Conversion of debt to equity and sale of assets as mechanisms for restructuring public companies
Can public companies and others operating on a large scale and needing to restructure their debt take advantage of in-court restructuring using the mechanisms in the Restructuring Law?
We will present the answer to this question using the examples of a restructuring involving conversion of debt to equity and involving the sale of the debtor’s assets. These are restructuring mechanisms deeply intruding into the debtor’s affairs, which until now have been conducted in Poland chiefly in out-of-court restructuring.
The reason for this practice could be traced to the regulations of the prior Bankruptcy and Rehabilitation Law of 2003, which discouraged businesses from using the procedure for bankruptcy with the possibility of concluding an arrangement with creditors, which prior to 1 January 2016 was the only available form of in-court restructuring.
The Restructuring Law, which entered into force on that date, eliminated many of the drawbacks of the previous law.
There are three notable advantages of the solutions introduced by the Restructuring Law greatly facilitating in-court restructuring.
First advantage. The Restructuring Law established a new type of restructuring procedure—proceedings for approval of an arrangement. This introduced the possibility for the debtor to come to terms with its creditors without the need to open judicial proceedings until the arrangement had already been accepted. Then the debtor files an application for approval of the arrangement already concluded, and information about the restructuring is announced.
This greatly facilitates the functioning of the debtor’s enterprise, which remains unhindered by disclosure of the debtor’s insolvency. If the rights of the debtor’s suppliers and customers are not infringed, they will learn about the insolvency only when the arrangement has been approved. This makes it easier to conduct large restructuring processes, covering only restructuring of financing and other major claims, and not affecting trade claims, often held by such a large number of creditors that it is not practically feasible to reach an arrangement with all of them.
This means that the restructuring proceeding may be conducted while maintaining in confidence the information about the need for debt restructuring, as is the case in out-of-court restructuring. Meanwhile, by introducing the institution of partial arrangements covering only selected categories of creditors (e.g. financial creditors and other large creditors), the Restructuring Law facilitates the conduct of in-court restructuring in general.
Second advantage. An important change significantly increasing debtors’ capacity to reach arrangements with creditors is that an arrangement is approved when a majority of the voting creditors, representing at least two-thirds of the total claims participating in the voting, vote in favour of the arrangement.
The prior regulations were much more demanding in this respect, as the same majority referred to the total amount of claims entitled to vote on approval of the arrangement—even the claims of creditors not participating in the voting.
The requirement to obtain a majority of votes of all creditors representing at least two-thirds of the total sum of the claims covered by the arrangement now applies only to approval of a partial arrangement or an arrangement concluded within a proceeding for approval of an arrangement. These are instances where the heightened requirement for the majority of votes for approval of the arrangement is justified by the atypical procedure for voting by creditors or the potentially far-reaching consequences of the arrangement.
Third advantage. The creditors have an easily measurable influence over the course of the restructuring proceeding, initiating or approving significant decisions connected with the conduct of the proceeding. The course of the proceedings connected with in-court restructuring of the debtor’s obligations has been decisively expedited. The changes in the law in this respect are too extensive and multifaceted to describe in detail here.
Conversion of debt to equity
Conversion of debt to equity is one of the restructuring instruments for which the mechanisms in the Restructuring Law and in-court restructuring are particularly well-suited.
In restructuring its obligations, the debtor in most instances wants to offer the creditors the possibility of exerting influence over the debtor’s enterprise and participating in the future increase in value of the enterprise if the restructuring is successful. Conversion of debt to equity serves this purpose admirably, on one hand enabling the debtor’s obligations to be reduced without unilaterally writing off the claim, and on the other hand gives creditors rights to the debtor’s capital which provide influence over the debtor’s enterprise and also can be traded.
Significantly, the conversion of debt to equity occurs by operation of the arrangement itself.
Pursuant to Art. 169(3) of the Restructuring Law, if an arrangement provides for conversion of claims into shares, the arrangement approved with legal finality takes the place of the acts referred to in the Commercial Companies Code connected with the increase in share capital, joining the company, taking up the shares, and making a contribution for the shares. Consequently, if the arrangement is approved, the creditors become shareholders even if they voted against the arrangement, and there is no need to obtain the approval of the existing shareholders for the conversion. Significantly, the new shares arise upon approval of the arrangement; the registry proceeding before the National Court Register only discloses the corporate rights that already came into existence by operation of the arrangement.
It should be noted that since it was adopted in 2007, the Competition and Consumer Protection Act has provided an exemption from the merger notification requirement if a concentration occurs within a bankruptcy proceeding and does not involve a market competitor’s taking control of an undertaking (Art. 14(4)). This provision was not amended upon adoption of the Restructuring Law, and proceedings under the new law are distinct from bankruptcy proceedings, which are conducted under the Bankruptcy Law.
