«In October 2011, the Reform of the Spanish Insolvency Act (the ‘Reform’) was published, coming into force on 1 January 2012, even if some of its ...»
Overview of the main financial aspects of the reform of the Spanish Insolvency Act
In October 2011, the Reform of the Spanish Insolvency Act (the ‘Reform’) was
published, coming into force on 1 January 2012, even if some of its aspects,
namely those relating to out-of-court refinancings, came into force immediately
after the publication of the Act. This Reform represents an extensive global
reform to the legal body but maintains the structure of the Act, while amending
substantial aspects of the Insolvency Act as well as many of its provisions.
From a financial perspective, due to the intensive refinancing experiences of Spanish companies during the last four years, the Reform has refined its framework in order to introduce some creditor-friendly mechanisms which are in place in other jurisdictions. For instance, it now supports out-of-court refinancings as an alternative to court insolvency proceedings in order to promote the reorganisation of companies in financial distress. The Reform’s preamble sets out that the new Act seeks to foster alternatives to formal insolvency proceedings, giving companies more economical and flexible alternatives through refinancing agreements. Additionally, the Reform introduces important modifications to the Spanish Insolvency Act which aim to streamline the insolvency proceeding, simplifying some aspects of the same and, for example, providing more flexibility to the sale of assets of the estate wi thin the insolvency proceeding.
In this regard, this article provides a general overview of the main modifications of the Insolvency Act from a financial perspective.
Enhancement of out-of-court refinancing agreements: clarification of certain aspects of the former regulation and introduction of the ‘Spanish scheme’ Before the reform, the Insolvency Act offered, through the former Fourth Additional Disposition, legal protection to certain refinancing agreements by providing that when meeting certain formal requirements, these agreements (and the acts performed through them) were not subject to clawback (these requirements consisted, for example, on the refinancing agreement being entered by three-out-of-five of the debtor liabilities when the agreement was executed, that the refinancing agreement was based on a viability plan that allowed the ongoing operation of the company in the short and medium term and significantly extended the credit available or, in turn, modified the debtor’s obligations).
The Reform comprehensively extends the Insolvency Act’s out-of-court refinancing scheme with a new section 6 of Article 71 (Article governing acts and transactions that can be subject to clawback and, therefore, avoided). Certain modifications have been made that, even though they do not affect the former Fourth Additional Disposition’s general structure and content, clarify and improve certain aspects of the former regime which required further clarification (ie, a group of companies’ treatment in out-of-court refinancing scenarios or a legal mechanism to appoint an independent expert).
More importantly, and constituting one of the major developments under the Reform, refinancing agreements meeting the requirements established in current section 71.6 of the Insolvency Act may be court-sanctioned. In this regard, the Fourth Additional Disposition introduces a mandatory court-sanctioned refinancing mechanism. This is to some extent in response to major Spanish companies (La Seda or Metrovacesa) having recently conducted their refinancings under the legal regime of foreign jurisdictions in order to take advantage of the different alternatives available for debt refinancing in these countries, which may be considered more creditor friendly. However, it is still uncertain whether Spanish judges will enforce these agreements in Spain.
Thus, if the refinancing agreement meets the requirements of section 71.6 of the Insolvency Act and has been entered into by creditors representing at least 75 per cent of liabilities held by the financial institutions at the time of the agreement, then the debtor may seek the sanction of the refinancing agreement before the court.
If the refinancing agreement is sanctioned by the court (in accordance with the streamlined procedure regulated in the Insolvency Act), the term of the moratorium agreed in the refinancing agreement will be extended to ‘hold out’ financial creditors if:
• their credit claims are not secured with an in-rem security such as pledges or mortgages; and
• the agreement does not represent a ‘disproportionate sacrifice’ for dissident financial entities as further determined by the court.
In the same court-sanction petition, the debtor may request the stay of all enforcement actions for up to three years.
The Reform also includes time limitations to court-sanctioning of the refinancing agreements so that a debtor cannot request this sanction more than once a year.
If the sanctioned financing agreement is breached, it will be necessary to appear before the court that sanctioned the agreement to obtain the judicial declaration of the breach of the agreement. This judicial declaration must be obtained before initiating enforcement actions or petitioning for the debtor’s mandatory bankruptcy. The decision declaring the breach of the refinancing agreement cannot be appealed.
Finally, and also in order to enhance out-of-court restructurings and mitigate the ‘duty to file’ which directors have under Spanish insolvency law, the Reform broadens those circumstances where debtors can request ‘protection’ vis-à-vis mandatory insolvency petitions by dissident creditors, included under the scope of such protections. Initially, this protection was only available for those debtors that were in a situation of actual insolvency and negotiating a pre-pack (PAC or Propuesta Anticipada de Convenio) with its creditors, even though it was already market practice to call upon this protection in other ways, such as to negotiate a refinancing agreement.
The Reform does not formally require the debtor to be in a situation of actual insolvency and, additionally, expressly includes within the scope of this protection (now called ‘section 5.bis’) those situations where the debtor may be negotiating a refinancing agreement with its creditors. Therefore, debtors may not only benefit from using section 5.bis when negotiating a PAC but they may also apply this mechanism when negotiating a refinancing agreement, clarifying a situation that was already de facto market practice.
Finally, as it was before the Reform, the debtor which files a ’5.bis petition’ before the Commercial Court has a four-month period during which it is not required to file for insolvency (even if the director’s duty to file has kicked in according to the Spanish Insolvency Act provisions) and, in addition, no creditor is entitled to file a petition for mandatory insolvency against the debtor.
