Spain: Prepetition Restructuring Agreements - ‘Homologación Judicial’ and Refinancing
The development of the Spanish prepetition restructuring regime
During the past few years the Spanish insolvency and restructuring regime has experienced numerous reforms of great depth and relevance. Following paths initiated in 2009 and 2011, during the years 2014 to 2016 the Spanish insolvency system has shifted from the view that insolvency proceedings should be the sole venue in which to handle financial and operational distress. Instead, a series of amendments have been introduced to the Spanish Insolvency Act aiming to, among other things, develop a prepetition restructuring regime to enhance restructurings that secure the viability of the distressed debtor through an expedited proceeding with no or very limited judicial intervention.
The first set of reforms was introduced in March 20141 and had its focus on out-of-court workouts. Among others, the effects of the section 5-bis automatic stay2 were extended to the prepetition phase to stay enforcements against the debtor who was negotiating an out-of-court restructuring with its debtors and the homologación judicial (also known in practice as the Spanish scheme) regime was amended to introduce a new set of majorities that affect both secured and unsecured creditors and include a more comprehensive list of the content of a restructuring that can cram down on dissenting creditors. In September3 of the same year, many of these changes (ie, content and majorities) were also included within the regime of the plan of reorganisation that can be entered in the context of ‘full blown’ insolvency proceedings or, in Spanish, concurso.
Inspired to some extent by section 363 of the US Bankruptcy Code, the Spanish legislator developed through the reforms the sale of business units within a concurso proceeding aiming to develop another mechanism available to debtors (and creditors) to secure the maximisation of the insolvency estate and enhance the recovery of creditors (the levels of recovery in Spanish insolvency proceedings have been traditionally very low if we compare these levels with other western jurisdictions). With respect to individual debtors, second chance or ‘fresh start’ proceedings were also amended in February 2015.4
A highly effective regime has turned Spain into a more competitive market to restructure debt, and companies and creditors are now seeking for Spanish schemes instead of turning to foreign jurisdictions for taking forth an out-of-court workout.
Individual and collective refinancing agreements
The Spanish legislator has developed an array of prepetition restructuring tools that include individual refinancing agreements, collective refinancing agreements and court-sanctioned refinancings (homologación judicial).
Individual refinancing agreements
An individual refinancing agreement is a notarised agreement (ie, executed before a public notary) that satisfies the following conditions:
- it improves the ratio of assets over liabilities;
- it ensures that the current assets are no less than the current liabilities;
- the value of the security interest5 is not of greater proportion of the outstanding debt owed to the creditors than of the debt prior to the refinancing, and does not exceed 90 per cent of the value of the outstanding debt owed to such creditors; and
- it does not increase the interest rate applicable to the debt prior to the refinancing.
Collective refinancing agreement
A collective refinancing agreement is a notarised agreement that satisfies the following conditions:
- it has the support of creditors (not only secured and unsecured creditors but also trade creditors) holding at least 60 per cent of the debtor’s claims at the time the refinancing agreement is executed (as evidenced by an auditor’s certificate);
- it extends maturity (term out) or grants new credit, or amends financial obligations; and
- it is based on a business plan that allows business activity to continue in the short and medium term.
The parties to an individual or collective refinancing agreement following the above requirements will benefit from the following effects:
- The transaction will be ‘shielded’ from avoidance (clawback) actions6 (including security interests granted and perfected in connection with such agreements and, arguably, other corporate actions). However, this protection will only relate to the challenges of other creditors, being the insolvency administrators (appointed in a future hypothetic insolvency proceeding of the debtor) still entitled to challenge the refinancing agreements, based only on a breach of the statutory requirements previously described for these refinancing agreements. This protection is absolute in the case of homologación judicial (which we will analyse in detail below) and not even the insolvency administrator is entitled to file for clawback.
- Signatories will not be considered de facto directors (and, therefore, related parties to the debtor for Spanish insolvency law purposes) with regard to the obligations assumed by the debtor in relation to the business plan, unless evidence to the contrary is provided. As a result, it is clarified that these creditors would not be equitably subordinated on the grounds of being de facto directors.
