EUROPEAN COMMISSION Brussels, 7.12.2022 SWD(2022) 395 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT REPORT

Accompanying the document Proposal for a Directive of the European Parliament and of the Council harmonising certain aspects of insolvency law {COM(2022) 702 final} - {SEC(2022) 434 final} - {SWD(2022) 396 final}



Table of Contents 1.Introduction 1.1.Political context 1.2.Scope of the initiative 1.3.Key insolvency concepts 1.4.Economic context 1.5.Legal context 2.Problem definition 2.1.What are the problems? 2.2.What are the consequences? 2.3.What are the problem drivers? 2.4.How will the problem evolve? 3.Why should the EU act? 3.1.Legal basis 3.2.Subsidiarity: Necessity of EU action 3.3.Subsidiarity: Added value of EU action 4.Objectives: What is to be achieved? 4.1.General objectives 4.2.Specific objectives

5.What are the available policy options? 5.1.What is the baseline from which options are assessed? 5.2.Description of the policy options 5.3.Options discarded at an early stage 6.What are the impacts of the policy options? 6.1.Benefits and costs of a targeted regime 6.2.Benefits and costs of a comprehensive EU regime 7.How do the options compare? 7.1.Benefits and costs across the elements of insolvency regime 7.2.Quantification of effectiveness 7.3.Assessment of judicial efficiency and adjustment costs 7.4.Coherence with national and EU law 7.5.Synthesis 8.Preferred option 9.How will actual impacts be monitored and evaluated? Annex 1: Procedural information Annex 2: Stakeholder consultation Appendix to Annex 2: Summary report – online public consultation Annex 3: Who is affected and how? Annex 4: Economic analysis

Annex 5: Detailed description of insolvency building blocks Annex 6: Recent insolvency-related reforms in Member States Annex 7: SME Test 10.List of references



Glossary Term or acronym Meaning or definition BCA Business Continuity Act BORIS Beneficial ownership registers interconnection system BRIS Business Registers Interconnection System CMU Capital Markets Union COMI Company’s centre of main interest CSR Country Specific Recommendations DRI Directive on Restructuring and Insolvency (Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency) EAPO European Preservation Order Procedure EBA European Banking Authority EBRD European Bank for Reconstruction and Development ECB European Central Bank ECOFIN Economic and Financial Affairs Council EIR European Insolvency Regulation (Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings) ELD Environmental Liability Directive ESRB European Systemic Risk Board EU European Union GDP Gross Domestic Product HLEG High Level Expert Group on Sustainable Finance IMF International Monetary Fund IP Insolvency practitioners IRI Insolvency registers’ interconnection ISSG Commission’s inter-service steering group JRC Joint Research Centre MS Member State MSE Micro and small enterprises NFC Non-financial Corporation NPL Non-performing loans OECD Organisation for Economic Cooperation and Development RSB Regulatory Scrutiny Board SDG Sustainable Development Goals SME Small and medium-sized enterprises TFEU Treaty on the Functioning of the European Union UNCITRAL United Nations Commission on International Trade Law WB DB World Bank Doing Business



1.Introduction 1.1.Political context It is a well-established view among stakeholders, researchers, international institutions and policy makers that the significant differences in insolvency rules across Member States constitute an important barrier to cross-border investments and a key obstacle to further economic integration. The European Central Bank (ECB) as well as the International Monetary Fund (IMF) recurrently flagged that tackling the divergence in national insolvency rules is key to achieving progress on the Capital Markets Union (CMU). The IMF “….identifies three key barriers to greater capital market integration in Europe: transparency, regulatory quality, and insolvency practices. [..] As the EU seeks to build an integrated capital market, how best to regulate the sector and improve insolvency processes become key questions.” According to the ECB “where insolvency and judicial frameworks are more efficient, risk-sharing through both capital and credit markets is higher [..] This empirical research finding shows that it is important to address the major shortcomings and divergence between insolvency frameworks which persist at the European level. This would require taking measures beyond the draft Directive on Insolvency, Restructuring and Second Chance”. Furthermore, multiple think tanks and other international bodies concluded on the significance of divergences in insolvency rules as an obstacle to cross-border investment. Regulators and market participants singled out differences in insolvency practices among the three most important barriers to market integration in a survey carried out by the IMF (2019) on the benefits of the CMU and the obstacles towards its realisation. The empirical analysis undertaken by IMF identified that convergence in insolvency regimes would yield the largest contribution to three key metrics of financial integration: higher cross-border asset holdings, a reduction in cross-country differences in corporate funding costs and improved risk-sharing across the EU Member States. Annex 4, Section 4 provides more details on the statistical analysis done by the IMF, ECB and academic researchers about the impact of more efficient and alligned insolvency rules on cross-border investment and risk sharing. The Commission’s first Action Plan on building a CMU in 2015 argued that “convergence of insolvency and restructuring proceedings would facilitate greater legal certainty for cross-border investors”. In 2015, the European Parliament adopted a resolution where it called to ease cross-border investment and indicated that for the CMU to work smoothly, insolvency rules must be made to work better in a cross-border context. This led to the adoption of the Directive on Restructuring and Insolvency in 2019, which pursued targeted harmonization in the specific areas of pre-insolvency measures and debt-discharge procedures. Since it did not cover rules governing insolvency proceedings, the expert group set up by the Commission and tasked with informing policy choices for the 2020 Capital Markets Union Action Plan emphasised that progress towards the CMU, as the integrated market for capital, requires addressing further the inefficiency and divergence of insolvency regimes across Member States. Similar recommendations were also put forward by a number of expert groups, organised by Member States and industry representatives. The CMU Action Plan from 2020 announced that the Commission would take a legislative or non-legislative initiative for minimum harmonisation or increased convergence in targeted areas of non-bank corporate insolvency law to make the outcomes of insolvency proceedings more predictable. The Council Conclusions (ECOFIN) of 3 December 2020 on the Action Plan encouraged the Commission to deliver on this initiative. In April 2021, Eurogroup concluded that national reforms of insolvency regimes shall progress in coherence with parallel work streams led by the EU institutions, which were undertaken in the CMU Action Plan. The European Parliament reiterated again in 2020 that for the CMU to work smoothly, insolvency rules must be made to work better in a cross-border context. 1.2.Scope of the initiative This initiative covers business non-bank insolvency procedures and does not include insolvency procedures for banks and consumers. The banks’ bankruptcy proceedings and recovery and resolution are governed respectively by the Winding up Directive and by the Bank Recovery and Resolution Directive and Single Resolution Mechanism Regulation, together with national liquidation law. Member States have national laws to deal with the bankruptcy of consumers, which are excluded from the scope of this initiative because of the limited cross-border dimension. Consumers do not typically raise funds from cross-border creditors and consumer bankruptcy procedures do not significantly contribute to the key objectives of the CMU. The intiative aims at a targeted harmonisation of substantive insolvency rules. The initiative excludes policy intervention on preventive restructuring of corporations, as well as on other matters that are covered by the Directive on Restructuring and Insolvency (DRI). The intiative nonetheless includes the aspects of restructuring and reorganisation proceedings where relevant to debtors in insolvency. The scope of DRI carves out traditional insolvency law (with very minor exceptions), covering only situations of pre-insolvency and post-insolvency. The DRI deals with the debt discharge of failed entrepreneurs only to the extent it is relevant to answer the question on when and how an entrepreneur, who has become insolvent, can make a fresh start after insolvency proceedings. Section 1.4 clarifies the relationship between the DRI and this initiative. 1.3.Key insolvency concepts

