Unpacking Malta’s new American-style bankruptcy framework

Anyone familiar with the business culture of the United States – as well as the multiple bankruptcies of former US President Donald Trump’s business empire – will know that bankruptcy in the US is very different to what bankruptcy means in Malta – until now.

By December 2024, the transposition of a comprehensive insolvency framework into Maltese law will see the introduction of several novel mechanisms that may lead to an entire revaluation of the business culture.

For the first time, Maltese individuals will be able to declare themselves bankrupt and apply to have their commercial debts – not personal – written off if they cannot be repaid within three years.*

The new framework is based on three legal instruments – the introduction of a pre-insolvency act and an insolvency practitioners act, and amendments to part three of Malta’s Commercial Code, relating to bankruptcy.

The reform is intended to regulate preventive restructuring, and is specifically intended to be used by debtors when they are exposed to the possibility of financial distress.

Significantly – and this is a novel feature within the local commercial landscape – preventive restructuring allows debtors to get up to one year of protection from judicial attack by their creditors.

It is important to note that eligibility to utilise the mechanism depends on the possibility that a company faces insolvency – in other words, it cannot be used by any company at any time to put off paying the money it owes.

Additionally, not all sectors are covered by the new law, with notable exemptions being financial services companies, like insurance and credit institutions as well as investment firms and collective investment undertakings, which are already heavily regulated and will continue to be regulated by their own sector’s structures.

During the restructuring period, the company will be allowed to continue in its day-to-day business, and will not give up total control of its operations, as happens when it goes into receivership.

However, a controller will be appointed to keep an eye on the company’s behaviour and ensure that no extraordinary actions are taken without its consent.

Another novel provision is the ability of the firm to renegotiate contracts that are causing more harm than good to the company. For example, a company facing financial difficulty with three years outstanding on its lease may strike a deal to have the contract declared null after just one year.

It is probably once again pertinent to point out that these drastic measures can only be utilised by companies facing bankruptcy, not just any business trying to get out of an onerous contract.

But what happens if all a company’s creditors – including key suppliers – get scared off by the insolvency proceedings and refuse to continue to do business with it?

Here, the framework allows the debtor to identify those contracts that are essential to its executive functioning, that is, ones that are so important for the running of the business that it would not be able to operate without them – effectively causing it to default and cause all its creditors to lose what they are owed.

In these cases, firms going through such pre-insolvency proceedings may also be eligible for interim financing if it is necessary to get them to the end of the process.

One major innovation that is central to the framework is the introduction of a ‘best interest of creditors’ test. Previously, an agreement could be forced on dissenting creditors, so if, say, 60 per cent of a company’s creditors agreed with a particular plan, the other 40 per cent would be lumped with it.

However, the new framework introduces a safeguard by stipulating that creditors cannot be forced to accept any deal if they are better off without it. Dissenting creditors may therefore vote against a restructuring plan if they can prove that their interests will be harmed if it goes through – although this does put the onus on them to conduct the relevant financial analysis.

There are caveats to this provision – if some particular creditors are unlikely to receive much money anyway, they are not allowed to stand in the way of a restructuring that can save the business.

An important test case for similar legislation is the UK, where, in the first year after its implementation, £5.2 billion in debt was amended and recovered, £500 million was equitised, and £600 million was written off.

All that said, it will likely take some time for the full ramifications of the framework to be internalised and utilised by the local business community.

*Of course, there are always likely to be certain cases where the division between commercial and personal debt is not entirely clear, as in the case of a delivery operator (a natural person, not a firm) who buys a van for their work but also uses it personally. In such cases, the total value of the debt can be apportioned, so if only 75 per cent of the van’s mileage is attributed to its use as a commercial vehicle, then only 75 per cent of the debt owed on it is dischargeable.