Distressed M&A in the Netherlands in ten questions

1. What is distressed M&A?

The term Distressed M&A is used for acquisitions which take place because the target or the seller is in financial distress. For a buyer it can be a very interesting opportunity to do such a transaction, because the valuation of the assets is often favorable. Additional liquidity is required to achieve a turnaround, and this liquidity has to be provided by the buyer. After the target has been reorganized (prior to, during or after the acquisition) the buyer can achieve, possibly with a manageable investment, a good return on his investment. Whilst this constitutes a tested and tried business model for private equity, it also provides an interesting option for strategic buyers, to expand their business and improve their position in the market. For the seller and the target, the deal is often sadly required to survive, and often imposed by financial parties. The subject is topical in the Netherlands, because due to the Corona crisis a lot of businesses are in financial distress or are expected to do so. It is expected the number of distressed transactions will increase in the Netherlands.

2. What is the difference with a ‘normal’ reorganization?

As soon as in these situations the control over a business changes, it will be designated as distressed M&A. Although there are many different types of distressed M&A transactions, the same tool set is often used that you would in a normal reorganization: debt restructuring, merger/demerger, split into viable and non-viable units (known in Dutch as: sterfhuisconstructie), new capital rounds, dismissal or reorganization of employees, foreclosure of security.

3. What is the difference with ‘normal’ M&A?

A typical distressed deal can be characterized as follows:

• the ‘forced’ element of the deal provides a typical environment and dimension, that differentiates it from a normal M&A transaction;
• the deal is run by different stakeholders: aside from the seller and the target, you are also often dealing with (one or more) financing parties or other creditors. You may have to negotiate with some of them. Sometimes you are exclusively dealing with creditors instead of with the shareholders (e.g. in the well-known Dutch HEMA sale, the sale was exclusively driven by bondholders who foreclosed on their security);
• there is usually very little time available to select a buyer and to close the deal: weeks or even days. The target usually has insufficient liquidity to pay its creditors and employees. There is a real threat of losing employees, customers and/or suppliers;
• the buyer has to accept a lot of risk. There is very little opportunity to perform a decent due diligence investigation. The buyer has to make his bid very quickly. The usual means of investor protection (representations, indemnifications, collateral, etc.) are absent in a distressed deal or are very thin at most;
• the distressed deal must be ‘creditor proof’. The transaction should not be prejudicial to creditors, or in danger of being annulled later on by creditors or by the bankruptcy receiver for that reason;
• a good tax structure of the deal is vital and an important driver for how the deal should be structured.

4. What is the role of the managing board and the supervisory board in a Distressed M&A transaction?

The managing board and the supervisory board play an essential role in this type of transaction, especially the boards of the seller. The supervisory board will become more active, and not seldomly a supervisory board or a delegated supervisory board member is the driver of the deal. The board of the target (and possibly the supervisory board) should radiate confidence in the future and the feasibility of the survival plan, and also execute that plan. Also, the board of the target plays an important role in retaining (key) staff. Given the time pressure of any distressed deal and the fact that some of the stakeholders (be it creditors or shareholders) are going to get disappointed, board members and supervisory board members will have questions on their role and the possible liability in connection therewith. Will they take the right decisions in that regard? Which risks are taken? Are we going to realize the best possible value (for the creditors)? Will the target company assume obligations that cannot be performed? Can we pay our creditors selectively and therefore treat some of them better than others? Are the directors or supervisory board acting in breach of their fiduciary duties?

5. How to deal with creditors in a distressed deal?

Creditors play a pivotal role in any distressed deal. Their role can vary to a great extent depending on the circumstances. As stated above, some creditors, often the banks or a restructuring manager appointed by the banks, can even be the driver of the entire transaction. Aside from that, there may be essential suppliers (in Dutch: dwangcrediteuren) whose factual position is indispensable for the future of the business and whose continued support is therefore crucial. But there can be other creditors, who have no knowledge of the distressed deal to come, and are possibly only confronted with the outcome thereof after the closing. They may be disappointed and sometimes even litigious. There has to be a thorough plan how to deal with these creditors. Dutch law in principle provides that creditors should be treated equally in line with their preference, but exceptions are possible in a negotiated deal or in a financial scheme. See also our comments on the upcoming financial restructuring act (known as WHOA, see paragraph 8), which will come into force in 2021.

