On 1 January 2023, the long-awaited reform of Swiss corporate law entered into force. Amongst various changes this reform also introduced some new regulations regarding the duties of the board of directors when a company is in financial distress. While some of these new regulations bring clarification to long disputed questions, others introduce new obligations which seem rather impractical and it has yet to be seen, whether they will overall support corporate restructurings or not. This short article tries to briefly highlight significant changes and potential points of uncertainty regarding such new regulations.
It is important noting that there is no group perspective in Swiss insolvency law. The board of directors of a company therefore needs to safeguard the interests of its respective legal entity (and its creditors) only and may not take decisions in the benefit of “greater good” of the group. Existing intra-group relationships and dependencies must in financial distress be scrutinized and treated as if they were regular third-party relationships. This applies in particular to up-/cross-stream loans and payments such as in cash pools.
Emphasis on Liquidity
Already under the previous law, if the board could not reasonably expect the continuation of the company’s business activities during the next 12 months (the company thus not being a going concern anymore), typically due to a lack of liquidity, financial accounting had to switch to – usually substantially lower – liquidation values (art. 958a II Swiss Code of Obligations (CO)), and the board of directors in principle had to file for bankruptcy if the interim balance sheet applying liquidation values showed an over-indebtedness. Lack of liquidity is thus one of the main reasons for corporate bankruptcies in Switzerland.
The reform takes this into account by introducing a new art. 725 CO, according to which the board must supervise the liquidity of the company and, if there is a threat of illiquidity, take appropriate measures. Though such duties are not new, as they could so far already be derived from the board’s general duty of care, they are now explicitly set forth in the law, and remind boards of the paramount importance of liquidity. While there is no legal definition of illiquidity under Swiss law, temporary failure to meet payment deadlines is not regarded as illiquidity. Whether illiquidity, or rather a threat of illiquidity, exists should rather be measured based on the company’s expected ability to pay its debts during the next twelve months (and thus its expected access to sufficient liquidity to do so). A threat of illiquidity and the consequently necessary appropriate measures should anyhow not be regarded as clear cut criteria but rather as a spectrum where with increasing indicators of liquidity problems, the board should gradually resolve on more and more drastic measures. Such measures can range from the liquidation of unnecessary assets and operative measures such as terminations of employment contracts, which are within the boards’ responsibility, to measures affecting the company’s share capital (e.g., capital increase), which require a shareholders’ meeting. Despite the fact that the obligation to draw up a liquidity plan as provided for in the draft bill was finally not included in the new law, such plan (which may be more or less granular) is in most cases not only helpful but simply required in order for the board to be able to assess the expected development of the company’s liquidity situation and take the appropriate measures in time.
As a rather concerning point, with the new art. 725 CO, also a provision was introduced that “the board files for composition proceedings if required”. Legal doctrine is rightfully of the view that this provision does not introduce an additional obligation of the board to file for composition proceedings in case of threatened or existing liquidity problems. As the exact interpretation of this provision by the courts is not yet certain, however, we recommend that in potential distress situations the board seeks legal advice at an early stage. Particularly also, since the new law (in case of a threat of illiquidity as well as capital loss or over-indebtedness) expects the board to take action “with the required urgency”. This term is not defined as well and therefore some scholars consider this provision superfluent, but the board should make sure that there is proof of the board’s quick response later, for example by holding board meetings more often and have them properly documented.
New Regulations and Clarifications regarding Capital Loss
Already under the previous law, if a company‘s annual balance sheet showed that the company’s net assets no longer covered half of (i) its nominal share capital and (ii) the statutory capital reserve and statutory profit reserve (a so-called “capital loss”), then this triggered additional obligations for the board. The new law clarifies that for calculating the relevant statutory capital reserve and statutory profit reserve only the blocked part of such reserves (i.e. the part not freely distributable) counts in the calculation and not their entire amount. As no more than reserves in the amount of 50% of the nominal share capital are blocked (or 20% for holding companies), this means that a capital loss may only exist if the net assets fall below 75% of the nominal share capital (or 60% of the nominal share capital for holding companies). This is a welcome clarification, as this question was debated under the old law.
