Global M&A trends and risks
Powerful new forces shaping in the M&A landscape
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Global | Publication | June 2022
Before the Dutch Act on Court Confirmation of a Composition Plan (Wet Homologatie Onderhands Akkoord, WHOA) entered into force, much was written about it already. Some conclusions were drawn quite early on: the WHOA would disadvantage small- and medium-sized enterprises (SMEs), give large companies a helping hand and become a tool especially for the ‘Zuidas’ (the financial district of the Netherlands located in Amsterdam). One year after its enactment, it remains to be seen whether these conclusions were justified.
The WHOA provides restructuring specialists with a new tool to restructure companies in financial distress. Although the number of bankruptcies last year was at an all-time low in the Netherlands, it does not alter the fact that the restructuring practice is evolving. Omar Salah, a lawyer at Norton Rose Fulbright and Professor of Global Finance & Restructuring Law at Tilburg University, reflects on the WHOA and the restructuring practice.
Under the WHOA, it is possible for a debtor to offer a composition plan which can bind dissenting creditors and shareholders to a restructuring plan. One of the conditions for the restructuring plan becoming binding is that a two-thirds majority of the creditors and shareholders adopt the plan. Once the plan has been adopted, the court can confirm the plan, which also binds the dissenting, non-voting and absent parties. This court confirmation is also referred to as the ‘homologatie’ of the composition plan.
The desirability for this form of composition plans has been debated for a long time, says Omar Salah. ''Basically, it's about the balance between debt and debt forgiveness. You see, as a debtor, it is important that you pay your debts, because you have entered into an agreement with your creditors. On the other hand, there is the concept of debt forgiveness: as a creditor, you waiver the debt of a debtor if you see that he cannot pay. The idea behind this is that it is better for all parties, because otherwise the debtor would be declared bankrupt and the creditors might receive even less.’’ This discussion has been going on since the sixteenth century at the time of Emperor Charles V. ''At that time, there was a prohibition on waiving debt and composition plans. He was not in favour of it'', says the professor.
In 1893 the current Dutch Bankruptcy Act was introduced without a composition plan, despite discussions about its desirability at the time. In 1935 a composition plan was introduced for the first time in the Dutch suspension of payments (surseance van betaling). “The suspension of payments - which was once intended as a restructuring tool - proved to be unsuccessful. The first reason is that it does not bind secured creditors. A second important reason is that the suspension of payments has in practice become the gateway to bankruptcy. Directors of companies that are technically insolvent use it as an intermediate step, because a bankruptcy petition requires shareholder approval.''
“Everyone who works in the field knows that you need secured creditors for a total solution in a restructuring'', Omar Salah continues. “The demand for composition plans came from a practical necessity. In 2012, the government answered that demand with the legislative project ‘Herijking Faillissementsrecht’ (Recalibration of Bankruptcy Law). One of its pillars was the introduction of the WHOA."
Was the introduction of the WHOA accelerated by the pandemic?
''The legislative process began for two reasons. One was the call to modernise the Dutch Bankruptcy Act. The second reason was the global financial crisis of 2008. As of 2014, the first drafts of the WHOA submitted for consultation were already underway. The COVID-19 pandemic did speed up the enactment of the law, but it was mainly the tail end of the discussion.''
The media repeatedly emphasised that the WHOA would be used to a large extent by the ‘Zuidas’, as it was also called ‘a toy of the Zuidas’ . What can be said about this after more than a year?
“Interestingly, the opposite has proven to be true. At the end of the year, there were about 90 court orders. There were more than 100 WHOA cases, of which, to my knowledge, only three involved large companies. The lion's share of WHOA cases concerned SMEs. So far, the law has been most extensively applied to SMEs.’’
This development can be explained by the fact that even before the WHOA came into force, there were certain prejudices, he emphasises. ''The view beforehand was that you would need expensive advisers to go through a WHOA process and that the WHOA was too complex for SMEs. On the contrary, the past year has shown that you don't necessarily need expensive advisors. Moreover, we have a pool of judges who have specialised in the WHOA and who have taken a pragmatic approach. The law is sophisticated but not unnecessarily complicated. That is why it has been a success for SMEs: it is more accessible than people thought.”
