Iceland: The aftermath

Author: | Published: 1 Apr 2012
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In October 2008, Iceland experienced a banking collapse of extraordinary proportions. The private sector's foreign debt increased drastically as the Icelandic currency dropped. The economic downturn led to a wave of foreclosures of share pledges by the banks which had financed the unprecedented number of buy-outs during the boom years of 2004 through 2007.

After three local banks with significant foreign operations had defaulted, the Icelandic Financial Supervisory Authority (FME) founded three new banks which took over the majority of the domestic assets and assumed liabilities of these local banks on the basis of Act no. 125/2008, commonly referred to as the emergency act. This complicated the matter; not all corporate debt was transferred to the new banks from the predecessors as the debts were duly considered bad assets.

The aftermath of the collapse can be characterised in two ways.

Firstly, by the microeconomic efforts, being the financial restructuring of viable companies. These restructuring efforts have, in many cases, led to the ownership of the creditors of the formerly highly-leveraged companies. These creditors turned proprietors are institutional investors and international as well as Icelandic credit institutions, both the newly-established ones and the failed ones that are in the process of winding up.

An Icelandic credit institution may only take over shares in its debtors, obtain voting rights in its debtors or appoint members to the board of directors of its debtors, on a temporary basis for the purpose of concluding transactions or reorganisations (classed as temporary operations). A reasoned notification to this effect must be sent to the FME. The FME must assess whether certain conditions are met, and the temporary operations must be completed before 12 months have passed from the time that the financial undertaking commenced the temporary operations. According to a notification from the FME, dated November 17 2011, approximately 132 companies are subject to temporary operations. The FME may extend the deadline if a reasoned application has been sent to it by the relevant financial institutions. According to the FME, it has received 74 applications for an extension of the deadline.

Should the temporary operations last longer than the deadline, or the extended deadline, the relevant credit institutions can become subject to daily and/or administrative fines. In addition, the Icelandic Competition Authority has generally granted short deadlines for Icelandic credit institutions to restructure their debtors and dispose of their holdings in these companies. This effectively means that Icelandic credit institutions now want to, or ultimately have to due to regulatory constraints, dispose of their holdings in Icelandic companies.

Consequently, it is to be expected that many Icelandic companies will soon be sold or exited through listing. For example, Hagar, a company operating various retail businesses in Iceland, was listed on NASDAQ OMX Iceland by Arion Bank in 2011.

The largest investors occupying the buy-side are the Icelandic pension funds, various investment funds, wealthy individuals and international investors eyeing Iceland's recovery. Since 2008 the number of bankruptcies in Iceland has been higher than ever before, reflecting the fact that many businesses were not eligible for financial restructuring. Court-appointed bankruptcy administrators are required by law to dispose of the bankruptcy estates' assets.

The aftermath of the collapse can secondly be characterised by the macroeconomic efforts undertaken for the purpose of stabilising the economy. CDS rates on Icelandic government debt have come down considerably and government spending has been cut back. In November 2008, the government introduced capital controls with the aim of stabilising the Icelandic króna (ISK). The effect of the capital controls on the M&A environment are discussed below.

The limiting factors for a healthy recovery and more deal-flow are first the scarce availability of funding as the banking system has yet to fully recover and so much of its activities concern the work-out of their own assets; secondly, the fact that sellers believe that the Icelandic corporates are undervalued and they are, in some cases, incentivised to wait for a positive development with respect to valuation; and thirdly, the capital controls, introduced in 2008, that add a layer of uncertainty to the valuation of companies; and finally the instability in the Icelandic economy makes investors cautious when it comes to choosing targets and valuing them. In general, the uncertainty surrounding the business environment results in investors continuing to discount the assets that are for sale.

The legal environment

On January 1 1994, the European Economic Area Agreement took effect in Iceland. As a member of the 30-nation European Economic Area, Iceland and its laws reflect the business environment of the European Union. Except in a few limited areas, Iceland adopts almost all EU corporate and commercial legislation and directives.

