The Dutch Scheme: a new restructuring instrument
The Dutch Act on Confirmation of Extrajudicial Restructuring Plans (“CERP Act” or “Dutch Scheme”; in Dutch: Wet homologatie onderhands akkoord, or WHOA) will enter into force on 1 January 2021. The Dutch Scheme provides a procedure for companies to restructure their excessive debt without invoking a suspension of payments or insolvency proceedings, by reaching an extrajudicial composition with their creditors and shareholders. Currently, a company’s creditors and shareholders all need to give their consent for a composition to be agreed, meaning that a single creditor or shareholder can block the composition. With the introduction of the CERP Act, however, this unanimity will no longer be required: once the composition has been accepted by a group of creditors or shareholders, the court can declare it binding in respect of all the creditors and shareholders that fall within the scope of the composition. It goes almost without saying that the mere prospect of an enforceable composition could make it easier to form a consensual composition. This makes the Dutch Scheme a welcome addition to the toolbox for corporate restructuring in the Netherlands.
The final element of the Dutch Scheme: court confirmation
In Dutch, homologatie is a somewhat archaic legal term that means confirmation. This confirmation, giving a composition binding effect in respect of all the creditors and shareholders affected, is the final element of the Dutch Scheme. Where the confirmation concerns an open composition, that composition will automatically be recognised by all other EU Member States. This contribution provides a closer look at this key final element under the new legislation: how do the courts go about completing the process?
The run-up: the request for court confirmation
A composition goes through a series of important steps before it can be confirmed in court. The CERP Act provides only a legislative framework. Debtors and restructuring experts must determine the details of the composition within the framework provided – preparing it, drafting it and offering it to the company’s creditors and shareholders whose rights will be affected by the composition and who, as a consequence, are entitled to vote on it (section 370 of the Dutch Bankruptcy and Insolvency Act (Faillissementswet). Those voting creditors and shareholders will then vote on the composition that has been offered (section 381 Insolvency Act). The resolution for the consent of a particular class of creditors or shareholders passes if two thirds or more of the total value of the debts or equity in that class accepts the composition. The debtor or (if appointed) the restructuring expert will prepare a report of the vote within no more than seven days after the vote was taken. That report must describe the outcome of the vote and whether the debtor or restructuring expert intends to refer the composition to the court for confirmation (section 382 Insolvency Act); this is possible only if at least one of the classes whose rights will be affected by the composition agreed to the composition (section 383(1) Insolvency Act).
The court’s review: grounds for refusing the composition
The essential premise is that the court will confirm a composition that has been offered under the Dutch Scheme (section 384(1) Insolvency Act), except if one or more of the general or additional grounds for refusing confirmation applies. The court will consider the grounds for refusal on its own motion or at the request of any of the voting creditors or shareholders. A party wishing to invoke a ground for refusal must make this known on time (or preferably have announced it beforehand), or else be barred from invoking that ground (section 383(9) Insolvency Act).
The general grounds for refusing to confirm a composition, which are laid down in section 384(2) Insolvency Act, are intended to ensure a legitimate opinion. The purpose of the additional grounds for refusal (section 384(3) and (4) Insolvency Act) is to ensure that the composition is reasonable and that the debtor’s assets are divided fairly. If necessary, the parties can use the dispute resolution mechanism to ask the court to review potential grounds for refusal before the composition is referred for confirmation (section 378(1)(e) and (f) Insolvency Act).
General grounds for refusal (section 384(2) Insolvency Act)
At a - The company does not meet the requirement of being pre-insolvent
The first general ground on which the court will refuse to confirm a composition is based on one of the essential premises of the Dutch Scheme: the debtor must be in a situation where it is reasonable to assume that it will be unable to continue to pay its debts (section 370(1) Insolvency Act). The debtor must be in serious financial distress that puts the survival of the company’s operations in jeopardy. If the debtor is not in that situation, the circumstances do not offer legitimate reason to intervene in the legal relationships through an enforceable composition. As a consequence, the court must refuse its confirmation.
At b - Shortcomings in the notification of the composition
A second ground for the court to refuse to confirm the composition is if the debtor has failed to fulfil the obligation to notify its creditors and shareholders. Providers of equity and borrowed capital must be notified in the correct manner of an imminent composition, the vote on that composition (section 381(1) Insolvency Act) and the court hearing (section 383(3) Insolvency Act). The court will make an exception to this ground for refusal if the capital providers, despite not having been notified correctly, announce that they will agree to the composition.
At c: Shortcomings in the information contained in the composition
Another reason for the court to refuse to confirm the composition is if the composition and its accompanying documentation do not contain the information that the law dictates to be necessary – in section 375 Insolvency Act – for stakeholders to come to an informed opinion on the composition. Among other information, this includes the debtor’s description of the nature and extent of the financial difficulties, and what attempts (besides the composition) it has undertaken to overcome those difficulties. Errors in the classification or, in the court’s opinion, a faulty voting process also constitute key shortcomings in the preparations for the composition that will cause the court to dismiss the request on its own motion. In the latter situation, however, the legislation provides for a hardship clause. Confirmation will not necessarily be refused by reason of a shortcoming – in the information provided, in the classification of creditors or in the voting process – that could not, within reason, have yielded another outcome of the vote.
