General
In the current difficult business environment with significant pressure on many companies’ cashflow resulting in reduced liquidity, companies may find themselves in default or on the verge of defaulting under their financing arrangements. This has already led creditors considering appropriate measures to safeguard their position and re-open the toolbox that was previously in more active use in the aftermath of the financial crisis. In a nutshell, debt creditors quite typically want to act before the debtor becomes insolvent to avoid formal insolvency proceedings such as bankruptcy or official restructuring, which are regulated in Finland by the Bankruptcy Act (120/2004, as amended) and the Restructuring of Enterprises Act (47/1993, as amended) respectively. The debtor, on the other hand, is aiming to preserve its financial position with survival in mind in order to get through the current crisis and continue its business operations in the best possible conditions when the times get better again.
Whilst the parties may have conflicting interests they also invariably have at least one common objective: a controlled solution to the distressed situation in which they find themselves. Formal insolvency proceedings are often associated with negative effects such as adverse publicity, length and inflexibility and thus are not always the desirable option for either the debtor or its creditors. Often, a more viable solution is to restructure the debtor’s financial position through a voluntary restructuring process approved by all parties – or as it is commonly known an “out-of-court restructuring” (given that restructuring measures are not always voluntary as such from the debtor’s or junior creditor’s perspective). A significant advantage of out-of-court restructuring is that it is based on freedom of contract and is, as a result, very flexible. Of course, this could also be seen as a drawback since all the relevant parties involved in the restructuring negotiations need to unanimously agree on the solutions to make them effective which means that one dissenting party can prevent a sensible arrangement being achieved.
Based on our previous experience, there are certain risks for creditors involved in out-of-court restructuring processes. A particular risk worth taking into consideration, and which is easily overlooked, is the risk of a potential claim for recovery of assets where the debtor eventually ends up in formal insolvency proceedings in spite of the out-of-court restructuring. Recovery of assets, as regulated by the Act on the Recovery of Assets to Bankruptcy Estates (758/1991, as amended) (the Recovery Act), is applicable to both bankruptcy and official restructuring and provides that a creditor which has inappropriately received a payment or other benefit from a debtor, may be ordered to repay such payment or the relevant transaction or series of transactions may be revoked and unwound. Even if each party involved in an out-of-court restructuring would consider the measures agreed as being sensible and justifiable, these may ultimately be considered to be unfair preferential treatment of creditors given that such out-of-court restructuring arrangements typically involve only major creditors, not all creditors.
Irrespective of the parties’ efforts to keep the debtor’s business alive through an out-of-court restructuring arrangement, the debtor may eventually end up in formal insolvency proceedings, e.g. if the Tax Authority, a pension insurance company or some other creditor, that has not been involved in the out-of-court restructuring process, is dissatisfied with the solution. At this point, careless restructuring measures may give rise to recovery claims and generally result in the relevant creditors being in a worse position than was intended when taking such measures or a potentially worse position than such creditors would have been in had the out-of-court restructuring arrangement not been entered into.
Grounds for Recovery Claims
As a general rule, a transaction which inappropriately favours a creditor or another party at the expense of other creditors by transferring assets of the debtor beyond the reach of other creditors or which increases the debtor’s liabilities in the five year-period prior to a trigger date (the definition of which depends on the type of proceedings) may give rise to a recovery claim. Significant factors are whether (i) the debtor was insolvent (otherwise than temporarily unable to repay its debts as they fall due), (ii) the transaction contributed to the debtor becoming insolvent, (iii) the creditor was aware or should have been aware of the debtor’s insolvency, and (iv) the creditor knew or should have known of the circumstances, based on which the transaction is to be deemed inappropriate. It should be noted that the general rule sets a relatively high bar for the bringing of recovery claims in order to avoid tenuous or frivolous applications being made.
In addition to this general rule, the Recovery Act contains additional stricter provisions relating to other issues including payments and security arrangements.
Payment of debt made later than three months before the trigger date may be recoverable if it is made (i) via an unusual means (other than money), (ii) prematurely (before becoming due and payable), or (iii) in an amount which could be considered as being significant in comparison to the assets of the bankruptcy estate.
