The Spanish economy is growing modestly, despite the political uncertainty resulting from the elected congresspersons' inability to reach agreements and form a stable government, the deadlocked situation in Catalonia and the European-wide discussion of Brexit. The Bank of Spain recently lowered its GDP growth predictions for 2019, down from an overly optimistic 2.4 per cent to a more conservative 2 per cent.
In terms of acquisition financing, the Spanish market is doing well. Domestic and international players are making hay while the sun shines; in private equity, for instance, over €5.8 billion was invested in 2018, while 2019 is expected to dwarf that record figure with a remarkable €4 billion in the first semester alone. Additional good news is that investments of over €100 million are also growing, as evidenced by the fact that the first half of 2019 has witnessed as many of those deals as in all of 2018.2
While most of these deals have been financed by international and local banks, lending funds are gaining traction, especially in mid-market deals where the complex environment requires tailor-made solutions that only direct lending can provide in the form of mezzanine or subordinated debt.
In terms of documentation, one can expect the traditional suite of documents found in other jurisdictions. The documentation begins with a commitment letter attaching a term sheet and – in most cases where the borrower (BidCo) is bidding for the target company – providing a certain funds commitment from the lenders (together with the equity commitment letter of the sponsor where the buyer is a single purpose vehicle). The long form facility agreement is not required until a later stage, typically coinciding with the execution of the share purchase agreement. Note that most business acquisitions are primarily structured as share deals due to transfer taxes that may accrue when transferring specific assets, as well as the legal and contractual impediments in connection with the transfer of specific liabilities; for mergers, see the explanation on financial assistance limitations set out below. Following the satisfaction of the conditions precedent set out in both the share purchase agreement and the facility agreement, the funds will be drawn on the closing date, coinciding with the pledge over the shares in the target and the execution of the hedging confirmation letters – either following the ISDA master agreement or the Spanish equivalent CMOF. The use of a closing protocol, pursuant to which the perfection of the acquisition and of the security interests are mutually linked as a condition precedent to one another, is now a market standard to avoid the chicken-or-egg dilemma affecting these deals.
II REGULATORY AND TAX MATTERS
Lending is a non-regulated activity in Spain, although specific regulatory authorisations and filings are required to act as a financing entity for the general public. Consequently, any domestic or foreign entity can provide funding and charge interest to third parties. However, some features of Spanish law are reserved to Spanish-licensed and EU-passported banks and financial institutions, mostly due to banks' historic hegemony in connection with the lending market. As a result:
- in terms of the security package, two types of in rem security are not available to regular companies: (1) floating mortgages and non-possessory pledges, which unlike the traditional security interests under Spanish law, allow for a single asset to secure a number of present and future underlying obligations; and (2) financial collateral, regulated by Royal Decree Law 5/2005 implementing Directive 2002/47 EC in Spain, which is especially attractive to creditors as it allows for the appropriation of the collateral and its enforcement is not halted by the opening of insolvency proceedings; and
- in terms of taxation, financial institutions are exempt from paying stamp duty when amending the term or interest of mortgage-backed financing and benefit from other tax benefits as further described below.
ii Sanctions, anti-corruption and money laundering
Spain's regulations on sanctions, anti-corruption and money laundering mostly stem from the European harmonised rules and guidelines. However, it is worth noting that any company executing a public document must evidence the identity and details of its ultimate beneficial owner or controlling person to the notary public. The definition contained in Spanish law defines the ultimate beneficial owner or controlling person as a natural person who directly or indirectly holds or controls more than 25 per cent of the capital or voting rights of the company, or directly or indirectly exercises control over it by other means (including in their capacity as directors of the company). The only companies exempted from identifying controlling persons are listed companies, financial institutions and public entities in all cases based or licensed in the EU or equivalent countries, and any subsidiaries and branches thereof.
iii General tax considerations
Lending is subject to, but exempt from, value added tax. Interest and other income received by Spanish lenders are subject to Spanish corporate income tax, and should, therefore, be included in their tax base upon its accrual (a concept based on the income disclosed on the financial statements of the Spanish lenders, with some adjustments established in the corporate income tax regulation).
