DIFC to up its game yet again – further modifications to its sophisticated restructuring and insolvency law
In September 2018 the Dubai International Financial Centre Authority (“DIFCA”) announced that it proposes to replace its current insolvency law with a new law to update the insolvency regime in the Dubai International Financial Centre (“DIFC”) and that it has launched a consultation in relation to the same.
Why are changes proposed?
The proposal to replace the insolvency regime with an updated version stems from a comprehensive review of the current insolvency framework. The current insolvency framework dates back from almost a decade ago in 2009. In the meantime, the DIFC has seen other countries, notably Singapore, undertake wholesale insolvency reforms. It is against this backdrop that the DIFCA states that it proposes to amend and enhance its current insolvency law to bring the regime in line with international best practice.
Key aspects of the reform
Key aspects of the reform include the following:
- the introduction of a new rehabilitation process. This will be a debtor-in-possession process allowing a debtor to effect a compromise with its secured and unsecured creditors;
- the introduction of a new administration process accessible in rehabilitation where there is evidence of mismanagement or misconduct;
- enhancing rules on voluntary and compulsory winding up and including more detail on wrongful trading provisions and adding an offence of misconduct in the course of winding up;
- incorporating the UNCITRAL Model Law on cross border insolvency proceedings (with certain modifications to cater for DIFC specific requirements); and
- enhancing provisions in relation to the enforcement of financial collateral.
In this briefing we take a closer look at the new rehabilitation plan and touch on the new administration procedure.
New tool: rehabilitation process
The introduction of a new process, called rehabilitation, will be a debtor-in-possession proceeding loosely modelled on the English law scheme of arrangement but with a cross-class cram-down mechanism.
Classes, voting and cross-class cram-down
Under the new rehabilitation process, a debtor will be able to propose a compromise with its secured and unsecured creditors. Creditors will be divided into classes for the purposes of voting. A class of creditors will approve the rehabilitation plan if at least ¾ in value of creditors voting approve the plan. The procedure will allow for a cross-class cram-down so that the plan can be approved, even if a class does not vote in favour, if at least one class of impaired creditors votes in favour and the court sanctions the plan.
Creditors or shareholders who are unimpaired by the plan will automatically be deemed to have accepted the plan. Where there is cross-class cram-down, the plan also needs to comply with the absolute priority rule, i.e. that no junior creditor gets paid before the senior dissenting creditors are paid. Valuation is to be assessed on a liquidation basis – so that no class of dissenting creditors or shareholders receives less than it would in a liquidation.
Moratorium and ban on ipso facto provisions
Where directors notify the court of their intention to propose a rehabilitation plan the court will convene an automatic moratorium (unless the company is ineligible for a moratorium, e.g. where it is party to a capital market arrangement). The effect of the moratorium is similar to the English law administration moratorium, so that (amongst other things) no petition for the winding up of the company can be presented, no landlord can exercise any forfeiture rights, no steps may be taken to enforce a security interest and no proceedings or legal process may be commenced or continued except with the permission of the court. An application for a moratorium shall not render any debts not otherwise due and payable so due. In addition, there is a limitation applied to ipso facto clauses such that a provision in a contract linked to an insolvency related term ceases to have effect during the moratorium period. There are certain safeguards, such that where the company has agreed to pay a counterparty during the moratorium but does not do so within 20 days, the counterparty is entitled to terminate the contract.
Unless the court orders otherwise the moratorium will apply for 120 days (although the court can extend this period). A creditor can apply for the moratorium to be lifted if the creditor can demonstrate that the creditor would suffer any significant loss for which the company cannot compensate and the balance of harm tips in favour of the creditor. The court may also terminate the moratorium upon the request of a creditor for cause, including bad faith. In such circumstance, a creditor can put forward an alternative rehabilitation plan.
The debtor is to select one or more rehabilitation nominees who must be registered insolvency practitioners and who have to be approved by the court. The nominee must prepare a report for the court stating that in his or her opinion:
- the rehabilitation plan has a reasonable prospect of being approved by the creditors;
- the company is likely to have sufficient funds to enable it to carry on its business during the moratorium; and
- meetings of creditors and shareholders to consider the rehabilitation plan should be summoned.
Day-to-day operations of the company remain with the debtor unless there is evidence of fraud or mismanagement in which case the court may appoint an administrator.
The court will be involved in a number of stages, granting the moratorium at the outset and then deciding at a first directions hearing on the correct classification of creditors. Once the meetings have been held and the requisite majority of creditors have approved the rehabilitation plan the court is involved in a post plan hearing at which it will sanction the plan if the plan is fair and there have been no breaches of the law or procedural irregularities.
The court may authorise the debtor to obtain new debt (both on a secured or unsecured basis) which has priority over existing unsecured debt, is secured over previously unsecured property or is secured by a junior security interest on property which is already secured. Importantly, if it is not possible to raise debt on this basis, the court can authorise the debtor to obtain new debt that is secured by a senior or pari passu security interest on property that is already secured. Existing security holders will need to be given “adequate protections” against any potential devaluation of the secured assets or their consent needs to be obtained.
New tool: administration process
If a rehabilitation process has commenced and there is evidence of dishonesty or mismanagement, creditors may apply to the court for the appointment of an insolvency practitioner as administrator. The administrator will displace management. The administrator will be given investigatory powers and anti-avoidance provisions previously available only to liquidators, such as wrongful and fraudulent trading.
Comment and where next?
The proposals are to be welcomed. As the proposals themselves say, they draw on international best practice and seek to modernise and bring DIFC insolvency law into line with current best practice. The new rehabilitation procedure takes the current scheme of arrangement process, which is voluntary and includes restrictions on reaching a compromise without the consent of relevant preferential or secured creditors, and incorporates elements from Chapter 11, such as cross-class cram-down and DIP funding. It is interesting that the UK government has also just announced major insolvency overhaul which will include in the UK the introduction of a restructuring plan that will also allow for cross-class-cram down and a separate restructuring moratorium. The DIFC proposals go that one step further with the introduction of DIP financing which is not contained in the UK government’s announcements.
The proposals are not yet law – although detailed drafting has been provided. The deadline for comments to the consultation is 17 October 2018. As and when they will be enacted they will be a significant step to make the DIFC even more attractive as a restructuring place of choice.