Preventive composition from bankruptcy represents one of the most important tools made available by the Egyptian legislator to protect commercial enterprises from reaching the stage of being declared bankrupt, where their financial conditions become disrupted in a manner threatening their ability to meet their obligations while a realistic opportunity remains to rescue the business and continue its operations.
This regime is governed by Restructuring, Preventive Composition and Bankruptcy Law No. 11 of 2018, as amended by Law No. 11 of 2021. The Law defines it as a procedure aimed at preventing the bankruptcy of a good-faith debtor. It differs from bankruptcy in terms of purpose, as preventive composition seeks to preserve the continuation of the business and settle debts pursuant to an agreement subject to judicial supervision and approval, rather than proceeding directly to collective proceedings over the debtor’s assets.
What Is Preventive Composition from Bankruptcy?
Preventive composition is a judicial procedure that allows a trader whose financial affairs have become disrupted to enter into an organized settlement with creditors, which may include granting payment extensions, modifying payment terms, or waiving part of the debt or interest, in accordance with the conditions prescribed by law.
The regime does not operate by automatically releasing the debtor from obligations, but rather by preparing a proposal that can be financially assessed and voted upon by creditors under a specified legal framework, and then submitted to the court for approval.
Who Is Entitled to Apply for Preventive Composition?
Article 30 provides that any trader who may be declared bankrupt, and who has not committed fraud or fault that would not be committed by an ordinary trader, may apply for preventive composition where their financial affairs have become disrupted in a manner likely to lead to cessation of payment.
A trader who has already ceased payment of debts may also apply for preventive composition, provided that the application is submitted within fifteen days from the date of cessation of payment and the remaining statutory conditions are satisfied.
Accordingly, preventive composition is not limited exclusively to the stage preceding cessation of payment; rather, within a narrow time frame, it also extends to the period after cessation has actually occurred.
May Companies Resort to Preventive Composition?
Yes, preventive composition may be conducted in relation to companies that satisfy the statutory requirements.
However, preventive composition may not be granted to a company in liquidation.
Article 31 also requires a company, before filing the application, to obtain the necessary authorization from the majority of partners or from the general assembly, depending on the type of company.
Conditions for Admissibility of the Application
It is not sufficient for a company merely to claim that it is experiencing financial distress. The Law establishes a number of conditions, the most important of which include:
- Continuous engagement in commerce during the two years preceding submission of the application.
- Compliance during that period with obligations relating to the Commercial Register and commercial books.
- No commission of fraud or fault that would not be committed by an ordinary trader.
- Obtaining approval from the competent body within the company to submit the preventive composition application.
- The company must not be in liquidation.
Timing is also particularly important where the company has already ceased payment, as the fifteen-day period prescribed by Article 30 must then be observed.
What Must the Preventive Composition Application Contain?
Following the 2021 amendment to the Law, a preventive composition application became more detailed than merely presenting the state of financial distress.
Article 35 provides that the application must contain the causes of disruption of the business and the proposed terms of composition, including:
- The manner in which debts will be paid.
- The ranking of debts.
- A proposal for dividing creditors into classes according to the nature and type of debt.
- The proposed financing.
- The amount of financing and its interest.
- The financing entity.
- The financing period.
- The manner of implementing the proposals.
Accordingly, an application for preventive composition should be presented as a financially viable rescue plan capable of analysis, rather than merely as a request for protection from creditors.
The Economic Court and the Bankruptcy Administration
The application is submitted to the Head of the Bankruptcy Administration at the competent Economic Court, after which the proceedings are governed by the special regime established by Law No. 11 of 2018.
Upon admitting the composition, the court issues a judgment opening the proceedings. Pursuant to Article 40, the judgment includes the appointment of a Composition Judge to supervise the proceedings, the appointment of one or more composition trustees, and the appointment of one or more experts to evaluate the debtor’s assets.
The Role of the Composition Trustee
The role of the composition trustee is not limited to monitoring implementation at the final stage.
The trustee conducts and follows up the composition proceedings, examines creditors’ claims and supporting documents, prepares the necessary reports on the debtor’s position and the composition proposals, and participates in assessing the feasibility of the proposed solution.
