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The Transfer Window: Part VIIs transfers and Brexit

The Transfer Window: Part VIIs transfers and Brexit
  • United Kingdom
  • Financial services - Insurance market

11-04-2017

On Friday 7 April 2017 the PRA published a ‘Dear CEO’ letter addressing firms’ contingency planning following the trigger of Article 50. The letter sets out the PRA’s expectations for contingency planning in relation to cross border activities between the UK and the rest of the EU. One particular such expectation is that the PRA be informed of any court-led transfers of insurance business, such as Part VII transfers.

We expect insurance groups that currently rely on passporting rights to carry on business in the European Economic Area (EEA) to consider and look to use Part VIIs as a mechanism to protect the existing and new business against the adverse impact of a likely loss of passporting rights into and from the EEA as a result of Brexit.  Furthermore, we are expecting to see an increase in the number of Part VIIs as businesses look further to create greater capital efficiencies in light of Solvency II.

An insurance business transfer is a regulatory mechanism, governed by Part VII of the Financial Services and Markets Act 2000. It allows a (re)insurer to transfer long-term and general (re)insurance business from one legal entity to another, subject to the sanction of the court. The procedure is often used for the sale of insurance portfolios, and to give effect to group reorganisations and consolidations.

The benefit of the Part VII process, particularly in the context of the Brexit timetable, is that in addition to the transfer of the insurance portfolio, the court can sanction the transfer of other rights, assets, contracts and liabilities that form part of the transferring insurance business.  This might include, for example:

  • outwards reinsurance contracts, thereby enabling the transferee to take the benefit of the transferor’s reinsurance at the same time as the liabilities under the transferring policies; and
     
  • other assets and contracts that are necessary to service the transferring insurance business and which, by their terms or nature, may require counterparty consent to their transfer.

In this briefing we look at some of the issues involved in recognition of Part VIIs in Europe and the US and consider whether Brexit is likely to impact the recognition of Part VIIs in the future.

Timetable

The below sets out a typical timetable for the Part VII. A number of factors impact the timing of a Part VII, the most important being:

  • Workload of regulators. As significant input is required from the PRA and FCA into the process and the timing can be impacted by regulator capacity, which is presumably one of the key drivers for the PRA making their request to have early sight of firms’ intentions.
  • For Part VIIs that are required to enable an insurance business to continue to service existing policies and trade in the EEA post-Brexit, this issue will be more acute as regulator workloads in the UK and the more popular EEA jurisdictions may become unmanageable. As happened in the UK leading up to implementation of Solvency II, there is a potential for the PRA to implement an embargo on Part VIIs.  It will therefore be critical to act early and get to the front of the queue.
  • Financial information. As the financial information used for the independent expert report needs to be relatively up-to-date, the timing of accounting year ends and the drawing of accounts tends to also play a factor.

As a result, whilst insurance Part VIIs can be effected as quickly as 6 to 12 months, it is more common for the arrangements to take 18 months to 24 months from start to finish, which could cause a problem for some insurance businesses given that we are now into the two year withdrawal period from the EU.

Overseas recognition issues

One of the considerations for the English courts in deciding whether to sanction a Part VII insurance business transfer is the extent to which it will be enforceable  - it is unlikely that the court would sanction a transfer unless it is likely from the outset that it could be enforced to a material extent.

Where the transfer involves any international dimension, for example, where the business is transferred between EEA states, the policies are governed by foreign laws, or policyholders are domiciled overseas, the issue of overseas recognition can make the difference between a successful and unsuccessful application.

Europe

As a matter of English law, once a Part VII transfer is sanctioned by a Court in the UK it will automatically (subject to certain limited rights of an EEA regulator to object) be recognised throughout the EEA.  EEA states were required by the life and non-life insurance directives (now consolidated under the Solvency II Directive) to implement legislation allowing insurance business transfers carried on in the EEA.  This was achieved in the UK through the Financial Services and Markets Act 2000.

The jurisdiction for determining whether a transfer of an EEA firm’s business should be sanctioned is placed with the home state regulator and/or Court. This means that the UK Court can sanction a transfer of contracts carried on through non-UK EEA branch offices of a UK firm, so it is not necessary for the parties to invoke processes of host courts or supervisors, although it is necessary for the UK regulators to consult with their counterparts in the host state or at least give them an opportunity to comment.

No additional steps need to be taken by the parties to secure recognition, although in many cases local law may require notice (for example in national newspapers) that the transfer has been sanctioned.  In addition, steps may be required to perfect the transfer of any assets that are required to transfer with the insurance portfolio (such as land registration requirements and share transfer certificates).

The extent to which the UK will continue to benefit from recognition across the EEA in respect of insurance business transfers upon the exit of the UK from the European Union will depend on the exit terms that are negotiated. Much focus has been on the extent to which UK insurers will continue to benefit from passporting rights into the EEA (and vice versa with regards to EEA insurers into the UK). A number of insurers are considering taking action to mitigate the risk of losing passporting rights by seeking local authorisation in other EEA States. In connection with these restructures, Part VIIs may be required.

Where a bi-lateral arrangement is agreed between the EU and the UK mirroring the arrangements under the Solvency II Directive then it is likely Part VIIs will continue to be recognised across the EEA states. However, where a similar bi-lateral arrangement is not agreed then it is less certain whether UK Part VIIs will have the effect of transferring non-UK policies/assets in the EEA.