The legal tradition in Iceland is the same as in the other Nordic countries, being between the Anglo-Saxon common law system and the continental European civil law system, but leaning more towards the civil law system. The principal source of law is specific acts issued by the Althingi (the Icelandic parliament). Traditionally, statutes are short and focused on specific issues, such as contracts, limited liability companies, securities trading, sales of goods or competition. It is common within the commercial law sector in Iceland to allow for the contracting parties to negotiate whether certain articles or chapters of the relevant acts will apply to their contractual relationship.

The legislative branch can authorise the executive branch of the government to issue executive orders. Executive orders are commonly used when there is a need to lay down technical or more detailed rules than are considered applicable in legislation, and must keep within the limits laid down in the respective legislation.

Iceland does not possess a single piece of legislation dealing with mergers and acquisition in particular. Laws relevant to these transactions are derived from specific acts as well as the general rules on obligations, contracts and torts. When mapping out the legal environment with respect to a merger or an acquisition in Iceland, one must first recognise the legal status of the target. In addition to legislation, the target's articles of association may affect the route chosen for an acquisition or tender offer. The articles of association of non-listed companies in Iceland may include restrictions on acquisitions of shares without the consent of the board of directors or provisions that include pre-emptive rights of the target company or its shareholders, respectively, should the target's shares be offered or sold to a third party.

Even though the Icelandic legal system allows for reliance upon statutory law and general concepts of fairness, loyalty and reasonableness, contracts concerning M&A transactions do not reflect that parties to such agreements choose to leave much for general law to govern. Most Icelandic M&A transactions involving medium to large companies will involve most of the same steps and document style as one would expect to see in a multinational deal governed by English law, but one should always take into consideration the counterparties and the fact that Icelandic documents will be construed in accordance with Icelandic legal tradition.

Any acquisition of shares or businesses in Iceland will necessarily involve a contract reflecting the underlying transaction. Therefore, the principles of liability for damages in contract for negligent or fraudulent misrepresentation, or damages under tort of deceit, or damages under the tort of negligence, and compensation or proprietary liabilities in relation to breach of the duty of loyalty apply. The principal remedies are rescission, discount, and damages for breach of contract, damages for tortuous loss and damages for breach of duty of loyalty.

Acquisitions of listed companies

If a shareholder, alone or in concert with others, acquires direct or indirect control of a listed company, the shareholder must extend a takeover bid to other shareholders in the company. For the purpose of chapter X of the securities trading act number 108/2007 the definition of "control" of a company constitutes a 30% holding of voting rights in that company or the right to appoint or dismiss a majority of the company's board of directors.

A decision on a takeover bid must be disclosed to the market without delay, and the bid must be presented to the employees of the takeover target. The takeover bid must be launched no later than four weeks after the shareholder knew (or ought to have known) that he had control or a decision on the bid had been taken. The offer period ranges from four to 10 weeks.

The put up or shut up principle applies in Iceland and the FME may require a person contemplating a takeover bid to provide, within a specified time limit, a public account of his intentions. The disclosure is binding for a period of six months.

The takeover obligation rests with the person acting in concert which, by increasing its holding, causes the takeover threshold to be reached. If that person is not the leading party in the group acting in concert, the FME may decide that the mandatory bid obligation should be transferred to the leader.

Shareholders who acquire control of companies in serious financial problems, or shareholders who are in the process of restructuring a company because of its financial problems, will not be subject to making a mandatory takeover offer if the board of the company approves such a restructuring effort and the relevant shareholders submit to the FME a written and reasoned application requesting to be released from the takeover obligation for a specified amount of time. Such exemptions have been granted since the collapse in 2008 and have proven to be in the interest of shareholders, creditors and the market as whole.

The purchase price in a takeover must reflect the principle of equal treatment of shareholders. Therefore, all shareholders of the same class of shares are to receive an offer on the same terms. The purchase price offered in a takeover must be equivalent to the highest price paid by the bidder or by parties acting in concert with the bidder, for shares in the target during the preceding six months before making the bid.