Legal regime of homologación judicial
A court-sanctioned workout or homologación judicial (regulated under the Fourth Additional Provision of the Spanish Insolvency Act) is a collective refinancing agreement that is supported by at least 51 per cent of the financial claims (excluding trade creditors – ie, commercial debt – or public creditors) and is additionally sanctioned or ‘homologated’ by the court. However, it is worth mentioning that homologación judicial is not per se a formal insolvency judicial proceeding.
Although the ruling of the Commercial Court No. 10 of Barcelona dated 29 November 2016 (FCC case) established that neither current nor imminent insolvency is a requirement to file for homologación judicial, the Bodybell (Ruling of the Commercial Court No. 11 of Madrid dated 22 July 2016) and Abengoa (Commercial Court No. 2 of Seville dated 24 October 2016 and dated 25 September 2017) rulings sustained that a refinancing agreement that is unnecessary to remove financial distress entails a disproportionate sacrifice for holdouts.
The concept of ‘financial indebtedness’ has been analysed in recent rulings. In the Abengoa case, the judge distinguished two different characterisations. On one hand, a concept of financial claim to ‘financial indebtedness’ based upon the Spanish Accounting Standard Board consultation dated June 2015:
The concept ‘holder of any financial debt’ is . . . any creditor who has provided financing to the company in its most intuitive sense, in other words, who has provided funds or cash to the company . . . . Consequently, this category should include the creditors as credit entities, regardless of the instrument used to execute the financing and if applicable, the guarantees demanded, as well as other persons, entities or intermediaries whether or not they are subject to financial supervision and who have financed the company through the capital markets (bonds, notes, etcetera) or bilateral or multilateral debt contracts (syndicated loans, etcetera). The financial liabilities category excludes, therefore, labor creditors, public sector creditors and commercial creditors, as well as other creditors whose financing granted does not conform to the above mentioned criteria envisaged for financial creditors.
In short, for a claim to be financial it should stem from a financing contract that involves granting of funds to the debtor. It would not be a broad concept but, rather, a restrictive one. Other forms of credit, such as instalments of commercial contracts or credit insurance to obtain better payment conditions from suppliers, should not count. The delivery of cash would be a requirement thereof. Therefore, not every monetary claim should be characterised as a financial claim. For a monetary claim to be financial, a repayment obligation under a financial agreement should exist.
On the other hand, the judge pointed out another characterisation under Standard 9 of the Spanish General Accounting Plan for companies.
Further, in recent times a heated debate has taken place in Spanish restructurings regarding the ability to extend effects of the sanctioned refinancing agreement to holders of contingent claims (either as a provision or as a ‘contingent liability’). In this regard, the Mercantile Court No. 2 of Seville, which presided over the Abengoa case, has concluded that contingent claims cannot be subject to a court sanction refinancing agreement on the basis that excluding the holders of contingent claims because they are not financial liabilities (but extending the effects of the agreement to them) entails depriving them from current procedural rights while imposing substantive future obligations on them. This is understood to be damaging to these creditors and, as the existing regulation on composition agreements with creditors within an insolvency proceeding cannot be applied by analogy as regards this point (there is no absolute equivalence between both cases), exclusion should entail non-extension of effects. The same criteria have been followed by the Commercial Court No. 10 of Barcelona when analysing the FCC case (contingent guarantees are not financial liabilities for the purposes of the Fourth Additional Provision of the Spanish Insolvency Act: they are contingent commitments that have not materialised and cannot be qualified as financial liabilities subject to homologación judicial). Following both cases, several contingent creditors to Grupo Isolux-Corsán have objected its homologation using such arguments, which as at the time of writing is still pending.
The key element of homologación judicial is the ability to cram down dissenting creditors (including absentees) holding financial claims. In order to cram down holdouts, additional majorities need to be achieved. These majorities will depend on the content of the refinancing agreement that will be crammed down on holdouts and whether such holdouts are secured or unsecured creditors.
With respect to unsecured creditors (creditors that do not benefit from in rem security, and also the deficiency portion of a secured claim) a majority of 60 per cent of the financial claims may cram down dissidents when the content of the refinancing consists of (i) payment deferrals of principal, interests and other due amounts, up to five years; and senior debt-to-profit participating loans (PPLs), up to five years. Further, support of 75 per cent of the financial claims is necessary for (ii) payment deferrals of principal, interests and other due amounts, from five to 10 years; unlimited haircuts (there is no express limitation in the rule); debt-for-equity swaps; senior debt-to-profit participating loans (PPLs), from five to 10 years, or convertible obligations or conversion into any financial instrument; and payments in kind or debt-for-asset swaps.
