Daniel Hayek, Christina Meyer and Chantal Joris of Prager Dreifuss examine the revised Swiss insolvency law and its implications for debtors and creditors
The collapse in 2001 of Switzerland's national airline Swissair, until then regarded as a symbol of the country's reliability and efficiency, sparked a debate over the need to amend Swiss insolvency laws. Criticism was raised that the Swiss Debt Enforcement and Bankruptcy Law (DEBL) had proven ineffective in facilitating the restructuring of companies in distress and was not adequate to deal with the insolvencies of large groups of companies. After years of controversies and negotiations in the Swiss parliament, the revised DEBL finally entered into force on January 1 2014. According to the relevant transitional provision, the revised law applies to composition proceedings filed after January 1 2014; composition proceedings initiated before 2014 (such as the large Swiss bankruptcies of Swissair group companies and Petroplus group companies) will still be governed by the previous law. Some of the changes have a direct effect on the treatment of claims resulting from defaulted lease agreements in Swiss bankruptcy proceedings and the admittance of such claims in bankruptcy proceedings.
This article provides a brief overview of the main amendments to the revised DEBL. It analyses the impact of the revision on creditors' claims resulting from defaulted lease contracts in Swiss insolvency proceedings, drawing on examples of the treatment of aircraft lease agreements in the Swissair composition proceedings.
Significant changes
The primary objective of the revision was to promote the restructuring of companies rather than their liquidation. The previous law already provided for a moratorium and composition proceeding, technically allowing for the restructuring and continuation of a distressed company. However, in practice, the vast majority of restructuring processes ended in the liquidation of the company, not in its survival. The shortcomings of the Swiss restructuring scheme were painfully exposed by Swissair's bankruptcy. The revisions, finally adopted more than 12 years after the grounding of Swissair, aim to facilitate companies' access to restructuring procedures. The amendments constitute selected adjustments of the law rather than a comprehensive reform. In particular, the revised DEBL does not provide for a special regime for groups of companies or large bankruptcies in general.
The revisions introduced some important changes to the moratorium and composition proceedings. Inspired by the US Bankruptcy Code's Chapter 11 procedure, the amended law allows companies access to composition proceedings and so to seek protection under a moratorium for mere restructuring purposes. Companies have the option to apply for composition proceedings without having to submit a draft composition agreement. Instead, they need to file a provisional restructuring proposal. The court will only refuse granting a provisional moratorium and open a bankruptcy proceeding, if it appears impossible that either restructuring or a composition agreement can be achieved. The provisional moratorium lasts for up to four months (as opposed to two months under the previous law), during which debt enforcement proceedings are stayed. This should give the debtor some time to take restructuring measures. A successful restructuring is easier to accomplish if the public is not aware of the financial difficulties of a company, therefore, contrary to the previous law, the publication of a provisional moratorium is not compulsory. The provisional moratorium is followed by the definitive moratorium, which can last up to 24 months, if the case presents itself as particularly complex. If restructuring is achieved, the moratorium is lifted by the insolvency court.
Another significant set of changes concerns preference claims, which allow creditors to challenge transactions that have occurred shortly before the commencement of bankruptcy or composition proceedings under terms that were not at arms' length. A company encountering financial difficulties may want to sell parts of its business to generate funds. To promote restructuring, the revised law provides that disposals executed during the composition moratorium can no longer be challenged if they have been approved by the composition judge or by the creditor's committee.
Further, preference claims against intercompany transactions have been facilitated. Companies within a group are explicitly considered as related parties. They now carry the burden of proof that a transfer, which has been made within one year prior to the opening of bankruptcy or composition proceedings, was not made without adequate consideration. The new law creates a presumption of disproportionality in the context of related party transactions. Related companies have to prove that they have not received advantages from the contested intercompany transaction, but that the transaction was in line with market standards.
The new law also provides for more flexibility for the transfer of employees in the event of a business takeover in cases of restructuring. Since the obligation to take over all employment agreements under Swiss employment law can be an obstacle to restructuring, such transfer is no longer compulsory in the context of a restructuring (article 333b of the Code of Obligations). To compensate for this relaxation of employment protection, the law provides that a company with at least 250 employees intending to dismiss at least 30 employees has an obligation to negotiate a social plan with employees or their representatives. The plan should address measures to avoid dismissals and a safety net to mitigate their consequences. If it is not possible to reach an agreement, an arbitral tribunal will establish the social plan by rendering an award.
Finally, the revised law has brought important changes in relation to long-term agreements, characterised by a continuing and repeated exchange of services, such as processing agreements, licence agreements, distribution agreements, and lease agreements.
Lease agreements: previous law
Lease agreements allow a lessee the use of a property over a period of time. They are usually classified as either finance or operating leases. Finance leases are characterised by a long duration of the contract, during which the lease object will be fully or almost fully amortised. At the end of the lease term, the lessee will usually have an option to purchase the leased asset. In contrast, operating leases are normally short compared to the life of the asset leased and the property of the asset will not pass to the lessee at the end of the lease.
