On 1 September 2004 the Bankruptcy Act 22/2003 of 9 July came into force. The

new Insolvency Act regulates the insolvency situations of both, legal entities and

individuals.

The aim of the new Act is to modernize the Spanish bankruptcy law that was ruled

by old and disordered norms, which could not provide appropriate solutions to the

bankruptcy situations of the XXI century´s economy. In order to adapt to the new

needs of the economy, the bankruptcy proceedings have been simplified.

Formerly, in Spain there were four bankruptcy proceedings, two for the commercial

debtors (quiebras y suspensiones de pagos), and two for the non-commercial

debtors (concurso de acreedores y quita y espera). The new Act contemplates a

singleinsolvency proceeding, which is simply called “bankruptcy” (concurso de

acreedores) and is applicable to all sort of debtors (legal entities and individuals).

This proceeding can conclude either with the approval of the settlement of creditors

or with the liquidation of the company.

In addition, the creation of certain courts (Juzgados de lo Mercantil). Particularly

specialized in dealing with matters related to Commercial Law, including insolvency,

shall ensure the improvement of the current situation and the correct application of

the new regulation These courts shall instruct the bankruptcy proceedings but shall

also hear and deal with other commercial law matters such as unfair competition,

intellectual property, publicity, any matter concerning to corporate law, transports

(national and international), general conditions of contracts, and the matters

assigned to the First Instance Court in section 8 of the Arbitration Act when it refers

to these matters.

Although the Justice Ministry insists on highlighting that the purpose of new

bankruptcy regulation is to support and ensure the continuity of viable companies

that are temporary involved in a insolvency situation, in our opinion the regulation

passed is far from facilitating the achievement of this goal.

On the contrary, we understand that eventually the payment of the debts is the

main aim of the new regulation. As a matter on fact, the achievement of the

payment of debts would explain certain measures foreseen in the new regulation

such as the temporary paralysis of mortgages, the possibility of reactivating loans

and credits or the possibility of resolving a judicial claim for outstanding rents by

paying the outstanding amounts to the plaintiff (with the prior regulation, bankrupt

companies were not able to adopt any of the above mentioned measures).

Furthermore, the new regulation reinforces the principle of the par conditio

creditorum, the judicial guarantees of the proceeding and the liability of bankrupt

company’s directors.

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The situation and perspectives created by these new insolvency regulation will not

only affect the bankrupt companies but they will also have important consequences

on all social agents involved in the market.

The Bankruptcy proceeding is initiated with the filing of an application for

commencement of a bankruptcy proceeding either by the debtor himself (so called

“voluntary bankruptcy”) or by one of his creditors (the so called “forced

bankruptcy”). If the Judge adjudges the debtor bankrupt, the next step will be the

appointment of the bankruptcy trustees, which function is to analyze and determine

the active bankruptcy estate (activos) and the existing debts (pasivos).

This stage is concluded with a report drafted by the bankruptcy trustee panel

(administración concursal), which includes the patrimonial situation of the

bankrupt, as well as the inventory of the active bankruptcy estate and the list of

creditors .Once the inventory and the list of creditors have been fixed, two

alternative stages can follow: i) the settlement of creditors, which aim is to

reach an agreement between the debtor and the creditors for the payment of the

credits, or ii) the liquidation, which aim is to liquidate the active bankruptcy estate

in order to pay the debts. The liquidation stage will be initiated if no agreement is

reached or in case of non-compliance by the debtor with the agreement.

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Unlike the former insolvency regime, the new Bankruptcy Act focuses on

encouraging companies to file a voluntary bankruptcy application when the first

signals of insolvency appear.

In this light, the law establishes several rules, among which we would like to point

out the following:

(i) The duty of the insolvent debtors to file a bankruptcy application

within two months from the date when they knew or should have known

the insolvency situation. According to the Law, the insolvency might be

presumed when , the debtor is regularly not able to comply with its

payment obligations.

In case of non-compliance by the debtor with the duty to apply for

commencement of bankruptcy, the bankruptcy could eventually be

classified as guilty which could lead to the imposition on the administrators

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or liquidators of the prohibition to fulfill any management functions for a

period of 2 to 15 years.

Besides, the Judge can condemn the actual directors, and all the

the company, totally or partially, the amount of the credits that remained

unpaid after the liquidation of the active bankruptcy estate.

In order to ensure a successful serving of the conviction of the directors

and/or liquidators, the law foresees that the Judge, might order the seizure

of goods belonging to the directors or liquidators, when it decrees the

involuntary bankruptcy. This seizure of goods can be avoided by paying into

court a security.

The new Act increases the liability of the directors of the bankrupt company

by way of extending the responsibility for the insolvency situation to the

directors, including both, the directors that were legally appointed and

directors that were in fact fulfilling directorial functions without being

expressly appointed to do so, and, lastly, also to the persons who have

fulfilled directorial functions in the company for a period of two years

previous to the bankruptcy.

