Parmalat, an Italy dairy company 2.

1 Introduction In December 2003, the Parmalat Group (Parmalat), a company so massive that it comprised 1.5% of Italys Gross National Product (GNP), suddenly collapsed and entered bankruptcy protection. The collapse of this multinational food and beverage giant was the result of the discovery of systematic financial fraud, which took place over a period of several years. On December 8, 2003, despite showing approximately $5 billion in cash on its balance sheet, Parmalat was barely able to avoid defaulting on a $150 million note payment that had come due. It was only able to do so by invoking a five-day grace period. Four days later, as public suspicion of Parmalats financial situation grew, the company was somehow able to locate money to make the note payment. On December 19, Bank of America announced that an account that Parmalat alleged contained approximately $3.9 billion of cash did not exist. It was at that moment that Parmalats insolvency was revealed to the public. Parmalats size and importance to the Italian economy as a whole presented a unique problem for the country. At the time, Italys bankruptcy law was inadequate, archaic, and poorly formulated to handle the bankruptcy of such a large company. To cope with this reality, Italy, through emergency legislation, rewrote its bankruptcy law in only four days. The result of this process was Decree-Law No. 347 of December 23, 2003 (the Marzano Law). The new law allowed the Parmalat bankruptcy to proceed under conditions that were more favorable to the company and to Italian national interests. Two examples of such national interests were the well-being of Italian stock and bondholders, and the interests of Italian dairy farmers, a group owed as much as 125 million.In Italys rush to safeguard national interests, it failed to exhibit the same level of concern for Parmalats banks and international creditors. The ad hoc nature of recent bankruptcy reforms in Italy, particularly the circumstances surrounding the creation of the Marzano Law in the midst of the Parmalat scandal, has negatively affected prospective creditor confidence. More generally, it has negatively affected investor confidence, resulting in some investors completely refusing to invest in Italian corporate debt.This note examines where Italy has made errors in the development of its bankruptcy law and policy from the creditors perspective. It also offers suggestions as to how Italy can modify its

bankruptcy laws to correct these problems and make Italian companies debt offerings more attractive to creditors. 2.2 Operational v functional Restructuring Parmalat was not difficult: it had a good underlying operation overburdened by enormous indebtedness. The success of the so-called 'Parmalat law' depended on the fact that, for the first time, the 'debt/equity swap' arrangement was introduced in order to deal with the insolvency of a company. Parmalat creditors had a very liquid exit when the new Parmalat was listed. The company now relies on litigation to fund its operations and the restructuring has been successful. However, the law for the restructuring of large enterprises may not prove so successful for a company with operational problems. For example, there is much speculation that legislation developed in response to Parmalat's collapse is not appropriate to deal with Alitalia's operational issues. The restructuring of a company with a weak business operation requires an industrial plan which cannot be implemented easily within the current legal framework. Further reforms may therefore be required to suit firms whose difficulties are more operational than financial. 2.3 Cultural issues Further, the Italian economy is still largely based on 'family' companies. Essentially, Italian entrepreneurship lacks a corporate culture. Distressed investors might appreciate the directness of dealing with an owner-manager but the feeling is not always mutual: owner-managers are aware that by inviting a fund into the fold their influence will be reduced. Thus, if the company is not perceived as an asset for the stakeholders (and not only shareholders) there is no incentive, other than a sentimental one, for the founder to rescue it This is not the end of the story, however. When a restructuring approaches, Italian banks gather into an exclusive club. Foreign investors are rarely invited, especially now that a period of consolidation has allowed the largest Italian banks to compete in terms of balance sheet capacity with the largest European institutions. The preferred exit strategy is recapitalisation of the debtor by an industrial buyer. If this is not feasible the Italian banks try to restructure the indebtedness among the original lenders. As a last resort, they might eventually consider the involvement of a foreign player.