At d: Shortcomings in the allocation of voting rights
The fourth ground that the law gives for the court to withhold its confirmation of a composition is if the amount for which a capital provider is represented in the vote is incorrect. The previous exception applies here too: if the amount for which a creditor or shareholder is represented in the vote is incorrect, but the vote could not, within reason, have had a different outcome, this will not stand in the way of confirmation.
At e: Absence of deal certainty
The court may also refuse to confirm the composition if fulfilment is not sufficiently guaranteed – if it is not certain enough, therefore, that the debtor will in fact be able to fulfil its obligations under the composition (a principle commonly referred to as “deal certainty”). Although the court must establish whether the debtor can make the payments described in the composition, however, payment does not need to be absolutely certain.
At f, g and h: Harmful new financing, deceit and payment of costs
Another possibility is that the debtor wishes to take out new financing to carry out the composition. If this causes material harm to the interests of the body of creditors, the law offers the court the possibility to withhold its confirmation (at f). If the composition was achieved through unfair means, such as deceit or preferential treatment, the court will also refuse to confirm it (at g). Assurances must be in place to guarantee that the fees and advances for the court-appointed restructuring expert, other experts and observer will be paid. The absence of such assurances also constitutes grounds for refusing to confirm the composition.
At i: Catch-all provision
The final general ground on which the court may refuse to confirm the composition covers all “other reasons that stand in the way of confirmation”. This is an open standard, giving the court a basis for considering objections or grounds not yet specified or included in the legislation when reviewing the request, with a degree of latitude to refuse confirmation on its own motion.
Additional grounds for refusal
If one or more of these general grounds for refusal apply, the court will refuse to confirm the composition without reviewing the actual substance. However, the court will need to review that substance if none of the general grounds applies, but an additional ground for refusal under subsection 3 or 4 has been invoked; essentially, the court will determine whether the composition leads to an outcome that is reasonable. The legislation offers several grounds for testing this.
At 3: “Best interest of creditors” test
Another key premise of the Dutch Scheme is that compositions must offer a better outcome for the company’s affected creditors and shareholders. To this end, the CERP Act imposes a test. If it is made plausible that the creditors or shareholders that voted against the composition, or that were wrongly excluded from voting, would be worse off under the composition than if the debtor’s assets were liquidated in insolvency proceedings, this offers an additional ground for refusal. This is referred to as the “best interest of creditors” test: an enforceable composition may not place creditors and shareholders in a worse position than they would be as a result of insolvency proceedings, unless they actually consent. The court must be able to determine this to a plausible standard. For this reason (and others), the composition must contain calculations of the projected value that can be realised if the composition comes about (“reorganisation value”), and of the projected value that can be realised if the debtor’s assets are liquidated in insolvency proceedings (“liquidation value”).
At 4: SME minimum, absolute priority rule, absence of a cash exit, liquidation value for secured creditors
Section 384(4) Insolvency Act sets out a number of additional grounds on which the court may refuse to confirm a composition. At the last minute, a clause was added under which every SME creditor is entitled to receive a minimum of 20% of its claim (subsection 4(a)). If an SME creditor is paid less than 20% of its claim, without any compelling reasons being provided, the court will refuse to confirm the composition. This standard poses a difficult hurdle to negotiate in practical terms, in particular: which creditors qualify as SMEs, and how do you determine what represents 20%?
Subsection 4 also requires that the value realised by the composition be divided according to the order of priority that applies. This “absolute priority rule” states that a creditor with a lower order of priority cannot be paid more than a creditor with a higher order (except if valid grounds exist to do so). The third ground for refusal comes into play if creditors do not have the option of a “cash exit”, i.e. payment in cash. Lastly, confirmation will be refused if a secured creditor is offered only shares or depositary receipts, without the option of another form of payment. This final ground was also based on an amendment that was presented and adopted at the last minute, and that deprives secured creditors of the possibility of also choosing a cash payment – now, non-cash payments are also acceptable.
Confirmation as the final element: no appeal
Confirmation as the final element is not a dead letter: no legal recourse is available to challenge the court’s decision on the request. The justification for this, of course, lies in the composition’s necessity. To avoid a looming insolvency, the composition will need to be carried out swiftly. However, this does not mean that the court cannot refer questions to the Dutch Supreme Court for a preliminary ruling on the correct way to implement the CERP Act. Logically, this is most likely to happen early on in the Dutch Scheme’s existence. An example of such a question is whether a particular new ground for refusing the request can apply under the catch-all provision (section 384(2)(h) Insolvency Act). It is fair to assume that the Dutch courts will in any case play an important role in further defining the various elements, such as not only the grounds for refusal, but also the application of facilitating relief measures.
Conclusion: be involved in the process and speak up on time
The basic rule is that the court will agree with any request to confirm an enforceable composition. However, the CERP Act also presents grounds on which the court may withhold its confirmation. The court will review the general grounds for refusal either on its own motion or at a stakeholder’s request, and if a stakeholder so asks will examine whether any of the additional grounds for refusal apply. As confirmation may be refused on multiple grounds, and since those grounds have implications for the basic foundations of the composition, it is essential to prepare the composition with due care. It is very important for all creditors involved to promptly object to any elements of the composition that harm their interests: if they do not, they risk not having the option of asking the court to refuse to confirm the composition. Only by objecting on time will creditors be certain of being able to invoke such features as the SME minimum, the best-interest test and the cash exit, or conversely have protection against a successful argument invoking any of those grounds.