Regarding secured financial claims, 65 per cent of the claims’ support is required as per content under (i) above and 80 per cent of the claims as per content under (ii) above. In this case, the secured claims amount is calculated by value of the security interest as defined above. Therefore, disputes may arise on the proper value assessment of the collateral to determine exactly where the value of the security breaks.
In terms of classes, as described above, the Spanish Insolvency Act does not take into account the existence of relative subordination agreements to determine the existence of different classes among creditors, which are the criteria used by the law to determine the existence or not of collateral securing the credit position in order to classify the creditor as secured or unsecured. However, developments in the definition of the concept of ‘disproportionate sacrifice’ may open the door to disparate treatment between creditors that do not share the same characteristics as we will further explain below.
Credits held by related parties to the debtor (that is, in general terms, shareholders and directors) are excluded and do not have the right to vote, but the effects of the scheme can be extended to them and will be bound by the homologation. Non-financial creditors, in turn, can also adhere to the scheme but cannot be crammed down in the context of a Spanish scheme.
A disputed issue is whether the threshold majorities should be determined as per all the financial claims or only those affected. Although the rulings of the Commercial Court No. 10 of Barcelona dated 29 November 2016 (FCC ) and of the Commercial Court No. 8 of Barcelona dated 13 February 2017 (Comsa) have held that the threshold majorities must be ascertained as per the affected financial claims, the Seville court sustained in the Abengoa case that the majority thresholds must refer to the total financial debt.
Special majority rules for syndicated facilities
With respect to syndicated agreements (for instance, syndicated facilities) a special voting rule applies, pursuant to which all lenders within a syndicated facility will be considered to support the refinancing scheme if creditors representing at least 75 per cent of the syndicated loan debt (or a lower percentage if agreed in the syndication rules established in the loan agreement) have voted in favour of the refinancing scheme. Therefore, in those cases where a 75 per cent majority is achieved, the remaining 25 per cent will be crammed down and the lenders holding that debt will be deemed to have accepted the refinancing. The relevance of this provision is twofold: (i) some courts (lately the FCC court in dicta) have argued that considering that there is a positive drag effect if the majority of 75 per cent is reached and considering that it is legally deemed that all creditors have voted in favour of the refinancing agreement the possibility of holdouts challenging the approval of the agreement is rejected; and (ii) the effects on syndicated holdout lenders go beyond the Spanish Insolvency Act ‘laundry list’ for extension of effects in homologation.
Content of the homologación judicial that can be crammed down on holdouts
In this regard, the list of potential effects that can be crammed down on holdouts is limited and narrowly construed and does not include the ‘crammable’ effects typical of restructuring, such as change of debtor or cancellation of security. There are examples where some parties when negotiating the restructuring deal have followed the criteria that in instances where more than 75 per cent of the creditors of a syndicated instrument support the refinancing, it can be deemed that all creditors support the agreement (in the sense that it is technically not a cram-down but a drag-along) and, therefore, the effects on holdouts can go beyond the mere provisions of the law. Some courts (eg, Bodybell) have further interpreted that, for example, securities can be cancelled if it can be shown that such security interests had no value and, therefore, the cancellation does not represent a sacrifice for holdouts (ruling of Commercial Court No. 11 of Madrid dated 20 October 2015).
It is also important to point out that the effects of the sanctioned refinancing do not have an impact on joint obligors and guarantors and, therefore, dissenting creditors affected by an extension of term or write-off at the principal obligor level will maintain their rights with regard to the joint-obligors and guarantors. This is the reason why the vast majority of the Spanish schemes are becoming group schemes where it is not only the principal obligor that files for court sanction, but also all the subsidiaries and affiliates that are obligors or guarantors of such debts.
Challenges to the homologación judicial: majorities and disproportionate sacrifice
A dissenting creditor may challenge a court-sanctioned workout if the relevant required majority has not been obtained or properly calculated, or if the refinancing imposes a disproportionate sacrifice on the creditor. Holdouts can only object to an homologación judicial through an appeal before the same court sanctioning the agreement. Although FCC sustained otherwise, the Seville Commercial Court No. 2 held in Abengoa that holdouts within a syndicate do have standing to object to homologation.
