In 2011, the Spanish legislator introduced the court-sanctioned refinancing agreement (‘Spanish Scheme’) in the Spanish insolvency system. While the introduction of the Spanish Scheme has been praised for providing new tools for debtors to reorganise out-of-court while addressing the collective action problem, certain of its provisions have made this instrument too rigid and, thus, ineffective for tackling Spanish restructurings. This has been especially the case in those instances where the majority of the debt structure of the borrower is secured, which is a frequent situation in Spanish work-outs.
However, certain recent case law developments may represent a major boost for the use of Spanish Schemes in the out-of-court restructurings of Spanish corporate borrowers. Indeed, these developments have turned ‘upside-down’ certain provisions of the Spanish Insolvency Act while making an extensive interpretation of key aspects of the Act relating to Spanish Schemes. This article will explain, by first outlining the current Spanish Scheme regulation, what these case law developments have consisted of, and how they may impact Spanish restructurings going forward.
The legal regime of Spanish Schemes of Arrangement under the Insolvency Act
The Spanish Scheme is an out-of-court mandatory refinancing technique which consists of a privately negotiated compromise between the debtor and its creditors that is subject to court approval after a very formalistic process to which strict adherence is required.
In addition to having to meet certain formal requirements set forth by the Spanish Insolvency Act, the Spanish Scheme must be supported by creditor financial institutions representing at least 75 percent of the total liabilities held by these institutions. The debtor has to follow before the commercial court a two-step process where the Spanish Scheme is preliminarily approved after the formal prima facie review made by the clerk of the court. This preliminary approval, if so petitioned, can result in granting in favour of the debtor a stay of individual enforcements during the period before the scheme is finalised.
The court then considers whether the refinancing agreement meets the formal requirements set forth by the Spanish Insolvency Act and does not represent a ‘disproportionate sacrifice’ for dissident financial entities. Additionally, if so requested, the court may decide the stay of all enforcement actions (personal actions primarily) that the creditor financial entities (i.e., the lenders) could initiate. Further, the Scheme is binding with respect to the term of the payment moratorium agreed in the refinancing agreement on creditor financial entities whose credit claims are not secured with an in-rem security (such as pledges or mortgages).
Therefore, as per the literality of the law, the Spanish Scheme can only consist of an extension of the payment moratorium and does not bind secured creditors for the secured part of their credit claim. Furthermore, the Spanish Scheme and its effects are, from a strict interpretation of the law, limited to financial institutions (entidades financieras), such as banks or cajas, and it is unclear whether it also binds, for example, bondholders or hedge funds (which can be active participants of a restructuring).
The Celsa case
Celsa, a Spanish steel maker, recently completed a refinancing of its financial indebtedness (approximately €2.8bn net debt) through a Spanish Scheme. The refinancing, as reported, has consisted of a five-year extension of the different debt groups (which were originally due between 2013 and 2015) with a repayment schedule which is set to kick off in 2015. Celsa decided to proceed through the Spanish Scheme in order to lower the lender consent threshold to 75 percent and, more importantly, to bind hold-outs which represented approximately 9 percent of the creditors (with around 91 percent of creditors backing, in turn, the deal). The dissenting creditors were secured creditors and benefited from certain in rem securities which secured their obligations under the relevant facilities.
In order to cram-down the dissenting entities, and despite the fact that these entities were secured creditors, the Celsa group filed with the Commercial Court (Juzgado de lo Mercantil) No. 5 of Barcelona the petition to approve the Spanish Scheme and cram-down these entities. The Commercial Court approved, following the procedure set forth by the Spanish Insolvency Act, the Spanish Scheme, making an extensive interpretation of the Spanish Insolvency Act and the Spanish Scheme legal regime. In particular, the judge considered that dissenting secured creditors should in this case be treated as unsecured creditors and, therefore, the Celsa refinancing should also be binding on these creditors.
This decision was fundamentally based on two main grounds: (i) the secured Celsa creditors did not have the ability to enforce security individually which is, in practice, equivalent to not having a secured credit (creditors were “formally, but not materially” secured); and (ii) article 56.2 of Spanish Insolvency Act, which allows the automatic stay of mortgage enforcements when the mortgaged assets are linked to the activity of the debtor, should also be applied in a prepetition stage, particularly taking into account that the purpose of the refinancing is precisely to prevent bankruptcy. Further, the judge pointed out, unless such automatic stay applied, the success of the transaction and Celsa’s restructuring could be seriously jeopardised. Moreover, the court forced dissenting creditors to accept a payment extension of five years (and not the three years set forth by the Spanish Insolvency Act). Insolvency Act).
This decision was challenged by certain dissenting creditors exclusively with respect to the payment extension of five years set forth in the Court decision. The challenge was grounded on the fact that the Spanish Insolvency Act only allows the Court to ‘term-out’ dissident creditors for a maximum three year period (and not the five years set forth in the Celsa restructuring).