Occasionally, situations arise where a certain degree of activism does become apparent - for instance, where a large target such as a private equity fund is involved. In such a scenario there is rarely a continuing family interest in the business; these are financial institutions and their interests are as international as private equity firms. The trading of the debt, however, is not pushed to the limit. This reduces the risk of a potential collapse of the debtor's capital structure; aggressive investors are not able to establish a dominant position whereby they could block a restructuring and thus dictate terms to other creditors - effectively holding them to ransom. In certain cases even this is not possible. The market is familiar with the Italian fronting structure used by international lenders. If the lender is Italian it receives repayment of the loan net of withholding tax. The Italian fronting bank then sub-participates the loan to other banks. This participation is available for trading. However, the banks do not have direct recourse against the borrower, and can only exercise very limited influence on the management of the loan by the Italian fronting bank against the borrower. For fiscal purposes, should this direct influence be established, the Tax Authority could qualify the Italian lender as a 'conduit', alleging a direct relationship between the borrower and the banks. As a result, withholding tax should apply on interest paid by the borrower to Italian banks. Ultimately distressed traders tend to stay clear of Italian fronting structures since they do not give any leverage to the investor to renegotiate the capital structure of the Italian borrower. 2.4 Scope for change There are indications that the landscape is changing. New funds are setting up in Italy, such as pure domestic hedge funds supported by a solid fundraising. Their partners are Italian executives with previous experience either in the UK or US. These funds are relatively small: none of them have more than A1bn (792m) assets under management. Currently their main mission is to introduce opportunities to large financial institutions - hedge funds or distressed desks of investment banks, but also industrial players - and to invest alongside them. More important is the broader impact of the credit crunch. Increased interest rates and new financial constraints have hemmed in many Italian companies. As a result, Italian banks may become less conservative in dealing with the crisis simply because they cannot be intimately involved with each ailing business. Italian funds may act as a gateway through which new players in the restructuring arena are

introduced to local shareholders. The market will hopefully open up over coming months. In the short term Italy will experience several restructurings as businesses seek to take advantage of the new legal framework. Some question-marks remain over the implementation of the new remedies provided by insolvency law reforms, particularly in relation to turnaround plans. 2.5 Turnaround plans A turnaround plan is an agreement with creditors that seeks to restructure a company's liabilities, staving off insolvency. Under the previous insolvency law, a turnaround could only be achieved by means of an injection of equity by way of capital increase that could not be unravelled or 'clawed back' on a subsequent insolvency. Changes in the structure of the company's debt were not 'fenced off' from the risk of claw-back on a subsequent insolvency. It is now possible to achieve a turnaround by means of a debt transaction that is protected from later challenge, thus placing the lenders in a more comfortable position. In particular, the protection is applicable to acts and payments made by the debtor and securities given over the company's assets, provided these have been entered into pursuant to a turnaround plan on which an opinion as to 'reasonableness' has been given by an expert. For large limited liability companies (societa per azioni), such an expert is appointed by the court. However, save for such appointments, there is no further court involvement or approval required. There are no specific requirements as to the financial condition of the debtor; the debtor does not have to be insolvent to implement a turnaround plan. The plan can be kept confidential, although disclosure is required for listed companies. The plan is not filed at court or at the Register of Companies and it does not provide a moratorium on legal proceedings. The advantage of the turnaround plan is that its implementation (the payment made by the debtor or securities given on its assets) cannot be challenged on a subsequent insolvency. Best practice is still being developed in relation to turnaround plans. There is a fear that improper use and consequent adverse rulings may have a negative impact on the restructuring market. In parallel with the opening of the restructuring market, there is a need to encourage case law in judicial proceedings that integrates and supports the set of rules provided by the reform of the insolvency law.

The underlying theme of the reform is to protect the goodwill of a company in financial difficulty for the benefit of the creditors, who are better in a restructuring than in an insolvent liquidation. While litigation should be avoided, the flexibility provided for restructuring cannot be pushed further to the detriment of the majority by value of unsecured creditors. The Italian distressed market is therefore becoming more attractive. However, the legislative framework will be tested over coming months. While uncertainty still exists, there is also cause for optimism. Basic Structure of Italian Bankruptcy Law Prior to the Marzano Law, insolvency in Italy was regulated for over sixty years by the Royal Decree of March 16, 1942, No. 267 (known as the Bankruptcy Law, or

Legge Fallimentare (LF)).The LF is still in effect, but has been amended many
times through the years.Under the LF, insolvency is a permanent, as opposed to temporary situation, and can be proved by default or other external factors that show a debtor is regularly unable to pay the obligations owed. A debtor who is in default is not ipso facto insolvent; lack of liquidity resulting in a default does not ipso

facto mean that the debtor is insolvent. Instead, the debtor may have sufficient
assets to pay all of the debt owed. Notwithstanding the definition of insolvency, typically Italian tribunals do not open bankruptcy proceedings unless a creditor has exhausted all other options. The LF is the main legislation governing the operation of the six insolvency procedures that are available: bankruptcy or fallimento,96 administrative winding up, preventive composition, composition after bankruptcy, controlled administration, and extraordinary administration of large insolvent enterprises (extraordinary administration). These insolvency procedures are divisible into three categories: liquidation procedures, composition procedures, and reorganization procedures. The liquidation procedures, which provide the ability to take over, preserve, and liquidate the assets of the debtor, include fallimento and administrative winding up. The composition procedures, which provide the ability to avoid a liquidation by special agreement between debtor and creditors,include preventive composition and composition after bankruptcy. Reorganization procedures, which are aimed at rescuing the debtor and, ideally, continuing operations, include controlled administration and extraordinary administration of large insolvent enterprises; the latter was originally added to the LF by Decree-Law No. 26 of January 30, 1979 (known as the Extraordinary Administration Law or Prodi Law).

