The European Lawyer

Switzerland Banking/Finance

11 Mar 2010

International Acquisition Finance - Switzerland

Editors: Homburger AG - René Bösch and Jürg Frick

1. SWISS M&A MARKET
Despite the credit market crunch in the fall of last year, the Swiss M&A market prospered in 2007. As compared with 2006, deal activity in Switzerland, measured by the number of deals announced, increased by roughly 25%. The aggregate value of deals for which values were disclosed, however, remained at about the same level as in the previous year. The average deal value of the top ten deals announced in 2007 was roughly US$4.5 billion (source: KPMG M&A Yearbook Switzerland 2007).
Strategic players are still predominant in Switzerland. With many Swiss corporations being strongly capitalized and showing healthy balance sheets, Swiss companies generally continued to act as buyers rather than becoming targets. The M&A activity by Swiss companies demonstrated a continued strategic focus on core business acquisitions and divestments of non-core businesses. Industry segments showing the most activity were financial services and insurance, healthcare and life science, chemicals and materials and, increasingly, sectors such as consumer goods and information, communication and entertainment (ICE).

The number of private equity transactions more than doubled in 2007, representing about 18% of the overall Swiss M&A activity. Major private equity transactions included the sale of Hirslanden Group, owned by BC Partners, to South African Med-Clinic, and Adecco’s acquisition of Tuja Zeitarbeit GmbH from Barclays Private Equity for US$1.1 billion. In terms of exit strategies, Switzerland has seen some private equity investments which were exited by IPO, e.g., u-blox or Uster Technologies, as well as secondary and trade sales.

2. DOCUMENTATION
The law governing acquisition finance transactions depends on various factors such as parties involved, structure and size of the transaction, as well as on financing instruments used. In general, Swiss law governs documentation for deals among Swiss parties and, in particular, if the target company is a Swiss entity. Should the target or the acquisition vehicle be a Swiss company, the equity portion of the deal will most likely be subject to Swiss law. Debt instruments such as shareholder loans may be governed by Swiss law as well, however, syndicated senior acquisition bank loans are most often governed by English law irrespective of the parties’ respective jurisdictions.

The standard documentation for the syndicated loan market provided for by the Loan Market Association (LMA) is well established in Switzerland, and, even if the parties decide not to use this standard documentation, they very often decide to draft Swiss law governed loan documentation which follows, to the extent possible, the structure of the LMA agreements.

Even if only Swiss parties are involved and the documentation is subject to Swiss law, the parties often prefer the documents to be in the English language.

3. ACQUISITION/FINANCING STRUCTURES
The shares in or the assets of a target company are usually acquired either by an existing, operative group company of the acquirer or by a company newly established for the acquisition. For leveraged buy-out transactions, it is customary to incorporate a new company, the shares of which are held by the private equity investor, any co-investors, the management team and other employees and, as the case may be, shareholders of the selling company reinvesting the proceeds of their sale.

In order to finance the acquisition, several different equity and debt financing instruments are usually employed. These instruments differ from one another in terms of their exposure to risks and their entitlement to profits. Because of these different risk-profit-profiles, the various instruments are not equally suitable for each type of investor.

In leveraged buy-outs, the managers and other key employees will typically be granted the opportunity to acquire common shares in the acquisition company. As common shareholders, they qualify as residual claimants of the acquisition company and they only participate in liquidation or sale proceeds of the acquisition company once all its creditors, as well as all shareholders with preferential liquidation rights or preferential entitlements to the sale proceeds, have been satisfied.

Private equity investors regularly insist on the receipt of preferred stock in the acquisition company. Swiss corporate law allows for shares with preferential dividend rights, preferential liquidation rights or privileged voting rights. Unlike these preferential rights, which may be set forth in the company’s articles of incorporation, preferential entitlements to sale proceeds are not provided for by Swiss corporate law and, therefore, may only be stipulated in an agreement amongst the shareholders of the company.

In addition to equity capital, an acquisition may be financed with a combination of senior debt, second-lien debt, mezzanine debt and shareholder loans. In addition to granting term loans to pay the purchase price for the target, senior lenders may also grant revolving facilities for working capital or guarantee purposes. Senior debt may be guaranteed or secured by security interests in assets of the target or the acquirer.

