Legal regime of conversion of credits into equity (upon creditors' initiative)

On March 3^rd it was enacted Law no. 7/2018, of March 2^nd (L 7/2018), which established the legal regime for the conversion into equity of credits held against a commercial company or under a commercial form with head offices located in Portugal.

This law excludes from its scope the possibility of conversion of credits held against (i) insurance companies, (ii) credit institutions, (iii) financial firms, (iv) investment firms, (v) public companies, (vi) state owned companies (with some exceptions) and (vi) companies with a turnover lower than EUR 1,000,000, resulting from the last approved financial exercise accounts. In addition, it is not admissible the conversion of credits held by state owned companies (with exception of those that are part of the State business sector).

According to this law, and with the exceptions mentioned above, creditors may convert their credits into equity provided that the following requirements are cumulatively met:

1.    the equity of the company is lower to its share capital; and

2.    the company has failed to pay its non-subordinated credits when fallen due for a period of more than 90 days, provided that (i) these are non-subordinated credits that represents more than 10% of subordinated debt; or (ii) if the debt respects to partial redemption instalments of principal or interest, these are non-subordinated credits that represent more than 25% of subordinated debt.

The creditors proposal must be signed by creditors that own , at least, two thirds of all liabilities of the company and must contain (i) a report by a chartered accountant attesting the verification of the requirements abovementioned, (ii) a document that describes the operation, comprising, namely, the envisaged share capital increase to be underwritten by the creditors and, when applicable, the previous share capital decrease to cover losses (in the event it is foreseeable that in a potential liquidation procedure there would be no amounts to be distributed to the shareholders) and (iii) proposals of amendments to company's by-laws, which may include the transformation of the corporate form and the exclusion of all shareholders should their shares be of no value.

Original shareholders have a pre-emption right in the share capital increase, to be paid in cash, which shall be mandatorily used in the redemption of the credits that were to be converted into equity.

Once received, the shareholders have 60 days to resolve on the approval or refusal of the proposal, without prejudice of further amendments being agreed in the meantime between the shareholders and the signatory creditors.

In the event the conversion proposal is refused, the shareholders meeting is not held, or the relevant resolutions are not approved or executed, proposing creditors may apply in a court of law for the judicial ratification of the proposal. The ratification ruling will then be sufficient to implement the share capital decrease or increase, amendments to the by-laws, transformation of the corporate form and exclusion of shareholders, as well as for the relevant registries. Once the period for appeal has elapsed, shareholders will have a 30 days period to acquire the share capital of the company resulting from the proposal, at the par value, as long as the credits held by the proposing creditors against the company are fully satisfied.

If, before registration of the share capital increase or the judicial ratification proceeding, the company is ruled insolvent, the proposal, the shareholders resolution and the judicial ratification proceedings are immediately terminated.

It is also emphasized that this law is related to other legislation recently published with specific concerns regarding the conversion of credits, from which we highlight the publication of Decree-Law no. 79/2017, of 30 June, which established the opportunity offered to shareholders who may convert in share capital its shareholders loan by virtue of share capital increase, as published in our Meet the Law on August 1^st, 2017, with access here, and the new extrajudicial framework for business recovery (Regime Extrajudicial de Recuperação de Empresas), which affords debtors in a difficult economic situation or eminent insolvency a possibility to negotiate an agreement with one or more of their creditors capable of recovering its situation.