The bid must, however, be at least equal to the latest transaction price for shares in the undertaking in question on the day before the takeover obligation arose or notification was given of the takeover bid. In addition, the FME has the authority to adjust a bid price under exceptional circumstances, provided that the principle of equal treatment of shareholders is observed.

If the bidder, or a party acting in concert with the bidder, pays a higher price than stated in the takeover bid during the offer period, the bidder must adjust the takeover bid and offer that price. If a bidder, or parties acting in concert with the bidder, pay a higher price or offer better terms for shares in the company in question during the three months following the conclusion of the offer period, those shareholders who accepted the original offer are to receive a supplementary payment corresponding to the difference. The offer must be made for cash consideration and/or listed shares; if the shares are not listed there must be cash alternative.

The neutrality rule applies to takeovers in Iceland, but the breakthrough rule and the reciprocity rule have not been implemented into Icelandic law. Therefore, the board of directors must not take any action, other than seeking alternative bids, which may influence the bid except with prior authorisation of a shareholders' meeting.

Should the bidder acquire more than nine-tenths of the share capital and voting rights in the target company, the bidder and board of the company may jointly decide that other shareholders will be subject to redemption of their shares. By contrast, a minority shareholder has a right to be bought out.

Capital controls

In the midst of the banking collapse the Althingi approved a temporary provision to the Act on Foreign Exchange number 87/1992. The provision authorised the Central Bank of Iceland (CBI) upon approval from the Minister of Economic Affairs to issue rules that limited certain types of cross-border capital movements or foreign exchange transactions related thereto, that the CBI considered likely to cause serious and substantial monetary and exchange rate instability. Initially, this was dictated by the rules on foreign exchange, which were amended several times.

The rules have now been implemented into the Act on Foreign Exchange. Article 13(a) of the Act on Foreign Exchange provides that the capital controls will be in place until December 31 2013. The CBI has issued a white paper report stating its plan and conditions for the gradual removal of the capital controls. It is uncertain whether the capital controls will be lifted on or around December 31 2013 or whether the authorisation for the capital controls will be prolonged (which would require a change in law by the Althingi).

The capital controls in the Act on Foreign Exchange provide for various restrictions, and exceptions, on cross-border capital movements and currency transactions specified in the provisions of Articles 13(b) – 13(n) of the Act. However, transactions involving actual imports and exports of goods and services are allowed, as are interest and dividend payments (provided that the underlying agreements are in accordance with the Act on Foreign Exchange).

Most capital transactions involving ISK against another currency are restricted for residents and non-residents of Iceland. Residents of Iceland must repatriate all foreign currency that they acquire. Large exporters and companies with large international operations can, however, apply for an exemption from certain provisions of the capital controls.

Foreign direct equity investment in Iceland is generally not limited by the capital controls, but if a foreign investor sells the Icelandic equity investment the proceeds can only be exchanged into foreign currency and transferred from Iceland if the investment fulfils the conditions set out in Article 13(m) of the Act on Foreign Exchange. These conditions are as follows:

  • The cash consideration for the respective investment must not be a current foreign exchange deposit within a domestic bank or foreign exchange received from export revenues, but new inflow of foreign currency;
  • The foreign currency that is used to purchase the relevant investment must be converted into ISK with an Icelandic bank; and
  • The new investment must be notified to the CBI within two weeks from the date of exchanging the new foreign currency into ISK.

Moreover, foreign investors can participate in auctions which the CBI proposes to hold. The CBI is offering to purchase foreign currency in exchange for ISK for long-term investment in the Icelandic economy, or in exchange for payment in certain Treasury bonds. The objective of these measures is to sell Icelandic króna for foreign currency to parties that have decided to invest in the Icelandic economy for at least five years.

Foreign investment in the form of loans is generally limited to intra-group borrowing and lending, and lending and borrowing activities of certain parties that are exempt from Article 13(g) of the Act on Foreign Exchange, such as Icelandic financial institutions.