Second-lien debt ranks junior to senior debt and it is only secured by second-ranking security interests over the assets of the target or the acquirer. Mezzanine debt in general is unsecured, ranks behind senior and second-lien debt and may be combined with equity kickers (see Sections 6 and 7 below).
Finally, shareholder loans are typically unsecured and subordinated to all other debt capital of the financed company. Should the company become over-indebted, repayment and interest payment obligations under shareholder loans are often deferred until the value of all of the company’s assets exceeds the amount of its payment obligations and, consequently, an unqualified audit report may be issued.

4. REGULATED TARGETS
Target companies regulated under Swiss law can be, inter alia, banks, securities dealers, fund management companies or insurance companies. All these entities have in common that they are licensed by a supervising authority, which as of January 1, 2009 will be the Financial Market Authority (FINMA) for all of them.

One of the general conditions to any such entity obtaining its license is that any individual or legal entity directly or indirectly holding at least 10% of its capital or voting rights must ensure that its influence will not have a negative impact on the prudent and reliable business activities of such entity. Accordingly, the identity of the acquirer and its business or other activities may be relevant to the grant and maintenance of the regulated target entity’s license. Examples of characteristics of a shareholder holding a qualified participation of 10% that may have a negative influence on the regulated entity are: a lack of transparency, unclear organization or financial difficulties of financial conglomerates as well as the influence of a criminal organization on the shareholder. Should the supervising authority take the view that due to a shareholder acquiring a qualified participation the conditions for the respective company’s licenses are no longer met, the supervising authority may require the acquirer to sell its participation, failing which it may suspend the voting rights in relation to such qualified participation or, if appropriate and only as measure of last resort, withdraw the existing license and require the entity to liquidate.

Should non-Swiss parties intend to acquire more than half of the voting rights of, or acquire otherwise a controlling influence on certain regulated Swiss entities, such as a bank incorporated under the laws of Switzerland, the granting of the relevant license becomes subject to additional requirements. In particular, the countries where the owners of such a controlling participation have their registered office or their domicile must grant “reciprocity,” which means that (i) Swiss residents and Swiss entities must be permitted to operate a bank in such a country, and (ii) such banks operated by Swiss residents are not subject to more restrictive provisions in this country, as compared to restrictions on foreign banks in Switzerland. Reciprocity, however, is not an issue for countries that are signatories to the General Agreement on Trade and Services (GATS).

5. LISTED TARGETS
Following recent attempts by hedge funds and other market participants to build up large stakes in traditional Swiss companies such as Ascom, Implenia, Saurer or Sulzer, as of December 1, 2007, the rules regarding disclosure of significant shareholdings in listed Swiss companies have been tightened considerably. In addition to the former disclosure thresholds of 5, 10, 20, 33 1/3, 50 and 66 2/3%, the Swiss Federal Parliament and the Swiss Federal Banking Commission enacted additional disclosure thresholds at 3, 15 and 25%. Furthermore, rules have been enacted stating that transactions involving financial instruments that may result in the acquisition of equity in a company “with regard to a tender offer” are deemed an indirect acquisition of shares and, therefore, are subject to disclosure as well. The meaning of “with regard to a tender offer” is unclear and a new concept in Swiss disclosure law and, as a result, the interpretation of this new condition may turn out to be problematic. Finally, conversion and share acquisition rights (call options) and share sale rights (put options) are now counted towards the disclosure thresholds even if they provide for cash settlement only. This amendment is aimed at addressing the situation in which an investor tries to hide behind cash settled options which, upon exercise, are nevertheless settled by delivery of shares.

If a party either directly or indirectly or acting in concert with other parties acquires more than 33 1/3% of the voting rights in a company listed in Switzerland, an offer must be made to acquire the shares of all other shareholders of the company. There is an exemption if, prior to such an acquisition, the company either raised the threshold to 49% (opting up) or abolished the mandatory tender offer obligation entirely (opting out). Both exemptions have to be provided for in the company’s articles of incorporation.