With respect to disproportionate sacrifice, the lack of a statutory definition of such concept has made it necessary to develop a concept of disproportionate sacrifice to ascertain whether this sacrifice is imposed on dissenting creditors in the context of a Spanish scheme.
In this regard, the EU Commission Recommendation of 12 March 2014, on a new approach to business failure and insolvency, provides that sacrifices imposed on dissenting creditors cannot reduce the rights of dissenting creditors below what they would reasonably be expected to receive in the absence of the restructuring; that is, if the debtor’s business was liquidated or sold as a going concern.
A few rulings have contributed so far to settle the concept of disproportionate sacrifice.
The ruling of the Commercial Court No. 3 of Barcelona dated 29 July 2014 (Petromiralles) upheld a workout that contemplated granting new security interests in favour of supporting lenders’ new money and antecedent debt. Although the holdouts’ antecedent debt was not extended to the corresponding part of the new security interests, the court sustained that this was an incentive to the extension of new money rather than unfair treatment. The court concluded that dissenters had the chance to adhere to the workout and grant new money, which made their challenge opportunistic.
Further, rulings (in both Abengoa and FCC ) set forth that holdouts can argue disproportionate sacrifice on the basis of a liquidation test following the criteria of the EU Commission’s Recommendation of 12 March 2014. Thus, dissenting lenders can escape homologation if they can prove with expert witness evidence that their recovery would be higher in a liquidation scenario. In addition, Abengoa and FCC rulings upheld that holdouts can raise the disproportionate sacrifice exception if they are treated less favourably than supporters that would be junior to them under bankruptcy priority rules. However, the ruling in FCC rejected the existence of an absolute priority rule under Spanish law, in that holdouts cannot raise disproportionate sacrifice on the basis that the capital stock partially or totally remains in favour of the old shareholders. The Abengoa case ruling shared this view.
The Proposal for a Directive of the European Parliament and of the Council on Preventive Restructuring Frameworks, Second Chance and Measures to Increase the Efficiency of Restructuring, Insolvency and Discharge Procedures and amending Directive 2012/30/EU (dated 22 November 2016), establishes the absolute priority rule.
Finally, the ruling in Abengoa also upheld that holdouts can argue disproportionate sacrifice based on the unfeasibility of the business plan or because it is unnecessary to remove financial distress.
Other effects of the homologación judicial
Fresh money granted as part of a homologated out-of-court workout earns the administrative expense treatment in a potential insolvency scenario: 50 per cent of the new money shall earn the pre-deduction treatment of administrative expense and the other half the general privilege treatment; that is, being paid after secured claims but before unsecured and subordinated claims.
Certain measures have been introduced to enhance debt-for-equity swaps within Spanish restructurings that tackle areas that range from limitations on equitable subordination, introduction of insolvency liability for shareholders upholding unreasonably their consent to debt-for-equity swaps in the context of a refinancing transaction, to reducing required corporate majorities, as well as tax advantages and exemptions in order for these transactions to be tax-neutral for both debtor and creditors at corporate tax level.
These measures can be divided into five large groups:
- Debt-for-equity swaps are part of the content that can be crammed down on holdouts in the context of a Spanish scheme. However, dissenters are allowed to choose between the proposed equitisation or a haircut in an amount equivalent to the par value of the shares.
- The Spanish Insolvency Act has excluded from the definition of ‘specially related parties’ for purposes of equitable subordination, those creditors who become shareholders of the debtor as a result of a debt-for-equity swap implemented in the context of a statutory refinancing agreement (ie, a collective refinancing agreement or a court-sanctioned refinancing agreement) or the enforcement of such security.
- Majorities required to approve debt-for-equity swaps by a shareholders’ meeting in the context of a refinancing have been lowered to simple (ordinary) majorities, instead of reinforced majorities.
- The Takeover Bid Royal Decree 2007 was amended with respect to those transactions consisting in debt-for-equity swaps where the target company is subject to serious financial distress. These transactions, as long as their goal is to restore the financial viability of the companies in the long term, are, in principle, exempt from the obligation to launch a takeover bid subject to an authorisation confirming this exemption from the Spanish Securities Market Authority (CNMV). This authorisation from the CNMV is no longer necessary provided that the equitisation is performed in the context of a court-sanctioned Spanish scheme backed by the favourable opinion of an independent expert.