According to Spanish law, stamp duty is triggered when a public deed or a notarial minute is granted, with an economic valuable content and which is eligible for registration with a public registry and not subject to transfer tax, capital duty or inheritance and donations tax. Thus, mortgages over real estate located in Spain trigger the accrual of stamp duty, which is a percentage – between 0.25 per cent and 3 per cent depending on the Spanish region where the relevant asset is located – of the total amount (principal, interest, default interest, etc.) secured by the mortgage – typically ranging between 120 and 140 per cent of the principal amount of the facility.
Stamp duty will also accrue when assigning mortgage-backed loans to the extent the assignment is recorded within the relevant land registry. It is not uncommon, however, that the parties decide to formalise the assignment through a Spanish notarial document that is not eligible for registration with the land registry or to structure the assignment by way of a sub-participation.
Furthermore, some guarantees granted by persons who are not engaged in business activities (e.g. individuals) may trigger Spanish transfer tax, and specific promissory notes and checks may also be subject to stamp duty. The rates vary throughout the Spanish regions, but are set around 1 per cent of the secured amount with respect to transfer tax and 0.3 per cent of the document's face value with respect to stamp duty.
iv Tax deductibility
Subject to the limitations described below (none of which are applicable to financial institutions), interest is a deductible expense for corporate income tax purposes, as is any transaction cost or fee. However, expenses arising from intercompany loans will not be deductible if they fall within either of two categories: (1) profit participating loans (regulated in Spanish Royal Decree Law 7/1996); or (2) loans directed at financing the acquisition of shares held by another group company or to increase another group company's share capital or equity – unless, in both cases described in item (2), valid economic reasons are evidenced.
As a general principle, companies may only deduct their net interest (the excess of financial expenses over financial income) up to an amount equivalent to the higher of: (1) €1 million; or (2) 30 per cent of their operating profit (a concept defined in Spanish law similar to EBIDTA). Any excess may be carried forward without a time limit to the extent the thresholds are respected.
With respect to acquisition financing in particular, the tax-deductibility of interest paid in consideration of a debt incurred in order to acquire the shares of the target is limited to 30 per cent of BidCo's EBIDTA (as defined in Spanish Law), disregarding for this purpose the EBIDTA corresponding to any company that merges with BidCo or joins the same tax group as BidCo within the four-year period following the acquisition. This limit does not apply if at least 30 per cent of the acquisition is financed with equity and the debt incurred is reduced every year by at least the proportional part required to reduce the debt to 30 per cent of the acquisition price in eight years, until this level of debt is reached.
v Withholding tax
Withholding tax at a rate of 19 per cent is levied on any interest paid (although refundable to Spanish-resident lenders from their own corporation tax), to the extent none of the following exemptions apply: (1) interest received by specific entities exempt from paying corporate income tax (mainly public authorities); (2) interest on principal received by banks and specific financial institutions; (3) interest on principal received by securitisation funds; and (4) any interest received from Spanish lenders belonging to their borrower's tax consolidation group.
Non-Spanish resident lenders that are the beneficial owners of the Spanish-sourced interest may benefit from an exemption of withholding tax in Spain provided that they fall within one of the following categories: (1) Spanish branches of foreign credit entities, duly registered before the Bank of Spain; (2) entities resident in an EU Member State not acting through a country or territory considered a tax haven under Spanish law or through a permanent establishment located outside the EU; or (3) entities resident in a jurisdiction that has entered into a double tax treaty with Spain that contains an exemption for interest payments and that are fully entitled to benefit from the treaty.
Note that, for these purposes, EU residents and treaty lenders should: (1) not carry on a business in Spain through a permanent establishment with which that lender is effectively connected; and (2) obtain a valid and in-force certificate of tax residency in their specific country of residence. The certificate should be provided to the borrower in a timely manner before any payment of interest is due or paid (whichever occurs first).
