[Revised version as of June 20, 2020]

Rethinking Priority: The Dawn of the Relative Priority Rule and a New ‘Best
Interest of Creditors’ Test in the European Union

Axel Krohn, doctoral candidate, Martin-Luther-University Halle-Wittenberg, Germany

In June 2019, the European legislator adopted the Directive on restructuring and insolvency1
(the ‘Directive’) aiming, inter alia, to provide the EU Member States with an effective tool set
for the early rescue of distressed companies (the ‘preventive restructuring frameworks’ 2 ).
Drawing on Chapter 11 of the U.S. Bankruptcy Code, the legislator provided for a restructuring
plan procedure and a cram-down mechanism. At the last minute, the legislator in Brussels
decided not to base the cram-down on the familiar ‘absolute priority rule’ (the ‘APR’), that is
that a dissenting class of creditors must be paid in full before junior parties may receive any
distributions under a plan, but a completely unknown version of a ‘relative priority rule’ (the
‘EU RPR’), which essentially provides for a partial redistribution of the reorganization surplus
in favor of lower ranking claimants, especially shareholders.

So far, the EU RPR has been controversial in the European literature, to say the least. Recently,
U.S. scholars Jonathan Seymour and Steven Schwarcz have joined the critics.3 It comes as no
surprise that the EU RPR caught their attention: The idea of ‘relative priority’ was first raised
and discussed in the U.S. and in recent years, new approaches have been presented. 4 The
EU RPR, however, has little in common with the U.S. interpretations. In the current debate, one
aspect of the cram-down seems to have fallen short. Not only has the European legislator
presented a unique priority rule, the Directive also introduces a novel and upgraded ‘best

1
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, OJ L 172 of June 26, 2019, at 18.
2
Directive, art. 8–15.
3
Seymour & Schwarcz, Corporate Restructuring under Relative and Absolute Priority Default Rules: A
Comparative Assessment, Duke Law School Public Law & Legal Theory Series No. 2019-84; U. ILL. L. REV.,
Forthcoming, Vol. 2021, No. 1, SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3498611 (last visited
June 20, 2020).
4
The term ‘relative priority rule’ goes back to a scholarly paper by James Bonbright and Milton Bergerman
published in 1928 (see Bonbright & Bergerman, Two Rival Theories of Priority Rights of Security Holders in a
Corporate Reorganization, 28 COLUM. L. REV. 127, 130 (1928)). In recent years, the idea of relative priority
was revived (with different narratives) by Anthony Casey (see Casey, The Creditor’s Bargain and Option
Preservation Priority in Chapter 11, 78 U. CHI. L. REV. 759, 789 (2011), proposing ‘option preservation priority’
to solve the ‘sell-or-reorganization question’, avoiding, however, the term ‘relative priority’) and Douglas Baird
(see Baird, Priority Matters: Absolute Priority, Relative Priority, and the Costs of Bankruptcy, 165 U. PENN. L.
REV. 785, 812 (2017), presenting an out-of-the-money option model to postpone the moment of valuation in
restructuring in order to reduce costs and the risk of errors). The American Bankruptcy Institute Chapter 11
Commission also presented an approach to ‘relative priority’ by recommending that immediately junior (out-of-
the-money) classes should be allocated the hypothetical option value connected to their stake as determined by the
Black-Scholes option pricing model (see AMERICAN BANKRUPTCY INSTITUTE COMMISSION TO
STUDY THE REFORM OF CHAPTER 11, 2012–2014: FINAL REPORT AND RECOMMENDATIONS (2014)
(‘ABI CHAPTER 11 COMMISSION REPORT’), at 214–224).

Electronic copy available at: https://ssrn.com/abstract=3554349

interest of creditors’ test (the ‘BIT’), which has so far received little attention.5 Interestingly, a
close look at the BIT provides an answer to a number of questions and objections that were
raised to the EU RPR. This article responds to the present criticism towards the EU RPR. On
this occasion, it explores the interaction between the EU RPR and the BIT. This article also
addresses the question for which jurisdictions the EU RPR could be of particular relevance and
what problems might arise in practice.

1. The mechanics of the cross-class cram-down

The preventive restructuring frameworks include a plan procedure relatively similar to that in
Chapter 11 of the U.S. Bankruptcy Code. As in Chapter 11, classes of creditors and shareholders
are to vote on a restructuring plan. The plan proposer (likely the debtor in most cases)6 has to
place stakeholders with a ‘sufficient commonality of interest’7 in the same class (Directive, art.
9(4)). Within a class, a stipulated majority must be reached in a vote that shall not exceed 75%
of the amount of the claims or interests in each class and, if applicable,8 of the number of
affected parties (Directive, art. 9(6)). A restructuring plan is deemed accepted if all classes have
voted for the plan with the required majority (Directive, art. 9(6)). If a plan is not approved by
all classes, art. 11 enters the picture: A judicial or administrative authority may, upon the
proposal or with the agreement of the debtor, nevertheless confirm a plan and make it binding
upon dissenting classes of affected parties under certain conditions laid down therein (Directive,
art. 11(1)). This provision is referred to as the ‘cross-class cram-down’.9

The instrument aims at overcoming hold-out scenarios and freeriding positions. A number of
jurisdictions in Europe have not yet provided for such a mechanism. The German pre-
insolvency workout practice10 gives one good example of why a cram-down is desirable: In
absence of a legal instrument of majorization or an obligation for affected creditors to accept
reasonable restructuring measures 11 , claimants are generally invited to free ride on the
sacrifices of other parties. Hold-out positions are also encouraged: While a majority of parties

5
See, however, Mokal & Tirado, Has Newton had his day? Relativity and Realism in European Restructuring, 74
EUROFENIX 20, 21–22 (2018–19), available at https://abi-globalinsolvency.s3.amazonaws.com/resource-
articles/Eurofenix_74_Winter_2018-2019-EU-Cross-Class_Cram-
Down.pdf?aVaD9SrC976VS1fkJlM4UGu_KrXfveu3= (last visited June 20, 2020). Recently, Stephan Madaus
presented a guide to the EU RPR discussing the BIT, see Madaus, Is the Relative Priority Rule Right For Your
Jurisdiction, STEPHAN MADAUS BLOG (January 18, 2020), available at https://stephanmadaus.de/wp-
content/uploads/2020/01/Is-the-Relative-Priority-Rule-right-for-your-jurisdiction-–-Madaus-WP-2020-1-1.pdf.
(last visited June 20, 2020).
6
It is left to the discretion of the EU Member States whether they provide for the possibility for creditors and
‘practitioners in the field of restructuring’ to submit restructuring plans (Directive, art. 9(1)).
7
It is reasonable to assume that in this respect only legal rights of the stakeholders are relevant and not their private
interests, see also Mokal, BEST PRACTICES IN EUROPEAN RESTRUCTURING: CONTRACTUALISED
DISTRESS RESOLUTION IN THE SHADOW OF THE LAW (‘CODIRE REPORT’) (Stanghellini et al. eds.,
2018), at 40.
8
It is left to the discretion of the EU Member States whether they require a majority of the number of parties
concerned in each class (Directive, art. 9(4)).
9
The U.S. equivalent in 11 U.S.C. § 1129(b)(1) is known under ‘cramdown’ or ‘cram down’. In this article, the
mechanism is referred to as ‘cram-down’ for simplicity.
10
Germany has no pre-insolvency or preventive restructuring procedure to date.
11
Bundesgerichtshof (Federal Supreme Court; ‘BGH’), judgement of December 12, 1991 (IX ZR 178/91)
(‘Akkordstörer’). This does not apply to shareholders: BGH, judgement of March 20, 1995 (II ZR 205/94)
(‘Girmes’); BGH, judgement of October 19, 2009 (II ZR 240/08) (‘Sanieren oder Ausscheiden’).

