The Bankruptcy Process and its Possible Impact on Operations Prior Leveraged Buy-Out

Concept and legal prohibition

In recent years have been very frequent in Spain called "leveraged purchases," also known in the trade as "leveraged buy-outs" (LBOs). These operations are characterized by acquisition of a majority stake in the equity of a target company (target company), funded by loans from such acquisition of a third party that are secured by the assets of the target company itself or reimbursed under heritage resources and cash flows expected from it. It may even happen that the purchase price is paid to the sellers postpone the target company itself, which is merged after purchase, and prior to payment of a price-purpose vehicle formed by the investor (typically a fund venture capital) for the sole purpose of buying the shares in question. That is, LBOs result in the buyer moves on equity target company's own target company or the cost of acquisition.

Thus, LBO operations contravene the prohibition on financial assistance for the acquisition of shares / units established themselves in Articles 81 of the Companies Act and 40 of the Law on Limited Liability Companies. Through this prohibition, the legislature seeks to preserve the integrity of the capital, preventing it, rather than draw on the contributions of external partners, funded from the assets of the company itself. The ban is also intended to protect the interests of third party creditors, who may be adversely affected their legitimate rights to payment by reason of the high debt that financial assistance operations can lead to society. On the other hand, is intended to protect minority shareholders against the majority and administrators. They may be tempted to allow third parties of their trust funds of the society to acquire the shares or require to ensure the success of the deliberations of the board.

Possible effects of a default

Despite its conflict with this prohibition of financial assistance, it is highly improbable, while the target company is a solvent company meets its obligations, someone shows interest in challenging the leveraged trading operation. Only the investor acquiring the shares in question (usually a venture capital fund), a case of seeing frustrated their economic expectations, could have any interest in challenging the legal validity of the operation and try to recover your investment. However, this possibility is remote, since it would be more than doubtful legitimacy of the investor to challenge as unlawful any transaction in which the same has been actively involved as a party, without prejudice to the discredit that might in the financial market to attack the fact validity of a transaction failed financially and preserving other successful LBO.

On the contrary, it would be more likely to occur are interested in contesting the case of LBO in a bankruptcy proceeding of the target company. Indeed, endanger those creditors who see the collection of their claims may find that a challenge to the LBO and subsequent reintegration into the target company of the price paid by it to the sellers (former partners) would be a notable increase in the assets of the company mass-actively with which to satisfy its debts and therefore creditors such credits.

Alternatives to challenge the LBO

The alternatives to such creditors would be basically achieved its purpose as follows:

First, the termination of the LBO ex Article 71.1 of the Bankruptcy Act. That provision states that once declared the contest will terminate acts harmful to the active mass performed by the debtor within two years prior to the date of declaration, although there had been no fraudulent intent. Do not enter here into play the legal prohibition of financial assistance for the acquisition of shares / units themselves, since the acts do not have to suffer indentured to any intrinsic defect, but the basis for the termination would be solely on the injury active mass. Here the termination interested in try to demonstrate to the Commercial Court that the indebtedness of the company derived target price to be paid to the sellers is a clear impairment of assets and payment of that price, lacking any counterpart favor of the target company or at least equivalent from the standpoint of the integrity of the bankruptcy claims, harmed the bankruptcy estate. The intention of those involved in the LBO would be completely irrelevant.

Second, the challenge to the LBO ex Article 71.6 of the Bankruptcy Act, under which the exercise of rescissory actions not preclude other actions to avoid acts of the debtor to proceed according to law, which may be brought before the bankruptcy judge. The exercise of this pathway, the self-interested-now invoke before the Commercial Court breach of the statutory prohibition on financial assistance for acquisition of shares / units themselves, null and void in accordance with Article 6.3 of the Code Civil. Unlike the previous alternative, in this case the action was not subject to time limitation, since the action of nullity does not prescribe ever.

Consequences of a successful challenge

Obviously, the consequences of successful challenge to the LBO would be traumatic both in terms of economic and legal terms. According to the action taken and the object of it, may be declared ineffective one or more of the payments received on account of price, which should therefore be reinstated by the vendors to the active mass. Particularly complex are the consequences of a declaration of nullity of the whole LBO transaction: sellers recover ownership of the target company, merging it with the car company would "dump" to be part of an illegal operation and invalid, and so on. Moreover, vendors, and partners of the target company, in addition to restoring the price paid based on the LBO could become subordinated creditors of the target company insolvent, to attend them legally established circumstances.

Assessment and suitability of a particular legal solution

Several authors have criticized the categorical prohibition of financial assistance for the acquisition of shares / units under our own corporate law, primarily because the LBO and the subsequent use of corporate debt can attend to targets or formulas perfectly legitimate corporate restructuring. Indeed, as noted Vaquerizo Alonso, the premium content to the new majority shareholder in the context of LBO should not be seen necessarily as an asset impairment or theft to society, since this would ignore the beneficial effects through the operation planned and are necessarily reflected in the increased value of shares / units at the time of purchase. This premium may reflect the new expectations of future performance of the company arising out of restructuring usually entails the replacement of most control, so for example, reducing operating costs, better utilization of social resources from changes in management, etc..

But this does not mean you should ignore the enormous potential of LBO to generate conflicts of interest between those who promote and those affected by them despite their lack of involvement in them, be denied that much of the risk associated with operation is supported by the creditors. Hence the desirability of legal remedies established by law to the problems that can generate the LBO, which would, for example, the establishment of a system of subordination of credits, so that took precedence in the payment to creditors existing prior to the LBO transaction against the creditor who participated in its design.

Mariano Jiménez RenedoMariscal & Associates, Eurojuris AbogadosMiembro of Spain