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Royal Decree-Law 4/2014 of 7 March adopting urgent measures on business debt refinancing and restructuring (the “RDL”) was published in Spain’s Official Gazette on 8 March 2014 and came into force on the following day.
1. INTRODUCTION: LATEST DEVELOPMENTS ON REFINANCING
The reform of Law 22/2003 of 9 July on insolvency (“Insolvency Law”) by the RDL is aimed at improving the treatment and relief of non-sustainable financial debt in companies with a viable activity, while at the same time protecting the legitimate interests of creditors to maximise their recovery expectation. In particular, the RDL focuses on the removal of certain obstacles and rigidities identified in practice which affect the success of refinancing processes. To that effect, it seeks to improve various aspects of the pre-insolvency institutions to ensure the viability of companies and avoid their insolvency, which would almost surely result in their winding-up.
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2. REFINANCING AGREEMENTS
The RDL maintains the refinancing agreements immune to claw back actions -which will be referred to as “collective”- regulated, until the entry into force of the RDL, in article 71.6 of the Insolvency Law, and creates a new category of refinancing agreements -which will be referred to as “non-collective”-.The latter will also be immune to claw back actions provided they meet certain requirements. In addition to these two categories, the RDL creates a new type of refinancing agreement in the context of cram down (see section 4.3.2(a)).
2.1 “Collective” refinancing agreements
New article 71 bis.1 of the Insolvency Law regulates “collective” refinancing agreements without changing the existing definition. “Collective” refinancing agreements and the transactions, acts, payments and guarantees/security of which they are composed are immune to claw back actions if the following requirements are met:
(a) the agreement must be entered into by creditors representing at least 3/5 of the debtor’s (financial and non-financial) liabilities [1];
(b) the debtor’s auditor must issue a certificate regarding the sufficiency of the liabilities required to execute the agreement [2]; and
(c) the agreement must be formalised in a public instrument.
The main novelty here is the removal of the requirement to obtain a report from an independent expert appointed by the Commercial Registry, although both the debtor and the creditors may request that the Commercial Registry corresponding to the debtor’s registered address appoint an independent expert who will report about the viability plan, the proportionality of security or any other circumstances that may be relevant. It is important to note that, although not expressly listed as an additional requirement, the RDL assumes, as could not be otherwise, that the refinancing agreement responds to a viability plan; otherwise, the special protection against claw back would not be justified.
The new regime will apply to “collective” refinancing processes initiated prior to the entry into force of the RDL if the appointment of an independent expert has not yet been requested from the Commercial Registry. Otherwise, the former regime will apply, unless the parties expressly opt for the new regime in the refinancing agreement.
2.2 “Non-collective” refinancing agreements
The RDL introduces the new category of “non-collective” refinancing agreements for which a safe harbour is created. The “non-collective” refinancing agreements are those which do not fall within the scope of article 71 bis.1 of the Insolvency Law, but which will be immune to claw back actions provided the following requirements are met:
(a) the initial proportion of assets in relation to liabilities is increased;
(b) the resulting current assets are equal to or greater than current liabilities;
(c) the value of the resulting security granted in favour of the creditors who enter into the agreement does not exceed either 9/10 of the value of the outstanding debt owed to those creditors, or the proportion of security (calculated in accordance with section 4.2) to the outstanding debt owed to such creditors prior to the agreement (this measure is intended to ensure that the secured percentage of debt is not increased in any way);
(d) the interest rate in favour of the intervening creditors does not exceed 1/3 of the rate applicable to the debt before the refinancing; and
(e) the agreement is formalised in a public instrument, with the intervention of all the affected parties, and includes a description of the reasons justifying its content from an economic point of view.
These requirements are very strict, and in practice we believe will rarely be met. Furthermore, in contrast to the rules concerning “collective” refinancing agreements, the negotiating process of “non-collective” refinancing agreements is not eligible for a pre-insolvency filing of article 5 bis of the Insolvency Law.
2.3 Novelties with regard to qualification and classification of claims
The RDL introduces two major novelties in relation to the qualification and classification of claims in the context of insolvency proceedings. Unfortunately, it fails to clarify the highly controversial article 90.1.6 of the Insolvency Law in respect of pledges “over” or “as security of” future claims.
