The European Lawyer

Spain Banking/Finance

11 Mar 2010

International Acquisition Finance - Spain

Editors: Uría Menéndez - Carlos de Cárdenas Smith and Ángel Pérez López

1. INTRODUCTION
As in other jurisdictions, acquisition finance transactions in Spain involve the lending of funds to an equity investor (often a private equity sponsor and, in some cases, the management of the purchased company) to acquire the target company and refinance its existing debt. The acquisition facility is paid with the cash flows generated by the target company, which are upstreamed to the purchase vehicle through dividend payments, loans and fees, or by pushing down the debt to the target company through a merger with the purchase vehicle. Leveraged acquisitions are attractive to lenders due to the high risk/reward ratios and the lucrative returns available (including up-front fees, interest rates and premiums on prepayments) when compared with other finance transactions. Leveraged acquisitions are also attractive to sponsors because their return is maximised by increasing the leverage, thus reducing the equity invested in the transaction.

Up until June 2007, when the consequences of the liquidity crisis started to affect the markets globally, including Spain, there had been a constant growth in the number of private equity investments in Spain. The increasing expertise and player sophistication, the liquidity in the markets, the strong competition between banks, and the aggressive approach of the sponsors contributed to this steady rise.

Acquisition finance transactions in Spain are similar to those of other countries in continental Europe, although some particularities in Spanish law tailor the structure of the transaction and the finance documents differently. The use of Spanish law to govern acquisition finance documentation has become the rule, and only very large transactions that need to be syndicated throughout Europe are subject to English law. In any event, acquisition finance transactions governed by English law require significant input from Spanish lawyers in many critical areas, such as corporate law (eg, financial assistance rules, corporate benefit), insolvency regulations, security packages and access to expedited enforcement procedures, among other issues.

The following sections of this chapter will focus, from a predominantly practical point of view, on (i) the analysis of the most typical structure in a Spanish acquisition finance transaction, (ii) the main financing alternatives available to the investors, (iii) the main issues relating to a senior facility agreement, (iv) an overview of the security interests available in Spain, and finally (v) some relevant intercreditor issues.

2. TYPICAL STRUCTURE OF A SPANISH ACQUISITION FINANCE TRANSACTION
Generally, investors set up a newly incorporated special-purpose vehicle (‘Newco’). Newco raises the finance to purchase the stock of the target company (‘Target’). Investors in Spain rarely finance the vehicle through high-yield debt issuances, due to corporate law restrictions on the issue of bonds, and the additional complexity and cost required to overcome them. They prefer to fund Newco through a combination of bank facilities and equity, the distribution of which will vary depending on the structure of the transaction and the situation of the credit markets.

An asset deal as opposed to a share deal is rarely used in Spain: an asset deal requires a transfer of each asset in accordance with certain rules and, probably, the consent of each counterparty to the company’s contracts, the change of the licence holder and the obtaining of authorisations. In addition, although it facilitates the acquirer to step-up the basis of the assets, thus generating a tax deductible goodwill, and may reduce indirect taxation, the asset deal usually implies a larger corporate income tax on the seller.

The cash merger structure is not operative in Spain. This occurs where Newco receives a loan and simultaneously merges with Target, with the transferors receiving cash in the merger in exchange for their shares in Target. The stock redemption structure, where Target uses the proceeds of a loan to redeem the stock of the selling shareholders and new shares are issued for the new investor and management, is possible under Spanish law, but the share capital decrease and increase trigger capital duty.

Newco is usually a private limited liability company (sociedad de responsabilidad limitada or ‘SL’). Like corporations (sociedad anónima or ‘SA’), SLs limit shareholders’ liability to the capital invested, but require less formalities to be set up, permit more flexibility on the drafting of their by-laws and require a smaller minimum share capital. As the process of incorporating a new company takes some time, the sponsors normally purchase Newco from companies that sell shelf companies.

Irrespective of the nationality of its shareholders, Newco tends to be a company resident in Spain and subject to Spanish Corporate Income Tax. The reason for this is that the Corporate Income Tax Group regime can be chosen together with Target and its group, provided that 75 per cent of the latter’s share capital is acquired. If a Spanish tax group is created, all member companies are taxed as a group instead of on an individual basis and intra-group transactions are adjusted to determine the group taxable base. The existence of a Spanish tax group allows for interest accrued on the financing documents to offset income generated by Target, thus reducing Corporate Income Tax that would be due if the different companies elected to file their returns on an individual basis.

Newco is funded with equity and with facilities provided by the lenders for the purposes of purchasing Target’s shares. It is advisable that the equity of the company – either in the form of share capital or share premium – represents at least 25 per cent of shareholders’ funds to avoid capital impairment tests and thin-capitalisation limitations. In this regard, Spanish Corporate Income Tax Law accepts a 3:1 thin capitalisation ratio on direct or indirect interest bearing financing entered into with related non resident parties, although such limitation does not apply to financing granted by residents in an EU member state.

In most instances, the initial share capital of Newco will need to be increased. Such increase is subject to one per cent capital duty, although the EU intends to abolish such capital duty on the increase of share capital. The financing usually comprises profit sharing loans (préstamos participativos) granted by investors. Profit sharing loans are deeply subordinated loans in which interest is determined, totally or partially, by reference to an economic variable of the company (profits, turnover, or other similar variables). Profit sharing loans are deemed equity for capital impairment tests set forth by the Spanish Corporate Law.

If Target’s management takes part in the transaction (ie, an MBO), the new investors will probably require the managers to ‘roll-over’ their stake in Target (instead of cashing out their shares as selling shareholders) into Newco. Thus, Newco will exchange the stock held by the managers for newly-issued Newco shares. Such exchange of shares may qualify for roll-over tax benefits under the Spanish laws implementing the Merger Directive, provided that a valid business purpose exists; thus, although Newco is not able to step-up the basis of the contributed shares, normally managers would be able to delay capital gains taxation until the shares in Newco are effectively transferred. Managers are usually not required to provide profit sharing loans in the same proportion as the new investors (sweet equity). New Individual Income Tax Law taxes at marginal rates – up to 43 per cent- interest obtained by an individual related to the paying company, including directors and shareholders holding a five per cent stake in such company.

The use of special-purpose vehicles can generate cash-trap issues which prevent the distribution of dividends or the repayment of intra-group loans that Newco may need to repay the acquisition debt, especially when up-stream loans in favour of Newco are prevented by financial assistance restrictions. This problem may be particularly serious in secondary buy-outs where second or subsequent acquisitions of Target generate an overlap of inactive holding companies. The repayment of intra-group loans to the relevant holding company is also limited by financial assistance rules. In addition, a Spanish company can only pay dividends or distribute voluntary reserves (such as share premium) if (i) the equity (patrimonio neto contable) of the paying company is equal to or higher than its share capital, and accounting losses from previous years, which reduce the net asset value of the company below the share capital, have been offset; (ii) research and development assets not fully amortised (for fiscal years starting before 1 January 2008, start-up expenses and goodwill not fully amortised) also limit dividend distribution capacity; (iii) any specific requirements set out in Target’s by-laws are met; and (iv) the payment is approved by the shareholders’ meeting.