- Finally, and very importantly, the Spanish Insolvency Act includes a new rebuttable presumption to determine the liability of shareholders of the debtor when they reject, without a reasonable cause, the debt-for-equity swaps, capitalisation processes or the issue of convertible obligations, which frustrate a collective refinancing or a court-sanctioned scheme. As a result of this, should the debtor finally file for insolvency, shareholders can be affected by the classification of the insolvency proceeding and, among other things, could be held personally liable for any shortfall for creditors within the insolvency.
This has been perhaps one of the major changes under Spanish law with respect to debt-for-equity swaps, and it has tried to address one of the key challenges that many Spanish restructurings face: the inability to force a cramdown on the equity, contrary to what happens in other jurisdictions. In this regard, under Spanish law, the cramdown of the equity, even if shareholders have no interest, always requires the approval of shareholders. This has jeopardised many Spanish restructurings and provides shareholders leverage in these situations, despite the fact that the real value at stake is zero, or close to zero. However, as we can see, the Spanish Insolvency Act has still not taken a firm step towards aligning the shareholders’ rights within a refinancing proceeding to their ‘real’ economic rights. In fact, as the Spanish Insolvency Act has not introduced restrictions to the rights of existing shareholders in the context of the refinancing of distressed debtors, in practice, debt-for-equity swaps in Spanish restructurings only take place when a consensual deal is put in place (and, therefore, blockades mounted by existing shareholders are prevented). Lenders can still follow other strategies, such as enforcement of pledges over the shares of the debtor, or force the liquidation of the debtor in bankruptcy, which can be less attractive to lenders and may not yield as effective results from a time and cost perspective.
The 2014 amendments to the Spanish Insolvency Act have focused primarily on prepetition and restructuring at pre-insolvency stages. The Spanish legislator finally realised that providing adequate and effective refinancing tools, as available in other EU jurisdictions, allowing out-of-court workouts, would be critical to grant Spanish high-leveraged debtors a true chance to restructure their financial debt in order to adequately deleverage and to secure their viability in the medium term, as opposed to previous inefficient and purely cosmetic ‘extend and pretend’ processes, which were value-destructive for the borrowing companies.
The Spanish scheme has emerged as an effective and powerful restructuring tool for Spanish companies at pre-insolvency stages. The protection against clawback (ring-fenced structures) and potential avoidance actions for these refinancing agreements, and the ability to cram down dissenting financial creditors once certain majorities were achieved under the Spanish scheme, have together proved very critical in the successful restructuring of large Spanish conglomerates. Before that, the English scheme of arrangement was successfully applied to some Spanish restructurings because of certain connections, such as the finance documentation governed by English law, so that the Spanish legislator decided to create similar local tools and mechanisms as available in other creditor-friendly jurisdictions.
For the past four years, since the latest relevant amendments to our Insolvency Act, there have been around 158 judicial decisions of homologation of Spanish schemes. As a result of the complex situations and the variety of cases, several controversial issues that were not expressly tackled by the legal framework have been challenged by financial creditors and resolved by the courts setting up diverse case law. However, grounds for objection to homologation schemes are limited, mainly the inaccurate calculation of majorities required by law to cram down dissenting creditors and the existence of disproportionate sacrifice on the debtor. Unfortunately, Spanish case law in this field is not totally defined yet, despite the efforts from judges of Madrid, Barcelona and Seville to set up certain uniformed principles and rules to follow on the main controversial issues. Recent cases such as Abengoa, FCC or Grupo Isolux-Corsán are providing colour, dealing with major controversial issues and setting up valuable criteria and tests for future cases.
Main discussions have been focused on the concept of financial debt and what should be captured for purposes of the majorities. For instance, latest rulings have confirmed that contingent claims should be excluded from financial debt. Another controversial issue discussed at large has been if the obligations imposed to dissenting creditors could be broadly extended to other items not expressly contained in the law and it has resulted that other terms could be imposed as well. Finally, it is still unregulated how parties would address disputes about the proper value assessment of the collateral to determine where the value of the security breaks since the claim amount not covered by the collateral asset will qualify as unsecured for purposes of the majorities. As a result, there have been no major developments about where the fulcrum security lies and the parties’ rights within the capital structure.