Security granted later than three months before the trigger date may be set aside if (i) no such security had been agreed upon when the secured debt was incurred; or (ii) control of the pledged object had not been transferred or other perfection actions required for the creation of the security had not been taken without undue delay after the secured debt was incurred.
It should be noted that the Recovery Act provides certain stricter restrictions on transactions between the debtor and a related party, e.g. a board member or an affiliate. Such restrictions include extensions to the critical times and presumption of the related party having known of the debtor’s insolvency. Although external financing arrangements do not usually meet the criteria of related party transaction, it is possible for a third party creditor to be deemed a related party if it is considered to have significantly influenced or controlled the decision-making of the debtor.
Some Restructuring Measures
We have listed below some of the typical out-of-court restructuring measures seen in Finland and briefly analyse them in the light of potential formal insolvency proceedings.
1) Covenant waiver and reset
A covenant breach under a loan agreement is often the first sign of financial distress of the debtor. In less serious situations where the debtor is only experiencing temporary issues, a waiver of a single covenant testing period might be all that is required. If more extensive restructuring is needed, waiver of current breaches may be supplemented by adjustments in future testing date frequencies and covenant levels.
As such, waiving or resetting of covenants should not raise any recovery risk concerns but it should be noted that breaching of these covenants and subsequent waiver or reset may indicate financial difficulties of the debtor or even its insolvency. This may mean that, when assessing the merits of a recovery claim, a creditor can be considered as having been aware of the debtor’s insolvency or at least obliged to further examine the financial position of the debtor more closely. A classic oversight is to state in the recitals of a restructuring agreement that the debtor is insolvent which makes it easy for an administrator to subsequently claim recovery as it is apparent that the transactions have been effected when the debtor was insolvent and all parties were aware of the insolvency at the time (unless it also is made clear that the parties justifiably considered that the debtor will be solvent as a result of the restructuring measures).
2) Increased reporting
A debtor’s financial difficulties will likely make its creditors more vigilant which may result in a requirement for more frequent reporting. During the restructuring process, the budget and development of the restructuring (e.g. divestment plan and cost cuts) will often be strictly monitored, which enables the creditors to react swiftly to any defaults or changing circumstances.
3) Increased creditor control
Creditors may feel a need to increase their control over a distressed debtor, e.g., by appointing a board supervisor, nominating a board member and/or submitting material decisions to the creditors for approval. In extreme cases, significant control may give rise to a potential recovery claim on the grounds of a related party transaction having been deemed to arise.
A good rule of thumb is that a board supervisor or contractual arrangements should not cause related party problems, but a board member nominated by a creditor may in some circumstances result in the creditor being a related party. It should also be noted that a board member may be personally liable for violation of law or the Articles of Association of the debtor and regardless of a board member being nominated by creditors, such board member should always act in the best interest of the debtor, not the creditors.
4) Debt rescheduling and/or reduction
One of the most common restructuring measures is rescheduling of the debt by (i) extending repayment dates, (ii) accelerating repayment dates, or (iii) a combination of both (i) and (ii). When planning the rescheduling, it is of the utmost importance that payments under the revised repayment schedule will be considered ordinary (i.e. neither delayed nor accelerated) in the light of the Recovery Act.
The crucial question is whether the ordinary nature of the payments is assessed in the light of the original repayment schedule or the revised repayment schedule. In simple terms, the first interpretation would lead all subsequent repayments to be open to potential recovery whereas there would be no recovery risk at all in the second interpretation. A good rule of thumb is that, to mitigate recovery risk, rescheduling (together with other restructuring measures) should enhance the debtor’s financial position instead of simply ensuring repayments to certain group of creditors.
Sometimes, the creditors may consider so-called ‘haircuts’ to their receivables in the form of an agreement reducing the principal amount of the debt. This might make commercial sense at the time of the restructuring but it should be borne in mind that straightforward reductions are permanent by nature meaning that, in any subsequent formal insolvency proceedings concerning the debtor, the creditor can only lodge a claim for the agreed reduced amount of the debt and not for the original, higher, debt amount. Therefore, it is always worth considering alternative structures in which the debtor would receive the benefit of the reduction in some way or another but the creditor would not permanently lose the ability to recover the full amount of its receivable.