Following the 2021 amendment, the composition trustee was given a clearer role in preparing a report covering the debtor’s financial position, the volume of its business, the duration of the composition, the method of payment, and a comparison between what creditors would receive under the composition and what they might receive from the sale of the debtor’s assets.
Does the Company Retain Management of Its Business?
Yes.
Article 46 provides that, following the judgment opening preventive composition proceedings, the debtor continues to manage their assets, but under the supervision of the composition trustee.
The debtor may carry out ordinary transactions required by the business, but may not freely undertake certain extraordinary transactions, such as creating mortgages or making transfers of ownership not required in the ordinary course of business, without first obtaining authorization from the Composition Judge.
This rule reflects the philosophy of the regime: preserving the business as a going concern while restricting transactions that may prejudice creditors.
When Are Actions and Enforcement Proceedings Stayed?
One of the most important effects of preventive composition is that Article 47 provides for a stay of all actions and enforcement proceedings directed against the debtor.
However, this effect does not arise merely upon filing the preventive composition application, but from the date of the judgment opening preventive composition proceedings.
Actions brought by the debtor and enforcement proceedings initiated by the debtor remain pending, with the composition trustee being joined in them.
This clarification is practically important because mere filing of the application does not grant the company immediate immunity from all creditor actions.
The Difference Between Filing the Application and Opening the Proceedings
Before the judgment opening preventive composition proceedings is issued, there is no comprehensive stay of all enforcement actions.
However, Article 34 provides that where there is both an application to declare the debtor bankrupt and an application for preventive composition, the bankruptcy application may not be determined before the preventive composition application is decided.
Accordingly, a distinction must be drawn between:
- The effect of filing the preventive composition application: Which has a specific effect on an application for declaration of bankruptcy.
- The effect of the judgment opening the proceedings: Which includes the stay of actions and enforcement pursuant to Article 47.
Does Interest on Debts Stop Accruing?
No.
Article 48 expressly provides that the judgment opening preventive composition proceedings does not cause debts to become immediately due and does not suspend the accrual of interest on them.
Accordingly, the statement that merely entering preventive composition automatically suspends interest or returns by operation of law is incorrect.
However, modification of interest, granting new payment periods, or waiver of interest may form part of the terms of the composition agreed upon and voted on.
May Debts Be Reduced under Preventive Composition?
Yes, and this reflects an important distinction from certain forms of restructuring.
Article 66, as amended, permits preventive composition to include:
- Granting the debtor additional periods to pay the debt or interest.
- Waiver of all or part of the debt.
- Waiver of all or part of the interest.
- Making the waiver without consideration or in consideration for ownership of one of the debtor’s assets.
- Participation in the debtor’s business as agreed.
Accordingly, preventive composition may reshape the company’s financial position more substantially than merely postponing maturities, provided that the voting and judicial approval requirements are satisfied.
How Do Creditors Vote on Preventive Composition?
Law No. 11 of 2021 substantially amended the voting system.
The system is no longer based on a single general majority of creditors, but rather on a class voting system.
The Composition Judge divides creditors into classes according to the nature and type of their debts, such as:
- Preferred creditors.
- Secured creditors.
- Employees.
- Ordinary creditors.
- Public Treasury debts.
- Suppliers and sellers.
Within each class, the decision is adopted by the creditors present who hold a majority in value of the debts represented in the vote.
Approval of the composition then depends on the numerical majority of the classes participating in the vote, together with the approval of holders of security interests over the assets covered by the composition proposal, pursuant to Article 60 bis.
Judicial Approval of the Composition
Approval by creditors is not the final stage.
After voting, the composition is submitted to the court for approval, and under Article 65 the court has authority to examine objections and assess whether the interests of creditors and the public interest have been observed.
The court may refuse approval even in the absence of an objection if it finds grounds relating to the public interest or the interests of creditors that justify refusal.
Accordingly, the regime combines the will of creditors with judicial supervision.
Does the Composition Apply Only to Those Who Approved It?
No.
One of the most important effects of the approval judgment is that Article 68 makes the preventive composition effective against all creditors whose debts are considered ordinary debts under the bankruptcy provisions, even if they did not participate in the proceedings or did not approve its terms.