Lease payments consist of two elements: principal payments (amortisation) and interest payments. While the monthly lease payments are constant, the percentage of principal versus interest changes with the annuity; the amount of interest owed declines by a constant monthly amount and the repayment of principle rises by this same amount.
Under the previous law, the fate of long-term agreements in the event of one party entering bankruptcy proceedings was often unclear. The DEBL did not provide for the statutory termination of long-term agreements in such cases. Therefore, if bankruptcy or composition proceedings were opened on one of the parties, the long-term agreements would in principle continue to remain in force, possibly running for 10 years and increasing claims against the party in distress. For creditors filing claims based on lease agreements in the Swissair bankruptcy, this was particularly favourable: since lease payments include principal and interest, they could obtain recovery on outstanding payments of interests for the whole duration of the contract, including the time after the opening of bankruptcy proceedings. This was in contrast to the legal position of other ordinary creditors, who under article 209 DEBL (which has remained unchanged) are only allowed to claim interests until the initiation of bankruptcy proceedings (except for claims secured by pledge). However, the longer the contract has been running at the date of the opening of bankruptcy, the less the interest portion of the lease payment will be and accordingly the extent of unequal treatment.
Creditors could, however, not rely on the acceptance of their claims on the whole duration of the long-term agreement. Since the law remained silent on this issue, it was unclear for creditors if their long-term agreements would remain in force after the opening of bankruptcy proceedings. In the case of lease agreements, parties would in practice often contractually agree on a right to terminate the agreement in case of the other party defaulting. Swissair, for instance, had concluded several aircraft lease agreements, which gave a right to the lessor to terminate a lease in the event of default of the lessee by taking possession of the aircraft or by requiring its return to a specified location.
Mostly though, long-term agreements would not contain any provision dealing with the event of insolvency of one of the parties. Under the previous law, it was up to the competent liquidator to decide how to deal with those agreements and to declare if they entered into a continuing obligation after the opening of bankruptcy or composition proceedings. If the liquidator entered into such commitments, these constituted liabilities of the estate, which would be satisfied first (even before privileged creditors) and were given right to full repayment (and not to a dividend only). Often, creditors would be faced with the situation where the agreement did not contain any relevant provision and liquidators remained silent, not clarifying if they were exercising their legal option to enter into continuing obligations instead of the debtor.
In cases of a liquidator remaining silent or issuing an unclear declaration, it was very difficult for creditors to estimate their recovery on claims based on long-term agreements. First, the amount of accepted claim against a bankrupt estate depends on the termination date of the agreement – on how long the creditor can charge the estate for services rendered under an agreement (processing fee, leasing fee, interests). Further, a creditor needs to know if an insolvent company has entered into the agreement, either explicitly or by implied behaviour, and therefore if part of the claims will be qualified as a liability of the estate. While the previous law did not provide any clarity for creditors, the revised DEBL contains an explicit regulation on the treatment of long-term agreements in bankruptcy and composition proceedings.
Lease agreements: revised law
Depending on the proceeding (bankruptcy or composition proceeding), the liquidator and the creditor now have different options in relation to existing long-term commitments.
Insolvency proceedings
A liquidator can ordinarily terminate a lease agreement, in accordance with the applicable legal and contractual conditions. The creditor will be able to successfully assert a third-class claim on outstanding lease payments (payments until the next termination date or until the end of the lease agreement). As under the previous law, this regime allows a creditor to obtain recovery on interest payments as part of the outstanding lease payments.
A liquidator may also enter into an existing lease agreement, either by explicit declaration or through implied intent (in particular through making active use of services rendered under the agreement). The liquidator can enter into the whole agreement or only part of it (article 211a paragraph 2 DEBL), for instance by using only two out of five leased objects. Claims for performance actually rendered after the initiation of bankruptcy proceedings constitute liabilities of the estate and are to be fully repaid. Claims incurred prior to bankruptcy and claims under the contract that do not relate to performance actually rendered are to be registered as regular third-class claims and only give right to a dividend.
In practice, there are many cases in which the liquidator will take no action at all. Under the previous law, if the liquidator took no action, it was unclear for how long the long-term agreement continued to exist, and so in what amount a claim could be filed by the creditors. The revision now seeks to rectify this and provide for legal certainty: if the liquidator takes no action toward the long-term agreement, the agreements continue to exist according to civil law. Article 211a DEBL establishes that a creditor may register its claim as an ordinary bankruptcy or composition claim only until the next termination date or until the expiration of the fixed term. The claim will be considered as an ordinary bankruptcy claim and not a liability of the estate.