The LF in its original form reflects the view of the times, namely insolvency was [viewed] as an offense to the economy, bankruptcy proceedings as a punishment for the entrepreneur, and liquidation of the assets as the only remedy available for creditors. This meant that bankruptcy involved not only significant economic losses, but also a serious social stigma. Historically, the LF was onedimensional, inflexible, and did not easily permit the successful reorganization of a company. Between 1988 and 2002, almost half of all bankruptcies in Italy ended in liquidation, with creditors only recovering thirty-eight cents on the dollar. As secured creditors were typically unable to recover their claims, in whole or in part, negative economic externalities, such as lower liquidity and an increased cost of debt financing, were generated. Two of the reasons for the original LFs lack of success were 1) that the process could last as long as seven to eight years, and 2) due to the fact that the system placed so much emphasis on the judiciary, the procedures were very costly and used significant portions of debtors assets. A large part of Italys challenge in its quest for reform was that, in order to change its laws, it first had to change its culture and the way Italians conceptualized insolvency and bankruptcy.

Admission to the amended procedure

Thresholds

The requirements that must be met by a company seeking to take advantage of the amendments made by Decree no 347 are that: it has employed at least 1,000 employees during the year preceding the commencement of proceedings; and its debts (including guarantee obligations) are at least 1bn. This compares to extraordinary administrations usual sphere of operation, which is to a company with at least 200 employees and whose debts are at least two-thirds of its balance sheet assets and of its profits during the last financial year.
Procedure

If a company satisfies the thresholds established by Decree no 347, it may apply directly to the Ministry of Industrial Activities (Ministero delle Attivit Produttive), also notifying the appropriate court (where the company is registered). The ministry will issue a decree immediately admitting the company to the extraordinary administration procedure and will appoint a special commissioner. Following the appointment of the special commissioner and notification to the court, the court will declare the company insolvent, on the basis of a standard procedures differ in the time

permitted for the preparation of the recovery plan. The special commissioner has 180 days to produce the plan, which is extendable by a further 90 days following a request by the special commissioner, during which time he must also produce a report showing the causes of insolvency and an assessment of the prospects of recovery. The extraordinary commissioner(s), on the other hand, must submit the plan within just 60 days, which is extendable by a further 60 days. In the standard procedure, the report showing the causes of insolvency and prospects of recovery is prepared as part of the admission process (see above) rather than together with the plan.
Approval

The special commissioner must present the restructuring plan to the ministry who can either reject it or approve it. If the ministry rejects it, and an asset disposal programme is not possible, then the special commissioner can apply to the competent court for a declaration that the extraordinary administration procedure be converted into the liquidation of the company. Pending authorisation of the restructuring plan, the special commissioner may carry out any transactions necessary for the running of the company or the group and preservation of the on-going business activity, provided that prior ministry approval is sought for each specific transaction or category of transactions. In the standard extraordinary administration procedure, however, the restructuring plan or disposal plan is approved by the ministry upon consultation with a supervisory committee made up of creditors. Additionally, in the modified procedure, if the ministry approves the plan, the special commissioner is entitled to exercise any clawback actions that are instrumental to the restructuring plan. This is a further divergence from the standard procedure where clawback actions may only be brought in a disposal plan scenario. report prepared by the special commissioner within 60 days of the ministrys decree (a further 60 days may be allowed) showing the balance sheet of the company and various other financial information. The special commissioner also has 60 days from the decree to request that the ministry admit other group companies to the procedure. In contrast, under the standard procedure, a company must apply to court by petition (rather than directly to the ministry) and admission to extraordinary administration is a two stage process rather than immediate. At the first stage, if the court finds that the company is insolvent it appoints one or three interim judicial commissioners (commissari giudiziali) whose task it is to prepare a report within 30 days of appointment containing a description of the causes of insolvency and an assessment of the existence of serious prospects of

recovery. The company is only admitted to extraordinary administration at the second stage if, relying on the report, the court decides that there are serious prospects of recovery realisable through a disposal or restructuring plan. If considered viable, the court appoints one or three extraordinary commissioner(s) (commissiari straordinari) and the company is admitted to the procedure.