6. MEZZANINE DEBT AND INTERCREDITOR ARRANGEMENTS
Typically mezzanine debt is unsecured, ranks behind senior and second-lien debt and may be combined with equity kickers (see Section 7 below). Mezzanine loans are usually subordinated by way of an agreement between the mezzanine lender and the company.  In such an agreement the mezzanine lender declares, with effect for all senior creditors, that in case of the company’s bankruptcy or composition with its creditors, the mezzanine lender’s claim shall rank behind the senior creditors’ and all other non-subordinated creditors’ claims. Because such declaration is effective without the senior creditors’ consent, it does not need to be set forth in an intercreditor agreement.

7. EQUITY KICKERS
Under Swiss law, an “equity kicker,” i.e., a means to participate in or to have the benefit of an increase in the borrower’s equity value, may have different forms. For example, a company may make interest payments on debt not in cash, but in kind (payment in kind or PIK). Typical equity kickers, however, are either conversion rights or option rights. A conversion right grants a creditor the right to convert such creditor’s loan into equity capital of the company. Upon exercise of the conversion right, the company’s loan repayment obligation is set off by the creditor’s obligation to pay the issue price for the new shares or, in other words, the creditor receives the shares in return for forgiving the company’s loan. On the other hand, an option right grants the creditor the right to acquire shares in the company that is independent from such a creditor’s repayment claim. In both cases, Swiss law requires the company to provide for conditional share capital in its articles of incorporation out of which shares can be issued upon a creditor’s exercise of its conversion or option right. A shareholder’s right to advance subscription of any such equity-linked debt instruments may only be waived or withdrawn for valid reasons, such as the financing of an acquisition, a placement or listing of a convertible bond or note abroad or if the granting of the advance subscription right before the pricing of such equity-linked debt instrument would have been unreasonably cumbersome for the company.

8. SECURITY
Under Swiss law, to secure a borrower’s repayment claim under a credit facility, guarantees and security interests over assets of the lender or a third party may be granted. In order to take a security interest over an asset under Swiss law, it is mandatory that the secured party obtain and maintain physical possession of such asset (in case of a pledge) or that the secured party acquire legal title and, where relevant, physical possession of such asset (in case of transfers or assignments for security purposes). At this point in time, the concept of a floating charge or floating lien is not known under Swiss law.

Furthermore, with respect to pledges, Swiss law is based on the doctrine of accessoriness, meaning that a valid pledge may only be given to the lender whose claim is secured by the pledge and not to a third party. Because of its accessory nature, a pledge cannot be vested in a third party (including a security agent) who would hold the pledge in its own name and right but beneficially for the lenders; rather, the pledge needs to be granted to each lender concurrently, although the lenders may agree to be jointly represented by a security agent. Alternatively, in the absence of manifest misuse, parallel debt structures should be acceptable under Swiss law.

The doctrine of accessoriness does not apply to other forms of security, e.g., transfers or assignments for security purposes. Therefore, it is permissible from a Swiss law perspective to grant such security directly to a security agent on behalf of the lenders.

The most common assets over which security interests are granted in connection with acquisition financing transactions are shares, bank accounts, receivables and intellectual property. On some occasions, mortgages are granted over real estate property.

Shares are usually pledged rather than transferred for security purposes. The perfection of a pledge over the shares of a Swiss company generally requires (i) a written contract among the pledgor, the pledgee and the security agent (if any), and (ii) the physical transfer of the share certificate to the pledgee or the security agent, as the case may be. Should the transfer of the shares be restricted, it is advisable to require the issuer of such shares to either abolish the transfer restrictions or at least obtain a board resolution approving in advance the transfer of the pledged shares to a third party acquirer upon enforcement of the pledge. 

A security over receivables is normally taken by way of a general fiduciary assignment. The perfection of the assignment requires a written assignment agreement and assignability of the relevant claims under the law by which they are governed. Usually, such fiduciary assignment is silent, which means that the third party debtors are only notified of such assignment in case of a default. Until such time, the third party debtor may satisfy its obligations by paying the assignor.

