Published: 24th January 2011
By Ofer Shapira, Adv.
Shapira & Co.
One of the significant changes in Israel's capital market and credit market between 2005 and 2008 was the dramatic increase in the extent of credit-raising through the issue of bonds, especially unsecured ones, to the public. Most of these unsecured corporate bonds were bought by public institutions, including mutual funds, pension funds, study funds, etc., which saw the bonds mainly as a tool to ensure constant interests in higher rates than government bonds.
A substantial part of the amounts raised in this way in Israel was used as "equity" in real-estate projects in other countries, particularly in Europe.
Needless to say that while the public was concentrating on those bonds as an investment vehicle, which would constantly produce income from the issuing companies, apparently it did not give enough weight to the fact that the bonds often represented debts of entities which were far from the base assets (see illustration 1).
Illustration 1 (click to open)
Also, when the business atmosphere in the countries (where the assets were) changed, the cash flow toward the issuing companies decreased or stopped and the issuing companies lost their ability to return their debts. Unfortunately the complicated structure of these concerns has put not only the issuing companies under difficulties but also put the bondholders in a delicate situation: if they initiate liquidation proceedings then in many cases specific loans in the countries can be accelerated and most chances are that the bondholders will lose all their money. If the bondholders do nothing then there is no likelihood that the issuing companies would ever be able to repay their debts.
In fact tens of companies got into such a situation, and that's how the problem became a nationwide crisis. In the peak of this bond crisis in the beginning of 2009 there were approximately 15 Billion Shekels (about 4.5 Billion US$) value of bonds that required such arrangements.
This article outlines few of the most common issues dealt with while working on such creditor's arrangements in Israel.
Priorities between different series of bonds
Many of the companies described below raised their credit in more than one series of bonds. When the issuing companies get into crisis then competition between the different series creates interesting situations.
The "easier" cases are those in which the series were issued by different companies in the group as illustrated in illustration 2. We say "easier" because under law shareholders are always subordinated to creditors of a company, so in case the assets are sold and money is paid back then apparently Series B will be fully repaid, and only then, if anything is left, the leftovers will be paid to the Parent company to be paid to its creditors, that is: Series A.
Illustration 2 (click to open)
But in practice things go different: following the reasons mentioned above, Series B bondholders are not interested in liquidation and therefore they will negotiate an arrangement with the Subsidiary. At the same time, and in order to win a better position Series A bondholders will apply for liquidation of the Parent, take over the Parent and will try to influence the scheme of arrangement negotiated by the Sub (by changing the management of the Subsidiary or otherwise) or object to the arrangement on behalf of the Parent in the course of the approval process required by law.
In one of the cases in which the shareholders objected to an arrangement, the court ruled that a scheme of arrangement would be approved despite the objection of the shareholders (Shtang case). But in few other cases, the result of the tension between the different series led to an arrangement that included the creditors of the Parent company and participation of Series A bondholders in the arrangement by receiving better values than they could get under liquidation of the group.
A more difficult question is raised when the same company issued a few series of bonds with different times of repayment as illustrated in illustration 3. In the regular course of business there is apparently no connection between the repayment of the one series and the repayment of the other. But what happens when it becomes clear that the issuing company will not be able to pay all of its debts and an arrangement is required? The question is asked because under liquidation all unsecured debts are in the same priority and enjoy the same position (pari-passu).
Illustration 3 (click to open)
Should the creditors be classified together as one group for the purpose of a scheme of arrangement? Or should every series be classified as a different group of creditors for the matter of the arrangement? In Israel, as in other countries, the approval of an arrangement requires an approval of at least the majority of the number of creditors who attend the meeting who represent at least 75% of the debt. Combining the two Series together gives the larger series more power.
In one case (Africa Israel case) the court ruled that until a company is actually under liquidation, an arrangement should reflect the different interests of each series. But there is not yet a decision or a law to decide whether different series of unsecured debts could be classified together for the sake of approving a scheme of arrangement offered be the issuing company.
Conflict of Interests between Bondholders
Another legal question is asked with respect to the procedure of approving a scheme of arrangement: What happens when an investor holds securities from both series described below? (see Illustration 4). Can he still vote in both meetings? On one hand, the voting power given to the bondholders as part of their "package of rights" is meant to allow the bondholders to reach the best decision for the group (i.e. the same series of bonds); allowing such bondholder to vote means he could use his vote to influence the decision of one meeting to the opposite interest of all other bondholders in that series. On the other hand, maybe the title in the bonds includes also a free voting power including voting in any way and for any reason, including in contrary to his group's interest.
Illustration 4 (click to open)
The case law in Israel has not yet said the last word on this issue, but at least in one of the cases the court disqualified the vote that was done under conflict of interests and approved the decision of the other bondholders disregarding the vote of the "affected" bondholders.
Anticipated Breach as a Cause for Liquidation
Two competing factors of insolvency: balance and cash flow. What happens when the two collide with each other?
What happens when a company has enough cash to temporarily go on with its business but its balance sheet shows clearly that the company will not be able to cover its debts in the future?
This is the case illustrated in illustration 5: A Company raised money in Shekels in July 2007 and used the money as equity for real estate investments in England. At that time the NIS 870M were about GBP 100M (GBP1 = NIS 8.7). By January 2009 the rate of the British Pound fell to GBP1 = NIS 5.5. The Company had gone into default with its specific lenders, and it looked like it had no source to repay the bonds.
Illustration 5 (click to open)
Can Series B apply for bankruptcy when the debt is far from being due?
In one case the court held that the company had enough time to raise more money and therefore the court refused to an insolvency motion submitted by a secured creditor (Proficiency). The court might also take into consideration the public interest of allowing the company to continue its business.
Under Israeli contract law a claim based on anticipated breach requires evidence showing clearly that the breach is clear (unlike mere suspicions of the creditor).
On the other hand – companies whose business is based on real property will find it difficult to convince the court they could find secret sources to fill in the gap of the missing finance. In many cases the bonds' terms also allow the bondholders to demand an immediate repayment in case of a material adverse change in the ability of the bondholders' ability to collect their debt. The use of such term might lead such company into liquidation or an arrangement with its bondholders.
As we see, schemes of arrangements often require a large degree of creativity and combination between law and business. No doubt that good ideas implemented successfully in schemes of arrangements in Israel could be used in other countries. Experienced insolvency practitioners are the right people to lead such arrangements everywhere.
Julie is a law graduate who qualified with Price Waterhouse in 1994. Julie joined Smith & Williamson in 1997 and became a partner in 2001. With Mike Stevenson, Julie set up Middleton Partners offices in Salisbury and Southampton, both of which are now part of Begbies Traynor.
Julie is a member of the Insolvency Practitioners Association and is a Fellow of The Association of Business Recovery Professionals. Julie deals with all aspects of Corporate Recovery and turnaround work and takes all form of personal insolvency appointments.