Under Spanish law it is possible to pay interim dividends (dividendos a cuenta), but sufficient earnings must have been generated from the beginning of the current fiscal year. Cash-trap issues arising from the overlap of holding companies may also prevent payment of interim dividends. An interim dividend is declared and distributed before the company’s annual financial statements have been approved by the shareholders. Payment of interim dividends may be approved by the shareholders’ meeting or by the board of directors, if the following conditions are met:

 (i) an accounting statement evidencing that there is sufficient liquidity for the payment must be drafted by the directors; such statement must be subsequently included in the notes to the annual accounts; and
 (ii) the amount to be paid cannot exceed the total profits obtained since the end of the last fiscal year, after deducting losses, if any, from previous fiscal years, amounts that must be allocated to mandatory reserves in compliance with Spanish law or the by-laws of the company, and the estimated tax payable on said profits.

Since 2005, recapitalisation transactions (known as ‘recaps’) have become commonplace. If Target’s cash flows during the first or second year following financial close are sufficient, investors will take advantage of the liquidity available in the capital markets to recapitalise Newco or Target. By means of recaps investors have managed to replace the equity in Newco with additional debt, thus maximising the leverage of the transaction.

3. OVERVIEW OF THE MAIN FINANCING ALTERNATIVES AVAILABLE  TO INVESTORS
In the vast majority of cases, banking facilities are used. Most of the acquisition deals have been financed with credit facilities provided by banks or saving banks (cajas de ahorros), combined with mezzanine or second lien debt provided by such banks or by specialised investors. Only relatively small transactions have not comprised different types of facilities or loans with different levels of seniority and, accordingly, different levels of return and degrees of risk.

Unlike other jurisdictions, such as the United States and the United Kingdom, debt security instruments are not commonly used to finance acquisition deals. SLs cannot issue or guarantee debt instruments. SAs may issue bonds or notes but the procedure is quite cumbersome in contrast with the short time in which acquisition deals must be structured and documented. In addition, given that Spanish law provides, as a general rule, that debt securities issued by an SA cannot exceed the equity (capital plus reserves) of such SA unless certain security interests are granted, the volume of the debt that can be issued will not be sufficient in many transactions. Similar problems are faced by warrant issues for mezzanine or PIK facilities (ie, those where interest accrued is capitalised and not paid until maturity).

Bridge equity facilities have not been used in Spain as far as we are aware. These became popular in leveraged buyouts in the United States and involve banks taking, in addition to their stake in the debt facilities, a portion of the investors’ equity on a short-term basis until permanent equity investors are found. Spanish insolvency regulations increase the risk of this investment, because the banks could qualify as parties related to the insolvent debtor and the claims of such banks under the debt facilities would be subordinated for insolvency purposes if their stake in the equity amounts to or exceeds five per cent in a listed company, or 10 per cent in a private company.

The main types of banking facilities and financing documents used in Spanish acquisition finance deals are the following:

(i) Commitment letters: these are a critical piece of any bid package, and allow private equity funds to bid on a more equal footing with strategic bidders who can self-finance an acquisition. The terms of commitment letters do not differ greatly from other countries and, at least until the 2007 liquidity crisis, have become increasingly ‘borrower-friendly’. Borrowers have achieved certainty of funds in many cases for periods of around three or four months. As the sellers of Target need certainty of closing and have become more reluctant to accept ‘financing out’ provisions in the acquisition agreements, borrowers have also tightened the conditions to funding, although they have failed to eliminate them completely because some formal conditions will still be required. Borrowers have also been able to eliminate ‘MAC’ (Material Adverse Change, affecting the borrower, the investors or the credit markets) clauses and the ‘diligence out’ provisions from certain commitment letters. ‘Market flex’ provisions have been tightened by limiting the changes in pricing, terms and structure that can be arranged without the borrower’s consent, and ‘reverse flex’ provisions became increasingly popular. Staple financing is also used in some cases but has not become very successful because the provider of the staple financing is usually an easy target to beat by other banks.

(ii) Bridge facilities: these are used when payment of the acquisition price and the refinancing of Target’s debt need to be made before a complex structure can be set up. The step-up of the interest rate of bridge financing, or its short maturity will normally create an incentive for the borrower to refinance.

(iii) Senior term loans: further analysis follows below under the section regarding senior facilities. However, it should be pointed out that usually four types of senior term loans are provided: (a) an acquisition loan granted to Newco to purchase Target, together with the equity and, if applicable, second lien or mezzanine facilities; (b) a term loan granted to Target to refinance Target’s existing debt; (c) a term loan granted to Target to finance capex investments; and (d) a term loan granted to Target to finance potential permitted acquisitions of other companies or assets.

Senior term loans granted to Target would be structurally senior to those granted to Newco, because they are closer to the source of the cash flows. However, the senior facility agreement and the intercreditor agreement correct this structural subordination by requiring the facility agent to distribute the proceeds pro rata among the senior lenders. Refinancing existing debt might become somewhat more risky, because the Spanish Insolvency Law may rescind payments made by an insolvent company during the two-year suspect period preceding the insolvency declaration, when those payments satisfy debts which were originally to fall due after the insolvency declaration. This provision, which if applied literally by the courts will probably have consequences that were unforeseen by the legislator, exerts pressure on any financier whose debt is being cancelled or refinanced to obtain some assurance that the borrower is unlikely to become insolvent in the following two years. In practice, this complicates any rescue refinancing with new lenders.

(iv) Senior revolving facilities: these are provided to Target to fund its working capital needs. Sometimes a ‘clean-down’ period of between five and 10 days per year is required to avoid the use of revolving facilities as a long-term loan and the application of certain regulatory capital guidelines which provide that, after one year of extending credit under a revolving facility, banks must increase their capital reserves to take into account the unused amounts.

(v) Ancillary facilities: these are still not very common in acquisition transactions governed by Spanish law. When used, the financing documents merely contemplate Target’s right to convert part of the revolving facilities into bilateral letters of credit, guarantees, or term loans with some of the revolving lenders. Such conversion would not be automatic, especially if the ancillary facilities are intended to rank pari passu with the senior facilities, because the security documents would normally need to be amended.

(vi) Second lien facilities: these are term loans which rank junior to the senior facilities and senior to the mezzanine facilities. Second lien facilities have typically been structured in Spain as an additional tranche under the senior facilities agreement. In some transactions, second lien facilities have benefited from independent second rank security interests, while in other transactions the second lien lenders have shared the first rank security interests with the senior lenders and agreed in the intercreditor agreement to transfer or turn over to the senior lenders any proceeds collected from the enforcement of such security interests, until all the obligations under the senior facilities have been paid.

