Croatia: Corporate Transactions During a Pre-Bankruptcy Settlement – Is that an Option?
→ Matthias Wahl
Approximately one year ago the new pre-bankruptcy settlement act came into force. Since then first attempts to acquire debtors under pre-bankruptcy settlement were made.
Pre-bankruptcy settlement act
Back in October 2012 the Financial Operations and Pre-Bankruptcy Settlements Act (Zakon o financijskom poslovanju i predstečajnoj nagodbi; PBSA) came into force under which undertakings as debtors are granted the possibility to request commencement of pre-bankruptcy settlement proceedings in order to (in a first step) avoid a regular bankruptcy proceeding and to try to ensure a going concern of the business carried out by such undertaking.
Spirit and purpose of PBSA
Neither the creation nor the implementation of PBSA was necessary since the Bankruptcy Act (Stečajni zakon) already provided for the possibility that the debtor (together with, or better an investor) could achieve a going concern in general; that is, without detailed provisions regulating such procedure and outcome as provided for now in PBSA, which could be considered as overregulated and thus unnecessary. It is thus questionable why PBSA was established. But in the meantime the general provisions in the Bankruptcy Act dealing with the possibility to achieve a going concern of an insolvent debtor were deleted.
Under the PBSA the entire procedure is determined in rather tight details and deadlines, whereby the pre-bankruptcy settlement proceeding has to be completed within 120 days as of the opening of such proceeding with the possibility to prolong it for an additional 90 days. The consequence of these detailed provisions is that all participating parties in such a process are bound to mere formalities and deadlines that make a possible investment during a pre-bankruptcy settlement procedure rather hard to achieve. When looking at the spirit and purpose of PBSA, this is contradictory. The PBSA is built upon the idea that the debtor (in joint efforts with its shareholder(s)) should recover and find a way to a going concern with the approval of its creditors.
In real life, however, a successful restructuring and achieving a going concern is most likely only if (i) the shareholder(s) invest additional capital into the debtor or (ii) an investor shows interest in the debtor’s business and is willing to invest. Provisions supporting the second option are, unfortunately, missing in the PBSA.
Acquisition during pre-bankruptcy settlement procedure
On the other hand the PBSA does not exclude the acquisition of shares of the debtor during a pre-bankruptcy settlement proceeding. The practical question is how to do this the most efficient way?
Such an acquisition process can be carried out more or less independently from the provisions of the PBSA, as long as such process is completed before the creditor’s assembly passes a resolution on the financial restructuring of the debtor and the competent commercial court approves the pre-bankruptcy settlement agreement. Once the financial restructuring plan is approved, an investor can acquire control over the debtor only by complying with the restructuring plan, and most likely will have to buy out the creditors in line with the restructuring plan to acquire control over the debtor.
Due diligence of debtor
This also means that worldwide accepted standard deal rules will most likely not be feasible to apply in the course of such potential acquisition. Even more, to conduct a reasonable due diligence exercise on the debtor is usually not possible within the deadlines of the pre-bankruptcy settlement proceeding and considering that the management and shareholder(s) are concentrating on preparing the required documents for the pre-bankruptcy settlement proceeding.
Thus, investors limit themselves to reviewing within a very short time (i) the financial data made available by the debtor (who has to draw up financial reports anyway when applying to commence a pre-bankruptcy settlement procedure) and its shareholder(s) and (ii) the legal data provided by the debtor and its shareholder(s).
If the investor decides to pursue the acquisition based on such a brief due diligence review, it must (i) find an agreement with the shareholder(s) of the debtor on the conditions of taking over the shares in the debtor and (ii) offer better terms and conditions on settling the debts of the debtor towards its creditors than the creditors would be entitled to under the pre-bankruptcy settlement plan in any event before the creditor assembly decides on the pre-bankruptcy settlement plan. Otherwise the investor would have no chance to acquire control over the debtor since the pre-bankruptcy settlement plan usually provides for a debt-to-equity swap in favour of the creditors, with the consequence that the shareholder(s) share in the debtor is diluted.
Such offer must be reflected in an amended bankruptcy settlement plan, which must be submitted to FINA by the debtor in due time after the first creditors assembly in which the creditors’ claims are asserted. This means that the investor must rely on the debtor as well to have a realistic chance to pursue the acquisition, including the goal to obtain control over the debtor.
Furthermore, if the investor requires merger control approval(s) by any competition protection agency (be it the Croatian agency, the EU commission, or any other agency), the approval(s) should be obtained before the relevant PBSA deadlines.
Alternative acquisition structure
If the investor does not have to rely on the cooperation of the shareholder(s) of the debtor because it has sufficient information on the debtor’s affairs and has decided to acquire a controlling shareholding in the debtor, it could directly offer to the creditors a better quota for their claims towards the debtor and acquire their claims towards the debtor. In such scenario, the investor could become the main creditor of the debtor and acquire control over the debtor by purchasing the claims of such creditors and implementing the pre-bankruptcy settlement plan with entering into the pre-bankruptcy settlement agreement. However, such way of acquisition can also be subject to prior merger control approvals from the competent competition protection agency/ies. In any case, these measures and prerequisites must be implemented also before the pre-bankruptcy settlement agreement is approved by the competent commercial court.