Corporate Recovery and Insolvency in Iceland
By Eiríkur Elís Þorláksson & Benedetto Valur Nardini
Posted: 2nd October 2017 10:151 Issues Arising When a Company is in Financial Difficulties
1.1 How does a creditor take security over assets in Iceland?
Security interests in Iceland are commonly divided into possessory and non-possessory rights, based on whether or not the party receiving the pledge takes possession of the pledged asset.
Possessory pledges take effect upon the delivery of the pledged assets, e.g. when a bond is handed over.
The two most common types of non-possessory pledges are mortgage bonds and letters of insurance. Mortgage bonds are bonds issued with certain assets, often real estate, set as collateral, and they are generally tradable as securities. However, taking security over assets after (or before) a debt has occurred, e.g. to insure against pre-existing and future debts in an ongoing business relationship, is done by requesting the issuance of a letter of insurance.
A letter of insurance is similar to a fidelity bond in that it is generally non-interest bearing, non-tradable and does not, in itself, create a claim. According to Act No. 75/1997, on Contractual Pledges, the pledged asset must be specified; the issuer cannot pledge all his assets or a specific collection of assets, with certain exceptions. The insured debt can be a certain amount, a certain maximum amount or all debt between the parties.
Furthermore, a party selling a product may retain the title to the product, to secure either his right to remuneration or the repayment of a loan granted by him to the buyer to facilitate the purchase.
Floating charges can be set upon specific groups of assets, such as the movable machinery of a contractor, or the inventory of a retailer, but only as specifically allowed by law.
1.2 In what circumstances might transactions entered into whilst the company is in financial difficulties be vulnerable to attack and what remedies are available from the court?
The Bankruptcy Act, No. 21/1991 (hereinafter the “Bankruptcy Act”), describes various circumstances in which measures by a company in financial difficulties may be rescinded. The circumstance may be either subjective, i.e. dependent on whether the other party to the transaction was in good faith, or objective.
The general subjective rule is that, during composition and bankruptcy proceedings, rescission may be claimed of measures which improperly benefit a creditor at the expense of other creditors, measures that thwart the possibilities of creditors for obtaining satisfaction from the bankrupt party’s assets, and measures that increase the bankrupt party’s liabilities to the detriment of his creditors, if the bankrupt party was at that time insolvent or became insolvent as a result of the measure, and provided that the party benefiting from the measure knew or should have known of the bankrupt party’s insolvency or the conditions that rendered the measure improper.
There are also objective circumstances where rescission is possible, e.g. in the case of gifts, unreasonably large wage-payments to relatives, unusual or early debt repayments and payments made after the reference date, as decided by the Bankruptcy Act. In most cases, the rescission period is limited to the six months preceding the reference date, but can be extended to up to 24 months if the transaction was made to a related party (such as companies in the same group) or if the company was already insolvent at the time.
The trustee in bankruptcy has six months to initiate legal actions from the time the claim could first have been made. This period does, however, not begin until the period for stating claims is over.
1.3 What are the liabilities of directors (in particular civil, criminal or disqualification) for continuing to trade whilst a company is in financial difficulties in Iceland?
According to the Bankruptcy Act, a debtor who is required to keep accounts has a duty to file for bankruptcy once he is unable to honour his financial obligations to his creditors in full when they are due, provided that it is not deemed likely that his payment difficulties will be over within a short period of time.
In the case of a company, those who are qualified to decide to seek bankruptcy on its behalf are duty bound to do so without delay, and may be liable to pay damages to the debtor’s creditors if they suffer any losses as a result of a delay in doing so. According to Act No. 2/1995, on Public Limited Companies (hereinafter the “Company Act”), it is the board of directors that bears this responsibility.
In the case of credit institutions, which are not subject to the general bankruptcy rules, their directors are obligated to notify the Financial Supervisory Authority under such circumstances.
While failing to comply with an obligation to seek bankruptcy is not in itself a criminal offence, various actions taken under such circumstances may often be, e.g. misrepresenting the financial status of the company during negotiations may amount to criminal fraud.
Directors, who are, in connection with business operations, found guilty of breaching the Icelandic Penal Code, No. 19/1940, or the Company Act, are disqualified from serving as directors for the next three years.