Electronic copy available at: https://ssrn.com/abstract=3554349

seek to find a joint restructuring solution in the common interest (which generally includes
personal sacrifices on the part of at least some stakeholders), hold-out creditors have two threats
on their side, namely (a) ‘give me more or I will not agree’ and (b) ‘give me more or I will
enforce and precipitate insolvency’.12 The Game of Chicken known from game theory well
describes the problem underlying the negotiations using the example of two parties, each with
individual goals but an overriding common interest: Two cars drive head-on towards each other.
The first driver to give way loses the game. If no car swerves, both collide and the game ends
in a catastrophe.13 The ‘catastrophe’ in restructuring negotiations is that no agreement can be
reached and the debtor slides into formal insolvency proceedings, resulting in direct and indirect
insolvency costs14 for the parties involved and a loss of going concern value. In principle, this
holds true for restructurings of all sizes. Looking at larger restructurings with more complex
capital structures, distressed debt trading (claims trading) poses a particular challenge in many
jurisdictions. Hedge funds with sub- or non-performing loan portfolios acquired on the
secondary market below par may jeopardize a collective success in a restructuring through
individually rational behavior aimed at maximizing the return on investment. 15 Though in
Germany hold-out scenarios and freeriders in practice seem not to be a major driver for pre-
insolvency restructurings (workouts) to fail entirely,16 the desire for individual profit among
creditors leads to a collective action problem potentially diminishing (going concern) value.

With respect to implementing the cram-down, the European legislator has provided national
lawmakers a high degree of flexibility 17 . First and foremost, Member States may choose

12
Armour & Deakin, Norms in Private Insolvency: The ‘London Approach’ to the Resolution of Financial
Distress, 1 J. CORP. L. STUD. 21, 42 (2001).
13
On the Game of Chicken and its connection with the ‘Tragedy of the Anticommons’ in property law, see Fennel,
Commons, Anticommons, Semicommons, RESEARCH HANDBOOK ON THE ECONOMICS OF PROPERTY
LAW (Ayotte & Smith, 2011), 35–37; De Weijs, Too Big to Fail as a Game of Chicken with the State: What
Insolvency Law Theory has to say about TBTF and Vice Versa, EUR. BUS. ORG. L. REV. 201, 214 (2013);
Madaus, Leaving the Shadows of US Bankruptcy Law: A Proposal to Devide the Realms of Insolvency and
Restructuring Law, 19 EUR. BUS. ORG. L. REV., 615, 636 (2018).
14
Direct costs include the transaction costs arising from the procedure, for example, the administrators’ or court
fees, while indirect costs comprise the economic losses caused by the procedure, in particular, through a loss in
reputation, see, for example, Warner, Bankruptcy Costs: Some Evidence, 32 J. FINANCE 337, 338 (1977);
Eidenmüller, UNTERNEHMENSSANIERUNG ZWISCHEN MARKT UND GESETZ (1999), at 74–76.
15
Garrido, OUT-OF-COURT DEBT RESTRUCTURING (WORLD BANK STUDY) (2012), par. 72 – also
noting that the existence of a distressed debt market and distressed debt investors is not to be demonized per se:
Concentration of debt in fewer hands helps streamline restructuring and, to a certain extent, distressed debt
investors help to discipline the debtor’s management. Claims trading has indeed become a global phenomenon –
for an interesting assessment from an Australian perspective, see Harris, Class Warfare in Debt Restructuring:
Does Australia Need Cross-Class Cram Down for Creditors’ Schemes of Arrangement, 36 U. QUEENSLAND L.
J. 73, 95 (2017).
16
CONTRACTUALISED DISTRESS RESOLUTION IN THE SHADOW OF THE LAW (‘CODIRE’) –
GERMAN NATIONAL REPORT (2018), at 4, available at https://www.codire.eu/wp-
content/uploads/2019/03/German-National-Report-2.pdf (last visited June 20, 2020); the fact that workouts may
nevertheless often succeed despite a restructuring-unfriendly legal environment, at least in the case of small and
medium-sized enterprises, be explained by the strongly developed relationship lending practice in Germany (which
often relies on a Hausbank as the main lender), see Ehmke et al., The European Union Preventive Restructuring
Framework: A Hole in One? 28 INT. INSOLV. REV. 184, 194 (2019).
17
A comprehensive presentation and discussion of all options under the Directive in relation to plan voting and
confirmation, including those relating to the cram-down, is provided by Richter & Thery, INSOL EUROPE
GUIDANCE NOTE ON THE IMPLEMENTATION OF PREVENTIVE RESTRUCTURING FRAMEWORKS
UNDER EU-DIRECTIVE 2019/1023 – CLAIMS CLASSES, VOTING, CONFIRMATION AND THE CROSS-

Electronic copy available at: https://ssrn.com/abstract=3554349

whether to stick with the EU RPR (Directive, art. 11(1)(c)) or instead provide for an APR
(Directive, art. 11(2)).18 As a starting point (and slightly simplified), the Directive ties a cram-
down plan to the following conditions. Besides meeting a number of procedural requirements,
the plan needs to:

1. meet a ‘best interest of creditors’ test with respect to dissenting affected parties,19
2. be approved by at least one of the voting classes of affected parties,20
3. ensure that dissenting voting classes of affected creditors are treated at least as favorably
as any other class of the same rank and more favorably than any junior class (EU RPR),
and
4. ensure that no class of affected parties can, under the restructuring plan, receive or keep
more than the full amount of its claims or interests.21

Two aspects of the cram-down deserve a closer look, namely the choice of the priority rule
(1.1.) and the BIT (1.2.). Furthermore, the interaction of the EU RPR and the (EU specific) BIT
should be considered (1.3.).

1.1. Absolute and relative priority

1.1.1. The APR

When examining ‘relative priority’, it is reasonable to begin with the familiar idea of ‘absolute
priority’. According to art. 11(2) of the Directive, Member States can refrain from the EU RPR
and instead ‘provide that the claims of affected creditors in a dissenting voting class are satisfied
in full by the same or equivalent means where a more junior class is to receive any payment or
keep any interest under the restructuring plan’. In other words, the Directive gives lawmakers
the option of an APR. In U.S. bankruptcy law, the APR has been elevated to an almost religious
status. Its origins go far back to the times of the restructuring of railroad companies in the U.S.22
The APR, where it exists, only applies directly where a plan is put to a test. Nevertheless, the
possibility of challenging a plan and taking it to court is omnipresent in negotiations and may
be exploited as a strategic threat by the parties involved. In this way, the priority rule shapes

CLASS CRAM-DOWN (April 2020), available at https://www.insol-europe.org/publications/guidance-notes (last

visited June 20, 2020).
18
The European Commission’s 2016 proposal for a directive (COM(2016) 723 final) did not see an EU RPR
option in art. 11, but a mandatory APR; the proposal is available at
https://ec.europa.eu/information_society/newsroom/image/document/2016-48/proposal_40046.pdf (last visited
June 20, 2020). For an overview of the nine amendments made to art. 11 of the Directive on the initiative of the
Council of the European Union, see Lynch Fannon et. al., JCOERE – JUDICIAL CO-OPERATION
SUPPORTING ECONOMIC RECOVERY IN EUROPE: REPORT 1 (2020), at 79, available at
https://www.ucc.ie/en/jcoere/research/report1/report1chapter/ (last visited June 20, 2020).
19
This condition directly applies to the ‘inner-class’ cram-down, i.e. a situation in which a dissenting creditor
within a class is bound by a majority vote (Directive, art. 10(2)(d)). Via reference in art. 11(1)(a) of the Directive,
the test also has to be met in a cross-class cram-down scenario.
20
See Directive, art. 11(1)(b)(ii). Lawmakers may also require the support of a majority of affected classes
(Directive, art. 11(1)(b)(i)).
21
In this regard, the wording of the Directive is slightly different from the proposal made by the pioneers of the
EU RPR. Originally, the ‘present economic value’ was intended to form the upper limit, see Mokal, supra note 7,
at 46. Most likely this idea was discarded as it would take away some incentive for creditors to agree to a plan.
22
Lubben, The Overstated Absolute Priority Rule, 21 Fordham J. CORP. & FIN. L. 581, 585–598 (2016).

