Carl Hugo Parment and Michael Gentili review criticism of the legal framework governing the restructuring market in Sweden, and discuss the need for more effective insolvency tools and procedures.
1. What trends, in terms of activity levels, affected industries or investor focus, have you seen in the restructuring and insolvency market in your jurisdiction over the last 12 months?
2. What is the market view on prospects for the coming year?
The consensus amongst market participants seems to be that there will be an increase in restructuring activity during the coming year. However, the likelihood of a significant rise in the frequency of insolvencies is fairly low assuming the prevailing low interest rate environment is maintained throughout the next year.
3. What are the key tools available in your jurisdiction to achieve a corporate restructuring – are they primarily formal, court-driven processes, or are informal out-of-court restructurings possible? Do you feel that the tools you have available are effective in terms of providing speedy, fair and predictable outcomes?
The choice between a formal court-driven corporate restructuring process (Sw. företagsrekonstruktion) or an informal out-of-court restructuring primarily depends on the severity of the financial difficulties faced by a company and, in particular, whether or not the restructuring target has urgent liquidity constraints. In situations where there is significant financial distress, there is a tendency to use the formal court-driven process as it – as a general rule – imposes an enforcement stand-still on the creditors of the restructuring target, and gives the restructuring target the right to postpone payments to its existing creditors. Furthermore, a formal restructuring provides conditional bankruptcy protection for a company during the restructuring period. However, wherever possible, the starting point is likely to be to try to accomplish a private out-of-court restructuring. The reason for this is primarily the contractual freedom associated with an informal restructuring and the relatively low success rate associated with formal court-driven restructurings in Sweden. Financially distressed companies will also in most cases want to avoid the publicity of a formal restructuring as it could negatively affect the business operations of the struggling company.
4 In terms of intercreditor dynamics, where does the balance of power lie as between shareholders and creditors, and as between senior lenders and junior/mezzanine lenders? In particular, how do valuation disputes between different stakeholders tend to play out?
The intercreditor dynamics are quite straightforward and basic in most financings in Sweden. The Swedish bank market has remained strong and healthy throughout the latest financial downturn and the local Nordic banks have to a large extent been able to protect their market share against competition from non-Nordic banks and alternative debt providers, such as debt funds and other forms of “shadow banks”. This, together with the fact that “second-lien”, mezzanine, PIK, and other junior tranches remain rather rare in Swedish deals, means that most intercreditor agreements have a conventional structure where power and control remain with the senior lenders.
However, it should be noted that the local high yield bond market has grown rapidly over the last couple of years, albeit from very low levels. The increased use of high yield bonds as a means of financing has of course impacted the intercreditor dynamics. In pari passu structures containing senior loans and senior bonds, the historic approach has been that the banks control the enforcement. The market is still somewhat unsettled as regards the control of enforcement, but some recent deals have been done on a “one $, one vote” basis (including deals where bank and bond tranches have been similar in size), so there has been a trend towards more bondholder control in the intercreditor agreements.
A trend towards more bondholder control can also be seen in intercreditor agreements in super senior revolving credit facility structures. Intercreditor agreements in such structures typically grant the bondholders control of enforcement subject to certain agreed enforcement principles and sometimes also consultation with the provider of the super senior revolving credit facility.
Finally, it should be noted that the use of accordion facilities, incremental facilities or other forms of additional funding (including bonds) in incurrence based financings also to some extent has had an impact on intercreditor agreements. Some borrowers seek to ensure that the intercreditor agreement allows and facilitates such potential future financings, which effectively means a longer and more complex intercreditor agreement compared to an initial all senior deal.
5. Have there been any changes in the capital structures of companies based in your jurisdiction over recent years caused by the retreat of banks from loan origination? In particular, have you found that capital structures now increasingly comprise debt governed by different laws (such as New York law governed high yield bonds)? If so, how do you expect these changes to impact on restructurings in the future?
6. Is there significant activity on the part of distressed debt funds in your jurisdiction? How successful have they been in entering the market, and how much has market practice (or law) evolved in response? If funds have not successfully entered the market, can you identify reasons why?
Both domestic and international distressed debt funds are active in Sweden. So far the deal opportunities have been somewhat limited, but there is a tendency towards the local banks monitoring their balance sheets more closely and taking a more active approach towards certain distressed credits, so there might be an increase in distressed deal opportunities going forward.
7. Are there any unusual features of your insolvency or restructuring law that an external investor should be aware of (such as equitable subordination, or substantive consolidation)?
There are no significantly unusual features in Swedish insolvency or restructuring law. However, it could be worth noting that a formal court-driven restructuring process (Sw. företagsrekonstruktion) provides a regime where new loans can be given a “super-priority” by the court-appointed restructuring administrator. Such claims with super-priority will rank before other claims of general priority, such as claims for compensation for the performance of auditing functions required by law, employees’ claims for wages and other forms of compensation to employees, certain pension benefits, and claims with priority connected to floating charges. Understanding this regime and the consequences of this super-priority is of great importance both for providers of “new money” in the form of “rescue financing”, as well as providers of “old money” that can find that the value of their floating charges are reduced by loans with super-priority.