5) New equity injection
An effective and straightforward way to enhance the debtor’s financial position is to inject new equity from shareholders and/or group companies. By way of example, this can take place in the form of commitment letters, guarantees and/or cash.
Insolvency is often a contagious condition in that a group company’s insolvency is often followed by the insolvency of other group companies. If a group company that has made an equity injection subsequently becomes insolvent, it is possible that such equity injections (in practice required by the creditors) could be subject to critical review by the administrator in terms of potential recovery. Given this potential recovery risk, the creditors should not feel too comfortable with equity injections being simply additional money in the structure but also pay attention to well-founded documentation and corporate benefit considerations of such transactions.
6) Sale of non-core assets
The debtor may have assets that are not vital to its business which can be sold to improve its working capital position or repay debts. When negotiating an agreement with creditors concerning a divestment plan and the use of proceeds received from the sale of such assets, it should be noted that using the sale proceeds for the benefit of only certain creditor(s) may give rise to allegations that a creditor or group of creditors has been inappropriately favoured at the expense of other creditors. Such payments could also be considered as being not in the ordinary course of business under the Recovery Act.
7) Additional financing
Whilst the aim in restructuring is usually to decrease the amount of debt, the debtor will have some working capital requirements in order to be in a position to continue its business. This is often solved by existing or new creditors granting a temporary bridge loan or rescue facilities to the debtor on a super-senior basis. This means that this additional financing will be the first in ranking order (based on contractual arrangements) if the debtor subsequently ends up insolvent and subject to formal insolvency proceedings.
The practical consideration for other creditors in this scenario is whether the debtor will survive after the restructuring measures or if the additional super-senior facilities simply reduce their share of proceeds from the bankruptcy estate.
8) Perfection of existing securities and/or creation of new securities
In Finland, it is rather common practice that certain securities, such as pledges over bank accounts and receivables, are perfected (made legally effective against bona fide third parties) only when a default occurs under the financing agreements. It is typical for creditors to require these soft pledges to be ultimately perfected in a distressed situation even if this usually means an additional administrative burden for the debtor (e.g. access to the pledged bank accounts will be blocked and receivables are paid through the creditor etc).
It is typical for creditors to conduct a security review at the beginning of restructuring negotiations to evaluate what securities need to be perfected and what additional securities might be available. These security-related measures basically always improve the creditors’ position but it should be noted that these arrangements are particularly vulnerable to recovery risk and are always closely reviewed by any administrator subsequently appointed in formal insolvency proceedings.
9) Interest rate adjustments / fees regarding waivers, standstill etc.
Creditors typically charge certain fees for restructuring, e.g. waiver, standstill or amendment fees. They may also demand higher interest rate in the future.
Although all these measures are justified in principle, it is possible that the increases and additional fees are so excessive that they could lead to claims for usury or result in an allegation of infringement of the duty of loyalty to the contractual counterparty. The bar for this kind of claim to have any merits is undoubtedly high but, at least in theory, it limits the use of such measures to some extent.
Creditors may also decrease interest rates, waive accrued interest, delay interest payment dates or capitalise interest etc. As mentioned above concerning debt haircuts, various deductions might make commercial sense at the time of the restructuring but it is always worth considering structures in which the debtor would receive the relief in a different way and the creditor would not permanently lose its receivable (so that the full amount of the receivable would benefit the creditor in potential formal insolvency proceedings).
10) Debt-to-equity swap
Depending on a creditor’s internal policies, it may be willing to agree on various reliefs for the debtor against the receipt of shares or option rights. For example, some or all of the debt may be converted into equity securities in the debtor. From a creditor’s perspective, whether debt-to-equity swaps are appropriate in the circumstances depends, firstly, on the estimation of the general future prospects of the debtor and, secondly, whether the debtor is more likely to end up in a bankruptcy or official restructuring.
