Our Dispute Resolution team analyzes the significant legal news on Commercial and Banking Litigation, Insolvency and Arbitration of the last month in this newsletter.

The transformation of the foreclosure procedure

Until the matter was referred to the European Court of Justice for a preliminary ruling regarding the early termination of the loan (secured with the mortgage), the lack of payment of the instalments of its mortgage loan by the debtor activated a special and summary foreclosure procedure (the Loan Deed foresaw the early termination when just one instalment was unpaid, although the Creditor used to wait until several ones were not paid).

The European Court of Justice (ECJ), in its Judgment regarding cases C-70/17 y C-179/17, declared unfair such early termination clause, giving the National Judge the chance to remedy such nullity of the loan contract, allowing for the subsistence of the contract even without such stipulation, in order to avoid the possibility for the Creditor to request full payment before the end of the loan term.

This Judgment could mean, in practice, a worse situation for the Debtor, since the Creditor seems to be now allowed to file an Ordinary Procedure (instead of the Foreclosure Procedure) to achieve the termination of the loan contract and repayment of the existing debt (ex article 1.124 of the Spanish Civil Code). The Creditor thus will be allowed to enforce the Ordinary Judgment according to the procedure foreseen in article 655 of the Spanish Civil Procedure Act, suggesting (ex art. 693) the lack of payment of at least three instalments of the loan (in the new Mortgage Act other scenarios are possible regarding non-payments: 3% or 12 instalments in the first half of the loan; or 7% or 15 instalments in the second half of the loan). But the Debtor will be deprived of the benefits of the foreclosure procedure (debt allocation in Court before the end of the auction, debt relief or sale of the property for at least 75% of the valuation), unless the Debtor itself voluntarily chooses the Foreclosure Procedure.

We are waiting for the Spanish Supreme Court to issue at least two judgments (or one agreed by the Plenary Court), with the same criteria to establish definitive jurisprudence about whether (i) the contract can subsist without an early termination clause, or (ii) the contract cannot subsist without such clause and therefore it must be substituted by the Spanish Judge, and what the terms  of that substitution might be.

In the meantime, we are representing the Funds and Banks, dealing with the foreclosure procedures excluded from the application of article 693, continuing with the existing procedure, or opting to terminate the existing one and taking the route of the Ordinary Procedure.

Latest legislative developments

On June 6, the European Council adopted the Directive on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (directive on preventive restructuring frameworks). 

In this way, the EU gives the reputable bankrupt entrepreneurs a second chance and makes it easier for viable companies with financial difficulties to access preventive restructuring frameworks at an early stage to prevent insolvency.

The overall objective of the Directive is to reduce the most important obstacles to the free flow of capital arising from differences in member states’ insolvency and restructuring frameworks, and to improve the rescue culture in the EU based on the principle of second chance. The new rules also aim to reduce the amount of non-performing loans in banks' financial balances and prevent the accumulation of such loans in the future.

The Directive needs to be formally transposed into each Member States’ national law. Although most of the aims of the Directive are already incorporated into the Spanish Insolvency Act, further changes must be implemented in Spanish legislation in order to integrate all the compulsory Directive Provisions.

Since in Spain creditors are usually unwilling to reach early composition agreements, the Directive will facilitate the rescue of the company at an initial stage. Therefore, the main modifications of the Directive will affect the debtor’s situation prior to the insolvency, which means adapting, among others, Article 5 bis of the Spanish Insolvency Act, as well as the Additional Provision 4ª.

For this purpose, Spain is planning on elaborating a Consolidated Text of the Spanish Insolvency Act. However, it is not clear when and to what extend all the provisions of the directive will be included in this new text.

We will follow up on how the Directive is implemented, and we will keep it updated in future newsletters. For more details on the Directive, please click here.

Judgements of interest

Judgement no. 279/2019 of the Spanish Supreme Court (Chamber One), of 22 May 2019

The Supreme Court limits director’s liability to cover insolvency deficit - Article 172 bis of the Spanish Insolvency Act.

Fraudulent insolvency. People affected by the classification. The Supreme Court has stated that, in order to hold a director liable, the court must be able to determine that the individual director generated or worsened the insolvency wilfully or with gross negligence. It is not justified that the accounting irregularity has prevented the insolvency administration from knowing the true causes of the generation or aggravation of insolvency.

Judgement no. 145/2019 of the Spanish Supreme Court (Chamber One), of 8 March 2019

The Supreme Court limits penalty clauses in insolvency proceedings when they respond to a punitive and non-compensatory purpose.

The Supreme Court has stated that, in an insolvency scenario, penalty clauses included in contracts must operate to compensate for the damages. However, when the penalty exceeds the compensatory purpose, and responds to a sanctioning purpose, they must not operate, because in this latter case all the various creditors are being punished in addition to the debtor.

Code of Good Practice of the Spanish Arbitration Club (CEA)

The Code of Good Practice of the Spanish Arbitration Club (CEA) was presented at the CEA International Arbitration Congress held in Madrid in June. The Code of Good Practice is a "soft law" that gathers the recommendations that the CEA submits to the entire arbitration community. It is a replacement of the 2005 one and it presents recommendations not only to arbitration institutions, but to all the professional participants in the arbitration process: arbitrators, lawyers, experts and financers. It has been issued to strengthen the standards of independence, impartiality, transparency and professionalism and, ultimately, arbitration practice.