CumEx fraud – time for Dutch civil actions?
The CumEx-fraud has been in the news a lot recently. Research by the Dutch research platform Follow the Money in …
On January 1, 2021 the Dutch Act on Court Sanctioning Of Private Composition To Avoid Bankruptcy (Wet homologatie onderhands akkoord ter voorkoming van faillissement) (the Dutch Scheme) entered into force. The Dutch Scheme provides for a restructuring mechanism for Dutch companies whereby a composition is offered to creditors outside of an insolvency procedure. The legislation is inspired by the UK scheme of arrangement and the US Chapter 11 proceedings and has been positively received. Although the Dutch Scheme has been implemented in the Dutch Insolvency Act (Faillissementswet) it should not be regarded as an insolvency procedure.
Existing agreements and obligations between creditors and the debtor
An important aspect of the Dutch Scheme is that the preparation and offering of a composition and/or the appointment of a restructuring expert (herstructureringsdeskundige) in accordance with the Dutch Scheme, as well as events and acts connected therewith or connected with the implementation of the composition, prohibits that (i) agreements can be amended, (ii) obligations of the debtor (i.e. the company) are changed, (iii) obligations of a creditor towards the debtor are suspended (opschorting) or (iv) agreements are terminated (ontbinding) and any contractual clauses which would have such an effect are deemed unenforceable (hereinafter referred to as the Ipso Facto Prohibition).
In addition, and in case a cooling-off period has been declared by the court, a default (verzuim) on the side of the debtor in the performance of obligations which has occurred prior to the cooling-off period becoming effective cannot result in (i) agreements being amended, (ii) obligations of the debtor being changed, (iii) obligations of a creditor towards the debtor being suspended or (iv) agreements being terminated, provided that security has been granted securing the performance by the debtor of obligations arising during the cooling-off period.
Understandably, these provisions have been included in the Dutch Scheme to ensure the effectiveness of the composition and the procedure. Nonetheless, creditors will be confronted with the far-reaching consequences of these provisions as soon as the debtor starts preparing a composition or a restructuring expert is appointed. Creditors should bear in mind that the Ipso Facto Prohibition will be triggered at the very beginning of preparations for a composition being initiated by their debtor even though it is unlikely that they will have knowledge of such preparations (even if the debtor opts for a public composition process).
Scope of the Ipso Facto Prohibition
Given that the Dutch Scheme has entered into force recently, there is very limited case law on the Dutch Scheme at this moment and so far none regarding the operation of the Ipso Facto Prohibition. The Explanatory Memorandum (Memorie van Toelichting) of the Dutch Scheme however provides some further guidance on this topic.
The Ipso Facto Prohibition is intended to override contractual clauses which would otherwise (automatically) result in (legal) consequences (for the debtor) in case a composition would be offered, including clauses which would result in termination of the contract due to the same. This also applies to clauses which are not triggered by the actual offering of a composition, but relate to events or acts which are connected therewith (e.g. negotiations of a composition or the implementation of a composition sanctioned by a court). Particularly relevant for lenders is that a composition involving a ‘debt-for-equity-swap’ cannot be blocked by a change of control provision in the agreement.
Based on the text of the Ipso Facto Prohibition in the Dutch Scheme and the notes in the Explanatory Memorandum, underlining its intended broad scope, it is unlikely that any type of ipso facto clause triggered by any event or act related to compositions under the Dutch Scheme will be enforceable. Hopefully, an even more clear outline will become available through case law in the coming years.
Consequences for financing agreements and lenders
Dutch Scheme related events of default
The Dutch Scheme and its consequences for agreements and ipso facto clauses are particularly relevant for lenders and finance documentation. Financing agreements usually include, amongst a wide array of other provisions, clauses that allow the lender to, amongst other things, accelerate the loan and enforce security rights upon the occurrence of a number of insolvency related events. It is clear that such a clause is considered to be an ipso facto clause and a similar contractual provision regarding events related to a composition under a Dutch Scheme (or the appointment of a restructuring expert in accordance with the Dutch Scheme) is unlikely to be enforceable under Dutch law. In addition, creditors can no longer enforce their in rem security rights (unless with court approval) as soon as a cooling-off period has been declared or such creditor/secured party has otherwise been informed of the composition procedure.
Lenders should also be aware that other clauses (triggering events of default) included in the financing agreement, such as restrictions on incurring financial indebtedness and negative pledges, are considered ipso facto clauses and will not be enforceable under the Dutch Scheme. This is due to the fact that the Dutch Scheme is also a tool to accommodate ‘rescue financing’ and if the aforementioned clauses would remain enforceable, the lender could block any attempt to financially restructure the debtor.
