Why banks cannot claim a cash-out

Introduction

The Dutch Act on Confirmation of Extrajudicial Restructuring Plans (“CERP Act”, in Dutch: Wet homologatie onderhands akkoord, or WHOA) is nearing completion. On 22 September, the Minister presented a Memorandum of Reply answering a series of questions from the Dutch Senate’s Permanent Committee for Justice. One of those questions concerned the decision to refuse banks a “cash-out” option, and whether this exception was incompatible with the principle that creditors may not be forced to continue to finance a company’s operations.[1]

Based on the Minister’s answers to these questions, the present blog discusses this exclusion of banks from the right to a cash-out.

Cash-out: what it means

Under the CERP Act, a “cash-out” refers to a creditor’s right to a cash payment for the same amount as the creditor could expect to receive in insolvency proceedings. This option allows creditors that vote not to agree to the composition (“dissenting creditors”) to leave the proceedings.[2] The effect of this right is that compositions that do not include a cash-out option may be refused confirmation.[3] Creditors with security interests that finance the debtor in a business capacity – i.e. finance businesses, but simply referred to as banks in this blog – are excluded from this rule.[4]

How banks came to be excluded

Initially, every dissenting creditor was supposed to have the right to a cash-out: if the cash-out option was not available to a dissenting creditor, the court would refuse the request to confirm the composition.[5] During the discussions in the House of Representatives last spring, however, the legislative proposal took many people by surprise by becoming the subject of a long debate.[6] The debate covered a number of issues, including the role that banks were expected to play in restructuring efforts, and specifically where the CERP Act was invoked. One of the concerns expressed by Members of the House was that banks would be able to disproportionately influence restructurings, and proceedings under the CERP Act in particular. More specifically, one of the arguments went, if secured creditors retained the right to cash payment, every composition would inevitably require a large, if not excessive, amount of cash, making it impracticable. Eventually, this led to an amendment depriving dissenting creditors of the right to a cash-out. After a series of modifications by the relevant Members of the House, the House of Representatives adopted the amendment in the new text of the legislative proposal.

As it now reads, section 384(4) states at (c) and (d) that a request for confirmation of a composition will be refused if:

“c. those creditors, not including creditors within the meaning described at d, do not have the right under the composition to opt for a payment in cash to the same amount as they could expect to receive in cash if the debtor’s assets were liquidated in insolvency proceedings, or

d. the creditors in question have a higher order of priority resulting from a pledge or mortgage within the meaning of section 278(1), Book 3 Dutch Civil Code and granted the debtor financing in a business capacity, and are offered shares or depositary receipts of shares under the composition as part of a modification of their rights, and that moreover do not have the right to opt for another form of payment."

In order words, as long as banks can opt not only for the offer of shares or depositary receipts but also for an offer of another form of payment (besides cash), the composition may be confirmed: the request for confirmation will then not be refused on this ground. In addition, this clause also allows the possibility to offer cash to the dissenting banks, if the necessary cash can be raised.

What we can learn from the Minister’s reply: protection for banks...

With banks no longer having a right to cash under the legislative proposal that was passed by the House of Representatives, but only to “another form” besides shares and depositary receipts, the Permanent Committee wished to know what precisely that other form was. The Minister took the opportunity of replying to that question to add a detailed discussion of the position of banks with regard to a cash-out.

The Minister started by explaining that “another form” might mean “amended finance terms, such as deferral of the debt or repayment in instalments”. At the same time, however, the Minister also announced that a dissenting bank “cannot be forced to keep financing the company indefinitely, or for an unreasonably long time”.

Next, the Minister discussed the protection that the CERP Act gives dissenting banks in that connection, describing three criteria for which the court must review the composition with a view to offering that protection. Firstly, the court must determine on its own motion whether performance of the composition is guaranteed (“deal certainty”):[7] dissenting banks must receive (immediately or in the future) whatever is apportioned to them under the composition. In principle, without this deal certainty, the composition cannot be confirmed by the court. This means that a plausible case must be presented that the debtor’s obligations will in fact be fulfilled. However, this does not serve to eliminate the risk, identified by Tollenaar, that banks will be forced to repeatedly provide financing,[8] in the manner of a perpetual motion machine. Secondly, confirmation will be withheld if it can be made plausible that a creditor will be left in a worse position as a result of the composition than in insolvency proceedings (the “no creditor worse off” principle). The Minister referred to the annotation[9] stating that, if the terms are amended, the new arrangements must be “on market terms” and that “as a rule this will mean that interest will be paid and the claim will continue to be secured.” Lastly, banks are entitled to a share in the added value, post-reorganisation, that accrues to each according to their statutory order of priority, based on the “absolute priority” rule. If ordinary creditors are not included in this composition, they will in fact be paid, in deviation from this statutory order of priority; however, this deviation is permitted only if the debtor has good reason.

Conclusion

Eliminating the right to a cash-out for banks indisputably represents a major and remarkable change to the CERP Act. According to the Minister’s Memorandum of Reply, dissenting banks will have adequate protection from the risk of being disadvantaged by the composition package. Whether that protection will in fact succeed depends on two key factors, however. First, it is vital for any dissenting bank to object promptly.[10] Second, the limited interests of these dissenting financing businesses needs to outweigh the success of the composition overall – which is far from certain, given the broad support for the idea that these extrajudicial compositions should help to save companies. A dissenting bank that seeks to block confirmation of a composition will need to come prepared and ready for action.

[1] Dutch House of Representatives 35 249, no. 3 (Explanatory Memorandum), p. 17.

[2] Dutch House of Representatives 35 249, no. 3 (Explanatory Memorandum), p. 3.

[3] Section 384(4)(c), in Dutch House of Representatives 35 249, A (Legislative Proposal for the CERP Act). Except where indicated otherwise, all references to sections refer to the relevant sections in this legislative proposal as passed by the House of Representatives.

[4] Section 384(4)(d).

[5] Section 381(4)(c), Consultation Act for the CERP Act, Dutch House of Representatives 35 249, no. 2, section 384(4) Legislative Proposal for the CERP Act.

[6] For an impression of this debate, see https://fd.nl/achtergrond/1338338/terwijl-corona-heerst-stokt-de-hervorming-van-het-faillissementsrecht.

[7] Section 384(2)(e).

[8] Letter dated 13 May 2020, from N. Tollenaar to the Dutch House of Representatives in response to the first version of the amendment (Dutch House of Representatives 35 249, no. 13), p. 2. Tollenaar draws a parallel with the repeated restructurings under Chapter 11 (also referred to as Chapter 22s, 33s etc.), Letter from Tollenaar, p. 5.

[9] Annotations on the amendment, Dutch House of Representatives 35 249, no. 24 (Modified amendment of cash-out).

[10] Section 383(9). A party’s failure to object promptly prevents it from subsequently invoking that ground for refusal.