Finally, it is worth reminding that beneficial owner status must be carefully reviewed in light of the European Union Court of Justice decisions of 26 February 2019 (in cases C-115/16, C-118/16, C-119/16 and C-299/16, N Luxembourg I et al, and cases C-116/16 and C-117/16, T Danmark et al).
Spanish market practice follows the standard no-FATCA-gross-up provisions published by the Loan Market Association, and borrowers do not make additional payments on account of FATCA withholdings as a general rule.
III SECURITY AND GUARANTEES
i Standard security package
Under Spanish law, a security interest can only secure one main obligation (principal and interest, costs, etc.). Therefore, each secured obligation will require its own security interest, with the exception of floating mortgages and non-possessory pledges described above. Additionally, although Spanish law allows multiple mortgages to be created over the same collateral, it is silent on pledges; nevertheless, this is now market practice and is generally accepted by legal scholars.
Although lenders usually require a security package that covers all the assets and rights (and, therefore, all potential sources of income) of the target and over BidCo to the extent structured this way, there is no way of covering all the assets of a company since the security interest to be created varies depending on the nature of each asset under Spanish law. Alternatively, if the relevant legal requirements are met, a chattel mortgage could be created over the business, which for these purposes includes the business premises and its facilities, commercial signs and lease and transfer rights.
The security package in a Spanish acquisition financing typically consists of a pledge over the shares of the target and over BidCo, to the extent structured this way, a pledge over the bank accounts of BidCo and a pledge over the credit rights arising from the share purchase agreement. Note that depending on whether the company whose shares are being pledged is a private limited liability company or a public limited liability company – and, in the latter case, depending on whether or not the company is a listed company – perfection requirements will vary.
Both the pledge over shares of a public limited liability company and the pledge over the bank accounts could be structured as financial collateral pursuant to Royal Decree-Law 5/2005, to the extent the creditors comply with the subjective requirements set out above. The most obvious advantage of applying the financial collateral regulations is the lenders' right to acquire the ownership over the encumbered asset, as opposed to the traditional Spanish-law principle of initiating an auction sale process.
Note that the region of Catalonia has special legislation regarding, among other matters, the creation of pledges (the most significant disadvantage being that the pledged collateral cannot be repledged except in favour of the initial pledgees and provided that the secured liability is distributed among the secured obligations), and will be applicable when, for instance, the corporate headquarters of the limited liability company is located in Catalonia, the share titles of the public limited liability company are deposited or registered in Catalonia, or the bank accounts are held in branches located in Catalonia.
To avoid the stamp duty cost described above, lenders may allow the borrower to grant promissory mortgages – in lieu of actual mortgages. These promissory mortgages do not accrue stamp duty but are not in rem security: the grantor of the promissory mortgage undertakes to create the mortgage if and when the agreed trigger occurs (at which moment the stamp duty will accrue).
Alongside the security package, the chargors are required to grant irrevocable powers of attorney in favour of the security agent in order to allow the latter to carry out specific actions aimed at perfecting, preserving and enforcing the charge. The powers of attorney must be documented in a Spanish public deed and contain specific wording to rebut any potential future challenges by the grantor regarding their irrevocable nature.
ii Security agent
Spain has neither signed nor ratified The Hague Convention of 1 July 1985. As a result, the concept of security agent or security trustee does not exist in Spanish law, and the idea itself is of dubious compatibility with certain core principles of Spain's legal system.
Under Spanish law, security interests are construed as ancillary to the underlying obligation; thus, a security interest governed by Spanish law must be granted in favour of the creditor itself. Parallel debt structures are not regulated under Spanish law and are not commonly used for implementing Spanish security interests securing a facility governed by foreign law given that Spanish law requires that contracts and obligations be based on a valid, legitimate basis in order to be valid and enforceable.
Splitting the legal title and equitable right is neither contemplated under Spanish law nor binding upon third parties. Thus, a contractual scheme implementing the same outcome that a trust would have would not be enforceable against third parties, including in cases in which the trustee were to breach its obligations.
If a Spanish company were to act as a trustee, the assets held in trust would not be considered as a segregated, separate estate and immune from other creditors of the security trustee.
