A comprehensive guide to Swiss composition agreements
Schellenberg Wittmer lawyer Olivier Hari explain how composition agreements can benefit distressed businesses facing bankruptcy
Under Swiss law, a bankruptcy order may be rendered against a distressed business either from the request of a creditor or upon the request of the debtor itself. Such bankruptcy order may be issued based on two different financial situations: in case of insolvency (the distressed business is no longer in a position to repay its debts when due, due to a lack of liquid funds), or in case of overindebtedness (i.e. if according to the last interim balance sheet, the liabilities of a stock company or a limited liability partnership are not covered by the assets). It is worth mentioning that the board of directors of a stock corporation or the managers of a limited liability partnership are even obliged to file for bankruptcy if the company is overindebted: indeed, in such a case, the board or the managers must inform the judge of the overindebtedness, this judge then having no other choice but to render a bankruptcy order.
Bankruptcy, however, is not inevitable. Swiss law provides efficient legal mechanisms that can allow a distressed business to escape from bankruptcy proceedings, meaning that instead of rendering a bankruptcy order, the judge is entitled to open in-court restructuring proceedings. In-court proceedings may also be combined with out-of-court restructuring.
As of today, two types of restructuring proceedings are available for distressed companies. Other mechanisms have been temporarily passed in order to overcome the Covid-19 pandemic, but they are due to be lifted soon and will therefore not be addressed by this analysis. Besides, financial institutions insolvency is governed by other provisions, not addressed here.
The first (composition proceedings) is a formal judicial reorganisation proceeding opened by the judge, requested by the debtor themselves, or a creditor, and supervised by a receiver (trustee) appointed by the court. It has influence only on the claims themselves (reduction, modification of terms) and their repayment. The second (stay of bankruptcy proceedings) is an informal out-of-court reorganisation proceeding for overindebted businesses that is only opened by the judge under certain circumstances and eventually conducted under the supervision of a receiver appointed by the court, where all the available restructuring techniques can be used.
The composition agreement
Composition agreement with creditors
So-called composition proceedings aim to offer distressed businesses – be they insolvent or overindebted – a formal in-court reorganisation concerning almost all types of debt and all categories of creditors. In a nutshell, in such proceedings, the debtor enters into a kind of agreement (the composition agreement) with almost all of its creditors. The contractual aspect of the arrangement must be put into perspective, as a composition agreement can be prepared and put in place by the creditors and the judge, against the will of the debtor.
Types of composition agreements
There are two different types of composition agreements: ordinary agreements (the distressed business is expected to survive and the legal structure of the debtor remains unchanged) and composition agreements that assign assets to the creditors of to a third party (the distressed company is liquidated and its business activities possibly sold to a third party).
A composition agreement is supposed to bind the debtor and all creditors
An ordinary composition agreement can be reached among the debtor and its creditors. According to certain composition agreements, the agreed terms of the claims can change. It is possible to postpone the repayment of all claims (so-called moratorium composition agreement), or to reduce the amount of all debts under a composition agreement that would provide for the partial release of the debtor from its debts, in which case the debtors only receive a dividend (so-called dividend composition agreement). The debtor's agreement to these two types of composition is mandatory.
A composition agreement that assigns assets may also be selected. According to this type of composition agreement, the debtor forgoes most or all of its assets to the creditors so that they sell them (a liquidator is appointed), or pursuant to which such assets (often the business itself in its economic acceptation) are sold and transferred to a third party. The proceeds of the sale are distributed to the creditors, and the debtor's agreement is not necessary. Such composition agreements allow a third party to buy the company on relatively favourable terms: in fact, a business can be acquired free of liabilities (but also without any reps and warranties, which is the only downside).
Commencing the proceeding: granting a moratorium
As aforementioned, either the debtor or a creditor can file a request for a short duration provisional composition moratorium aimed at assessing the financial situation of the distressed business, followed by a true mid to long-term moratorium, aimed at preparing the composition agreement.
The provisional moratorium may be granted for a maximum duration of four months. If, during the provisional moratorium, prospects of a reorganisation or the approval of a composition agreement appear, a true moratorium shall be granted, which may last 12 months – or even 24 for complex matters.
The court will simultaneously appoint one or two receivers, whose most important role will be to supervise the debtor and then to assess acceptance of the creditors' composition agreement. The receiver is generally in contact with the creditors and can help the debtor prepare a draft composition agreement. The receiver has to convene the creditors to a meeting, which takes place at the end of the moratorium and allows the creditors to obtain clarification regarding the debtor's situation and to vote on the composition agreement.
The judgment by which the court grants the debtor or creditor a true moratorium must be published in the Swiss Official Gazette of Commerce, whereas a provisional moratorium may stay unpublished, allowing for a silent restructuring.
Composition agreement acceptance: creditors' involvement
A composition agreement is supposed to bind the debtor and all creditors, meaning that all creditors must take part in the acceptance process. In this regard, the creditors whose claims are presented before the moratorium – which are therefore subject to the composition agreement – are asked at the very beginning of the proceedings to file their claim with the receiver.
Creditors that file their claim in due time will then be allowed to vote in favour or against the proposed composition agreement and to receive appropriate related information. Creditors that fail to file their claims on time or at all will not be entitled to take part.
