The Acquisition and Leveraged Finance Review: Bulgaria

Overview

The covid-19 crisis significantly affected the EU region, where most foreign investments in Bulgaria come from. As expected, the M&A activities in Bulgaria were also substantially reduced. The businesses that continue to generate interest from investors are in the areas of telecommunications, TV media, IT services, energy and recently, real estate developments.

Regarding existing large-scale loans involving Bulgarian obligors, although Bulgarian authorities were slow to implement assistance measures for companies affected by the pandemic and such assistance, once available, was insufficient, there was no visible increase in bankruptcy proceedings against Bulgarian obligors, neither in 2020 nor in 2021. It is worth noting that due to certain flaws in the Bulgarian insolvency procedure, creditors usually prefer to find other mechanisms to collect their debts. It is also possible for a surge in insolvencies to appear only several years after the start of the pandemic. For example, the effects of the 2008 financial crisis were mostly felt in the period between 2012 and 2014, when there was a two-to-threefold increase in insolvency proceedings compared to the previous years.

The temporary bank loans moratorium and the continuing policy of the ECB and EU central banks (including in Bulgaria) to keep interest rates low is another major difference compared to the financial crisis in 2008. At that time, interest rates increased sharply, making loan repayment instalments exceedingly burdensome, but there is no such effect now including on both local and cross-border loan arrangements.

Hence, it is still hard to say whether we will see a worsening in M&A activity and a surge in the restructuring of existing loans, or whether M&A activity will recover to its pre-covid level.

Regulatory and tax matters

i Licensing/registration of lenders

Under Bulgarian law, lending money on a commercial basis may only be performed by banks licensed by the Bulgarian National Bank (BNB) and financial institutions registered with the BNB. The major difference between the two types of lenders is that banks take deposits while financial institutions extend loans using their own resources.

Banks licensed in another EEA Member State may provide lending in Bulgaria under the EU freedom to provide services – following a notification to the BNB by their home Member State regulator, or under the freedom of establishment by opening a branch in Bulgaria. Banks from outside the EEA should obtain a licence from the BNB to exercise bank activities via a branch before lending in Bulgaria.

Non-banking financial institutions from another EEA Member State may provide loans in Bulgaria following a notification to the BNB by their home Member State regulator under Article 34 of Directive 2013/36/EU. Non-banking financial institutions seated outside the EEA may not provide loans in Bulgaria.

There is no official guidance from the BNB as to the meaning of 'providing lending activities in Bulgaria' but we believe this occurs when foreign lenders, even if they do not have a physical presence in Bulgaria, target the Bulgarian market in order to offer lending activities repeatedly and on a commercial basis to borrowers in Bulgaria. There is no restriction on the freedom to provide requested services (i.e., the right of persons and entities domiciled in Bulgaria to request the lending services of a foreign entity on their own initiative). As this is a fairly common scenario in cross-border acquisition financings, it may be wise to have in place a suitable reverse-solicitation clause in the finance documents.

ii Sanctions, anti-corruption and money laundering

As an EU Member State, Bulgaria has transposed the relevant EU legislative acts with respect to anti-money laundering (AML) and terrorism financing, and applies the sanctions imposed at EU level. The local Act on the Measures Against Money Laundering and the Act on the Measures Against Terrorism Financing provide for extensive due diligence to be conducted by banks on borrowers before entering into a loan agreement. Potential borrowers are subject to know-your-customer (KYC) checks that must identify their representatives, direct and indirect shareholders (including if there are any offshore companies among them), beneficial owners, potential politically exposed persons and source of funds. As banks tend to be very cautious in avoiding breach of the above laws, recently their AML/CFT policies have often been stricter than the statutory requirements.

The risks associated with sanctions and potential breach of anti-corruption, terrorist financing and AML laws may be further contractually mitigated by appropriate representations and warranties in the finance documents.

iii Tax issues

In general, there is withholding tax paid on interest payments under a loan in Bulgaria. If there is a double tax treaty between Bulgaria and the respective foreign country, the rules in that treaty must be followed so withholding tax on interest payments may or may not be due in accordance with such treaties.