 The facility agreements in Spain also establish that second lien debt cannot be prepaid until the senior debt is repaid in full. In addition, intercreditor agreements normally impose ‘blockage periods’ and ‘standstill periods’ to second lien creditors. Second lien debt is generally used to finance the purchase of Target’s share capital and is therefore affected by financial assistance rules, as discussed below in the security package section. Second lien facilities normally have a longer maturity date than senior debt, but shorter than mezzanine facilities.

(vii) Mezzanine facilities: these have become increasingly commonplace in Spain. Initial mezzanine lenders are often banks that also participate in the senior syndicate, but the loans are normally assigned after financial close to specialised investors. Mezzanine facilities are term loans that are utilised to acquire Target, and are therefore affected by financial assistance rules, as discussed in the security package section below. Because the mezzanine facilities are junior to the senior and second lien facilities, they are disbursed in bullet drawdowns, cannot be early prepaid until the senior and second lien facilities are paid in full and have longer maturity dates. However, in most other respects, mezzanine debt mirrors senior debt.

(viii) Hedging agreements: as the credit facilities bear a variable interest rate, Newco and/or Target frequently enter into interest-rate hedging agreements with the mandated lead arrangers of the credit facilities, so as to ensure that the borrowers’ ability to service the debt is not affected by interest rate movements. Interest rate hedging agreements usually cover between 50 per cent and 75 per cent of the amount of the senior facilities and must remain in force for between three and four years from financial close. If there is a mismatch between the currency of Target’s cash flows and the currency of the financing, currency exchange-rate hedging agreements will also be required. The facility agreements may include the execution of appropriate hedging agreements as a condition precedent for financial close, or a covenant requiring the borrower to execute the relevant hedging agreements within a short period of time. Hedging agreements will rank pari passu with the senior facilities.

Hedging facilities are usually documented under separate master agreements, attaching schedules which include specific provisions to make the master agreement conform to the main terms (eg, representations and warranties, covenants, events of default) of the remaining finance documents. Two types of master agreements are used in Spain: the ISDA master agreement and the Contrato Marco de Operaciones Financieras or CMOF, developed in 1997 by the Spanish Private Banks Association – Asociación Española de Banca Privada (AEB) – as a local master agreement.

All the abovementioned facilities have different terms for use, margins, maturities, interest rates, fees, and so on. Although not essential to Spanish structures, second lien and mezzanine facilities may also be structurally subordinated to senior facilities. Structural subordination may be achieved by creating a holding company, either in Spain or abroad (Luxembourg and the Netherlands are the preferred locations), that owns 100 per cent of Newco and receives the second lien and mezzanine financing to later transfer the funds to Newco through inter-company loans.

Due to time constraints, syndication is normally carried out once the acquisition deal has been closed and the acquisition and refinancing facilities have been drawn.

4. MAIN ISSUES OF THE SENIOR FACILITY AGREEMENT
4.1 Closing and conditions precedent
Acquisition finance transactions can be closed in two steps, namely signing and closing, or only in one, when signing and closing occur simultaneously which is quite common in Spain. On signing, the credit facility documents are signed and notarised. On closing, the conditions precedent to draw down must be fulfilled (or waived), security documents must be executed and notarised, and Target must execute an accession deed by virtue of which it accedes to the facility documents as borrower and guarantor of certain tranches of debt not affected by financial assistance rules. In practice, conditions precedent are satisfied at closing of the purchase agreement, so that the initial drawdown is used to pay the price.
Conditions precedent in Spain are quite similar to those found in other jurisdictions and include valid execution of the acquisition and financing documents, delivery of the financial statements of Target and Newco (if any), delivery of legal opinions, structure memos, legal, insurance and technical diligence reports, correctness of the representations and warranties and absence of events of default. There are, however, some peculiarities that can be summarised as follows:

(i) Acquisition and financing documents are formalised into public deeds before a Spanish notary public. If Target is not a listed company, the transfer of shares will be documented in a public deed. Finance documents are also documented in public deeds since it facilitates their enforcement before the courts. As a general rule, security documents must be notarised. This is so despite the fact that Royal Decree-Law 5/2005 of 11 March 2005 (‘RDL 5/2005’), implementing in Spain Directive 2002/47/EC of the European Parliament and the Council of 6 June 2002 on financial collateral arrangements, issued new regulations on financial collateral arrangements which provide that the granting of security over the shares or over credit rights arising under bank accounts do not need to be notarised or registered. The courts have not yet interpreted the scope of application of RDL 5/2005 and there is a lot of discussion among banks and their advisors as to its effects.

(ii) The notary public will review the notarised powers of attorney. Non-Spanish institutions must execute their powers of attorney before a notary of the country of incorporation of the grantor and legalise them by affixing an Apostille pursuant to The Hague Convention of 1961.

(iii) According to Spanish law, individuals and companies residing in Spain that receive loans from non-residents in an amount of EUR 3 million or above must report these loans to the Bank of Spain. The Bank of Spain allocates a so-called financial operation number (‘NOF’) to each transaction. Obtaining a NOF is normally a condition precedent for financial close if there are non-resident lenders.

(iv) Spanish Royal Decree 925/1995 of 9 June 1995, as amended, and developing money laundering regulations require certain entities and individuals, including credit entities, to comply with ‘Know your customer’ rules. Foreign banks are also subject to their local money laundering regulations, which in general terms include information requirements similar to those contemplated in the Spanish regulations.

(v) Pursuant to Spanish law, shares may not be delivered, transferred or pledged until they are registered with the appropriate Commercial Registry (Registro Mercantil). Newco is normally incorporated with the minimum share capital, and at financial close the equity investors subscribe a capital increase to fund part of the acquisition price. Given that the newly issued shares will not be registered with the Commercial Registry at financial close and therefore cannot be pledged, the finance documents will include a condition subsequent requiring the creation of a pledge over the new shares within a maximum period of time. Alternatively, the security documents may contemplate an automatic extension of the pledge to the new shares.

(vi) Legal opinions delivered on financial close by the lenders’ and borrowers’ counsel usually carve out the effects of any applicable bankruptcy, insolvency, moratorium or similar laws affecting creditors’ rights generally. They may also include qualifications in connection with financial assistance in the event that Target and Newco are expressly required to merge in the future.

(vii) As discussed above, in recent years, certainty of funds provisions have become more frequent in facility documents.

4.2 Prepayment and repayment
Prepayment options and ordinary repayment clauses are very similar to those found in other jurisdictions.

Financial assistance rules prevent Target from prepaying any acquisition loan (at least until the merger between Newco and Target, as discussed below). In addition, it is generally understood that refinancing of acquisition loans cannot be repaid with another loan provided to Newco or Target and secured with Target’s assets. It could be said that acquisition debt is ‘earmarked’ and any refinancing of the same is tainted by the financial assistance restrictions.

Some senior term loans (especially those not affected by financial assistance restrictions) are assigned during the syndication process to institutional investors, such as collateralised loan obligations (CLOs) and loan participation mutual funds which hold the loan for the long term. To this end, the senior facility agreement normally provides that (i) voluntary prepayments of the senior facilities will trigger prepayment fees if made during the 18 to 24 months following financial close; and (ii) such institutional investors will be entitled to reject the pro rata payment of their tranches unless the remaining tranches of the credit facilities have already been prepaid.