2 Formal Procedures
2.1 What are the main types of formal procedures available for companies in financialdifficulties in Iceland and can any of these procedures be used in a restructuring?
The main formal procedure is to file for bankruptcy at the district court. If a judge accepts the request, the bankruptcy estate takes over all the financial rights and obligations of the company and a trustee, appointed by the court, assumes control of its liquidation as well as any ongoing business operations. More than one trustee may be appointed if deemed necessary. Bankruptcy is generally not a part of a company’s restructuring, but the Bankruptcy Act does allow a debtor to seek a composition agreement with his creditors even after bankruptcy proceedings have started.
A company in financial difficulties has the option of two formal procedures for restructuring its debts.
Firstly, it can apply to the district court for a moratorium, in which to seek reorganisation of its finances with the assistance of a lawyer or an authorised public auditor of its own choosing. During a moratorium, no debts shall generally be paid unless it is clear they would be paid in case of bankruptcy.
Secondly, it can apply for a licence to seek composition with its creditors, with the assistance of a court-appointed agent. In composition, a certain majority of creditors can make a binding agreement with the company on the settlement of its debts. A valid composition agreement is also binding upon the debtor’s other creditors, with certain exceptions.
Financial institutions can seek a moratorium or composition in a similar manner to other companies but they are subject to a different bankruptcy process, i.e. winding-up proceedings, according to the Act on Financial Undertakings No. 161/2002 (hereinafter the “Act on Financial Undertakings”), where the district court appoints a winding-up committee of up to five people who shall work under the supervision of the Financial Supervisory Authority.
2.2 What are the tests for insolvency in Iceland?
As described in the answer to question 1.3, a debtor who is required to keep accounts, such as a company, has a duty to file for bankruptcy once he is unable to honour his debts to his creditors in full when they become due, provided that it is not deemed likely that his payment difficulties will be over within a short period of time.
Accordingly, when measuring solvency, the ability to cover debts is the most important factor. In order to evaluate whether the payment difficulties are only temporary, the debt-to-asset ratio can be an indicator of future solvency. Financial institutions, however, are required to maintain a certain equity ratio and may be subject to winding-up proceedings if they fail to do so.
2.3 On what grounds can the company be placed into each procedure?
A company which is insolvent as described in the answer to question 2.2 is obligated to file for bankruptcy at the district court in its home venue.
Creditors also have various grounds on which to demand the bankruptcy of a debtor, unless the debtor is able to show that he is solvent. These grounds are (i) if a debtor has fled the country or is in hiding for financial reasons, (ii) if the debtor has been the subject of an unsuccessful attachment or debt enforcement proceedings in the last three months, (iii) if the debtor has been granted a moratorium which has expired in the last month, (iv) if the debtor’s licence to seek composition has been cancelled in the last month, and (v) if the debtor has not, within three weeks, complied with a creditor’s demand that he declare in writing that he will be able to pay his debt to the creditor.
Regarding a moratorium, the district court judge shall deny such requests if (i) a request for bankruptcy is delivered before the moratorium request, (ii) the debtor has been granted a moratorium or successfully sought composition in the last three years, (iii) the debtor is obviously obligated to file for bankruptcy, (iv) the debtor is not in serious financial difficulties or has not shown he is, (v) the plans for negotiation offered by the debtor are unrealistic, unclear or unlikely to succeed, (vi) there is a reasonable suspicion that the debtor is being dishonest, and (vii) the request is otherwise insufficient or the chosen assistant unqualified.
Similar conditions apply to requests for composition as to requests for a moratorium, the main exception being that insolvency does not preclude a debtor being granted composition.
2.4 Please describe briefly how the company is placed into each procedure.
Moratorium, composition and bankruptcy proceedings all begin when a district court judge accepts a written request for the appropriate procedure. Moratorium and composition requests are made by the debtor; bankruptcy requests by either the debtor or his creditors, as described in the answer to question 2.3.
Decisions by the district court to deny requests for bankruptcy proceedings or a licence to seek composition can be appealed to the Supreme Court, but decisions to deny a request for moratorium cannot.
2.5 What notifications, meetings and publications are required after the company has been placed into each procedure?
A moratorium decision shall be immediately followed by a written invitation to all known creditors to a meeting with the assistant, where the assistant shall supply a detailed register of the debtor’s assets and liabilities. Furthermore, the assistant shall inform the creditors of the plan for reorganisation and ask for their input on the matter. Extensions to the moratorium may be granted upon written submissions to the district court.