Insolvency proceedings aim at ensuring the orderly winding down or restructuring of companies or enterpreneurs in financial and economic distress (i.e. that have been declared insolvent). These are compulsory and collective procedures that take over the contractual enforcement of claims against the insolvent debtor, which would be otherwise exclusively left to the individually agreed enforcement mechanisms between a given counterpart and the debtor. This section provides a general overview of central concepts whereas Annex 5 describes the main features of insolvency systems in the EU Member States in detail. The proceedings typically include tools that ensure a timely declaration of insolvency, so that it does not affect the possibility to either restore the going concern or to ensure a cost-effective liquidation, as well as tools to maximise the recovery value of the company’s assets being liquidated. The main insolvency features relate to: 1.Governance of the proceedings; 2.Tools to recover asset values from the liquidated company; 3.Tools to distribute recovered values among creditors. The governance of proceedings involves actions, such as defining when a business should be declared insolvent, and therefore should be subject to insolvency proceedings. It, for example, includes the obligation of directors to file for insolvency in due time before depleting the value of the company’s assets (e.g. to avoid the situation where directors make large pay-outs to themselves and other employees of the company). The governance of proceedings also cover the institutional aspect: notably, if the proceedings are run before a court or another competent authority, or if an insolvency practitioner is appointed to steer the procedure and administer the estate. The insolvency regime may also include several tools to ensure proper identification of the debtor’s assets and recovery of their market value. These tools may include (i) transaction avoidance tools, i.e. actions to challenge past transactions that have been concluded to deprive creditors of the debtor’s assets; (ii) pre-pack liquidation, i.e. the possibility to conduct negotiations on the sale of the company or its parts as a going concern before insolvency filing with the deal finalised in insolvency, to avoid significant value destruction due to protracted insolvency proceedings, or (iii) access rights to asset registries, to ensure proper tracing of the company’s assets. Finally, the value distribution tools of an insolvency regime include tools that govern the orderly allocation of the recovered value of the company’s assets among creditors. Such distribution tools may for example include a pre-determined creditors’ ranking that establishes the order of priority among various types of creditors, providing ex-ante clarity to creditors about their chances to recover value in case of insolvency and avoiding a lengthy case-by-case assessment based on court discretion in insolvency. Another tool is creditors’ committees that ensure that all represented creditors’ views are heard in insolvency, leading to a better coordination among creditors and more efficient decision making (lack of coordination among creditors often leads to disruption in insolvency cases). A business is part of a complex web of relationships with suppliers, investors and creditors, employees, clients, public authorities (e.g. tax and social security authorities) etc. All of these groups are direct or indirect providers of financing and creditors of the business. The opening of insolvency proceedings directly affects the rights and positions of all these stakeholders. The rights of each type of creditor and some of their incentives differ in the event of an insolvency. Insolvency law is further strongly linked to questions of property law, labour law and freedom of economic activity. From the perspective of the CMU, the outcome of insolvency proceedings and the allocated recovered value therein is of particular importance to the supply of capital and credit in the economy and particularly to providers of financing to companies. When deciding on their offers, providers of financing consider the future risk of the company becoming insolvent and the value of recovered assets for the price that they will charge for the capital offered to that company. Recovery values, recovery time and the judicial costs of insolvency proceedings are all affected by differences in national insolvency laws that ultimately influence this risk assessment and thus have bearing on the willingness to invest and provide financing across borders and on the terms of such financing. Banks as the most common type of lenders to businesses often enjoy a senior creditor status and hence a privileged treatment in insolvency. Since the market share of other financial investors and inter-company loans has been increasing over the last years, the recovery value of the insolvent businesses’ assets in an insolvency case is critical not only for banks, but also for other providers of equity and debt financing. Furthermore, value recovery could also be relevant for other companies such as suppliers, including many SMEs, which often suffer (disproportionately more than larger companies) from their trade partner becoming insolvent (often leading to what is known the insolvency domino effect). Finally, public authorities are creditors in insolvency cases because of due tax or social security contributions. Often tax claims enjoy a privileged treatment in creditors’ ranking. Furthermore, employees, who are in a vulnerable situation in insolvency as they may lose their jobs, enjoy special privileges in some systems in relation to due wage claims. The longer insolvency proceedings last, the bigger the adverse effects on the value that can be recovered in a liquidation (“melting ice cube” phenomenon). Moreover, any judicial proceedings, including insolvency proceedings, are associated with costs. Complex judicial proceedings are associated with very high costs (including in particular the costs related to insolvency practitioners (IPs) who often have to be appointed in insolvency proceedings). For SMEs, the costs of proceedings can be so high, that very little or nothing is left for allocation to creditors after paying the costs. The impossibility to pay for the costs remains to be a major reason why in many cases proceedings are not even opened for SMEs, depriving them of orderly liquidation. Figure 1 presents a visualisation of central decision points during the insolvency process. 1.4.Economic context Efficient and harmonised insolvency rules underpin the efficient allocation of capital, economic recovery from recessions and thus also economic growth. In contrast, lengthy and inefficient insolvency procedures undermine economic growth by preventing capital reallocation from businesses with low profitability and high indebtness. Such businesses are investing less and are less likely to pursue innovative activity, which slows down the diffusion of technical progress and ultimately the growth potential. Capital allocation is impaired because economic resources locked in distressed entities (zombie companies) are not available for more productive uses. Banks’ exposure to bad loans impairs their capacity to provide credit to new business. Insolvency rules impact on economic activity not only if a company needs to wound down and the remainings of the estate be distributed to its creditors. The expected recovery value, time and costs have an impact much earlier by affecting to what extent and under which conditions companies can get access to funding they need for their operations and growth. As further detailed below, inefficient insolvency procedures and divergences in procedures across Member States discourage the supply of cross-border funding, as evidenced by a high home bias in portfolio investment and a low proportion of cross-border credit.