Change of control
However, the implications of the Dutch Scheme for financing agreements are not limited to the aforementioned types of event of default. As mentioned above, ‘debt-for-equity-swaps’ under a composition cannot be blocked by a change of control provision. This could have a highly undesirable effect for lenders in case they have voted against a composition, but are overruled by other lenders or creditors (in a different creditor class) voting in favor of the composition, resulting in the composition being approved by a class of creditors entitled to receive payment of (part of) their claims in a bankruptcy scenario (generally referred to as the ‘cross class cram down’ possibility) and such composition being subsequently declared generally binding by the court. The lenders would then end up with an equity interest in the debtor, which would mean that the equity interest in the debtor becomes part of the balance sheet of the lender and the lender will have certain rights and obligations as a shareholder of the company. Financial institutions are usually keen on avoiding this. Some comfort can be found in the right for creditors to oppose the composition at the judge overseeing the procedure and argue that it is unreasonable. According to the Explanatory Memorandum, the creditor would then need to prove that the composition puts it in a significantly worse position compared to the outcome of a bankruptcy scenario.
Material adverse change
Financing agreements tend to include a ‘material adverse change’ (or MAC) clause as well. A MAC clause stipulates that if an event or circumstance occurs which in the (reasonable) opinion of the lender has or is reasonably likely to have a material adverse effect, this constitutes an event of default (opening up possibilities for the lender to accelerate the loan and enforce security). The definition of a material adverse effect is often the subject of negotiations but in general, this relates to a material adverse effect on (i) the business and (financial) condition of the borrower, (ii) the ability of the borrower to perform its payment obligations and comply with financial covenants and (iii) the validity, enforceability and effectiveness of security rights. By nature, the MAC clause is an ipso facto clause.
Given that a MAC clause is an ipso facto clause, together with the fact that, in practice, it is not easy for lenders to invoke a MAC clause (as the threshold for triggering it is quite high), it is unlikely that lenders would be able to invoke this clause in case of (preparations for) a composition. The fact that a MAC clause is not specifically tied to Dutch Scheme events or circumstances does not change this.
Other contractual provisions
Another important question is whether it is possible to include clauses in the financing agreement dealing with the Dutch Scheme in view of the Ipso Facto Prohibition. For instance, one can think of a notification requirement for the debtor towards the lender as soon as preparations for a composition start or additional information or reporting obligations being triggered by the same.
It is not immediately clear from the relevant section of the Dutch Scheme or the Explanatory Memorandum whether a distinction can be made between contractual obligations having a more severe adverse effect on the borrower (such as events of default resulting in a higher interest margin or default interest being payable, acceleration and enforcement, a draw stop and representations/undertakings that no (preparation for) a composition may be initiated without prior written consent of the lender etc.) and clauses which result in notification or information requirements only. If the latter type of clauses are allowed, an interesting question is what the (contractual) consequences would be if the borrower does not comply with such notification or information requirements.
One could argue (and maybe speculate) that such a clause has a greater chance to survive the Ipso Facto Prohibition if the adverse consequences for the debtor are limited (although this is not a criterion reflected in the relevant section of the Dutch Scheme or the Explanatory Memorandum). Aside from whether such provisions would qualify as an ipso facto clause, if the borrower would have to disclose in one way or the other to the lender that it is starting (or considering to start) preparations for a composition, this would disrupt any private composition process and could also be detrimental to the effectiveness of a public composition process if other creditors have not been able to take note of the composition process being initiated at the same moment. The lender could then act on the basis of information which is not (yet) available to other creditors of the borrower. It seems unlikely that this is reconcilable with the (purpose of the) Dutch Scheme.
Practical advice for lenders
As described above, it seems to be very difficult for lenders to contractually mitigate the (effects of the) Dutch Scheme by relying on the customary clauses in the finance documentation and even by including specific provisions relating to compositions under the Dutch Scheme. Parties should bear in mind that the condition for a debtor to initiate a proceeding under the Dutch Scheme is that it the debtor finds itself in a situation in which it is reasonably likely that it will not be able to continue to meet its financial obligations. The Explanatory Memorandum further clarifies this by describing a situation in which the debtor is currently still able to make payments but without any realistic expectation to avoid insolvency in the future (without restructuring of its debt).
Although this may not be suitable for each type of financing and for each type of borrower, lenders could consider including (additional) forward looking financial covenants or reporting obligations (e.g. cashflow or liquidity forecasts). In most financing agreements, financial covenants are backward looking and tested over periods in the past (which, of course, could also indicate a decline in the (financial) performance of the company). Lenders could argue towards the borrower the necessity (or desirability) of such covenants on the basis of their exposure to Dutch Scheme risks and the fact that there is already a certain forward looking element in (LMA) financing agreements through the MAC clause but also, as a Dutch market specific undertaking which is sometimes included, the ‘keep honest’ obligation for the borrower to notify the lender in case it expects a default to occur under its financial covenants. As is customary, reasonable headroom should be included in the projected covenants (to arrange that these are only breached if the borrower is heading towards a positition in which it would no longer be able to meet all financial obligations in the (near) future).
Another option (or maybe in addition to the above) could be to intensify the monitoring of the financial condition of the borrower by way of including additional information and reporting obligations. This is less burdensome on the borrower in terms of potential contractual consequences and does not provide the lender with the right to take immediate action if the information or reports show that the financial condition of the borrower is likely to deteriorate and would merely serve as an early warning. Such a provision could also be accompanied by a an obligation for the borrower to provide the lender with satisfactory evidence on how the borrower envisages to steer away from the projected financial difficulties.
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