The Legal 500

The approval of the Concurso Law (Ley Concursal) in Spain on 9 July, 2003 was the realisation of a long sought-after aspiration in Spanish property law – namely the reform of the legal instruments for dealing with distressed businesses. Today, only a few years later, day-to-day practice shows that some of the old problems are resurfacing.

Despite the short time that the Concurso Law has been in force, it has already become clear that the proceeding it regulates is inadequate for dealing with over-leveraged businesses, consumers and families because of its expense, lack of flexibility and slowness. Together these usually make it necessary to resort to the out-of-court remedies used in other European countries to avert insolvency. The fact is that the proceeding as it currently stands is daily proof of the need for new approaches so that the Concurso Law can again function optimally, as it did in the initial months after it came into force.The problems afflicting the current legislation are several and diverse in nature.

On a general level, it takes too long to carry out a business restructuring through the courts. This problem is increasingly exacerbated by the rising number of insolvency orders and the scale of the insolvencies, all triggered by the current climate of economic recession. Where it is possible for the business to continue as a going concern, a lengthy concurso proceeding increases the doubts of workers, suppliers and customers about the company’s survival, severely hampers debt recovery efforts and, in short, jeopardises the array of commercial and legal relationships built up by the debtor before the court proceeding began. In most cases, these extremely grave problems overlap with the huge practical difficulties faced by the debtor in securing additional financing during the proceeding. Neither should we overlook the numerous and substantial costs of the court proceeding which will slowly, but relentlessly, drain the company of its assets, affecting its chances of survival (court fees, publication of numerous notices, the court procedural representative’s fees, the fees of the concurso managers, etc.).

The problems do not disappear, either, if the court proceeding is commenced with the resolute intention of liquidating the company and distributing the value of its assets among creditors. In a liquidation context, frequently situations arise where the assets become obsolete or definitively lose their value because they have not been used for a long time, and this very often goes hand in hand with the time needed to draft and approve the liquidation plan – the implementation of which does not usually serve as a shining example either.In view of all the above, there are a growing number of entrepreneurs who, conscious of the lack of dynamism in concurso proceedings, are seeking out distressed-business turnaround experts so that, after studying the specific characteristics of the case, they can design a ‘bespoke road map’ to help overcome problems of liquidity, over-leveraging, or inefficiencies in production at the distressed business. Most times it involves setting in motion out-of-court debt restructuring processes in tandem with the implementation of fixed cost-cutting plans and structural/production downsizing strategies.Out-of-court debt restructuring processes are also well regarded by the creditors (generally speaking, financial institutions) of a distressed business, as it would be required under the regulatory framework to provide for a substantial proportion of its debt in a court restructuring process. It is also easier for a distressed business to turn to these processes, because Spanish entrepreneurs are still extremely concerned by the stigma of a formal restructuring process being started, as well as by the publicity this brings, the potential liabilities that may emerge in the course of such a process, and by its excessive length when compared with an informal restructuring process.

In fact, the last two years have seen the initiation of numerous informal restructuring processes outside the extremely saturated commercial court system. The debtors are companies from the real estate industry (although there are also an increasing number of firms from other industries) with severe liquidity problems although they have not yet stopped servicing their debt. Other cases involve ad hoc defaults on payment, although the financial institutions are conscious of the debtor’s delicate state and have agreed to delay enforcement of their claims for a certain time. In such cases, the debtor has organised an informal committee of creditors, and explained the situation to them basically with a threefold objective: to secure the support of a majority of the financial institutions for its business/divestment plan and for the refinancing plan – typically involving the rescheduling of debt repayments for up to three years; to halt court actions by the financial institutions for a reasonable time while the terms and conditions of the refinancing package are being defined; and to seek a temporary moratorium on interest payments that, while brief, will be necessary in order not to further impair the company’s already scarce liquidity.

Apart from the foregoing, it is increasingly common in informal restructuring processes for the financial institutions themselves to agree to buy up the debtor’s assets for a price equal to or greater than their most recently appraised value, thereby enabling the debtor’s liability to the banks to be reduced while disposing of the assets on terms that would be difficult to match in the market. In short, experience shows that a fair number of these informal restructuring processes are completed in a substantially shorter time than a court insolvency proceeding, not to mention the saving in costs and the preservation of the company’s value and reputation – assuming it can carry out the process on a confidential basis.

Against the success of some of these processes, critics have argued that, from an academic standpoint, informal restructuring processes in reality ‘mask’ insolvency and only serve to delay the onset of court insolvency proceedings. These same critics stress that the agreements reached in out-of-court restructuring processes may be unwound in the event of a later court insolvency proceeding, since it is common for such agreement to envisage additional safeguards for the financial institutions. Indeed, the detractors of refinancing processes have gone even further by pointing out to the directors of the distressed company the potential risks that may ultimately be posed by such processes if the company finally has to seek protection through a court insolvency proceeding and it is determined that the refinancing deal led to, or aggravated, the company’s insolvency.

To finally close the circle of ‘adverse effects’, those in the anti-refinancing camp have highlighted the likelihood of the main players in the refinancing process (financial institutions) being held to be ‘accomplices’ for the distressed company’s situation, due to their having deliberately contributed to worsening its financial position as a result of the new financing terms.Needless to say, just the mere possibility of any of the above consequences materialising has caused deep concern among the financial community and among companies that have completed the renegotiation of their debt or are in the process of carrying out major refinancing processes. This concern has also spread to central government, which, in recent weeks, has been working on a legislative reform (not yet published at the time of writing) aiming to mitigate some, if not all, of the most adverse effects of the case made against the amicable debt renegotiation processes. In this connection, the Spanish media recently reported that with this legislative reform, the Government was seeking to exclude out-of-court refinancing processes – and the agreements reached in the course of such processes – from the list of acts that were voidable in the context of a court insolvency proceeding.The final wording of the legislative reform – the publication of which has been fast-tracked – seems likely to contribute towards banishing the arguments against refinancing arrangements from the business arena as well as giving financial institutions greater comfort so that they can continue lending to distressed businesses.

Lastly, we believe that the reform that has been announced does not seek to recast the system, but rather to clarify the legitimacy of the principles and spirit of out-of-court restructuring processes. Pending the final wording of the reform, the interpretational problems that threatened to make Spain the exception to the rule followed in other countries in the new economy (where out-of-court restructuring processes have never raised issues of legitimacy) should ideally be eliminated once and for all.

Antonio Fernandez is head of Garrigues’ restructuring and insolvency group. Juan Verdugo is an associate in that group