Ten things to know
In the current economic climate, with global inflation on the rise and fluctuation in regional economies, many businesses are considering restructuring and/or rescheduling indebtedness. This may be to streamline businesses, focus on core strengths, enhance efficiencies or due to financial difficulties that the group encounters. There are common issues to consider in any restructuring, and particular legal issues when questions of solvency arise.
Particular considerations may apply depending on the jurisdiction and we recommend obtaining legal advice at an early stage in order to assess and preserve all available options, particularly on any cross-border restructuring.
We are a global law firm, experienced in advising on complex cross-border restructurings (both solvent and insolvent), with a presence in many overseas jurisdictions, enabling us to advise on the intricacies of local law within the context of any multi-jurisdictional restructuring.
In no particular order, here are the top ten points businesses should consider when contemplating a restructuring:
Company law framework: A restructuring often involves a corporate reorganisation and one of the first questions to consider is what the applicable company law permits. This will inform or even dictate the structure of any reorganisation; for instance, whether it is effected by way of merger or amalgamation, transfer of assets and liabilities, dividend in specie, reduction of capital, continuation, solvent or insolvent liquidation, deregistration or striking off. Often, a restructuring will involve a combination of the above procedures, and it is critical to get the right legal advice at the outset, as this will not only impact timing, but also whether the restructuring has been completed validly and in compliance with relevant local laws, without residual liability to group companies, and potentially individual directors.
Directors’ duties: These vary from jurisdiction to jurisdiction, but most common law-based jurisdictions typically require directors to consider what is in the interests of shareholders as a whole or, if there is a question over the company’s solvency, the interests of creditors. Boards should be obtaining advice promptly where questions of solvency arise in order to protect themselves from potential personal liability if wrongful or insolvent trading-type liabilities or offences exist in a particular jurisdiction. In addition to broad fiduciary duties, company and insolvency law will impose specific obligations/liabilities in certain circumstances. For instance, if an intra-group transfer at an undervalue occurs and local laws treat this as a distribution to shareholders, where the company does not have sufficient distributable reserves, directors may be personally liable to contribute to the assets of the company.
Intra-group transactions: Key issues to consider in the context of an intra-group restructuring are the value at which the transaction takes place: book value, market value or some other value, and the consideration received (cash, non-cash or outstanding intra-group receivable), as this may not only have an accounting impact but also legal consequences - both in a solvent situation where a company may need sufficient distributable profits to cover any deemed distribution (as noted above), and where insolvency may ensue and a transaction is treated as being at an undervalue or where the transaction is otherwise regarded as an unfair preference. Directors’ duties will also be relevant as duties are typically owed by directors to the individual company of which they are a director, rather than by judging actions by their effect on the group as a whole. Companies should consider whether certain transactions should be ratified by shareholders (assuming the relevant companies remain solvent) even if shareholder approval would not otherwise be required (albeit that ratification may not in itself absolve directors from liability, depending on the nature of the breach). Other common issues involve dealing with restrictions in contracts relating to a change of control or assignment/novation (depending on implementation structure), managing employee transfers (and whether the law allows automatic transfer of employees with a business or whether they have to be terminated and rehired) (and when), data transfer restrictions and any overarching legislation governing or otherwise impacting on a business transfer; for example the Transfer of Business (Protection of Creditors) Ordinance in Hong Kong.
Reallocation of capital and new capital: One of the reasons to restructure may be to reallocate capital more efficiently among a group or between businesses, particularly for financial services providers. It is important to consider not just the optimum capital structure going forward, but how to achieve this in the most efficient way, as well as what is legally possible and what might require regulatory approvals (see below). Legal advice should also be sought on minimum capital adequacy, liquidity requirements and asset ratios in the relevant jurisdiction, as well as tax and accounting implications. If a company is undergoing restructuring due to financial difficulties, issues may arise as to whether it may raise fresh capital from lenders by creating security which is accorded super priority. Legal advice should be sought on the plausibility of these arrangements and whether they would be subject to clawback concerns.
Approvals: For groups which include regulated businesses, most typically in the financial services sector, any restructuring may be subject to regulatory approval – perhaps in multiple jurisdictions. Local law advice should always be sought and, depending on the regulator, early consultation may be advisable. Approvals or regulatory notifications may be required not just for a transfer of ownership of a company or business (or a portfolio of business) but also, among others, changes in controllers (direct or indirect), changes in directors or other management personnel, changes in location, payment of dividends or other distributions, disposals or acquisitions of assets, or voluntary licence revocations. If leased premises are involved, landlord’s approval may also be required if the relevant lease or tenancy agreement contains a prohibition clause against sub-letting of the premises and stipulates that the tenant is deemed to have breached that clause in case of reconstruction, amalgamation, merger, voluntary liquidation or change in the person(s) who own(s) a majority of its voting shares or who otherwise has or have effective control of the tenant.