In case of a capital loss, the old law obligated the board to immediately call a shareholders’ meeting to resolve on restructuring measures. Under the new art. 725a CO the board is now obligated to implement restructuring measures itself and propose further measures to the shareholders’ meeting only if necessary. This means that the focus to react to a capital loss lies more with the board and may also spare a struggling company the extra expense to call a shareholders’ meeting, which is a welcome change.
Additionally, a company facing a capital loss must newly have its financial statements reviewed (limited audit) by an external auditor even if it otherwise validly opted out from an audit. While this new duty is meant to ensure that the board does not depict the financial situation of the company in its financial statements better than it actually is, it is questionable, whether this new requirement will have much influence on the restructuring of the company (apart from triggering additional costs).
As mentioned above, as in case of threatened illiquidity, also in case of a capital loss, the board has to act with the required urgency. Interpretations vary from a duty to take action within a few weeks up to one quarter. In our view, the appropriate timing needs to be assessed individually based on the intensity of the capital loss and the complexity of the intended measures.
New Rules regarding Suspected Over-indebtedness
As under the previous law, if the board has, at any time, a justified concern that the liabilities of the company are no longer covered by its assets (so-called “over-indebtedness”), it must prepare interim accounts at both going concern and liquidation values and have them audited by its auditor.
The new law now explicitly states that if the board reasonably expects the business to be continued (i.e., if the going concern assumption still applies) and the balance sheet at going concern value does not show an over-indebtedness, the interim accounts at liquidation value can be omitted. If on the other hand the going concern assumption does not apply anymore, the interim accounts at going concern value can be omitted (and are no longer decisive). The courts’ practices vary whether they request an audit of the interim accounts even if an over-indebtedness is very obvious and the board files for bankruptcy.
If the interim accounts show an over-indebtedness, the board must file for bankruptcy or for composition proceedings (similar to chapter 11 in the US) (art. 725b III CO), unless creditors subordinate their claims in an amount sufficient to cover the over-indebtedness (art. 725b IV 1 CO). Such subordinations need to be open-ended and also include a prohibition for the creditor to set-off the subordinated claim.
Under previous case law, in case of over-indebtedness the board could delay a bankruptcy filing during a grace period if it promptly implemented restructuring measures and there was a realistic prospect of financial recovery. The duration of such grace period was much debated but often 4-6 weeks were indicated. The revision codified the concept of a grace period, stating that the board may delay a bankruptcy filing if there is realistic prospect that the over-indebtedness is cured within 90 days from the date the interim financial statements are available and if the creditors’ claims are not additionally jeopardized (art. 725b IV 2 CO). While the duration of the grace period has been arguably extended, the new law rather narrows room for manoeuvre as the over-indebtedness must actually be cured within the grace period (i.e., a delay is not permitted if the effect of the implemented measures unfolds later than 90 days) and does not allow for any extension of the grace period. Due to the uncertainty of the assessment of realistic prospect in hindsight, it might under the circumstances be preferable to file for composition proceedings when facing an over-indebtedness.
On a positive note, the new art. 634a CO clarifies that a debt- equity swap is permitted even in situations where the company is over-indebted – which was disputed by some scholars under the old law.
Conclusion
The provisions regarding financial distress of the revised Swiss corporate law bring some welcome clarifications but raise new questions and concerns at the same time. While the new focus on liquidity makes sense and the supported restructuring by means of debt-equity-swap are welcome, the lack of safe harbour rules in case of financial distress causes uncertainty and thus bears the danger of resources of already struggling companies being allocated ineffectively. Major clarifications by case law may take ample time. Meanwhile, the already mentioned composition proceedings may thus sometimes be the preferred solution.