Electronic copy available at: https://ssrn.com/abstract=3554349

the entire negotiation process and provides a useful guideline. This is often described with the
metaphor of a shadow cast.23 Looking at the APR in Chapter 11 today,24 it should be noted that
it only applies to dissenting classes of unsecured creditors and shareholders. Germany, on the
other hand, has implemented an APR in its insolvency restructuring procedure
(Insolvenzplanverfahren) covering all ranks of claimants. 25 If Member States choose to
implement ‘absolute priority’, the European legislator has, once again, granted extensive
flexibility: The second subparagraph of paragraph 2 allows for derogations from the APR, as
defined above, ‘where they are necessary in order to achieve the aims of the restructuring plan
and where the restructuring plan does not unfairly prejudice the rights or interests of any
affected parties’. Therefore, the Directive not only allows for a (strict) APR between all ranks
of claimants, but also hybrids or limitations, for example, following the U.S. model,26 as well
as a standardization of exceptions and restrictions, for example, a ‘new value exception’27.28

Essentially, the APR can be described as a waterfall functioning according to the simple law
‘senior first’. The creditors with the highest priority receive their share, next the rank below is
considered and so on until the claimants of a certain rank can no longer be completely satisfied
with values. After that, no lower ranking claimant receives any value. In its simplicity, the rule
establishes a clear guideline for negotiations. The results achieved in practice, however,
regularly deviate from what an applied APR in theory would require.29 In U.S. restructuring
practice, the rule is breached, for instance, in connection with ‘first day motions’, the
assumption of executory contracts and leases or as part of court approved settlement
agreements.30 In their recent article on the EU RPR, Seymour and Schwarcz have dealt in great
detail with the idea of the APR as a ‘penalty default rule’ incentivizing consensual plan
solutions in the shadows of a costly and uncertain valuation of the debtor’s company:31 ‘Rather

23
See, for example, Baird, supra note 4, at 788.
24
11 U.S.C. § 1129(b)(2)(B).
25
Section 245(2) of the German Insolvency Act (Insolvenzordnung).
26
On the notion of a dual waterfall system in Chapter 11 (one distributional waterfall reflecting of ‘asset-based’
claims and the other ‘firm-based’ claims), see Jacoby & Janger, Tracing Equity: Realizing and Allocating Value
in Chapter 11, 96 TEX. L. REV. 673, 689-691(2018).
27
Under a ‘new value exception’ shareholders may retain an interest in the company, ‘even if dissenting senior
classes are not fully satisfied, if in consideration for their retained interest they contribute new funds or new value
that is at least equal to the value of their retained interest’, see Tollenaar, PRE-INSOLVENCY PROCEEDINGS
(2018), par. 6.97. On the limits of the exception under U.S. law, see Bank of America National Trust & Savings
Association v. 203 North LaSalle Street Partnership, 526 U.S. 434 (1999).
28
Stephan Madaus submitted a proposal for the implementation of the Directive into German law, which included
a cram-down that was based on the U.S. provision in 11 U.S.C. § 1129(b)(2) and thereby provided for an APR
waterfall limited to the ranks of unsecured creditors and shareholders; furthermore, the proposal included a
standardized ‘new value exception’, see Madaus, Restrukturierung als Aufgabe des Zivilrechts – eine
Diskussionsgrundlage für die Umsetzung des Restrukturierungsrahmens, STEPHAN MADAUS BLOG (August
16, 2019), at 5, available at https://stephanmadaus.de/wp-content/uploads/2019/08/Madaus-Zivilrechtliche-
Umsetzung-der-Restrukturierungsrichtlinie-eine-Diskussionsgrundlage-WP-2019-08.pdf (last visited June 20,
2020). For a brief description of the ‘mitigated APR’ in the new Dutch pre-insolvency procedure refer to the end
of this section.
29
Lubben, supra note 22, at 583 (‘Indeed, sensible corporate reorganization requires frequent departures from
absolute priority’); Roe & Tung, Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditor’s
Bargain, VA. L. REV. 1235, 1237–1238 (2013) (‘Priority is not in fact absolute. It is often up for grabs’, at 1237).
30
Lubben, supra note 22, at 583 (footnote 13).
31
Seymour & Schwarcz, supra note 3, at 15–24.

Electronic copy available at: https://ssrn.com/abstract=3554349

than attempting to predict the favored outcome of the parties, the penalty default encourages
the parties to opt-out of the default.’32

Also, it is commonly understood that there are drawbacks connected to the APR. Some scholars
have expressed skepticism about the rule because of the complex and costly valuation
bargaining that arises in practice.33 The restructuring of a business is naturally accompanied by
uncertainty about the debtor’s going-concern value. The APR only addresses in what order
value should be distributed, but it cannot give an answer to the question of how much value
each stakeholder should ultimately receive. Parties therefore fight over the amount of value that
the waterfall carries, that is, the size of the going concern surplus. Senior creditors are generally
keen to keep figures as low as possible so that they share less with junior classes. At the other
end of the waterfall, the interest is reversed – the more value reaches junior classes, the better.
Others raise fairness concerns: Cutting off junior classes from receiving value, they argue,
deprives these classes of the option value connected to their stake while secured creditors
benefit by receiving the exclusive right to the future possibilities of the debtor post
reorganization.34 Finally, critics contend that the rigid form of the rule makes it difficult for
prepetition equity security holders (‘old equity’) to retain or receive equity in the reorganized
debtor if certain creditors remain uncooperative and invoke the strict APR waterfall (also a
form of a hold-out problem).35 In certain cases it may, however, be critical or at least valuable
to further involve certain individuals in the business, for example a founder, by means of an
equity interest.36 A particular need to keep old equity in the picture may arise in the case of
(owner managed) (micro,) small and medium-sized enterprises (‘(M)SMEs’).37 One can also
look at this from an incentive standpoint: Why should an owner manager enter a restructuring
proceeding earlier than absolutely necessary when he or she has a prospect of a weak
negotiation position and a loss of control and ownership under a rigid APR?38 Against this
background, the U.S. – home country of APR (!) – recently amended Chapter 11 of their
Bankruptcy Code in a way that this very APR no longer applies to small business
reorganizations.39 National legislators in Europe would be well advised to take this into account
when implementing a priority rule. With its draft Act on Confirmation of an Extrajudicial
Restructuring Plan (Wet homologatie onderhands akkoord, the ‘CERP’), the Netherlands is the
first country in the EU to present a bill for implementing the Directive. The final version of this
bill, which is expected to pass through the Dutch Senate in June 2020 and enter into force in

32
Seymour & Schwarcz, supra note 3, at 21.
33
Baird, supra note 4, at 821.
34
ABI CHAPTER 11 COMMISSION REPORT, supra note 4, at 213–214.
35
ABI CHAPTER 11 COMMISSION REPORT, supra note 4, at 226.
36
ABI CHAPTER 11 COMMISSION REPORT, supra note 4, at 226. This issue can to some degree be addressed
by a ‘new value exception’ (see note 22).
37
Mokal, supra note 7, at 34; Wessels & Madaus, INSTRUMENT OF THE EUROPEAN LAW INSTITUTE –
RESCUE OF BUSINESS IN INSOLVENCY LAW (2017), at 336, available at
https://www.europeanlawinstitute.eu/fileadmin/user_upload/p_eli/Publications/Instrument_INSOLVENCY.pdf
(last June 20, 2020).
38
In this sense Korobkin, Vulnerability, Survival, and the Problem of Small Business Bankruptcy, CAP. U. L.
REV. 413, 425 (1994).
39
In February 2020, 11 U.S.C. §§ 1181–1196 (subchapter V of Chapter 11) came into effect. According to 11
U.S.C. § 1181(a), inter alia, 11 U.S.C. § 1129(b) (which contains the APR) does not apply in a small business
debtor reorganization under subchapter V.

Electronic copy available at: https://ssrn.com/abstract=3554349

July 2020 or shortly afterwards, 40 addresses the aforementioned flexibility problem by
providing for a ‘mitigated APR’ in Article 384(4)(b) CERP. In principle, the distribution of
value realized with the plan must vis-à-vis dissenting voting classes not deviate from the
ranking that applies upon enforcement against the debtor’s assets.41 Deviations are, however,
possible if there are reasonable grounds and the interests of the dissenting creditors or
shareholders are not prejudiced thereby. The legislator has not further specified the
characteristic of these ‘reasonable grounds’. It is also noteworthy that the UK – as the new
prominent non-EU member in Europe – has recently decided against the explicit
standardization of an APR as a condition for the use of cram-down powers in its new
restructuring procedure, which is part of the Corporate Insolvency and Governance Bill
published by the UK government on May 20, 2020.42 Section 901G of the Bill instead merely
provides for a sort of BIT for creditor protection that uses the alternative ‘most likely to occur
to the company if the company or compromise were not sanctioned’ as a comparator 43
(paragraph 4).

