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New rules on business reconstruction - new tools to save viable businesses - reconstruction act

| Insight

On the 15th of April 2020, the Norwegian government proposed a new temporary act on reconstruction of businesses (Prop. 75 L (2019-2020)) to remedy financial problems caused by the outbreak of Covid-19. The government proposes extensive changes to the rules on debt negotiation in the current Norwegian Bankruptcy Act. The concept of debt negotiations is replaced by the term "reconstruction" which reveals a far more forward-looking approach than what the previous rules gave leeway to.

1.    Introduction

The main purpose of the bill is to establish an effective tool for clearing up corporate debt problems. The aim is to ensure that companies that are profitable under normal circumstances can be saved to a greater extent, and furthermore to ensure jobs and values. The rules do not intend to contribute to the continuation of loss-making businesses at the creditors’ expense. The rules should help to sort out which businesses can be viable.

The rules on debt settlement are long overdue for revision. The proposal expresses that the rules on reconstruction are initially proposed to be temporary rules, but that these should form the basis for further development to become permanent rules.

The proposal encompasses all industries and gives hope that viable businesses can be salvaged through successful reconstructions.

The following gives a brief overview of some of the most important proposed amendments.

2.   The debtor’s financial position – basic conditions for opening reconstruction

Under current rules, the debtor can only request the opening of debt negotiations when the debtor “cannot fulfill his obligations as they mature.” In other words, according to the rules of today, the debtor must be “illiquid.” This is proposed changed so that the debtor can request the opening of reconstruction negotiations already when the debtor “has or for the foreseeable future will have serious financial problems.” With this, there is no longer a requirement that the debtor must be illiquid – incapable of payment – in order to request reconstruction. This can help increase the chances of success in a reconstruction process.

However, if a claimant requests the opening of reconstruction negotiations, the creditors must make it probable that the debtor is unable to fulfil his obligations as they fall due. This implies a stricter requirement for opening of debt negotiation than if requested by the debtor himself.

3.     Relief of preferential rights for VAT and tax claims

It is proposed that an exemption from the public creditors` preferential rights for tax and VAT etc. may be made if this is deemed appropriate. Previously, there was no room to waive the preferential right. In practice, the preferential rights has made it difficult to find solutions for the business, as there is often not sufficient funds to contribute to solutions for other creditors after full coverage of the preferred creditors.

The department has in the regulations proposed a temporary exemption from the preferential right for claims on tax and VAT, etc. pursuant to section 9-4 of the Recovery Act. Exceptions are given after a more appropriate assessment and there is no automaticity in giving exceptions. It is further stated that the deviation from the preferential right will not be continued in a permanent scheme without this being further investigated.

4.    Financing the reconstruction process and the debtor’s business during the process

Whoever requests the opening of the reconstruction negotiations must explain how the operation of the business should be financed during the reconstruction negotiations. Furthermore, the court may order the person requesting reconstruction negotiations to provide advance or security for the costs of the reconstruction process.

However, the proposal extends the framework for financing the process by allowing the debtor to also establish new collateral in machinery and plant, inventory and outstanding claims with so-called super priority for loans granted for continued operations during the reconstruction period. The fact that the loan has “super priority” means that the security of the mortgage takes precedence over existing mortgages, cf. section 19 of the proposal. In addition, such loans are also proposed to be secured by statutory mortgage with priority over existing mortgages pursuant to section 6-5 of the Mortgage Act. A loan agreement with such collateral can only be entered into with the consent of the restructuring committee. The debtor shall, before the reconstruction committee gives its consent, submit a budget for the operation showing that such a loan is needed.

Affected mortgagees may petition the court for the reconstruction committee’s consent to be reversed. If the collateral of existing mortgagees is significantly impaired, or the court finds that there is no sufficient need for such a loan, the court may reverse the reconstruction committee’s consent.

The rule that is now proposed is new compared to the existing Bankruptcy Act. It is now possible to establish security with special priority ranking higher than other existing mortgages to finance continued operations during reconstruction and financing of the reconstruction negotiations. The financing cannot be used to cover debt from the time before the reconstruction was opened, but only for further operation during the process and to cover the costs of the reconstruction.

5.    No longer a minimum settlement requirement to the creditors (minimum dividend)

The requirement for minimum dividend has been one of the major weaknesses of the current system with rigid and formalistic rules requiring minimum dividend of at least 50% or 25% respectively. This made the old debt negotiation rules less flexible. In many cases, a debt negotiation solution would give creditors more coverage than a bankruptcy, even though the debt negotiation gave creditors less than 25%.

The proposal eliminates the minimum dividend requirement for the creditors both by voluntary reconstruction with the agreement of all of the creditors and a compulsory composition with at least 50% of the creditors. However, the proposal must be seen in the context that voluntary reconstruction requires the approval of all creditors and a compulsory composition requires the approval of at least 50% of the creditors. For creditors, the alternative will often be bankruptcy and a forced composition will often give a better result than bankruptcy proceedings.

6.    Rules of approval

The current rules have somewhat more complex voting rules, where the majority requirement depends on whether the proposal is more than 25% dividend or more than 50% dividend. The presented proposal simply implies either full support from the creditors in a voluntary reconstruction or more than 50% support from the creditors in a reconstruction containing a forced composition. The amendment means that a coercive agreement can be adopted by a majority, i.e. more than half of all known claims that have voting rights. A majority of the eligible votes must have actively voted in favor of the proposal.

