Timothy Goodger looks at the impact of new European legislation surrounding the winding-up of insurance businesses

On 20 April, it will be a year since all member states of the European Economic Area (EEA) were required to enact national legislation to implement the European Union (EU) Directive 2001/17/EC on the reorganisation and winding-up of insurance undertakings. However, in January of this year, the European Commission referred eight EEA states, Belgium, Greece, France, Luxembourg, the Netherlands, Finland, Sweden and the UK, to the European Court of Justice for not having implemented the directive.The directive, originally adopted by the EU in February 2001, applies to 'winding-up proceedings' (whether insolvent or not, voluntary or compulsory) and to so-called 'reorganisation measures' of insurance undertakings in the EEA. Primarily, the directive deals with the priority of payment of insurance claims in those circumstances with the aim of protecting all 'insurance creditors' of direct insurance and direct life assurance. This article focuses on the effect of the directive in the UK, and looks at how France and Spain have implemented it.Although there is a focus on the issue of priority given to insurance creditors before reinsurance and other creditors, the directive importantly provides for cross-border recognition of insurance insolvency proceedings.It addresses not only the relevant law to be applied to the winding-up proceedings (ordinarily being the state in which the undertaking has its head office), but also the proceedings relating to its subsidiaries and branches in other EEA states so that one law governs them. That will dictate which procedures are adopted for the admission of claims and the distribution of assets to creditors, and counterparties to transactions with insurance undertakings should be aware of this.

Required stipulationTo achieve the objectives of the directive, member states are required to stipulate which of two methods insurance undertakings should adopt to give priority to insurance claims. The first method is for insurance claims to take absolute precedence in respect of assets representing the insurer's so-called insurance technical provisions. The second is for insurance creditors' claims to rank in priority only behind certain preferential claims, including claims by employees, and rights over particular assets of an insurance undertaking. A member state can establish a ranking between different categories of insurance claims in the context of either method.The referral of the UK to the European Court comes as something of a surprise since the Insurers (Reorganisation and Winding-up) Regulations 2003 came into force in the UK on 20 April 2003, with the intention of giving effect to the directive. The regulations did not affect insurance insolvencies or measures of EEA insurers or any branch of an EEA insurer before that date. The UK regulations apply where there has been an intervention by administrative bodies or judicial authorities intended to preserve or restore the financial situation of an insurance undertaking. Consequently, it applies not only to the winding up of undertakings but administration orders, and the implementation of certain schemes of arrangement.The UK has implemented the second method so that the order for the priority of payment of debts of a UK authorised insurer is that 'preferential creditors' come first (but since 15 September 2003 it covers employee claims only); then 'insurance debts'; and then all other debts. The stakeholders in an insolvency or reorganisation therefore will fall into three distinct camps.The answer as to why the European Commission maintains that the UK has not implemented the directive may lie in the fact that the UK has not introduced regulations applying to Lloyd's. Although to a certain extent creditors may be partially protected at Lloyd's because of the existence of the Central Fund, there is no priority for insurance creditors. The regulations for Lloyd's have still to be finalised by the UK Treasury using a consultation process and publishing draft regulations. In addition, it may have been the EU's intention that the directive apply also to solvent schemes of arrangement, whereas in the UK it is a commonly held view that they are a specific exception.

