"Bulgaria transposed the Restructuring Directive's prohibition to terminate contracts via ipso facto clauses, but also (deviating from the Directive) prohibited contractual set-off in restructuring, thus rendering the preservation of many contracts performed via contractual set-off / netting of payment meaningless. So, in drafting ipso facto clauses the impossibility to perform contracts in restructuring, due to the contractual set-off prohibition, may be utilised as an additional trigger for termination, now".
As of July 2017, there has been a pre-insolvency restructuring regime for corporate entities in Bulgaria who are in a state of "likelihood of insolvency", but not actually insolvent, in order to restructure and preserve them as a going concern. This regime is called "stabilisation" but will also be referred to in this article as "restructuring". It was not harmonised with the EU Restructuring / Second Chance Directive 2019/1023/EC (the "Directive"), which was only in a draft form when the regime was introduced in Bulgaria.
Bulgaria transposed the Directive only recently by means of an amendment to the existing restructuring, published on 1 August 2023 (the "New Law").
Prior to the New Law, the restructuring proceedings were applicable for all corporate entities in Bulgaria except banks, insurance undertakings and certain public law companies.
The New Law expanded these three exceptions by further disapplying the restructuring regime (which is a court supervised one) to all financial entities as per art. 1(2) of the Directive as well as to certain pension companies for which there are specific pre-insolvency restructuring measures imposed by their supervision administrative authority. This personal scope amendment to the restructuring regime should be taken into account when drafting ipso facto clauses (see item 3 below) with counterparties to which the exceptions apply under the New Law.
The New Law entered into force on 5 August 2023 making no exception for contracts concluded prior to that date, so parties should comply with the ipso facto regulations under the New Law (analysed below) even in contracts concluded earlier.
Major amendments under the New Law
The most important amendment in the New Law is in the "likelihood of insolvency" criterion as a prerequisite for the restructuring application.
It is now defined as the debtor's expected inability to make payments (as opposed to the former regime when only certain payments were relevant) based on their maturities over the next 12 months (as opposed to six months, previously). The six-month threshold prior to the New Law proved to be too short, as applications were submitted too late and courts regularly found an actual insolvency as opposed to a "likelihood of insolvency" when deciding on them.
Another novelty is the express obligation of the debtor's management to take steps for restructuring should there be "likelihood of insolvency". So far there has been a similar obligation only to file for opening of insolvency when the prerequisites for the latter are in place. Therefore, as the restructuring regime (as opposed to the insolvency regime) was optional, the number of actual applications for restructuring was negligible, with almost none of them being upheld and followed by actual restructuring proceedings. Thus, management bodies would be well advised to have an action plan in place now to identify in a timely manner the occurrence of "likelihood of insolvency" and to take restructuring steps to comply with the new statutory requirement.
Although the New Law is expressed as transposing the Directive, it does not follow it verbatim and there are substantial differences between the Bulgarian restructuring regime and the Directive.
In this article I will focus only on the newly imposed prohibitions on ipso facto clauses.
Ipso facto clauses are contractual stipulations for termination or acceleration of contracts when certain pre-agreed events occur, including restructuring/insolvency proceedings or filing to open such proceedings. Such clauses are widely used in credit agreements as well as in certain financial contracts as derivatives.
General notes on the ipso facto prohibitions
So far there have been no statutory restrictions on ipso facto clauses in Bulgaria both under the applicable pre-insolvency reorganisation proceedings and insolvency proceedings.
Likewise, ipso facto clauses have been treated favourably in court disputes. As these clauses have never been a problem for local lawyers, there is no academic writing on the logic behind and permissible scope of potential prohibitions on them.
Given this lack of experience with limitations on ipso facto clauses, it comes as no surprise that the prohibitions under the New Law are quite contradictory and raise many issues. Therefore, the two novel prohibitions (to be reviewed in items 3.1 and 3.2 below) should be interpreted as closely as possible to art. 7(4) and (5) of the Directive, which contain the model prohibitions that the New Law was meant to introduce in Bulgaria.
Prohibited ipso facto rights triggered by the filing for or opening of restructuring
The first prohibition under the New Law bans any withholding of performance, termination of, or any objection to the performance of contracts only on account of the filing for or the opening of restructuring proceedings. As compared to the model prohibition in art. 7(5) of the Directive, the Bulgarian rule (i) applies not only to rights agreed in a contract (as per the Directive) to withhold/object to performance or terminate a contract, but to any such statutory rights triggered by operation of law, (ii) applies to any contract and not to "executory contracts" only, (iii) makes no express reference to "acceleration" among the prohibited rights, and (iv) makes no express reference to "request for / granting of stay of individual enforcement" among the prohibited triggering events, but such triggers are rendered meaningless, as stay on enforcement operates automatically under the New Law, rather than upon an order of an administrative or judicial authority (as referred to in art. 6(2) of the Directive).