The number of corporate insolvencies in the EU is in the range of 120,000 to 150,000 per year. Data shows a substantial decline in bankruptcy declarations in 2020, which is primarily due to the public support measures during the COVID-19 crisis. Many more businesses cease to exist in the EU each year, which suggests that a substantial number of businesses are wound down without recourse to public insolvency procedures. The introduction of debt moratoria and other means helped companies and entrepreneurs overcome the Covid-19 induced economic downturn at the expense of increasing the debt level in the corporate sector and the creation of a larger number of businesses exposed to debt overhangs. While many observers anticipated a pronounced increase in corporate bankruptcies, it has not yet materialised. It is however not excluded that it may still occur in the future, especially since the energy price shock and supply chain bottlenecks have increased the likelihood of a severe slowdown of economic growth in the EU. Accordingly, the IMF cautioned in its assessment of the euro area’s economic recovery prospects that “Insufficient efforts to address labor market rigidities, debt overhang, and inefficient insolvency processes could impede efficient reallocation of resources, thus leading to significant labor market hysteresis, low productivity growth, and sizable economic scarring.” Although the proposed changes to insolvency rules will not be in place to support adjustment to and recovery from the current economic shocks, the latest economic developments demonstrate the vulnerability of the EU economy to sizeable economic shocks and distress. If and when future shocks hit the EU economy, corporate adjustment and the winding-down of insolvent firms should imperatively take place under more efficient and better-aligned insolvency rules in the EU, which suggests a need to act as soon as possible. There is currently no information about the share of insolvency cases in which cross-border creditors are involved, neither for intra-EU nor for creditors from third countries. However, the data on the share of cross-border exposure of the EU companies may be seen as proportionate to the (potential) share of cross-border bankruptcy cases. It can hence allow for an approximation. This data suggests that a significant number of all insolvency proceedings in the EU - 10%-20% are likely to involve claims of cross-border creditors. This number should, however, not be interpreted as implying a low importance of insolvency rules for cross-border investors: the current level of cross-border investment (which may be subject to potential cross-border insolvency proceedings) is impaired by the existing cross-border obstacles, including those on divergent and inefficient insolvency regimes. It is, thus, likely to underestimate the true level of importance of cross-border insolvency proceedings, once these obstacles are removed (including via this initiative). More details on economic context are discussed in Annex 4, Section 1. 1.5.Legal context 1.5.1.The limited scope of prior EU action The intiative covered by this impact assessment seeks to increase the convergence of substantive insolvency rules of the EU Member States. It is different in terms of its objective and scope from any existing EU law. This section sets out how the EU law developed in the areas of pre-insolvency (preventive restruturing), insolvency and post-insolvency (second chance) over the course of the last years and where the current intiative fits in this context. The Union started to legislate in the area of insolvency about twenty years ago. In the beginning, the EU did not aim at creating the convergence between the domestic substantive insolvency frameworks. Rather it intended to ensure a smooth coordination and cooperation between the national regimes in cases of cross-border insolvency. The EU Insolvency Regulation (EIR, first adopted in 2000, recast in 2015) was adopted on the legal basis for judicial cooperation in civil and commercial matters (Article 81 TFEU). The EIR introduced uniform rules on international jurisdiction and applicable law that – for cases of cross-border insolvency – determined in which Member State the insolvency proceedings have to be opened and which law is to be applied to the questions at hand. In parallel, there were uniform rules that ensured that the judgments taken by the courts having jurisdiction in these cases are recognized, and if needed, enforced in the territory of all Member States. The EIR has no impact on the content of national insolvency law. It determines the applicable law but does not prescribe any features or minimum standards for that law. Therefore, it does not address the divergences across the Member States’ insolvency laws (and the resulting problems and costs). The approach of judicial cooperation hence did not comprehensively address the issues that are relevant from the perspective of cross-border investment. Accordingly, the EIR only allowed cross-border investors to establish which law would be applicable in the event of an insolvency of a debtor, but it left unchanged substantial divergences in national insolvency rules. These differences continued to weigh on cross-border investors’ ability to anticipate the outcome for value recovery in case of insolvency in another Member State and hence impair cross-border investment and, more generally, capital market integration in the EU. The first Action Plan on building a CMU of 2015 led to the adoption of the Directive on Restructuring and Insolvency in 2019. The DRI pursued targeted harmonization in the specific areas of pre-insolvency measures and debt-discharge procedures but not in relation to the rules governing insolvency proceedings per se. It obliged Member States to introduce preventive restructuring procedures with certain minimum standards and to provide fair debt discharge for failed entrepreneurs. The preventive restructuring procedures are only available to debtors in financial distress before they become insolvent, (i.e. when there is only a likelihood of insolvency) and are based on the fact that there is a much greater chance to save ailing businesses when tools for restructuring their debts are accessible for them at a very early stage and before they become definitively illiquid. These rules do not bring about any harmonisation of the rules governing insolvency. The minimum standards on the second chance for failed entrepreneurs, set out in the DRI, do not address the way insolvency proceedings are conducted either. They rather relate to the discharge of debts for insolvent entrepreneurs as a consequence of insolvency and could be described as a regulation of post-insolvency effects. Nevertheless, the DRI includes a few cross-cutting rules that also affect insolvency matters to a very limited extent. These rules contain very general high-level principles concerning specific topics (the training of judges, some professional standards for insolvency practitioners and the means of communication in insolvency proceedings) which were so horizontal in nature that it would have been artificial to regulate them for pre-insolvency and post-insolvency proceedings but not for insolvency proceedings. The initiative covered by this impact assessment does not seek to reopen the elements already covered by the DRI. Beyond these limited elements, the DRI does not harmonise any substantive insolvency law; its restructuring rules are expressly applicable only on the condition that the company in question is not yet insolvent. As a result, the substantive insolvency laws of Member States are currently not approximated at the EU level and as acknowledged by the EIR remain “widely differing”. The limited scope of the DRI can be explained by the fact that pre-insolvency restructuring proceedings were considered important in order to create frameworks allowing to preserve value by avoiding insolvency proceedings where possible in a situation where such frameworks were previously entirely absent in many Member States. The relative novelty of such pre-insolvency proceedings to a considerable number of national legal orders made this an adequate topic for a first step of harmonising substantive law in the broader area of insolvency law because of the reduced number and sensitivity of clashes with the long-established principles under national law. This first step having been achieved, the initiative covered by this impact assessment aims at taking the next step by seeking the convergence of the rules governing insolvency where a debtor cannot be returned to viability in pre-insolvency restructuring but has to enter into insolvency proceedings. Figure 2 provides for a schematic representation of the coverage of the areas (pre-insolvency, insolvency, post-insolvency) and actors by the existing legal acts, as well as identifying the existing gap in EU law (substantive rules on insolvency proceedings). ASPECTS AREAS CROSS-BORDER PROCEDURAL ASPECTS SUBSTANTIVE ASPECTS PRE-INSOLVENCY INSOLVENCY POST-INSOLVENCY PROCEE- DINGS EIR - Applicable law -International jurisdiction - Recognition of the effects of opening insolvency and of further judgements taken in the course of the insolvency proceedings - Group coordination proceedings DRI - Debtor in possession - Stay of individual enforcement actions -Restructuring plans - Cross-class cramdown - Protection for new financing and interim financing - Duties of directors NOT YET REGULATED AT THE EU LEVEL - Material elements of insolvency (transaction avoidance, asset tracing, duties of directors (and liabilities) of companies to file for insolvency, pre-packs) - Procedural elements of insolvency (opening of insolvency proceedings, special insolvency rules for micro- and small enterprises) - Distributional elements of insolvency (ranking of claims, creditors’ committees) DRI - Debt discharge proceedings - Reasons for disqualification ACTORS TARGETED EIR - Powers of insolvency practitioners in cross-border situations DRI - Training of judges - Training of insolvency practitioners - Supervision and remuneration of practitioners DRI - Honest entrepreneurs - Possibility for Member States to extend to consumers 1.5.2.The divergences between national laws on key features of insolvency law There are important differences across Member States with respect to various aspects of substantive insolvency law. This section illustrates some of these differences across the relevant elements as a basis for the discussion of why they emerged as problem drivers in Section 2.3 of this impact assessment. More details on differences across Member States are provided in Annex 5. Rules on transaction avoidance to protect the insolvency estate against undue transactions and thus ensuring the preservation of value for creditors exist in all EU Member States. Apart from few exceptions, they cover a broad range of reasons and recipients and define a maximum timeframe for the retrospective period for voidable transactions. However, the features of national systems diverge considerably. In certain Member States, like France, Germany, Poland, Portugal and Sweden, all legal acts are subject to avoidance rules, regardless of whether they were performed by the debtor, the defendant or a third party, provided that they are detrimental to the general body of creditors. By constrast, in other Member States, like Czechia, Malta, the Netherlands, Slovenia and Spain, only transactions by the debtor that have disadvantaged the general body of creditors are covered. Different EU regulations enable taking evidence and other asset tracing and recovery measures in civil or commercial matters across EU Member States , although excluding the insolvency proceedings. The EIR does not specifically address the issue of asset tracing in the context of cross–border insolvency proceedings. It provides that the powers of insolvency practitioners are governed by the lex fori concursus . Thus, the EU landscape is very fragmented in this respect and each Member State has its own rules and entrusts the insolvency practitioners with different powers in respect to the asset tracing. In relation to directors’ duties and liability in the vicinity of insolvency, only a duty to convene a meeting exists in EU company law (2017 Company Law Directive) but there is no obligation to take a decision on re-capitalizing or liquidating the company in difficulty. Member States take different strategies to protect creditors in the vicinity of insolvency by imposing varying duties on directors. In a significant number of Member States , directors must file insolvency proceedings within a certain period of time of their company becoming insolvent. The time in which filing must be done, however, varies widely across the EU (e.g., “immediately” in Germany, within one month in Belgium, within two months in Spain, no express time limit in some Member States). Some Member States make it clear that in the vicinity of insolvency, the focus of directors should shift to the creditors’ interest. In Hungary, the change in duty involves the interests of creditors as a priority, and directors could be held liable for a form of wrongful trading. The German approach provides that the directors must call a meeting of shareholders in case of “serious loss of the subscribed capital” to take measures to safeguard both the interests of the company and its creditors. Some Member States (like Italy ) require that, in case, of “serious loss of the subscribed capital”, the board shall call a meeting and have the company decide, upon losing half of its subscribed share capital, whether to recapitalise or wind down the company’s business and liquidate it. When an insolvent business has to be liquidated, creditors can usually achieve a greater recovery rate if the business or a part thereof is sold as a going concern, i.e. as an operating, value generating economic entity. An effective form of a sale of the business as a going concern in insolvency proceedings is the “pre-packaged sale” or ‘pre-pack’, where a non-public negotiation phase between the debtor and some possible buyers precedes the formal opening of the insolvency proceedings. Whereas the liquidation of the debtor through a going concern sale is allowed in most of the insolvency laws of the Member States, pre-pack mechanisms exist only in a handful of Member States. Those that govern pre-packs, do it differently. For example, the sale of the entire assets of a debtor on a going concern basis is only possible outside of court in France, it requires court involvement in Belgium unless the pre-pack is organised as amicable settlement. Whereas pre-pack sales must achieve the continuation of the business in France, the German rules intend to liquidate the business.