Turning to the EU RPR, the third of the aforementioned concerns (inflexibility) seems to have
been the driving force behind the creation of the rule. Although the European legislator itself
has not given a strong explanation of its motives,44 this is clear from what the pioneers of the
EU RPR 45 provided.46

1.1.2. The EU RPR

Indeed, applying a strict and snapshot-based waterfall to a ‘dynamic organism’, that is a debtor
with constantly changing assets and debt values, is not exactly self-evident. The APR in its
rigidity makes it sometimes difficult to negotiate an optimal value creation or conservation in
a going concern. The idea of value maximization has not only been given a special place in the
Directive,47 it is generally one of the most frequently repeated justification for restructuring.
Looking at corporate restructuring from an ex post perspective, formulating a demand for more

40
https://resor.nl/dutch-scheme/ (last visited June 20, 2020); a non-official English translation of the Bill is
available at https://resor.nl/wp-content/uploads/2020/05/English-Translation-Bill-on-New-Dutch-Scheme.pdf
(last visited June 20, 2020).
41
According to Book 3, Title 10 of the Dutch Civil Code (Burgerlijk Wetboek), any other law or instrument based
upon it or under a contractual arrangement.
42
Bill available at https://publications.parliament.uk/pa/bills/cbill/58-01/0128/20128.pdf (last visited June 20,
2020).
43
This UK BIT is fairly similar to the BIT provided for in the Directive, see section 1.2. of this article.
44
The justification given by the European legislator, which can be summarized with that the rule helped overcome
concerns by Member States with respect to the cram-down mechanism in the genesis of the Directive, was
somewhat sparse and admittedly confusing, see Note from Presidency to Council 12536/18 as of October 1, 2018,
at 5.
45
When this article refers to the ‘pioneers of the EU RPR’, this refers to the members of the EU-funded CoDiRe
project. In the course of the project an investigation of various insolvency law systems in Europe has taken place
and scholars from different European jurisdictions have developed best practice recommendations; further
information available at https://www.codire.eu (last visited June 20, 2020).
46
Mokal, supra note 7, at 45–47. Videos of the final conference of the CoDiRe project, which took place on July 5,
2018, are available at https://www.codire.eu/final-conference/ (last visited June 20, 2020): A presentation of the
EU RPR can be found in the video ‘4 - Lunch Time Panel III: The Proposal Directive: Drafting Implications of
the Four-Country Project’.
47
See, for example, recitals 2, 15, 16, 70 and 71 of the Directive.

Electronic copy available at: https://ssrn.com/abstract=3554349

flexibility is therefore not far-fetched. It is worth emphasizing that flexibility is not (and should
not be) an end in itself, but a means to maximize (going concern) value to the benefit of all
stakeholders of an enterprise. In terms of preserving or creating value, making it possible to
reward certain stakeholders in a restructuring willing to contribute to the common good against
irrational or tactical behavior of certain stakeholders, seems reasonable.

That it makes sense in particular cases to dispense with a strict APR does not necessarily mean
that the EU RPR is the right path to follow. One may think of a number of ways to soften the
APR. To trace the gene code of the EU RPR, it is useful to take a step back and have a look at
the restructuring landscape in Europe and some challenges the European legislator had to face
in the genesis of the Directive.

First, one should note that the Directive has a particular focus on facilitating the restructuring
of (M)SMEs. The European legislator stressed that SMEs represent 99% of all businesses in
the EU (Directive, recital 17).48 According to recital 59, ‘the restructuring plan should, for the
purposes of its implementation, make it possible for equity holders of SMEs to provide non-
monetary restructuring assistance by drawing on, for example, their experience, reputation or
business contacts’. By contrast, Chapter 11 of the U.S. Bankruptcy Code, which served as an
inspiration for the European legislator, was drafted primarily with major restructuring cases in
mind, as the ABI Chapter 11 Commission studies have shown. 49 Only recently, the U.S.
legislator has introduced a new Subchapter V of Chapter 11 for the reorganization of small
businesses, in which the APR is not applicable.50 It also seems that many commentators on the
APR in the past have written with a view to restructuring of larger enterprises. The European
legislator sought to pursue a different approach. When the APR states that ‘equity is wiped out
first’, in the case of larger (public) companies this means that (financial) investors lose their
money. However in smaller businesses, the shareholders often provide more than just capital.
Here, it may be crucial to the success of the business going forward not to wipe out
entrepreneurs and families who are involved in the day to day operations by default.51 Also,
Chapter 11 relies conceptually on an active involvement of creditors, 52 which (unsecured)
creditors in SME cases often do not even aim for, since the amount of debt is limited and the
costs of active participation relatively high.53 A stronger position of debtors in negotiations thus
takes into account the realities in SME cases. Finally, since the needs of SMEs were at the

48
The legislator based its assessment on a definition of SMEs provided for in the Annex (art. 2) to the Commission
Recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises,
OJ L 124 of May 20, 2003, at 36. When implementing the Directive into national law, Member States are to
formulate a definition of their own (Directive, art. 2(2)), which may correspond to the EU definition.
49
See De Weijs & Wessels, Proposed Recommendations for the Reform of Chapter 11 U.S. Bankruptcy Code,
Amsterdam Law School Legal Studies Research Paper No. 2015-14; Centre for the Study of European Contract
Law Working Paper No. 2015-05, at 3, SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2595577 (last
visited June 20, 2020).
50
See note 39.
51
See ABI CHAPTER 11 COMMISSION REPORT, supra note 4, at 226. Of course, this is not the case for small
companies that are part of a corporate group. Members of a corporate group may match the characteristics of SMEs
in terms of revenue and the number of employees, but they lack the particular interdependence of the business
with an entrepreneur, see Wessels & Madaus, supra note 37, at 366.
52
See De Weijs & Wessels, supra note 49, at 15.
53
In this sense Davis et. al., MICRO, SMALL AND MEDIUM ENTERPRISE INSOLVENCY – A MODULAR
APPROACH (2018), at 49.

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forefront, the European legislator paid special attention to the particular features of national
insolvency and restructuring laws that specifically affect smaller companies (leading to the next
point).

Second, it was a major challenge in the development of the Directive to draw up a legal
framework that (a) provides an appropriate degree of harmonization and (b) at the same time
offers the necessary flexibility for national legislators to formulate a procedural framework
tailored to their specific needs. As a matter of fact, insolvency and restructuring proceedings
across Europe are far from uniform. A feature on which jurisdictions differ greatly is the
ranking of claims, or respectively, the order of priorities. 54 Germany, for example, is very
similar to the relatively straightforward U.S. model.55 A number of jurisdictions, however, have
certain preferential (priority) claimants ranking ahead of even secured creditors. For example,
France and, in limited form, Italy and Portugal prioritize employee claims.56 More significantly,
in a number of countries tax authorities enjoy preference.57 Italy gives a good example of how
they complicate restructurings: In many cases, fiscal authorities are one of the major creditors
of distressed companies, though they are hard to negotiate with and frequently prove to be
uncooperative. 58 In particular, this holds true for restructurings of MSMEs. 59 One may of
course question why certain jurisdictions have made the choice of granting tax claims priority
and whether the answer to that issue should be amending the priority rule instead of promoting
a change with regard to the priority status. The pioneers of the EU RPR held that ‘such choice
is related to a diffuse and deeply-rooted understanding of public interest as prevailing over
private interests, which goes well beyond the issue of business restructuring’.60 Whether this
answer is ultimately convincing may probably be debated. What is certain, however, is that
uncooperative behavior of preferential (priority) creditors can lead to a structural hold-out
problem that is fueled by a rigid APR waterfall. In the current debate, which is very much
guided by the model of U.S. restructuring law, it should therefore be pointed out that a number
of European jurisdictions have special features which have not been addressed at all in U.S.
literature.

