1 Introduction

Spain introduced different amendments in the insolvency legislation—the so-called ‘emergency legislation’—with the purpose of containing the risk of a ‘bankruptcy pandemic’.Footnote 1 As with emergency insolvency legislation that was introduced in other jurisdictions, the idea was to limit the damage resulting from the disturbances in economic activity triggered by the Covid pandemic.Footnote 2 There was a risk of overburdening of the insolvency system, on the one hand, and major uncertainty about the development of the public health situation and the recovery prospects of enterprises, on the other hand, which could have dramatic consequences in terms of destruction of value and loss of social welfare. There was an obvious risk of liquidation of viable businesses in the absence of sufficient judicial, professional or even financial resources to restructure valuable firms.Footnote 3 As to the latter, an upsurge in the costs of financing and restructuring, due to the greater difficulties in assessing the level of risk in projects—which in turn increased the risk aversion of financing providers—and in distinguishing viable from non-viable firms, could be expected to frustrate any attempt to restructure viable firms.Footnote 4

Among other provisions, the Spanish emergency legislation suspended the duty to file for bankruptcy and stayed creditors’ petitions to open bankruptcy proceedings until 30 June 2022.Footnote 5 The obligation to dissolve for aggravated losses was also suspended until the end of the exercise 2022.Footnote 6 In order to protect ongoing restructuring processes, the emergency legislation permitted debtors to modify compositions and refinancing agreements or to adopt a new refinancing agreement within a year of a previous confirmation of another refinancing agreement until 31 December 2021.Footnote 7 Likewise, creditors’ petitions to declare a breach of a composition or a refinancing agreement were stayed.Footnote 8 In addition, the debtor’s duty to file for the opening of the liquidation phase of bankruptcy proceedings was suspended and creditors’ petitions to open this phase were stayed until 31 December 2021.Footnote 9 The Spanish emergency legislation also sought to promote the provision of funding by insiders: it eliminated the automatic subordination of claims resulting from the provision of funding and arising after the declaration of the first state of alarm in bankruptcy proceedings opened until 14 March 2022,Footnote 10 and gave super-priority to insiders’ claims resulting from loans granted with the purpose of supporting the enforcement of compositions which were adopted or amended in the two years following the declaration of the first state of alarm.Footnote 11

In this commentary, drafted in response to the paper prepared by Ignacio Tirado for this special issue, I offer some reflections on the effectiveness of the insolvency law measures adopted in Spain during the Covid crisis (see infra Sect. 2), and on the provision of public funding during this crisis and the repayment of the corresponding claims (see infra Sect. 3). I conclude that the insolvency measures were inherently ill-suited for achieving the policy goal of preserving businesses, and that there was a good case for the provision of public funding. However, in the Spanish case this funding came too late, and there are now significant – legal and non-legal – challenges associated with restructuring these funds where they were extended by way of loan or guarantee rather than as grant.

2 The Effectiveness of the ‘Emergency Legislation’

In a paper published in 2021, I expressed doubts about whether the amendment of Spanish insolvency law could provide an effective answer to the threats arising from the pandemic crisis.Footnote 12 Now, the available data—despite not being totally clear—are suggestive of a rather poor result. In particular, these measures had only limited effectiveness since (a) they could not address a non-negligible number of situations of financial distress; (b) they were unilateral in the sense that they required the extension of relief to debtors in the real economy without addressing the effects on their creditors; (c) they externalised the costs of restructuring to creditors; and (d) they were not apt to address an economic crisis—as, in part, the pandemic crisis was—, and the liquidity constraints caused by this shock.