The debtors can file an application for commencement of bankruptcy

(voluntary bankruptcy) in case of an imminent insolvency, that is to

say, when they foresee that they will not be able to regularly comply with

their obligations.

(ii) The creditors are also entitled by the law to file an application for

commencement of bankruptcy. The law prizes the creditor that initiated the

proceeding by regarding a part of its credit – i.e. up to one fourth – as a

privileged credit.

(iii) The creditors are entitled to file an application for commencement of the

bankruptcy proceeding if one of the following circumstances occurs:

- In case of non-payment by the debtor of the mandatory taxes or of

the social security quotas during a period of three months previous

to the date of the filling of the bankruptcy application, or nonpayment

of the salaries and other labour compensations amounts

corresponding to the last three monthly wages;

- general default in payment obligations;

- general seizure of goods;

- transfer of goods in fraud by way of liquidation of the patrimony in a

hurry or ruinously.

(iv) If the credit of the creditor filing the bankruptcy application is due, the

debtor must deposit the amount in court at the disposal of the creditor. It is

then is up to the creditor to either accept the payment of its credit and

renounce continue with the bankruptcy procedure or to continue with the

proceeding and reject the payment.

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(v) If the application for commencement of thebankruptcy procedure is filed by

the debtor (voluntary bankruptcy), the debtor will be allowed to keep his

administration and disposal faculties, notwithstanding the supervision by the

bankruptcy trustee. If, on the contrary, the application for commencement

of the bankruptcy procedure is filed by the creditor (forced bankruptcy) only

the bankruptcy trustee will be allowed to administrate and dispose over the

patrimony. However, the Judge may, case to case, decide otherwise for

good cause.

The declaration of bankruptcy implies some effects to the debtor, the creditors, the

contracts and on certain actions executed by the debtor before the declaration of

bankruptcy.

- Possibility of resolving the intervention in the communications of the debtor, the

obligation of living in the city where his office is registered, the registration of

the debtor's registered office.

- Intervention or suspension of the managing faculties of the debtor.

- The debtor can continue his business unless the Judge sentences the partial or

total cessation of the company's activity.

- Possibility of seizure the goods of the directors of the company or liquidators (by

means of a legal appointment or by means of facts), or the ones who were so in

the two years previous to the bankruptcy. It will only be applicable when the

insolvency is due to the directors' actuation and the debtor's goods are not

enough to pay the credits.

- Prohibition of new trials against the debtor that affect his patrimony.

- Suspension of the executive actions (acciones ejecutivas) against the debtor.

- Paralysis of the execution of collateral (garantías reales).

- Prohibition of compensation.

- Suspensions of accruance of interests.

- Validity of the contracts with reciprocal obligations.

- Non validity of the clause relative to the automatic termination of the contract

due to the declaration of bankruptcy of any of the parties.

- Termination of contracts of successive or running completion in case of

breaching the contract after the sentence adjudging the debtors bankrupt.

- Possibility of modifying the labour conditions.

- Enervation of eviction in rents.

- The debtor's actions that are prejudicial for his goods can be rescinded during

the two previous years to the date of declaration of bankruptcy.

- In some cases it is presumed when there is prejudice: gratuitous transfers and

payment of non due obligations.

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- In other cases the prejudice is presumed but it can be proved the contrary:

lucrative transaction non gratuitous made by people specially related to the

debtor and collaterals related to preexisting obligations.

- For the other cases the bankruptcy trustee will have to prove the prejudice

made.

Effects of the sentence of rescission: declaration of inefficacy of the act and

restitution of the considerations. If one of the parties who contracted with the

debtor acted dishonestly, then the credit is postponed.

The credits are classified based on the principle of prior tempore potior iure, which

leads to the following classification of credits

(i) Privileged credits (general and special): those are the credits that have

preference in the repayment in case of liquidation of the company and are

not affected by the settlement of creditors, except if the creditors holding

this type of credits have voted in favour of the settlement agreement. The

special credits are credits that affect specific goods whereas the general

credits affect all the bankrupt’s goods.

(ii) Subordinated credits: those are the credits that will only be paid out once all

other credits (privileged and ordinary) have been paid.

(iii) Ordinary credits: those are the credits, that are not classified by the law

neither as privileged nor as subordinated. These credits will be paid out after

the payment of privileged credits and before the payment of subordinated

credits. In case of settlement of creditors, ordinary credits will be paid out as

stated in the agreement.

In order to ensure the payment of the ordinary creditors the law foresees the

following measures:

(i) Limitation of the privileges granted to labour credits.

(ii) Temporary paralyzation of the foreclosure on the assets of the company

affected to the company’s activity.

(iii) Reduction of the privilege granted to the Public Treasury and the Social

Security up to 50% of the amount of their credits while the remaining

amount will be considered as an ordinary credit.

(iv) Creation of a new category of credits: the subordinated credits that will only

be paid when the rest of the credits are paid, which means that, in fact,

there is a high possibility for those credits to eventually remain unpaid. .

