The Debt-Equity Swap - a Comparative and Constitutional Analysis of the Rights of Minority Shareholders and Creditors in the Pre-Insolvency Procedure

The financial crisis that arose in 2007 and 2008 had a major influence on the Croatian economy: within a period of 4 years the number of business enterprises which were not able to meet their financial obligations grew by 29%, while the amount of unmet financial obligations at the end of 2014 exceeded HRK 32.5 bn (about USD 5.4 bn). If the businesses in financial distress are not able to overcome the reasons for bankruptcy, filing becomes inevitable. However, neither financial issues nor the initiation of bankruptcy proceedings inevitably lead to the liquidation of the debtor. Reorganization can be conducted either before or after the bankruptcy proceedings have been initiated. The concrete moment is determined by the general legal framework and the economic environment of the debtor. Depending on the moment of reorganization there exist various instruments which allow the debtor to confront the financial issues and prevent liquidation. The authors use a comparative approach to examine the legal framework of corporate reorganisation. This paper analyses the pre-insolvency debt/equity swap. The Croatian insolvency legislation is inspired to a significant extent by German law, which was in turn modelled after the bankruptcy law of the United States. The implementation of new legal instruments like the debt/equity swap can be the motor of modernization of a legal system, but it can also be the source of legal inconsistencies within the system. For this reason, the paper focuses on the adaptation of the final effects of this institute within the pre-bankruptcy procedure on the Croatian legal system. As the debt/equity swap has an intense impact on the rights of shareholders and the debtor’s creditors, the analysis centres on the limitation of the rights of minorities within these categories who oppose the debt-equity swap. In this regard the reasons for the limitation of rights are scrutinized from the constitutional aspect and compared to leading Croatian constitutional cases on similar issues. Based on the results of this paper, in the second paper the authors will focus on the various issues of strategic insolvency procedures in a broader sense