Third, the pioneers of the EU RPR seem to have been inspired by the idea of a pure and separate
restructuring procedure emancipated from the traditional ‘laws of insolvency law’ (in
particular, the classic view of insolvency law as a set of rules for overcoming common pool

54
McCormack et al., STUDY ON A NEW APPROACH TO BUSINESS FAILURE AND INSOLVENCY:
COMPARATIVE LEGAL ANALYSIS OF THE MEMBER STATES’ RELEVANT PROVISIONS AND
PRACTICES, University of Leeds (2016), at 112, available at
https://ec.europa.eu/info/sites/info/files/insolvency_study_2016_final_en.pdf (last visited June 20, 2020).
55
For a good description of the distribution sequence in Germany, see CODIRE – GERMAN NATIONAL
REPORT, supra note 16, at 10.
56
McCormack et al., supra note 54, at 114.
57
McCormack et al., supra note 54, at 114.
58
CODIRE – ITALIAN NATIONAL REPORT (2018), at 36, available at https://www.codire.eu/wp-
content/uploads/2018/12/Italian-National-Report.pdf (last visited June 20, 2020).
59
CODIRE – ITALIAN NATIONAL REPORT (2018), supra note 58, at 36.
60
Danovi & Riva, CODIRE REPORT (Stanghellini et al. eds., 2018), at 160.

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problems61). A strong indication of this is a reference in the CoDiRe Report62 to a 2018 paper
by Stephan Madaus. 63 In essence, Madaus was concerned with developing a differentiated
normative understanding of restructuring and insolvency proceedings, the former being an
instrument for collective debt collection and the latter enabling a fresh start start between a
debtor and its creditors by means of a contractual renegotiation.64 Other legal scholars, for
example Sarah Paterson,65 have also wrestled with the relationship of ‘restructuring law’ and
‘insolvency law’ in the past. During the construction of the Directive, the European lawmaker
was confronted with the particular challenge of creating a solely preventive (‘pre-insolvency’)
procedure and leaving formal insolvency proceedings in Member States untouched. Therefore,
the European legislator was in no position to fully implement a normative separation and create
its own comprehensive restructuring law precisely because it could not intervene in formal
insolvency proceedings of Member States, including insolvency related rehabilitation
proceedings. Germany, for example, will in the future likely 66 have two restructuring
proceedings, one pre-insolvency and the other (which is already existing) as part of the German
Insolvency Act (Insolvenzordnung)67 . Nevertheless, these studies seem to have served as a
source of inspiration for questioning traditional laws of insolvency law and breaking new
ground. In the words of Bob Wessels: ‘It is not about insolvency law as we know it’. 68 A
conceptual differentiation of the European restructuring frameworks from Chapter 11 and the
accompanying classical law and economics literature, which often sees an reorganization plan
as an instrument of collective debt collection, 69 allows to reconsider the entitlement to the
reorganization surplus and thus the design of the priority rule. It is no coincidence that those in
Europe are most strongly opposed to the EU RPR, who are strongly influenced by this very law

61
A good illustration of the common pool problem is provided by de Weijs, Harmonisation of European
Insolvency Law and the Need to Tackle Two Common Problems: Common Pool & Anticommons, 21 INT.
INSOLV. REV., 67, 68–72 (2012).
62
See note 7.
63
Mokal, supra note 7, at 46, with a reference to Madaus, supra note 13, 615.
64
In a nutshell, the doctrinal approach includes a differentiation in a sense that ‘restructuring law’ is addressing
the ‘tragedy of the anticommons’, i.e. the problem of underusing a common good (or, specifically, the debtor’s
potential value created as a going concern), while insolvency law (in a narrow sense) is concerned with the ‘tragedy
of the commons’, i.e. overusing a common good (in this case by value-destroying individual enforcement actions),
see Madaus, supra note 13, at 632–636. Madaus’ theory goes beyond the challenging question of a characterization
of pre-insolvency proceedings in private international law. Specifically on this question of characterization, see
Mevorach & Walters, The Characterization of Pre-Insolvency Proceedings in Private International Law, EUR.
BUS. ORG. L. REV., published online February 26, 2020, available at
https://link.springer.com/article/10.1007/s40804-020-00176-x (last visited June 20, 2020).
65
Paterson, Rethinking the Role of the Law of Corporate Distress in the Twenty-First Century, LSE Law, Society
and Economy Working Papers 27/2014, available at http://eprints.lse.ac.uk/60583/1/WPS2014-27_Paterson.pdf
(last visited June 20, 2020).
66
See, in this sense, for example, Goetker, SANIERUNGSRECHT (Flöther, 2018), at 27–29; Madaus,
Erkenntnisse aus der ESUG-Evaluation für die Richtlinienumsetzung: Wie passt ein präventiver
Restrukturierungsrahmen in das deutsche Recht?, 22 NEUE ZEITSCHRIFT FÜR INSOLVENZRECHT –
BEILAGE (2019) (‘NZI-BEILAGE (2019)’) 59, 61; for a different opinion, see Dahl & Linnenbrink, Die
Umsetzung der EU-Richtlinie durch den deutschen Gesetzgeber, 22 NZI-BEILAGE (2019) 45, 46.
67
The ‘insolvency plan procedure’(Insolvenzplanverfahren) is set out in sections 217–269 of the German
Insolvency Act (Insolvenzordnung).
68
Wessels, The Full Version of My Reply to Professor De Weijs et al. (2019-03-doc10), BOB WESSELS BLOG
(March 22, 2019), available at https://bobwessels.nl/blog/2019-03-doc10-the-full-version-of-my-reply-to-
professor-de-weijs-et-al/ (last visited June 20, 2020).
69
Jackson, THE LOGIC AND LIMITS OF BANKRUPTCY LAW (1986), at 14.

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and economics approach and see nothing but an insolvency proceeding in the Directive.70 On
this occasion it should be mentioned that also in the U.S. the question of who is entitled to the
reorganization surplus is not naturally answered in the sense of the APR and that very intensive
thought has been given to where the reorganization surplus actually comes from and who should
therefore participate in it and to what degree.71 These approaches come much closer to the
EU RPR than the recent advocates of relative priority in the U.S. do.
Returning to the Directive, the European legislator found itself in a dilemma when creating it.
On the one hand, there was the ambition of a powerful restructuring framework that provides
(viable) businesses with an effective tool set to overcome financial hardships and thereby, inter
alia, prevents the build-up of non-performing loans,72 stimulates cross-border activities,73 and
ultimately fosters a proper functioning of the European internal market.74 On the other hand,
the Directive was not allowed to severely undermine national insolvency proceedings
(including insolvency related restructuring proceedings) or, by drastically improving the
debtor’s position, even overcome market laws. In this situation it was not possible for the
legislator to fully rely on the comprehensive economic analysis of U.S. bankruptcy law.
Liquidation and reorganization75 proceedings in the U.S. are forged from one piece: They stand
side by side as two chapters of Title 11 of the U.S. Code.76 A purely ‘preventive’ or ‘pre-
insolvency’ restructuring proceeding in the European sense does not exist. This becomes clear
in small but important details. To be sure, a debtor may voluntarily file under Chapter 11 at any
time and irrespective of insolvency or any other court test at entry (11 U.S.C. § 301(a)). One
may therefore conclude that Chapter 11 is essentially a hybrid of a preventive (pre-insolvency)
proceeding and a formal rehabilitation procedure77 with a practical focus on pre-insolvency
cases. Unlike in a Chapter 11 case, however, debtors in a European preventive restructuring