Re a) The amendments introduced in Spanish insolvency law at the onset of the pandemic were not useful to address situations of financial distress which somehow ‘fell outside’ the legal system. This was in particular the case for small and micro enterprises.Footnote 13 Preventive restructuring frameworks are costly for them—mainly in terms of negotiating with creditors, procuring professional financial advice, etc.—and they do not usually make use of these instruments when financial distress looms on the horizon. Since bankruptcy proceedings can also be very costly—due, in particular, to the costs of the procedure, as well as its length and the loss of reputation—, it is not uncommon that these firms just try to sell their last valuable assets on the market, pay their creditors and close down.Footnote 14 In the case of individual entrepreneurs, only the possibility of benefitting from a discharge provides a certain incentive to file for bankruptcy.Footnote 15 Moreover, small and micro undertakings often deal with financial distress when it is too late to achieve a turnaround. They do not have experts who can detect financial difficulties at an early stage and they cannot adopt appropriate measures to redress the situation. In some cases, they do not even keep accurate accounting records which could reveal these difficulties.Footnote 16 Then, bankruptcy proceedings are often opened when the business is no longer viable and the best solution is to liquidate the assets and distribute the proceeds among creditors.Footnote 17

Small and micro undertakings probably need specific answers to address financial distress.Footnote 18 The recent amendment of the Spanish Insolvency Act—Texto Refundido de la Ley Concursal, hereinafter TRLC—has introduced specific regulation in this regard.Footnote 19 Conversely, it seems that Spanish emergency legislation has not been very helpful for these firms, which represent a very significant part of the Spanish business fabric. Data are still obscure since the suspension of the debtor’s duty to file for bankruptcy and the stay of creditors’ petitions for opening bankruptcy proceedings were only lifted at the end of June 2022.Footnote 20 Nevertheless, the available information shows that more than 24,000 companies were dissolved in Spain during 2021.Footnote 21 In contrast, only 4,705 bankruptcy proceedings were opened over companies in Spain during the same period of time and the typical company which filed voluntarily for bankruptcy was not even a small, but a micro undertaking.Footnote 22 Likewise, barely 29 refinancing agreements were confirmed by Spanish commercial courts during the same period.Footnote 23 The continuous reduction in the size of insolvent companies filing for bankruptcy is considered a consequence of the stay of creditors’ petitions in the sense that larger companies have better access to restructuring tools than small or micro enterprises and could therefore avoid bankruptcy proceedings during this period.Footnote 24 What is more, the difference between the number of companies which dissolved (24,000) and the number of companies which filed for bankruptcy (4,705) or restructured (29) renders a quite impressive number of companies which, in a general context of difficulties, opted for ‘closing down’ or ‘extinction’ instead of filing for bankruptcy or trying to restructure, even when the obligation to dissolve for aggravated losses was suspended until the end of the exercise 2022.Footnote 25 To make matters worse, in 2021, 94% of the bankruptcy proceedings opened over companies – as explained, mostly micro undertakings—finished with the liquidation of the debtor’s estate, while only 6% finished with the adoption of a composition between the debtor and its creditors.Footnote 26

Re b) One of the objectives of Spanish emergency law was to protect the restructuring processes which were already pending when the first alarm state was declared in Spain on 14 March 2020.Footnote 27 In this sense, the emergency legislation provided for the possibility—which at that time was not foreseen by ‘regular’ Spanish insolvency law—of amending compositions adopted within the framework of bankruptcy proceedings as well as amending refinancing agreements adopted between the debtor and its financial creditors and confirmed by the commercial court with the purpose of avoiding bankruptcy proceedings. Furthermore, Spanish emergency law also provided for the possibility of obtaining judicial confirmation for new refinancing agreements within a year of a previous confirmation.Footnote 28 According to ‘regular’ restructuring law, a debtor could not obtain confirmation for a new agreement before one year had passed.Footnote 29 These measures aimed at alleviating the liquidity pressures suffered by firms which were under restructuring when the pandemic hit. These pressures could cause debtors to breach the compositions or the refinancing agreements and, as a result, they could frustrate the ongoing restructuring processes. However, the said measures were adopted from a unilateral point of view which did not consider the financial difficulties that creditors themselves might be experiencing at that moment or could experience as a result of extending the time for payment of claims or imposing haircuts. In other words, this approach disregarded creditors’ financial situation and could spread distress by ‘forcing’ them to extend credit to the debtor,Footnote 30 as I explain further below. Hence, these measures were not appropriate to address the problems which arose from a systemic crisis—as the pandemic crisis was—and which could reach economic sectors which had not initially been affected by the pandemic.Footnote 31