6. How to deal with employees in a distressed deal?

As stated above, there is very little time to close the distressed deal. This means that the requirements to consult with the works council (in Dutch: ondernemingsraad) and the labor unions will come under time pressure as well. These consultation requirements are in full force, notwithstanding the distressed situation, so it is important to comply with these regulations as you would in any M&A transaction in the Netherlands. This means that, if there is (or should be) a works council in place in the target and/or the seller, this works council should be given the opportunity to render a (positive or neutral) advice, and should do this in a stage where the works council advice can still influence the transaction. If the advice is not (or likely to be not) positive, it is recommended to try to agree with the works council on how to proceed. Usually, works councils in distressed situations are committed, and concerned about the prospect of ending up in a worse situation, so they will usually be cooperative and mindful of the time stress. In any event, it is advised to keep the works council involved in the process and take their role seriously. Disregarding the works council could lead to litigation and seriously delay the process. Consultation requirements with the labor unions have to be met prior to the closing, and are especially important when dismissals are expected to happen. Unfortunately, a distressed deal will usually mean that there will be one or more rounds of dismissals. Dutch law has strict procedures when it comes to the termination of employment contracts. A termination or dismissal which is contrary to the law is null and void. There are roughly two different methods to dismiss an employee for redundancy:

• after approval by the Employment Insurance Agency (in Dutch: UWV); or
• through individual settlement agreements.

The procedure through the Employment Insurance Agency requires an economically well-substantiated plan. It should be noted that in this procedure, the employees who qualify for redundancy need to be selected on the basis of the reflection principle (in Dutch: afspiegelingsbeginsel) and therefore they cannot be selected on the basis of their suitability in the new (relaunched) operation. So this means that the buyer should be aware that in this trajectory the business may lose some of its best employees. An advantage of the Employment Insurance Agency procedure is that only the legally required transition payment (in Dutch: transitievergoeding) needs to be offered as a severance payment, deducting the time the procedure took place. Therefore, choosing for this system will enhance manageability and allows for a better predictability. Negotiating individual (bilateral) termination agreements, is also an option, but it usually means you have to offer a higher severance payment, exceeding the legally required transition payment. In addition, the employee may not agree to a termination if he or she knows that he or she will not be considered redundant on the basis of the reflection principle described above, so that the employer has no alternative for a dismissal through the Employment Insurance Agency. The advantage of choosing for individual settlement agreements is that you can get a faster outcome, without having to await an uncertain procedure through the Employment Insurance Agency.