To perfect mortgages over real property, including, among others, land, houses or building rights, a notarized deed as well as the entry of the mortgage into the Cantonal land register is required. The costs for creation and perfection of a real property mortgage depend on various factors such as the registration fees of the land register and the fees for the notarization of the mortgage agreement. These fees vary from Canton to Canton and, in certain Cantons, may be significant. Swiss practitioners prefer the creation of mortgage certificates (Schuldbrief) because mortgage certificates constitute negotiable securities that may themselves be sold and pledged. Mortgage certificates are issued by the Cantonal land register and may be in bearer form or registered form. A bearer mortgage certificate can easily be transferred by physically delivering it to the transferee. The transfer of a registered mortgage certificate may be transferred in the same way, but also requires an endorsement to the transferee. A mortgage certificate may be given as collateral either by way of pledge or outright transfer of the certificate for security purposes. In both cases, a written security agreement is needed. The main difference between the two types of security materialises in bankruptcy. A pledged mortgage certificate will fall into the debtor’s estate and, as a result, the pledgee will only have a preferential right to the proceeds of its sale. Conversely, if the mortgage certificate was transferred for security purposes, it will not fall into the debtor’s estate and the secured party holding the certificate may realise it by private sale. 
For limitations on financial assistance see Section 10 below.

9. CORPORATE THIN CAPITALISATION RULES
Swiss company law does not provide for any thin capitalisation rules or restrictions on debt financings. Swiss tax law, however, does provide that if certain levels of debt are exceeded, tax authorities may deny the deduction of interest on the portion of such loans granted to group companies that exceeds these levels . The level of acceptable debt in relation to the equity capital of a Swiss company generally depends on the market value of the company’s assets; for example, for finance companies the debt-to-equity ratio shall not exceed 6:1. If the applicable threshold is exceeded, the interest payments in relation to the portion of the debt exceeding such a threshold are no longer tax deductible and capital tax is due on the exceeding portion of the loan. In addition, the interest rate on debt financings must be determined on an arms’ length basis (i.e., must not exceed the maximum interest rates published by the Swiss Federal Tax Administration annually), failing which Swiss dividend withholding tax (currently levied at the rate of 35%) will be levied on the interest payments if the loan has been granted by a parent or sister company. Both maximum debt-to-equity ratios and maximum interest rates do not apply to third party debt. Due to these limitations on investor financing, in practice, third party acquisition financing prevails over investor financing.

In addition, one needs to take into account that under Swiss company law, if a company’s liabilities exceed its assets, the company is required to take measures to restore its balance sheet. In particular, if the claims of the company’s creditors are no longer covered, either based on the company’s going-concern value or based on the liquidation value of its assets, the company’s board of directors must notify the competent bankruptcy judge, unless some of the company’s creditors agree to subordinate their claims to those of the company’s other creditors.

There are no specific shareholder liability issues in a relation to thin capitalisation or restrictions on debt financing under Swiss law. The obligations of a shareholder are limited to the payment of the subscription amount. There has been much debate about the potential conversion or recharacterisation of a loan granted by a parent to a subsidiary into equity, in case of the subsidiary’s too-thin capitalisation or its financial collapse. However, Swiss courts and prevailing doctrine have so far declined to support such a conversion or recharacterisation.

10. FINANCIAL ASSISTANCE
The granting of security by a Swiss company to secure debt used to purchase its own shares or the shares of a subsidiary is not subject to any particular company law rules, provided that if the company is buying its own shares, it shall not purchase more than 10% of such shares. However, restrictions under corporate benefit rules apply to grants of upstream (to a direct or indirect parent company or shareholder) or cross-stream (to any other group company that is not fully owned by the Swiss company providing the security) security that may significantly impact the value of such security. Such upstream or cross-stream security is only permissible if the value of the security does not exceed the granting company’s freely available reserves and profit carried forward at the time of the security’s enforcement and if it is granted on arms’ length basis, i.e on conditions under which an independent party would also have provided such security. However, the arm’s length requirement can lead to practical difficulties: (i) the benefitting shareholders often do not wish to provide any consideration for the security, and (ii) it is difficult to determine what amounts would constitute adequate consideration.