The finance documents normally provide for several mandatory total or partial prepayment provisions that are triggered by events such as a change of control in Newco or Target, an IPO of Newco or Target, the sale or transfer of all or a substantial part of the assets of Target, the collection of insurance proceeds under Target’s insurance policies and the indemnification proceeds from the sellers under the acquisition documents. Some loans contain ‘cash sweep’ provisions that require the borrower to use every year a certain percentage of the excess cash flow to prepay the loan.

4.3 Representations and warranties
Representations and warranties in Spanish acquisition finance documents do not differ greatly from what is standard in other jurisdictions. These representations include due incorporation and existence of Newco and Target, group structure, lack of conflict, validity and enforceability of the finance documents, perfection of security, compliance by Newco and Target with applicable laws, permits, licenses and authorisations, ownership of real estate, correctness and accuracy of the information, including financial statements, disclosed regarding Newco and Target, absence of non-permitted liens or encumbrances over the assets of Newco and Target and absence of events of default. It is also customary to represent that Newco has never carried out any other business activity. It is worth mentioning that the borrower will normally request a ‘clean-up period’ from the lenders with respect to Target. This period enables the borrower to clean-up Target after the acquisition to make sure that all the representations made with respect to it are true and accurate. During this period, if a representation is not correct, the lenders will not be entitled to accelerate the loan for such reason. The ‘clean-up period’ will range between three and 12 months.

4.4 Positive and negative covenants. Financial covenants
Spanish acquisition finance documents contain standard positive and negative covenants, similar to those found in other jurisdictions.

As a specific Spanish matter, the pari passu covenant admits the exception, not only of any permitted guarantees, but also of those claims that have priority by operation of law. Pursuant to Spanish Insolvency Law, security interests give a priority to senior lenders limited to the proceeds obtained from the enforcement of the security. However, any remaining unpaid senior debt will be considered an ordinary claim and will rank together with other unsecured ordinary claims.

Covenant-lite loans, which became popular in the United States, have not been used in Spain as far as we are aware. Covenant-lite loans are characterised by including bond-like incurrence financial covenants instead of traditional maintenance financial covenants. Maintenance financial covenants are far more restrictive and are breached if the borrowers fail to meet any financial test every quarter or semester, whether or not the borrower takes any action to breach such financial covenant. Therefore, if, for example, the Target’s cash flow deteriorates to the point where its debt to EBITDA ratio exceeds the agreed threshold, the financial covenants contemplated in Spanish acquisition finance facilities will automatically be breached. Equity cures were increasingly used -until the summer of 2007, which marked the start of the financial crisis- to remedy the breaches of financial covenants. Mulligan clauses, which require two consecutive defaults of certain financial covenants to qualify as an early termination event under the credit facilities, were also used until the summer of 2007.

4.5 Financial assistance restrictions and incentives to merge
The acquisition facility is paid with the cash flows generated by Target, which are either upstreamed to Newco through dividend payments, loans and fees, or by pushing down the debt to Target. The latter is possible through a merger with Newco. However, such merger can give rise to financial assistance issues because, ultimately, the assets of Target would be financing the acquisition. Before discussing whether a merger is possible and under what circumstances, it is worth reviewing the main provisions on financial assistance in Spain.

The Spanish Corporations Law (LSA) states that an SA cannot advance funds, grant loans, issue guarantees, or provide security or any other kind of financial assistance for the purposes of acquiring its own shares or shares of its parent company by any third party. Similarly, although it is stated in broader terms, the Spanish Private Limited Liability Companies Act (LSL) provides that an SL cannot advance funds, grant loans, issue guarantees, or provide security or financial assistance for the purposes of acquiring its own shares or the shares of any company of the same group.

There are no whitewash procedures in Spain. The LSA established some exceptions to the rule that prohibits the provision of financial assistance to SAs. These include, for instance, financial assistance provided to the personnel of a company to acquire shares of that company or another company of the group, and financial assistance provided by a credit institution in the ordinary course of its business as long as a reserve is created. The LSL does not contemplate any exception.

Unlike in other EU jurisdictions, the breach of the rules on financial assistance in Spain does not give rise to criminal liability. However, a breach will have the following consequences:

(i) The LSA and the LSL state that any act in contravention of the prohibition will be sanctioned with a fine up to the aggregate face value of the shares acquired. Directors (and senior executives of an SA) of the offender company and, as the case may be, directors of the parent company who have induced the subsidiary to commit the infringement, will be held liable. The amount of the fine will be determined in light of the importance of the breach and the damage caused to the company, its shareholders and third parties. Proceedings can be initiated by the Spanish Securities and Exchange Commission (Comisión Nacional del Mercado de Valores or ‘CNMV’) within three years following the financial assistance transaction.

(ii) Any directors of the company who are in breach of the financial assistance rules may be liable to the company, its shareholders and creditors for breach of their duties.

(iii) Neither the LSA nor the LSL establish the civil law consequences of a breach of the financial assistance rules. Although there is no significant case law and the opinion of scholars is not unanimous, it is generally accepted that a transaction that constitutes financial assistance (eg, the granting of a loan, guarantee or security interest) is void. Whether the underlying acquisition of shares is also void is less certain. We believe that, as a general rule, the underlying transaction should be considered valid.

The prohibition applies even if the financial assistance is provided after the acquisition is completed. What is relevant is that it is provided to acquire shares of the parent company. As discussed above, the acquisition debt will be ‘earmarked’ and will continue to be affected by the financial assistance restrictions even if a post-closing refinancing transaction takes place.

Since the boundaries of the financial assistance prohibition are unclear and there is no case law dealing with mergers used to push down debt, many finance documents will not require directly a merger but, rather, include a financial covenant the purpose of which is to reach the same result. This financial covenant requires the individual EBITDA of Newco to represent 75 per cent or more of the consolidated EBITDA of Newco, Target and its subsidiaries within a date falling between 18 and 24 months from financial close. A breach of the covenant usually triggers a step-up of the applicable margin. Its purpose is obviously to foster the merger between Newco and Target in order to push down Newco’s debt to Target.

A merger performed one or two years after the acquisition, as a separate and independent transaction, and which is carried out in compliance with a covenant under the acquisition finance documents, should not be considered a breach of the financial assistance prohibition. This is further strengthened by the fact that mergers need to follow a special procedure aimed at protecting interests of shareholders and creditors of the companies involved, which is the final purpose of the financial assistance prohibition.

In any event, merger structures between Newco and Target are quite common in Spanish leveraged transactions. The CNMV, which is responsible for the application of the rules on financial assistance, requires that, in the context of a takeover bid of a listed company, the acquirer must state in the prospectus who it intends to finance the acquisition and, in particular, if it intends to merge with the target company. This seems to be a good indication that the CNMV does not find the merger to be unlawful.

