Debt-for-equity swaps in Bosnia and Herzegovina
Naida Custovic
Independent Attorney-at-Law working in cooperation with Wolf Theiss, and Lana Deljkic
Sarajevo
Naida Custovic (Bio)
Ever since the recent financial crisis, debt-for-equity swaps (DES) have become an increasingly interesting topic in Bosnia and Herzegovina (BiH). There are hardly any corporate lawyers in BiH who have not, over the last few years, received at least one query from their client regarding the possibility to convert a claim into the share capital of a local company. Such elevated interest in DES is understandable. As the local companies developed problems servicing their debts due to prolonged negative cash flows, they began looking for a way to get rid of the debt without having to undergo bankruptcy. However, this seemingly simple question proved to be rather challenging from a BiH law perspective. The reason for this primarily lies in the fact that BiH law provides for very limited guidance on this topic.
Scenarios for the use of DES
With convertible bonds as an exception, the laws in BiH do not recognise the concept of DES under 'ordinary' circumstances. The laws only contain a handful of rules regulating DES in certain exceptional situations, namely in the course of a privatisation process and in bankruptcy proceedings. Thus, the Law on Business Companies of the Federation of Bosnia and Herzegovina (FBiH) stipulates that the amount of investment under a privatisation agreement may be used to increase the share capital of the privatised company upon fulfillment of all obligations of the investor under such agreement. However, such conversion is not permitted in relation to the companies working in the sectors of energy, telecommunications, postal or railway transportation. The FBiH Law on Bankruptcy Proceedings further provides that a reorganisation of the debtor (which should enable the debtor to survive the insolvency and to continue their business after the bankruptcy proceedings) can, inter alia, provide for the conversion of claims of the bankruptcy creditors into the debtor's share capital. The situation in Republika Srpska (RS) is similar to the one regarding the FBiH: the RS Law on Privatisation of State Capital sets out certain rules on DES in respect of privatised joint stock companies; however, in relation to limited liability companies the law does not specify. The RS Law on Bankruptcy Proceedings contains rules on DES in relation to the reorganisation of the bankruptcy debtor, identical to the ones set out in the FBiH Law on Bankruptcy Proceedings. The legislation in Br_ko District is somewhat different. The Law on Privatisation of BD does not address the issue of DES; however, the BD Law on Bankruptcy, Forced Settlement and Liquidation stipulates that a forced settlement (a process similar to the aforementioned reorganisation in FBiH and RS) may also involve DES.
Since the relevant laws in BiH neither expressly allow nor prohibit DES outside of the aforementioned situations, one might argue that the absence of an explicit prohibition means that such a swap should be possible. A generally accepted principle of the BiH civil law is that everything, which is not explicitly or implicitly forbidden, is allowed. Accordingly, in order to determine whether DES are possible in BiH, one must first determine whether such swaps are contrary to any general principles of the BiH civil and/or company law. In this context, one must primarily consider whether DES, as such, are detrimental to the debtor and their shareholders, or the company's other creditors.
Benefits
From a debtor's corporate perspective, DES can have a positive impact by enabling the debtor to continue their business and compete more effectively on the basis of a significantly reduced debt burden. Furthermore, the traditional alternative for over-indebted companies is to accept an inevitable bankruptcy procedure, which most likely leads to the liquidation of the company's assets and dissolution of the company itself. That alternative may provide some value to certain creditors, but it more often than not destroys an opportunity to rescue a business and hence create further value in the longer term. Finally, DES practically means a subordination of a claim to the claims of all other creditors of a company in the case of bankruptcy proceedings. Hence, DES in principle result in benefits for the company's other creditors, as well as for the company/shareholders (provided that the swap is executed on a consensual basis).
Court practice
Still, recent practice of the local courts sets out that DES in BiH are prohibited outside of the statutory exceptions. In several cases the courts have ruled that a DES is contrary to the company law rules prohibiting repayment of the shares to the shareholders. Furthermore, the courts also found that a DES does not constitute a 'contribution' to the company's share capital within the sense of the law, and that such a swap does not effectively increase the company's share capital.
From the available court practice, one might conclude, that the courts have taken a rather formalistic approach when deciding on the permissibility of DES, without going into the substance and considering the economic results of such swaps. Consequently, the courts seem to have disregarded the most significant characteristic of DES, which is that they constitute an indirect contribution to the company. Moreover, although the formal procedure for capital increase may have not been observed, a DES still comprises the key features of a share capital increase, i.e. the transfer of benefits to the company.
Misuse
There is no doubt that DES opens many possibilities for misuse, it should therefore be under heavy scrutiny by the registry courts. However, possible misuses should not be used as arguments to, a priori, prohibit DES. Other methods could be applied to avoid misuse (e.g. requiring an audit report in order to prevent false presentation of the claims).
Conclusion
Published court practice concerning DES in BiH is still rather limited. All available court decisions were adopted by the courts in the first and second instance only. To the best of our knowledge, the supreme courts in BiH have not yet considered cases involving DES. When this happens, we hope that they will be more open to the fact that BiH companies could benefit from DES.