2.3.1 Treatment of fresh money in the context of insolvency proceedings
During the two years following the entry into force of the RDL, claims resulting from fresh money provided to the debtor in the context of a refinancing agreement regulated by the Insolvency Law and executed after the entry into force of the RDL, will be deemed claims against the insolvency estate (créditos contra la masa) for their total amount (and not merely 50%, as was the case to date). In this regard, it would be advisable to stipulate in the refinancing agreement that, if fresh money is provided in the future, it will be considered part of the refinancing agreement so that it may benefit from such privileged treatment. During the same period, this classification will also affect fresh money provided by the debtor (although it is difficult to conceive how the debtor could provide fresh money to itself) or by persons specially related to the debtor, unless fresh money is provided in the context of a share capital increase.
It would have been desirable for the treatment not to include the two-year limitation and for it to be extended to any kind of fresh money, not only that provided in the context of a refinancing agreement, as it will not always be possible to fulfil the requirements for the adoption of such agreement and the effects of fresh money are equally positive, irrespective of the source.
2.3.2 Protection of the creditors capitalising debt
The RDL, as described in section 3.2, modifies the concept of “persons specially related to the debtor” to expressly exclude from its scope and, therefore, from a possible risk of subordination, holders of financial liabilities who have capitalised all or part of their claims in the context of a refinancing agreement.
Likewise, the exception currently regulated in the Royal Decree on public takeover bids is now broader so that creditors who capitalise claims against listed companies which financial viability is in serious and imminent danger are exempt from the obligation to submit a takeover bid (oferta pública de adquisición), provided these capitalisations are carried out in the context of a cram down refinancing agreement with a favourable report from an independent expert.
2.3.3 Protection of creditors of the refinancing against the “de facto” administration regime
In the absence of evidence to the contrary, it is presumed that creditors who have entered into a refinancing agreement do not qualify as the debtor’s “de facto” directors (administradores de hecho) for the obligations assumed by the debtor “in connection with the viability plan”. This clarification is positive, since it avoids any doubts arising with regard to the undertakings and restrictions assumed by the debtor in refinancing. In our opinion, this category could include, for example, asset divestment programmes, the faculties of the creditors to monitor the degree of compliance with the business plan, the authorisation regime to carry out certain investments or to incur additional indebtedness, etc.
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3. OTHER MEASURES TO FAVOUR REFINANCING
3.1 Stay of enforcements
3.1.1 Pre-insolvency scenario
From the moment a notice of pre-insolvency is submitted (it may not be filed again by the same debtor within a one-year period), judicial proceedings may not be initiated for the enforcement of assets necessary for the continuation of the debtor’s professional or business activity, and proceedings already initiated will be stayed. Enforcements of security may be initiated within that period, but will be stayed. The enforcement of public law claims (créditos de derecho público) is exempt from this regime. Although it is difficult to understand why the stay is limited to the assets referred to and judicial enforcements, excluding other assets and out-of-court and administrative enforcements, the amendment considerably enhances the pre-insolvency institution of article 5 bis, conferring similar effects to those of the US Chapter 11.
The stay will last until: (a) a “collective” refinancing agreement is formalised; (b) an application for cram down of a refinancing agreement is granted leave to proceed (admitido a trámite); (c) an out-of court payment agreement (acuerdo extrajudicial de pago) is adopted; (d) there are sufficient adhering creditors for a proposal for an early composition agreement (propuesta anticipada de convenio) to be granted leave to proceed; or (e) the insolvency is declared.
Furthermore, the RDL establishes that individual enforcements sought by holders of financial liabilities -see section 4.1- cannot be initiated (or, if they have already been initiated, will be stayed) when it is “justified” that a percentage no lower than 51% of creditors holding financial liabilities have supported the start of negotiations of a refinancing agreement, undertaking not to initiate enforcements in the meantime. Attention must be paid to the type of justification that will be required by courts, since a simple declaration by the debtor appears to be insufficient.
