New topics affecting the leveraged market
The current rebirth of LBOs in Spain comes alongside innovation brought by case law and local legal changes worth highlighting since we understand they may give rise to changes to a very standardised market practice.
From a tax perspective, recent legal changes, together with those already approved in the last year mainly concerning tax treatment of the acquisition finance in an LBO structure, must also be carefully considered in order to avoid undesired surprises.
Pledges of the balance over bank accounts
These pledges are very often regarded as a pure lawyers' document with little room for change. A recent court ruling from the European Court of Justice (the "Ruling") on a case brought by a request from the Latvian Supreme Court has for the first time addressed certain aspects of the Financial Collateral Directive (Directive 20012/47/EC) (the "FCD") in a way that has a clear impact on pledges over bank accounts in EU Member States. In the Spanish market it is customary for pledges over bank accounts to be structured in a double way:
- As pledges over bank accounts subject to the Spanish Civil Code, which are generally (as other security interests) subject to the provisions of the Spanish Insolvency Act in case the pledge is declared insolvent or goes through a pre-insolvency restructuring process; and
- As pledges over the cash in a bank account pursuant to Spanish Royal Decree Law 5/2005 ("RDL 5/2005"), which implements the FCD in Spain and allegedly creates a safe harbour in case of insolvency of the pledgor.
How is the Ruling relevant? As you may know, the FCD reduced the administrative burden on collateral takers by providing for the removal of formal requirements but only if the financial collateral is "provided" to the collateral taker and such provision of collateral is evidenced with writing. Collateral is deemed "provided" if it is delivered, held, registered or transferred to the collateral taker and therefore is in the possession or under the control of the collateral taker. This concept of "in possession or under the control", which is not defined in the FCD, has now been clarified in the Ruling, where it is considered that (i) the requirement of the collateral being "in possession or under the control " of the collateral taker for the purposes of the FCD would become completely ineffective if the collateral provider was entitled to continue to dispose of collateral (e.g. withdraw monies from a bank account) freely; and that (ii) financial collateral over cash deposited in a bank account requires the collateral taker having the legal right to limit the use of monies in that account in so far as is necessary to guarantee the secured obligations, which entails that the collateral taker will only benefit from the insolvency protection provided by the FCD (and RDL 5/2005) if and to the extent balance in the pledged account has been blocked. This clearly does not tie in well with market practice in the lending market, where (i) typically pledgors have the right to withdraw monies from the account until the relevant account bank is notified that an event of default has occurred; and (ii) pledges are usually granted over operating accounts that the relevant borrower and/or guarantor needs to use in its ordinary course of business.
What is the solution? It is not an easy one. Lenders will have to balance the commercial impact of requesting the borrower (and guarantors) to have at least part of the cash blocked in an account (with the inherent cash flow implications) and having a bank account security interest which is perfected but lacks immunity in case of an insolvency (and hence is subject to, for example, the one year stoppage on enforcement provided for by the Spanish Insolvency Act).
Right of minority shareholders to request a buy-back of their shares
The Spanish Companies' Act (Ley de Sociedades de Capital) was amended in 2011 to, inter alia, create a buy-back right for minority shareholders in non-listed in the event of a lack of distribution of dividends provided certain criteria (as set out below) were complied with. The application of this new article 348 bis was suspended but this suspension lapsed on 31 December 2016, which may have an impact on leveraged transactions going forward. The requirements that have to be met cumulatively for this to apply are as follows:
- The Company needs to have been registered with the Commercial Registry for at least five years.
- That the relevant minority shareholder has voted in favour of the distribution of dividends. Some case law issued following the short period in which article 348 bis was in force (from 2 October 2011 to 22 June 2012) stated that those shareholders who: (i) have not paid-in their capital upon request; (ii) have not voted; or (iii) hold non-voting shares; will not be entitled to this right.
- That the GSM does not pass a resolution agreeing to distribute at least on third of the previous year profit stemming from the ordinary course of business.
The minority shareholders will have a period of one month from the date on which the GSM was held to exercise their right.
This obviously can't be disregarded when structuring financing transactions where minority shareholders play a role, like LBOs when management is allocated shares in Target or in the relevant Newco purchasing Target's shares (provided such Newco is a Spanish Company). The typical restriction on distributions to shareholders in finance documents might in some cases be deficient to bring into line with the rights of some minority shareholders who might be more inclined to profit distribution.
Tax news
In relation to the always relevant tax implications of leveraged finance transactions, we thought it useful to highlight the measures impacting the limitations on financial leverage, achieved through the introduction, at the end of 2014, of limitations on the deductibility of financial expenses (being, in general terms, the maximum deductible amount equivalent to 30 per cent. of the EBITDA), even if those are accrued under third party financing, and that become more strict in case of LBOs transactions.
There have been other measures recently approved (by Royal Decree-Law 3/2016) mainly aimed to increase tax collections that help the Spanish Government to reduce the public deficit and that may impact the business model of funds involved in the acquisition of Spanish companies. The most relevant amongst those could be summarised as follows:
- The reversal of impairment losses of stakes that were tax deductible in tax periods beginning prior to 1 January 2013, shall be incorporated at least in equal parts into the taxable income for each of the first five tax periods beginning on or after 1 January 2016.
- The following limitations for offsetting pending carried forward tax losses are established, which depend on the turnover achieved by the taxpayer during the previous 12 months: i) if the turnover in the prior fiscal year is less than EUR 20 million, the applicable limit is 60 per cent of the taxable income of the year for tax periods started in 2016 and 70 per cent for those tax periods started as from 2017; ii) if the turnover in the prior fiscal year is equal to or higher than EUR 20 million but less than EUR 60 million, the applicable limit is 50 per cent of the taxable income of the year; and ii) f the turnover in the prior fiscal year is equal to or higher than EUR 60 million, the applicable limit is 25 per cent of the taxable income of the year.
- New limitations on the application of generated or carried forward tax credits to avoid international or internal double taxation, applicable to large companies. For those taxpayers whose turnover is equal to or higher than EUR 20 million, the amount of those tax credits to avoid internal or international double taxations, generated in the relevant fiscal year or carried forward from previous fiscal years, cannot jointly exceed 50 per cent of the tax payable (before the deduction of tax credits). The excess can be deducted in the following fiscal years, together with the tax credits generated in the relevant fiscal year, subject to the abovementioned threshold although without any timing limitation.
- Last but not least, losses arising from the transfer of stakes in entities shall not be deemed deductible for Corporate Income Tax purposes provided that said stakes would have granted the right to obtain exempt income, both for dividends or in capital gains made in the transfer of shares. Likewise, losses arising from the transfer of stakes in entities resident in tax havens or subject to a tax on profits with a nominal rate lower than 10 per cent shall neither be deemed deductible for Corporate Income Tax purposes.
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