Fedra Valencia and Jaime Ruiz Rocamora of Cuatrecasas Gonçalves Pereira explore whether the treatment of secured creditors with guarntees in rem could be leading towards cramdown:
"Debt capitalisation and loan-to-own structures should play a major role in the years to come, without altering the common use of guarantees in rem as an additional protection for creditors."
The treatment of secured creditors with guarantees in rem has evolved significantly in the framework of the modernisation and harmonisation of Spanish insolvency law. Before the enactment of the Insolvency Act 22/2003, holders guarantees in rem (ie, mortgages and pledges) had a so-called right of total abstention, that allowed them to refrain from participating in insolvency proceedings and keep the nature of their guarantee intact unless appearing at the general creditors meeting. Under the last reform of insolvency law through the Royal Decree Law 4/2014, secured creditors with guarantees in rem can be crammed down while negotiating refinancing agreements.
Before the Insolvency Act 22/2003
Before the enactment of the Insolvency Act 22/2003, there were two proceedings in Spain for insolvent companies under which creditors secured by mortgages and/or pledges could refrain from particpating in insolvency proceedings, relying only upon the guarantee securing their claim, which could not be affected by the outcome of the proceedings. Besides, there was no automatic stay on the enforcement of guarantees in rem. The value of the assets mortgaged or pledged was excluded up to the amount of the obligation secured, and the enforcement of the guarantee could continue regardless of whether the company was declared insolvent. Even if the enforcement was accumulated to the insolvency proceedings (once declared) and the outstanding proceeds, if any, were added to the debtor’s estate, holders of guarantees in rem had an absolute right of abstention from insolvency proceedings and were fully shielded against them.
The Insolvency Act 22/2003 and subsequent major reforms by Royal Decree Law 3/2009 and Act 38/2011
The Insolvency Act 22/2003 amended the archaic Spanish rules on insolvency, gathered diverse rules from various statutes and harmonised the Spanish insolvency law in line with the last reform of the Spanish Code of Civil Procedure by Act 1/2000 and the European Union Insolvency Regulation 1346/2000.
The right of abstention of secured creditors with guarantees in rem was somehow adjusted, among others, by amended sections 134 and 157 of the Spanish Insolvency Act 22/2003, which extended the effects of insolvency proceedings to secured creditors with guarantees in rem. On the one side, section 134 states that ordinary, subordinated and secured claims could all be affected by the terms of a composition agreement with creditors in case secured creditors may vote for it or accept its terms after approval by the statutory majority of ordinary claims. On the other side, section 157 states that ordinary claims must be paid on a pro rata basis, together with any secured claims with special privilege (among others, secured claims with guarantees in rem), in the portion that might not had been satisfied with the enforcement of the asset/right guaranteeing the claim. Therefore the stay and set-off on payments approved by ordinary creditors could affect secured creditors with a guarantee in rem at least in cases where the value of the asset and/or right securing the claim was not sufficient to cover the claim in full.
Since the enactment of Act 22/2003, claims from creditors with guarantees in rem are admitted as specially privileged claims (ie, secured claims) and would only be affected by a composition agreement with creditors if secured creditors vote for that agreement. Otherwise, secured claims would be paid for by the enforcement of the asset or right securing the claim, taking into consideration that section 56 now imposes a temporary stay on enforcement proceedings against the estate of the insolvent company (section 56 has been amended by subsequent reforms of the Insolvency Act 22/2003).
Of the reforms introduced by Act 38/2011, section 155.4 establishes that secured claims with guarantees in rem must be paid for by enforcing the asset or right securing the claim through public auction, unless the insolvency court authorises, at the request of the debtor trustee or the creditor within a composition agreement with creditors, the direct sale of the asset or its assignment to the secured creditor or a third party as payment of the secured claim.
The reform of the Insolvency Act 22/2003 by Royal Decree Law 4/2014
Royal Decree-Law 4/2014 has gone one step further regarding the treatment of the once absolute right of abstention of secured claims with guarantees in rem. It allows the terms of a refinancing agreement (a stage before insolvency) to be imposed on dissenting secured claims with guarantees in rem. In particular, the reform distinguishes between the amounts covered by the value of the asset or right securing a claim and the amounts exceeding it.