This clearly distinguishes preventive composition from judicial restructuring, an important aspect of which is based on binding the parties who approved and signed the restructuring plan.
Debts Not Covered by the Composition
The composition does not extend to all obligations without exception.
Article 68 excludes from its scope:
- Maintenance debts.
- Debts arising after the judgment opening preventive composition proceedings.
The position of holders of security interests and other creditors with special legal positions also differs according to the nature of the debt, the terms of the composition, and the voting process.
What About Guarantors and Joint Debtors?
As a general rule, persons jointly liable with the debtor and the debtor’s guarantors do not benefit from the terms of the composition.
However, where the composition is concluded with a company, partners who are liable with all their assets for the company’s debts may benefit from its terms unless the composition agreement provides otherwise.
Accordingly, when assessing the effect of the composition, a distinction must be drawn between the company, managers, partners, and guarantors depending on the form of the company and the source of each person’s obligation.
New Financing and Its Role in Rescuing the Company
Financing became a fundamental component of the preventive composition framework following the 2021 amendment.
The report prepared by the composition trustee must examine whether the composition requires new financing, its amount and duration, and the interest payable on it.
This reflects the legislator’s recognition that addressing financial distress cannot always be achieved merely by reducing debts; the company may require new liquidity to purchase raw materials, restart operations, or retain customers and employees.
What Is the Importance of Preventive Composition for the Company?
Its practical importance appears at several levels:
- Preventing direct progression to bankruptcy where the company remains capable of rescue.
- Preserving continuity of the business while management remains with the debtor under supervision.
- Staying actions and enforcement after the opening of proceedings to provide time for negotiation.
- Reorganizing debts and interest through a collective proposal.
- Allowing reduction of part of the debts or conversion into other arrangements as agreed.
- Allowing new financing to be incorporated into the rescue plan.
- Avoiding loss of the operational value of the business that may result from dismantling or liquidation.
Preventive Composition Does Not Mean the Company Is Financially Sound
Resorting to preventive composition essentially means acknowledging the existence of genuine financial disruption requiring treatment.
The objective is therefore not to conceal financial distress or preserve an unrealistic financial appearance, but to manage it legally in a manner that enables creditors to make an informed decision.
The Law permits the court to fine the trader if it is established that the trader deliberately created the appearance of disruption in the business or artificially caused such disruption in order to obtain protection.
Protecting Creditors from the Debtor’s Transactions
Although the debtor continues to manage the business, the Law prohibits certain transactions that may deplete the company’s assets or prejudice creditors.
The court also orders termination of preventive composition proceedings if, after filing the application, the debtor conceals or destroys part of their assets, carries out bad-faith transactions detrimental to creditors, or violates the restrictions imposed on their transactions.
Accordingly, the protection granted to the debtor is matched by strict supervision of good faith and transparency regarding the debtor’s financial position.
Does Preventive Composition Protect the Company’s Reputation?
Preventive composition may help the company avoid the more severe consequences of being declared bankrupt, but it is not a completely confidential procedure.
The judgment opening the proceedings is entered in the Commercial Register and a summary is published pursuant to Article 44, while the judgment approving the composition is also published pursuant to Article 67.
Accordingly, preventive composition should not be presented as a means of concealing the company’s crisis from the market, but rather as a regulated legal mechanism for managing that crisis.
When Is Preventive Composition Appropriate?
It is more appropriate where:
- The underlying commercial activity remains capable of generating revenue.
- The problem concerns the timing or volume of debt maturities.
- There is a realistic opportunity to reschedule or reduce indebtedness.
- Creditors would be better off under the composition than through liquidation of the company’s assets.
- The company requires a period of protection to reorganize its financial position.
- Management is capable of continuing operations and correcting the causes of distress.
When Might Preventive Composition Not Be the Solution?
Preventive composition may not be viable where the business itself is not capable of continuing, there are no realistic cash flows sufficient to implement any settlement, or the value of the assets and operations does not justify continuation of the business.
The purpose of preventive composition is not to delay bankruptcy at any cost, but to rescue a business that has a genuine economic prospect of continuing.