Creditors were ‘forced’ to grant financial support to debtors which were in a restructuring process because the amendments to compositions or refinancing agreements or new refinancing agreements were effectively imposed on them. The emergency legislation put creditors ‘between the devil and the deep blue sea’: if they refused the amendments or the new refinancing agreements proposed by the debtor, they would become trapped in a dead-end road. Under the ‘regular’ insolvency regime, a breach of a composition or a refinancing agreement—which at that time could not be amended or, in the case of refinancing agreements, could not be so easily ‘replaced’ by a new one—permitted creditors to file a petition requesting the court to declare the breach and, following the declaration of the breach, to file for bankruptcy—in the case of refinancing agreements—or to obtain, from the judge, the opening of the liquidation phase of bankruptcy proceedings—in the case of compositions.Footnote 32 However, under the emergency legislation, creditors were deprived of these powers since creditors’ petitions for declaring a breach were stayed and renegotiation between the debtor and its creditors was promoted ex lege: this stay gave the debtor the chance to negotiate with creditors the amendment of compositions or refinancing agreements or to adopt a new refinancing agreement.Footnote 33 Moreover, if the renegotiation failed and no amendment or agreement was adopted in the time provided for by the emergency legislation, the opening of the liquidation phase of bankruptcy proceedings or creditors’ petitions for bankruptcy would still be stayed for quite a long period of time.Footnote 34 The possibility to initiate individual actions against the debtor’s estate in the meantime—in particular in the case of failed refinancing agreements—constituted an unsatisfactory option which reintroduced the common pool dilemma and thus risked destruction of value. Hence, in such a situation, it is easy to understand that creditors—or, at least, a relevant majority of them—finished by accepting the amendments or the new refinancing agreements proposed by the debtor which became then binding for all the affected creditors, including dissenting and non-participating creditors.

Re c) Measures provided by Spanish emergency law produced redistributive effects. As explained earlier, these measures arguably effectively ‘forced’ creditors to provide credit to the debtor—in particular when creditors had to extend the time for payment of their claims—and imposed losses on them when they had to accept new haircuts. By extending credit or assuming losses, the costs of restructuring were imposed on creditors. However, it is far from clear that it ought to have fallen to creditors to assume the costs of supporting restructurings in a crisis with the characteristics of the pandemic crisis. The pandemic crisis was caused by circumstances which were external to firms—actually, it was an exogenous crisis—and these circumstances were also unpredictable.Footnote 35 This means that creditors could not take them into consideration when they assessed the level of risk of the projects and extended credit to the debtor. Thus, imposing on them the cost of keeping firms under restructuring alive during the crisis does not seem justified.

Moreover, under Spanish law protective measures related to insolvency were adopted with the purpose of preserving businesses and employment, despite the fact that insolvency law serves other objectives.Footnote 36 The protective measures were granted to debtors irrespective of what their financial situation was before 14 March 2020. More precisely, the stay of creditors’ petitions to open bankruptcy proceedings was automatically granted to all debtors, even to those who were insolvent before the first declaration of the state of alarm such that the Covid pandemic was not the source of their difficulties. It was also granted for a very long period of time—more than two years—, exceeding by far the duration of the disturbances in economic activity caused by the pandemic.Footnote 37 In addition, creditors’ petitions to declare a breach of a composition or refinancing agreement were automatically stayed for many months until the end of 2021 regardless of whether restructuring processes deserved to be protected—i.e., once the public health situation was more clear, ‘lockdowns’ were lifted, social distancing measures were relaxed and it was easier to differentiate viable from non-viable undertakings. Measures of this kind increased the risk of artificially keeping alive firms which did not merit protection, again with the consequence of fostering redistribution between the debtor and its creditors. Data for 2022 show that around 50% of the bankruptcy proceedings opened during this period were the result of failed restructurings.Footnote 38 As is well known, keeping unproductive firms alive renders more difficult the efficient redeployment of assets and may inhibit investment in valuable undertakings ex ante.Footnote 39