During composition, the agent shall, immediately after being appointed, issue (twice) in the Law and Ministerial Gazette (hereinafter the “Gazette”) a notice to creditors to declare themselves to the agent within four weeks. All known creditors shall also be sent a personal notice. Once the period to state claims is over, the agent shall compile of list of claims and notify any creditor with whom he disagrees regarding the validity of the claim or the creditor’s right to vote on composition. A meeting to decide on the composition proposal shall be held within four weeks after the end of the period to submit statements of claims. The district court shall be notified if a composition is not reached and an advertisement shall be published in the Gazette. A successful composition agreement shall be put before the district court for confirmation or refusal.
The bankruptcy process begins in a similar manner to the composition process, especially regarding the declarations of claims to the agent (or trustee, in the case of bankruptcy), the handling of claims and notifications to creditors, although the period to state claims is longer, generally two months. A meeting to discuss the received claims shall be held within a month after the end of the submission period, as announced in the notice to creditors. Other meetings shall be announced in the Gazette with at least a week’s notice or by a personal notice to each creditor that is eligible to take part. The trustee handles all notifications to the authorities which would previously have been handled by the management body.
Before selling a property of the estate which creditors have security interests in, the trustee must, unless those creditors are sure to receive their payments in full, invite those creditors to a meeting of lien holders to vote on the matter.
2.6 Are “pre-packaged” sales possible?
The formal procedures available do not account for pre-packaged sales. Negotiating for the result of bankruptcy proceedings or composition beforehand, at least to some extent, is not forbidden and may be advisable, but all the normal procedures, including notifications and waiting periods, must be followed.
3.1 Are unsecured creditors free to enforce their rights in each procedure?
The moratorium, composition and bankruptcy procedures all preclude unsecured creditors from enforcing their claims.
3.2 Can secured creditors enforce their security in each procedure?
Secured creditors are awarded certain protection and priority rights, but they can generally not enforce their rights until the end of each procedure or the liquidation of the secured asset.
3.3 Can creditors set off sums owed by them to the company against amounts owed by the company to them in each procedure?
A moratorium does not limit a creditor’s right to set off claims.
During bankruptcy proceedings, a creditor can set off claims as long as (i) he acquired his claim no later than three months before the reference date, (ii) he neither knew or should have known that the company was insolvent, (iii) he did not acquire the claim in order to set it off against another claim, and (iv) the company’s claim against him came into being before the reference date.
Low-priority claims against the bankrupt company, such as claims for interest payments and gifts, can only be used to set off to the extent that the estate’s assets suffice to cover them upon distribution. Conditional claims can only be used to set off once the condition is fulfilled.
Upon the conclusion of a composition agreement, claims that could have been settled in the manner described above if the debtor had been declared bankrupt will not be affected by the composition.
4 Continuing the Business
4.1 Who controls the company in each procedure? In particular, please describe briefly the effect of the procedures on directors and shareholders.
During moratorium and composition proceedings, shareholders and the management body maintain their positions formally, but decisions regarding the company’s assets and obligations are severely limited and always subject to the approval of the assistant/agent.
During bankruptcy proceedings the estate takes over all financial rights and obligations of the company, directors are relieved of their duties and shareholders become holders of very low-priority claims.
4.2 How does the company finance these procedures?
The costs of moratorium and composition proceedings are financed by the company (debtor) itself and are, in case bankruptcy follows, considered priority claims.
The costs of bankruptcy proceedings are borne by the estate, but if bankruptcy was requested by a creditor, and that creditor’s claim is accepted by the trustee, the creditor is responsible for any costs of the proceedings which the funds of the estate do not suffice to cover.
4.3 What is the effect of each procedure on employees?
None of the three procedures necessarily affect employees. However, all the procedures, even if successful in ensuring the continuation of business operations, are likely to involve measures to cut costs, such as the termination of employee agreements. Of the three, bankruptcy proceedings are most likely to lead to an end of business activities and employment opportunities.
4.4 What effect does the commencement of any procedure have on contracts with the company and can the company terminate contracts during each procedure?