When the draft agreement is ready, the creditors are called to a creditors' meeting, during which the receiver (or receivers) reports on the debtor's financial situation and goes over the draft composition agreement. The composition agreement is deemed to be accepted by the creditors if a qualified double majority votes in favour – both a majority counted per head and a majority counted in terms of value claim must be reached. Those that are not allowed to vote include the secured creditors, for the part of the claim that is effectively secured; the so-called privileged creditors (notably employees' claims, social insurance claims, whose claims must by law be repaid in full); and individuals whose personal relationship with the debtor may lead to a conflict of interest.
Alongside the creditors' acceptance process, the judge must also ratify the composition agreement accepted by the creditors, provided that certain legal conditions are met. In particular, the judge must verify that privileged creditors are repaid in full, the agreement is fair and of a favourable nature, the debtor provides repayment securities and, in cases where the business is transferred to a third party, the third party has warranted the payment due for such a transfer.
The court's ratification entails the binding nature of the composition for all claims brought either before the moratorium, or during the moratorium without approval of the receiver.
A particular case: sale of the business to a rescue company via composition agreement
A business activity may be rescued by the sale of the fixed assets of a distressed business (i.e. the assets that are requested for the business activity) to a so-called rescue company, through a composition agreement with asset assignment. The rescue company is often an ad hoc vehicle founded by the shareholders of the distressed company, the case may be with additional shareholders (or without certain shareholders, which are therefore squeezed). Creditors of the distressed business may be repaid using the proceeds of the sale, but not only: it is also permitted to grant to these creditors participating rights in the rescue company along with the founding shareholders (shares, non-voting equity, profit-sharing certificates).
Mixed: in/out of court restructurings
Judicial framework for extrajudicial restructurings
Mixed restructurings are also permitted in Switzerland. In particular, a debtor may file before the judge an application aimed at getting a moratorium (judicial process) to negotiate and reach with its creditors a consensual private agreement with the intention of adjusting and/or renegotiating its financial obligations.
Judicial frameworks for such mixed restructurings are the composition proceedings from one side and the stay of bankruptcy proceedings from the other.
If a composition moratorium is requested to allow the debtor to take out-of-court restructuring measures without the risk of bankruptcy, the various steps necessary for in-court proceedings won't make sense anymore. It means that the call to creditors, the creditors' meeting/vote and the judge ratification will be avoided, converting the composition moratorium into a pure moratorium.
Stay of bankruptcy proceedings is reserved to overindebted stock companies and limited liability partnerships. If notified of a situation of overindebtedness, the judge shall normally issue a bankruptcy order. At the request of the board of directors/the managers or a creditor, it may decide to postpone the bankruptcy. In this case, the judge shall take all appropriate measures to preserve the value of the assets and may appoint a receiver whose role will be defined in the stay of bankruptcy judgment (mainly debtor's supervision).
The stay will not necessarily be published in the Gazette, protecting the distressed company from very bad – and sometimes even disastrous – attention
The stay of bankruptcy judgment will not necessarily be published in the Swiss Official Gazette of Commerce, protecting the distressed company from very bad – and sometimes even disastrous – attention.
The duration of the moratorium is not limited by law. The typical duration is between six and 18 months. At the request of the company or a creditor, it may be lengthened several times. At the moratorium expiry date, the company must no longer be overindebted. Otherwise, the judge will have no other choice than to issue a bankruptcy order.
Provisions of the Swiss Code of Obligations governing stay of bankruptcy proceedings has been recently changed by the Swiss Parliament. As of consequence, the stay of bankruptcy proceedings shall disappear. The composition moratorium will serve as the only judicial reorganization's framework.
Out-of-court restructuring techniques and measures
All techniques and measures shall be used in order to achieve a unique goal, i.e. successfully restructuring the company (and erasing the overindebtedness arising from the financial statements).
The reorganisation may, for example, be: sale of part of the business (even the profitable part, but the sale must be made at market price and be fair, otherwise creditors may successfully challenge the transaction); rethinking the size of the company or ceasing to engage in certain activities, especially if they are unprofitable; the withdrawal of financial reserves; the re-evaluation of immovable property and participation; the increase of capital through the sale of new shares for consideration; deletion of the whole share capital (by cancelling the share) and, immediately thereafter, increase of the share capital. The company can also try to get creditors to agree to enter into standstill agreements, to write off part or all of their claims, or to subordinate their claims – but the debtor must, to a certain extent, ensure the equality of treatment among the creditors.
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Olivier Hari is highly specialised in general corporate law, transactional matters, finance transactions, companies restructuring, distressed refinancing, distressed M&A, crisis communication, complex national and cross-border insolvency and restructuring proceedings, and related litigation proceedings. His personal experience as board member (chairman) allows him to understand the expectations of directors and other business leaders from a legal perspective. He is also regularly appointed by the courts to monitor and support distressed companies. He is of counsel in Schellenberg Wittmer's corporate & commercial, M&A, capital markets and restructuring & insolvency groups, and is also a Professor of Law (University of Neuchâtel and Geneva). As such, he is the author of numerous publications in the fields of corporate law, capital markets law and insolvency law.