As far as corporate income tax is concerned, interest expenses are deductible for corporate income tax purposes in Bulgaria. Bulgaria has tax treaties with many foreign countries and the specific treaty must be checked to ascertain if interest expenses are deductible for corporate income tax purposes (as a rule, they are deductible). Further, there are rules for thin capitalisation whereby a certain portion of the interest expenses may not be recognised for corporate income tax purposes. Thin capitalisation, in turn, does not apply to interest payments on financial leases and bank loans, except where the parties are related or the lease or loan is guaranteed or secured by, or is extended on the instruction of, a related party. Lastly, since 2019 an interest deduction limitation rule has been applicable, whereby exceeding borrowing costs would not be recognised for corporate tax purposes for the current year. 'Borrowing costs' mean the costs or amounts recognised for tax purposes that lead to a reduction in the financial tax result, which includes all interest expenses on any type of debt, other expenses and amounts, economic equivalent to interest, as well as other costs and amounts incurred in connection with fundraising, expenses and amounts for penalty interest for late payments and contractual penalties that are not related to financing. 'Excess of borrowing costs' is the amount by which the total amount of the costs of loans exceeds the total amount recognised for tax purposes revenues or amounts that lead to an increase in the financial tax result, as well as other income or amounts economically equivalent to interest. This interest deduction limitation rule is not applicable when the excess of borrowing costs for the current year does not exceed €3 million.

As far as tax reporting is concerned, provided that lenders are not subject to Bulgarian corporate income tax (including capital gains) derived from loans to Bulgarian obligors, there are no tax reporting issues for lenders as a result of having Bulgarian obligors located in Bulgaria.

In general, there is no stamp duty chargeable in Bulgaria.

Security and guarantees

i Guarantees

Regarding guarantees, Bulgarian obligors are normally required to provide guarantees under the law governing the loan agreement.

On certain occasions, however, non-EEA lenders under non-Bulgarian-governed loans require that a Bulgarian obligor provide a guarantee governed by Bulgarian law and subject to the jurisdiction of Bulgarian courts. This is primarily to avoid potential problems with the recognition of non-EEA court judgments. In such cases, the specific rules in Bulgaria about surety and joint-and-several-liability may require specific structuring of a Bulgarian guarantee to repay a loan under a foreign system of law.

In both cases, certain limitation language is normally considered.

ii Limitation language

The restrictions under Directive 2012/30/EU, including the prohibition on financial assistance, are applicable only to joint-stock companies in Bulgaria (similar to the German Aktiengesellschaft). Any type of guarantee or provision of security interests by such companies for the acquisition of their own shares is invalid. As the other widely used type of corporate entity in Bulgaria – the limited liability company (similar to the German Gesellschaft mit beschränkter Haftung) is not mentioned – neither in Directive 2012/30/EU, nor in the Bulgarian transposition legislation, the dominant view among practitioners is that the financial assistance rules do not apply to such entities.

However, regarding limited liability companies, there are express capital preservation rules (whereby shareholders are entitled only to dividends and liquidation quotas), certain casuistic avoidance rules for transactions detrimental to the other creditors and for transactions at undervalue (whereby transactions favouring related parties may be caught), as well as tax law requirements for arm's-length arrangements to transactions in favour of related parties. Therefore, it may be prudent to insert certain representations and warranties and some specific declaratory provisions to minimise possible risks concerning guarantees or security interests for the acquisition of a limited liability company's own shares.

Other limitation language that it is wise to consider using in financial documents is to minimise the risk of the respective guarantor becoming automatically overindebted as a result of guaranteeing a loan to its parent.

iii Security

Typically, the security package under acquisition financings contains a pledge over shares, a non-possessory floating charge pledge over the whole enterprise or over a limited pool of assets of the Bulgarian obligor, as well as a non-possessory fixed charge pledge over certain valuable assets.

The pledge over shares in different types of corporate entities is governed by different rules imposing different formalities, that is, the pledge over:

  1. shares or quotas in a limited liability company must be documented in a notarised agreement and must be registered with the Commercial Register;
  2. materialised shares in a joint stock company takes place by endorsement and delivery of the paper materialising the shares; and
  3. over dematerialised shares in a joint stock company must be documented in a notarised agreement and must be registered with the Central Depository (where dematerialised shares are kept as electronic book entries).

As a market standard, the pledge over shares is combined with a pledge over the dividends and other receivables stemming from the shares where and the respective rules for possessory or non-possessory receivables pledge apply as per the parties' arrangements.

Another typical security in large-scale financings is the pledge over the whole enterprise of the Bulgarian obligor, which is similar to the English floating charge crystallising over the particular assets within the enterprise on the date when commencement of enforcement is registered (in the same registry where the pledge is registered initially by way of establishment). This pledge must be documented in a notarised agreement and must be registered with the Commercial Register. As an element of the enterprise pledge, a fixed charge may be agreed in the same agreement – over particular valuable assets such as movables, receivables and real estate properties requiring additional secondary registration in a public register that is different for the different assets. Following such secondary registration, the pledgor may not deal with the fixed charge assets. Notably, as the standalone mortgage over real estate property is expensive in large-scale financings (as the registration fee is a proportion of the secured obligation without a cap) banks normally require their corporate borrowers to establish security interest over real estate property only as an element of the enterprise pledge.