Regarding the amount exceeding the value of the asset or right securing the claim, the terms of a refinancing agreement will be extended to dissenting secured claims with guarantees in rem depending on the percentage of approval of the refinancing agreement. If the refinancing agreement is approved by claims representing 60 per cent or more of the financial debt, secured claims would be forced to accept any stay on payments, which may not exceed five years, or alternatively, the capitalisation of such claims into participative loans within the same statutory period. If the refinancing agreement is approved by claims representing 75 per cent or more of the financial debt, secured claims would be forced to accept any stay on payments, which may not exceed 10 years, any write-off on payments (unlimited), the conversion of such claims into shares of the debtor or into financial instruments with the same ranking, expiration and features of the original debt or alternatively, the assignment of claims that might have been agreed in the refinancing.
The terms of a refinancing agreement can also be imposed on the dissenting secured creditor in the amount covered by the value of the asset or right securing the claim and would depend on the percentage of secured claims with guarantees in rem accepting the refinancing agreement out of the overall debt secured with guarantees in rem. If the refinancing agreement is approved by claims representing 60 per cent or more of the financial debt, the terms of this refinancing could be imposed on the amount of secured claims covered by the value of the asset or right guaranteeing the claim with the same limitations as above, if 65 per cent or more secured claims with guarantees in rem accept the proposal. However, if the refinancing agreement is approved by claims representing 75 per cent or more of the financial debt, the terms of this refinancing could be imposed on the amount of secured claims covered by the value of the asset or right guaranteeing the claim with the same limitations as above, if 80 per cent or more secured claims with guarantees in rem accept the proposal.
The Prelude of Royal Decree-Law 4/2014 explains that the extension of the terms of refinancing agreements to secured claims with guarantees in rem is not subject to the existence of a guarantee in rem, but to the face value of the guarantee in rem. The reform tries to anticipate what would happen if the estate of the company being refinanced was eventually liquidated within insolvency proceedings, which is why the reform also includes objective rules of valuation to determine how much is and how much is not covered by the value of the asset/right guaranteeing the secured claim.
Heading to further amendments?
For now, this breach of the shield (right of abstention) that once protected secured claims with guarantees in rem only applies at stages before insolvency such as refinancing agreements. However, further and future amendments in sight could extend the rules of Royal Decree-Law 4/2014 to insolvency proceedings. Spanish insolvency law may be heading, sooner rather than later, towards a cram-down mechanism, equivalent to the one on Chapter 11 of the United States Bankruptcy Code, where an insolvency court can involuntarily impose a composition agreement with creditors within insolvency proceedings over the objection of some classes of creditors, such as secured claims with guarantees in rem.
There is no definition of a guarantee in rem in the Spanish legal system. There are no classes of creditors under the Spanish Insolvency Act. However, all sources of international insolvency law point in the same direction. The Recommendation of the European Commission on a new approach to business failure and insolvency (March 2014), the World Bank’s revised principles and guidelines for effective insolvency and creditor rights systems (2011) and its out-of-court corporate debt restructuring analysis (January 2012), together with the International Monetary Fund final progress report on the financial sector reform in Spain (IMF Country Report No. 14/59 – February 2014), all address similar concerns about restructuring companies that may not be financially viable, but are definitely sustainable from an economic standpoint.
The amendments could go even further. The Insolvency Act 22/2003 considers secured (ie, general privilege) the claims held by public administrations. Why would a claim held by the Spanish tax authorities be classified as secured? The loss of the privilege held by the public administrations in Spain could facilitate many more restructurings, a fact that cannot be ignored.
This article does not intend to warn financial investors and foreign investment funds about the current (and future) reduction of the benefits that guarantees in rem formerly gave within insolvency proceedings in Spain. However, it cannot be ignored that the once absolute prerogatives of these guarantees are clearly coming to an end. In a global context of economic distress, the need to restructure economically viable companies is vital. The guarantees held by secured creditors will retain mechanisms to ensure that their senior ranking is honoured, but insolvency rules cannot risk the loss of value that entails endless insolvency proceedings currently held before the Spanish courts. Debt capitalisation and loan-to-own structures should play a major role in the years to come, without altering the common use of guarantees in rem as an additional protection for creditors.