Supreme Court Sets Out When Equitable Subordination Is Admissible

In this briefing, we look at the Supreme Court's judgment (no. 276/2015 of 28 May 2015) regarding the interpretation of equitable subordination.

In the insolvency proceedings of Servifonia Plus, S.L. (Servifonia), Royal Bank of Scotland (RBS) held a claim for a total amount of €21,645,672.78, corresponding to the balance of a mortgage loan linked to an interest rate SWAP over a hotel in the Canary Islands.

Of this amount, €20,789,287.81 was ranked as a claim with special preference and €856,384.97 was ranked as an ordinary claim by Servifonia's Insolvency Administration ("Administración Concursal").

Congelados Roper, S.L. (Congelados Roper) filed an insolvency procedural claim ("demanda incidental") against Servifonia's Insolvency Administration and RBS challenging the list of creditors.

By virtue of the insolvency procedural claim, Congelados Roper asked the Court to alter the ranking of the claim held by RBS, so that the claim, totalling €21,645,672.78, would be ranked as a subordinated claim given that, according to the opinion of Congelados Roper, RBS would be a specially related person ("persona especialmente relacionada") to Servifonia in accordance with article 93 of Act 22/2003, dated 9 July, on Insolvency (Spanish Insolvency Act) and, therefore, equitable subordination would apply to RBS's claim.

Claims made by Congelados Roper

The claim filed by Congelados Roper points out that the draft report prepared by Servifonia's Insolvency Administration (item 1.3), section "Grupo de empresas y relaciones de la concursada con personas especialmente vinculadas" (Group of companies and the insolvent company's relationship with specially related persons) shows that RBS is a specially related person to Servifonia on account of the following facts:

• Drago Mediterranean Holdings Coöperatif, U.A. (Drago Mediterranean), which is 99 per cent owned by Drago Real Estate, is the parent company of Servifonia.
• RBS is a shareholder of Drago Real Estate, owning 17.43 per cent of its share capital.

Therefore, Congelados Roper contended that there was (i) a direct connection between Servifonia and Drago Real Estate, since the latter is the majority shareholder of Drago Mediterranean (sole shareholder of Servifonia); and (ii) an indirect connection between Drago Real Estate and RBS, since RBS holds a significant quota in the share capital of Drago Real Estate, and which is, moreover, higher than the quota set out in article 93.2.1 of the Spanish Insolvency Act (5 per cent or 10 per cent), which would entail the subordination of the claim held by RBS in accordance with article 93.2.3 of the Spanish Insolvency Act in relation to article 92.5 (as stated above, the so-called "equitable subordination").

Defence pursued by Ashurst, acting on behalf of RBS

RBS denies holding a stake in Drago Real Estate and states that such stake is held through another company called RBS Spil, whose corporate address and corporate purpose are different.

In addition, the acquisition of the quota of Drago Real Estate by RBS Spil took place five months after the claim arose (i.e. the day the loan was granted and the interest rate SWAP was formalised between RBS and Servifonia).

Supreme Court upholds decisions of the Mercantile Court and the Provincial Court of Madrid

The Mercantile Court ("Juzgado de lo Mercantil") dismissed the claim filed by Congelados Roper and Congelados Roper then appealed the judgment before the Provincial Court of Madrid ("Audiencia Provincial de Madrid"), which dismissed the appeal and upheld the judgment issued by the Mercantile Court.

Both judgments are based on the following interpretation: RBS was not a shareholder of Servifonia at the moment when the claim arose, as required by article 93.2.1 of the Spanish Insolvency Act, in order to determine that a person is specially related in terms of ranking a claim as subordinated in accordance with article 92.5.

The judgment of the Provincial Court of Madrid was appealed by Drago Mediterranean (sole shareholder of Servifonia and assignee of the outcome of the proceedings as a result of an assignment agreement entered into between Congelados Roper and Drago Mediterranean dated 20 February 2013) to the Supreme Court, which dismissed the claim and upheld the judgments issued by both the Mercantile Court and the Provincial Court of Madrid.

The Supreme Court determines that, in order to consider a person as "specially related" under article 93.2 of the Spanish Insolvency Act, focus must be placed on the moment the claim arises (i.e. the formalisation of the interest rate SWAP and the granting of the mortgage loan between RBS and Servifonia).

In this case, the Supreme Court (in line with the Mercantile Court and the Provincial Court of Madrid) determined that on 24 July 2006 (the day on which the mortgage loan was granted and the interest rate SWAP was formalised), neither RBS Spil nor RBS were shareholders of Drago Real Estate. Therefore, RBS could not be considered as a specially related person to Servifonia in accordance with article 92.3.1 of the Spanish Insolvency Act, which means that the equitable subordination of the claim of RBS is inadmissible.

Conclusion

This is the first judgment of the Supreme Court where equitable subordination is interpreted. The judgment clearly states that the key factor in determining whether such subordination is admissible or not, is the moment the claim arises, regardless of the proximity of (i) the date on which the claim arises; and (ii) the date on which the shares are acquired.

Ashurst advised RBS throughout the proceedings, which took over five years in total.