Unlike the liquidator, the lease provider is not given the option to terminate the agreement under the DEBL. In practice, however, lease contracts often provide for a right to terminate the agreement in the event of insolvency of one of the parties. Further, the option to terminate the agreement is provided under the law of contracts (article 83 of the Swiss Code of Obligations). A lease provider may withdraw from the contract if the counterparty has become insolvent and is unable to provide a security (for example, a bond) for the consideration within a reasonable time.
The lease provider has a duty to mitigate his losses. If the estate does not enter into the agreement and make use of the lease object, it can be leased to a third party. The proceeds generated will reduce the amount of the claim admitted. In the Swissair composition proceedings, lease providers of aircrafts would file claims based on alleged losses under the aircraft lease agreements. The liquidator accepted the claims on outstanding payments for the duration of the lease agreement only for the period of time, in which the creditor had not received lease payments on the recovered object by a third party (a subsequent lessee of the relevant aircraft). In practice, the claim on the whole duration of the contract would be accepted, but only as a conditional claim. After the lease provider handed in an account of the lease payments received by third parties, the assessment of the accepted claim became final, often based on a settlement reached. This practice is now explicitly enshrined in article 211a DEBL.
In summary, the treatment of long-term agreements in insolvency proceedings has not been significantly amended with the revision. Most importantly, creditors with claims based on long-term agreements are provided with greater legal certainty on the admittance of their claims and are now able to estimate their recovery more accurately.
Composition proceedings
The rules governing composition proceedings give the liquidator the same options as the rules applicable in bankruptcy proceedings: a liquidator may terminate a lease contract or enter into it. Only those claims on performances, which were actually rendered after the opening of composition proceedings, constitute liabilities of the estate. Any other claim under the long-term agreement has to be registered as a regular third-class claim.
In contrast to the rules governing bankruptcy proceedings, the amended law on composition proceedings now gives the debtor the opportunity to extraordinarily terminate long-term agreements other than employment agreements. Legislators have acknowledged that certain long-term agreements may make a restructuring difficult and costly. In view of the overarching objective of the revision to facilitate restructuring rather than the liquidation of companies, article 297a DEBL gives the debtor the option to extraordinarily terminate long-term agreements at any time, subject to only two conditions. Refraining from terminating the long-term commitment would make the restructuring aim impossible, and the liquidator has given his consent to the termination. The right to extraordinarily terminate these long-term commitments exists only during the moratorium, which ends with the conclusion of a composition agreement.
The counterparty is entitled to full compensation. The compensation granted only entitles a creditor to file an ordinary composition claim, and will therefore be limited to a dividend. The bankruptcy rule in article 211a DEBL is applied analogously. The compensation is owed for the period until the next termination date or for the whole duration of the contract. Further, payments from a subsequent lessee will reduce the compensation. Therefore, if the composition proceedings end in liquidation of the company, it does not make any difference if the liquidator has ended the contract during the ordinary period of termination or extraordinarily. The dividend owed will be the same. In contrast, if liquidation is avoided and an ordinary composition agreement is concluded, the right to extraordinarily terminate bears some significant advantages for the distressed company: instead of having to compensate for the full amount of payment owed, only a dividend has to be paid. This alleviates the burden on the distressed company and increases the chances of it eventually surviving.
The possibility for the debtor to release himself from long-term commitments can undoubtedly facilitate successful restructuring. Some commentators criticised that companies could abuse this right and apply for the opening of composition agreements to get out of unfavourable long-term commitments.
The amended rules, given that they are insolvency rules, will apply to all long-term contracts of a Swiss debtor in a composition proceeding, irrespective of the substantive law applicable on the underlying agreements. Usually, long-term lease contracts do not provide for an option of premature termination. The revision of Swiss insolvency law has therefore created a new statutory right of termination in relation to lease contracts, which cannot be excluded contractually.
As in bankruptcy, the initiation of composition proceedings gives the lease provider the option to act in accordance with article 83 of the Swiss Code of Obligations and eventually withdraw from the contract.
Outlook
The new Swiss insolvency law is likely to encourage the restructuring rather than the liquidation of a company in distress. The rules governing the moratorium proceeding create incentives to apply for a provisional moratorium in a timely manner. Companies will now have enough time to take restructuring measures without the public being aware of their financial difficulties, and the changes in employment law in relation to business takeovers should further facilitate this process.
The regime dealing with the treatment of long-term agreements (including lease agreements) is particularly debtor-friendly. Swiss legislators have provided a debtor with the attractive option to terminate such agreements at any time with immediate effect during the moratorium phase. Distressed companies can now free themselves from specific long-term commitments that jeopardise the financial stability of the whole company. If an ordinary composition agreement is reached, creditors will have to content themselves with being compensated by only a dividend.
In conclusion, the revised law on composition proceedings brings significant advantages for the debtor in reorganising their business. In cases of a company entering into liquidation, however, the rules have remained largely unchanged. From a creditors' perspective, the most significant change in relation to long-term agreements is that there is now legal certainty on their termination and therefore the amount of accepted claims.
Originally published by International Financial Law Review, May 2015.
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