7. Can a prepacked insolvency provide a solution in Distressed M&A?

An insolvency whereby a sale of assets has been prepared under judicial supervision prior to the proceedings (“prepack”), was unknown in the Netherlands until a decade or so ago, as there is no legislation to support this practice. Yet, in a number of situations this type of reorganization has occurred successfully, and with the help of the judicial authorities, which is quite extraordinary. In this type of prepacked insolvency, essentially the sale of (a part of the) assets constituting the business of the debtor is prepared prior to the adjudication of the insolvency of the debtor. Such preparations usually consist of selecting one or more prospective buyers and negotiating an asset purchase agreement, in which the selected purchaser will purchase, after the adjudication of bankruptcy, these assets with the aim of continuing the business. The distinctive feature of the prepacked insolvency is that these negotiations are to be observed by the ‘envisaged receiver’ and the ‘envisaged bankruptcy judge’ whose participation has been sought in advance by the debtor. As a result of these preparatory activities in the ‘silent pre-insolvency phase’, the sale of the assets can be effectuated very swiftly after the adjudication of the insolvency, in which the aforementioned receiver and judge are subsequently appointed by the bankruptcy court. And most importantly, the business activities can be continued seamlessly. The advantages of this type of prepacked insolvency are mostly a better realization of sales proceeds for the creditors, combined with the preservation of the business and the preservation of (an important part of) the jobs connected thereto. Yet, the practice is remarkable, because as stated above, there is no statutory basis for the above-described ‘silent pre-insolvency phase’. A bill to provide statutory legal basis to this practice is still pending before the senate (the Dutch Upper House), awaiting the European developments (see below). The pace in which a number of such insolvencies were settled (leaving behind those jobs that were not transferred to the new relaunched business) earned them the negative connotation of ‘flash bankruptcy’ (in Dutch: flitsfaillissement), in connection with the fact that these insolvencies usually also entailed forced redundancy of employees. A key element of these successful prepacked insolvencies is indeed that there is no protection under the Transfer of Undertakings (Protection of Employment) regulations or TUPE regulations. The TUPE Regulations basically provide that with the transfer of an undertaking, the employees (and their existing terms and rights) follow such undertaking by operation of law. In the Dutch legislation implementing the TUPE Regulations an exception is made for insolvency. On the basis of this exception, the protective rules are not applicable if the “employer is bankrupt and the business forms part of the assets.” In this manner, the employees do not transfer to the relaunched business by operation of law, and so those that are not part of the transfer are left behind in the insolvent estate. This also means the new relaunched business can freely select (and cherry-pick) the employees for the new business (so contrary to the reflection principle explained above in the previous paragraph 6). The Dutch labor unions have been successful in attacking a prepacked insolvency in the Smallsteps case, in which the European Court of Justice held that in that prepacked insolvency there still was a TUPE and hence a transfer of employees’ rights. So the insolvency exception could not be claimed in this matter. According to the court of justice the prepack in the Smallsteps case “is aimed at preparing the transfer of the undertaking down to its every last detail in order to enable a swift relaunch of the undertaking’s viable units once the insolvency has been declared and in order to avoid the disruption that would result from an abrupt cessation of the undertaking’s activities on the day of the declaration of insolvency, so as to safeguard the value of the undertaking and the employment posts.“ […] In those circumstances, and subject to determination by the referring court, it must be held that since such a procedure is not ultimately aimed at liquidating the undertaking, the economic and social objectives it pursues are no explanation of, or justification for, the employees of the undertaking concerned losing the rights conferred on them […]” The European Court of Justice furthermore attacked the lack of a legal basis, and held that the procedure was not under the supervision of a public authority. The Smallsteps case has left the restructuring practice wondering for a while whether a prepacked insolvency without TUPE protection would still be possible. However, the Dutch Supreme Court still seems to be in favor of the prepack approach. In the recent Heiploeg matter of 29 May 2020, see link (in Dutch), the Dutch Supreme Court ruled that a  a successful prepacked insolvency without TUPE protection is possible. The Supreme Court has, however, referred the matter to the European Court of Justice with five questions for a preliminary ruling. After this ruling, we will have more certainty about the future of the prepacked insolvency in the Netherlands. The Dutch restructuring practice is eagerly awaiting the European Court of Justice’s ruling on this. It is expected that we will also have more certainty about the application and added value of this type of restructuring in the Distressed M&A practice. However, we do expect in this regard that with a real and actual change of control (other than in the Smallsteps matter described above), there is a very good chance for the prepacked insolvency to be successful in the sense that the TUPE regulations do not apply.