One of the criticisms of the WHOA is that the interests of the creditors are not sufficiently protected. And while the financing and restructuring lawyer believes that these interests are indeed protected, he does observe some important nuances. “In practice you see that the courts protect the interests of the creditors. In a couple of cases in which the request for confirmation was rejected, one of the reasons was that the creditors had not been adequately informed. The premise was that creditors were being allowed to vote on a composition plan that they did not fully understood. In a number of cases, it even concerned a composition plan that had already been adopted by a majority of the creditors. However, the court observed that even though the composition plan had been adopted, the creditors were not sufficiently informed. Therefore, the request was rejected. You see that the judges, as guardians of appropriate disclose of information, assess this strictly.”
“Yet, it is fair to say that the possibilities for creditors to intervene are very limited'', he continues. “That ensures that the lead of a restructuring lies with the debtor. It is also referred to as a ‘debtor-in-possession’ proceeding. This law gives a debtor fairly far-reaching powers to implement a restructuring. That is quite risky for a creditor and illustrates why it is important to be proactive as a creditor.”
The WHOA provides opportunities for companies in financial distress to raise new capital. Salah outlines a possible scenario: “Let’s suppose you have a private equity sponsor that would like to buy a company in financial distress. Its purpose will often be to strengthen the company's equity, without ending up with a large debt burden. The WHOA allows such investors to make the capital available and the company to restructure its debt. This prevents throwing good money after bad money.”
Another possibility for these companies is to use a debt-for-equity swap, whereby the company's debts are converted into share capital. “Previously, this solution was difficult to implement, because shareholders had the ability to obstruct it. Now, under the WHOA, you include a debt-for-equity swap as part of the composition plan and if a majority adopts it, you can cram down those who voted against it. The WHOA also provides for a cross-class cram down. Even if one shareholder class votes against the plan, the plan can be crammed down if at least one class that is 'in the money' (a class that would also receive value in the event of bankruptcy, ed.) votes in favour of the plan. So this tool gives the possibility to implement a debt-for-equity swap and bind dissenting shareholders. As a result, the equity capital of the company can be strengthened.''
An important aspect of the confirmation of a composition plan is the disclosure of information to creditors and shareholders. Several court judgments have now shown that value is attached to this disclosure of information. This also provides an important practical lesson: "If the disclosure of information is incomplete, the request for confirmation will not be approved by the court. We have seen this go wrong a few times in practice.''
A second lesson is that the decision-making process must be done meticulously. ''You have to go through the process very carefully. The parliamentary history of this law states the composition plan can be ratified only if the decision-making process has been carried out without concessions. In essence, that means going through the proceeding properly and making sure everyone is well informed.''
''Another lesson is that you have to be proactive'', says Salah. He explains this using a chess analogy. ''Don't only consider what you are doing now, but think two steps ahead.'' The professor clarifies: ''Being proactive means knowing that you have a restructuring option with the WHOA; it requires you to think about the options in a timely fashion when you are dealing with a company that is in financial distress. Otherwise, someone else will beat you to it and you will be faced with a situation where a composition plan may be crammed down.''
What does this mean for private equity investors?
''In addition to shareholders, you can also force banks and bondholders to work in a joint solution. This translates into a strategic game between shareholders and private equity sponsors on the one hand, the lenders on the other and, of course, the company itself. Where previously you could hold things off for a while, now, as a private equity investor, you must think proactively about taking these steps. If you don't, the banks or bond holders will take the lead, and you may find that a solution is imposed on you.”
Besides Amsterdam, Omar Salah also works in London for Norton Rose Fulbright. In his international practice, he sees the rise of so-called distressed debt funds. These funds buy up the debt of companies in financial distress, so that after a successful restructuring the company is worth more and can be sold again. Salah underlines the economic function of these funds. ''These funds clean up assets in the economy that would otherwise lose value. In banking jargon, you could speak of non-performing loans. The bigger the market for distressed-debt funds, the more demand there is for these types of products. They create a secondary market for this kind of product. It is a very concrete form of supply and demand.”
