Cutting debts; a forced composition agreement (WHOA)

On January 1, 2021, the Homologation of Private Arrangements Act ("WHOA") entered into force on an accelerated basis. The hope is that this will prevent a good number of (corona) bankruptcies. In this article I go through the (complex) legislation of the WHOA in a nutshell and explain when a company is eligible for reorganization through a WHOA agreement.

How it was.

Until Jan. 1, 2021, 3 agreements actually existed for the reorganization of companies (in legal entities): the out-of-court settlement, the bankruptcy settlement and the moratorium settlement. Only with the latter two variants could creditors be forced to settle (subject to conditions) by having the agreement declared generally binding by the court. We call this homologation.

These agreements are offered in "insolvency proceedings" under the Bankruptcy Code and are supervised by an administrator/treasurer and a bankruptcy judge. This helps to ensure that the agreement provides the best deal for creditors and it is therefore reasonable for them to agree to the agreement (whether forced or not).

The out-of-court settlement did not have those safeguards and, moreover, all creditors had to agree to the settlement and some (preferential) creditors had to be offered double percentages. If one creditor refused, the settlement was off the table and the reorganization did not go through. Bankruptcy then often followed (unnecessarily). Unless the debtor could prove that the refusing creditor abused his power by not agreeing; that is a very difficult procedure.

Thus, an out-of-court agreement could hardly be enforced

How it is.

The fact that a single creditor could ensure that an agreement would not succeed was a thorn in the side of legal practice and also of the legislator. Indeed, it led to many unnecessary bankruptcies, where creditors were often worse off than if the agreement had succeeded.  

To ensure that refusing creditors could still be forced to accept a settlement, the WHOA was created and, under pressure from the corona crisis, this law was accelerated.

Thus, the WHOA is an addition to the private agreement; when it is determined during the preparation of the agreement that everyone agrees, one can choose to no longer submit the agreement to the court.

Under circumstances, all creditors can be bound by the court to a settlement. What these conditions are, I detail below.

The procedure

A WHOA procedure consists (roughly) of 3 phases: the preparation, the proposal and vote on it, and the homologation. The procedure is included in the Bankruptcy Code in sections 369 Fw through 387 Fw and aims either to achieve a reorganization of debt and/or contracts or to liquidate the company.

The proceedings can be initiated by the debtor, but also by shareholders, creditors and the Works Council. The starting point must always be that the settlement must lead to a better result than bankruptcy. The party offering the settlement must prove this.

The WHOA also provides for the creation of two new positions in insolvency law: the restructuring expert and the observer.

The restructuring expert supervises the settlement and offers the settlement, with or without the debtor. The observer sees to it - at the request of the creditors - that the agreement does indeed lead to the best arrangement for the creditors. If WHOA proceedings are opened by shareholders, creditors or the Works Council, this always sees a request for the appointment of a restructuring expert.

The agreement can be offered in so-called classes, the class division being made by the debtor. If one class agrees by a majority vote as well as by a majority of the capital represented in the class, the accord can, as a rule, be ratified. The other classes are then also bound. We call this a cross class cram down.

The agreement may also provide for the modification of current agreements and (if the contracting party does not consent) the termination of those agreements.

Finally, the legislature has also allowed financial compensation other than money to be offered. Consider a conversion of debt into equity(debt for equity swap).

After the accord is homologated, all creditors have an enforceable title as to the amount due to them.

Preparation

The WHOA requires thorough preparation. A lot has to be mapped out in order to determine which agreement will be presented to the creditors as well as to assess the chances of success. To start WHOA proceedings, the following conditions must first be met:

1. It must be a company (i.e. not a natural person without a profession or business) that is not a bank or insurer;
2. There is talk of impending bankruptcy;
3. There must be a generally viable business (based on valuations);

It is then necessary to determine which arrangement should be presented to the creditors.

1. The basic principle here is that the arrangement to be offered must be more favorable to the creditors than the expected distribution in bankruptcy or liquidation. For small creditors, even they must be offered at least 20% value of their claim.  
2. It is also necessary to assess whether the liquidity problems are caused by excessive debt or, on the contrary, by ongoing contracts weighing too heavily on the company.
3. Of course, the creditors' burden should also be brought into the picture so that it can be assessed whether the settlement is likely to succeed.

It is important to involve a tax specialist and/or accountant at this stage in connection with the necessary forecasts and valuations of the company.

At this stage, the debtor can also already make a draft class division. There are no guidelines for this except that "small creditors" must be taken into account. Small creditors are creditors with a claim for goods or services rendered or tort claims that have fewer than 50 employees.   

If everything is properly prepared, the agreement can be offered.

The opening of a WHOA proceeding occurs by the debtor filing an opening statement with the clerk of the court. It follows from the procedural rules that it must then also be indicated whether the debtor wishes to open closed or public WHOA proceedings.

The court may then be asked to determine some issues in advance:

1. The content of the information contained in the agreement, including the values and assumptions and assumptions used by the debtor;
2. the class division;
3. admission to the vote of a creditor or shareholder;
4. the procedure for voting and within what time frame the vote would reasonably be allowed to take place
5. whether, if all classes agree to the agreement, a ground for rejection would still prevent the homologation of the agreement;
6. Whether, if not all classes agree to the agreement, a ground for rejection would still prevent the homologation of the agreement,
7. or, the board of a legal entity refuses, without good reason, to consent to putting the agreement to a vote or the filing of the homologation petition.

Creditors are entitled to submit their views on these decisions. The court will consider those views in deciding whether to adopt one of the circumstances listed above. The decision is then binding on all creditors who have been given the opportunity to submit views.

Offering and voting

The agreement is then submitted to the creditors at the registry for 8 days. Voting is done in classes.

For voting purposes, each creditor has one vote within its class. If the majority (2/3) within the class have agreed and represent more than 2/3 of the indebtedness of that class, then the agreement has been adopted by that class.

A good class cram down in important because one consenting class can cause all classes to be bound by the agreement. We call that a cross class cram down.

Creditors who oppose homologation of the composition and have valid reasons for doing so have an obligation to protest! If they do not complain to the restructuring expert or the debtor in time, they are no longer entitled to invoke a ground for rejection for homologation. Creditors must therefore be sharp and stay sharp.

Homologation

If at least one class agrees, then the accord can be submitted for homologation. The court then tests whether the agreement meets the requirements and whether there are no more (well-founded) objections to the agreement. The court then declares the agreement generally binding. We call this homologation.

After the court pronounces the homologation of the accord, the accord is generally binding on all creditors to whom the accord was offered. The judgment of homologation then provides an enforceable title for the company's creditors.

If the business owner then executes the agreement, it is then rid of its debts. The accord is then successful and the company is saved. Without bankruptcy.

Discussion point.

There is much debate about whether WHOA is the most appropriate procedure for sole proprietors and SMEs. In particular, this has to do with the costs that have to be incurred to arrive at a final homologation. For example, valuations and appraisals must be prepared.

Legal assistance is also desired to manage the settlement and follow the proper procedure to the appropriate judicial authority.

Finally, the debtor must pay the costs of the restructuring expert, unless the restructuring expert was appointed at the request of the joint creditors.

Also, the threshold of a distribution of at least 20% to small creditors is too high for some companies and only a lower percentage can be offered.

That makes that offering a non-binding agreement, a normal out-of-court settlement, still seems to me to be a good restructuring option for those parties as well. If such an agreement fails, they can always request that a restructuring expert be appointed by the court to push the agreement through after all.

My colleagues and I are available to guide your company through a WHOA settlement as a restructuring expert or legal counsel. We are also available when you are facing a WHOA litigation as a stakeholder.