According to the Bankruptcy Act the following credits are included in this

subordinated credit category:

- Credits which have been subordinated by contract.

- Interest of any kind of debts.

- Fines and sanctions.

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- Credits generated by means of interest.

- Credits hold by creditors related with the debtor.

- Credits that have not been communicated on time by the creditor to

the bankruptcy trustee panel.

As regards the creditors who are specially related with the debtor, the law

distinguishes the following cases:

If the debtor is an individual the specially related persons are deemed to be

the spouse of the bankrupt or any person with a similar affective

relationship, the ancestors, descendants and brothers of the bankrupt or

his/her spouse or couple, and the spouses of these relatives.

If the debtor is a legal entity, the specially related persons and entities are

deemed to be the shareholders who are personally liable for the company's

debts, the shareholders who own 5% of the capital stock in listed

companies, the shareholders who own 10% of the capital stock in non listed

companies; the directors (by means of legal appointment or by means of

fact), the liquidators and people with powers of attorney granted by the

company, and also the persons that were fulfilling those functions during a

period of two years previous to the filing of the application for

commencement of the bankruptcy procedure; and lastly, the companies that

belong to the same group as the bankrupt company as well as their

shareholders.

All the credits hold by the above-mentioned specially related persons are

considered as subordinated credits. which means that they rank after all the

other credits and have therefore a very little chance to be effectively paid

out. This fact will for sure have severe consequences with regard to the

financing system of the companies, as the administrators or the parent

companies that used to grant loans to the companies with economic

difficulties will have from now on to assume an high risk of non-payment in

case of an insolvency of the company.

Before including a credit in the creditors list, the bankruptcy trustee panel has to

verify and expressly accept the credit to be included in the list.

For that purpose, within in one month after the publication of the judgement

adjudging the debtor bankrupt the creditors have to serve notice and to submit the

documents that prove the existence of their outstanding credits. If the notice is not

served after the expiry of the above-mentioned period of one month, the credit will

be qualified as a subordinated credit.

The new Law completely modifies the institution of the bankruptcy trustee. From

now on, , the bankruptcy trustee panel will have to be made up by a lawyer (with

5 years of practice), an economist, an auditor (with 5 years of practice) and a

creditor. Furthermore, ff the creditor is a company he will have to appoint an

economist or an auditor as its legal representative.

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The bankruptcy trustee panel is appointed by the Judge. Among other functions, it

is the panel´s duty to supervise or even manage the whole activity of the

debtor(depending on the decision of the Judge) and to draft a report on the

economic situation of the bankrupt.

It is important to point out that the new Bankruptcy Act limits the content of the

settlement of creditors, as it forbids settlements of creditors with a release of more

than 50% of the amount of the credits and with waiting periods for more than five

years, with some exceptional cases. Moreover, it forbids the settlement of credits

for the purpose of winding up the company, which used to be very usual in the

former suspension of payment proceeding.

The settlement of creditors is passed by the creditors’ meeting with a majority of

50% of the total amount corresponding to the ordinary credits. The quorum

requested has been lowered compared to the former regulation in order to ,

facilitate the approval of an agreement. The debtor or any creditor that represents

at least a 20% of the total amount corresponding to the ordinary credits can submit

a proposal for the settlement of creditors. Eventually, the judge is competent to

decide on the settlement of creditors.

Unlike the prior regulation, the bankrupt can now oppose to the settlement of

credits approved, as the final approval of the settlement is not conditioned on

obtaining the final approval by the debtor. The new law changes considers that the

non-acceptance by the debtor is definitely not the best way to ensure the

effectiveness of the settlement of creditors.

The following persons are also entitled to oppose to the judicial resolution

approving the settlement of creditors:

- any creditor not attempting to the creditors meeting

- creditors who have voted against the settlement of creditors

- bankruptcy trustees and creditors that represent 5% of the total amount of

credits if they consider that the compliance of the settlements of credits

approved is objectively impossible.

In conclusion, we would like to point out that, notwithstanding the Spanish

legislator’s declarations, the new Act does not at all improve the chances of

continuity of viable companies and maintenance of jobs. Moreover, it seems that

the real aim of the new regulation is to obtain the payment of the debts. Before

the adoption of the new Insolvency Act, the Catalan Entrepreneurs Association

"Foment del Treball" had drafted an Insolvency reform published in July 1999, titled

“Restructuring and liquidating companies and patrimonies law” ("Ley de

reestructuración o liquidación de empresas y patrimonios", which was drafted by

the Insolvency Department of BROSA under the supervision of Mr. Pedro Brosa.

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The aim of this text was to support and help the companies showing capacity to

overcome the economic difficulties.. Unfortunately, it has not been taken into

account when drafting the New Insolvency Act passed. Now the preservation of the

viable companies will depend on the effort of all sectors: companies, financial

entities, suppliers, clients and, of course, lawyers.