In addition, these funds can offer a solution to companies in financial distress, he says. ‘’On the one hand, by offering rescue financing to companies in financial distress, where other financiers consider this too risky. On the other hand, by working together to restructure. If you are a bank and you have a €100 million loan that is non-performing, you could sell it to such a fund. A fund would step in at much lower entry point. If you buy a loan in the distressed debt market, you buy it at a discount. If you bought a loan of €100 million at a huge discount, you are also willing to settle with the debtor for an amount between the nominal value and your entry point. From the debtor's point of view, it offers opportunities for restructuring. It is therefore also a form of rescue for companies in distress. That is why it may be of benefit.”
''In the distressed market, the opportunities are different'', Salah emphasises. ''Not everyone dares to take those risks and not everyone understands those risks. You can see that distressed debt funds, especially in London, are very profitable. Such parties will increasingly look to the Dutch market, also because of the WHOA. You now have more legal certainty with the WHOA, because now there is a tool which you can use to implement a restructuring.’’
Aren't these funds opportunistic?
“Absolutely. But even when you talk about opportunistic investments to save companies, it can have a positive impact. It’s about seeing an opportunity in the market that others would have overlooked. The downside is that these types of parties have quite assertive - some might even say quite aggressive - strategies for making returns. This does not always contribute to a successful restructuring or add value for the company itself. In that sense, opportunistic behaviour can certainly be negative too.''
Another trend Salah sees is the maturing of the restructuring practice. That trend is international: from Europe to the United States and from Singapore to India. ''We were talking about the balance you are constantly looking for between repaying debt and waiving debt. We are increasingly moving towards a business rescue culture. As a result, whereas companies in distress used to have one fate - namely bankruptcy - today restructuring has increasingly become a real alternative for them.’’
Do you see foreign companies looking at the Netherlands because of the WHOA? Or is this yet to become apparent in the future?
‘’Foreign companies are looking at the WHOA. I see that in practice too. They used to say: 'We are going to restructure and these are the two options, namely the English Scheme of Arrangement and the US Chapter 11 (respectively the restructuring proceedings in the United States and in the United Kingdom, ed.)'. We now see the demand to restructure in Europe, and people are looking into their options. Then they place the WHOA next to the US Chapter 11 and the UK Scheme of Arrangement. The WHOA is still relatively young and new. Therefore, there is a certain reluctance among some parties. Those other instruments are more mature.''
The WHOA is inspired by the Scheme of Arrangement and the Chapter 11 proceeding. The Dutch law will be evaluated three years after its enactment. Omar Salah looks ahead and mentions a number of learning points. “Currently there is little room for creditor intervention. How will this develop in practice? Will the creditors not feel a greater need to do so? In the United States, there are creditors' committees that are very active. We do not have them in the Netherlands. I think that is a very interesting point to keep an eye on. Now it is in the hands of the courts. One of the questions that will come up is: should we give creditors more options under the WHOA?.”
The second learning point relates to employees. ''Under the WHOA, the choice was made not to affect the position of employees. The law stipulates that the debts of all creditors may be included in the restructuring, except for the obligations to employees. The reality of a restructuring is that, if everyone makes concessions, you have to think actively about what the justification is for keeping one group out. You see that there is an economic imperative to have everyone share the pain.''
''The third point I think is a very important one for the international restructuring practice'', Salah emphasises. ''With the WHOA we have an instrument that is also attractive internationally. European insolvency proceedings are recognised in the Netherlands in a well-functioning system under the European Insolvency Regulation. This provides for automatic recognition of insolvency proceedings within the EU. If there is an insolvency proceeding in the United States or in India, so outside the EU, recognition in the Netherlands is quite complex. Several countries have implemented the UNCITRAL Model Law on Cross-Border Insolvency. That UNCITRAL Model Law provides a clear framework within which foreign insolvency proceedings may be recognised. In the Netherlands, there is a gap in the legislation in this area and I am a great advocate of the implementation of the UNCITRAL Model Law along the lines of the US Chapter 15 proceeding.''
Nina Varumo is a freelance portrait and documentary photographer based in Stockholm. A recent project of hers Kvinnor till sjöss (‘Women at sea’) is on ongoing photo series highlighting the working life of female seafarers in order to change the stereotypical image of what and who is a seafarer.
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