Conversations With Octus: DLA Piper Discusses Funds’ Views on Spanish Debt Restructurings

Editor’s Note: In the latest installment of the Expert Views series, Octus’ Chief Credit Correspondent Chiara Elisei speaks to Jose Maria Gil-Robles, Head of Corporate at DLA Piper Spain and Juan Verdugo, Head of Restructuring at DLA Piper Spain on the Spanish restructuring framework and how funds view and deal with it.

The Spanish restructuring framework has evolved significantly in the past few years, particularly after new legislation in September 2022 introduced the so-called Spanish restructuring plan, featuring creditor classes, new-money privilege and cross-class cramdown.

Read Octus’ analysis of the restructuring plan tool HERE and a review of it one year on HERE.

Chiara Elisei: Spain’s Consolidated Bankruptcy Law (Texto Refundido de la Ley Concursal) is approaching its three-year anniversary, and several domestic debtors have resorted to it since it came into force, while institutional investors have been closely monitoring its application.

From the conversations you had with funds, what’s their overall assessment and the main pros and cons?

Jose Maria Gil-Robles: For many, Spain remains a jurisdiction where the interests of the debtor receive more attention than those of the creditor. However, most investors see as a step forward the ability to cram down trade creditors, as well as the option to suspend enforcement of guarantees provided by group companies not subject to a restructuring plan, if such enforcement could lead to the insolvency of the guarantor and the debtor itself. They also view the temporary moratorium instrument (pre-insolvency) as a positive, given it provides stability while a restructuring is being agreed, and can be used not only by large companies but also SMEs, in line with other countries.

On the downside, investors note that restructuring in Spain continues focussing on debtor liabilities, and often it is not accompanied by an operational restructuring. If the restructuring does not entail changes in the management team and the plan goes ahead thanks to the alliance between the debtor and some of the creditors (public or commercial) who approve a nonconsensual plan (involving the cramdown of other creditors, usually financial ones), this raises doubts about the debtor’s viability, because the debtor may be denied access to fresh credit by the crammed-down financial creditors and, therefore, find it very difficult to finance the new business plan, with high chances of needing a second restructuring in the near term. Investors also warned that the risk departments of dissenting lenders are likely to place the debtor on a “blacklist” and refrain from extending further credit – an issue that becomes more severe as the number of financial creditors dragged into the nonconsensual plan increases.

CE: In Spain, it appears that debtors remain in the driving seat when it comes to presenting a restructuring plan, with some notable exceptions such as steelmaker Celsa, where a group of creditors submitted their own plan as soon as the new law enabled them to do so. Additionally, contrary to other jurisdictions, competing plans have not gained much momentum.

Juan Verdugo: Funds view negatively that restructuring processes continue to be led by the debtor and not by the creditors, despite the fact that the reform was supposed to change this trend. The lack of provisions on competing plans is also a major shortcoming in their opinion. The general position of our courts so far has been to apply the rule of temporal preference (first come, first served), so that only the first of the plans submitted is processed.

According to funds, this benefits debtors because they are the ones who, in most cases, have the necessary information to develop and propose a restructuring plan, in an agile and timely manner. It also discourages the parties from exploiting all the possibilities of striking a consensual deal and present the best possible plan. Investors believe Spanish law should be amended so that competing plans can be submitted, which would in turn promote the negotiation of consensual plans among affected stakeholders.

CE: Another issue that funds flagged is the so-called “duty shifting.” Can you explain why it is a reason for concern?

JMGR: Investors reckon that in a restructuring scenario, the debtor should prioritize creditors’ interest over shareholders, in what is known as “duty shifting”. Unlike insolvency proceedings, in a restructuring process, creditors cannot rely on the work of the judge and the receivers, but it should be primarily the debtor’s directors who defend their interests. But this is not the case in Spain, because the regulator did not consider it appropriate to regulate the administrators’ trust duties towards creditors in pre-insolvency scenarios, based on the understanding that the criteria for the protection of stakeholders under the Restructuring Directive were already implicit in Spanish legislation.

CE: Since the Covid-19 pandemic public debts have increasingly become a meaningful part of balance sheets.

What role do public debts play in restructuring?

JV: The situation of public debt in Spanish restructuring is paradigmatic: from having no role – or practically none – before the reform, it has now become decisive in approving a restructuring plan, even when the restructuring does not affect those claims as much it does affect others. Private creditors do not like the overprotection granted to public claims, also because those privileges are often extended to other claims, which are not strictly speaking public, or would not be so in an insolvency scenario.

For investors, this effectively represents an expropriation of value from the private-law claims affected by the restructuring in favor of public claims, without any form of compensation or remuneration. As such, some funds suggested that the Spanish law should be amended so that holders of public claims affected by the plan are deprived of voting rights.