8. Can the new Financial Restructuring Act (WHOA) play a role in Distressed M&A?

The Financial Restructuring Act (in Dutch abbreviated to WHOA) has been recently adopted, and will come into force on 1 January 2021. The WHOA will enable a court-approved financial composition, including a cross-class cram down (meaning all classes of creditors can be forced to conform to a certain restructure, and minority objections are “crammed-down”), which is inspired by the English scheme of arrangements and the US Chapter 11. In the current situation, the debtor needs to seek approval from each and every creditor if it wishes to reorganize its debts. You can find a blog on the WHOA on our website. It is too early to conclude whether this new WHOA act will be used a lot in Distressed M&A. But there are certainly elements in the WHOA that will make it interesting to apply in a distressed deal. That a new business owner provides the relaunched company the opportunity to survive with a significant new capital round, will no doubt provide a first building block for the survival plan under the WHOA: the plan is necessary and feasible. Of course, the plan shall have to meet the other conditions of the WHOA. Hence, the haircuts that are offered to the creditors shall have to meet the compulsory minimum. The creditors may also not be worse off than in a regular insolvency. The survival plan can also be tailored to only affect the financial creditors, and offer the trade creditors 100% of their receivables. If the court approves the composition (in Dutch: homologatie) then the composition can be forced onto non-cooperative creditors and even shareholders, if the minimum number of support votes have been obtained. Also, the possibility exists to apply to the court to interfere in certain rights of contract parties. This can go quite far. In this sense, already the threat of a WHOA procedure could enable a faster result in a distressed deal. Finally, the WHOA has an interesting international dimension. It is based on and intended to be admitted to the list of insolvency proceedings under the EU Insolvency Regulation. This means inter alia that if the Dutch court has jurisdiction, also non-Dutch creditors and security are bound by the scheme. The court approval will then be recognized in many other European countries on the basis of the EU Insolvency Regulation.

9. Will the Dutch competition authorities facilitate a distressed deal? Is a ‘failing firm defense’ possible?

Competition law requirements remain in full force and effect, even in a distressed situation. Therefore, even a distressed deal shall have to be notified to the competition authorities if the thresholds for a merger notification are applicable. Consequently, a distressed deal can in such case only be executed and closed with approval of the competition authorities. However, if the situation is so urgent that a decision cannot be awaited without bringing a great extent of damage to the seller or the target, then the Dutch merger authorities can grant an exemption of the required waiting period. If the distressed deal causes significant restriction of competition on a certain market, then the failing firm defense could possibly provide a remedy. This remedy entails that without a ‘rescue merger’ the possible objections from a competition policy perspective are basically the same as in a situation where the merger would not be effected. Therefore, the deal should, notwithstanding these objections from a competition standpoint, be approved nevertheless. The failing firm defense has been successfully put forward in a matter of two health care institutions in the south of the Netherlands (in Dutch). As far as we know, this is the only failing firm defense successfully put forward in the Netherlands, and Ploum acted as advisor on this case! If in the Netherlands the thresholds for a merger notification are not met, but they are met in any other relevant jurisdiction, then it should be checked under local applicable law if an exemption or a failing firm defense is possible. This is often possible.

10. How can Ploum help you in a Distressed M&A?

Ploum has the ideal team to assist you in any Distressed M&A matter. We can represent any party in the process, be it the buyer, the seller or the target, and we can also represent you as creditor or individual shareholder. Running a distressed deal requires teamwork. Different legal focus areas are required, such as corporate (including civil law notarial services), insolvency, employment, finance and security, liability of directors or supervisory directors, contracts, lease law and competition. Our firm has experts in all such areas. Not only are different legal disciplines applicable, reorganizing and restructuring also requires multidisciplinary cooperation with tax firms, accountants and corporate finance advisors. And furthermore, your advisor should deal with other stakeholders such as banks, creditors, labor unions, (international) regulators. As Ploum we are used to act in such a dynamic environment, and have all the legal and social expertise and experience to advise, counsel and complete a distressed deal quickly and competently. Tom Ensink (t.ensink@ploum.nl), M&A, with many thanks for the contributions of Albert Wiggers (a.wiggers@ploum.nl), M&A Michelle Westhoeve (m.westhoeve@ploum.nl), employment Suzanne van Aalst (s.vanaalst@ploum.nl) and Vincent Terlouw ( v.terlouw@ploum.nl), insolvency and director’s liability Frank Barendrecht (f.barendrecht@ploum.nl), competition