Furthermore, it should be noted that the Swedish Company Reorganisation Act permits a court-approved debt composition among unpreferred creditors. Such debt compositions are subject to obtaining specific consent levels from the unpreferred creditors. If the relevant thresholds are met, non-consenting creditors will also be subject to the composition. The result of the composition is that creditors’ claims are subject to a hair-cut. One important feature of such court-imposed debt composition is that, in addition to the writing off of a portion of unpreferred creditors’ claims, all subordinated claims are effectively extinguished. This is an important feature when trying to accomplish a successful restructuring. A somewhat unusual feature of this regime is that subordinated creditors have their subordinated claims extinguished without any corresponding reduction of the equity interests of the shareholders.
8. Are there any proposals for reform of the legal framework that governs insolvency and restructurings in your jurisdiction?
During the last couple of years, extensive criticism has been directed at the legal framework governing corporate restructurings in Sweden. It has been generally agreed by both practitioners and legal scholars that corporate restructurings under Swedish law have proven to be overly time consuming and costly and not suitable for medium-sized and smaller businesses. Further, Swedish corporate restructurings are often unsuccessful, resulting in the debtor being deprived of both crucial time and resources, thereby having an adverse effect on the position of the creditors in the bankruptcy proceeding which follows. The critique directed against the current Swedish legislation has primarily been:
(i) that the reorganisation proceedings are too costly and time consuming. Creditors often face duplicated costs as it is common for reorganisations to fail and debtors to be placed in bankruptcy proceedings soon thereafter;
(ii) that there is an unwillingness to co-operate between secured and unsecured creditors during reorganisation proceedings. The key decisive factor under current legislation is the debtor and its owners’ interest in the continued operations of the debtor. This creates a conflict with the interests of the creditors, whose main interest should be to protect their claim against the debtor insofar as possible;
(iii) that the debtor maintains its right to dispose of its assets and manage the business during the restructuring proceedings, and the administrator works on behalf of the debtor. Accordingly, there is a lack of a neutral party in the restructuring process, as well as the means necessary to force the debtor to take actions which are necessary in the eyes of the trustee but disputed by the debtor. The result is that the restructuring proceedings are dependent on the co-operation of the debtor; and
(iv) that the Swedish Bankruptcy Act and the regulations governing corporate restructurings are too different. A corporate restructuring proceeding cannot be automatically and easily converted into bankruptcy proceedings, and instead a completely separate bankruptcy proceeding is required. As a consequence thereof, the choice between whether a debtor should go into corporate restructuring or bankruptcy proceedings is often decided based upon factors which are of little or no significance to the creditor collective, such as the subjective wish of the debtor.
Accordingly, in 2010, the Swedish government published an investigation (the Swedish Insolvency Investigation (SOU 2010:2)) on the possible reform of the legal framework governing insolvency and corporate restructurings. The Swedish Insolvency Investigation’s primary finding is that to overcome the flaws of the current legislation the creation of a combined legal framework governing both corporate restructurings and bankruptcy proceedings would be preferable. The Swedish Insolvency Investigation clearly states that notwithstanding the criticism directed towards the current legislation, the availability of an effective corporate restructuring instrument is important. The express purpose of any new legislation should therefore be to provide for corporate restructuring proceedings which are attractive enough for the debtor to initiate such proceedings at an earlier stage, thereby increasing the chance of success and reducing the possible adverse effects that such proceedings may have on the interests of the creditors. The Swedish Insolvency Investigation has, however, as of yet not led to any legislative changes.
In June 2015, the Nordic-Baltic Insolvency Network published its Nordic-Baltic Recommendations on Insolvency Law. The Nordic-Baltic Insolvency Network was established by a Swedish initiative in 2010, and consists mainly of a number of academics and expert practitioners from Sweden, Norway, Denmark, Finland, Estonia, Latvia and Lithuania. The main catalyst for the formation of the Nordic-Baltic Insolvency Network was the financial crisis that the Baltic States endured, revealing considerable differences between the insolvency systems of the Baltic States, but also between the Baltic States on one hand and Nordic countries on the other. The main purpose of the Nordic-Baltic Insolvency Network is to encourage efforts towards a harmonisation of the substantive insolvency laws of the member countries. It can be noted that the framework for a harmonised insolvency legislation recommended by the Nordic-Baltic Insolvency Network is aligned in many material respects with the findings of the Swedish Insolvency Investigation, among other things, proposing corporate restructuring proceedings that are more easily converted into bankruptcy proceedings, insolvency regulations that are based on and steered by the overall objectives of the regulations as such, rather than the special interests of certain parties, as well as clearer rules on the ability of the debtor to dispose of assets and manage the business while subject to restructuring proceedings.
9. If it was up to you, what changes would you make?
On the basis of the findings of the Swedish Insolvency Investigation and the fact that legislative measures are yet to be taken, we would introduce legislation permitting general debt compositions outside the framework of a formal insolvency proceeding. Under current Swedish law, where non-consenting creditors can be forced to accept the composition, general debt compositions are only available within the frame of such formal court-driven proceedings. Introducing a regime for general debt composition outside formal restructuring proceedings would therefore be likely to allow more creditors and debtors to find consensual solutions and thereby avoiding costly and time consuming formal proceedings.
Another change to consider would be to implement legislation that deals with the treatment of shareholders in financial restructurings. Currently, the Swedish insolvency regime primarily addresses various creditor issues while unfortunately failing to provide effective tools for the restructuring of the equity of a financially distressed company. Ideally, the insolvency regime should provide tools for working both with the debt and equity interests.