With respect to opening of insolvency, there are typically two insolvency tests under national law that are used as insolvency triggers: the balance sheet test or the cash flow-based test. Different Member States use the general cessation of payments (cash-flow) test and the balance sheet test in different combinations to establish a commencement standard. Regardless of the causes that lead to insolvency, there is no unambiguous definition of “insolvency” across all Member States (numerically identifiable and therefore easily predictable or monitored). Hence, one can currently expect as much as 27 different answers under each Member State law or the question whether a business is (in)solvent, or likely to be insolvent that is whether or not it is making a profit sufficient to provide a return to the business owner while also meeting its commitments to business creditors or where it has sufficient cash resources to sustain itself through a period when it is not returning a profit. Moreover, in some Member States (e.g. the Netherlands) the court has relatively wide discretionary powers in assessing whether the debtor has ceased to pay its debts. In most Member States, large companies and MSEs are treated alike and there are no special procedural alleviations to cater for the specific situation that micro- and small enterprises (MSEs) face when they are in financial distress. Small- and micro enterprises do not even have access to liquidation proceedings in a number of Member States, as in most cases such debtors have no or only very few assets left when becoming insolvent, which circumstance barres them from the opening of insolvency proceedings (i.e. Austria, Germany, Greece and Italy) or results in an immediate termination of insolvency proceedings (i.e. Belgium and Spain). Simplified liquidation procedures for MSEs are available only in Czechia, France, Greece, Lithuania, Romania and Slovakia. While some features of the ranking of claims of creditors are common to all Member States (e.g. the prioritization of secured over unsecured creditors), national systems are substantially divergent. Almost all the Member States ensure a preferential treatment of secured credit, but the position of secured creditors vis-à-vis other claims, specifically those relating to taxes and/or employee rights varies significantly. In the Netherlands – historically known to be a ‘creditor-friendly’ jurisdiction – secured creditors are granted a strong position in respect of their claims as (in principle) these outrank other creditors (including those with a right of preference). Only in specific exceptions may other claims take priority over secured claims. The most important example of this is the preference that is granted to the Dutch tax authorities for certain categories of tax debts over certain movable assets located on the premises of the debtor. In turn, in France – a jurisdiction historically known for being debtor-friendly – secured claims are (in principle) outranked by other claims. In Spain claims concerning salaries, taxes and social security withholdings are granted (in said order) a status of ‘general privileged claims’ , however, these are still outranked by ‘insolvency’ claims, and special privileged claims (i.e., secured with in rem security over specific collateral (e.g., mortgage or pledge). On the other hand, in Germany certain categories of secured creditors do not fall within the ranking order since they shall benefit from an exclusive right over the economic value of the assets and, in practice, rank ahead all other creditors. Creditors entitled to separate satisfaction are completely excluded from the concept of insolvency creditors: they are granted a priority right of satisfaction and have the possibility to pursue their claims outside the rules of the relevant insolvency legislation , i.e., in normal civil proceedings. In relation to specifically protected interests, Germany, for example, keeps workers in the same rank as all other unsecured creditors because its law and social safety net shelters workers from the consequences of their employers’ insolvency. In the vast majority of jurisdictions a creditor committee may/must be appointed and its general role is to safeguard the interests of creditors. The amount of input that committees have in the administration of the insolvency, however, varies greatly. This difference affects the actual extent of creditor involvement in the proceedings. For example, while in some Member States they are merely carrying out an advisory role (e.g. in Denmark), in other Member States (e.g. in Greece) the functions of the committee are, principally, to support and supervise the insolvency practitioner (and even control the insolvency practitioner) and give consent for some actions to be taken by him/her. Similarly, in Austria for certain important transactions (e.g. sale of the business), the consent of the creditor committee is a precondition for their validity. In other Member States, such as Germany, for transactions of particular importance, such as entering into a loan contract with considerable burdens on the insolvency estate, the insolvency administrator needs the approval of the creditor meeting or of an appointed creditor committee. In Romania, the creditor committee can request the removal of the debtor’s right to manage its affairs. 2.Problem definition 2.1.What are the problems? Insolvency rules are fragmented along the lines of national insolvency systems (see section 1.5). They thus deliver different outcomes characterised by different degrees of efficiency across Member States in terms of the time it takes to liquidate a company and the value that can eventually be recovered (see Figure 3 ). This leads to a pronounced length of insolvency procedures, and a low average recovery value in liquidation cases (see Table 1). Differences in national regimes also create legal uncertainty as regards the outcomes of insolvency proceedings and lead to high information and learning costs for cross-border creditors. Low recovery values, long insolvency procedures, administrative costs of the procedures matter not only for the efficiency of a company’s liquidation. Even more important is that these three factors and the uncertainty surrounding them determine the magnitude of the risk premium that creditors factor in when they undertake an investment. A high risk premium increases the cost of capital for the corporation and, if the risk is particularly high, dissuades investors to provide credit and cross-border investors to consider investing abroad. 2.1.1.Costly and lengthy (national and cross-border) insolvency proceedings lead to low recovery values If companies are liquidated, the recovery value is usually a low proportion of the initial investment. Whereas investors may be able to estimate the likelihood of insolvency, they face uncertainty about the consequences of an actual insolvency, which will depend to a considerable extent on the length and complexity of the individual case. Moreover, the predictability of outcome in insolvency cases and of recovery rates for cross-border creditors also depends on the level of discretion exercised by courts and IPs in insolvency cases. Insolvency laws do not offer adequate guidance on how the discretion should be exercised by courts (and insolvency practitioners). Divergences in insolvency laws may increase uncertainty to such an extent that investors are not able to predict, quantify and manage the risks that affect their investment. This exposure to uncertainty will be mirrored in a higher risk premium demanded and in consequence higher funding costs for the corporate sector or even in greater reluctance to do business with foreign companies at all. Beyond the impact on risk premium, a lengthy insolvency proceeding reduces the present value of the expected investment returns, as the opportunity cost for creditors and investors of allocating these funds in other more profitable investments increases with passing time. Uncertainty about the possible value or time of recovery is an important factor for financial investors that need to generate returns or obtain additional refinancing if an investment is not redeemed in time to manage their liquidity needs. A protracted time to recover some value may even lead to creditors becoming at risk of becoming insolvent themselves, leading to a possible cascade of defaults. This could be the case, especially for business partners that are not financial institutions, but rely on outstanding payments for the delivery of their products and services. The scale of the problem is expected to be large: recovery values and recovery time determine recovery rates, which in turn determine the level of cross-border asset holdings and risk sharing. The insolvency experts interviewed in Deloitte/Grimaldi (2022) stated that they would expect sizeable gains in terms of lower costs and shorter duration of proceedings from the initiative subject to this impact assessment, pointing to considerable inefficiencies in the current insolvency regimes. Nevertheless, a comprehensive quantification of these inefficiences is not feasible due to a lack of data on recovery rates and on the degree to which they are influenced by the length and complexity of insolvency procedures. Even many banks struggle to report recovery rates for non-performing loans despite credit provision being their daily business. Despite considerable efforts to produce data on the outcome of insolvency proceedings, little data is available to date. Annex 4, Section 2 explains the different data sources and their limitations. The analysis conducted in this impact assessment relies primarily on two sources: The World Bank Doing Business indicators presented in the charts above and data from the benchmark study carried out by the European Banking Authority (EBA) in 2020. The two sources, however, contain rather different data. In the World Bank exercise, insolvency experts are asked to assess the outcome of insolvency procedures based on a narrowly defined illustrative bankruptcy case. In contrast, the EBA collected actual data from banks in the EU Member States on gross replacement rates, net replacement rates (i.e. after judicial costs), time for recovery and judicial costs. The World Bank Doing Business data yielded recovery rates in the case of liquidation in an EU Member State between 32 and 44 %, with an average for the Member States concerned of 38%. The recovery rate in the five best performers outside the EU was 50 to 51%. Data from the World Bank shows that the length of insolvency procedures and judicial costs in EU Member States tend to be higher than in other OECD countries (see chart above). National insolvency experts that provided estimates for benchmark scenario used for the World Bank Doing Business insolvency indicators pointed to a range of 1.5 to 3.5 years for the duration and judicial costs between 9 and 15% for EU Member States, which compares to 1.2 years and 5% costs for the fifth best performer in the panel of non-EU countries. The EBA benchmarking exercise on national loan enforcement in insolvency (see Table 1 ) found that on average it takes 3.4 years and costs 1.4% of the recovery value to enforce corporate loans in the EU. Judicial costs for SMEs loans, however, are much larger in proportion, at 3.5% of the recovery value, while their time of enforcement is about the same as for corporate loans. The EBA benchmarking exercise also found that the simple average of recovery values of corporate loans in the EU is 40% of the amount outstanding at the time of the default and 34% for SMEs.

Corporate loans SME loans Simple average Weighted average Median Simple average Weighted average Median Recovery value1 40.4 26.2 16.2 33.8 35.1 4.9 Time to recovery2 3.4 3.9 2.7 3.3 3.5 2.2 Judicial costs1 1.4 0.5 0 3.5 1.2 0 The EBA benchmark exercise also revealed substantial variations across Member States, with the average recovery time ranging from 0.6 to 7 years and judicial costs ranging between 0 to above 10%. The pronounced differences across EU Member States, documented in the EBA and World Bank data, suggest that procedures in some Member States suffer much more from delays and result in additional costs. Both data sources also show that enforcement regimes in some Member States yield considerably less efficient outcomes than the best performers in the EU. The World Bank data suggests that the average outcome for EU Member States is less efficient in terms of recovery values, time and judicial costs than in the best performers outside the EU. It is unlikely and no analysis exists that demonstrates that these differences could be entirely explained by debtor characteristics. 2.1.2.Low predictability of insolvency proceedings lead to high information costs and constitute barriers to cross-border investments Differences in legal systems across Member States fragment the single market and increase transaction costs for cross-border business: “disparate national law rules may lead to higher transaction costs, especially information and possible litigation costs for enterprises in general and SMEs and consumers in particular. Contractual parties could be forced to obtain information and legal advice on the interpretation and application of an unfamiliar foreign law.” Already in the mid-1990s, “legal uncertainty was regarded by the European Commission as the main reason for the fact that the economic dynamics triggered by the process of European integration in the early nineties developed more slowly than expected and desired”. Transaction costs are caused by “(a) costs of collecting information, (b) costs of legal disputes, (c) costs of setting incentives for pushing through legal claims, and (d) other transaction costs” and these “costs are higher in international transactions than in domestic trade”. Legal uncertainty and associated transaction costs could also be expected specifically in the case of differences in insolvency regimes. The divergence of insolvency regimes across EU Member States discourages cross-border investments through high information and learning costs and low predictability of outcome of recovery rates. Large divergences in time to recovery, judicial costs and recovery rates among Member States suggest that cross-border investors in the single market are at a higher risk of being unable to predict outcomes of insolvency proceedings if they allocate their investment portfolio across several/different Member States. Information costs and low predictability of the investment outcome in insolvency and recovery rates play a key role for cross-border creditors, since they need to account for all possible scenarios and so the conditions and prospects for recovery of their investments in case of failure of the company they are invested in. This aspect is even more important for unsecured funding operations, which require significant knowledge of procedures and conditions affecting recovery rates in insolvency. The higher is this knowledge, the easier and more accurate will be the calculation of loss given default and probability of default and therewith the price discovery of financial assets, which is key to the orderly functioning of capital markets. The more dissimilar the insolvency system abroad is from that in the home country, the less can domestic experiences and those made in other jurisdictions be used to assess the expected return on a cross-border investment if the debtor becomes insolvent. The consistent finding in empirical studies is that geographical distance and clusters of legal traditions are important determinants of cross-border investments. This confirms the notion that familiarity matters, suggesting that the more similar the rules, the lower the threshold to engage and undertake the necessary due diligence. Greater differences in substantive insolvency laws make it more costly to assess the risks of cross-border investments compared to those realised in a home Member State. High information barriers with respect to claim procedures increase the costs of legal advice. Recent studies presented empirical evidence that the outcome of insolvency proceedings and their respective design have a significant effect on the magnitude of cross-border investment across EU Member States. The effect is material even when using different data sources and specifications for measuring insolvency and cross-border investment. The statistical support at macro level that convergence of insolvency regimes to best practices would foster capital market integration implies by inversion that inefficient and diverging insolvency regimes are an obstacle to cross-border investment. Due to the methodological difficulties of (objectively) measuring information and learning costs, the empirical research about the transmission channels is still scarce. The effects of insolvency regimes on the magnitude of cross border investment should be overall comparable to those of other institutional determinants such as investor protection, accounting standards or corporate governance for which the empirical literature established a significant link to cross-border investment. While there is no data about the magnitude of information and learning costs that cross-border creditors face, these costs can be approximated through the substantial home bias in investment. Home bias describes the under-proportionate investment in cross-border equity and debt (and hence over-proportionate investment in home equity and debt). Home bias is evidenced in a large body of empirical research, and the literature attributes an important role of informational frictions and uncertainty avoidance in explaining it. 2.1.3.Stakeholders’ perspectives 129 stakeholders submitted replies to the public consultation on this initiative, which is a sufficiently large number to derive quantitative results about their positions. These results can, however, not be considered fully representative for the EU. Stakeholders from one large Member State are over-represented, while there were no submissions from some EU Member States. Like all public consultations, there is also a self-selection bias, implying that stakeholders for whom the issue is particular pertinent are overrepresented. The replies to the public consultation on this initiative revealed that stakeholders find that the problem created for the internal market by differences in Member States’ insolvency frameworks is serious. 54% of the respondents who provided an answer to the question perceived the problem for the internal market stemming from the divergence in insolvency rules as important, attributing a score between 3 and 5 (with 0 meaning no problem and 5 meaning an extremely significant problem). Note: 0 means 'no problem' and 5 means 'extremely significant problems' An especially large representation of German respondents (58 out of 129) created a geographical bias in the response rate. The responses revealed a geographical split across the Northern and Southern Member States. They also showed that researchers and the business sector see a higher need for policy measures than public authorities. The views and level of ambition of insolvency practitioners and legal experts differ depending on the issue.

