A Major Shift of the Italian Supreme Court on Bankruptcy Buy-Outs (concordati fallimentari)

Restructuring Alert

With a decision taken on 28 June 2018 (decision n. 17186) the united chambers (sezioni unite) of the Italian Supreme Court have ruled that whenever a bankruptcy buy-out proposal (proposta di concordato fallimentare) is filed the interest of the subject filing such proposal is technically conflicted with the interest of creditors with the consequence that the subject filing the proposal cannot vote on it.

Under Italian law a bankruptcy buy-out proposal can be filed by the debtor (after 1 year from the opening of the bankruptcy proceedings), any creditor and any third party. The proposal must be approved by the majority of (unsecured and impaired secured) creditors (in amount of claims) and the majority of classes, if any (this means that a subject filing a buy-out proposal votes on the proposal whenever it is a creditor of the debtor and is eligible to vote).

The Bankruptcy Law (Royal Decree 267/1942) bans expressly from voting only (a) affiliates of the debtor (and relatives, where the debtor is an individual), (b) assignees of the claims of such affiliates (and relatives) and (c) assignees of claims where the assignment occurred following opening of the bankruptcy proceedings, unless the assignor is a bank or a financial intermediary.

Exclusions from voting of subjects other than those expressly provided by the Bankruptcy Law had so far been largerly discussed by the legal doctrine especially on grounds of possible conflicts of interest but had not been upheld by the courts (other than in few local courts).

The leading case on the subject was till now a decision of the Supreme Court of 2011 that excluded the occurrence of a conflict of interest between a creditor filing a bankruptcy buy-out proposal and the rest of creditors on various arguments, the main being the absence of any community of interest among creditors.

The scenario has now been revolutionized by the united chambers of the Supreme Court. The main reasoning of the court is that in any majority vote system the decision of the majority cannot be tainted by any possible conflict due to the forced dragging of the minority that is imposed by such voting system. According to the court, this principle is a general principle of the Italian law system that applies automatically regardless of any provision to the contrary set out in single laws. In the context of a bankruptcy buy-out – goes the ruling - the interest of the subject filing the proposal is to minimize payments to creditors while the interest of creditors is the opposite and consequently a conflict arises which taints the majority vote: to avoid such conflict the subject filing the proposal must be banned from voting (where eligible) is the conclusion of the court. The limited voting restrictions set out in the Bankruptcy Law must be extended by operation of the general "absence of conflict" principle applying to any majority vote, says the court, and must be interpreted extensively. Finally the court mentions as possible alternative to the voting ban the allocation of the claims held by the subject filing the proposal in a single class as imposed by the Bankruptcy Law in respect of creditors plans (proposte concorrenti) filed in the context of in-court restructurings (concordati preventivi); however, the court refrained from ruling on this alternative because it was not applicable to the specific case decided by the court that dated back to years in which creditors plans were not allowed (they were introduced only recently).

This decision will affect the practice of purchasing claims with a view to file a bankruptcy buy-out proposal and control the vote on it, a practice that is widespread especially among financial investors. Separating the entity filing the proposal from the entity purchasing the claims will not help whenever the entities belong directly and indirectly to the same group as the court has extended the ban also to affiliates.

It remains to be seen how courts will apply the principles set by the united chambers and whether conflicts will be detected (especially where hidden behind fronting bank structures) but certianly it is an important decision that will have spill-overs (the obvious one being in-court restructurings).