70
See Tollenaar. The European Commission’s Proposal on Preventive Restructuring Proceedings,
30 INSOLVENCY INTELLIGENCE 65, 71 (2017); Eidenmüller, Contracting for a European Insolvency Regime,
18 EUR. BUS. ORG. L. REV. 273, 289–291 (2017); De Weijs, Jonkers, & Malakotipour, The Imminent Distortion
of European Insolvency Law: How the European Union Erodes the Basic Fabric of Private Law by Allowing
‘Relative Priority’ (RPR), Amsterdam Law School Legal Studies Research Paper No. 2019-10; Centre for the
Study of European Contract Law Working Paper No. 2019-05, at 14, SSRN:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3350375 (last visited June 20, 2020); Rotaru, Droit et
Croissance, THE RESTRUCTURING DIRECTIVE: A FUNCTIONAL LAW AND ECONCOMICS ANALYSIS
FROM A FRENCH LAW PERSPECTIVE, at 15–16, 48.
71
See, for example, Tene, Revisiting the Creditors’ Bargain: The Entitlement to the Going-Concern Surplus in
Corporate Bankruptcy Reorganizations, 19 BANKR. DEV. J. 287 (2003) (‘Any additional value (that is, the
going-concern surplus), should not be distributed under bankruptcy law, but rather left for the parties to allocate
among themselves through a process of structured negotiations’, at 288); Harner, The Value of Soft Variables in
Corporate Reorganizations, 2015 U. ILL. L. REV. 509 (2015) (putting forth the idea of a ‘contributory priority
scheme’ that seems closely related to the concept of the EU RPR, see at 538); Jacoby & Janger, supra note 26
(analyzing the ‘dual waterfall’ system in Chapter 11, at 689–691).
72
Directive, recital 3.
73
Directive, recital 7.
74
Directive, recital 1.
75
‘Reorganization’ is the term used in the U.S. in connection with Chapter 11 of the U.S. Bankruptcy Code.
Businesses file under Chapter 11 in order to restructure their debt and/or business.
76
Chapter 7 governs the process of a liquidation bankruptcy and Chapter 11 of a reorganization bankruptcy. It
should be noted that debt restructuring in the U.S. is subject to a constitutional peculiarity. Due to Art. I, s. 10, cl.
1 of the U.S. Constitution (the ‘Contract Clause’), states are prohibited from using their contract law jurisdiction
to pass a bill ‘impairing the obligation of contracts’. Consequently, any debt impairment was reserved for the
federal legislator under the ‘Bankruptcy Clause’ in Art. I, s. 8, cl. 4 of the U.S. Constitution. It therefore is not
surprising that there is no requirement for an (insolvency) test at entry for a debtor’s voluntary filing under
Chapter 11 (see 11 U.S.C. § 301(a)). For a comprehensive description, see Madaus, supra note 13, at 628–629.
77
Mevorach & Walters, supra note 64, at 10.

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framework may break off negotiations and exit proceedings at any time and without procedural
consequences.78 In a voluntary Chapter 11 case, the debtor is always faced with the risk of
losing control and experiencing the appointment of a trustee or an examiner and maybe even a
conversion to Chapter 7 liquidation.79 One may see in this a disincentivizing counterbalance to
the non-existent hurdle at the beginning of the procedure. In any case, this illustrates well –
among other features80 – that, despite strong parallels to Chapter 11, the normative approach of
the European legislator to the creation of a restructuring procedure shows significant
differences in its underlying concept. Against this background it comes as no surprise that there
have been calls in Germany for a clear separation (‘Abstandsgebot’) between the preventive
restructuring framework and formal proceedings (which include the Chapter 11 inspired
insolvency restructuring procedure81).82 Nevertheless, it must be recognized that the Directive
allows for a variety of interpretations and possible implementation concepts, 83 which may well
be oriented (more) closely to Chapter 11. At least for those who see in the Directive a new
approach to the early restructuring of companies, a new narrative may be described: The
European preventive restructuring frameworks tell the story of a viable (albeit ailing) debtor
not yet at the gates of formal insolvency proceedings and therefore not yet obliged to hand over
the keys (and maybe equity) in full to its creditors. The EU RPR fits into this picture with its
intention to strengthen the position of the debtor with regard to the going concern surplus and
to create an incentive to enter proceedings in the first place. Whether this new ‘European
dualism’ between (EU) pre-insolvency and (national) insolvency rules is ultimately convincing,
however, remains to be seen.

Having decoded the genes of the EU RPR, it can be stated that the rule is most attractive for (a)
jurisdictions that would likely face structural hold-out problems under an APR regime (i.e.
jurisdictions with strong and inflexible ‘preferred creditors’) and (b) in particular for (M)SME
restructurings. This does not mean that lawmakers may not experiment with the flexibility of
the EU RPR in legal systems with limited hold-out potential under an APR or with respect to
larger restructuring cases. Flexibility, however, is not necessarily beneficial and may turn
against certain stakeholders (especially less sophisticated unsecured creditors).84 The potential
for abusing the EU RPR requires a counterbalance, that is an instrument that respects and
guarantees pre-insolvency rights of stakeholders without undoing the desired flexibility by the
back door. At this point the focus should turn to the BIT.

78
See Balz, Insolvency Proceedings and Preventive Frameworks, UNTERNEHMENSRESTRUKTURIERUNG
IM UMBRUCH?! (Ebke et. al. eds., 2017), 71, 76.
79
See Balz, supra note 78, at 76.
80
A number of distinguishing features have been identified by Mevorach & Walters, supra note 64, at 13.
81
See note 67.
82
See, for example, Siepmann, PRÄVENTIVE RESTRUKTURIERUNG (Morgen, 2019), art. 4 par. 32; Hölzle,
Zur Umsetzung des präventiven Restrukturierungsrahmens in Deutschland, 41 ZEITSCHRIFT FÜR
WIRTSCHAFTSRECHT (ZIP), 585, 586 (2020).
83
Vasile Rotaru has comprehensively demonstrated that the policy lacks a coherent conceptual foundation, see
Rotaru, supra note 70, at 20–26.
84
In that sense Lubben, supra note 22, at 606 (‘Flexibility in the furtherance of preserving going concern value
seems laudable, while flexibility in service of undercompensating disfavored creditors is properly loathed’).

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1.2. The BIT

The European legislator has not only introduced a new priority rule, but also made changes to
the BIT as we know it. Again, the idea originates in U.S. bankruptcy law: According to 11
U.S.C. § 1129(a)(7)(ii), the use of cram-down powers requires that each holder of a claim or
interest in an affected class will receive or retain under the plan value that is not less than the
amount that such holder would receive or retain if the debtor were liquidated under Chapter 7
of the U.S. Bankruptcy Code. In other words, the BIT requires that the value that an affected
party, not the class as a whole, receives does not fall short of what it would receive in a
hypothetical liquidation (whether piecemeal or as a going concern). In terms of creditor
protection, this BIT is of little significance in a APR regime.85 The coexistence of these two
cram-down conditions determines, however, what the ‘waterfall’ in theory is about: the
reorganization surplus, i.e. the difference in value between the value recoverable in a liquidation
of the debtor’s assets and the value of the firm in a reorganization. Under a strict APR regime,
this precise differentiation is of little relevance, as the order of entitlements in relation to the
liquidation value and the reorganization surplus is the same.

The BIT from the Directive is different. The EU definition in art. 2(1) of the Directive reads as
follows:

(…) ‘best-interest-of-creditors test’ means a test that is satisfied if no dissenting creditor

would be worse off under a restructuring plan than such a creditor would be if the
normal ranking of liquidation priorities under national law were applied, either in the
event of liquidation, whether piecemeal or by sale as a going concern, or in the event of
the next-best-alternative scenario if the restructuring plan were not confirmed.

Recital 52 further specifies:

Satisfying the ‘best-interest-of-creditors’ test should be considered to mean that no

dissenting creditor is worse off under a restructuring plan than it would be either in the
case of liquidation, whether piecemeal liquidation or sale of the business as a going
concern, or in the event of the next-best-alternative scenario if the restructuring plan
were not to be confirmed. Member States should be able to choose one of those
thresholds when implementing the best-interest-of-creditors test in national law. That
test should be applied in any case where a plan needs to be confirmed in order to be
binding for dissenting creditors or, as the case may be, dissenting classes of
creditors. As a consequence of the best-interest-of-creditors test, where public
institutional creditors have a privileged status under national law, Member States could
provide that the plan cannot impose a full or partial cancellation of the claims of those
creditors.

Seymour and Schwarcz have pointed out that the definition is rather vague with regard to what
the comparator of the test should actually be (piecemeal liquidation, going concern sale or the

85
Seymour & Schwarcz, supra note 3, at 42.

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next-best-alternative scenario).86 There are likely two reasons for that: First, the Directive also
provides for an APR that EU Member States can opt for. Granting the national legislators with
some flexibility to form a BIT depending on their choice of priority seems plausible. Second,
it should be noted that lawyers and decision makers from various jurisdictions were involved
in the genesis of the Directive. In particular, the cram-down mechanism and its composition
posed a problem for a number of Member States.87 It can therefore be assumed that the final
wording in its open form is the result of a compromise. The pioneers of the EU RPR, however,
were very clear about how the BIT should be shaped and combined with the EU RPR. In their
view, the scenario that is ‘most likely to materialize if the plan were not confirmed’ (that is a
‘next-best-alternative scenario’ in the sense of a ‘then realistic scenario’)88 should form the
benchmark.89 In the further analysis of the EU RPR, it therefore seems reasonable to read the
BIT in this way (being the ‘EU BIT’). So, the pressing question is what exactly is different
about the EU BIT?