Re d) Insolvency law is apt to deal with a financial crisis, but not with an economic crisis as, in part, the pandemic crisis was. It was not a question of restructuring past over-indebtedness which made it impossible for the debtor to develop valuable new projects. This crisis put in question certain models of business and the adjustments introduced by the emergency legislation were not apt to create a new demand for certain products and services.Footnote 40 Moreover, restrictions imposed on the economic activity—i.e., through ‘lockdowns’ and social distancing measures—gave rise to temporary situations of lack of demand, with corresponding reduction in revenues and serious liquidity constraints. At the same time, uncertainty and the financial difficulties of certain credit providers seriously limited debtors’ chances of obtaining new money. In this context, granting financial support for firms with a recoverable business model was a more effective solution than tweaking insolvency processes.Footnote 41

In this vein, Spanish emergency legislation also amended insolvency law to provide positive incentives to ‘insiders’ to finance companies during the crisis. Under ‘regular’ or pre-pandemic Spanish law, claims of these creditors arising from loans or similar financial transactions are automatically subordinated in bankruptcy proceedings.Footnote 42 In contrast, the emergency legislation gave administrative expense status to insiders’ claims resulting from loans granted to the debtor with the purpose of supporting the enforcement of compositions which were adopted or amended in the two years following the declaration of the first state of alarm—from 14 March 2020 to 14 March 2022. This ‘super-priority’ is only enforceable if restructuring fails and the liquidation phase is opened over the debtor’s estate.Footnote 43 Moreover, emergency legislation eliminated the automatic subordination of insiders’ claims resulting from the provision of funding and arising after the declaration of the first state of alarm in bankruptcy proceedings opened until 14 March 2022.Footnote 44 Providing incentives to insiders to finance the debtor should be viewed in a positive light. Insiders are often in the best position to provide new money because they have superior information about the situation of the company and its prospects. The provision of financial support by insiders can also help to reduce moral hazard in the adoption of decisions related to restructuring since it gives insiders something more to lose once the value of their previous investments is approaching zero.Footnote 45 Despite being reasonable measures—and not only in the pandemic context—it is obvious that they could only provide very limited assistance in tackling the pandemic crisis. In particular, when the crisis was at its peak, it was far from obvious that insiders would be in a position to provide new funding to the company, given the potential that they might end up in financial difficulties as a result of the shock.

3 The Provision of Public Funds and Their Recovery

The analysis in Sect. 2 above suggests that the provision of public financial assistance to viable firms which were not in distress before March 2020 was likely to be a more effective route to protecting them against the pandemic crisis than emergency modifications to insolvency law.Footnote 46 Under the circumstances described above, debtors experienced serious difficulties in obtaining the necessary funding to overcome financial distress and avoid bankruptcy. In the context of an exogeneous and systemic crisis—whose impact in the most affected sectors of the economy could also spread to other sectors—and of uncertainty as to how the crisis would evolve, governments were in the best position to provide financial support to valuable firms. Thus, in many jurisdictions governments adopted the role of lender of last resort to afford the necessary liquidity to businesses which could not obtain it in the market.Footnote 47 In recent times, this is the line of action followed in Spain as regards the legislation adopted to mitigate the effects of the Ukraine war.Footnote 48 However, during the Covid crisis, public financial support took time to arrive.Footnote 49 In addition, the excessively demanding requirements for obtaining government grants discouraged applications, in particular from small and medium enterprises.Footnote 50