The sale of non-core assets by Target to fund the repayment of the acquisition loan should not be considered financial assistance if the funds are channelled to Newco via dividends (which can be paid as described above), share capital decreases for the purpose of returning contributions to shareholders, or repayment of intra-group loans previously provided by Newco to Target. These proceeds should not be pushed up through inter-company loans granted by Target to Newco, given that the financial assistance prohibition would then apply.

4.6 Events of default
The regulation of events of default in Spanish finance documents does not significantly differ from that of other jurisdictions. Arguing that it is a syndication issue, lenders usually require that, upon the occurrence of an event of default (and in the event of junior lenders, subject to any standstill periods provided in the intercreditor agreement), any lender is entitled to terminate the facility agreement with respect to its individual participation, even if the majority of the lenders has agreed not to terminate. However, such individual lender should not be entitled to request the enforcement of security.

Pursuant to the Spanish Insolvency Law the declaration of bankruptcy of the borrower does not entitle the lenders to terminate the facility agreement and any provision allowing the lenders to terminate the facility agreement would be unenforceable. As a result of this restriction, lenders usually include certain pre-insolvency situations as events of default, such as material payment defaults or renegotiation of the debtors’ obligations. This enables them to terminate the facility agreement just before the debtors’ formal declaration of insolvency.

5.  GUARANTEES AND SECURITY
Senior, second lien and mezzanine lenders and hedging entities usually comprise a syndicate of lenders seeking a ‘security package’ that is as extensive as possible. The cost of creating security in Spain and the prohibition of fiancial assistance create certain limitations on the lenders’ wishes. Guarantees and security must be granted by Newco, Target and all its subsidiaries (or a group of them qualifying as material subsidiaries) but, Target and its subsidiaries will not be able to secure all the debt, in particular, acquisition debt will need to be excluded to avoid breaching financial assistance rules.

5.1 Common issues relating to personal guarantees and security interests
(i) Ancillary rights: The rights of the lenders under the security package are ancillary to their rights under the secured obligations. For this reason, any assignment of a stake in any of the facilities implies a proportional assignment of its guarantees and security. To enable the immediate enforcement in the event of default, the facilities are normally formalised in a public deed. Likewise, the assignment of the relevant portion of the syndicated facility must be carried out in a public deed to avoid enforcement problems. In addition, each guarantee, mortgage or pledge comprising the security package is indivisible in nature under Spanish law, and each of them secures the full and punctual fulfilment of all the secured obligations. Consequently, the partial fulfilment of the secured obligations will not extinguish the relevant guarantee, mortgage or pledge proportionally. The relevant guarantor, pledgor or mortgagor would be entitled to cancel the relevant security or guarantee only after the secured obligations have been fully discharged.

(ii) Security agent: The facilities, the hedging and the intercreditor agreements will establish that the guarantees and security interests will only be enforced by the security agent to avoid partial foreclosures of the security package by any member of the syndicate of lenders. The concept of security agent does not exist under Spanish law and if the enforcement of the security package is carried out by such security agent, it will need to prove that it is duly and expressly empowered for such purpose. Notwithstanding the authority usually conferred upon the security agent by the relevant finance agreements, the security agent may need to prove that it is duly and expressly empowered by means of a power of attorney granted in its favour by each of the lenders and hedging entities. The power of attorney must be notarised and, if applicable, apostilled according to The Hague Convention of 1961.

(iii) Financial assistance restrictions: As discussed above, financial assistance rules impose certain limitations on LBOs, acquisition financings and similar transactions. Newco usually receives a loan to acquire shares in Target. Newco then pledges the shares it has acquired from Target. However, Target cannot issue any guarantee or provide any security (eg, mortgages or additional pledges) to the lenders financing the acquisition. Tranches of debt used to refinance pre-existing debt (provided it was not originally acquisition debt) of Target or its subsidiaries are not affected by financial assistance rules and can be guaranteed by providing security over the assets of Target and its subsidiaries. Newco may also repay the acquisition loans with proceeds obtained from Target’s dividends, provided that any such dividends are distributed in accordance with applicable regulations. As discussed above, on certain occasions Newco will merge with Target after the acquisition in order to push down the debt.

(iv) Guarantees and security of future obligations: Spanish law permits the creation of guarantees and security interests in favour of obligations arising in the future (such as, those arising under the hedging agreements if not signed at financial close), provided that the main features defining the future obligation are duly determined at the date of creation of the guarantee or security interest. Such main features are the maximum amount payable under the obligation, the identity of the counterparty and the termination date of such obligation. Otherwise, the relevant guarantee or security would have to be perfected at the time when the relevant obligation can be duly identified and the parties are able to properly determine the obligation to be secured.

(v) Corporate benefit issues: Directors of a Spanish company have fiduciary duties. They must act diligently and loyally in accordance with any applicable laws as well the company’s by-laws. They must also always act in the best interest of the company (interés social). If financial assistance restrictions do not apply, directors of a Spanish company would not be prevented from providing a guarantee or granting security over the assets of the company to secure the borrowings of its parent or affiliate companies. However, the directors must consider whether these transactions are in the best interest of their company.

The question that is normally raised is whether the general good of the group is an acceptable basis for concluding that there is a corporate benefit. There is no regulation or case law that provides a clear answer to this question. Nevertheless, we believe that a transaction that is of interest for the group may also be construed to be in the interest of the company providing assistance as long as over a period of time, the resources and support from the rest of the group can also benefit the company providing the assistance (eg, through inter-company loans or by receiving guarantees to secure its own obligations). In practice, when a company has a single shareholder or is controlled by a reduced number of shareholders and they all agree to the provision of assistance, it is less likely that directors will face any liability unless the company becomes bankrupt, in which case creditors would be entitled to claim. Spanish banks are normally reluctant to accept any language limiting the scope of the guarantees or security interests due to corporate benefit issues.

(vi) Other restrictions: SLs cannot grant loans, issue guarantees or provide financial assistance in favour of shareholders or directors, unless such transactions have been authorised on a case-by-case basis at the shareholders’ meeting. To avoid a conflict of interest, any shareholder that is a beneficiary of financial assistance must abstain from voting on the relevant resolution in the shareholders’ meeting.

5.2 Personal guarantees
Newco, Target and each of its subsidiaries, or a group of them qualifying as material subsidiaries, will usually guarantee the obligations of Newco and Target under the facility agreements and the hedging agreements, subject to the financial assistance restrictions discussed above.

According to Spanish law, a personal guarantee (fianza) may be created by means of an agreement between the creditor and the guarantor or by operation of law. Personal guarantees can be formalised in a public deed, stating or making clear reference to the guaranteed amount; a so-called liquidation clause – pacto de liquidación – will establish a process to calculate the outstanding debt and will give the lenders access to an expedited enforcement procedure. Otherwise, an ordinary court proceedings will have to be initiated to determine the amount due and enforcement will inevitably be delayed.