As a result, it is advisable and standard practice to treat the granting of cross- and upstream security in the same way as a distribution by the granting company to its shareholder(s). This means that the board of directors and the shareholders of the granting company must approve the granting of such security. In addition, appropriate limitation language should be included in the security documentation so that the enforcement of the security is limited to freely distributable reserves and profit carried forward of the granting company at the time of the enforcement (as determined in accordance with Swiss generally accepted accounting principles and confirmed by the granting company’s auditors). It should be pointed out that certain aspects of upstream and cross-stream security are unsettled under Swiss law and will likely remain so until the Swiss Federal Court has the opportunity to review and decide the validity of such security.

In addition, a Swiss target company may grant loans to its acquirer for the purpose of financing its purchase only if this is within its corporate purpose (i.e., within the general description of such a company’s purpose as set forth in its articles of incorporation) and such a loan can be financed out of the freely available reserves and profit carried forward of such a company and is made on an arm’s length basis.

The outlined Swiss rules on financial assistance do not mean that the lenders will have no access to the cash flow of the target. In particular, the rules do not prevent a Swiss company and its subsidiaries from providing guarantees or granting security interest for acquisition or other debt. However, such granting of security is subject to the corporate benefit rules described above.

The so-called “debt push-down structures” or “on-lending-structures” are generally accepted in Switzerland. It is quite common that the lenders make funds available to the target and/or its subsidiaries and that the target or its subsidiaries grant security for the amounts borrowed by them. To allow the target to satisfy its repayment obligations, subsidiaries will upstream funds to the target either by way of dividends or repayment of intra-group loans. However, such upstreaming is subject to company law restrictions. Moreover, such financing structures must generally be within the interest of the company (i.e., the target) and must not seriously jeopardize the target’s commercial existence.

11. DIRECTORS' LIABILITY
The members of the board of directors as well as any person entrusted with the management of a Swiss company shall be liable to the company and any shareholders and creditors of the company for damages caused by willful or negligent violation of their duties.

In general, if directors or officers transact on behalf of the company with bona fide third parties in violation of their statutory duties, the transaction is nevertheless valid as long as it is not outright excluded by the company’s business purpose. Directors and officers acting in violation of their statutory duties – whether transacting with bona fide parties or performing any other acts on behalf of the corporation – may, however, become liable to the company, its shareholders and (in bankruptcy) its creditors for damages caused to any of them. The liability is joint and several, but the court may allocate liability among the directors and officers in accordance with their degree of culpability.

12. LENDERS' LIABILITY
Under Swiss law, the concept of lenders’ liability is not known as self-contained concept. There are no specific liability rules, meaning that liability of lenders may only arise if lenders exercise their rights and obligations against their clients in violation of the general rules and laws applicable under Swiss law.
For instance, lenders’ liability issues may arise if lenders incorrectly terminate a facility agreement or do not act in good faith in exercising their rights under a facility agreement. As a general rule, lenders must exercise their rights with due care and balance their own interests with those of their borrowers.

13. LEGAL OPINIONS
Opinions rendered by Swiss lawyers are generally based on standard assumptions and subject to standard qualifications that follow, inter alia, the guidelines on legal opinions in international transactions issued under the auspices of the International Bar Association. In addition, specific tailormade assumptions and qualifications will be introduced to address the particular aspects of the relevant transaction. Thus, legal opinions in relation to acquisition financing transactions usually address issues of financial assistance, the taking of security, in particular by way of pledge, fraudulent conveyance rules and choice-of-law rules.

As elsewhere in Europe, it has become standard practice that validity and enforceability opinions regarding the lenders are provided by counsel to the lenders, whereas counsel to the borrowers either do not issue an opinion or limit their opinions to issues of due capacity and corporate authorisation.

14. POST-ACQUISITION RESTRUCTURING
Following the acquisition of a listed company, acquirers usually wish to delist the company and take it fully private by way of a squeeze-out. In addition, restructurings are often carried out as a debt push-down whereby the acquisition debt is refinanced at a level closer to the operating assets, which eliminates the effect of structural subordination on the lenders and potentially increases the value of security available to lenders.