Note: Average rating on a 0-5 scale with 0 means 'no problem' and 5 means 'extremely significant problems'. Number of responses on the x-axis. Source: European Commission. When asked for the reasons, stakeholders indicated that differences in national insolvency frameworks deter cross-border investment/lending. In a follow-up workshop with selected stakeholders, these stakeholders reported on practical difficulties resulting from the fragmentation or different performance rates of the national insolvency frameworks. These stakeholders expressed strong support for greater convergence in insolvency rules in the EU. Annex 2 provide more details about stakeholders’ views. 2.2.What are the consequences? The first consequence of lengthy, costly and very divergent insolvency proceedings is the impact on capital allocation, which is likely to be less efficient compared to the situation when insolvency regimes are more efficient and overall more similar across Member States. Creditors and investors anticipate the consequences of inefficient insolvency regimes in their decision to provide credit or to invest. They will demand a higher risk premium or insist on other safeguards such as collateral, which increases capital costs for the corporates. This higher risk can also discourage investors from undertaking the investment at all, limiting the supply of funding available to companies, leading to higher funding costs for corporations and, more broadly, to less efficient capital allocation in the EU economy. The design of insolvency systems therefore has consequences for the provision (supply) of credit, capital costs and the allocation of capital. The academic literature reviewed in Annex 4, Section 4 found empirical evidence of significant adverse effects of inefficiencies in insolvency regimes on cross-border capital flows, credit provision, funding cost and, ultimately, the adjustment capacity of the economy, with follow-on effects on the diffusion of technical progress and productivity growth. Whereas the earlier economic research found that better insolvency regimes lead to more lending to the economy in cross-country comparisons, newer studies point that positive effects of more efficient insolvency regimes are better visible in funding costs or non-price credit conditions in advanced economies. Annex 4 gives more details of this literature. Since they impair cross-border investment, both differences and inefficiencies in insolvency regimes fragment the single market for capital in the EU and deter the realisation of the CMU that seeks to build an integrated market for capital in the EU. Since market practitioners consider divergence of insolvency regimes a central obstacle to cross-border investment, absence of tangible progress in this policy field could jeopardise the credibility of the overall CMU project. The studies quoted in the introductory section provide evidence that more efficient (and more converging) insolvency regimes spur cross-border investment and macroeconomic risk sharing. Finally, differences and inefficiencies in insolvency regimes can also have an impact on business relocations. Business can relocate either to declare bankruptcy and avoid paying creditors (insolvency tourism), or to gain certain advantages that would allow them to benefit from the availability of more favourable insolvency laws. In practice, however, while the possibility for the company to migrate to a different and more favourable jurisdiction may be an option in theory, this may end up being costlier and more inefficient than staying in the debtor’s own jurisdiction. A recent study finds that relocation can only be an option for large companies. In any event, the reduction or elimination of key differences between national insolvency laws and an enhanced degree of efficiency of insolvency regimes across the EU would remove incentives for relocations that are driven by the existing divergences. 2.3.What are the problem drivers? The members of the expert group on insolvency, the stakeholders in the public consultation and the external contractor performing the economic study in the preparation of this Report recognised the differences in certain targeted aspects of insolvency rules as drivers of the problems identified above. Insolvency tools available in these areas appear to be very different across Member States (See also Section 1.4. of this impact assessment). For several of these elements, rules are missing completely in some Member States’ insolvency regimes; where they exist, their design may deliver suboptimal outcomes, at least in some of the Member States. They are grouped below according to the role they primarily play in triggering various problems. One driver might lead to several problems. Similarly, several drivers might contribute to the same problem and reinforce it. 2.3.1.Inadequately designed (or missing) features and large cross-border divergences on asset recovery proceedings Some of the components of insolvency regimes help recover as much capital as possible from the insolvent company. If they are missing or not well designed, there is scope for moral hazard because the owner, debtor or director of a company may face an incentive to procrastinate on filing for insolvency (“gamble for resurrection”) or to use their better knowledge of the company to redirect resources away from the estate, thereby leading to a lower value that can be distributed to creditors. Detecting whether transactions have been initiated for this purpose or whether assets are placed in hidden places allows increasing the recovery value. Without suitable measures that govern transaction avoidance, it is difficult to claw back assets that were alienated in the vicinity of insolvency, for example transactions to benefit owners or transactions at unjustified prices. Member States have currently very different rules to govern transaction avoidance aimed at the rescission of, or the compensation for, transactions that are detrimental to creditors and had been performed prior to the opening of insolvency proceedings. Divergences among Member States go across all the key elements of transaction avoidance, such as the suspect periods, the legal acts concerned, the limitation period and so on (Grimaldi and Deloitte 2022). For example, only transactions of the debtor are considered in some Member States (Czechia, Spain, Malta, the Netherelands, Slovenia), whereas all legal acts performed by the debtor, the defendant or a third party that are detrimental to the general body of creditors are subject to avoidance actions in others (Germany, France, Poland, Portugal, Sweden). There are also divergences in the suspected periods and in the limitation periods across Member States. Such differences lead to information and learning costs in particular for cross-border investors and makes cross-border investments, especially in companies in financial difficulties, more costly. Consultations with stakeholders (see Annex 2) revealed problems related to asset tracing, especially where the asset is situated in another Member State than the one where the proceedings have been opened. Each Member State has its own rules and entrust the insolvency practitioners with different powers in respect of asset tracing. This implies that powers of insolvency practitioners may not include coercive measures if they are not provided by the applicable law, unless ordered by a court of the specific Member State or the right to rule on legal proceedings or disputes. Missing or cumbersome possibilities of asset tracing impair the capacity of courts, insolvency practitioners or other parties with a legitimate interest to determine and locate the assets, examine the revenue generated by often fraudulent activity, and follow its trail. As a “follow the money” tool, asset tracing is of particular significance in an insolvency context, as debtors have an incentive to remove assets from the insolvency estate. Directors and managers’ have a key role in the vicinity of insolvency. It is detrimental to the recovery value if rules are absent or ineffective that govern (i) when directors have to file for insolvency, (ii) whether their goal should shift to the creditors’ interest, or (iii) whether they are liable if it is found that they acted, prior to the advent of formal insolvency proceedings, with intent to defraud creditors. Procrastination in the start of the process, including of attempts to engineer restructuring solutions early on, however, tend to reduce the recovery value. Duties (and potential liability) for directors are very differently defined across the EU. In some Member States there is not even such a duty, while in others there is a duty to file within a very short timeframe or more generically in a ‘timely manner’. As illustrated in Annex 5 Section 2.3, the time in which filing must be done varies widely across the EU and directors have different obligations vis-à-vis shareholders. This divergent landscape generates additional costs, uncertainty and, hence, obstacles for investors that operate cross-border. This can be further complicated by the fact that investors can also hold directors’ positions in various companies and face different obligations in companies in different Member States. This is particularly the case, in both large and small innovative companies, for very active investors with large stakes that want to be more engaged with the governance of their (invested) companies. Recovery values are low and could be different across Member States, everything else being equal, also because pre-pack sales are not available in Member States. At present, many Member States either do not have pre-pack procedures or have very different rules regulating them. Some of those Member States that have rules on pre-packs are among those with the highest recovery rates (Denmark, Netherlands and Sweden). 2.3.2.Inadequately designed (or missing) features and large cross-border divergences in the governance of insolvency proceedings Procedural efficiency is determined by the capacity of public actors such as courts and insolvency practitioners to deal with the liquidation of a company.