In acquisition finance transactions, lenders usually require that personal guarantees can be called on first demand. First demand guarantees are abstract and independent from the main or underlying obligation, create a primary liability on the guarantor and are not regulated by law. These guarantees are not affected by the particulars of the main or underlying obligation between the creditor and the debtor and, therefore, are not subject to the so-called beneficio de excusión which would permit a guarantor to delay payment to the beneficiary of the guarantee until all the assets of the debtor have been liquidated. Likewise, these guarantees will expressly provide that the guarantor is not entitled to oppose to the creditor any of the exceptions and defences of the debtor.

Under Spanish law, the guarantor can guarantee the same or less, but never more, obligations than the main obligor. In addition, certain actions of a creditor may release the guarantor. For instance, according to the Spanish Civil Code, if the creditor extends the term of payment in favour of the debtor without the consent of the guarantor, the guarantee will be terminated. Accordingly, when financing agreements are amended or novated in Spain, the banks will require the ratification of all the guarantees by the guarantors.

5.3 Security interests
Main features
In addition to their status as ancillary rights discussed above, the most relevant features, common to all forms of security interests are the following:

(a) the relevant collateral is ‘separated’ and ‘reserved’ for the benefit of a certain creditor which, while preserving its full claim against the remaining assets of the pledgor or mortgagor as an ordinary creditor, will have a privileged right against the relevant collateral. Certain creditors that are privileged by operation of law (such as employees, the tax authorities and the Social Security system) will not be entitled to be paid with the proceeds obtained from the foreclosure of the collateral, unless the secured obligations have been fully discharged and any surplus remains;

(b) security interests are enforceable and binding vis-à-vis third parties, provided that they are executed in public deeds (with the exceptions explained below);

(c) the security interest follows the collateral asset, without prejudice to any transfer of the ownership of such asset;

(d) any person creating a security interest upon an asset must hold full and valid title over such asset; and

(e) Spanish law prohibits any form of foreclosure of a security agreement which permits direct and immediate appropriation of the secured asset by the holder of the security interest (the so-called pacto comisorio) except if foreclosed pursuant to the regulations of RDL 5/2005, or Catalonian Law 5/2006 enacting the security interests chapter of the Catalan Civil Code of 10 May 2006.

Types of security interests
The security interests that can be created under Spanish law are basically the following:
(a) Pledges (prendas): Pledges involve the delivery by the pledgor to the pledgee of a movable asset (including securities) or a right to cash held by the former as security. Subject to financial assistance restrictions, the standard pledges in Spanish acquisition finance deals are: (i) pledges over 100 per cent of the shares of Newco, Target and its material subsidiaries; (ii) pledges over the credit rights arising from the balance of the bank accounts opened by Newco, Target and material subsidiaries; (iii) pledges over the credit rights (including receivables) arising from the material agreements entered into by Newco, Target and the material subsidiaries, or rights against the vendors of Target under the acquisition agreements; (iv) pledges over the credit rights arising from insurance policies (except those covering liabilities for damages to third parties) contracted by any of the aforementioned companies; and (v) given that the hedging will also constitute an asset whenever the instrument may entail payments by the hedging provider to the acquirer (eg, when the hedging takes the form of an interest rate swap), the rights of the acquirer under the hedging facilities are usually pledged for the benefit of the lenders.

 In order to be effective vis-à-vis third parties and to ease enforcement procedures, the pledge must be executed in a public deed. Possession of the assets pledged must be transferred to the pledgee or to a third party until the debt has been repaid or, as the case may be, foreclosure of the pledge occurs. The transfer of possession (ie, physical delivery) in pledges of shares is carried out by delivering the share certificate representing the shares. Dematerialised securities (represented by means of book entry accounts) are pledged when the pledge is registered with the entity responsible for the book entry accounts. In the case of pledges over credit rights, the parties can agree that the transfer of possession will take place by means of the execution of the relevant pledge agreement but to make sure that payments made by the assigned debtor to the borrower do not release the assigned debtor, the lenders will normally serve notice to the assigned debtor informing him/her that payments must be made to the lenders and not to the borrower.

 The main costs related to the creation of a pledge are the notarial fees, which vary in proportion to the amount secured: from €90 (for pledges of up to €6,000) to €2,182 (for pledges amounting to €6 million). Fees corresponding to higher amounts must be agreed upon with the notary.

(b) Real estate mortgages (hipotecas inmobiliarias): In order to be effective against any third party, real estate mortgages must be executed before a notary public as a public deed and registered with the land registry (Registro de la Propiedad) where the asset is located. The costs and taxes arising from the creation of a real estate mortgage are significant. A one per cent stamp duty tax, the notarial fees described above and the land registrar’s fees (applied on a sliding scale), are all linked to the amount secured by the mortgage (ie, principal, interests and costs). The fees of the land registrar are approximately €2,182, if the amount secured by the mortgage exceeds €600,000.

 As these costs are so significant, mortgages are uncommon in Spain beyond asset finance transactions. In addition, real estate mortgages are normally taken out for defensive purposes rather than for secure repayment of loans (the liquidation value of the mortgaged assets in a forced sale would most likely be significantly lower than the principal amount of the senior, second lien, mezzanine and hedge debt). Instead, they are aimed at discouraging other potential creditors from attaching such assets. Likewise, borrowers are not likely to have significant creditors other than the lenders (because borrowers are subject to strict positive and negative covenants, including the so-called ‘negative pledge’ covenant), and most significant creditors other than such lenders (eg, tax and social security authorities and employees) would be preferential by operation of law.

 It is standard practice in Spain for borrowers to grant an irrevocable power of attorney in favour of the security agent to create the mortgage, pursuant to an agreed form of mortgage deed, or to increase the amount secured by an already existing real estate mortgage upon the occurrence of certain events (ie, a breach of any financial covenant or the occurrence of an early termination event). However, this approach bears the risk that, pursuant to the Spanish Insolvency Law, any security interests created during the two years prior to the debtors’ declaration of insolvency to secure pre-existing obligations may be rescinded as discussed below.

(c) Chattel mortgages (hipotecas mobiliarias): Chattel mortgages must be executed in a public deed before a notary public and registered with the Registry of Chattel Mortgages and Pledges without Transfer (Registro de Hipoteca Mobiliaria y Prenda sin Desplazamiento). The collateral of the chattel mortgage may be: business premises and industrial plants, as a whole; cars, trains and other motor vehicles; airplanes; machinery and equipment; and intellectual and industrial property. There is a specific type of mortgage for ships (naval mortgage).

 Chattel mortgages are seldom used in Spain because: the mortgagor would not be able to sell the relevant assets without the mortgagees’ consent; most of the assets that can be mortgaged with a chattel mortgage (ie, mainly those that are not movable) can be covered by a real estate mortgage if expressly agreed to by the parties in the deed of real estate mortgage; and in most cases, those assets that cannot be covered by a real estate mortgage are not sufficiently valuable to warrant the cost of creating the chattel mortgage, which is the same as the cost of a real estate mortgage. Chattel mortgages are normally used only when either the mortgagor does not own the real estate where the assets are located and therefore cannot create a real estate mortgage that will extend to and cover chattel or intellectual and industrial property rights that are material for the business of Target exist.

