Pre-insolvency, an alternative for the survival of the company

Given the impact of the pandemic on businesses in Spain, it is worth remembering pre-insolvency as an alternative legal mechanism for the survival of companies.

Back to normality, companies may explore legal ways to face a situation of insolvency, and, most times, the insolvency proceedings seem to be the appropriate tool. But there are more viable and less drastic alternatives, such as pre-insolvency. The pre-insolvency process does not have to culminate in the company’s entry into insolvency proceedings if, within the established period, the insolvency situation is remedied, for example, through refinancing.

Advantages of the pre-insolvency under the RDL 16/2020

Pre-insolvency can be particularly useful as it allows the debtor to enter into negotiations with his creditors and renegotiate the amount and payment dates of its debts.

Let’s remember that in Spain, because of the crisis caused by the COVID 19 pandemic, the Royal Decree Law 16/2020 was established (until December 31, 2020):

• The debtor in a state of insolvency will not have the duty to apply for a declaration of insolvency
• The judges will not accept applications for necessary insolvency submitted by creditors since the declaration of the state of alert. The state of insolvency is presumed to be a consequence of the crisis if the debtor was not involved in any of the events entitling the creditor to apply for a declaration of insolvency before March 14, 2020
• If the debtor has applied for voluntary insolvency before December 31, 2020, the application will have a preference, even if the creditor’s submission for necessary insolvency was earlier
• If the debtor notified before September 30, 2020, about the opening of negotiations with creditors to reach a refinancing agreement, an out-of-court settlement, or accession to an early settlement proposal, the general regime established by law will apply.

What is pre-insolvency?

Regulated in Spain by the Insolvency Law, pre-insolvency consists of the competence the debtor has to notify the court that he is in a situation of insolvency and that he has begun negotiations with his creditors.

The application for pre-insolvency intends:

• Avoiding an insolvency procedure by reaching an agreement that allows the viability of the company; or
• Obtaining the necessary accessions for an early proposal of an agreement, which will speed up, if necessary, the future and inevitable processing of the insolvency proceedings.

In short, it consists of a declaration to the court, which gives us a period of three months, plus an additional fourth month, to make a final attempt to negotiate with our creditors, especially with banks, to try to refinance the company’s debt and be able to rescue it.

The pre-insolvency takes place before the declaration of insolvency to avoid it. In Spain, the law requires that the application for insolvency be made within two months after the debtor became aware of his insolvency (or should have become aware of it). At that time, he may decide whether to report the pre-insolvency situation or to apply directly for insolvency.

According to the Insolvency Law, from then on, a company in a pre-insolvency situation has three months to negotiate with creditors and solve its liquidity problems.

If no agreement is reached within this period or pre-insolvency phase, the company will have an additional month to declare the insolvency before the competent Commercial Court.

Failing to reach an agreement does not imply liability for the company’s directors, unless:

• They did not use the time to negotiate
• It was a delaying measure
• The insolvency situation aggravated in this period.

The pre-insolvency procedure is, therefore, a legal measure applicable simultaneously to the refinancing of companies that are or become insolvent.

See infographic

For further information about the pre-insolvency procedure in Spain,