Notwithstanding all of the above, it is common in Spanish syndicated lending to appoint a security agent that is responsible for day-to-day issues and, if and when required, initiates the enforcement proceedings; however, in order for the security agent to appear on behalf of all secured creditors and accept the creation of, or enforce, the security interests, the security agent will need to evidence that it has been validly empowered by each of the secured creditors to carry out the corresponding task. In order for the powers of attorney to be valid in Spain, they must be notarised in the grantor's jurisdiction of incorporation and bear the apostille of The Hague Convention of 5 October 1961 (or be legalised, in cases where the grantor's jurisdiction of incorporation is not a party to the Convention).
iii Financial assistance
Spain has yet to implement the provisions of Directive 2006/68/EC loosening the restrictions on financial assistance. This means that Spanish financial assistance rules are stricter than the norm in the European Union. Spanish companies are prohibited from advancing funds, making loans, providing guarantees, security or any kind of financial assistance to a third party for the acquisition of its shares or shares of its controlling company and – for private limited liability companies – any other company of its group. The norm does not establish a time frame limitation, thus impacting any refinancing of acquisition financing. Transactions in breach of the prohibition would be declared null and void and lead to fines being imposed on the company's directors (for up to the nominal value of the shares acquired as a result of the breach). The two safe harbours – stock option plans for employees and transactions executed by credit institutions in their ordinary course of business – are not applicable to the majority of transactions, and the traditional solution of conducting a forward merger with the BidCo has been limited by Spanish merger rules if the acquisition financing was granted in the three years preceding the merger. Notwithstanding the above, financial-assistance rules do not establish any specific limitations on distribution of dividends or on share capital reductions. Those corporate transactions will not generally be regarded as prohibited under financial-assistance rules and will be permitted insofar as the corporate benefit test is passed.
iv Corporate benefit
Directors of a Spanish company must perform their duties loyally and diligently in accordance with applicable law and the company's articles of association, and give preference to the interests of the company over those of any other person, including the interests of its parent company or group. Notwithstanding this general principle of law, numerous legal scholars and some case law have vindicated the corporate benefit in guaranteeing indebtedness of group companies that benefits the group as a whole. In any case, directors should analyse corporate benefit on a case-by-case basis considering, among other circumstances, the structure of the group, the nature and amount of the guarantees given, the purposes of the financing and the direct and indirect compensation received as consideration for the security or guarantee. Downstream guarantees are easier to justify in terms of the parent's corporate benefit as the subsidiaries' financing is likely to impact the future distributions to the parent. Upstream or cross-stream guarantees may, in turn, prove more challenging as the guarantor's corporate benefit is not always tangible. If a court determines that the corporate benefit was breached, the directors would be liable for damage caused by the breach, and their decision would be declared void even if the declaration would not prejudice good-faith third parties.
IV PRIORITY OF CLAIMS
i Priority of claims
Spanish insolvency law differentiates between creditors against the estate (consisting of expenses incurred in the course of the insolvency proceedings or necessary for the continuity of the business), which are paid at maturity and before the repayment of the unsecured creditors, and insolvency creditors, which are those whose credit rights arose before the opening of the insolvency proceedings.
Insolvency creditors are in turn divided among: (1) secured creditors (who are to be repaid with the proceeds of the sale of the encumbered asset); (2) privileged creditors, an exhaustive list consisting of, inter alia, employees and public authorities – including tax and Social Security – (who are to be repaid with any excess proceeds following repayment of credits against the estate); (3) ordinary creditors, a concept that captures any creditors not belonging to any other category (and who are repaid pari passu with any excess proceeds after repayment of the privileged creditors); and (4) subordinated claims.
Subordinated creditors are those holding any of the following claims (and in the following order): (1) claims that were reported late to the insolvency receivership; (2) contractually subordinated claims; (3) claims for interest of any kind; (4) claims for fines; (5) claims held by creditors holding a special connection with the insolvent company (see explanation for equitable subordination below); (6) claims held by creditors found to have acted in bad faith in the context of claw-back proceedings; and (7) claims held by creditors found to be acting consistently to the detriment of the insolvency proceedings.
ii Enforcement of security with an insolvent chargor
Secured creditors will be impacted by the chargor's insolvency differently, depending on whether or not the security is financial collateral subject to Royal Decree-Law 5/2005. Financial collateral is not limited, restricted or in any way affected by the initiation of insolvency proceedings, and thus may be enforced upon acceleration of the facility.
