New rules allow for share dilution without shareholder consent in companies with payment difficulties

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Published 20 September 2022
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On 1 August this year, the new Swedish Corporate Restructuring Act (Sw. lagen (2022:964) om företagsrekonstruktion) entered into force. The Act contains many new features compared to previous legislation and provides the administrator with several new tools for the purpose of handling the debtor’s financial difficulties and ensuring the survival of the business. Among the new features is the possibility of stipulating, in a restructuring plan, that new shares shall be issued in the debtor company. A consequence of this, which has not received much attention, is that it can lead to severe dilution of the existing shares without shareholder consent. Advokat Johan Linder, from Advokatfirman Schjødt’s business group for restructuring and insolvency, describes in the following what normally applies and what the new rules may entail.

If a limited company needs new equity through issuance of new shares, the main rule is that such a share issue is made with pre-emption rights for the existing shareholders in proportion to their shareholdings. The shareholder participating in such a share issue with his full shareholding will maintain his shareholding in the company, while an owner that chooses not to participate in the share issue will find his proportion of the shareholding reduced. Such a reduction in ownership is usually referred to as dilution. The more new shares that are issued, the greater the diluting effect.

In the case of a pre-emption rights issuance, the dilution is thus a consequence of the individual shareholder’s own choice, even though this may be influenced by, for example, financial possibilities to participate in the share issue. However, it is also possible to dilute existing shareholders without their consent, namely through a targeted new share issue.

The Swedish Companies Act (Sw. aktiebolagslagen (2005:551)) contains detailed regulations on what a proposal for issuance of new shares shall contain. If it is a question of a targeted new share issue, i.e., a share issue where the existing shareholders do not have pre-emption rights, the reasons for this and the basis for the subscription price shall appear in the proposal. If the intention is that the payment for shares can be made by way of set-off against a claim on the company, this must be specifically stated and the circumstances important for the assessment of the provision must be stated, as well as the identity of the creditor, the amount of the claim and the amount to be set-off. If the proposal results in the share capital or the number of shares being increased beyond the limits specified in the articles of association, these limits must be adjusted through a decision to amend the articles of association.

A decision on a targeted new share issue requires a 2/3 majority, calculated based on both the number of votes cast and the shares represented at the shareholder meeting. In public limited companies, and subsidiaries thereof, the majority requirement is 9/10 if the share issue is targeted to legal or natural persons who are related to the issuing company or to employees of the company or to another company in the same group.

Corresponding rules apply to issues of warrants and convertible instruments.

These decisions all require that a qualified majority of shareholders can force a dilution against the will of the minority, provided however that a general shareholder meeting may never make a decision aimed at giving undue advantage to a shareholder according to the so-called general clause.

On 1 August this year, the new Swedish Corporate Restructuring Act entered into force, introducing rules that provide the possibility to dilute shares even without a single shareholder supporting the proposal. This primarily applies to larger companies, i.e., companies with at least 250 employees and an annual turnover exceeding EUR 50 million or a balance sheet total exceeding EUR 43 million. However, depending on the circumstances, it may also apply to smaller companies.

An obvious prerequisite for the new rules to be applicable is that a decision has been made to initiate a corporate restructuring, which in turn presupposes that the company in question has payment difficulties or will soon have such problems. An additional condition for initiating a corporate restructuring is that there are reasonable grounds to assume that a restructuring can secure the viability of the business.

Within the framework of a corporate restructuring, the debtor, the company, can request a so-called plan negotiation where the parties concerned, mainly the creditors, can take a stand on the restructuring plan that has been prepared. In contrast to the previous legislation, however, not only creditors without preferential rights (so-called unsecured creditors) are entitled to participate and vote on the plan, but any party that is directly affected by the proposed plan, which may include the owners. The affected parties shall be divided into classes, where the owners and others with similar interests in that case shall form a separate class.

The main rule is that a restructuring plan shall be supported by a 2/3 majority (both in terms of number and amount) in all classes in order to be deemed adopted and that it then, as a starting point, shall also be established by the court. However, it is also possible to establish the plan even though the required majority has not been achieved in all classes (so-called cross-class cram-down). For such a cram-down to be possible, a number of conditions must be met and one of these is that the debtor agrees to it. However, this last condition does not apply to large companies (see above). Of importance is also which of the classes that did not approve the plan, as the review is based on mutual priority between the parties concerned. A party with a higher priority shall not be put at a disadvantage in favour of someone with a lower priority.

A restructuring plan can contain a variety of measures that become binding on the parties concerned if the plan is adopted. For example, a number of company law measures that normally require a decision by or authorization from the general shareholder meeting can be implemented by being included in a restructuring plan, which is then established. No special decision by the general shareholder meeting is then required. However, the plan must contain the same information as a proposal for a new share issue that is presented at a general shareholder meeting, and the general clause must be respected. If the share issue requires a change to the share capital limits in the articles of association, such a change can also be implemented in the same way.

One measure that can be carried out in this way is a targeted new share issue where payment shall either be made through set-off (so-called debt-to-equity swap) or by ”fresh” money being supplied to the company. If a restructuring plan contains a provision for such a targeted new share issue, which by its nature results in dilution of the existing shares, it is the voting rules described in the Swedish Corporate Restructuring Act that determine whether the share issue will happen and not the majority rules of the Swedish Companies Act. This applies even if, according to the Swedish Companies Act, the share issue would be subject to the requirement of a 9/10 majority (see above).

A share issue that would normally require almost unanimity among the shareholders can therefore, in a situation like the one described, be carried out even without a single shareholder supporting it. The fact that the debtor must agree to a cram-down means in practice that this will not be possible in smaller owner-managed companies, but in slightly larger companies where there is no identity between owner and management it is quite possible, and in the very large companies, as mentioned, consent is not required at all.