The Court, however, by virtue of a later decision issued in August, confirmed its original ruling and provided that the maximum legal term of three years applied only to enforcement actions and not to extensions of term and, therefore, such extension of five years was allowed under the Spanish Insolvency Act. Additionally, the Court implied that such extension was necessary in order to ensure the viability of the debtor and did not represent a “disproportionate sacrifice” for the dissenting creditors.
The criteria of the commercial judges of Catalonia regarding Spanish Schemes
The Celsa decision is only the tip of the iceberg in connection with the case law developments that Spanish Schemes are likely to suffer in the coming months. In this regard, the Celsa decision anticipated, to some extent, the criteria issued shortly after by the Commercial Judges of Catalonia during the course of one of the several seminars that they regularly held in order to unify jurisprudential criteria when addressing certain insolvency matters. During the last seminar these judges addressed the issues regarding Spanish Schemes that had been frequently raised during the two years that this legal device has been in place.
In summary, the Commercial Judges of Catalonia with respect to Spanish Schemes provided the following criteria:
Quorum. In connection with the debate as to whether the three-fifths majority of all lenders (which applies to a general refinancing agreement for claw-back purposes) also applies to court-sanctioned Spanish Schemes, or whether these schemes are only subject to the 75 percent majority of financial creditors, the commercial judges determined that the 75 percent majority is the only majority applicable to Spanish Schemes. The judges believe that, due to the fact that court-sanctioned Spanish Schemes can only apply to financial entities, it does not make sense to take into account the favourable vote of other creditors (i.e., trade creditors) which are not going to be bound by this scheme. This can facilitate the achievement of the relevant majorities when it comes to court- sanctioned refinancing scenarios.
Disproportionate sacrifice. This concept is not statutorily defined and should, therefore, be defined according to the specific circumstances of the case. The judges provide a set of guidelines as to how the existence (or absence) of this sacrifice must be assessed, which consist of analysing: (i) the general effects that the Scheme has with respect to the dissenting creditors; (ii) how the payment to these creditors will be impacted as a result of the Scheme; (ii) whether or not the total assets of the borrower are encumbered; (iv) whether security will be granted to dissenting creditors to secure their credit rights under the restructuring; (v) the percentage of hold-outs (the lower the percentage of existing dissenting creditors the more sacrifice that can be requested from these hold-outs); and (vi) the term petitioned regarding stay of enforcement actions.
Enforcement stay. The judges clarify to which ‘stay’ the three-year maximum limitation period should apply, providing that this stay applies exclusively to enforcement actions (with no distinction as to whether this action is in rem or personal) and not to the extension of payment set forth in the refinancing agreement which can be more than three years.
Compromise under a Spanish Scheme. The judges of Barcelona provide that the only compromise that can be crammed-down to dissenting creditors in a Spanish Scheme scenario is a payment extension (new maturity calendar, new mandatory prepayment regime, etc.) which must be justified by a viability plan that allows the borrower to maintain its operations in the short and medium term. Therefore, compromises consisting of new money financing or write-offs will not be approved in the context of a Spanish Scheme. Therefore, with respect to this particular issue, the judges have narrowly interpreted what a Spanish Schemes can consist of and, therefore, these Schemes continue to be less flexible than, for example, English Schemes of Arrangement, where almost any type of compromise or arrangement may be proposed: extensions, write offs, debt-for-equity swaps, etc.
Secured creditors. As provided in the Celsa case, the judges understand that secured creditors can be bound by Spanish Schemes when these secured creditors do not have the ability to enforce security individually. Further, these same judges understand that article 56.2 of the Spanish Insolvency Act, which allows the automatic stay of mortgage enforcements when the mortgaged assets are linked to the activity of the debtor, should also be applied by analogy in a prepetition stage considering that the purpose of the refinancing is precisely to prevent bankruptcy and unless such automatic stay applies, the success of the transaction could be seriously jeopardised.
Despite the fact that the above is a very relevant development, certain key issues have not been addressed, such as, for example, how the concept of ‘financial entity’ should be construed when it comes to Spanish Schemes. Therefore, this remains to be a relevant untested issue which could also impact Spanish Schemes depending on how narrow or broadly judges interpret the concept.
The criteria set forth by the Commercial Judges of Catalonia cannot be considered case law and it is instead subject to the different decisions that the Supreme Court, the Provincial Courts and the other Spanish commercial courts may decide regarding this matter. However, we understand that the conclusions reached by the Commercial Judges of Catalonia will likely act as a guide for judges to interpret the legal provisions regarding Spanish Schemes going forward.
Therefore, it will be key for investors (and their advisers) to understand these criteria and how they can impact their current and future restructuring transactions and investment strategies, as well as closely monitoring other decisions which may be adopted by other Spanish courts that may or may not follow the lead of the Catalonian judges.