Even if a reconstruction proposal is passed by a sufficient majority, it must be confirmed by the court before final reconstruction is binding. Under section 48 of the proposal, the court may refuse to confirm a reconstruction proposal either when the proposal will be offensive or when the proposal is not reasonable and fair to the creditors.

7.     Conversion of debt to equity

The Bankruptcy Act does not currently have any rules for converting debt into equity in connection with debt negotiation. Thus, such a scheme requires acceptance from all creditors. This must also be addressed at the General Assembly in accordance with the rules of the Companies Act.

The report proposes new rules that allow the restructuring to be based on the conversion of debt into equity. In this connection, it is proposed that the General Assembly should be able to make the decision to increase the capital by a simple majority. Similarly, it is also proposed that the decision to reduce the capital should be made by a simple majority at the General Assembly. The proposed provisions appear in section 35 and section 27, second paragraph of the bill.

The bill provides for a security valve where the court is given the right to decide that the debt restructuring scheme shall include all creditors if weighty considerations warrant it, and the creditors who have opposed the scheme obviously have no reasonable cause for this.

8.     The debtor’s contracts, etc.

Pursuant to section 7-3 of the Recovery Act, the debtor’s contracts continue in full force and effect even if a debt negotiation has been decided. This continues with the new bill, but with some changes that further limit a contracting party’s ability to terminate the contract as a result of payment default.

As a starting point, the debtor’s contracting party may not terminate the agreement on the basis that debt negotiations have been opened, cf. section 7-3 a of the Recovery Act. If the agreement has already been revoked before the opening of the debt negotiation, there is no longer a binding agreement. As a general rule, the amendment proposal states that a contracting party cannot uphold the termination of the contract made in the last four weeks prior to the filing date of the debt negotiation petition on the basis of the debtor’s payment delay, cf. the proposal in the report related to the amendment of section 7-3 a of the Recovery Act. Exceptions to the termination ban will be those cases where the termination is justified in matters other than payment defaults or the parties have adjusted to the termination of the agreement before the filing date. The latter will typically apply in cases where, for example, a new contract has been entered into with a new contracting party to complete the contract that has been terminated.

9.    Simpler rules for small businesses

The Bankruptcy Act currently has no special rules on debt negotiation for small businesses. The rules are the same whether the debt negotiation applies to a listed company or a sole proprietorship. The department points out that there is a need to discuss the need for special rules for small businesses. On this basis, the department proposes a regulatory warrant in section 61 of the bill so that provisions can be made at a later date. There are currently no proposals for such rules.

10.    Stricter requirements to the content of the debtor’s petition for reconstruction

Reconstruction can be requested both by the debtor and a claimant. The conditions for opening the reconstruction are somewhat different depending on whether the reconstruction is requested by the debtor or a claimant. We refer to clause 1 above about the debtor’s financial position as conditions for the opening of reconstruction.

A petition for reconstruction from the debtor must, pursuant to section 3(2) of the proposal, contain:

  • a brief account of the financial problems;
  • a brief account of how the reconstruction will be carried out;
  • a sketch of how the debt is thought to be arranged;
  • an account of how the operation of the business will be financed during the reconstruction negotiation;
  • a task over its assets and its debts,
  • an account of how registration and documentation of accounting information is arranged.

11.    Closing remarks – brief about the main lines of the process

A petition for reconstruction is submitted to the District Court which decides whether the conditions for opening reconstruction have been met, cf. section 2 of the proposal.

If the court finds the conditions for opening reconstruction for fulfilled, it will appoint a reconstructor and a creditor committee, cf. section 8 of the proposal. The reconstructor shall be a lawyer with experience in insolvency legislation.

The debtor must within 4 weeks submit a draft reconstruction plan of the business for the creditors` review and comments. The proposal shall be presented at the creditor’s meeting, cf. section 22 of the proposal. Unless a majority of the creditors – calculated by amount of outstanding debt – reject the draft from the debtor, the reconstruction negotiations shall continue based on the draft. If the debtor’s draft reconstruction does not receive sufficient support, the reconstructor shall, in cooperation with the debtor, examine whether other solutions can be supported by a majority of the creditors.

The process continues after this until a final vote that, upon full approval, provides the basis for a “voluntary reconstruction” or by a majority of more than 50% of creditors provides the basis for a “reconstruction with compulsory composition”. The latter requires the affirmation of the court in order for this to be valid, cf. sections 48 and 49 of the proposal.

A reconstruction may, pursuant to sections 27 and 34 of the proposal, be based on:

  1. Payment deferral;
  2. Percentage reduction of debt;
  3. That the debt is completely or partially converted into equity;
  4. Transfer of all or part of the debtor’s business and assets to a new owner, without the debtor’s business being liquidated (reconstruction transfer);
  5. Transfer and liquidation of all or part of the debtor’s business and assets in exchange for the debtor being released for the portion of the debt not covered by the liquidation (voluntary liquidation agreement);
  6. A combination of these schemes, and possibly in combination with other measures.

The proposal is expected to be considered in the Norwegian Parliament shortly.