Moratorium and composition proceedings do not, in general, affect contracts made with the company. However, composition proceedings allow for the rescission of transactions entered into whilst the company was in financial difficulties, as seen in the answer to question 1.2.
Bankruptcy proceedings have the same effect regarding transactions made during financial difficulties, but also entail a general right for the estate to choose whether or not to take over the rights and obligations under mutual contracts.
5.1 Broadly, how do creditors claim amounts owed to them in each procedure?
During a moratorium the creditors need not state their claims. The debtor’s assistant will call the creditors to a meeting where he will exhibit an exhaustive and itemised list of the debtor’s assets and liabilities, estimating the value of each asset and stating the computed amount of each liability as at the reference date. The assistant will, among other things, describe in what manner he deems reorganisation of the debtor’s finances possible. Following that the debtor’s assistant will, during the meeting, seek the opinions of the creditors relating to his plans, and their proposals as regards the measures to be taken.
Composition claims shall be declared to the composition agent within four weeks from the period he first publishes a notice in the Gazette calling upon the debtor’s creditors to do so. In addition, the agent will send all known composition creditors a notification providing the same information as stated in the published notice. A creditor shall prepare his statement of claim in the same manner as in the case of bankruptcy. Only the creditors who have stated their claims to the composition agent within the appropriate period have a right to vote on the debtor’s composition proposal. A failure to state a claim within the period does not have the effect of cancelling the claim. The debtor shall settle all claims affected by the composition agreement, regardless of whether they were submitted or not.
During bankruptcy proceedings, a creditor must submit a written statement of his claim to the trustee in bankruptcy within a specific period, usually two months, from the first publication of proclamation in the Gazette. Any documents supporting the claim shall be enclosed with the statement. If a claim against a bankruptcy estate is not stated to the trustee in bankruptcy before the aforementioned time period is over, it shall, with very few exceptions, be cancelled with respect to the estate. Consequently, that creditor will not receive any payments from the estate when its assets are distributed.
5.2 What is the ranking of claims in each procedure? In particular, do any specific types of claim have preferential status?
During bankruptcy proceedings, certain claims are given priority. A composition agreement does not affect certain priority claims. During a moratorium a debtor is allowed to pay claims to the extent it may be certain that the obligation would be fulfilled considering its rank in the order of preference in the event of a bankruptcy. The priority ranking of claims against a bankruptcy estate is, roughly, as follows:
1) Assets and interests belonging to a third party in the possession of the bankruptcy estate.
2) Costs of the bankruptcy proceedings.
3) Claims arising against the bankruptcy estate after the reference date due to agreements concluded by the trustee in bankruptcy or damages to others caused by the bankruptcy estate.
4) Claims arising after the reference date due to approved measures during a moratorium or a composition.
5) Claims secured in the bankruptcy estate’s assets.
6) Claims for wages, pension contributions and all associated employee claims etc.
7) Claims for remuneration to a moratorium assistant or composition agent, and for the refund of their necessary outlays after the reference date.
8) Deposits held with financial undertakings pursuant to the Act on Financial Undertakings.
9) General claims.
10) Claims for interest and various costs arising against the bankruptcy estate after the bankruptcy proceedings.
5.3 Are tax liabilities incurred during each procedure?
Yes, certain tax liabilities may be incurred during moratorium, composition and bankruptcy proceedings.
6 Ending the Formal Procedure
6.1 What happens at the end of each procedure?
A successful moratorium, where the debtor’s assistant has managed to reorganise the company’s finances, has the effect that the restrictions on the debtor from making certain dispositions are lifted. The same applies following a successful composition, provided that the debtor fulfils his obligations in accordance with the composition agreement. If the moratorium or composition are unsuccessful the debtor is generally forced to petition for bankruptcy proceedings. Bankruptcy proceedings conclude with the end of the corporate existence of the company, and the trustee in bankruptcy is relived from his duties.
7.1 Is a formal statutory procedure available to achieve a restructuring of the company’s debts in Iceland and, if so, to what extent is it supervised by the court?
As described in the answer to question 2.1, there are two formal statutory procedures available to companies who need to restructure their debts: a moratorium to seek financial reorganisation; and a licence to seek a binding composition agreement with creditors.
In both cases, the company must send a written request to the district court in its home venue, with detailed information about the company, its debts and why its request should be granted. A company requesting a moratorium may hire its own assistant to assist with the reorganisation, as long as the assistant fulfils certain qualifications, but a company in composition is appointed an agent by the court.
