Covid-19 has resulted in several companies experiencing dramatic loss of income and major financial difficulties. This entails, among other things, unnecessary bankruptcies, as well as loss of values and jobs. To remedy the situation, the government has proposed for a temporary Act on Reconstruction (Prop. 75 L (2019-2020)). The Act on Reconstruction is now passed by the Storting. In this newsletter we will give a brief overview of certain main elements of the Reconstruction Act.
For a brief summary of this news letter, click here.
Today, the rules on debt negotiations are set out in the Bankruptcy Act. To make such rules more effective the Government has passed a new temporary Reconstruction Act. The Reconstruction Act will replace the Bankruptcy Act’s rules on debt negotiations.
The Reconstruction Act has changed the terminology. Debt negotiations in the Reconstruction Act is referred to as reconstruction and reconstruction negotiations. This is to emphasize that reconstruction is not only debt restructuring, but also, if necessary, restructuring of the company and its business.
2.1 Exemptions to public debt priority
Under current legislation, public debts including tax are first ranking claims to be covered prior to other claims in judicial debt negotiations. This often decrease chances of dividend to other creditor classes.
As pointed out in the underlying report to the Ministry, this likely results in several companies, rather than entering into debt negotiations, file a petition for bankruptcy and subsequently start new a company, taking over all or parts of the bankrupted company’s business. This is detrimental both for prioritized and other creditors.
Permanent changes in the priority rules was at this point considered too comprehensive to regulate in the Reconstruction Act. Exemptions from the priority of tax and VAT claims etc. may, by separate regulation, be made applicable to reconstructions.
The purpose is to incentivize reconstruction rather than bankruptcy and thereby increase chances of dividend to other creditor classes.
2.2 Lower threshold for opening judicial debt negotiations
Today reconstruction proceedings may be petitioned by a debtor that cannot meet its obligations as they fall due, i.e. the debtor must be illiquid.
In the report to the Ministry, it is pointed out that one problem with today's rules is that reconstruction proceedings often is requested at a too late stage, where the debtor has little or no funds or liquid or assets. Reference is also made to the importance of the debtor having liquidity to carry out a successful reconstruction.
According to the Reconstruction Act reconstruction proceedings may be petitioned by a debtor that has or will in foreseeable future have significant financial difficulties. Reconstruction can in other words be initiated at an early stage to increase the likelihood of achieving sensible solutions, even at a time where a company is not illiquid, provided it likely will have significant financial problems in relatively near future.
2.3 Financing the reconstruction period
During the reconstruction proceedings a debtor cannot settle debt or mortgage its assets without the consent of the creditors. Today there is no legal basis for granting priority or priming security to financing of debt negotiations or continued business during such process.
The report to the Ministry points out that it is assumed that several debtors fail to request debt negotiation because there are no prospects of financing its operations during the debt negotiation period.
According to the Reconstruction Act a statutory first priority priming lien (senior to existing first priorities) may be established for costs and operations during reconstruction. The purpose is to enable financing of the process and continued business with reduced risk for a super senior lender.
2.4 Debt to equity conversion
2.4.1 Shareholders’ resolutions
The Bankruptcy Act does not have specific rules on the conversion of debt into equity in connection with debt negotiations.
The Ministry points out that it may be to the benefit of the creditors if the creditors, as an alternative to or in addition to dividend, are granted rights in the company e.g. by converting the debt into equity. This decision will have to be made in accordance with applicable Norwegian company law rules.
Currently, resolutions necessary to implement solutions whereby debt is converted to equity require a qualified majority in the general meeting (normally 2/3). Consequently, a relatively small minority of shareholders may block such decisions.
According to the Reconstruction Act for the purpose of a reconstruction, the relevant resolutions shall only require simple majority decisions (more than 50%). This will include resolutions on capital increase, capital reductions and issuance of financial instruments.
2.4.2 Creditor consent
Within four weeks of opening of reconstruction proceedings the debtor shall present a draft plan for reconstruction of its debt. The plan may include deferral of debt and/or a pro rata reduction of debt, a sale of assets or business, and debt write-off. Unless the draft plan is rejected by a simple majority of creditors (calculated by amount), the debt negotiations will continue. Voluntary reconstruction is achieved if the plan is accepted by all creditors. A plan for reconstruction including compulsory debt composition may be achieved with simple majority creditor consent, provided the court approves the plan.
One question is whether a debt to equity conversion will optional for creditors or if a plan including such conversion will be binding also on a minority of non-consenting lenders. The preparatory report to the Ministry sets out that for the purpose of a successful reconstruction would be an advantage if a reconstruction plan would be binding for all creditors, as that would provide a higher degree of predictability, in particular for potential investors.
On the other hand, as discussed in the report, it would likely not be preferable to make creditors shareholders of a company against their will. If a creditor is dissatisfied with a plan the creditor voted against, such creditor may use that argument in court when the plan is to be approved, and there is a risk that the plan is then rejected by the court. On this basis the Reconstruction Act has a mechanism whereby debt to equity conversion as a main rule is voluntary and shall require each relevant creditor’s consent. However, the Reconstruction Act also has a “security valve” mechanism whereby the court is given authority to rule that a debt conversion is to apply to all creditors if there are weighty arguments in favour thereof and the opposing creditors obviously has no reasonable grounds to object. The Ministry points out that such exception to the main rule is to be applied with caution. It is further held that public offices (state and municipalities) normally will have reasonable grounds to reject a debt to equity conversion. If a creditor has reasonable grounds to reject, may also depend on how liquid the relevant shares are. It should also be taken into account what other options there would be for reaching a sensible solution for the debtor and the other creditors.
According to the Reconstruction Act a debt to equity conversion will generally be an option for the creditors, and they may object to such conversion. The exception will have a very limited application. As a main rule the consent of each relevant creditor would be required for debt to equity conversion.
2.5 Simplified rules for smaller businesses
Currently, the rules on judicial debt negotiations apply regardless of the size and nature of the company’s business. Debt negotiations may however be cost and time consuming, which may be more challenging for the smaller companies.
The Ministry refers to how the Covid-19 pandemic has affected many small businesses like restaurants, hair salons, shops and others that would otherwise not have been on the verge of debt negotiations or bankruptcy. Simplified rules on reconstruction may thus enable continuation of such businesses. With reference to the need for further assessments in this respect, such simplified rules may be provided for by regulation at a later stage.
2.6 Impact and proposed duration
The above is a summary of certain of the new rules. A main purpose of the Act is the enable successful debt negotiations and thereby reduce bankruptcies. The proposed legislative changes will have direct consequences for a number of companies, their creditors and employees, and is likely to have a stabilizing effect on businesses affected by the current market situation. The Act is passed by the Storting and the Act is expected to take effect shortly.