The Difference Between Preventive Composition and Restructuring
Although both regimes seek to prevent collapse of the business, they are not the same procedure.
Restructuring seeks to reorganize financial and administrative operations under a plan that is binding upon the parties who approved and signed it.
Preventive composition, however, is a more collective regime centered on creditors, voting, and judicial approval, and approval of the composition produces effects that, in certain cases, extend to creditors who did not approve it, particularly holders of ordinary debts.
The Difference Between Preventive Composition and Bankruptcy
Bankruptcy presupposes satisfaction of the conditions for a declaration of bankruptcy and gives rise to a collective regime for managing the debtor’s position and assets.
Preventive composition, however, seeks to prevent that outcome through a judicial settlement preceding or accompanying the early stage of cessation of payment.
Accordingly, preventive composition remains a rescue mechanism, whereas bankruptcy is a regime for addressing a situation in which the conditions for declaration of bankruptcy have been satisfied.
Can Failure of Preventive Composition Lead to Bankruptcy?
Yes, and this connection became clearer following the 2021 amendment.
Article 65 bis provides that in certain circumstances – including refusal to approve the composition or termination of its proceedings – where the court establishes that the debtor has ceased payment, it must, on its own initiative, declare the debtor bankrupt in the same judgment, without prejudice to the right of interested parties to appeal the bankruptcy judgment.
Accordingly, an application for preventive composition is not a risk-free procedure; before entering it, the company must genuinely assess its ability to present a settlement capable of being approved and implemented.
Invalidation of the Composition Due to Fraud
If fraud by the debtor is discovered after approval, the composition may be invalidated.
Forms of fraud include, in particular, concealing assets or debts, fabricating debts, or deliberately exaggerating them.
Article 71 regulates specific periods for bringing an invalidation action and the effects of the judgment issued in such proceedings.
Termination of the Composition for Non-Performance
Termination of the composition differs from its invalidation.
Invalidation relates to fraud affecting the composition, whereas it may be terminated if the debtor breaches its terms after approval or in other cases specified by Article 72.
In either case, creditors are not required to return amounts previously received, and the debtor is discharged to the extent of amounts actually paid in accordance with the applicable legal provisions.
The Importance of Early Intervention
The greatest value of preventive composition appears when the company resorts to it before liquidity, assets, and commercial relationships have been exhausted.
The earlier negotiations and assessment begin, the greater the likelihood of preparing a proposal that creditors can accept.
However, waiting until the business has completely ceased operating, multiple judgments have been issued, enforcement proceedings have commenced, and key suppliers have been lost may significantly reduce the prospects of successful composition.
What Should Be Reviewed Before Applying for Preventive Composition?
- The date on which financial disruption began and the date of cessation of payment, if any.
- The list of creditors and classification of their debts and security interests.
- Projected cash flows.
- The value of the company’s assets and their ability to be sold or operated.
- Pending actions and enforcement proceedings.
- Taxes, social insurance obligations, and employees’ rights.
- The financing required to continue operations.
- The minimum terms likely to be accepted by each category of creditors.
- A comparison between creditors’ expected recovery under the composition and their expected recovery in bankruptcy.
Conclusion
Preventive composition from bankruptcy is a legal tool for rescuing a viable company when it suffers financial disruption threatening cessation of payment, or when it has already ceased payment and no more than the statutory period for applying for composition has elapsed.
Mere filing of the application does not provide comprehensive protection from creditors; rather, the stay of actions and enforcement proceedings results from the judgment opening preventive composition proceedings. Opening the proceedings also does not automatically suspend interest on debts.
In return, the regime permits rescheduling debts and interest or waiving part of them, and the composition proposal is subject to assessment by the composition trustee, voting by classes of creditors, and then judicial review and approval.
Its true importance lies in providing the business with an opportunity to continue under the debtor’s management, together with temporary collective protection and organized negotiations with creditors, rather than leaving each creditor to pursue enforcement individually in a manner that may dismantle a business that could otherwise have been rescued.
Mostafa El Rouby Law Firm and International Arbitration provides services for assessing the legal positions of distressed companies, evaluating the suitability of restructuring or preventive composition, preparing and following up the relevant procedures, and negotiating with creditors according to the financial and legal position of each company.