3.1.2 Insolvency scenario
The RDL limits the stay of enforcements to those assets that are necessary (and not the previously established “ascribed to” (afectos)) for the debtor’s professional and business activity. Additionally, it is not possible to stay the enforcement of security over shares or quotas of companies exclusively destined to hold assets and the liabilities necessary for their financing, provided this enforcement does not constitute a cause of termination or modification of those contractual relationships of the company that allow it to continue exploiting such assets or carrying out its activities. This rule seems intended to favour the sale of “project” companies that can subsist autonomously outside of the group of the insolvent debtor.
3.2 New presumptions of fraud or gross negligence of the debtor for the qualification of the insolvency proceedings
Fraud (dolo) or gross negligence (culpa grave) will be presumed when the debtor or, as the case may be, its representatives refuse to capitalise claims or issue convertible securities or instruments without reasonable justification, thus frustrating the achievement (consecución) of a “collective” refinancing agreement or a refinancing agreement eligible for cram down, as long as the agreement acknowledges a right of first refusal (derecho de adquisición preferente) in favour of the debtor’s shareholders over the securities or instruments issued or arising from the capitalisation, if the creditors dispose of them. This right may be excluded if the creditor transfers the securities or instruments to a company of its own group or any holding entity.
Capitalisation will be deemed reasonable if, prior to the debtor’s refusal, an independent expert has so declared [3].
Shareholders who reject the capitalisation or issue of convertible instruments and the debtor’s representatives who hinder it may be considered accomplices (cómplices).
For the first time in the Spanish legal system, this measure clearly expresses the principle according to which directors must act in the interest of creditors, not shareholders, when a company is close to or falls within a pre-insolvency situation. Shareholders, especially those with control and key to the capitalisation of the company and its survival, must exercise their rights in a responsible way and must not shield themselves behind the limitation of liability inherent to their condition. This must be based, as could not be otherwise, on appropriate assessments.
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4. CraM DOWN MECHANISM
The RDL substantially revises the cram down mechanism, extending its effects vis-à-vis non-participating or dissenting unsecured creditors and clarifying its scope vis-à-vis secured creditors.
4.1 Holders of financial liabilities
The creditors considered for the purposes of the cram down (both in number and the imposition of measures) will be the holders of financial liabilities, whether or not subject to financial supervision. It must be noted that the substitution of “liabilities held by financial institutions (pasivo titularidad de entidades
financieras)” with “financial liabilities (pasivo financiero)” significantly broadens the subjective scope of the mechanism. We see no reason why this mechanism should not be applied to any creditor (whether a natural person or a legal entity), no matter how the debt has been documented or formalised (loans, bonds, leasing agreements, guarantees, insurances, etc.). In addition, any other creditor will be entitled to voluntarily adhere to the cram down agreement.
If part of the financial liabilities includes syndicated loans, all creditors holding an interest in the syndicated loan will be deemed to have adhered to the refinancing agreement if it is favourably voted upon by at least 75% of the liabilities represented by the loan, or a lower majority if so established in the syndicated loan agreement [4]. This measure will have a very significant impact in practice, as it prevents dissenting votes from the minority creditors of a syndicated loan and appears to make sterile the provisions for qualified majorities above 75% for these purposes.
4.2 The new concept of Security Value
Until now, the relevant distinction for cram down purposes was whether or not a creditor held a security interest. The RDL adopts the security “value” of each creditor (the “Security Value”) as the new core concept of the cram down system, and establishes a dual cram down regime which distinguishes between:
(a) the amount of the claim not exceeding the Security Value
(the “Covered Amount”); and
(b) the amount of the claim exceeding the Security Value
(the “Non-Covered Amount”), to which the cram down effects will be extended in the same way as unsecured claims.
Each creditor’s Security Value, which cannot fall below zero or exceed the amount of the secured claim, will be calculated according to the following formula:
9/10 of the fair value of collateral |
- |
claims with prior ranking security over collateral (e.g., other security interests with prior ranking) |
= |
Security Value |
The RDL establishes methods for the determination of the fair value of collateral by an independent third party (e.g., in the case of real estate, the valuation will be performed by a property valuation company (sociedad de tasación)).
