New temporary reconstruction legislation

Bankruptcy protection during creditor negotiations

On 11 May, 2020, a new, temporary act on reconstruction of companies in distress came into force in Norway. Which options does it offer, and what is it lacking?

The new act is based on a proposition from 2016

The new “Temporary Act on Reconstruction to Remedy Financial Distress Caused By the Outbreak of Covid-19” (the Reconstruction Act) was passed by the Norwegian Government on 11 May 2020.

The new act is based on a proposal for a new restructuring legislation by Judge Leif Villars-Dahl, which was subject to a public hearing in 2016. Villars-Dahl cooperated with a reference group of four people, one of whom was Partner Stine D. Snertingdalen in Kvale.

When this article is written about one month after enactment, two reconstruction processes have been initiated under the new legislation.

The corona pandemic has caused serious financial difficulties for many businesses

In Norway, strict measures were introduced by the government in April 2020 to stop the rapid spread of the Covid-19 virus, including closing restaurants, pubs, cinemas, stopping or significantly reducing travelling by plane, train, tram, bus etc. Furthermore universities, schools and kindergartens were closed and most people studied and worked from their homes during April and beginning of May. Many are still working from their homes in June.

This has deeply affected the economy of a wide range of businesses. The income stopped while expenses continued. Numerous employees were temporary suspended with the help of governmental aid, and governmental loans and other crisis packages were put in place.

The strict measures are gradually being lifted, and businesses are in the process of restarting their operations. However, many companies will face increased debt due to postponed payments of costs such as taxes, VAT and rent. At the same time, they will experience lower income as it takes time for various markets to return to their activity level prior to the Covid-19 crisis.

Many of these companies will need tools to reduce their debt and protection from creditors while negotiating a restructuring plan, in order to avoid bankruptcy. The judicial debt negotiation regime, which was applicable up until 11 May of this year, was rarely used and often unsuccessful. It was mainly applied to reduce a company’s unsecured debt.

The Reconstruction Act replaces this legislation, and provides some additional tools and more flexibility, hopefully giving it a higher success rate than its predecessor.

The Reconstruction Act

When can a company file for reconstruction?

Where the previous legislation required a company to be without capacity to pay their debt as it fell due before they could file, the Restructuring Act allows a company to file for reconstruction if it has, or in the foreseeable future will have, serious financial difficulties. The legislators have deliberately made this threshold low and vague, in order to incentive more companies to file while they still have some liquidity left to fund the reconstruction costs, and to be able to present a reconstruction plan the creditors are willing to accept.

Petition requirements

The petition must show how the reconstruction shall be organized and financed. In short, the company must show the court that they have a plan for the process. Further, an advance payment to cover the reconstruction costs must be made, normally minimum NOK 300,000.

Automatic stay

The company is protected from any creditor pursuit throughout the restructuring proceedings, such as bankruptcy petitions, attachments and enforcement proceedings, as well as contracts being terminated due to payment default prior to the opening of proceedings. However, a financial institution’s security over financial instruments, such as pledged bank accounts and shares in subsidiaries, are exempt from the automatic stay.

The debtor is in possession but under supervision

The company, represented by its board of directors, remain in control while being supervised by a court-appointed administrator and one to three creditor representatives, together forming the reconstruction committee. They are granted access to the company’s financial information, and decisive powers and authority to give orders in certain matters.

The reconstruction committee shall give a recommendation to the creditors with respect to the plan proposed by the company, and inform the creditors’ what their alternative outcome is expected to be in a bankruptcy/liquidation.

An auditor may also be appointed to assist the reconstruction committee.

Financing during the reconstruction process – “DIP financing”

In addition to the advance payment to be made when the petition is filed and any income from the business operations during the reconstruction proceedings, the company may – if further financing is needed – obtain a “debtor in possession financing” with security on superpriority. This financing may only be applied to cover costs of the reconstruction work and of the business operations during the reconstruction proceedings. Two kinds of security are provided:

  1. A statutory lien of 5 % the value of all of the debtor’s assets that already secures the debtor’s obligations on priority before existing security holders, and
  2. an additional floating charge (i.e. exceeding the mentioned 5 %) in inventory, receivables and/or machinery and plant, on priority before existing security holders.

Such financing requires consent from the reconstruction committee. The court may, however, reverse the committee’s consent, either at its own discretion or upon a petition from affected security holders, if their overall security is substantially deteriorated by the superpriority financing or if there is not really a need for the financing.

The reconstruction plan: voluntary or compulsory reconstruction

The reconstruction plan to be proposed to the creditors may either be for a voluntary reconstruction, where only one creditor can overturn the plan, or for a compulsory composition, where 50 % in amount of the creditors with voting rights binds the remaining creditors. Certain groups of creditors will not have voting rights, such as secured creditors within the value of the secured asset, closely related parties and employees as far as their claim for wages etc. are preferred claims.

In a voluntary reconstruction, the company is at full liberty with regards to how the plan is composed and is not required to treat its creditors equally. However, it is sufficient to obtain 75 % (in amount) votes for the plan, as long as no one explicitly votes against the plan.

In a compulsory composition, the plan must include one or more of the following:                     (i) payment extension, (ii) debt reduction, (iii) debt-to-equity swap, and/or (iv) a sale of whole or part of the business with the choice of liquidating the company thereafter.

Tax claims are not given priority

It has been decided by regulation that tax claims, except for employees’ tax deduction, shall not have preferential rights under the temporary Reconstruction Act.

Failed reconstruction /the plan does not obtain the required vote

If a plan is overturned, the company may suggest a new plan. However, the court may dismiss a plan even if the voting requirements to accept the plan has been met, if the plan appears offensive or is unfair or unreasonable towards the creditors.

A central element in the reconstruction committee’s and court’s evaluations of a plan is that it must give a better result for the creditors than in a bankruptcy.

A failed reconstruction proceeding will transform into bankruptcy/winding up proceedings, unless the debtor can prove to the court that the company is solvent.

In essence: what is new in the Restructuring Act?

 In essence, some of the most important new tools are the automatic stay during the entire process, the considerably lower threshold for filing for reconstruction, and a possibility to fund the proceedings through “DIP financing”. Furthermore, some companies may be helped by tax and VAT claims no longer having preferential status and the increased flexibility of no longer having a requirement for a minimum dividend payment, as well as being able to include debt to equity swap and a sale of the business as part of the reconstruction plan.

 What is the legislation missing?

In spite the new tools, the Restructuring Act is still lacking certain important mechanisms in order to become an even more effective restructuring option for large businesses in Norway.

Some of the most important shortcomings are:

  • No financial aid with respect to salary payments, including severance pay and vacation allowance, which one for instance could introduce through the Wages Guarantee Fund, copying the Swedish reconstruction rules on this point;
  • No rules enabling the debtor to renegotiate disproportionately burdensome contracts;
  • The absence of voting in classes, which would for instance facilitate that a majority of finance creditors could bind a minority of finance creditors;
  • Rules on pre-pack sale of businesses.

It should also be mentioned that Norwegian rules on international insolvency proceedings, was passed in 2016 but are still in force. This reduces the legal certainty of the recognition of foreign insolvency proceedings in Norway, and vice versa.

Further legislative work

The interim legislation is only in force until 1 January 2022.

By then, a new and permanent reconstruction legislation needs to be in place. This will hopefully be based on the Reconstruction Act and the EC Insolvency Directive of 2019, and inspired by our neighbouring countries’ implementation of the directive, addressing, amongst others, the shortcomings mentioned above.