Effects in the UKThe long-term effect of the directive may be that undertakings dedicate themselves only to undertake direct insurance or reinsurance business.That might ensure that counterparties have confidence to do business with those undertakings. The short-term result, however, may have the opposite effect. Reinsureds may decide it is more secure to place business with dedicated EEA reinsurance undertakings or non-EEA undertakings carrying on insurance and reinsurance outside the EEA. This may result in a loss of confidence in some undertakings dealing in both insurance and reinsurance business, particularly if their overall credit rating is in question.Alternatively, potential reinsurance creditors may seek (enhanced) security from those with whom they obtain reinsurance. Security might be by way of letters of credit or ring-fencing funds for a reinsured's benefit or by charging property, although the latter is unlikely to be acceptable to undertakings.Banks may begin to review their positions in relation to undertakings.For some undertakings, wholesale restructuring may be the only way to instil long-term confidence and ensure stability. Restructuring may be complicated by the need to allocate capital between undertakings and to obtain regulatory approval as well as comply with solvency margins. However, if undertakings lose their ability to balance the insurance and reinsurance sides of their business, they also may become more exposed than before to swings in either market where previously one compensated the other.It is notable however that there had not been a spate of restructuring in the UK prior to the UK regulations, nor has there been since. Start-up operations since April 2003 may have considered the effect of the directive.The difficulty for those administering insolvencies in the UK will be deciding how to apply the regulations and ensuring that they have been applied correctly. One can envisage scope for argument when liquidators have to consider whether the more esoteric products are insurance, reinsurance or neither. The dynamics between stakeholders in an insolvency of an undertaking, involving a mixed book of direct and reinsurance business, may necessitate officeholders making applications to the courts for directions to ensure that none are able to assert that they have suffered prejudice. Readers may be familiar with a similar scenario arising in Australia in respect of the interpretation of s562A of the Corporations Act and s116 of the Insurance Act 1973 where the Australian courts gave directions in the liquidations of HIH and New Cap Re. Since the UK's implementation of the directive, however, the UK provisional liquidation of Home Insurance Co's UK branch appears to be the only UK insurance undertaking where such issues might remotely arise.The courts have considered whether the directive should apply in certain cases, such as the recent approval of the scheme of arrangement for Pan Atlantic Insurance Co Ltd, which had been placed in provisional liquidation before the regulations came into force.The directive may also affect some schemes of arrangement indirectly because insurance creditors' perception might be that they would prefer to be paid 100% of a claim if an undertaking is placed into liquidation rather than agree to a scheme of arrangement under which they may receive a lesser percentage of their claim. In addition, after a recent application involving a scheme of arrangement for Marconi, the courts are likely to have regard to whether creditors would be treated differently in a liquidation compared to a scheme.

FranceFrance has yet to pass legislation to implement the directive although it has prepared a draft bill. Various amendments to the bill have been required, following submission of the bill to the French Senate in July 2003 and then to the Commission of Finance. The bill adopts the same method as the UK, giving precedence to insurance claims, ranking in priority behind some preferential claims such as wages, national insurance and taxes.It is too early to anticipate the impact the directive will have on the French insurance industry. However, in France, insurance and reinsurance business tends to be undertaken by separate entities. This is in contrast to the UK insurance industry where undertakings regularly enter into direct insurance as well as reinsurance business. Thus there may be no noticeable impact when the French legislation is passed, although the position of insurance creditors will be strengthened.

SpainAlthough Spain is not one of the countries that have been referred to the European Court, it did not implement the directive in 2003, but has now sought to do so by passing what is known as Law 34/2003 on 4 November 2003. That law gives precedence to insurance claims over and above any other claim against the insurer, with respect to those insurance assets representing the insurance technical provisions of the undertaking. It adapts the Spanish insurance legislation on insurance and modifies some aspects of Law 30/1995 on Regulation and Supervision of Insurance. As a result, every insurer must represent, at any time and independently of a possible winding-up, the claims that may take precedence over the assets that are the technical provisions. As well as providing for mutual recognition of member states' reorganisation measures and winding-up legislation and necessary cooperation between the competent authorities, the new law will not involve important changes in Spanish winding-up proceedings.However, given the recent approval of the new law, there has been no visible impact on the Spanish insurance market so far.It is perhaps regrettable, but likely, that only a major insolvency will result in active consideration of the possible issues and their being worked through.Timothy Goodger is a Partner in the insurance practice at London law firm Elborne Mitchell. The writer would like to thank Spanish law firm Goni & Co, as well as French qualified lawyer Helene Cohen, of Elborne Mitchell, for their contributions.