Plurality of security: if one creditor holds two or more security interests over various assets (we assume, as security for the same claim), its Security Value will be equal to the aggregate result of applying the formula over each asset.
Security jointly held by various creditors: if a creditor holds security jointly (en proindiviso) with other creditors, its Security Value will be equal to its percentage of participation in the total value of the security, in accordance with the rules governing the joint security regime.
4.3 Effects of cram down refinancing agreements
4.3.1 Immunity to claw back actions
The RDL establishes that cram down refinancing agreements will not be subject to claw back provided they satisfy all requirements applicable to “collective” refinancing agreements, except for the requirement of 3/5 of total liabilities, which is replaced by the financial liabilities thresholds described in section 4.3.2 [5]. This is a highly positive measure as it greatly increases legal certainty for those creditors who have made sacrifices in the framework of the refinancing.
4.3.2 Categories of refinancing agreements eligible for cram down
If the refinancing agreement eligible for cram down is entered into by creditors (excluding those who are specially related parties of the debtor) whose claims represent at least:
(a) 51% of the financial liabilities: the agreement will be exclusively immune to claw back as indicated in section 4.3.1, but its effects will not extend to non-participating or dissenting creditors. For systematic and semantic purposes, it would have been desirable to regulate this category in article 71 bis of the Insolvency Law, together with the other categories of agreements not subject to claw back;
(b) 60% of the financial liabilities: it will be possible to impose on the unsecured claims and the Non-Covered Amount of secured claims of non-participating or dissenting creditors: (i) extensions (esperas), either of principal, interest or any other owed amount, for a period not exceeding 5 years, or (ii) a conversion of claims into profit participating loans (préstamos participativos) for the same (maximum, we assume) period.
These effects may be extended to the Covered Amount of secured claims of non-participating or dissenting creditors, when the agreement has been entered into by creditors whose claims represent 65% of the Covered Amount of the claims of all creditors holding financial liabilities; and
(c) 75% of the financial liabilities: it will be possible to impose on the unsecured claims and the Non-Covered Amount of secured claims of non-participating or dissenting creditors: (i) extensions exceeding 5 years and up to 10 years; (ii) debt reductions (quitas) (apparently without limitation); (iii) a conversion of claims into shares or quotas of the debtor [6]; (iv) a conversion of claims into profit participating loans exceeding 5 years up to a maximum of 10 years, convertible bonds, subordinated loans, loans that allow for the capitalisation of interest (préstamos con intereses capitalizables) or any other financial instrument with a ranking, maturity or features different from those of the original debt; or (v) assignments of goods or rights in payment (cesión de bienes o derechos en pago) of the whole or part of the debt.
These effects may be extended to the Covered Amount of secured claims of non-participating or dissenting creditors, when the agreement has been entered into by creditors whose claims represent 80% of the Covered Amount of the claims of all creditors holding financial liabilities.
4.4 Enforcement
4.4.1 Stay of enforcements
Once the court has accepted the cram down refinancing agreement, enforcement proceedings (also of security) may only be initiated (or, if applicable, seeking the debtor’s declaration of insolvency) if a breach of the refinancing agreement is judicially declared. This measure would “de facto” equate the period of stay of enforcements with the extension determined by the cram down refinancing agreement (unless a breach of the agreement occurs previously). This is essential to ensure the practical effectiveness of the agreed extension, and is, therefore, a noteworthy improvement.
4.4.2 Enforcement of security
The RDL establishes that in the event of the breach of a court-approved cram down refinancing agreement, creditors will be entitled to enforce their security in accordance with a system of allocation of the proceeds of enforcement that will take into account –and update, under specific circumstances- the Security Value calculated for cram down purposes. It must be highlighted that if the proceeds of the enforcement of security are equal to or higher than the original debt existing prior to the cram down, the Security Value and the debt reductions agreed in the framework of the cram down will become ineffective and the creditor will collect the proceeds of enforcement up to the limit of the original debt before cram down.
4.5 Process for the court approval of a refinancing agreement eligible for cram down
The following novelties on the processing of the cram down mechanism must be outlined:
(a) The stay of individual enforcements will be applicable from the moment the cram down application is admitted for processing until the judge grants it (not only one month, as previously).
