Reflections on the involuntary bankruptcy of a hotel business
Under the Insolvency Law, a creditor can request that a defaulting debtor be declared insolvent, provided that it is able to demonstrate that any of the indicators of insolvency referred to in article 2.4 of this Law are present. A recent ruling dated March 16, 2016, in which the no. 11 Commercial Law Court for Madrid declared the involuntary bankruptcy of a hotel, based on the understanding that there had been a generalized cessation of payments, gives us cause to reflect on how a situation of involuntary bankruptcy can be avoided.
In the case of a hotel business, as with many other kinds of businesses, liabilities can be divided up into those of a financial nature (debts deriving from the financing provided for the hotel) and debt incurred through its actual activity (payments to suppliers, employees, public bodies, etc.).
Although it is very important, to ensure that a hotel continues to function, not to default on payment obligations related to its day-to-day activity, it is no less important to ensure that its financial debt is structured in such a way that it can be assumed, and if it is not, to look into the possibility of refinancing it using any of the mechanisms envisaged in the Insolvency Law. The reasons for this are explained below.
In the case of the ruling dated March 16, 2016, the no. 11 Commercial Law Court for Madrid declared the involuntary bankruptcy of a hotel at the request of an investment fund which had acquired the creditor rights of a financial institution from which two mortgage loans had been obtained by the hotel. Despite the debtor’s opposition, it was declared insolvent because the hotel had ceased to make payments to both the investment fund in question (to which it was in arrears for a very considerable sum) and the lessor under the finance lease agreement entered into in respect of one of the real estate properties on which the hotel was located, which was owed several payments, as had been confirmed in a court ruling.
These two entities accounted for the greater part of the hotel’s liabilities, and its situation of default had become sustained, rather than consisting of single or isolated non-payments. As a result, the conclusion reached was that it met the requirements which, according to case law, must be fulfilled for the understanding to be that there has been a generalized cessation of payments, i.e. the situation should be definitive, generalized, complete, and imply an inability to pay which is absolute.
The submissions of the hotel, in which it referred to its wish to restructure the financial debt on which it had defaulted and claimed that it was up to date with payments to all its suppliers, employees, etc., were to no avail. It was precisely the selective default on its financial debt which had enabled it to pay its other creditors because, as the debtor itself acknowledged, its billings were not sufficient to cover all its payment commitments, and this was a clear sign of insolvency.
Although one of the consequences of a declaration of involuntary insolvency is the suspension of powers of administration and disposal of the debtor’s assets, in this case, the ruling in question ordered, as an exceptional measure, that these powers be merely placed under the supervision of the court. This was because it was considered more advisable, in view of the complexities of managing a business of this kind, that the debtor should continue to steer the ship, particularly since there were reports which apparently confirmed the hotel’s viability and indicated that there were investors who might be interested in it. The court clarified in its ruling, however, that the current manager of the hotel should not continue to run it indefinitely, and that once the insolvency manager had been able to assess the economic position of the business, he/she could, if such action was considered appropriate, take over the control of the hotel’s management.
The question this raises is whether the involuntary bankruptcy of the hotel company could have been avoided, thereby averting some of the damaging consequences of such an outcome – in terms of legal costs, time, reputation, impact on the day-to-day business, supervision of the business by the court, loss of control of the management of the business, etc.. The answer would appear to be that it could have been, particularly in view of the existence of reports which confirmed – with varying degrees of accuracy – the viability of the business. The hotel could have been one step ahead and, seeing that it was unable to make the payments due on its financial liabilities, could have made use of any of the restructuring mechanisms envisaged in the Insolvency Law in order to reach a refinancing agreement which its financial creditors would consider reasonable. It could even have requested judicial endorsement of such agreement to assure its creditors that if the hotel’s business plan failed, the refinancing would not be examined in the event of a subsequent insolvency process.
The initiation of negotiations aimed at reaching a refinancing agreement, along with the mechanism established in article 5 bis of the Insolvency Law for the communication of such negotiations to the Court, would have prevented any third party from filing an involuntary bankruptcy petition, at least while the negotiations were ongoing. The mechanism established in article 5 bis—commonly referred to as “pre-bankruptcy”—would also have made it impossible for any foreclosure proceedings to be initiated against the hotel during that period.
The negotiations between the hotel company and its creditors could also have resulted in an advance proposal for an arrangement, which could have included a formula for the transfer of the business to a third party in the event of there being an offer to acquire it. What is clear is that in such situations, the important thing is to be one step ahead and adopt a pro-active stance, and be aware that there are various formulas available whereby a situation of structural crisis in a hotel business can be definitively overcome.
Garrigues Restructuring and Insolvency department