This is important in light of the fact that the capital controls have facilitated two separate markets with ISK: the foreign exchange market operated by the CBI whose official rate of the ISK is published daily on the CBI's website (commonly referred to as onshore ISK); and ISK held by foreign banks in so-called number 27 (or vostro) bank accounts that can generally not be applied to investments in Iceland except for the purposes of purchasing Icelandic government bonds (commonly referred to as offshore ISK). The exchange rate offered for offshore ISK reflects the limited usability.

Legal advice on capital controls should be obtained by investors before entering into negotiations about any type of acquisition or merger involving a resident and a non-resident of Iceland.

Merger control

The Competition Authority is responsible for monitoring mergers of companies. A merger is considered to have taken place according to Article 17(1) of the competition act number 44/2005 upon:

  • the merger of two or more previously independent companies or parts of companies;
  • one company taking over another;
  • the acquisition, by one or more persons already controlling at least one company, or by one or more companies, whether by purchase of securities or assets, by contract or by any other means, of direct or indirect control of the whole or parts of one or more companies; or
  • the creation of a joint venture performing on a lasting basis all the functions of an autonomous economic entity.

A notification to the Competition Authority is required if the total turnover in Iceland of the merging companies is at least ISK2 billion ($16 million). Calculation of this turnover must include the turnover of parent companies and subsidiaries, companies within the same group and the turnover of companies directly or indirectly controlled by the parties to the merger. A notification is also required if at least two of the companies participating in the merger have a domestic minimum annual turnover of ISK200 million.

In addition, if the Competition Authority is of the opinion that there is a significant probability that a merger which has already taken place, while failing to meet the conditions set out above, may substantially reduce effective competition, the Competition Authority may require the merging parties to submit a notification of the merger, provided that the combined annual turnover of the undertakings concerned exceeds ISK1 billion.

The merging parties must jointly file a notification to the Competition Authority about the respective merger before completion and after either the conclusion of an agreement, the announcement of a public bid, or the acquisition of a controlling interest in a company. A merger falling within the scope of the provisions of the competition act must not take effect while it is being examined by the Competition Authority. The Competition Authority may, on request, grant an exception from the obligation that a merger should be not take effect while it is being examined by the Authority.

The Competition Authority will, within 25 working days, notify the merging parties if it sees reason for further investigation of the competitive impact of the merger. If no notification is received from the Authority within this period, the Competition Authority cannot annul the merger. A decision on the annulment of a merger must be made no later than 70 working days from the time that a notification from the Competition Authority, stating that it sees reason for further investigation, is sent to the parties notifying the merger. If it is necessary to obtain further information, the Competition Authority may extend this time limit by up to 20 working days.

If the Competition Authority is of the opinion that a merger will obstruct effective competition by giving one or more companies a dominant position or by strengthening such a position, or will result in a significant distortion of competition in the market in other respects, it may annul the merger.

Thorolfur Jonsson
  Thorolfur Jonsson is a partner at LOGOS legal services. He was admitted to the bar in Iceland in 2000. In addition to his Icelandic law degree, he holds a master’s degree in law from Harvard Law School with an emphasis on international finance. He wrote a textbook on securities regulation which was published in 2004 and has published an article on takeover bids. Moreover, Jonsson has lectured at the University of Iceland and Reykjavik University since 1999. He specialises in financial services, securities regulation, corporate law, mergers and acquisitions, and financial restructuring.

LOGOS legal services
Efstaleiti 5
103 Reykjavík

T: + 354 5 400 300
F: + 354 5 400 301

Halldor K Halldorsson
  Halldor K Halldorsson is an associate and a member of LOGOS legal services corporate and banking group. He specialises in financial services regulation, securities regulation, general corporate law, transactional M&A and financial restructuring.

LOGOS legal services
Efstaleiti 5
103 Reykjavík

T: + 354 5 400 300
F: + 354 5 400 301