Partial arrangement as an alternative form of debt restructuring
Under the Polish Restructuring Law, in principle an arrangement covers all claims against the debtor except for those expressly identified in the law as outside the arrangement. But sometimes it is not necessary to reach an agreement on all the debtor’s obligations in order to carry out an effective restructuring. This happens when the debtor only has difficulty servicing selected obligations that are otherwise essential to operation of its business. For such situations, parliament introduced the institution of a partial arrangement.
A partial arrangement allows the debtor to conduct negotiations and agree on arrangement proposals more efficiently and with much less effort, without unnecessarily involving creditors whose participation in the proceedings would be inexpedient. But to take advantage of this solution, the conditions indicated in the act must be met.
Formal conditions for a partial arrangement
A partial arrangement will not be applicable in all restructuring proceedings. The parliament has allowed it only in the procedure for approval of an arrangement (postępowanie o zatwierdzenie układu) and in the accelerated arrangement procedure (przyspieszone postępowanie układowe)—based on the simplicity of these proceedings. The law recognises that in the case of comprehensive restructuring as takes place in arrangement proceedings (postępowanie układowe), and even more so in the case of remedial proceedings (postępowanie sanacyjne), the idea of making arrangements only with a selected group of creditors should be completely rejected. However, Art. 192 of the Restructuring Law allows for a partial arrangement “alongside” remedial proceedings, with respect to claims not covered by those proceedings.
Requirement of fundamental impact on the business
The law explicitly indicates that a debtor may submit arrangement proposals covering exclusively obligations characterised by a “fundamental impact on the continued operation of the business.” The general wording of this criterion is deliberate and legitimate, so that it does not contradict the essence of the partial arrangement, which is to ensure that the debtor is free to decide which of its claims will be included in the restructuring. Moreover, a line of case law is forming holding that the court may not dismiss an application to open accelerated arrangement proceedings on the ground that restructuring of certain debts will not have a fundamental impact on the continued operation of the business (Gliwice Regional Court order of 17 October 2017, case no. X Gz157/17, unpublished). Nevertheless, the leeway provided to the debtor in this context does not allow the debtor to act arbitrarily.
Criteria for selecting creditors covered by the arrangement
Arbitrariness in selecting between debtors is also prevented by the requirements for classification of creditors in Art. 180(2) of the Restructuring Law. Under that provision, in selecting creditors, the debtor should use objective, unambiguous and economically justified criteria not aimed merely at excluding creditors opposed to conclusion of an arrangement. These criteria must relate to the legal relationships from which the obligations covered by the arrangement proposals arise. Thus, Art. 180(2) is specifically intended to prevent selection of only the most “aggressive” creditors to participate in the arrangement (although in the debtor’s subjective opinion, obligations towards them may be of the greatest importance).
The criteria for selecting among creditors are subject to review by the restructuring court. In the accelerated arrangement procedure, review is conducted ex ante, and if these criteria are found to be incorrect the debtor can propose alternative grounds for distinguishing between creditors. However, in the procedure for approval of the arrangement, there is an ex post examination. In legal practice, this should be regarded as a shortcoming of the partial restructuring mechanism, because if the court rejects the selection criteria after the fact it will effectively throw out the entire restructuring procedure up to that time.
Division of creditors into interest groups
Identification of creditors to participate in the arrangement on the basis of objective, clear and economically justified criteria is a fundamentally different procedure and separate from the division of creditors into interest groups referred to in Art. 161 of the Restructuring Law. But this does not preclude a division into interest groups among the creditors admitted to the partial arrangement. This allows the debtor to offer different arrangement proposals to creditors from different interest groups.
Admittedly, there are also cases where the courts have held that this approach is impermissible (e.g. Warsaw Regional Court order of 29 May 2017, case no. XXIII Gz 486/17). However, this should be regarded as contrary to the principles of economics and, as it is based on the provisions on voting on the arrangement, incompatible with the canons of systemic interpretation. We have found in our own practice that the courts tend to agree to approve partial arrangements dividing the creditors into interest groups.
Other benefits of a partial arrangement
The possibility of entering into a partial arrangement has undoubted advantages from the debtor’s point of view, linked to increasing the efficiency of the proceedings and reducing the amount of work involved in conducting negotiations. Also, taking advantage of this form of restructuring carries potential benefits for creditors—particularly tax aspects. In an interpretation dated 23 May 2019 (no. 0114-KDIP2-3.4010.51.2018.2.MS), the director of the National Tax and Customs Information Office accepted the position that the portion by which a receivable to be paid to a creditor is reduced in accordance with the arrangement may be treated by the creditor as written off and included in tax expenses. This in turn reduces the creditor’s tax base for purposes of corporate income tax.
Partial arrangements in the practice of out-of-court restructuring
Especially in a proceeding for approval of an arrangement, the partial arrangement sits at the intersection of in-court and out-of-court restructuring. For this reason, partial arrangements are also used in the practice of out-of-court restructuring. Often a partial agreement worked out with selected creditors (usually financial institutions) constitutes an appendix to a previously signed restructuring agreement. In such a scenario, the restructuring agreement establishes the general framework of the restructuring, the timetable, the commercial terms, and the creditors’ and debtor’s rights and obligations, and appoints an arrangement supervisor acceptable to all parties. It is advisable for the supervisor to participate in the process from the beginning and to approve the arrangement proposals formally. In this approach, the restructuring has a good chance of success, as everything, including the arrangement proposals, is prepared contractually, outside of court proceedings. Then the opening of the proceedings is merely a technical, formal step aimed at gathering the votes of creditors covered by the partial arrangement, completing the documentation, and submitting an application for approval of the partial arrangement to the court.
A partial arrangement can also be used for debt restructuring in the form of conversion of debt into shares in the debtor. Much has already been written about debt-to-equity conversion as a form of restructuring under the Polish Restructuring Law, and we will not cover that topic in this analysis. Nevertheless, debt-to-equity conversion in an arrangement has many advantages. Essentially, the order approving the arrangement supersedes most corporate acts, and for example excludes subscription rights. Also, in this situation, the conversion is effective upon final approval of the arrangement by the restructuring court, and entry of the share capital increase in the National Court Register is merely declaratory. Legally, debt-to-equity conversion can be carried out as part of a partial arrangement and addressed to a specific set of creditors, e.g. secured creditors. The debtor may be interested in converting into equity only the claims of a specific group of creditors to avoid serious dilution of the debtor’s capital if the conversion had to involve the claims of most or all creditors. As a simplified restructuring procedure, a partial arrangement can be an excellent legal instrument for converting debt owed to a selected group of creditors into shares in the debtor.
In short, a well-prepared partial arrangement may be an effective form of restructuring the debtor’s liabilities towards important creditors, in particular lenders, especially if it involves partial forgiveness of the debt or conversion into shares in the debtor’s capital. We can only hope that processing by restructuring courts and the operation of the National Debtors Register improve significantly, as the current waiting time in many courts for approval of a negotiated partial arrangement is still too long to meet the expectations of market participants.
Mateusz Tusznio, adwokat, restructuring adviser, Banking & Project Finance practice, Wardyński & Partners