Enforcement of security that does not qualify as financial collateral but that is deemed necessary for the continuity of the insolvent company's business (which generally encompasses all – or substantially all – of its assets) will be paralysed upon the opening of the insolvency proceedings until the earlier of: (1) the approval of a creditors composition agreement (and provided that the secured lender has not voted in favour of it, in which case it will be bound by its terms); and (2) one year since the opening of the insolvency proceedings, provided that the insolvency court has not opened the liquidation phase.
iii Equitable subordination
Spanish insolvency law imposes equitable subordination upon creditors of an insolvent company that either: (1) hold, directly or indirectly, 5 per cent or more of the borrower's share capital, if the borrower is listed, or 10 per cent or more in the case of a non-listed borrower; or (2) were appointed or de facto directors, liquidators or general representatives of the insolvent company in the two years immediately preceding the opening of the insolvency proceedings. Assignees acquiring any such claims in the two years immediately preceding the opening of the insolvency proceedings will be affected by equitable subordination, unless proven otherwise.
In contrast, creditors meeting either of the two requirements as a result of debt-for-equity transactions contemplated in a court-sanctioned restructuring agreement will not be deemed subordinated with respect to any other claim they may hold.
Spanish Insolvency Law allows the insolvency court (upon the insolvency receiver's or, alternatively, any creditor of the insolvent company) to rescind any action taken or agreement reached by the insolvent company in the two years immediately preceding the opening of the insolvency proceedings, provided that the court concludes that the action or agreement is detrimental to the insolvency estate, without requiring any fraud or bad faith from either the insolvent company or its counterparty.
The law provides for some scenarios where the detriment cannot be rebutted (such as: (1) actions or agreements made or executed by the insolvent company for no consideration; and (2) prepayments of unsecured indebtedness maturing after the opening of the insolvency proceedings) and determines that actions taken in the ordinary course of business and under normal circumstances cannot be rescinded. However, what constitutes 'ordinary course of business' and, by extension, the detrimental nature of an action or agreement, is by and large left for the insolvency court's interpretation on a case-by-case basis. In some cases, the burden of proving the inexistence of a detriment is transferred to the counterparty of the insolvent company: (1) sales of assets to persons subject to the equitable subordination; (2) creation of rights in rem to secure preexisting indebtedness or a refinancing thereof; and (3) prepayments of secured indebtedness maturing after the opening of the insolvency proceedings.
In principle, when an action or agreement was at the time undertaken or executed the most feasible alternative to prevent further deterioration to the insolvency estate, the action should not be considered detrimental to the insolvency estate and thus would not be rescinded. By the same token, actions and transactions that adversely affect the par condition creditorum (the right of all creditors to be treated equally) may be considered detrimental (for example, actions, agreements or transactions that, while benefiting some creditors, reduce the likelihood of others being paid) even if the debtor's assets are not reduced as a consequence of those actions.
Spain is bound by Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I). As a result, the choice of a law other than Spanish law is valid and would be recognised by Spanish courts to the extent that it does not infringe Spanish public policy or mandatory provisions of Spanish law.
Despite the above, the choice of English law (or any other foreign law) is rare in purely Spanish transactions and increasingly uncommon in larger transactions following the approval of pre-insolvency and court restructuring regulations.
If, however, the agreement is subject to a law other than Spanish law and a Spanish company is an obligor, input will be required from a local lawyer with respect to, inter alia: (1) the analysis of the corporate benefit and financial assistance limitations described above; (2) the structure of the security to be created by the Spanish obligor; (3) the corporate approvals required by the Spanish obligor; (4) the insolvency-related issues to be taken into account; and (5) the access to expedite enforcement proceedings vis-à-vis the Spanish obligor.