An important consideration in relation to existing insurance policies is that unless passporting rights are retained in some form (for example, in relation to legacy business), UK insurers will not be able to pay claims by policyholders in the EU, and vice versa.  It would be surprising if the negotiations between the EU and the UK resulted in a position that is so clearly unfavourable for policyholders.

Accordingly, notwithstanding the long-term deal struck between the UK and the EU, there may be good reasons to think that, at least from a policyholder protection point of view, some kind of transitional measures or grandfathering measures may be agreed for existing business. This may mean that insurers will be permitted to continue to run-off business and possibly be permitted to transfer existing business without having to effect separate transfers in each relevant jurisdiction.

Where a bi-lateral agreement cannot be agreed and there are no transitional or grandfathering arrangements available then the position falls back to whether there is a general recognition of court orders in the relevant jurisdiction. This will depend on the relevant jurisdiction within the EEA as to whether a Part VII order would be recognised. However, it is notable that in many EEA states Court orders are only normally recognised in the context of disputes so there would be uncertainty as to whether future Part VII Court orders would be recognised in the EEA following Brexit.

United States

The parties’ best chance of achieving recognition of the transfer in the US is by seeking relief under Chapter 15 of the US Bankruptcy Code.  A close reading of Chapter 15 suggests that a case could be made for recognition of a transfer, but developing caselaw’s interpretation of the statute, and the mixed results in earlier US court decisions applying the predecessor statute, suggest that the first test case should be carefully chosen.

The transfer must qualify as a “foreign proceeding” under the US Bankruptcy Code. "Foreign proceedings" is defined as "[A] collective judicial or administrative proceeding in a foreign country … under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganisation or liquidation."

The definition includes proceedings that relate to insolvency or adjustment of debt which is filed for the purpose of reorganisation or liquidation. In addition, Chapter 15 adopted certain presumptions for the US Courts to apply when interpreting the term. For example, if the foreign Court certifies that the proceeding is a foreign proceeding and the Chapter 15 petitioner has been appointed as the foreign representative, the US Court is entitled to presume that the proceeding is eligible for recognition. However, early decisions by the US Courts indicate that they will not rubber stamp Chapter 15 petitions based solely on statutory presumptions.

There is some debate over the issue of whether transfers could meet this requirement. An insurer’s potential liability to its policyholders is likely to constitute a "debt", but "adjustment of debt" is not defined, and there is disagreement over whether transfers are sufficiently related to the "adjustment" of debt.

On the one hand, a transfer typically does not involve the final determination and payment of policyholders’ claims or the insurer’s related liabilities to other creditors, so those claims against the transferor are not finally settled. 

On the other hand, a transfer involves a significant modification of the transferor’s debts to its policyholders by transferring liabilities to the transferee and absolving the transferor of future liabilities. As such, there is an adjustment of debt because the transferor’s debts are finally resolved.

A further issue is whether a transfer is "filed for the purpose of reorganisation". The Bankruptcy Code does not define "reorganisation." Under the predecessor statute, US courts differed over whether a transfer qualified as a foreign proceeding.  One Court denied recognition after concluding that it did not constitute a functional equivalent of a reorganisation under US bankruptcy law.  Another Court recognised a transfer as a foreign proceeding without much discussion or analysis.

Some commentators maintain that the foreign proceeding must involve a company which is undergoing financial distress in order to qualify for recognition, notwithstanding that solvent schemes of arrangement are increasingly recognised by US Courts.

The issue or recognition in the US was considered by the English High Court in Sompo Japan Insurance v Transfercom, where the Court said that "If it appeared that the transfer would have little or no significant effect, it raised an issue as to whether in its discretion the Court should sanction the transfer. It is established that, on comparable applications under the Companies Act 1985, the Court will not act in vain."

In relation to policies in the US, the Court said that the evidence of US law suggested that, at least where the policy was placed through the London Market, US states’ laws would recognise the transfer of liabilities effected under Part VII, even though the policy was governed by the law of the US State.  However, the Court recognised that the evidence was not definitive, and on the facts, Sompo did not have substantial assets in the US against which any judgment could be enforced, so the issue was not fundamental to the particular transfer.

Overall the Court was not convinced that the transfer, once sanctioned, would definitely be effective as regards proceedings in foreign jurisdictions.  The Court’s decision to sanction the transfer was based on evidence which established that over 27% of the policies in number and by reference to reserves were governed by English law, and it was reasonable to suppose (but not certain) that the transfer would be effective in any relevant jurisdictions as regards those policies. The proposed transfer would therefore achieve a substantial purpose.  The fact that it extended to a larger class of business not governed by English law was not a good ground for refusing to sanction the transfer.  Whether the transfer was recognised as effective in the United States or elsewhere would, if necessary, be tested in due course in proceedings in those jurisdictions.

Conclusion

The issue of recognition of Part VII transfers within and outside Europe will continue to raise questions. However, in light of the Brexit vote and the uncertainty of the terms of the UK’s exit from the European Union this uncertainty now potentially extends to future portfolio transfers. As firms consider their strategy for dealing with the potentially adverse impact of losing passporting rights under a ‘hard’ Brexit, it is likely that firms will look to reorganise their business and Part VIIs will need to play a role in those reorganisations.

The PRA have asked that firms respond to their call for contingency plans by 14 July 2017. If firms have not yet considered how they will deal with their cross-border business after March 2019, now is the time to do so.

Download a visual timeline of the Part VII transfer here