The first novelty is obvious. With the new comparator, the EU RPR addresses the distribution
of a special form of reorganization surplus, which could be referred to as the next-best-
alternative scenario surplus. Depending on what the next-best-alternative scenario is in a
particular case, the EU BIT will exceed the traditional liquidation baseline. In theory, the test
will limit the surplus free for distribution to what can only be achieved by cooperative effort –
taking into account that the debtor is not due for formal insolvency proceedings. At the same
time the test respects claimants’ pre-insolvency rights, that is the ‘realizable value’ of existing
claims and equity rights.90 This is consistent with the spirit that drove the pioneers of EU RPR:
As explained above, a key idea in the development of the EU RPR seems to have been to detach
the priority rule from the ‘laws of insolvency law’ as they have been handed down from the
classic law and economics advocates.91 The EU BIT defines a congruent baseline that no longer
(necessarily) refers to an insolvency related distribution, that is to the value that can be
recovered in a liquidation of the debtor’s assets. Depending on the case, the comparator may
indeed be a debtor’s liquidation in form of a piecemeal sale or a going concern sale.92 In other
cases, however, it may, for example, be a different restructuring plan with adequate support93
or even the continuation of the debtor’s business without any restructuring plan if insolvency
is not predominantly likely94. Contrary to what Seymour and Schwarcz seem to suggest,95 the
application of the EU BIT thereby does require a valuation of the debtor’s business in the next-
best-alternative scenario, and a precise one in fact.96

86
Seymour & Schwarcz, supra note 3, at 42.
87
Note from Presidency to Council 12536/18 as of October 1, 2018, at 5.
88
The wording may indeed be interpreted differently, see Mokal & Tirado, supra note 5, at 21–22.
89
Mokal, supra note 7, at 44–45.
90
Madaus, supra note 5, at 2.
91
See section 1.1.2 of this article.
92
Mokal, supra note 7, at 44; Madaus, supra note 5, at 2.
93
Mokal, supra note 7, at 44; Madaus, supra note 5, at 2.
94
Madaus, supra note 5, at 2. Whether this is a realistic scenario depends on how early the preventive restructuring
frameworks can be accessed, that is in what way Member States interpret and implement the criterion of a
‘likelihood of insolvency’ from art. 4(1) of the Directive.
95
Seymour & Schwarcz, supra note 3, at 25–26.
96
Madaus, supra note 5, at 7.

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The second innovation of the EU BIT concerns the function it has under the cram-down
mechanism. As mentioned above, the BIT has little relevance in an APR regime, since the bar
it sets is relatively low whereas the APR itself follows the same order of entitlements and
provides comprehensive protection of creditors’ rights. While the APR has been extensively
studied in the literature and by courts, the BIT long lived in the shadows – owing to its low
significance. It is therefore not surprising that the EU BIT has so far received little attention in
the evaluation of the EU cram-down mechanism. However, instead of merely focusing on the
EU RPR (and demonize it as disrespecting creditor rights),97 one should look at the cram-down
mechanism as a whole and especially the interaction of the EU RPR and the EU BIT. The gap
in creditor protection created by the flexibility of the EU RPR is in theory98 largely, or at least
partly, filled by the EU BIT.

1.3. The interaction of the EU RPR and the EU BIT (in theory)

In a 2019 paper, Rolef de Weijs, Aart Jonkers and Maryam Malakotipour dealt extensively with
the EU RPR and delivered a scathing verdict. They mainly feared a ‘distortion of the insolvency
process’ and argued the EU RPR would curtail creditors’ rights and transfer wealth from
creditors to shareholders.99 They held that the APR, on the other hand, were a ‘basic rule of
creditor protection that upholds basic non-bankruptcy law: equity is wiped out first’.100 The
consequences they pictured along implementing an EU RPR could give indeed a cause for
concern: ‘If insolvency law is allowed to develop in such a way that it no longer respects the
basic fabric of our private law, our market economy and our society changes’101. The authors
illustrated their view with, inter alia, a model calculation in which secured creditors and
shareholders squeeze junior (unsecured) creditors almost entirely out of the capital structure.102
People familiar with the history of US bankruptcy law may believe that the times of equity
receiverships are dawning again under the EU RPR.103

The theory postulated in this article, however, suggests that due to the interaction of the
EU RPR and the EU BIT, the scenarios presented (as well as the feared consequences in
general) are highly exaggerated. One should be aware that the reorganization surplus is not
available and ready for distribution from the outset. This is something that does not seem to be
considered in the model calculations presented by de Weijs et al. They were probably set up as
if the fight for the reorganization surplus were a zero-sum game, that is a situation in which one

97
See section 1.3 of this article.
98
Likely practical problems are discussed in section 2 of this article.
99
De Weijs et. al., supra note 70, at 1–2. Similar concerns were raised by German scholar Moritz Brinkmann in a
blogpost (in German), see Brinkmann, European Insolvency & Restructuring, TLE-009-2019 (March 25, 2019),
available at https://www.tax-legal-excellence.com/die-relative-vorrangregel-aus-art-11-1-c-der-
insolvenzrichtlinie-nicht-nur-untauglich-sondern-brandgefaehrlich/ (last visited June 20, 2020). Also sympathetic
to this view is Vasile Rotaru, who analyzed the Directive from a functional law and economics standpoint, see
Rotaru, supra note 70, at 48. A summary of the main arguments put forward against the EU RPR by academics is
provided by Richter & Thery, supra note 17, par. 132.
100
De Weijs et al., supra note 70, at 1.
101
De Weijs et al., supra note 70, at 2.
102
De Weijs et al., supra note 70, at 18.
103
The APR developed as a response to abuses in the federal equity receiverships (forerunners of today’s
Chapter 11 cases), in particular with regard to the practice of squeezing out the general unsecured creditors, see
Lipson, The Secret Life of Priority: Corporate Reorganization After Jevic, 93 WASH. L. REV. 631, 672 (2018).

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participant’s gain equals the loss of another. In reality, this is not the case. Often a Pareto
efficient 104 value preservation can only be achieved by cooperation between various
stakeholders. They will need to contribute to the business as a going-concern by providing, for
example, future finance, workforce, supplies, licenses or rental space. 105 Think of the
reorganization surplus as a moving target.106 To hit a moving target, sometimes the marksman
has to move. And cooperation, of course, requires participation. Contrary to what the critics
seem to suggest, things are not being turned upside down. The EU RPR/EU BIT interaction
guarantees that secured creditors will always receive at least the value of their collateral (that
is what they would receive in an individual case of enforcement) plus a large piece of the
remaining surplus (which is yet to be defined) under ‘relative priority’. Unsecured creditors can
also rely on the next-best-alternative scenario as a protective shield and further claim a part of
the premium. In comparison with an APR regime, some will certainly receive more and others
less. In theory, however, large distortions are being absorbed by the EU BIT.

Following this logic, the question could now be raised as to why senior creditors need to be
treated relatively better at all with regard to the next-best-alternative scenario surplus.107 This
may be explained in the light of fairness. In the eyes of the creditors, a restructuring naturally
implies a bet on the debtor’s future returns.108 The restructured business may still prove to be
unsustainable and the debtor slide into a formal insolvency proceeding eventually, destroying
some or all going concern value along the way. In formal insolvency proceedings, the entire
going-concern value is made available to creditors for their satisfaction. One may therefore
conclude that the contribution creditors make to the business going forward outside insolvency
(or a formal insolvency proceeding, respectively) becomes more significant the higher their
entitlement to value in the event of insolvency is.109 Admittedly, the concept of a ‘relatively
better treatment’ between ranks is not set in stone and may therefore be challenged. One could,
for example, also consider designing (relative) priority by introducing a multiplier between
ranks and require that classes of unsecured creditors should be treated twice or three times as
favorably as equity classes. This would, of course, be in no way less arbitrary. And looking at
the EU RPR approach, it is precisely the absence of clear parameters that allows for the
flexibility that may well be crucial in certain cases.