Without the involvement of public actors in insolvency proceedings, the possibility of creditor runs leads to a market failure, i.e. creditors who claim first will be served first and those that claim last will receive only what is left. A market failure occurs since this can lead to companies being liquidated prematurely. Since it is not rare that companies face liquidity shortages and payment difficulties, there is a risk that creditor runs lead to the liquidation of viable companies that face temporary difficulties. The absence of lighter procedures for micro and small companies (MSEs) contributes to the workload of courts and insolvency practitioners. MSEs are often not wound down properly but remain in limbo. Incentives to close their cases are distorted because the costs of proceedings can easily exceed the value of the estate. For MSEs, in particular, traditional long and complex liquidation procedures easily cost more money than what they are able to generate in proceeds for creditors. To allow an orderly liquidation of MSEs, some Member States already have a lighter regime, which may even avoid the launch of standard proceedings if resources are structurally limited (size of the firm). However, the picture is rather patchy across the EU and the conditions and the definitions of eligible MSEs vary considerably. While France and Greece introduced simplified rules for MSEs recently, MSEs for example in Austria, Germany and Italy will find their application for opening insolvency proceedings rejected if their remaining asset value is too low to cover the expenses of that insolvency proceeding. Companies normally face financial distress some time before an insolvency procedure is initiated. From the perspective of the creditor, the insolvency trigger is therefore a determinant of the length of time s/he is exposed to uncertainty. In the absence of a harmonised definition there could be as many as 27 different answers to the question of whether a business is (in)solvent and the insolvency procedure should start, which creates high information and learning costs for cross-border creditors. In some Member States the main determinant is the cash flow, i.e. a company is declared insolvent when it cannot pay its debts as they become due. In other Member States, it is also the value of a company’s liabilities on its balance sheet outweighing the value of its assets. Most Member States apply a combination of both determinants and many also require a durability criterion (See Table A5.1 in Annex 5). 2.3.3.Inadequately designed (or missing) features and large cross-border divergences on procedures for distribution of recovered values A number of components in insolvency regimes govern the position of all types of creditors and define rules that determine the share of the value of the estate that can be paid to each creditor. Their design impacts on their bargaining position and incentives of each creditor to support the resolution of the insolvency case. Knowledge of these rules is important for investors and creditors when they decide to provide credit or to invest. Transparency and fairness of these rules is also important for those business partners of a defaulting company that became creditors through their provision of goods and services to the defaulting company. Creditors are heterogeneous. There are differences in the type of claims on a defaulting company (financial, trade credit, labour liabilities, obligations vis-à-vis public authorities). Creditors’ different priority status (secured, senior, junior) generally entails high information and learning costs for (other) creditors and have a substantial impact on the recovery prospects and risk premia. The large divergences across Member States on how distribution of recovered value is organised mean that costs are even higher for creditors acting cross-border, which may hamper their willingness to do business. Cross-border creditors will in particular need to understand what the existing rules mean for their position in the group of creditors and relative to preferred creditors, debtors and other stakeholders, such as employees or public authorities. They are likely to be disadvantaged, facing obstacles to coordinate with domestic creditors due to different legal regimes, language and less knowledge about the (divergent) insolvency systems and domestic actors. Creditors from third countries encounter problems identical to those of cross-border creditors within the EU. The potential drivers that contribute to determining the distribution of recovered value among the different creditors include the ranking of claims and creditor committees (in the scope of this initiative) and a few others (which are not in scope and briefly discussed in a separate section below). The ranking of claims is of key interest to creditors since it determines the distribution of the remaining value of a defaulted company. It presents an important source of uncertainty because the impact of the ranking of creditors on the expected recovery rate is generally hard to predict for all creditors. They are a particular challenge for cross border creditors since systems are substantially divergent across Member States and the differences are not sufficiently transparent. For example, a number of Member States afford particular privileges to tax and other governmental claims (for example Italy, France, Spain). Some Member States give a priority or even super-priority ranking (trumping all other claims including those of secured creditors) to the claims of employees (unpaid wages). A new phenomenon with potential impact on the ranking of claims concerns the remediation of environmental damage. Given their impact on the risk premium and, hence, the cost of lending, divergences in this area may act as a significant deterrent for engagement by cross border creditors. While creditor committees exist in most Member States, different rules across Member States and limited powers and scope in some of them (see Table A5.9 in Annex 5) for creditor committees contribute to the high information and learning costs for cross-border creditors, in particular due to the difficulty to coordinate their actions during proceedings or the risk of facing hold-up problems. Cross-border creditors are, in particular, disadvantaged by language barriers and unfamiliarity with domestic proceedings. Unless they hold a sizeable claim against the defaulting company, cross-border creditors are likely to face a bargaining disadvantage relative to domestic creditors. As creditors’ committees provide an institutional guarantee that creditors can articulate their views in the insolvency proceedings, in particular thanks to their oversight by the insolvency practitioners, cross-border creditors may specifically benefit from this tool to compensate their disadvantages listed above. Thus, rules on creditor committees can have a decisive impact on the recovery value. 2.3.4.Stakeholders’ views about problem drivers When the DRI was negotiated as well as in their replies to the public consultation, Member States reasoned that the close links of insolvency law with other areas of national law would make full harmonisation of insolvency rules not feasible at this point. Many stakeholders, however, argued that the complexity and opacity around national insolvency laws is a barrier to cross-border investments as it makes it costly to understand and measure the risk in investing in the EU. This applies to both EU as well as non-EU investors. Stakeholders expressed divergent views in the public consultation about the importance of the different problem drivers as an obstacle to the single market. For example, insolvency practitioners highlighted in particular divergent rules on asset tracing and avoidance actions as important obstacles. Financial institutions identified the insolvency trigger and the ranking of claims as the key obstacles, whereas non-financial business indicated asset tracing and the ranking of claims. Firms that provide consultancy or other services to businesses flagged the insolvency trigger, directors’ duties in the vicinity of insolvency and the ranking of claims as most concerning. Researchers argued that both avoidance actions and the ranking of claims needed to be harmonised, whereas public authorities generally considered the need to act on any of the proposed elements as low. Note: 0 means 'no problem' and 5 means 'extremely significant problems'. The relevance of the different problem drivers can also be derived from the indications about their cost and time saving potential that the insolvency experts surveyed in Deloitte/Grimaldi (2022) attributed to them. The existence of cost and time saving potential suggests that current rules are not efficient. Table 2 shows how many of the insolvency experts supported measures in this area and their assessment of the effectiveness of EU harmonisation from the perspective of cross-border insolvency procedures. It suggests that foreign investors would derive benefits mainly from measures that improve asset recovery and transparency, and perhaps see less in relative terms direct benefits from common MSE regimes and creditor committees. Similarly to the results of the public consultation, German and Swedish respondents were less supportive of wider harmonisation efforts than French, Spanish or Italian respondents. Respondents from Romania and Poland were on average even more supportive than those from the Southern Europe in this survey, differing from the views of respondents from Central and Eastern Europe in the public consultation, to which neither Polish nor Romanian stakeholders contributed. Avoidance actions Asset tracing Directors duties Pre-packs MSE Ranking of claims Trans-parency* Creditor committee Approval rate+ 82.4% 85.8% 74.1% 70.0% 53.4% 61.6% 87.5% 51.6% Score** 0.7 1.0 0.8 0.6 0.4 0.5 1.1 0.3 Note: + a % share of the 120 interviewed insolvency experts who indicated an increase in effectiveness out of all positive replies to “Considering the overall effectiveness of the cross-border insolvency procedure, as concerns the liquidation of debts and the satisfaction of the claims of creditors, please provide us your estimate of the change in the overall effectiveness determined by the introduction of EU rules” [in this area]. * A glossary of insolvency terms and of the equivalent professional figures in different jurisdictions. **. The score is defined as 0 indicating no efficiency gains, 0.5 marginal gains, 1 normal gains and 2 significant gains and likewise for negative values.

Source: FISMA with Survey data from Deloitte/Grimaldi. 2.3.5.Out -of-scope drivers The proper functioning of the courts and the high quality of judges can significantly contribute to reducing the length of proceedings and increase the ability to distinguish viable from non-viable companies . The long recovery time documented above is also the result of (insufficient) court capacity. In the same way, the qualifications and incentives of insolvency practitioners can have a significant impact on the running and outcome of insolvency proceedings. On the one hand, costs for insolvency practitioners, for example, reduce the payback to creditors and often make the opening of bankruptcy procedures non-economical for smaller companies. On the other hand, insolvency practitioners often play an essential role in ongoing proceedings. Notably, they can act on transaction avoidance and trace assets, manage the operations of the insolvent estate and influence how the debtor’s assets are sold. The powers and efficiency of insolvency practitioners thus affect the length of the insolvency framework and therewith the trust cross-border investors place on the efficient treatment of their claims. The exposure of insolvency practitioners to conflict of interests, the absence of mandatory professional assurance and – possibly – standards relating to their remuneration makes them sensitive to moral hazard that can compromise their role as neutral and independent actors. Nevertheless, despite their importance, this initiative excludes an intervention on the capacity and quality of judicial systems and qualifications and incentives of insolvency practitioners. First, major interventions to improve capacity and quality of domestic courts and insolvency practitioners adds a major complexity to the overall EU action, such as the need to have significant political support (currently lacking) for major reforms of domestic judicial systems and significant investments in available infrastructures and personnel. Moreover, the Directive on Restructuring and Insolvency is already expected to lead to some convergence towards more efficient court structures and framework for insolvency practitioners. As the Directive is being transposed, it is still too early to take stock or envisage another EU intervention.