While we have seen that under the Spanish scheme dissenting creditors holding financial claims can be crammed down, there is no cramdown of equity under Spanish law. However, there has been a major step forward by imposing personal liability to shareholders of the debtors when they reject, without a reasonable cause, the debt-for-equity swaps, capitalisation processes or the issue of convertible obligations, which frustrate a collective refinancing or a court-sanctioned scheme. However, we expect that in the future shareholders ‘underwater’, holding no ‘real’ economic interests, could be automatically crammed down, as happens with creditors.
The introduction of a new privilege regime for ‘fresh money’ has proved insufficient and has not helped significantly to rescue transactions in Spain, as in other jurisdictions. We believe there have not been enough incentives to fund providers to deploy their money at prepetition or post-petition stages in Spain. One main drawback is the fact that it has only been available in the context of refinancing schemes. Moreover, the interim period of two years provided by law has already elapsed, so now only 50 per cent of the amount would qualify as a super-privileged claim. Finally, there is not a concept of ‘priming lien’ under Spanish law, so we do not have the flexibility to rank ahead as required for certain complex restructurings where there are no assets free of charge available for new money creditors.
It is not expected, in the medium term, that any new act will be passed in Parliament to amend the Spanish Insolvency Law. As a result, we should be alert to court resolutions and emerging case law trends to determine key issues regarding out-of-court restructurings.
Which corporate debtor
Secured creditors cramdown?
Refinancing agreement – Collective
All corporate debtors
Clawback protection (only with regard to creditors)
Refinancing agreement – Individual
All corporate debtors
Clawback protection (only with regard to creditors)
Spanish scheme – ‘Basic’
Holders of financial debt
51% financial debt
Spanish scheme – ‘Reinforced’
Holders of financial debt
60% or 75% financial debt
Holders of financial debt
Stays/conversion into PPL/haircuts, etc
Holders of secured financial debt
65% or 80% secured financial debt by value of security
Holders of secured financial debt
Stays/conversion into PPL/haircuts, etc
Only if there are, among other requirements:
60% or 75% if transfer of assets in lieu of payment
All creditors (except public creditors)
• Haircut (up to 25%)
• Extension of term (up to three years)
1 Royal Decree Law 4/2014, 7 March and Law 17/14, 30 September.
2 The directors of a company are obliged to file for bankruptcy upon current insolvency, within two months following the date on which the debtor knew or should have known that it was not able to meet regularly its payment obligations as they come due (cash flow insolvency). Upon imminent insolvency, when the debtor foresees that it will be unable to pay obligations regularly within the short or medium term, directors have the duty to file for insolvency. Companies can obtain an additional four-month period to tackle insolvency out-of-court, if they serve notice (the ‘5-bis notice’) with the court that would have jurisdiction over the bankruptcy proceeding. For such purpose, companies must state that they are engaged in negotiations aimed at reaching either an out-of-court workout – in the vast majority of the cases – or a pre-packaged plan of reorganisation with regard to a subsequent bankruptcy proceeding.
3 Royal Decree Law 11/2014, 5 September and Law 9/2015, 25 May.
4 Royal Decree Law 1/2015, 27 February and Law 25/15, 28 July.
5 Defined according to Royal Decree 4/2014 as the result of deducting the outstanding debts covered by the pre-emptive security on a given asset from nine-tenths of the reasonable value of that asset, while that value must not be less than zero or greater than the value of the claim held by the creditor or the value of the maximum secured liability agreed. Depending on the type of asset, ‘reasonable value’ is defined as follows: (i) for listed securities, the weighted average selling price obtained in one or more regulated markets for the last quarter for the refinancing agreement, as certified by the management board of the relevant capital market; (ii) for real estate assets, the value established in the valuation report issued by an authorised appraisal firm; and (iii) for other assets, the value established in the report issued by an independent expert in accordance with local GAAP. Such reports are not required if the value has been determined by an independent expert within six months before starting the negotiations for the refinancing scheme nor in the case of cash, current accounts, electronic money or fixed-term deposits.
6 Under Spanish insolvency law the concept of clawback includes all ‘acts or transactions performed within the two years prior to the debtor’s declaration of insolvency that are deemed to be prejudicial to the debtor’s estate can be avoided. Fraudulent intention is not required.’