In a bankruptcy scenario, a debt-for-equity swap is basically identical to simple debt reduction given that this kind of transaction is permanent by nature and the debtor’s bankruptcy would result in the equity being lost in its entirety whereas there is at least some prospect of receiving a part of debt capital back from the bankruptcy estate.
In contrast to the bankruptcy scenario, a debt-for-equity swap might be a very appealing option for unsecured creditors if the debtor is more likely to end up in official restructuring (or to survive without any formal insolvency proceedings). This is because haircuts of unsecured debt are possible in official restructuring without the consent of the creditor but the equity of the debtor cannot be reduced without the consent of the equity holder(s) (even if it can be diluted with certain measures).
Mitigating Legal Risk
Out-of-court restructuring is, in essence, making economic decisions as to how to optimize the outcome for both the debtor and its creditors. These decisions are, to a large extent, linked to a commercial analysis as to what may happen in the alternative scenarios of bankruptcy and official restructuring, whether chosen right away at the time of the initial distress or if taking place at a later stage. This requires close interaction between the debtor or the creditor and their legal and/or financial advisers. In our opinion, mitigating legal risk is often, firstly, creating the right context for financial advisers to make an informed assessment of various potential scenarios and, secondly, pointing out pitfalls in potential strategies as well as providing tools for alternative solutions to mitigate identified risks.
It follows that one of the key means of mitigating legal risk is the proper documentation of transactions including the background to those transactions. For example, the risk of potential recovery claims can arguably never be ruled out, but it can be mitigated through the use of thorough well-drafted documentation. Carefully drafted documentation can effectively evidence that the actions taken were justified and appropriate in the prevailing circumstances. For instance, proper recording of the assessment and existence of corporate benefit and solvency considerations in respect of both the restructuring agreements and the relevant corporate resolutions can make all the difference when assessing transactions in hindsight.
Various restructuring measures may seem plausible at first sight but include material practical risks that are ultimately detrimental to the creditors. Optimally, the creditors should be at least aware of such risks when assessing potential solutions so that they can consider if those are worth taking. In the best case, some of these risks may be avoided after being identified.
Authors / Contacts:
Antti Rintakoski
Partner, Banking and Finance
antti.rintakoski@hpp.fi
+358 50 344 5606
Klaus Majamäki
Senior Counsel, Restructuring and Insolvency
klaus.majamäki@hpp.fi
+358 50 3737 283
Valtteri Jalo
Associate, Banking and Finance
valtteri.jalo@hpp.fi
+358 40 043 1319
About HPP’s Banking and Finance:
HPP’s banking and finance team has wide-ranging experience in complex and often high-value financial arrangements. We assist clients on assignments relating to syndicated lending, acquisition finance, project finance, bonds, high yield bonds, unitranche and direct lending, mezzanine finance, sale and leaseback, factoring and other asset finance, real estate finance and financing rounds of growth companies. We also regularly advise our clients in voluntary restructurings, contingency planning and distressed situations.
In addition to debt financing, our banking and finance group advises on financial regulation in general as well as fund establishment and other fund-related arrangements from both the fund management and investor perspective.
Our expertise is based not only on the ability to consider legal issues, but also on practical business experience. A number of the lawyers in our banking and finance team have gained in-house experience in the banking and financial sectors as well as in listed companies, giving us a good understanding of the commercial drivers in finance transactions.
About HPP’s Restructuring and Insolvency
HPP’s expertise covers all areas of insolvency proceedings and related legal issues based on several decades of experience of advising on and managing insolvency processes. We regularly work with all areas of insolvency law, including administration of corporate restructuring processes and bankruptcy estates and representing creditor’s interests in insolvency proceedings. We also provide our clients with input on potential insolvency issues in financing and corporate transactions including transactions involving distressed assets.
Our experts participate actively in the development of insolvency law and practice in Finland and our lawyers hold positions including the Chair of the Advisory Board for Bankruptcy Affairs, the Bankruptcy Law Revision Committee appointed by the Finnish Bar Association as well as many international insolvency organisations. Our team is recognised internationally as a leading team in Finnish insolvency matters.