Under Swiss law, two forms of squeeze-out are available to an acquirer: (i) a squeeze-out following a public tender offer that resulted in the acquirer holding more than 98% of the voting rights in the Swiss target company, or (ii) a squeeze-out merger between the acquirer and the target. A squeeze-out merger is effected by way of a merger whereby minority holders in the target will be cashed-out rather than provided with new shares in the merged company. However, a squeeze-out merger can only be effected if 90% or more of the shareholders in the target company so resolve, meaning in practice that the acquirer needs to obtain a majority of at least 90% of the voting rights in the target company to effect a squeeze-out merger.

15. DEBT RESTRUCTURING
In Switzerland debt restructurings generally occur in two forms: (i) on a purely private and contractual basis, or (ii) under the protection of a court, such as within the framework of composition or bankruptcy proceedings.

Traditionally, lenders and borrowers have aimed to work together on debt restructurings before the company reaches such a stage of financial distress that it needs to seek the protection of the court. This is because Swiss insolvency laws do not afford proceedings that are as flexible and debtor-friendly as the chapter 11 proceedings in the United States. Contractually agreed debt restructurings usually involve the suspension of certain payments for a particular period of time, the refinancing of pre-existing debt at different levels with new commercial terms, equity injections by lenders or unrelated third parties (new equity investors), as well as debt/equity swaps. However, with respect to the use of debt/equity swaps  in recent years, lenders have exercised some restraint as a result of a dispute amongst scholars as to whether a debt/equity swap will only be effective without further recourse against the lenders if the debt to be converted is of sufficient value and substance on a going-concern basis. While the predominant view is that current Swiss law does not prescribe such value protection in relation to the debt to be converted, the recently published proposal for a revision of Swiss company law has reignited the debate.

Under Swiss insolvency laws, a borrower may seek the protection of a court for composition proceedings (Nachlassverfahren), which are designed to either liquidate the company in an orderly fashion, meaning that the assets of the company are assigned to the creditors in order to be liquidated and accounted against their claims or, on the other hand,  that the company agrees with its creditors on a partial write-down of their claims. While originally designed to afford a borrower an alternative to a bankruptcy proceeding, recent experience has shown that composition arrangements under Swiss law are subject to such rigid rules that they nonetheless usually lead to the liquidation of the company. As an alternative, the debtor may seek, or be put by way of application of its creditors into, bankruptcy, in which case the company will be liquidated under the authority of the administrator in bankruptcy. In both bankruptcy and composition proceedings, the debtor loses control over its assets, such control then being exercised by either the commissioner in composition proceedings or the administrator in bankruptcy proceedings. In particular, the realisation of pledged assets will no longer be possible by way of private sale or auction, but will be managed by the composition commissioner or the bankruptcy administrator.

16. ENFORCEMENT OF SECURITY
The conditions under which security may be enforced are determined by Swiss statutory law as well as the relevant provisions of the security agreement. This applies to both pledged assets and assets transferred by way of security.

For the secured party to enforce the security, it must have a secured claim, and this claim must be due. Further conditions for the enforcement of the security may be set out in the relevant security agreement.
In the case of pledged assets, there are two main forms of enforcement. First, a creditor may employ private enforcement, which is only permitted when the parties have agreed to it in advance. Private enforcement is possible for all types of assets, but in practice mainly occurs in connection with moveable assets. Such private enforcement may take place by a private sale, public auction or, with regard to assets the value of which can be objectively determined, by the pledgee itself purchasing the assets and applying the proceeds to the claims. Second, and upon the adjudication of bankruptcy over a Swiss debtor exclusively, the enforcement may follow the rules set out in the Swiss bankruptcy law, which generally means that the security is realised by selling the pledged assets in a public auction managed by the bankruptcy administrator. However, in certain cases, the bankruptcy administrator may also agree to a private sale of the pledged assets.

Enforcement in a strict sense is not necessary in the case of assets transferred for security purposes, as the ownership has already been transferred to the secured party. Enforcement in this context simply means that the obligation to return the transferred assets under the security agreement terminates.