ITALY'S 2005 BANKRUPTCY REFORMS: ONE STEP CLOSER

UNCLAS ROME 002109

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN IT
SUBJECT: ITALY'S 2005 BANKRUPTCY REFORMS: ONE STEP CLOSER
TO CHAPTER 11



1. (U) Summary. Following Parmalat's financial crisis in
December 2003, the Italian Parliament began the first
comprehensive reform of Italian bankruptcy law since 1942.
The bankruptcy reforms, first enacted as a Decree Law and
later ratified by Parliament, bring Italian bankruptcy
proceedings more in line with U.S. Chapter 11 proceedings.
The reformed bankruptcy law seeks to preserve the integrity
of the corporation through expanded use of the "concordato
preventivo," ("preventive accord") under which companies
facing bankruptcy can enter into debt restructuring
agreements with their creditors. The reform also shortens
the "claw-back" period, during which transactions entered
into by the corporation can be voided, and introduces an
out-of-court restructuring procedure. End summary.

Italy's 1942 Bankruptcy Law
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2. (U) Italy's previous bankruptcy law, enacted by Royal
Decree in 1942, was based on the premise of "decotus ergo
fraudator" ("bankrupt and therefore a swindler") and focused
on making creditors whole through liquidation of the
corporate assets and dissolution of the corporate body. The
1942 law was written at a time when corporations were rare
and individual traders and small partnerships, whose main
asset was land, dominated the Italian economy. The law
focused on liquidation of the debtor's assets because, when
the main asset was land, it was the most effective way to
make the lender whole.


3. (U) As the Italian economy developed, and corporations
replaced individuals and partnerships as the main drivers of
the economy, the 1942 law came under increased criticism from
legal commentators for its emphasis on liquidation and
cumbersome procedural rules. The shortcomings of the law are
best illustrated by the following statistics:

- In 1998, out of bankruptcies valued at 5.5 billion euros,
only 1 billion was actually paid to creditors. Legal and
liquidators' fees totaled 250 million euros. Bank management
fees totaled 750 million euros.

- Italian bankruptcy cases could last as long as six years,
compared to an average of six months in Germany, seven in the
U K, and eight in France.

- In 1999, creditors' claims accepted by liquidators totaled
7.5 billion euros. Of these, only 11 percent were actually
paid out, leaving unpaid claims in the amount of 6.7 billion
euros.

The 2005 Law
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4. (U) Parmalat's 2003 financial crisis, in which the
company was found to have overstated its assets by eight
billion euros, made clear the need to reform Italian
bankruptcy law. Parmalat's bankruptcy was managed using an
emergency decree by then-Industry Minister Antonio Marzano
that allowed Parmalat to enter into a debt-equity swap with
its creditors. The aim of the "Marzano Decree" was to
preserve the company's assets through the continuation or
transfer of business activity. This enabled the corporation
to continue to do business, working its way out of
bankruptcy, and in the process, preserved the livelihoods of
many of Parmalat's 36,000 employees and the roughly 5,000
dairy farms which depended on sales to Parmalat.


5. (U) The most important part of the 2005 bankruptcy law
reform is an extension of the "Marzano Decree" principles to
smaller companies, amending an existing procedure called
"concordato preventive" ("preventive accord"). The
"concordato preventivo" is a judicial procedure oriented
towards the reorganization of the activity of the insolvent
company through an agreement between the debtor and its
creditors. The new "concordato preventivo" allows smaller
corporations to restructure their debt (as Parmalat did)
rather than face liquidation. Unlike the 1942 bankruptcy
law, the debtor is no longer required to be insolvent to be
admitted to the new "concordato preventivo," provided that
the debtor is in a pre-default situation, such as a temporary
financial crisis. The debtor's proposal to creditors may now
provide them with an assignment of assets or company shares
in order to partially satisfy their claims. The "concordato
preventivo" allows for the division of creditors into classes
and for the restructuring of debt in almost any form,
provided that the restructuring plan is approved by the
creditors holding the majority of the company's unsecured
debt. In fact, the secured creditors do not have the right
to vote, although it seems that they must be fully satisfied
by means of the debtor's restructuring plan. Expanded use of

the "concordato preventivo" should result in an increased
willingness by lenders to extend credit to corporations,
because there is less chance they may than face lengthy and
expensive liquidation proceedings that do not result in the
substantial recovery of their loans.


6. (U) The 2005 bankruptcy reform shortens the claw-back
period of Italian bankruptcy law to a maximum of one year,
down from two years under the 1942 law. The shorter
claw-back period strikes a balance between the company's need
to solve financial and economic problems by selling a
business or activity, and the principle of guaranteeing to
all creditors equal treatment in case of future bankruptcy.
This reduction of the claw-back period will reduce the number
of pre-bankruptcy transactions which the insolvent
corporation can have voided ("clawed-back"),lowering the
administrative and legal costs associated with bankruptcy.
It should also make vendors more confident in extending
credit to customers since "ordinary course" transactions are
exempt from the law's claw-back provisions unless the
corporation can prove that the creditor knew of the debtor's
insolvency at the time of the transaction.


7. (U) The last reform introduced by the 2005 bankruptcy law
is an out-of-court restructuring process. Under this
provision, companies may ask the court to approve a

restructuring plan provided that the plan is agreed to by
creditors holding 60 percent of the corporation's debt and
has been approved by an independent expert. This procedure
differs from the "concordato preventivo" (described in
paragraph five) in that it does not provide for the division
of creditors into classes, and requires approval by creditors
holding 60 percent of all debt, as opposed to the simple
majority of those holding unsecured debt required to approve
a "concordato." Like the other reforms in the 2005 law, the
introduction of an out-of-court settlement procedure should
lower the administrative costs associated with bankruptcy.
There are some ambiguities in the law, however, and experts
are divided on issues such as which party is responsible for
paying for the cost of the independent expert's evaluation of
the restructuring plan.

Criminal Penalties
--------------


8. (U) The new law retains criminal penalties for
bankruptcy. If an individual's conduct has caused "actual
damage" to creditors, that individual may be sentenced to six
to ten years' imprisonment. This provision of the law
retains the 1942 law's view of bankruptcy as an offense
against the economy. Legal commentators expect these
provisions to be abolished or narrowed in future revisions of
the law. Mario Draghi, Governor of the Bank of Italy, has
noted that the penal provisions of the new law are "based on
a punitive view of bankruptcy," and has argued for their
modernization.

Comment
--------------


9. (U) The 2005 revision of Italian bankruptcy law makes
great progress in lowering the administrative, legal, and
business costs of bankruptcy. It is perhaps a good sign that
some judges have complained that the 2005 law diminishes
judicial power in bankruptcy procedures. Even with the new
law's streamlined procedures, debt recovery proceedings in
Italy take five times as long as the OECD average, in large
part due to the slow pace of judicial proceedings.
Participants at a May 18 Rome conference on bankruptcy hosted
by the Italian Banking Association generally gave the law
favorable reviews, praising it for increasing the speed with
which restructuring plans can be implemented and for
increasing creditors' involvement in debt restructuring.
Although critics of the new law are in the minority, there is
a consensus that it needs fine-tuning. Bank of Italy
Governor Draghi, for example, has noted that the new law only
applies to half of all businesses in Italy, and has urged
that its scope be broadened. Although it remains to be seen
whether the new law will make financial institutions more
willing to extend credit to small or start-up businesses,
which are key to re-energizing the Italian economy, Italy now
has a modern bankruptcy law which should increase creditors'
confidence in their ability to recover their assets from a
debtor facing bankruptcy.
BORG