Consequences Problems Drivers 2.4.How will the problem evolve? In the absence of an initiative on the convergence of insolvency laws, EU action would remain restricted to the few general provisions in the Restructuring Directive on insolvency proceedings concerning digitalisation, training of judges and insolvency practitioners and data collection and to country specific recommendations issued each year towards several Member States. This does not leave ground to believe that action would be taken across Member States to move in the direction of a coordinated or comparable solution for the problems and problem drivers identified above (see Annex 6 for a review of progress with insolvency reforms in the Member States). The expected phasing out of policy measures to keep distressed companies as going concerns during the Covid-19 economic downturn and the significant adjustment challenges for the economy are likely to increase the number of business exits in the future. The exposure of the EU economy to energy price shocks and supply-chain bottlenecks evidenced in 2022 reveal the vulnerability of the EU economy to pronounced economic shocks. Whenever these hit the economy, companies may come into conditions where their debt level turns out unsustainable or may find that changes to demand and factor costs make their business models no longer viable. The baseline scenario is therefore one in which a rising number of insolvency cases will continue challenging the capacity of judicial systems. The absence of converging insolvency regimes will imply that the magnitude of cross-border investment and extent of cross-border business relationships would remain below its potential. 3.Why should the EU act? 3.1.Legal basis Since the objective of this initiative is to ensure the functioning of the Single Market, the EU has the right to act under the Treaty. Article 114 TFEU provides a suitable legal basis for the approximation of legislation and administrative actions in Member States. The use of Article 114 is justified by problems for the functioning of the Single Market, which result from the disincentives to invest across borders (described in more details above) as a consequence of the divergences and inefficiencies in national insolvency laws. 3.2.Subsidiarity: Necessity of EU action The functioning of the single market is in the interest of the EU and all Member States. Without EU actions, there is no mechanism to foster that elements of national insolvency regimes would become more similar over time. An important obstacle to the functioning of the single market for capital and the completion of the CMU would remain unadressed and many companies would be deprived of access to (cross-border) investment. Member States’ different starting points, legal traditions and policy preferences imply that reforms at national level in this area are unlikely to lead to converging insolvency systems. Member States that assess their insolvency regime as already well-functioning may not undertake any reforms that make elements of their system more similar to those in other Member States. Among those Member States with higher recovery rates, there are only two that have undertaken insolvency reforms in the last years or committed to doing so in the recovery and resilience plans. Member States that consider their insolvency system as in need of reform are likely to focus on improving elements that promise an increase of effectiveness of the national system and tailor them to their domestic preferences rather than aiming to make them more similar to those in other Member States. Since cross-border creditors are not part of the electorate, there is a risk that national reforms will be biased towards the interest of domestic stakeholders and not place sufficient attention to the interests of and disadvantages faced by cross-border creditors. 3.3.Subsidiarity: Added value of EU action Action at the European level is better suited to substantially reduce the fragmentation of insolvency regime and ensure convergence of targeted elements of Member States’ insolvency rules towards the rules that would work well across all Member States. Rules at national level with a cross-border component, such as cross-border asset tracing, information to cross-border creditors, would be less suitable to address the needs of cross-border creditors and imply higher information and learning costs for them than if they were following a common design at EU level.

Measures at the EU level would ensure a level-playing field and avoid distortions of cross-border investment decisions caused by both lack of information about and actual differences in the designs of elements in insolvency regimes. This would help to facilitate cross-border investments and competition while safeguarding the orderly functioning of single market. Since divergences in insolvency regimes are a key obstacle to cross-border investment, addressing this obstacle will be crucial to realise a single market for capital in the EU. EU action would act as motor of reform and help overcome policy inactivity in the Member States to address issues with core insolvency rules. The options proposed respect the principle of proportionality, are adequate for reaching the objectives and do not go beyond what is necessary. They aim at striking a balance between establishing pan-European standards in targeted areas, while at the same time, leaving sufficient flexibility to Member States to adapt to local conditions and to maintain the consistency of insolvency rules with the broader national legal system. 4.Objectives: What is to be achieved? 4.1.General objectives This policy initiative aims to contribute to the more efficient allocation of capital in the single market and enhance market integration under the CMU. While it cannot and will not, on its own, achieve capital market integration in the EU, it could, alongside other CMU measures (outside the scope of this initiative), contribute to the creation of more favourable conditions for better market integration. ·A first general objective is to allocate capital in the economy more efficiently, which means supporting the provision of credit to companies and improving the adjustment capacity of the EU economy as elements crucial for balanced economic growth and a highly competitive social economy. This requires accomplishing more efficient (non-bank) insolvency regimes in the Member States that are able to generate a higher recovery value of liquidated companies in a shorter time and at lower costs than at present. ·The second general objective is to ensure the free movement of capital in the single market by fostering investors’ trust and increasing cross-border investment, with the ultimate objective of creating a level playing field for all economic operators in the EU concerned with regards to insolvency rules regardless of their location. This demands to make the design of insolvency regimes more similar across Member States and reduce the information and learning costs that they entail for cross border creditors. . Both general objectives reinforce each other. The more efficient the insolvency regimes at national level, the more conducive they are to cross-border investment in the single market. The more similar the elements of insolvency rules are in Member States, the more active would be cross-border investors and therewith - the more intense would be competition among providers of funding and the lower would be the cost of financing for companies. 4.2.Specific objectives The initiative aims to initiate a completion of the toolbox used in insolvency cases by adding specific, targeted elements to insolvency regimes, pursuing the following specific objectives: ·The development of more efficient and similar rules in Member States for better value recovery, notably in the fields of transaction avoidance, asset tracing, directors’ duties and pre-pack procedures. ·The development of more similar rules in Member States for more efficient insolvency proceedings, notably with respect to MSEs procedures, insolvency triggers and insolvency rule transparency to support a timelier conclusion of insolvency proceedings for non-bank companies. ·The development of more similar rules for efficient and fair distribution of recovered values in Member States, notably in the field of creditor committees and the ranking of claims to reduce legal uncertainty and information costs related to insolvency processes for cross-border creditors. Insolvency rules need to be consistent with the wider legal system in the Member States such as company law, labour law and property law. The convergence of insolvency rules should not compromise neither the consistency of national insolvency regimes with other parts of the national legal systems nor a fair treatment of debtors, creditors and other stakeholders in companies undergoing insolvency procedures. 5.What are the available policy options? The problem analysis identified a number of elements related to the value recovery tools, governance of proceedings, and tools for efficient value allocation typically used in insolvency cases that insolvency experts identified as either missing in national insolvency laws in some Member States or inadequate in other Member States to address the problems of overly lengthy and costly insolvency proceedings and low predictability of insolvency proceedings, notably for cross-border creditor. Building on those findings, this section assesses how the problem would evolve if there is no intervention (baseline scenario) and what policy options can be considered to address such problems. Annex 5 complements this section by providing more details on the individual building blocks. 5.1.What is the baseline from which options are assessed? Without action at EU level, Member States are likely to either keep their existing insolvency regimes unchanged over the next years or introduce limited changes that would very likely not be aligned across the EU. After the transposition of the Directive on (preventive) Restructuring and Insolvency, which had to be concluded by July 2022, Member States are unlikely to enhance further the convergence between substantive elements of their national insolvency regimes. Against the forecast of rising bankruptcy figures in light of winding down of public support measures related to Covid-19 and slowing economic activity as a consequence of the energy inflation shock, a rising case load is likely to increase further the duration of insolvency proceedings. This could be partially mitigated by action by Member States to improve court capacity. Annex 6 reports on what kind of measures Member States already envisage to undertake in the area of insolvency in their reform and resilience plans. Furthermore, were not already done, Member States could also improve judicial capacity by making better use of digital means, as well as react to a rising number of insolvency cases by reallocating courts and judges’ capacity to address bottlenecks. While such measures would partly help address the first identified problem, they are unlikely to happen in a uniform matter across the EU.

