In a recent article, we propose a new rule for determining the proper forum for insolvency proceedings. Currently, the Model Law on Cross-Border Insolvency, promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”), looks to a debtor’s center of main interest (“COMI”) to determine the proper forum for a foreign main-insolvency proceeding. This rule is flawed. It is both inflexible and manipulable. It is also indeterminate and neither requires nor allows advance commitment by debtors. As a result, it leads to uncertainty, increases litigation costs, and opens the door to opportunistic manipulation by debtors. These costs, in turn, raise the cost of credit for all companies.
We propose a better approach – the “Commitment Rule” – for determining the proper insolvency forum. The rule allows debtors to signal an advance their commitment to a particular insolvency forum. To make this commitment public and binding, the debtor must put it in its company’s constitution. This upfront and observable commitment eliminates uncertainty and opportunistic manipulation.
The Model Law on Cross-Border Insolvency (“Model Law”) was promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”) in 1997. During its now more-than-a quarter century life, it has been adopted in more than 60 jurisdictions around the world and, in our view, has played a major role in the improvement and successful management of insolvency proceedings with a cross-border element.
Built on the idea of “modified universalism,” the Model Law envisions the commencement of a main proceeding in a single jurisdiction, even if other proceedings can also be opened and the laws of other jurisdictions can still be relevant for certain aspects of the proceeding. Once the proceedings are opened, the Model Law’s rules facilitate cooperation and assistance for the successful management of insolvency proceedings.
The adoption of modified universalism as a regulatory model to address cross-border insolvency enhances value for all parties. Therefore, in contrast to those favoring the adoption of a fragmented (or “territorialist”) approach, we argue that a centralized procedure to deal with cross-border insolvency is superior. Yet, the Model Law has a major flaw: the use of the COMI rule to determine the proper forum for a foreign main proceeding. The COMI rule creates uncertainty and litigation costs and opens the door to opportunistic behavior by debtors. Moreover, these problems are exacerbated by the different interpretations countries have given the rule, depending on whether they put more or less weight on the presumption of the registered office and the various factors for rebutting the presumption. They have also adopted different approaches to assessing when the COMI needs to be determined. For instance, while the United States and Singapore determine the COMI based on the date of the application for recognition is filed, the United Kingdom and Australia use the date of the filing of the foreign proceedings and the date of the hearing of the recognition application, respectively, as the relevant dates to determine the debtor’s COMI.
In our view, the COMI rule presents the worst of all worlds by allowing debtors to manipulate forums at the time of filing while preventing them from committing to an efficient forum ahead of time, and then opening the door to expensive litigation. This state of affairs undermines the legitimacy of insolvency proceedings and prevents market negotiations that produce value for creditors and contribute to the effective reorganization of viable businesses. By stifling markets, the COMI rule hinders the development of financial markets, entrepreneurial innovation, and economic growth more generally.
The Commitment Rule is a further development of the proposal we submitted to the Secretariat of UNCITRAL Working Group V (Insolvency) in an open letter on September 14, 2023. In addition to the benefits noted above, the rule would allow companies to choose a more efficient insolvency forum that can benefit debtors, creditors, and society at large. Hence, this approach can be particularly beneficial for countries without developed restructuring ecosystem, which often include emerging markets and developing economies, and therefore countries where the adoption of active policies to promote entrepreneurship, access to finance, and economic growth is most needed.
Contrary to what some critics have argued, the Commitment Rule would not lead to debtors choosing an insolvency forum that disadvantages sophisticated lenders. If a debtor made such a selection, it would expose the debtor to an increase in the cost of debt or even the loss of access to credit markets. The risk of opportunistic behavior when initially choosing the insolvency forum exists only with respect to vulnerable creditors, such as tort claimants and employees, which do not have the ability, information, or bargaining power to adjust the conditions of their claims.
To mitigate this risk, which also exists under the current COMI rule, we suggest different strategies. For example, if countries want to protect these creditors, a defined group of vulnerable creditors (decided locally by each jurisdiction) such as tort claimants and employees could be given preferential treatment in the ranking of claims. If another jurisdiction sought to override this policy choice, that would be a basis for denying recognition of the foreign proceeding.
A possible drawback of the Commitment Rule is its rigid nature, which might hamper a change of insolvency forum for valid reasons, such as when the creditors as a whole desire a change. In response, we suggest various approaches to facilitate the change of insolvency forum while preserving the benefits of the Commitment Rule.
If UNCITRAL wants to favor predictability over flexibility, we argue that the Commitment Rule might include a requirement that debtors notify all pre-existing creditors of any change in the forum specified in their constitutions. Then, if no creditor (or if fewer than a certain percentage of creditors) objects within a reasonable time (e.g., 3-4 weeks), the forum change would become effective. By adopting this approach, none of the company’s pre-existing creditors would be required to accept an insolvency forum that did not exist when they extended credit. This would be the most creditor-protective approach.
A second approach would be to require approval of a majority or super-majority of creditors, which would provide more flexibility. Nonetheless, it might also create costs, such as holdout problems and a potential increase in the cost of credit from sophisticated lenders pricing their loans on the basis of an unwanted insolvency forum.
For that reason, building on a proposal suggested in an article one of us co-authored, we argue that UNCITRAL can consider a third approach: allowing debtors to choose how the insolvency forum would be changed should the need arise. In other words, the debtor would follow the rules governing the constitutional provision establishing the insolvency forum. To facilitate the implementation of this approach, we provide a non-exhaustive list of amendment rules that companies could adopt, depending on the type of flexibility that they wanted and the signal that they wanted to send to their lenders. These amendment rules might include: (i) requiring consent by, or not having the veto of, a minimum number or percentage of creditors; (ii) delaying the effective date of a change in the constitution; (iii) allowing the change of the insolvency forum provided that it is approved by a particular individual (for example, an arbitrator, adviser, or designated independent director) or group of people (e.g., board of directors, company’s independent directors, external committee of legal and financial advisers). The debtors would write their amendment rules while considering the demands and expectations of the credit markets. Again, sophisticated lenders would take the adopted rules into account when they priced their loans. Knowing this, would have incentives to choose a method that was trustworthy, value-enhancing and protective of the interests of the creditors. As discussed above, vulnerable creditors would be protected separately, through mechanisms that might include a priority (if adopted locally, not in the Model Law) or a public policy exception for the recognition of the proceeding. This approach would facilitate the change of insolvency forum while providing a level of protection to creditors that does not currently exist.
The COMI rule provides the worst scenario for predictability, litigation costs, access to finance, and freedom to choose a value-enhancing insolvency forum. In contrast, the Commitment Rule presents a rare win-win legal reform requiring no major tradeoff. It would reduce strategic forum shopping and minimize litigation costs while preserving beneficial former choice to promoting the development and selection of efficient insolvency forums. These improvements support the development of financial markets, entrepreneurial innovation, and economic growth more generally. Therefore, we urge UNCITRAL to consider adopting the Commitment Rule as part of the Model Law.
This post comes to us from Anthony J. Casey, the Donald M. Ephraim Professor of Law and Economics and faculty director of the Center on Law and Finance at the University of Chicago Law School; Aurelio Gurrea-Martínez, an Associate Professor of Law and Head of the Singapore Global Restructuring Initiative at Singapore Management University; and Robert K. Rasmussen, a Professor and the J. Thomas McCarthy Trustee Chair in Law and Political Science at USC Gould School of Law. It is based on their recent article, “A Commitment Rule for Insolvency Forum,” available here.