Quoted companies wishing to restructure their capital and borrowings, whether as part of a corporate rescue or some other transaction involving existing or new investors, may want to consider undertaking a debt for equity swap with their creditors.
A debt for equity swap is where a creditor converts debt owed to it by a company into equity in that company. It may be used as part of any number of different transactions including:
- as part of a corporate restructure in circumstances where a company is having financial difficulties as a way of strengthening the company's balance sheet and dealing with issues such as over gearing;
- as part of a restructure to attract new investors who have the means to inject new equity and/or new management skills; or
- to facilitate the exit of the existing investors and transfer the company to new investors.
For creditors, a debt for equity swap may be a way to avoid crystallising losses which would be incurred if an administrator was appointed to the company or if the assets against which breached loans were secured were brought to market.
It may also provide a means for creditors to maximise their returns by participating in any future growth of the company.
The key element of a debt for equity swap is that the creditor acquires an equity interest in the company. The nature and extent of this interest is a fundamental preliminary issue which involves consideration of:
- the value of the company and whether equity is to be issued to creditors at a discount to that value;
- the amount of the debt to be substituted for equity and the extent to which existing and new investors will be diluted;
- the type of equity interest which will be used (e.g., ordinary shares, fixed coupon ordinary shares, preference shares or equity warrants);
- the rights which will attach to the equity interest (e.g., priority as to income and capital, veto rights over certain decisions of the company or the right to appoint directors); and
- the restrictions which will be imposed on the equity interest (e.g., restrictions on transfer or limits on voting rights).
Other matters which may be relevant include:
- the identity of the creditors (this may not always be readily apparent in the case of debt which has been syndicated and traded on the secondary loan market);
- the value of the debt to creditors (again, in the case of the secondary loan market where debt is often sold at a discount, this may not equate to the amount owed by the company); and
- the importance of the existing management of the company.
Debt for equity swaps can be implemented on a contractual basis (i.e., not using a statutory procedure), however such debt for equity swaps will only be binding on those creditors who agree to participate.
A debt for equity swap implemented using a statutory procedure will bind all creditors if it is agreed to by the requisite majority (i.e., it can be used to "cram down" objecting or more junior creditors).
The two statutory procedures are:
- Schemes of arrangement
Where the company makes an arrangement or compromise with its creditors or classes of its creditors using a statutory procedure set out in the Companies Act 2006.
A scheme of arrangement must be approved by at least 75% in value, and a simple majority in number, of those voting within each class of affected creditor. It must also be sanctioned by the court.
- Company voluntary arrangement
Where the company makes an arrangement or compromise with its creditors implemented under the supervision of an insolvency practitioner in accordance with a statutory procedure set out in the Insolvency Act 1986.
A company voluntary arrangement must be approved by at least 75% in value of creditors and a simple majority in value of shareholders present and voting (however, a company voluntary arrangement will only affect the rights of secured or preferential creditors if they agree to the proposal).
For both statutory and non-statutory debt for equity swaps, shareholder approval is often required to approve matters necessary to effect the swap such as creation of new shares, directors' authority to allot shares, amendments to the articles of association and disapplication by shareholders of their pre-emptive rights.
Furthermore, both the company and the creditor will need to consider any rules or regulations they must comply with which may affect the debt for equity swap such as:
- the Listing Rules or AIM Rules (for listed or AIM companies);
- the Takeover Code (for both public companies, and private companies whose securities have been traded on a public market at any time during the last 10 years); and
- the Financial Services and Markets Act 2000 (for FSA regulated businesses).
In addition, issues such as the tax implications and accounting treatment of the debt for equity swap, implications for any final salary pension schemes and competition law merger requirements will also need to be considered by the parties.
If you would like to receive a full briefing note on debt for equity swaps please contact Graham Stedman at Nabarro LLP on 020 7524 6449.