The COVID-19 crisis is causing financial difficulties for numerous companies. Often, bankruptcy seems to be the only escape. Based on the characteristics of US Chapter 11 proceedings, Swiss restructuring law was revised in 2014 so that judicial composition proceedings could be made more effective.

Composition proceedings allow companies to continue operations, and are a preferable alternative to bankruptcy proceedings, which can lead to the value-destroying breakup of an entire company. Particularly in the current crisis, in which financially healthy companies find themselves in economic distress through no fault of their own, composition proceedings can be a promising alternative that helps to preserve numerous jobs.

Unfortunately, despite the considerable advantages they offer, restructuring by means of composition proceedings is still not widely used.

The legal basis for composition proceedings is found in Art. 293 et seqq. of the Federal Act on Debt Collection and Bankruptcy (Bundesgesetz über Schuldbetreibung und Konkurs). Financially distressed companies initiate composition proceedings by filing requests with a competent court. Along with a request, the concerned company needs to present its income and assets. It must also submit a restructuring plan, which describes the envisaged restructuring measures (e.g. the sale of profitable parts of the business).

Importantly, neither over-indebtedness nor the insolvency of the company is a prerequisite for such a request. Debtors are encouraged to initiate composition proceedings as early as possible since early commencement increases the chances of a successful restructuring. Experience shows, however, that most debtors are reluctant, and wait until the company is over-indebted or insolvent before initiating composition proceedings.

After proceedings have been initiated and provided that the statutory requirements are met, the court grants a provisional moratorium (provisorische Nachlassstundung). Since a company's restructuring efforts can be adversely affected if its need for restructuring is revealed, there may be no public announcement during the provisional moratorium in justified cases.

In the majority of composition proceedings, a provisional moratorium is accompanied by the appointment of an administrator (Sachwalter) who will conduct the moratorium proceedings and assess the chances for a restructuring. The administrator also supervises the debtor's actions.

As a restructuring measure, the administrator is entitled to give his consent for the extraordinary termination of long-term contracts, such as rental contracts. This measure reduces the company's high fixed costs.

During the second phase of the moratorium – the final moratorium proceedings (definitive Nachlassstundung) – the administrator in the majority of cases prepares the composition agreement (Nachlassvertrag), which is submitted to the creditors for approval. A composition agreement will directly restructure the company (often combined with a waiver or partial waiver of claims by the creditors) or initiate the company's liquidation, especially after a profitable part of the business has been transferred and thus "rescued" from insolvency.

Rescue of profitable business parts

The profitable parts of a financially distressed company may be transferred to a rescue company or a third party. Often, these sales take place during the provisional moratorium by means of an asset deal, which covers, among other things, the transfer of goods, financial assets and intellectual property rights. In addition, contractual agreements of the company with third parties (e.g. rental and service agreements) may also be subject to such a transfer.

Special rules apply to employees: regarding transfers of businesses outside of insolvency proceedings, employment relationships are transferred to the acquirer ex lege. In order to facilitate the restructuring and continuation of the profitable parts of the business, when business transfers are conducted during composition proceedings, the law allows the acquirer to take over only a part of the employees (so-called "cherry picking"). Similarly, the joint liability of the acquirer for employees' claims that were due prior to the transfer does not apply in asset deals during a moratorium.

In principle, the parties to an asset deal are free to negotiate the purchase price. However, in practice the determination of the purchase price is often result-driven. With sale proceeds and the company's existing assets, the privileged claims (e.g. employee claims) must be fully covered. Furthermore, when determining a purchase price, the administrator must ensure that the non-privileged creditors receive a higher dividend than in bankruptcy proceedings. The corresponding dividend in composition proceedings is usually between 10% and 20%.

A number of approvals are required for the completion of the asset deal. In addition to the approval of the management bodies of the parties, the approval of shareholders may also be required if the sale of the business (or part of the business) leads to the de facto liquidation of the financially distressed company. For the transfer of the company's contracts to third parties, consent of the respective counterparty to the contract is required, although in practice explicit consent is only obtained for significant contracts.

If fixed assets (Anlagevermögen) are to be sold by virtue of the asset deal, approval by the competent court or by the creditors' committee is mandatory. Although obtaining such approval may be time consuming, the advantage to the acquirer is that the purchase price may no longer be subject to claw-back claims on the grounds of being allegedly too low.

Uncertainty regarding VAT liabilities

A recent decision by the Federal Supreme Court has caused uncertainty in the restructuring sector. The Federal Supreme Court has considerably extended the tax succession for VAT debts in regard to the acquisition of businesses. According to Federal Supreme Court case law, the purchaser will be liable for outstanding VAT debts in the event of a business transfer. The decision in question was not issued in the context of judicial restructuring proceedings. For this reason, it remains uncertain whether the liability for VAT debts also applies to business transfers as part of composition proceedings. If this were the case, the tax succession could significantly jeopardise any restructuring undertakings.

As explained above, profitable parts of a business may be rescued by their sale in the course of composition proceedings. It would be regrettable if the Federal Supreme Court's case law on tax succession for VAT liabilities undermines such undertakings. An immediate clarification of the legal uncertainty created by the Federal Supreme Court is vital. The Swiss Tax Administration is currently evaluating an interpretation guideline for the applicability of the new Federal Supreme Court case law to business transfers.

This publication is based on an article which has been recently published in German in the Swiss newspaper 'Neue Zürcher Zeitung'.