely, the DIP or IP needs funding of its operations in order to have time to find a
turnaround or reorganization solution and has leverage to renegotiate the supply agreement
because of:
- The customer’s need
- The IP’s right to select these contracts that shall be continued
- De facto control on output
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6. CUSTOMER FUNDING – RENEGOTIATION OF AGREEMENTS
The customer(s) will seek an undertaking from the insolvent supplier company to deliver the
goods already ordered and to accept further orders for as long as (term) required to find a
replacement supplier or complete the work in the case of specific supplies or services.
As the insolvent business is prohibited to operate at a loss, the IP will seek an agreement
whereby the customer (or group of customers) will undertake to compensate the insolvent
company for all of the losses incurred during the term of the continuation agreement.
Conversely, the customer(s) will seek a cap to their obligation to cover operating losses and
circumscribe which losses they are prepared to cover (e.g. excluding certain costs such as
external advisors),
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7. CUSTOMER FUNDING – RENEGOTIATION OF AGREEMENTS
The usual terms of a continuation agreement provide for the funding of the interim cash
needs of the insolvent business:
• Price increase (sometimes in ransom proportions)
• Reduced payment terms (including for outstanding instalments) or upfront payments
• Assistance in selection of purchaser of business
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8. CUSTOMER FUNDING – RENEGOTIATION OF AGREEMENTS
There is a large amount of risk in continuation agreements:
- the losses incurred by the insolvent company may be higher than expected and new calls
for funding may be issued
- The insolvent company may lose key employees and ability to complete or continue
production
- Need to strike a balance between risk of disruption of supply chain and risk of dealing with
insolvent business
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9. NEW FRENCH LAW TOOL : IMPLICIT HARDSHIP CLAUSE
New Code Civil : The French Code Civil has just been extensively refurbished, effective on 1st October 2016,
A new feature is Article 1195 which provides for an implicit hardship clause in all contracts.
True enough, the hardship provision can be contracted out and it is to be expected that most commercial
contracts will do just that.
However, the new article 1195 is the expression of a cultural change from the former rule of sanctity of
contracts and the recognition of the inherent unforeseeability of economic circumstances.
It may facilitate renegotiations in pre-insolvency and insolvency procedures,
It will also provide guidelines (when a body of court decisions is created over time) for negotiations,
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10. CUSTOMER FUNDING TAKE AWAY
• Many supply agreements include duties for the supplier to inform the purchaser of any
financial difficulty
• Purchase departments closely monitor key suppliers
• Check your contracts subject to French law
• The logic of continuation agreements can be applied to consortium or JV members who can
have a vested interest in providing financial support to another member of the group in
order to avoid joint liability for the distressed member’s default
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11. EQUITY FUNDING
• Restructuring often involves a negotiation between creditors and shareholders
• Creditors call for shareholders to agree to bring in new money in the form of equity or
accept debt equity swaps in counterpart for the haircuts they are accepting
• Shareholders may be reluctant to accept dilution for either affective or strategic reasons,
including a better negotiation of the price of their exit or dilution
• One of the main obstacles in French restructurings was the ability of shareholders to ‘block’
debt-for-equity swaps
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12. EQUITY FUNDING – CRAM DOWN
• The court can force the sale of the management’s interest in the insolvent company (article
L.631-19-1 Code of Commerce) as part of a plan presented by a new investor, by creditors
or by other shareholders.
• Since last year, the court has the power to evict all shareholders (not only the management)
under article L.631-19-2 of the Code of Commerce:
• By designating a court officer to convene the general meeting which shall dilute the former
shareholders in the event of an approved debt-equity swap
• By forcing the sale of the opposing shareholders’ interest to the proponents of the approved plan
(if insolvent business has 150 or more personnel)
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13. NEW MONEY – French rules art 611-11 C.Com
• New money has to be new
• Can be cash or in kind
• It has to be contributed in the framework of a conciliation procedure (court assisted
creditor voluntary agreement) and approved by the court
• New money privilege ranks 3rd after wages and court costs on the price of the sale of the
business and/or assets
• In the event of a payment plan in the context of a judicial reorganization new money
creditors are not subject to the reductions and/or reschedulings imposed to other prior
creditors without their explicit consent .
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14. PUBLIC FUNDING
• Closely scrutinized by the EU Commission (illegal state aids)
• At all stages of an insolvency (except liquidation) and starting in pre-insolvency, public
creditors (tax, social security and other) are now allowed to consent to debt reduction and
reschedulings
• Anticipated payment of tax credit (R&D)
• Various fundings available from state down to regional level
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15. Thank you!
Any questions?
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SMITH D’ORIA
15, rue du Temple 75004 Paris – France
Tél: +33 (0)1 58 80 80 00
Fax: +33 (0)1 44 61 42 87
www.smithdoria.com