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Friday, August 14, 2015

The Law of Second Chances Takes Effect in Spain

One of the drags on the ability of Spain's economy to recover from the financial crisis of 2007-2009 was the lack of a mechanism for consumers to obtain relief from the debts they ran up in the years leading up to the crisis, debts that were mainly incurred in the form of residential mortgages incurred in the housing boom that paralleled the trajectory of the US's housing boom in those years.
As Spain had no meaningful procedure for individuals to obtain debt relief, it had no method to free up post-crisis wages and salaries from the legacy debt of pre-crisis mortgage debt.  This not only dampened overall demand but had the secondary effect of weighing down the Spanish financial system, in a manner very similar to the Japanese banking system a generation earlier, with "zombie" loans, that were neither collectible in accordance with their terms, nor dischargeable, and not susceptible to robust valuation as they lingered on financial institution's balance sheets, given the uncertainty surrounding the prospects for ultimate recovery.

Slowly, Spain's government, led by the center-right Partido Popular that replaced the Socialist coalition that governed into the crisis era, has instituted measures to facilitate consumer debt relief for the first time.   There have also been business insolvency reforms, which I am not going to touch on here (for those interested, here are links to some rather spirited memos by Latham and Dentons on those reforms; with regard to the Dentons memo, please be forewarned that there is an egregious mis-translation -- the word "quitas" in Spanish means "discharge," not "pay-off" (you see why I used the word "egregious?)).  It's unlikely that there will be very many English-language explanations of Spain's consumer bankruptcy law, which took effect at the end of July, so this seems like an area I can add some value with a post.

Spain's new consumer bankruptcy law -- which is generally referred to as "la ley de segunda oportunidad", or "the law of a second chance" and also applies to small businesses (less than  five million euros of debt) -- bears a number of rough resemblances to the US consumer bankruptcy regime, for better or worse.  For example, among the eligibility requirements, there is a stringent "good faith" requirement as well as a requirement not to have availed oneself of the procedure within a prescribed period of years.

In general, as one firm of lawyers explains here, the consumer insolvency procedure is basically erected on top of the pre-existing procedural structure for insolvent businesses in Spain to consumers.  As with larger business reorganizations, the individual or small business debtor is encouraged to commence a "concurso" outside of court, which, that firm indicates, can last a long time and requires the debtor to "wait patiently".   An administrator is appointed and s/he prepares a report.  There are negotiations.  If there are disputes over how the debtor is conducting his, her or its affairs, there can be resort to a judge. And, as the firm says there are "large etceteras" in that process.  If, when all is said and done, there is debt remaining after reaching the requisite threshold of agreement with the creditors, the debtor can ask the court to discharge it.

Or, the individual / small business debtor can take a slightly different path, submitting his or her affairs to a notary (individual debtor) or insolvency mediator (small business) who then is expected to facilitate a similar accord among the creditors.

But, if these corporate insolvency analogues fail, there are two other paths to a discharge for the individual or small business.  First, a debtor who, through a judicial proceeding a) liquidates his or her assets, (b) pays in full all of what we would call administrative and statutory priority claims and secured creditors, and c) delivers immediately at least a 25% dividend to unsecured creditors, is entitled to a discharge at that point and need not make further payments out of future income.  Second, a debtor who cannot obtain an agreement with creditors and also cannot meet the necessary payment thresholds for immediate discharge, can get a discharge at the end of, and subject to either full compliance or a "strong effort" to comply with, an approved 5-year payment plan (note also that, should the debtor experience a material, favorable change in circumstances during the term of the payment plan, the creditors may ask for more payments).  It was not clear to me whether the debtor in the latter case must liquidate assets.  The preface to the statute makes a very big deal about the fundamental importance of requiring the debtor to liquidate assets.  But, in the case of a small business debtor, liquidating assets seems quite at odds with the goal of servicing a debt repayment plan over 5 years.  But, in any case, these two options are roughly similar to our chapters 7 and 13, although stricter in, among other respects, the sense that Spain effectively reverses the US "means test" choosing to route debtors of lesser means into their version of chapter 13.  This blogger asserts that the law is still too creditor-friendly, pointing particularly to the ability of creditors to extract more from the debtor during the payment period if circumstances improve materially.

Mortgages are handled in one of three ways.  First, the mortgagor can, of course, keep servicing the mortgage.  Second, the mortgagor can cede the property to the lender and then any deficiency runs through the process above (except, as I read the commentary on the law, the deficiency cannot be discharged nonconsensually through the 5-year payment plan method).  Third, depending on a large number of eligibility criteria, the value of the house, the amount of the annual mortgage payments and the proportion of the mortgagor's annual income that those payments represent, and several "special vulnerability" criteria, the mortgagor is eligible for a procedure that is formally outside of the insolvency laws, known as the "Code of Good Practice" a mortgage restructuring protocol that Spanish banks have adopted "voluntarily" (in the sense of, it's always better to settle with the regulators than to find out what they will do if you don't). There is a hierarchy of debt relief steps that the lenders are supposed to afford the mortgagor under the Code, beginning with lowering the interest rate and stretching out the amortization, and for more difficult debt burdens, write-offs of various magnitudes.  Overall, this strikes me as reasonably similar on the big-picture level, to the US approach, with the Code of Good Practices being analogous to HAMP and similar out-of-court protocols in the US.  One thing I could not tell was whether the 10% haircut that Spain now imposes on secured claims in corporate insolvencies exists in this consumer context as well.

I couldn't find anything in over half a dozen sources I read regarding exemptions. Most references to liquidation of the debtor's assets described it in plenary terms suggesting to me that exemptions are insubstantial.  Certainly there does not appear to be any "homestead exemption".

Although not quite as debtor-friendly as the US consumer bankruptcy regime, and probably too encrusted, even at birth, with substantive complexities and procedural inefficiencies, the "Law of Second Chances" is a big step forward conceptually for Spain and likely to have some positive effect on its economy, which, for unrelated reasons, has finally begun to grow at a normal pace.