Early warning indicators in the Italian Code of enterprise crisis and insolvency

Type:
Media

Date:
2020-08-18

Introduction

In recent years, the Italian insolvency framework has been the subject of heated debates. It had become clear to everyone involved that a general reform of the Insolvency Law is mandatory. The new law also known as “Code of enterprise crisis and insolvency”[1] was initially set to enter into force on August 15, 2020. It should have represented the final step of more than fifteen years of struggles to modernize the insolvency framework.

Early 2020, Italy took center stage as the first European country to face the challenges imposed by the pandemic. In the midst of the struggle to contain the spread of the virus, unprecedented measures were taken by the Italian government to safeguard the wellbeing of the Italian people. Amongst many other crucial decisions, the government was forced to postpone the entry into force of the new Code until September 2021. The decision was based on a general attempt of guarantying the continuity of Italian companies affected by the worldwide health emergency.

The Code proposes a system designed to perform in the context of a stable economic framework. However, it had rapidly become clear that such a framework is not to be expected shortly, thus making postponement as the inevitable choice. In the unlikely event that the Code would have entered into force on August 15, most Italian enterprises already subject to the pandemic effects would have triggered most of the early warning indicators.

Under the new provisions, companies are to be monitored constantly, to swiftly intervene in crisis situations with detailed corporate recovery plans. As key objectives, the new insolvency law proposes improved ways of anticipating insolvency and protection offered to the entrepreneurial environment. To better understand the causes that determined the government to postpone the much-anticipated Insolvency Law, a further description of the early alert indicators is required.

Early warning indicators

In terms of the available tools through which companies are to anticipate a crisis, a series of alert indicators were developed with the help of the National Council of Chartered Accountants and Accounting Experts. The first two indicators to be taken into consideration are the Net Worth and Debt Service Coverage Ratio. In the event that the Net Worth is negative, a preliminary assessment can be made concerning the likeliness of the business to be facing a crisis.  The Debt Service Coverage Ratio evaluates the solvency of a company with respect to its medium- and long-term debts. The ratio consists of the operating cash-flow for the upcoming six months and the financial flow to service the debt. If the ratio is less than 1, a second warning sign can be assumed.

Additional indicators should be considered if the Debt Service Coverage Ratio is either unreliable or not available, as follows: Liquidity when referring to the relationship between short-term liabilities and short-term assets; the Capital Adequacy referring to the ratio between total debt and shareholders’ equity; Sustainability of Financial Charges relating to the ratio between finance charges and turnover; Social Security and Tax Debt in terms of the relationship between social security, tax debt, and assets; Liquid return of assets referring to the relationship between assets and cash-flow.

As company controllers, statutory auditors, internal control committees, and external auditors have a duty to analyze all of the above indicators and keep the board of directors informed at all times. The material evidence containing early signs of distress will be presented to the board of directors, which in return must reply within 30 days with a preliminary crisis plan. If no such action is taken by the board or if the plan is inadequate, the controller has to inform the relevant authorities.

Specialized Crisis Unit

Having set the required indicators to detect an imminent crisis, the new law has also implemented an alert procedure with the assistance of a new specialized unit named OCRI or Corporate Crisis Settlement Body. The unit will be composed of 3 experts and will be present in each Chamber of Commerce. The newly formed unit will be receiving reports from either the board of directors or the internal controllers (mentioned earlier) as well as from the public creditors which are required to report companies within 90 days if no payment has been made. OCRI can either dismiss the reports or acknowledge the crisis at which point it will also identify the possible measures to be implemented.

The second objective of the newly founded unit is to assist the company when seeking and negotiating agreements with the creditors. This process must be completed within 3 months from the start procedures and can only be extended once by another 3 months.  The procedure can be concluded by either reaching an agreement with the creditors and immediate commencement of the recovery plan or by failing to reach such an agreement, at which point OCRI will recommend to the company the initiation of an insolvency settlement procedure within 30 days. Fail to comply with OCRI recommendations will most likely result in the initiation of judicial liquidation by the prosecutor previously informed by OCRI. At any time during the negotiation process with the creditors, if protective measures are needed, the president of OCRI will appear before the Court alongside the interested parties.

In view of the government’s decision to postpone the new insolvency Code, the Italian entrepreneurial climate will have some much-needed time to recover from the dire effects of the pandemic. Nevertheless, as of September 2021, Italy will look to improve its business environment through the new measures that pave the way for a better understanding of early prevention and business continuity.

 

Article written by Alex Airinei

 

[1] Legislative Decree 14 of February 2019

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