Developments in the enforcement of share pledges under Dutch law
Financial restructurings are becoming increasingly common in the current financial climate, also in the Netherlands. Since the implementation of the Dutch scheme of arrangement on 1 January 2021, a relatively new tool to restructure debts of Dutch corporate entities in order to prevent their insolvency is available in the Netherlands. Under the Dutch scheme of arrangement, a creditors composition is binding on all creditors if a sufficient number of (classes of) creditors vote in favour of the scheme. In principle, the preferential order of priority for secured creditors, e.g. creditors who hold a pledge over shares in a Dutch company, must be respected both in a Dutch scheme of arrangement and in insolvency proceedings. However, secured creditors have another tool in the toolbox, which pre-dates the Dutch scheme of arrangement and which has proven its value in achieving financial debt restructurings outside of insolvency and schemes of arrangement. This key technique used in financial debt restructurings is to effectuate a debt-for-equity swap by way of enforcement of a pledge on shares. In this blog, we will provide a short overview of the enforcement process for a share pledge and developments in this regard.
Under Dutch law, a right of pledge can be enforced if the borrower is in default in the performance of the payment obligations secured by the right of pledge. This means that not every event of default under a facility agreement constitutes a default under Dutch law that would authorise the pledgee to enforce the right of pledge. However, an event of default that is not a payment default may become a payment default if the facility is accelerated as a result of the event of default.
The enforcement of a right of pledge can occur in three ways:
public sale through a public auction;
private sale with court approval; or
private sale with the pledgor’s consent.
The default rule for enforcement of rights of pledge is that the enforcement takes place in the form of a public auction, without involvement of the courts. This public auction route is rarely used, primarily because the pledgee is unlikely to be in a position to set up a proper due diligence, without any cooperation of the pledgor and the company, and there are no clear instructions in Dutch law or guidance how this public auction should be organised.
Private sale
A right of pledge over shares in a Dutch private limited liability company is typically enforced by way of a private sale, which requires either the pledgor’s consent or court approval.
The pledgor may validly consent to a private sale only after the pledgee has become entitled to commence enforcement action. If other parties have an interest in the shares that are subject to the right of pledge, e.g. holders of lower ranking rights of pledge or creditors that have imposed an attachment on the shares, they also need to consent to a private sale. For that reason and because of risks of annulment of the consent granted by the pledgor and of directors' liability for those acting as management, the route of obtaining the pledgor’s consent is used less frequently than obtaining court approval for a private sale. In practice, therefore, a right of pledge over shares is preferably enforced by means of a court approved private sale.
Enforcement process
As explained above, a private sale with court approval is the most common and often the preferred method. This could be e.g. a sale of the pledged shares through a controlled auction process or a private sale to a newly incorporated entity set up by creditors, such as bondholders or lenders. In the case of the latter, we typically see that the secured creditors offer to acquire the shares for a symbolic amount of one euro and consequently convert all or some of the secured liabilities into further shares issued by the company whose shares are acquired in the course of the enforcement process. Although Dutch law does not have a specific statutory basis for creditors bidding on pledged shares in combination with a debt-for-equity swap (credit bidding), the prevailing opinion in Dutch legal literature and practice is that it is not prohibited.
In Dutch deeds of pledge over shares, it is market practice that voting rights on the shares are transferred to the pledgee, under the conditions precedent that (i) an event of default has occurred (and is continuing) and (ii) delivery of a notice by the pledgee to the company and the pledgor. This allows the pledgee to take control of the company, to act as shareholder and to exercise shareholders' rights (including the appointment and removal from office of directors) if and when an event of default occurs. This is an optional step and should be carefully considered in the context of an enforcement process in view of the potential corporate and tax risks of taking such a step.
The petition submitted with the relevant court to seek the court’s consent to a private sale of shares must be accompanied by a valuation report from a reputable valuation expert. Such a report usually provides a range for the value of the company’s shares. This valuation report allows the applicant to demonstrate that the purchase price for the shares is fair. As such, the valuation report is useful both in the context of the enforcement of the pledge over shares and (should this not materialise) for any subsequent creditors composition, whether in our out of the context of insolvency or a Dutch scheme of arrangement.
After the application is filed, the court will schedule a hearing. The court may refrain from doing so if there is no opposition or if the parties involved state that there is no need for a hearing. The court invites interested parties to attend the hearing and allows them to file a position paper. The court considers a party an interested party if its interests are sufficient to justify its participation in the proceedings, given the potential impact of the judgment on it and any other way it may be affected by the subject matter that is dealt with in the proceedings. Any interested party may submit a competing valuation report and may also present alternative bidders who are or might be willing to pay a higher price for the shares. The available case law shows that courts have often dismissed these arguments on the basis that there were either no alternative bids supporting the competing valuation or, if there was an alternative bid, such bid was conditional or not fully funded.
Before rendering a judgment, the court must examine whether, at the time the application was made, the requested alternative to a public auction would achieve the maximum possible value. It follows from case law that the court reviews and assesses the bid in light of the entire intended restructuring: not only the purchase price for the shares is taken into account, but also the non-cash consideration (i.e. the amount of the debt reduction that is offered as part of the bid).
The court may only allow or deny the request: it cannot approve a competing bid. If the court allows the request, no appeal is possible except on limited technical grounds. After the court has given its approval to the private sale, the pledgee may sell the shares in accordance with the court decision.
In syndicated financing transactions, bond transactions or any other financing where there are multiple creditors, the security is typically created in favour of a security agent for the benefit of the secured creditors. The security agent acts on the instruction of the secured creditors in accordance with the relevant finance documents or intercreditor agreement.
In conclusion, the enforcement of a right of pledge over shares by way of court approved private sale is and remains a useful technique to be considered in financial debt restructurings of Dutch entities. It has been applied in major debt restructurings in the Netherlands in recent years and held its own since the introduction of the Dutch scheme of arrangement in 2021.