The phrase "only on account of" when listing the prohibited triggering events is an indication that the New Law should be construed narrowly so clauses referring to other triggering events should not be prohibited. Nevertheless, "the opening of restructuring" as one of the prohibited triggering events should arguably be construed as also covering such other effects that occur automatically with the opening of restructuring. In particular, contractual clauses that refer, for example, to "stay on individual enforcements" should be caught by the ban. Under the Directive, such a stay should be a prohibited trigger for ipso facto clauses when it is "granted" by administrative or judicial authority, i.e. in such Member States where the stay does not occur automatically with the opening of the proceedings. However, as in Bulgaria the stay occurs automatically with the opening of the proceedings, it is not listed as a separate prohibited event, clearly indicating that the Bulgarian lawmaker treated it as being covered by the reference to "opening" of the proceedings.
However, if consequences that occur automatically with the opening of restructuring have the specific effect of blocking performance under the contract (an example of which will be provided below) and this specific effect is agreed as an ipso facto triggering event too, it should be permissible. This would be in line with recital 41 of the Preamble to the Directive, which provides that the ipso facto ban should apply "provided that the debtor complies with its obligations under such contracts which fall due during the stay". Arguably, events similar to actual non-performance, including impossibility to perform (following the opening of restructuring), should also not be caught by the ban.
By way of example, the above logic under the New Law may be applicable when drafting ipso facto clauses under standard netting agreements (e.g. as per ISDA models or otherwise when financial settlement rather than delivery is contemplated). When such contracts involve Bulgarian counterparties, it is customary to agree on automatic early termination ("AET") clauses referring inter alia to the filing for or opening of restructuring. Although under the above ban such clauses may be vulnerable, paradoxically parties may avail of some other rules under the New Law to continue having an enforceable AET clause.
This is because in Bulgaria, in deviation from the Directive, special requirements and restrictions are in place on set-off in restructuring, when effected unilaterally by one of the parties. The analogous restrictions on unilateral set-off in insolvency are unanimously construed as tacitly overriding any contractual set-off arrangement, so the same should apply to contractual set-off in restructuring. It is worth noting that many standard financial agreements (including ISDA models) rely as a settlement mechanism on the "netting of payments", where on each payment day the mutual obligations are expressed in one and the same currency and are set off to one net amount, so only the party owing the larger amount pays the difference. This standard mechanism for settlement now seems impossible in Bulgaria following the opening of restructuring, so a carefully drafted ipso facto clause relying on that impossibility for performance as initially agreed may be the best way to ensure a valid AET in the context of the New Law.
Prohibited ipso facto rights triggered by the debtor's non-payment
The second ipso facto prohibition under the New Law is on any withholding of performance, termination of or any objection to the performance of contracts that have been entered into prior to the opening of the stabilisation proceedings and that are essential for the continuation of the debtor's business "only on account that the contracts are not paid".
As compared to the model prohibition in art. 7(4) of the Directive, the Bulgarian rule (i) applies to any contract and not to "executory contracts" only, and (ii) most importantly refers to non-payment of "contracts concluded prior to stabilisation", where the Directive refers to non-payment of "debts that came into existence prior to the stay". Therefore, there is no clear indication in Bulgaria that only a failure to pay prior to the opening of stabilisation is a prohibited ipso facto triggering event.
This is a serious omission and since the New Law should not be construed as validating unjust enrichment (i.e. where creditors should not withhold performance during the restructuring even though their debtor does not pay), it should be construed narrowly, in the light of the Directive, as prohibiting ipso facto only on account of pre-restructuring non-payment. In any case, there are ways to mitigate the risk arising from this prohibition, however construed, by carefully drafting the ipso facto clause.
Summary
This brief overview has pointed out a number of inconsistencies in the New Law that clearly originate from a lack of experience with regulating prohibitions on ipso facto arrangements in Bulgaria. As the New Law is expressly stated as transposing the Directive, it must be interpreted as closely as possible to the Directive's rules, which may clarify debatable points and result in reasonable solutions. Alongside this, businesses should carefully analyse the new prohibitions and mitigate the risks by paying more attention to how they draft each ipso facto clause. When this is not possible, shorter periods of contract validity (to be re-executed afterwards at regular intervals) may be stipulated or other appropriate steps should be taken to mitigate the risks of being caught by the prohibitions.
By Tsvetan Krumov, Partner, Schoenherr