JMGR: Another inconsistency spotted by the funds is that claims held by creditors linked to the debtor – which are subordinated by definition – may fall outside the scope of the restructuring, or, when affected by the plan, have a say in the voting on nonconsensual restructuring.

For many investors, the problem stems from the fact that the Spanish rule grants voting rights to all creditors whose claims are affected by the plan, which ends up attributing decision-making power also to subordinated creditors. In their view, this issue could be resolved by amending Spanish law to deprive subordinated creditors of voting rights, except in two specific cases: when they are “in the money” and therefore have a genuine stake in the restructuring, or when the plan is consensual and the participation of the subordinated creditors in the negotiations is accepted by a majority of the remaining classes of creditors.

CE: Spanish legislation grants considerable room for discretion to the initiator of a restructuring process to define the scope of the affected debt, but at the same time requires justification as to why some claims are part of the restructuring and some are not.

How is this balance playing out?

JV: Investors have no conceptual problem with such flexibility, but as debt scopes do not always follow clear, justified, or equitable criteria, this may jeopardize creditors’ confidence and the viability of the restructuring process itself. The funds we spoke to have identified several cases where this flexibility has been used to leave out of the scope subordinated claims, liabilities unduly considered as public law claims, claims of creditors who opposed the plan and so on. Usually, in these cases, a few creditors take all the pain, and whoever initiates the plan does not offer objective and plausible reasons as to why the sacrifice should be borne exclusively by them.

Moreover, the fact that the Spanish legislator has not expressly provided for a procedural channel to challenge the definition of the restructuring scope, only increases the risk of arbitrariness and malpractice.

CE: In Spain, as in the other member states of the EU, class formation must conform to objective criteria, meaning that unsecured claims should only be in different classes only when clear and indisputable grounds appear.

Is this the case in the restructurings implemented recently?

JMGR: According to funds, in a significant number of restructuring processes there have been instances of artificial structuring or manipulation of classes, for example, through their “multiplication.” The greater the number of classes, the higher the chances of securing a majority among them. Investors feel that this is done with no apparent purpose other than securing a majority of classes (which may represent a very small percentage of the company’s liabilities) in order to impose a particularly burdensome restructuring plan on a minority (in number) of classes (which, however, account for the majority of the liabilities).
The principle of minimum intervention, which does not allow the Spanish courts to put a stop, ex officio and at an early stage, to these actions, is also disappointing in the investors’ opinion and often results in creditors deciding to challenge the plan, to try and prove in a higher court the infringement of legal rules, including the fraudulent or abusive intent of the debtor.

CE: In Spanish restructurings, the absolute priority rule has been designed to protect the recovery of senior creditors by prohibiting “leakage” – of money or equity instruments – in favor of junior creditors or shareholders.

Can this be circumvented somehow?

JV: The Spanish system provides for an exception to the rule, allowing the court to approve a restructuring that does not comply with the principle of absolute priority, as long as it is essential to ensure the viability of the company and does not cause unjustified damage to creditors. The problem for investors is that, in practice, evidence that these criteria are met is either not present or far from conclusive. Instead, the debtor should be forced to produce an economic-financial analysis showing that, without an exception to the absolute priority rule, the business would not be viable.

CE: Strictly related to the absolute priority rule is the practice of gifting, that is, the voluntary transfer of the restructuring surplus from higher-ranking claim classes in favor of lower-ranking classes or the shareholders.

While the practice has limited precedent in Spain, it has recently been under the spotlight in Naviera Armas’ case, where bondholders who took over the business “gifted” some of the equity to former shareholders, the Armas family. Bank lenders, who were fully written off and received no equity, challenged it but the court ruled that gifting did not breach the absolute priority rule.

JMGR: Generally speaking, the main problem with gifting lies on the reasons behind it, as in certain cases there may be an incentive to artificially undervalue the debtor, leaving the dissenting class in the middle out of the money. It also raises the question of whether the senior creditor is transferring the restructuring value that really belongs to them or whether, on the contrary, such value should be given, at least in part, to the dissenting middle class. In the latter scenario, the middle class would have good reasons to oppose gifting on the grounds that the absolute priority rule is not being abided by.

CE: Some restructurings have also shown different treatments for claims with the same ranking. How does it happen and what can be done to avoid it?

JV: A less favorable treatment for some claims versus others of the same ranking may occur through various mechanisms. Firstly, by defining the scope of the restructuring in a self-serving manner, excluding – without proper justification – claims that share the same ranking as those affected by the restructuring. Alternatively, the class formation may be made so that claims of the same rank are placed in different classes, resulting in different treatment.