As a result, since 1 January 2016 conversion of a debtor’s obligations into equity including assumption of control over the debtor pursuant to an arrangement between the debtor and its creditors in restructuring proceedings has required notification of the intended concentration to the Polish competition authority or the European Commission. For this reason, Art. 118(3) of the Restructuring Law requires that if an arrangement provides for restructuring of the debtor’s obligations by conversion into shares, voting on the arrangement cannot go forward unless the consent of the president of the Office of Competition and Consumer Protection or the European Commission is presented at the meeting of creditors, or it is demonstrated that such consent is not required.
Sale of the debtor’s assets
Mechanisms from the Restructuring Law can also be resorted to when it is necessary to sell elements of the debtor’s assets in a broader restructuring of the debtor’s enterprise. While there is nothing preventing such sales from being conducted in out-of-court restructuring processes, the Restructuring Law does provide at least a few useful methods for selling the debtor’s assets that are not available in out-of-court restructuring.
In particular, the debtor’s arrangement proposals may provide for satisfaction of creditors by liquidation of the debtor’s assets, and submission and acceptance of such a proposal results in conclusion of a liquidating arrangement between the debtor and the creditors. A liquidating arrangement may provide for appointment of compulsory administration over the debtor’s enterprise for the duration of performance of the arrangement, or other mechanisms ensuring effective execution of the arrangement with respect to disposal of the debtor’s assets. The mechanisms of the Restructuring Law eliminate the need for the debtor to obtain corporate approvals to dispose of its assets.
Generally, sale of assets during restructuring proceedings does not wipe out mortgages or other encumbrances on the debtor’s assets established in favour of creditors.
There is a different rule, however, in the case of sale of the debtor’s assets in recovery proceedings (postępowanie sanacyjne), which is the type of proceeding most deeply intruding in the management of the debtor’s assets and the furthest reaching in-court restructuring procedure. As a consequence of a sale in a recovery proceeding, encumbrances against the debtor’s assets in favour of third parties are expunged.
Significantly, sale of the debtor’s assets in a recovery proceeding may occur prior to approval of an arrangement, for a period of up to 12 months after opening of the recovery proceeding, exclusively on the basis of a restructuring plan performed by the administrator appointed for the debtor’s enterprise. Under Art. 315(1) of the Restructuring Law, such plan is subject to approval by the judge-commissioner based on a non-binding opinion of the creditors’ council. The creditors’ council itself does not have the authority to consent to sale of the debtor’s assets by the administrator.
Sale of the debtor’s assets in a recovery proceeding before voting on an arrangement provides a useful restructuring tool which intrudes deeply not only in the debtor’s enterprise but in the rights of the creditors. Under Art. 312 of the Restructuring Law, all execution proceedings against the assets of the debtor included in the recovery estate commenced prior to the date of opening of the recovery proceeding are stayed by operation of law, and directing execution against the debtor’s assets included in the recovery estate or securing a claim against such assets is impermissible during the pendency of the recovery proceeding. This rule applies to all executions, even if the claim being enforced was not covered by the recovery proceeding or the claim is secured by collateral. The recovery proceeding is the only restructuring proceeding that interferes so extensively with the rights of creditors. Not only the debtor, but also the creditors, must deal with the fact that the debtor’s assets may be sold during the course of a recovery proceeding and such sale will extinguish mortgages and pledges with consequences analogous to those of a sale of the debtor’s assets in a bankruptcy proceeding.
And what about public companies?
Even though the restructuring of public companies is conducted within a judicial proceeding, it is fully subject to the Public Offerings Act, the Securities Trading Act, and the EU’s Market Abuse Regulation (596/2014), which govern procedures for inside information, acquisition of significant stakes of shares, and acting in concert with respect to voting at the general meeting of a public company, conduct of long-term policy with respect to the company, or acquisition of its shares.
Crossing by a single creditor or group of creditors acting in concert, pursuant to conversion or conclusion of an agreement, of the threshold of 33% or 66% of the shares of a public company makes it necessary to conduct a tender offer for sale or exchange of, respectively, 66% or 100% of the public company’s shares. Only shares acquired in a bankruptcy or execution proceeding are free of this requirement.
It should also be stressed that even in the case of conducting a proceeding for approval of an arrangement, which by its nature is confidential until the arrangement is accepted, a public company must comply with obligations regarding inside information. Any delay in disclosing inside information about commencement of negotiations by the debtor with creditors on conclusion of an arrangement must be justified by the circumstances set forth in the Market Abuse Regulation. In particular, the public company must in a position to demonstrate that immediate disclosure of the inside information could prejudice the legitimate interests of the company, delay in disclosing the information would not mislead the public, and the confidentiality of the information is ensured. Moreover, if a public company discloses inside information to creditors in connection with voting on an arrangement, such disclosure must be accompanied by full disclosure of the inside information.
Krzysztof Libiszewski, M&A and Corporate practice, Wardyński & Partners