(d) Pledges without transfer of possession (prendas sin desplazamiento): this pledge must be executed in a public deed before a notary public and registered with the Registry of Chattel Mortgages and Pledges without Transfer. Assets eligible for this type of pledge are: harvests; fruits of agricultural plots; animals in agricultural plots; harvesting machinery; raw materials in warehouses; merchandise in warehouses; art collections; and credit rights arising from permits, licenses and authorisations, subsidies or from other agreements with governmental authorities, and other credit rights not represented by securities and not qualifying as financial instruments for the purposes of RDL 5/2005. Pledges without transfer of possession are seldom used in Spain.

Until December 2007, the regulations governing chattel mortgages and pledges without transfer did not allow the creation of other liens or encumbrances over the pledged assets. Therefore, such security interests, when used, tended to secure only the rights of senior lenders. However, new regulations enacted by Law 41/2007, of 7 December 2007, on the mortgage market, have just permitted the creation of second or subsequent ranking chattel mortgages or pledges without transfer of possession over the mortgaged or pledged assets.

 Other forms of security available under Spanish law, such as fiduciary transfers of title or sale with reservation of title, are not used in the acquisition finance practice. Spanish law does not have a concept of floating charge. Therefore, the substitution of collateral (securities, cash or receivables) from time to time will be considered a new ordinary pledge and a cancellation of the previous pledges. Such a new pledge must therefore comply with the same requirements (transfer of possession and formalisation in a public deed) than those of the original pledge. As an exception and where agreed by the parties, article 9 of RDL 5/2005 and article 16 of Catalonian Law 5/2006, permits a pledgor, to substitute all or part of the assets constituting collateral for other assets of equal value.

 Security interests are governed by the principle of prior tempore potior iure (the date of creation determines the priority of the security). In the event of real estate mortgages, chattel mortgages and pledges without transfer, which must be registered with the corresponding public registries, the priority is determined by the date and time when they were registered with the public registry, which is backdated to the date on which presentation of the relevant document occurred. In the case of pledges, which are not registered in any public registry, priority is determined by the date of the transfer of possession. However, Spanish law allows creditors to agree on the ranking that each of their claims will have.

Security interest and the Spanish insolvency law
The Spanish Insolvency Law has a wide impact on security interests. Below is a summary of the main provisions that must be taken into account.

Types of creditors and claims: In the event of the bankruptcy of a Spanish company (concurso de acreedores), creditors will be divided into two categories:

(A) Bankruptcy creditors (acreedores concursales) who will have a claim against the bankruptcy estate (masa activa). The claims of the bankruptcy creditors will be divided into three categories:

 (1) Privileged claims, which include the following, in descending order:
  (1.1) claims with ‘special’ privilege – that is, those secured by specific assets or rights (eg, mortgage, pledge) – which will be paid from the proceeds of the sale of those assets and rights; and
  (1.2) claims with a ‘general’ privilege, which will be paid using the surplus assets of the bankruptcy estate after the claims that constitute the créditos contra la masa (see paragraph (B) below) and claims with special privilege have been paid. Claims with a general privilege rank as follows and are paid in the following order: (i) certain labour claims; (ii) tax claims; (iii) social security claims (up to 50 per cent of their amount); (iv) civil liability claims arising from tort; and (v) claims of the insolvency petitioner (up to a quarter of their amount).

 (2) Ordinary claims, which are paid after privileged claims. Any claim that does not qualify either as privileged or subordinated is an ordinary claim. Therefore, in the absence of a specific rule, all claims are ordinary.

 (3) Subordinated claims, which are paid last, in the following order: (i) claims that were reported late to the receivers (administración concursal); (ii) claims stipulated as subordinated under an agreement; (iii) claims for interest of any kind; (iv) claims for fines; (v) claims of related persons (eg, directors, shareholders); and (vi) claims of persons that have been found to have acted in bad faith in a challenge to an insolvency proceeding.

(B) Creditors against the bankruptcy estate (acreedores contra la masa) who will be paid before any assets are distributed among the bankruptcy creditors. These claims are settled on their respective due dates, regardless of the stage of the proceeding, but without disturbing those assets to be used to pay claims with a special privilege. The list of creditors against the bankruptcy estate is a closed one and includes expenses incurred in processing the proceedings and expenses that are basically necessary for the debtor to continue its business (eg, salaries, utilities).

The credits of the senior, second lien, mezzanine and hedge creditors will qualify as special privileged credits up to the value of the collateral attached by the security interests, while any surplus that could not be paid with the proceeds collected from the enforcement of the security interests would in principle qualify as an ordinary credit.

Extinction of security interests granted in favour of certain subordinated credits. The classification of a bankruptcy credit as subordinated credit implies the extinction of any security granted in its favour. The relevant order or judgment declaring the extinction of such security will furthermore provide the necessary measures to render it ineffective and, in particular, will provide for the restitution of the possession of the goods constituting the extinguished security and the cancellation of registrations relating to the creation of the security made in the relevant registries.

Clawback. The transactions executed by the debtor during a two-year period prior to the initiation of insolvency proceedings (referred to as the ‘suspect period’), to the extent that they are detrimental to the debtor’s estate, may be challenged and rescinded even in the absence of fraud.

Some transactions are presumed detrimental to the debtor’s estate and are not subject to any challenge (eg, the disposal of assets without consideration and the payment of non-matured obligations). In some other cases, prejudice is presumed although this presumption is subject to challenge (eg, the disposal of assets in favour of persons specially related to the debtor, and security granted to guarantee pre-existing non-secured obligations). In all other cases, prejudice must be evidenced by the party who applies for clawback actions. Obligations assumed by the debtor in the ordinary course of business are not subject to clawback actions.

The presumption concerning the creation of security interests in favour of pre-existing obligations or of new obligations replacing previous ones, may significantly affect the commercial practice regarding financing and re-financing, because it may comprise both the creation of security interest in favour of previously unsecured obligations and the extension of pre-existing security interests. It may also affect practices involving the promise of the creation of new pledges regarding new material subsidiaries or the granting of an irrevocable power of attorney in favour of the security agent in order to create a real estate mortgage (pursuant to an agreed form of mortgage deed) or to extend the amount of the secured obligations under the previously existing mortgage. There is uncertainty as to how the case law on this issue will develop.