Recovery plan
Contents

In principle, the provisions of Decree no 347 are intended to assist when there is a possibility that the business of the insolvent company may be restructured and reorganised and not when the only option available is clearly an asset disposal plan. Accordingly, Decree no 347 requires the recovery plan to be a plan for the economic and financial restructuring and reorganisation of the enterprise that must be capable of implementation within two years. However, should the special commissioner require disposals of assets or going concerns in order to restructure the company, the ministry may grant authorisation. Under the standard procedure the recovery plan may, as an alternative to a restructuring plan, be for the disposal of the going concerns of the company which is to be completed within one year (with a three month maximum extension).

Parmalats Scandal and the Resulting Marzano Law

On the one hand, over the course of the LFs life, reforms have come slowly. On the other hand, over the past ten years, there has been an almost constant stream of piecemeal reforms, the result of which is a very different Italian bankruptcy law and a changing Italian legal culture. Fortunately, Italy has been able to learn from its mistakes and adapt to current events. However, that said, many of the reforms that Italy has made over the past ten years have come at the heels of major scandals, and have accompanied the demise or near demise of massive Italian companies. As one study put it, Italy used scandals to jumpstart reform. The first of these incidents, the Cirio Incident, occurred in November 2002 and precipitated the first major reform in 1999, the Prode-bis Law. The second of these incidents, the more momentous Parmalat scandal, occurred shortly thereafter, in December 2003. Parmalat and its Effect on Italian Bankruptcy Law

In December 2003, Parmalatthe massive Italian food and beverage company that accounted for 1.5% of Italys GNP entered bankruptcy proceedings,and became the largest bankruptcy that Europe had ever seen.t remains the largest to this day, almost six years later. At the time of its collapse, Parmalat was Italys eighth largest company. In just a few days, Parmalat went from being ranked among the top ten international companies in the food products industry, to corporate insolvency with over $8 billion missing from its balance sheet. Shortly thereafter, Calisto Tanzi, the founder, owner, and controlling shareholder of Parmalat, and a number of others were charged with crimes in connection with the fraud. Others who were charged include all of Parmalats then current upper level management, and some of its past managers as well, two former auditors, two high profile bankers, Citigroup, Deutsche Bank, Morgan Stanley, UBS, and over fifty other individuals working for Parmalat in various capacities. To mitigate the blow of losing such a massive company to bankruptcy, Italy, through emergency legislation, rewrote its bankruptcy law in only four days. The Italian government did so to allow the Parmalat bankruptcy to proceed under conditions that were more favorable to the company and Italian national interests, as previously mentioned. The resulting Marzano Law focused its reform on the Extraordinary Administration (EA), or

Amministrazione Straordinaria, procedure. This reform accomplished two tasks

simultaneously. It launched Italy into its current quest for systematic insolvency reform, and eliminated virtually all certainty regarding political risks in Italy, thus causing a drop in the availability of foreign credit and sending Italy into a tumultuous, ten-year regulatory period. The ultimate result of the Parmalat scandal on bondholders was an estimated recovery of about seven pennies on the dollar.

Conclusion
The emergency decree is intended to assist major companies to restructure by allowing direct application to the ministry for immediate admission to the extraordinary administration procedure. It also increases the timeframe within which investigative work can be carried out and proposals formulated, recognising the need for more time in larger, more complicated cases. The main features of the modified regime are: the absence of an interim judicial stage, which is replaced by an immediate admission to extraordinary administration and the appointment of a special commissioner; the power of the special commissioner to conduct urgent disposals or take any steps necessary to protect

the continuity of the groups activities at any stage before or after ministry approval of the restructuring plan; the emphasis on a restructuring and reorganisation of the company rather than a break-up of its business; and the extension of powers to a special commissioner intent on achieving the restructuring plan to reverse transactions and recover assets, powers which are, under the standard regime, only available in the context of a disposal plan. The political impetus is also very much evident in the modifications introduced by the emergency decree. Perhaps the true genesis of the recent modifications, in particular following on from the recent collapse of another Italian food group, Cirio, is the pressure the Italian government has come under to be seen to be engaging in regulatory overhaul. It will be interesting to see whether Italys own brand of dynastic capitalism, illustrated by the family ownership of Cirio, Parmalat, Fiat, Telecom Italia and the Benetton Group, and now the subject of much criticism, can survive the Parmalat financial scandal or whether Italys corporate culture will be forced to adapt to include greater external inspection. However, recent rebukes by the Security and Exchange Commission (SEC) in the wake of the Parmalat crisis should be seen in the context of even its inability to prevent the Enron and WorldCom debacles. Proposals to strengthen the regulatory powers of Consob, the Italian stock market regulator, to mirror those of the SEC are unlikely to dispel the disquiet felt by the financial markets or shareholders. It seems no system can fully protect against corporate fraud.