(b) The judge in charge of the cram down procedure: (i) must decide on the cram down application within a fifteen-day period, and (ii) may only verify the concurrence of the majorities established for cram down purposes (in addition to the fulfilment of the other formal requirements) and the effects that may be crammed down in each case.
(c) The existence of a disproportionate sacrifice will not be automatically reviewed by the judge, but must be alleged by those non-participating or dissenting creditors who decide to challenge the resolution approving the cram down.
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5. OTHER IMPORTANT DEVELOPMENTS ON REFINANCING
5.1 Classification of the risk of restructured claims by the Bank of Spain
Within one month from the entry into force of the RDL, the Bank of Spain will establish and publish homogeneous criteria to classify as “normal risk” those transactions restructured (operaciones reestructuradas) as a result of a refinancing agreement.
5.2 Renewal of the exclusion of certain impairments to determine the cause of the winding-up of companies
For financial years ending in 2014 the RDL renews the exclusion of losses due to impairment arising from tangible fixed assets, real estate investments and stocks for the purposes of determining whether the debtor falls within a/an: (a) mandatory capital reduction, (b) winding-up cause, or (c) objective cause of insolvency (presupuesto objetivo de concurso).
5.3 Tax aspects
From a tax standpoint, the adaptation of the General Accounting Plan to the International Financial Reporting Standards hindered the debt capitalisation transactions when these were not totally carried out by the shareholders of the affected companies or not in proportion to their respective holding: the difference between the debt acquisition value and its fair value generated an accounting income (ingreso contable) which formed the taxable base (base imponible) of the Corporate Income Tax; the acquisition by shareholders of claims from third parties also generated accounting income -and positive income (rentas positivas) in the Corporate Income Tax- upon the capitalisation of the acquired claim for the difference between the value of the claim and its acquisition value.
The RDL corrects those effects, by calculating the effects on the taxable base of the Corporate Income Tax without taking into account the accounting treatment of claim set-off:
(a) The company in which the claim is capitalised will determine its effects in the taxable base of the Corporate Income Tax according to the difference between the corporate value (valor mercantil) of the share capital increase -share capital plus premium- and the value of the credit for tax purposes.
(b) The companies that subscribe the capital increase by means of a claim set-off will determine their effects in the taxable base of the Corporate Income Tax for the difference between the proportional part of the value of the capital increase and the tax value of the claim.
As regards the debt reductions and extensions carried out in the framework of the Insolvency Law, their recognition as income in the taxable base of the Corporate Income Tax is deferred: it will be made as the financing expenses arising from the refinancing or restructuring agreement are recognized from time to time; if the accounting income is greater than the financing expenses to be registered, they will be allocated proportionally.
Stamp duty to be paid by the debtor in the event of debt reductions and other agreements for refinancing or out-of court payment agreements approved in the context of the Insolvency Law is also removed.
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[1] Although the RDL defines these agreements as “collective”, the determining factor is not the plurality or collectivity of creditors, but rather, that the creditor (or creditors) entering into the agreement represents at least 3/5 of the debtor’s liabilities.
[2] If the debtor has not appointed an auditor, the auditor will be appointed by the Commercial Registry corresponding to the debtor’s registered address or, in the case of a group of companies, the parent company’s registered address.
[3] If more than one report has been issued, the reasonableness of the capitalisation must be recognised in the majority of them.
[4] There is no express reference in the RDL to what would happen if that majority was not reached. We understand that under such circumstances the claims of each syndicated creditor would be considered separately for the purposes of calculating the cram down majority and that the dissenting creditors would not be entitled to drag along the creditors in favour of the agreement –in this respect, it must be borne in mind that the purpose of the RDL is to assure company viability.
[5] Consequently, the auditor’s certificate must refer to the fulfilment of the financial liabilities threshold, not the total liabilities threshold.
[6] Non-participating or dissenting creditors will be entitled to choose between capitalisation and a debt reduction for an equivalent amount, which will be automatically applicable if such creditors do not expressly opt for the capitalisation.
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