Enforcement of security
(a) Overview. According to Spanish law, a secured party is not entitled to appropriate the collateral affected by a pledge or a mortgage, nor to dispose of the collateral as it deems fit. The appropriation of collateral by the creditor (pacto comisorio) is generally prohibited. Accordingly, a creditor must initiate the enforcement of the security interest and use as payment of the debt the proceeds obtained in the sale of the collateral in a public auction or through other proceedings aimed at ensuring that a fair value is obtained from the sale of the collateral. Depending on the case, these proceedings are monitored by a court or a notary public. The only exceptions to the prohibition of the pacto comisorio are the following:
 (1) Financial collateral arrangements: RDL5/2005 regulates financial collateral arrangements, among others. Only cash, securities (valores negociables) and financial instruments can be given as collateral in financial collateral arrangements subject to RLD 5/2005. It is also important to note that the scope of RDL 5/2005 is rather confusing, as it is unclear whether financial collateral arrangements can be granted to secure all types of monetary obligations or whether they can only be granted in connection with obligations related to the settlement of financial instruments (eg, derivatives). Banks in Spain have been cautious and seem to have adopted the latter view.

 (2) Pledges of credit rights: As an exception to the general rule requiring the enforcement of pledges through public auction, the pledge of credit rights can be ‘foreclosed’ by way of set-off since these credit rights are considered ‘liquid’. Therefore, the asset need not be ‘transformed’ into cash because it is a right to claim an amount of money, for instance, the balance of a bank account or the right to receive an insurance payment.

(b) Types of enforcement proceedings. In general, creditors are entitled to initiate three different actions: (1) the so-called declaratory proceeding (juicio declarativo); (2) the enforcement proceeding (juicio de ejecución) provided for under the Civil Procedure Law (Law 1/2000, of 7 January 2000); and (3) the procedure regulated in the Civil Code. These procedures are aimed at selling the relevant asset in a public auction. In the declarative and executive proceedings, the sale is monitored by a court. In the proceeding regulated in the Civil Code, the sale is monitored by a notary public. In this proceeding, if, after two auctions, the relevant asset is not purchased, the creditor may acquire control of the pledged asset, provided that it accepts the full discharge of the debtor. Special enforcement procedures are contemplated in cases where RDL 5/2005 becomes applicable.

 If the creditor has a real estate mortgage, the creditor is entitled to choose between several alternative proceedings provided for in the Spanish Civil Procedure Law to judicially obtain satisfaction of a secured debt: the so-called declaratory proceeding, the enforcement proceeding and the mortgage foreclosure proceeding (juicio hipotecario). In addition to the above, if this is provided for in the public deed of mortgage, the creditor is entitled to use a notarial proceeding (procedimiento notarial extra-judicial).

(c) Enforcement after the declaration of bankruptcy. After the debtor is declared bankrupt, the enforcement of security interests (eg, mortgages, or pledges) affecting assets owned by the debtor and devoted to its professional or business activities (presumably most of the debtor’s assets) will be stayed until the first of the following circumstances occurs: approval of a creditors’ composition agreement (unless the content has been approved by the favourable vote of the creditor secured by the security, in which case the creditor will be bound by whatever has been agreed to under the creditors’ composition agreement); or one year has elapsed since the declaration of bankruptcy without initiation of liquidation proceedings. As an exception to this rule, enforcement will not be stayed if at the time of declaration of bankruptcy the announcements of the public auction had been published.

6.  INTERCREDITOR ARRANGEMENTS
In general, the rights of lenders of a syndicate are independent from each other. Thus, each bank has a separate claim against the borrower, which would, in principle and unless otherwise stated in the relevant finance documents, allow each lender to individually take whatever actions it deems appropriate to protect its rights. As this is a risk for the transaction, intercreditor agreements seek to limit lenders’ freedom of action and to ensure that most decisions or actions taken by the lenders are properly coordinated.

Intercreditor agreements in Spain are similar to those of other jurisdictions, although the particularities of the Spanish Insolvency Law must be taken into account. A mere translation of an anglo-saxon intercreditor agreement is a perfect recipe for disaster.

As in other countries, intercreditor agreements provide (i) a collective response to breach of covenants or representations and events of default and the coordination in the exercise of rights; (ii) an agreement for the enforcement of security; and (iii) a commitment to share the proceeds resulting from payment or enforcement of security.

Certain rules to ensure that all creditors with the same ranking are paid on a pro-rata basis at all times and before any junior lender is paid (with certain exceptions allowing certain interest payments to junior lenders) are also contained in intercreditor agreements. This normally implies that lenders agree that payments made by the borrower under the facilities must be channelled through the agent (which will distribute them according to the agreed sharing and priority rules) and that any amount they receive from the borrower will be re-channelled through the agent.

Intercreditor agreements will normally also provide that junior lenders are not entitled to terminate and accelerate the junior facilities upon the occurrence of an event of default until a certain ‘standstill period’ has elapsed. The duration of the ‘standstill period’ will depend on the seriousness of the breach and will range between 60 and 180 days. The so-called ‘blockage periods’, which commence upon the occurrence of any event of default under the senior facilities and block any payment to the junior lenders during such period, are also becoming common in Spain. As discussed above, second lien debt in Spain is sometimes subordinated in right of payment to the senior debt and intercreditor agreements also impose on second lien debt ‘blockage periods’ and ‘standstill periods’.

It is also becoming common to include in the finance documents a call option in favour of the second lien and mezzanine lenders which allows them to purchase the first lien debt at par (plus unpaid and accrued interest) within a specified period of time after the occurrence of certain events, including the acceleration of the first lien debt or the insolvency of the borrower.

However, Spanish intercreditor agreements have certain particularities. Among these are the role of the security agent, the concerns surrounding the execution by the borrowers of the intercreditor agreement and the existence of certain provisions set out in the Insolvency Law which can change the mechanics of payment sharing or convert some lenders in subordinated creditors.

Firstly, a common feature of Spanish acquisition finance transactions with different layers of creditors is the existence of a common security agent. This is not for convenience, it is necessary to appoint a common ‘depositary’ when several pledges over the same asset exist. This also helps to mitigate the risk of unilateral enforcement by lenders.

Secondly, and unlike in other jurisdictions, borrowers as a general rule are not parties to the intercreditor agreement. Most law firms will recommend that borrowers do not become aware of the internal relationships between their creditors. While a borrower can validly agree to waive any right arising from the intercreditor agreement, if it becomes insolvent, the courts or the administrators of the borrower could try to use the intercreditor agreement to block or delay payments.

Finally, the normal mechanics of sharing of payments and priority may not work in an insolvency scenario. As discussed above, the Spanish Insolvency Law divides creditors into privileged, ordinary and subordinated, but it does not differentiate between senior or junior lenders in the same way as the facilities purport to do. The Spanish Insolvency Law recognises contractual subordination, but only when the debtor subordinates itself to all the creditors (deeply-subordinated provisions), not when, as is more common, the debtor subordinates itself to certain creditors (the senior lenders). This means that for an insolvency court, senior and junior lenders will rank equally for insolvency purposes. Given that during an insolvency process junior lenders may receive payments from a court or from the administrators of the insolvent debtor, or even obtain certain debt cancellations by set-off against their claims, the intercreditor agreements contain turn-over provisions that require the junior lenders to turn over to the agent any payments received in breach of the rules set out in the intercreditor agreement. The agent, in turn, will distribute the proceeds among the preferred creditors.