‘New money’ privilege: pre- and post-petition financing under Spanish insolvency law The Reform additionally promotes out-of-court restructurings by introducing the privilege granted to new lending or ‘new money’ provided through the Insolvency Act’s ring-fenced refinancing agreements as a mechanism to facilitate the viability of Spanish corporations under situations of financial distress without having to turn into insolvency proceedings to solve their financial troubles. Thus, the Insolvency Act now privileges the credit claims of those entities which were party to refinancing agreements meeting the requirements of section 71.6 of the Insolvency Act and made cash injections
available to the debtor through those agreements, so that:
• 50 per cent of the pre-petition claim will be allowed as an administrative expense (crédito contra la masa) with a super-priority over any other pre-petition claim except claims secured with in-rem securities. In this regard, administrative expenses are paid as they become due, contrary to insolvency claims which are always paid at the end of the case.
• 50 per cent will be allowed as a general secured claim (privilegio general) junior to administrative expenses and in-rem securities, but senior to general ordinary unsecured creditors. However, the above ‘new money’ classification does not apply when cash injections were made available or by a specially related person (persona especialmente relacionada) ex section 93 of the Insolvency Act, through a share capital increase tran saction, credit facilities, or acts or transactions with similar purposes.
To further enhance the access to financing of financially distressed companies, under the second paragraph of section 84.2.11 of the Insolvency Act, in the event of subsequent liquidation (ie, the universally called chapter 22 scenarios), claims resulting from a composition agreement will be treated as administrative expenses. This will provide such credit claims with a super-priority over any other pre-petition claim which is expected to promote ‘exit financings’ within incourt reorganisation proceedings.
Despite all of the above, we understand that, contrary to what is the case in other jurisdictions and despite all the efforts that have been made by the legislator to promote the access by the debtor to both out-of-court and ‘exit’ financing, the Reform should have also included a complete and systematic regulation of post-petition financing (as, for example, is the case with DIP financing in the US) in order to provide the debtor with the ability to finance its working capital necessities during the insolvency proceeding as well as the direct and indirect costs that usually arise in such proceedings.
Claims trading in insolvency: ban on voting rights relating to composition agreements become more flexible Before the Reform, the holders of credit claims that had been transferred postpetition could not vote when deciding on the approval of composition agreements proposed within an insolvency proceeding. Consequently, this provision has prevented, again contrary to what happens in other jurisdictions, the development of an insolvency credit claim market in Spain and the active participation of professional investors in bankruptcy.
To allow the ‘insolvency claims market’ to develop, and to promote new alternatives to the reorganisation of companies in bankruptcy (and, why not, provide new ‘exit strategies’ to insolvency creditors other than the ‘wait and see’ strategy to which these creditors were indirectly forced pursuant to the former legislation), the Spanish legislator has amended section 122 of the Insolvency Act, modifying the ban on voting rules to allow holders of credit claims acquired inter vivos post-petition to vote for approval of composition agreements, but only if the transferee is a ‘financial entity subject to supervision’.
Sale of assets of the estate within insolvency proceedings after the reform of the Spanish Insolvency Act In line with other successful sales of the debtor as a going concern that have been recently performed in bankruptcy courts in Spain, the Reform has further facilitated the possibility of similar procedures taking place in other future insolvency proceedings by broadening those circumstances where debtors are entitled to sell estate assets in the common phase of the insolvency proceeding.
This is an important development, especially taking into account that the Spanish Insolvency Act does not authorise, as a general rule, the sale of the estate assets before the approval of the composition agreement or the initiation of liquidation.
This flexibility can provide advantages for the bankrupt estate (by, for example, avoiding the depreciation of estate assets, maximising therefore the value of the estate’s assets and having access to new liquidity in order to finance the debtor’s operations during the insolvency proceedings) and it can also be advantageous for the creditors, being consistent with what should be the ultimate aim of all insolvency proceedings: the maximisation of the recovery for all creditors.
For instance, the Insolvency Act (in the new third paragraph of section 43) introduces two new exceptions to the above-referenced general rule (in addition to the exception consisting on transactions performed in the ordinary course of
business). These two exceptions are:
• assets sales that are necessary to continue the debtor’s operations in bankruptcy (the insolvency judge has to be informed of these sales afterthe-fact and cause must be shown); and
• sales of assets that are no longer necessary for the business activity of the debtor pursuant to a selling price that coincides ‘substantially with the value given to them in the inventory’, meaning that such value is considered to be substantially the same when ‘in the case of real estate assets the difference is less than ten per cent, and in the case of movable property it is less than 20 per cent, and there is no higher bid’ (the insolvency administrators must inform the judge of the offer and prove that the assets are not needed, and the offer will be approved if no higher bid has been submitted within ten days).
Finally, in those instances where binding purchase offers to buy the debtor as an ongoing concern are jointly filed with the insolvency petition, the insolvency proceeding will be conducted through an abbreviated procedure (procedimiento abreviado) in order for the sale to close as soon as possible and the proceeding to be fast and procedurally streamlined.
What is next?
There is no doubt that this Reform has been a major step forward in improving the Spanish insolvency framework after several years of application in courts. In fact, most of the amendments were recommended by a committee of insolvency experts created for this purpose. Although it has been welcomed by judges, insolvency practitioners and investors, it would be desirable to introduce additional amendments to facilitate the sale of distressed assets, to extend the out-of-court refinancing to loans secured by mortgages/ pledges and to creditors other than financial entities, and to promote the financing of distressed companies before resorting to liquidation. All of the above would help to strengthen and to further develop a true distressed debt and asset market in Spain.
Fedra Valencia García (email@example.com) Iñigo de Luisa Maiz (firstname.lastname@example.org) Ignacio Buil Aldana (email@example.com) Cuatrecasas Gonçalves Pereira Madrid, February 5th, 2012