A significant part of the public financial support granted by Spanish authorities to businesses consists of repayable loans and guarantees of loans provided by private financial institutions where the State shares pari passu the risk of default with the lender.Footnote 51 The repayment of this financial assistance by firms contributes to internalising the costs of keeping valuable businesses alive during the crisis once the difficulties caused by the Covid crisis have been surmounted. Likewise, the repayment of this assistance is required to alleviate the massive increase in public debt that this public funding represents for the State.Footnote 52 In the case of guarantees, risk sharing with private lenders may help to limit the impact of eventual default on public finances. Nevertheless, the repayment of claims arising from state-issued or state-guaranteed loans becomes challenging when the loan must be recovered within the framework of restructuring proceedings.

On the one hand, these claims may represent a significant part of the liabilities of debtors who have not been able to surmount the difficulties caused by the Covid crisis. Then, there is a risk that restructuring processes may be dominated by unpaid public creditors that may be reluctant to act as economic owners of the firms in distress since they do not have the appropriate skills.Footnote 53 In particular, public creditors have neither the information, nor the knowledge to assess the financial situation of the debtor, the viability of the business and the prospects of restructuring. The same happens with the evaluation of the contents of the restructuring plan and, in particular, of the ‘appropriateness’ or ‘reasonableness’ of the terms offered to creditors. Public creditors cannot simply leave this evaluation to other creditors—i.e., financial creditors—who have the appropriate skills. Since they do not share the same interests—i.e., public creditors may be constrained in their decisions by tax and social policies; they will not be interested in converting their claims into equity, etc.—, this does not seem to be a good option.Footnote 54

On the other hand, in the recent amendment of the Spanish Insolvency Act, the legislator has limited the possibility for restructuring plans to cut down on so-called ‘public claims’, defined in a way that will include a significant part of the claims arising from public support. This amendment limits the ability to alter such public claims to cases where the debtor has not defaulted on the payment of its tax and social security claims and the age of the existing public claims is less than two years since the day of their accrual.Footnote 55 So, a debtor who has, for example, defaulted on the payment of tax debts cannot propose a plan that affects public claims and if it has already obtained a three-year extension of the time for payment of certain public claims, these claims cannot be affected by the plan. In addition, no haircuts can be imposed on these claims (such that only a maturity extension is possible) and, as a general rule, any extension of the time for payment is limited to twelve months since the confirmation of the plan.Footnote 56 These limitations aim to ensure a swift and full recovery of these claims, but may significantly hinder the possibility of restructuring debtors’ liabilities, since an important part of them—those arising from public support—will not be affected by the restructuring plans or only in very limited way. This may jeopardise the effectiveness of the plans and destroy value by dragging viable businesses into bankruptcy and, probably, liquidation. As a result, the aim pursued by the measures of public funding—basically, to avoid the liquidation of businesses, the destruction of employment, etc.—would be frustrated and public resources would be wasted.

The repayment of financial support does not justify such a result.Footnote 57 Actually, in a crisis with the characteristics of the pandemic crisis, there are no good reasons to insulate the State from the restructuring of debtors’ liabilities. On the contrary, credit risk should also be transferred to the State—as to other creditors—, and the State will then have to assume the role of loss absorber of last resort as the default of loans provided to surmount the Covid crisis materialises.Footnote 58

4 Conclusion

Insolvency law is ill-suited to serve objectives other than enabling individual creditors to act as a sole owner would act and to maximise the value of the debtor’s estate in the interest of the group. The case of the Covid crisis is no different. The characteristics of the pandemic crisis—which was an exogenous, time-limited and systemic crisis—make public financial support a more appropriate tool to address the tensions experienced by viable businesses than emergency insolvency legislation. One of the problems is now to balance the general interest in reducing the impact on public finances by recovering these funds, with the general interest in facilitating the restructuring of viable (and valuable) firms in distress as a result of the crisis. In this balance, the State cannot be insulated from the restructuring of debtors’ liabilities and should now assume the role of loss absorber of last resort.