Tax: Tax is often key in any restructuring and, even if not, any restructuring should be implemented on a tax efficient (or tax neutral) basis. It is helpful to consider proposed structuring proposals from a legal and accounting perspective and then obtain tax advice on their implications to consider optimal structuring (or vice versa, depending on the factors driving the restructuring). Common issues involve the application of transfer pricing rules to intra-group transactions, reservation of tax assets, application of stamp duty (to share sales, share issues (if applicable in the jurisdiction) and distributions in specie) or availability of intra-group relief, and treatment of consideration payable/assets received and capital gains taxes (if applicable).
External financing: Restructuring a group (either on a solvent or insolvent basis) may have implications on any external financing in place. Any facilities should be checked for restrictions on corporate actions contemplated by the relevant restructuring (e.g. change of control, disposal/acquisitions of assets, winding up, mergers/amalgamations), as well as restrictions on incurring new indebtedness, and arrangements for obtaining lender consent, where required. If a company has a composition of debts, there is a danger of an automatic crystallisation of a floating charge when a company cannot meet its debts as and when they fall due, which gives rise to the need of restructuring. It may also be necessary to consider the governing law and jurisdiction provisions of facilities and whether these are capable of being changed in order to help facilitate forum-shopping in appropriate cases, where another jurisdiction might offer a more benign restructuring environment. In addition, borrowers may need to approach lenders for minor amendments to, or more substantial restructuring of, their external financings in order to avoid any disorderly defaults. Borrowers should be communicating with lenders as early as possible in order to avoid nasty surprises, and give time to find a mutually satisfactory compromise.
Insolvency law framework: This, of course, varies from jurisdiction to jurisdiction but, critically, it is important to understand whether the jurisdiction in question offers a universalist and debtor-friendly environment in which a debt restructuring can be implemented, or adopts a more creditor-friendly approach. In some common law jurisdictions, it may be possible to put the company into provisional liquidation, which may result in an automatic stay of proceedings (known as a moratorium) that would provide provisional liquidators with sufficient breathing space to put in place a scheme of arrangement or restructuring agreement amongst creditors. In a limited number of jurisdictions, such as Hong Kong, seeking the implementation of a scheme of arrangement does not result in an automatic moratorium, until sanction of the local court is obtained following approval of the required majority of creditors in terms of numbers and value. If the relevant jurisdiction does not offer a moratorium framework, the company may consider the possibility of entering into standstill arrangements with the creditors pending the implementation of the restructuring. If a company conducts business in a jurisdiction, but is not incorporated in that jurisdiction, a question arises as to whether the local courts would accept jurisdiction to open (main) insolvency proceedings in respect of that company. Similarly, if the company’s assets are not located in the jurisdiction of its incorporation, issues of the court’s recognition of foreign liquidation proceedings arise. As noted above, specific consideration should be given to directors’ duties in each relevant jurisdiction in restructuring and insolvency scenarios, as well as to whether transactions entered into in the lead-up to any insolvency proceedings may be susceptible to challenge once insolvency proceedings have been commenced.
Sales out of insolvency proceedings or enforcement scenarios: Where insolvency office-holders have been appointed or a creditor has appointed a receiver, it will be necessary for any parties dealing with the office-holder or receiver to satisfy themselves as to the powers these third parties have in respect of the company, as well as the residual rights or obligations of the directors of the company (if any), and the process for any purchase of assets from an insolvency office-holder or receiver (and the limited buyer protections available in such cases). Invariably, these differ depending on the particular process, and the local laws of the jurisdiction in question.
Implications for listed companies: Solvent restructurings intra-group often will not have any implications under the relevant listing rules if they are wholly intra-group. Where third parties have interests, the application of the rules should be considered. Similarly, if a company is in financial difficulties, in breach of its external financing facilities or on the verge of insolvency, these will all have implications under the listing rules in many jurisdictions (e.g. in terms of market announcements required to be made) and specific advice should be sought promptly.
EU Taxonomy Regulation and aviation: A transition to sustainability
On 5 April 2023 the long-awaited draft amendment to Delegated Act EU 2021/2139 including draft technical screening criteria in Annex 1 (the Draft Delegated Act) was published by the European Commission heralding the inclusion of aviation as a transitional activity within the EU Taxonomy Regulation. Following consultation, the draft was then updated on 13 June 2023 and published as part of the European Commission’s sustainable finance framework.