Investors emphasize that class composition should always take into account the existence of a common interest among the creditors grouped into the same class based on objective criteria. But, at the same time, Spanish law allows unsecured claims to be separated (disaggregated) into different classes of claims, where there are sufficient reasons that so justify, resulting in claims of the same rank being affected differently. Investors do not question this flexibility, but rather the fact that it can be done without sufficient grounds, for the benefit of more junior creditors or shareholders, and without the consent of the creditors who are mostly hit under the restructuring.

CE: Is the concept of “disproportionate sacrifice” proving effective when restructuring plans are formulated?

JMGR: Funds noted that the concept of “disproportionate sacrifice” is a useful tool as it provides a limit to what can be imposed on dissenting creditors in a restructuring, and offers an additional guarantee as it is designed to prevent the value of the restructured debt from falling below the share that would correspond to the creditor in a bankruptcy liquidation.
In their view, if the most high-profile Spanish restructuring processes since the adoption of the new system had been scrutinized more strictly, it would have been concluded that a disproportionate sacrifice was being demanded from some creditors.

Elements that warrant closer monitoring when approving a plan include whether the sacrifice a creditor is required exceeds that of other creditors or the sacrifice is not distributed equally among different classes of creditors with similar positions; whether the loss imposed on the creditor surpasses what is needed for the viability of the business; whether the loss is imposed when the debtor is not reasonably viable; or whether creditors in non-equivalent positions (e.g. unsecured and subordinated creditors) receive the same treatment.

CE: The lack of transparency and information asymmetry is a longstanding issue in restructuring. Has Spain made progress in this respect?

JV: Spanish law allows the debtor to apply for a moratorium or a pre-insolvency in order to negotiate a restructuring without this being shown in public registries. While maintaining confidentiality offers clear advantages, it has also drawn criticism from the investor community, due to its strategic use by certain debtors, particularly when combined with information asymmetry and the absence of any obligation to negotiate with all creditors.

Another controversial area is that Spanish law does not require the debtor to make available to creditors the full package of documentation and information supporting the restructuring plan. Investors insist that “good practice” in Spanish restructuring would be for the debtor to provide detailed and relevant documentation from the early stages of the negotiations, as a way to build a more solid and effective plan.

CE: The role of the restructuring expert has grown in importance under the latest reform. Are the experts keeping up with the expectations?

JMGR: Investors noted that the restructuring expert tends to work in the interest of the person who has appointed them, and therefore may not be strictly independent. However, they identified ways that would allow them to promptly replace the expert appointed by the debtor, or by a minority of creditors, where they become aware of circumstances that give rise to concerns.

Investors are certainly very demanding in terms of independence, informed judgement, experience that the expert should grant, and are particularly vigilant to dynamics that deviate from restructuring standards or best practices.

CE: Why does the provision of interim and new financing remain unattractive in Spain?

JV: The privileges granted to new financing’s provider, in the event of a subsequent insolvency, are of no or very little value. As such, most investors will only consider interim or new financing in the following cases: if they need to protect their previous exposure; as part of a takeover or buying a stake in the debtor; if the debtor owns assets that can be pledged as collateral on a preferential basis or, should this not be possible, where creditors who are already secured agree to share their collateral with the new-money provider.

CE: Finally, how do funds see Spanish courts and their rulings?

JMGR: Generally speaking, it is hard for investors to understand why there are so many contradictory pronouncements on basic elements of the restructuring system, which increases uncertainty and the risk of generating local case-law “à la carte.“

Funds believe that having the ability to appeal against a judgement approving a restructuring plan before a higher court, would not only encourage settlement and reduce the risk of abuse, but would also be more respectful of the principle of legal certainty and, in the long run, reduce interpretation discrepancies. Obviously, they are aware that a restructuring cannot be subject to an appeal for a long time, so any amendment to the appeal system should enable decisions to be taken in an urgent and promptly manner.

JV: Investors also perceive the judges as more inclined to protect the rights of shareholders than those of creditors. While they have no problem with the minimum intervention principle observed by the judges analyzing the restructuring plan, they believe that such principle should evolve towards a more qualified intervention when the judge is called upon to approve the plan. Indeed, the Spanish system should convey the clear message that a judge can refuse to approve a nonconsensual plan if there are doubts about the fulfillment of the requirements for such approval.

Finally, a recurring theme in discussions with investors is the excessive length of the processes, a view that does not take into account the lack of material and human resources in Spanish courts, which is due to budgetary constraints and has nothing to do with the professionalism of judicial bodies. But this is indeed a key challenge, as restructuring negotiations should take place at an early stage, and the system will be more effective if it is able to provide a prompt response to the urgent needs of distressed businesses.