With respect to jurisdiction, the choice of Spanish courts is the norm to the extent the principal borrower is a Spanish company. Arbitration is nearly unheard of.
VI ACQUISITIONS OF PUBLIC COMPANIES
Acquisitions of Spanish listed companies are typically effected through takeover bids with cash consideration, which may be voluntary or mandatory if certain requirements are met.
i Mandatory bids
If a transaction has the effect of giving 'control' over a Spanish listed company, the buyer will be forced to launch a mandatory, unconditional bid for all of the shares in the target and for an 'equitable price', within one month of acquiring such control. For these purposes, 'control' means direct or indirect acquisition of at least 30 per cent of the voting rights of the target or, absent this percentage, being entitled to appoint, within 24 months of acquisition, a number of directors that, combined with the existing directors already appointed by the same buyer, constitute a majority of the board. Control may reside in a single entity or in various acting in concert.
ii Voluntary bids
Insofar as the requirements to launch a mandatory bid are not met, the buyer may freely decide the number of shares, the purchase price and the conditions precedent – including minimum level of acceptance – of the offer.
iii Financing takeover bids
Bidders launching a takeover bid over a Spanish listed company must evidence to the regulator – the National Securities Market Commission – that they have the necessary funding to finance the cash payments contemplated in the bid, and either make a cash deposit at a credit institution or – a more common solution – provide a bank guarantee (which is issued in the context of the facilities agreement used to finance the acquisition itself).
Certain-funds clauses are typical in these structures, even though there is no legal requirement to publicly disclose the documentation. Instead, only information regarding the guarantees posted (and the guarantor's details), the economic terms of the financing, the creditors' details and the impact on the target's balance sheet, if any (including a detailed explanation if the target's cash flow is to serve the debt).
Spanish law grants bidders a squeeze-out right, and a sell-out right to minority shareholders, provided that: (1) the bid was launched for all of the target's voting rights; (2) at least 90 per cent of the bid's addressees accepted the offer; and (3) the bidder's resulting stake in the target is at least 90 per cent of the voting rights. Both rights will force the transfer of the minority stake within three months and at the same price offered in the bid.
VII THE YEAR IN REVIEW
Further integration and measures to reduce costs and improve capitalisation are expected in the Spanish banking sector. Spanish institutions are currently implementing concentration processes and are still very active in selling loan portfolios and distressed real estate assets, which are now conceived as large-scale deals.
Large restructuring transactions (some of which are the continuation of previous restructuring processes) have continued to play an important role, as significant deals closed during 2019 remain ongoing.
Leveraged loans have increased finance M&A activity. Furthermore, a large number of Spanish companies have refinanced their debt or issued bonds to improve its terms. Finally, a notable number of medium-sized companies have either entered alternative debt capital markets for the first time or continued the trend of issuing securities to reduce their dependency on banks.
Project finance is also due to increase, particularly as new policies that boost public spending on infrastructure and renewable energy projects now have access to more competitive pricings by means of executing PPAs.
Within this context, the Spanish General Codifying Commission is currently drafting a consolidated Spanish Insolvency Law that will likely introduce certain amendments to the insolvency framework to match new preventive-restructuring tools (including majorities, cross-class cram down and allowing the sale of the entire business of the insolvent debtor as a going concern), as well as the rules applicable to the receivers.
Finally, the Real Estate Credit Agreements Law was enacted on 16 March 2019, which partially transposes Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No. 1093/2010. The main purposes of the Real Estate Credit Agreements Law are to: (1) increase legal security; (2) eliminate any lack of transparency regarding real estate credits; and (3) reduce the litigiousness associated with specific unfair contractual clauses.
Domestic and international banks operating in Spain continue to be exposed to demanding regulations, low interest rates and high competition due to the existence of alternative sources of financing, which are developing into real competitors to traditional bank lending.
Traditional lenders must, therefore, pay close attention to the potential effects these challenges pose for their businesses and activities and decide which alternatives are best to address them.
Ultimately, the way lenders tackle the current challenges and adapt to new regulatory requirements will determine acquisition-finance volumes for the upcoming years.