104
‘A particular situation is said to be Pareto or allocatively efficient if it is impossible to change it so as to make
at least one person better off (in his own estimation) without making another person worse off (again, in his own
estimation)’, Cooter & Ulen, LAW AND ECONOMICS (2008), at 17.
105
Madaus, supra note 5, at 3.
106
Coherently, practitioners refer to the point in the capital structure at which the ‘value breaks’ (fulcrum layer)
as a ‘moving target’, de Chapeaurouge & Hafner, Loan-to-Control als Strukturalternative des Praxisgebiets
Distressed Mergers and Acquisitions, HANDBUCH DER UNTERNEHMENSSANIERUNG (Knecht et al. eds.,
2018), 845, 850.
107
This idea may take some readers by surprise. However, almost twenty years ago Omar Tene made such a
demand with a number of good arguments, see Tene, supra note 71, 288: ‘We propose that bankruptcy law
preserve for secured creditors an amount equal to the liquidation value of their collateral plus interest at the market
rate for the duration of the automatic stay. Any additional value (that is, the going-concern surplus) should not be
distributed under bankruptcy law, but rather left for the parties to allocate among themselves through a process of
structured negotiations.’
108
Madaus, supra note 5, at 3.
109
Madaus argues more generally that ‘some cooperating stakeholders may expect a different distribution based
on their legal entitlements’, see Madaus, supra note 5, at 4.

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2. Is the ‘EU RPR/EU BIT cram-down’ desirable (in practice)?

‘Is EU RPR desirable?’ asked de Weijs et al.110 From what this article has set out to describe,
the question should rather be ‘Is the EU RPR/EU BIT cram-down desirable?’. At this point an
assessment is made as to whether the interaction between EU RPR and EU BIT would work in
practice.

A concern about the EU RPR/EU BIT cram-down is that it comes along valuation uncertainty
not only vertically (as under an APR regime) but also horizontally: Under an APR only those
will contest a plan who believe that they should or could have received (more) value under the
waterfall of distribution. The likely contesters are mezzanine or junior creditors and maybe pre-
petition shareholders (that is the pre-restructuring equity) who argue that they should have been
kept in the picture (to a greater extent).111 From the perspective of senior classes, on the other
hand, the fight is about not sharing too much value with lower ranking classes. U.S. practice
shows that senior creditors seek to avoid these negotiations where possible (what is there to win
for them if there are sufficient assets with the debtor?) and instead prefer going concern sales
(‘today we sell firms in bankruptcy to the highest bidder’).112 One could therefore assume that
it would make sense to simplify valuation bargaining and not make things worse.

Under an EU RPR, however, all ranks of stakeholders are likely to disagree with a plan solution.
In absence of the clear structure of an APR waterfall, there is much potential for all ranks to
question if their new stake reflects the next-best-alternative scenario value (how much was this
again?) plus a fair piece of the surplus (how much was this again?) under the EU RPR. In fact,
there are now two unknown values that mark out the realm in which the EU RPR operates. At
the bottom end is the next-best-alternative scenario value guaranteed by the EU BIT, at the top
lies the reorganization value of the debtor’s enterprise. If value bargaining under an APR is
tough, negotiating a sweet spot between two uncertain hypothetical values will likely be
tougher. In particular, that will be a challenge in larger restructurings. This does not come
without irony as the U.S. version of ‘relative priority’ introduced by Douglas Baird at its core
presents a solution to the problem of costly and complicated valuation of the debtor’s firm.113
From a penalty default rule standpoint, one could now argue that there is little to complain
about the EU RPR: The combination of an EU RPR and EU BIT will likely cause severe
uncertainty with respect to any attempt of valuation, a judicial being no exception. In contrast
to an APR regime, however, one essential feature is missing: a clear guideline for negotiations.
Under an APR, no one questions that (more) senior people go first in principle. This gives them
some control of the restructuring process. In view of valuation uncertainty, senior creditors
nevertheless tend to share some value with junior (potential out-of-the-money) creditors in
order to reach a consensual plan solution. 114 What they receive can be seen as ‘calculated
sacrifice’. Under an EU RPR, on the other hand, this ‘give-and-take’ loses its guidance. Carried

110
De Weijs et al., supra note 70, at 13.
111
Harris, supra note 15, at 85 (‘Clearly, the higher the company’s estimated value, the more likely the value
breaks down the priority ranking’).
112
Roe, Three Ages of Bankruptcy, 7 HARV. BUS. L. REV. 187, 205–207 (2017).
113
Baird, supra note 4, at 812–821.
114
Seymour & Schwarcz, supra note 3, at 19.

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by horizontal valuation uncertainty and a lack of clear entitlement paradigms, the praised
EU RPR flexibility could come at the expense of plan negotiability and plan acceptance. It is
doubtful whether the debtor could regularly find the necessary majorities for a consensual plan.
As a result, more plans could end up in court.115 In addition to a longer duration of proceedings
and expected higher costs for the parties involved, it seems doubtful whether it is appropriate
and sensible to give the decision-making power to a judge with no skin in the game. It should
also be borne in mind that courts in the EU Member States tend to be less experienced and
qualified in valuation and fairness matters than the U.S. courts. Also Madaus, who seems to
have gained some sympathy for the idea of an EU RPR for some Member States, has made it
very clear that the courts are not the appropriate decision-makers in these questions.116 Finally,
it is difficult to imagine that certain sophisticated parties with the necessary financial strength
will not, in larger cases, try to exploit this ubiquitous uncertainty to their own advantage – for
example, by threatening to hold-up the proceedings to the detriment of all parties.

It is likely that there will mainly be a disadvantage for unsophisticated junior creditors. As
stated above, secured creditors will receive under the EU BIT at least what they would receive
in an individual case of enforcement – a value that can probably be pinned down with at least
a reasonable degree of accuracy. Unsecured creditors, on the other hand, will lack any point of
reference and probably have difficulties demonstrating what the next-best-alternative scenario
is from their perspective. This is particularly true as they tend to have less insight into the
debtor’s situation and fewer resources at hand than (secured) financial creditors relying on
sophisticated monitoring. One can therefore assume that they are easy prey in complicated
expert battles and that the protection of the EU BIT, which may be convincing in theory, falls
short in practice. To mitigate this at least to some extent, national lawmakers should refrain
from the option in art. 11(1)(b)(ii) of the Directive, which allows for the confirmation of a plan
that is supported by only one class. It would instead be more appropriate to require the support
of a majority of affected classes (Directive, art. 11(1)(b)(i)). 117 One could even consider
whether one supporting class should be a class of unsecured creditors. This, however, would in
turn come at the expense of flexibility and, again, generate hold-out risk.

3. Conclusion

When implementing the cram-down from the Directive, national legislators may choose
between a familiar APR and a novel EU RPR. This article responds to the extensive criticism
levelled at the EU RPR. What has not been considered adequately so far is the new interaction
between the EU RPR and an ‘upgraded’ EU BIT. The new EU RPR/EU BIT cram-down
reflects existing criticism of the APR and was designed to create flexibility, particularly where
the APR has proven to be too strict and often disadvantageous: in cases of (M)SME
restructuring. Especially in jurisdictions where hold-outs of preferred (priority) creditors are

115
In this sense also Seymour & Schwarcz, supra note 3, at 49.
116
‘Assigning the decision to a judge disconnects the decision-making power from the risk-bearing parties. The
creditors are those who suffer losses if a restructuring turns out to be bad. Even more, a restructuring decision
requires decision-making under uncertainty as the conditions of the future business development are mostly
unknown. Decision theory suggests that such a type of decisions are better left to a larger group of persons instead
of a single expert.’, see Madaus, supra note 13, at 634.
117
For other reasons this is also suggested by Madaus, supra note 5, at 4.

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likely, the new rule could unfold benefits. In theory, the EU BIT absorbs large distortions in
the allocation of reorganization value, whereas the flexible EU RPR addresses merely that part
of the reorganization surplus that can often only be generated by means of actual cooperation
between stakeholders. Whether this interaction could prove successful in practice is another
question. The fact that two hypothetical values now mark out the realm in which the EU RPR
operates and the rule itself lacks a clear guideline for entitlement gives cause for concern that
the new flexibility could come at the expense of plan negotiability and plan acceptance. In
particular unsophisticated junior creditors could be worse off under an EU RPR/EU BIT cram-
down as they will likely have difficulties in defending their rights under the EU BIT.

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