Beyond COVID-19: Crisis response or road to recovery?
Crisis response or road to recovery?
In the current economic climate, and particularly in the context of the implications of COVID-19 (coronavirus), many businesses are considering restructuring and/or rescheduling indebtedness. This may be to streamline businesses, enhance efficiencies or due to financial difficulties. 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 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 knowledge in international jurisdictions 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 or striking off. Often, a restructuring will involve a combination of these and it is critical to get the right legal advice at the outset as this will impact not only timing, but whether the restructuring has been completed validly and in compliance with relevant 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 early advice 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. As well as 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 to that extent.
Intra-group transactions: Internal group restructurings almost always involve intra-group transactions. Key issues to consider are the value at which the transaction takes place: book value, fair value or some other value, and 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), but also 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 on an individual company basis and not to an entire group; 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), data transfer restrictions and any overarching legislation governing or otherwise impacting on a business transfer.
Reallocation of capital and new capital: One of the reasons to restructure may be to more efficiently reallocate capital among the 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 both minimum capital adequacy and liquidity requirements in the relevant jurisdiction, as well as tax and accounting implications. If a company is undergoing restructuring pursuant 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.
Regulatory 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 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 license revocations.
Tax: Tax is often key in any restructuring, and even if not, the way any restructuring is implemented should be done on a tax efficient (or tax neutral) basis. It is helpful to consider strawman 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), and treatment of consideration payable/assets received and capital gains taxes (if applicable).
External financing: Restructuring a group (either on a solvent basis but most certainly on an 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 put in place for obtaining lender consent where required. 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 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 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 that would provide provisional liquidators with sufficient breathing space to put in place a scheme of arrangement or restructuring agreement amongst creditors. 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 of 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 whether transactions entered into in the lead up to any insolvency proceedings will 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 party 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 on 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.
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