The procedures are subject to the approval of the district court, and when a composition agreement has been reached it is put to the district court for confirmation or refusal. Otherwise, during both procedures it is the assistant/agent who supervises the procedure, not the court.
7.2 If such a procedure is available, is a debt for equity swap possible and how are existing shareholders dealt with?
A moratorium is a short respite for a company from paying debts, during which it seeks to reorganise its finances, with professional assistance, by freely negotiating with creditors. As such, debt-for-equity swaps are possible during a formal moratorium, much like any other legal reorganisation options, but subject to the same conditions as if a moratorium were not taking place, e.g. the agreement of the shareholders’ meeting.
There are no specific legal options available to facilitate debt for equity swaps during formal financial reorganisation procedures.
7.3 Is a moratorium available as part of the restructuring process?
Both the moratorium for financial organisation and the composition process involve a moratorium on payments.
7.4 Can dissenting creditors be crammed down?
Creditors cannot be crammed down as a result of the formal moratorium process, but during composition agreements, a certain majority of creditors can agree to terms regarding the relinquishing of claims which are binding upon those creditors who object to the agreement.
However, creditors do not have to relinquish their claims to a greater degree than others, or be subject to a less favourable payment period. Composition agreements that include disproportionately unfavourable terms must be accepted by those affected by those terms in order to be confirmed by the district court.
7.5 Is consent needed from other stakeholders for a restructuring?
Restructuring during a moratorium may require the consent of other stakeholders, such as shareholders, if it involves decisions which would normally require such consent.
Composition, on the other hand, does not require the consent of other stakeholders than the creditors who declared valid claims during the composition proceedings.
8.1 What would be the approach in Iceland to recognising a procedure started in another jurisdiction?
Along with Denmark, Sweden, Norway and Finland, Iceland is a party to the Nordic Bankruptcy Convention, according to which a bankruptcy opened in one Nordic country comprises all assets and liabilities that the bankrupt party possesses in the other Nordic countries.
Furthermore, Iceland has implemented the European Parliament and Council Directive 2001/24/EC, which aims to ensure that credit institutions are subject to a single winding-up procedure.
Otherwise, procedures for bankruptcy and reconstruction started in another jurisdiction would not preclude e.g. the execution of liens or independent bankruptcy proceedings in Iceland.
Atlantik Legal Services
Atlantik Legal Services is an Icelandic law firm that specialises in servicing companies and investors in the fields of commercial litigation, securities law, corporate law and tax law.
The firm has an experienced M&A team that has been involved in complex cross-border deals and employs both legal and financial specialists. The services provided include advice on debt and tax restructuring, due diligence, mergers and acquisitions, financing and insolvency.
The company has over the past few years represented multinational enterprises in complex litigation following the collapse of the Icelandic banking system in 2008. Furthermore, the company has assisted foreign entities in acquiring Icelandic companies as well as assisting Icelandic companies working on large scale international projects in Europe and Africa.
Eiríkur Elís Þorláksson
Atlantik Legal Services
Höfðatorg, 105 Reykjavík
Tel: +354 415 4725
Eiríkur Elís Þorláksson is an assistant professor at Reykjavík University School of Law and a litigator at Atlantik Legal Services. He graduated with a Cand. jur. degree from the University of Iceland, Faculty of Law, in 2001, and received an LL.M. degree in International Finance Law from King’s College London in 2008. His areas of expertise include litigation, insolvency law, commercial law and private international law. Eiríkur has been a member of the Icelandic Bar Association since 2001 and an attorney to the Supreme Court of Iceland since 2008.
Benedetto Valur Nardini
Atlantik Legal Services
Höfðatorg, 105 Reykjavík
Tel: +354 415 4725
Benedetto Valur Nardini is a partner at Atlantic Legal Services. He graduated with a Cand. jur. in 2006 from the University of Iceland, Faculty of Law. Benedetto is a corporate attorney with extensive experience in corporate planning and restructuring. He specialises in general corporate law, financing and securities law, competition law, contract drafting and negotiation, insolvency law, insurance and re-insurance, contracting and real estate laws. Benedetto is a District Court Attorney and a member of the Icelandic Bar Association.