The prospect of a rising case load and widening divergence in the efficiency of insolvency procedures should be seen against the backdrop of a gradual improvement in cross-border investment flows stimulated by other CMU policy measures and the resulting more important role of cross-border creditors in this context. Increased cross-border activity is likely to exacerbate further the issue around the length and ensuing bottleneck of insolvency proceedings across Member States. Ongoing (or future) CMU measures in other areas will not make this initiative superfluous, but should contribute to addressing other obstacles to cross-border investments. In doing so, these proposals may also implicitly raise the potential number of cross-border insolvency cases in the future. The Commission proposal on the European Single Access Point for company data, once agreed by the co-legislators, should increase the visibility of companies across the EU and hence further facilitate cross-border investment. The upcoming Commission proposal on the Listing Act should make the use of funding through public markets by companies more attractive, also contributing to more public offers of securities cross-border. Cross-border activity is likely to remain significantly below its potential if structural barriers, at least in the area of insolvency, remain unaddressed. The importance to tackle the insolvency-related barriers would remain irrespective of progress made on other determinants. Slow and costly treatment of cross-border creditors’ claims in a liquidated estate and low value recovery, unless tackled, will serve as a serious obstacle and disincentive for them to engage in cross-border investment in the future, reducing the EU growth potential overall. The assessment of the quantitative impact of the envisaged policy measures will use, as a benchmark, the EU averages for recovery values, judicial costs and recovery time experienced by banks as creditors. Since the numbers pre-date the COVID crisis, they are not distorted by the low bankruptcy numbers accomplished by the public support measures in the last years. They are the most recent indicators that represent “normal” business conditions and therefore considered to be suitable for the baseline. Although these values may not be necessarily representative of all creditors, variations in their values would be expected to closely mirror variations for other creditors. 5.2.Description of the policy options Available policy options have been carefully selected and grouped, among others, considering the experience during the negotiatons of the Restructuring and Insolvency Directive, the deliberations and final recommendations of the expert group, the results from the public consultation, a study by an external consultant and extensive interactions with stakeholders. More specifically, the impact assessment considered the areas put forward for harmonisation of insolvency regimes by stakeholders in the public consultation. Furthermore, the group of experts on restructuring and insolvency law elaborated on the scope of these areas. Finally, the external study (Deloitte and Grimaldi (2022)) provided further analysis on the impact of harmonisation in these areas and how the rules in question are currently applied in Member States. Measures that target different elements of insolvency proceedings are packaged in two options that differ in their degree of ambition. Option 1 focuses on targeted elements for which some commonalities already exist across Member States. They would not necessitate that Member States overhaul fundamental principles of their current national insolvency laws (and other areas of national law that are related to insolvency laws). Option 2 is more ambitious as it aims to address the problem more holistically. It includes some elements that certain respondents (e.g. corporates) to the public consultation signalled as obstacles to the efficiency of insolvency proceedings and the removal of which would be beneficial to foster cross-border integration. These in particular concern a trigger for insolvency proceedings and the ranking of claims. As set out in later in this impact assessment (see in particular sections 7 and 8), the higher ambition in option 2 may, however, lead to potential conflicts with other areas of law in Member States, determined by differences in legal tradition, history and policy preferences across Member States. The composition of those packages was intensely analysed, especially on the elements that distinguish the two options. The elements presented in option 1 reflect recommendations by insolvency experts about what they considered appropriate. Option 2 is a credible alternative to Option 1, reflecting the perspective of wider economic and business interests. Given the number of building blocks and links between them, the present grouping of options was considered the only feasible approach to present options with different levels of ambition. Each option, by design, covers a number of elements to ensure that the reform under each option has a meaningful impact (which would not be the case if, instead of grouped options, each element would be presented as a separate option). No additional elements have been identified in interactions with stakeholders and experts, which would also be politically feasible and could thus be incorporated in either (or both) options. Both options suggest legislative changes, namely through a new Directive, whereas the option to pursue them through a Recommendation was discarded from the onset (see section 5.3). 5.2.1.Option 1: Targeted measures on procedural efficiency and value maximization (‘Targeted harmonisation’) Option 1 presents targeted measures grouped based on the problem driver they primarily address. 5.2.1.1. Measures targeting value recovery Under this option, a set of targeted measures would aim to increase value recovery for all creditors, including cross-border creditors in the EU. More specifically, these measures would aim to increase the effectiveness of transaction avoidance rules and subsequent asset tracing for its recovery across the EU. Furthermore, they would aim to introduce more discipline on timely filing of insolvency to avoid unnecessary value destruction in case of delayed filings. Finally, they would seek to put in place harmonised rules on procedures allowing for better value recovery through a pre-pack arrangement. In the case of transaction avoidance, a minimum set of harmonised conditions for exercising avoidance actions would be introduced. 84% of the respondents to the public consultation supported a more comprehensive harmonisation of avoidance actions and for the harmonisation of elements such as the different avoidance grounds, of the objective and subjective conditions leading to avoidance, as well as of the time periods prior to the opening of insolvency, which count as relevant for avoidance claims. More concretely, the following key elements of the transaction avoidance legal framework would be clarified in EU law: types of suspicious transactions, avoidance grounds, related parties, the period during which the avoidance measures can be enacted, and, finally, legal consequences of avoidance, including the liability of third parties and rights of the opponent. Transaction avoidance measures would be complemented by measures strengthening asset traceability through a better-facilitated access by insolvency practitioners to asset registers, notably in a cross-border setting (i.e. when assets have been moved to/acquired in another Member State during the period relevant for transaction avoidance rules). In the public consultation, almost 85% of the stakeholders favoured harmonised rules on assistance (including the interconnectivity of relevant registers) in the cross-border tracing of assets of the insolvent debtor. This would be achieved by enhancing in EU law the access rights of practitioners to a registry in another Member State. This can also build on the already existing arrangements for access to EU-wide interconnected registries (BRIS, BORIS, etc.). Furthermore, to avoid potential asset value losses due to a delay in filing for opening the insolvency proceeding, directors would be obliged to timely file for insolvency within a pre-defined period of time (e.g., at least within the three months of failing the insolvency test of the Member State). Directors failing to comply with this obligation would be held liable. The public consultation yielded widespread support (81%) for minimum harmonization at EU level of the duties and obligations of directors in the event of vicinity of insolvency or when the company is insolvent. In particular, the most beneficial aspect of harmonization would be to impose a duty on the director, once the company is insolvent, to file for insolvency proceedings (71%). Finally, under this option, a minimum set of harmonised standards for a pre-pack liquidation procedure would be introduced to maximise the value preservation in the sale of all or part of the business. The pre-pack rules would set out harmonised conditions for conducting negotiations on the sale of the business before insolvency filing, with the deal finalised in insolvency, hence enabling the realisation of the value of the insolvency estate right or shortly after the official opening of the proceedings. The pre-pack arrangement could thus avoid significant value destruction, which usually happens, when the assets can be realized only at a later stage of the proceedings, long after the opening. The pre-pack rules would include safeguards to ensure transparency and equal treatment of creditors, to avoid abuses. In addition, these safeguards would need to ensure that employees’ rights are not unduly curtailed by the pre-pack administration, including the right to information and consultation. 5.2.1.2.Measures targeting procedural efficiency With SMEs being the backbone of the EU economy, it is important to ensure that the new rules work well also for smaller companies in the EU, for whom the cost of the ordinary (i.e. established) insolvency procedure is prohibitively high, and where a more rapid debt discharge would allow to unblock the entrepreneurship capital for new projects. Under this option, a special harmonised insolvency procedure would be set out in EU law tailored to the needs of micro and small enterprises (MSE). This MSE insolvency proceeding would be designed proportionally to the needs of MSEs, their creditors and other stakeholders, allowing them to be wound down orderly at low costs. Instead of establishing derogations for MSEs from the existing general rules of insolvency proceedings, this option would suggest a bespoke MSE procedure at EU level. This specific procedure should follow a flexible, modular approach, in which the default liquidation process is run with reduced formalities and without the involvement of lawyers or insolvency practitioners. Additional elements, such as the involvement of an insolvency practitioners or the ordering of a moratorium could be included optionally, on the request of the debtor or creditors, thereby keeping costs as low as possible. The procedure would set out simple rules on the entry conditions and the administration of procedures (including digitalisation and automation of key procedural steps and the use of electronic auctions to generate revenues from MSE assets). In order to make this procedure attractive for MSEs, the procedure would be coupled automatically with a debt-discharge. The system shall ensure that liquidations could also be carried out where the debtor’s assets do not cover the costs of the procedure. In addition, under this option, Member States would be required to further enhance transparency of the key features of their respective insolvency rules, by making such information easily accessible to investors on a public website and in a pre-defined user-friendly format, with the e-Justice Portal as default option. This would take the form of a brief factsheet document with standardised key information that would be essential for (potential) investors to make a “glance-through” assessment of the insolvency framework in a given Member State, in a comparable way. The factsheet would provide targeted information about relevant insolvency triggers. It would also contain information on the average duration of an insolvency proceeding in a given Member State. A requirement for Member States to raise awareness among the potential investors on these factsheets would be part of the option.

5.2.1.3.Measures targeting the distribution of recovered values To ensure a distribution of recovered values that is perceived as fair and predictable, this option introduces requirements for improving the representation of interest of the creditors throughout the proceedings and for enhancing the transparency about the ranking of claims. In relation to the representation of the creditors in the insolvency proceedings the option would set out the minimum harmonisation requirements on creditors’ committees. These measures would encompass the establishment of the committee, the organisation of meetings, the voting rules and the powers and duties of the creditors’ committees. As regards the ranking of claims of different types of creditors, the option would introduce enhanced transparency requirements to ensure that Member States make public the easily readable information on the ranking of claims in their jurisdiction in a simplified (user-friendly) format, possibly on the e-Justice portal. This disclosure should include references to national laws setting the ranking and possible exceptions to the standard ranking of claims in corporate insolvency. 5.2.2.Option 2: A more comprehensive harmonisation of insolvency regimes in the EU (‘Wide harmonisation’) Opt