Less often lenders will require a non-possessory pledge over a pool of certain types of assets (rather than the whole enterprise), usually dictated by the specific business of the pledgor or non-possessory standalone pledge over particular assets – dictated by the possibility of using a different enforcement route (as opposed to the fixed charge over the same assets as a part of the enterprise pledge).

Financial collateral under Directive 2002/47/EC has been transposed in Bulgaria in a manner where it may be used to secure any obligation that may be performed by payment of money or delivery of securities, thus potentially covering loan arrangements as well. However, the requirement for transfer of possession or control may be inappropriate under loan arrangements where the borrower normally retains possession of the asset to use it and generate income, thus repaying the loan. The only type of asset that seems suitable to be used as financial collateral in large-scale acquisition financings seems to be shares in joint-stock companies. However, Directive 2002/47/EC was transposed in Bulgaria with a specific nationality restriction on the eligible counterparties, which albeit not very clearly may be construed as requiring that the financial institutions (to be eligible counterparties under financial collateral) should be from EEA Member States. Therefore, banks and other financial institutions from states such as the United Kingdom, the United States or Japan may be prejudiced to enjoy the benefits of being eligible counterparties under financial collateral when dealing with Bulgarian borrowers.

iv Holding security interests for multiple lenders

Typically, under foreign law-syndicated loans a parallel debt for a security agent is agreed to ensure that such security agent validly holds a security interest in favour of multiple lenders. As far as such concept is valid under the respective foreign law governing the loan agreement, it should be respected by Bulgarian courts as well. There has been no problem so far with registering a security agent acting under a parallel debt as secured creditor in the registries where security interests are established or with registering out-of-court enforcement in Bulgaria by such agent. Further, to the best of our knowledge there has never been a dispute before a court where Bulgarian courts refused to apply the law governing a parallel debt arrangement as contravening Bulgarian public policy.

On the contrary, in Bulgaria there is a legal concept very similar to the English 'parallel debt' called 'contractual joint creditorship' where each creditor may claim the whole debt although he or she did not provide it or provided only a portion of the consideration for it. The only difference from the English parallel debt is that no new or parallel debt is created but all or some of the lenders agree to be joint creditors for a single debt via contractual arrangement (without creating a new or parallel one). Further, there are specific cases where Bulgarian law expressly permits a person to take security interests without being a lender at all (similarly to English parallel debt) as (1) financial collateral, under the EU Financial Collateral Directive as transposed in Bulgaria; and (2) when security is provided for bonds (in favour of a bonds trustee) under the Public Offering of Securities Act. Given these specific cases under Bulgarian substantive law recognising a holder of security interests on behalf of multiple lenders, who provided no underlying loan, arguably the English parallel debt concept should not be manifestly contrary to Bulgarian public policy.

However, due to the lack of a benchmark piece of Bulgarian case law (as opposed to France, Poland and, recently, the Czech Republic) expressly upholding the English parallel debt, some banks have been very cautious and as a result it is common for all lenders in a syndicate to take security in their own names in Bulgaria. There is no technical obstacle under Bulgarian law when registering security interests to list more than one person as a secured creditor and to describe the secured obligation as encompassing different claims, thus creating a first-ranking security in relation to multiple claims of lenders. Problems may arise however when it comes to amendments to the pledge agreement, as well as assignment or enforcement of claims secured in this manner, as all foreign lenders registered as secured creditors have to provide formal powers of attorney to Bulgarian lawyers, as well as some declarations and corporate certificates on each such occasion to make the respective amendment, assignment or enforcement effective including via registrations in local registries. To overcome such problems, it seems reasonable, in addition to having all members of a bank syndicate registered as holders of security in Bulgaria, to stipulate cumulatively that one of these creditors (a security agent) acts as a foreign law parallel debt creditor under each secured obligation and to register that security agent as a secured creditor not only for his or her claims but for the claims of all remaining creditors as well. Further, a power of attorney should be granted to the security agent to execute or perfect any amendments to the pledge agreement, as well as to assign and enforce claims, avoiding a huge amount of paperwork in each case.

IV PRIORITY OF CLAIMS

The Bulgarian Obligations and Contracts Act establishes the ranking of claims over a debtor's property in the case of a court-bailiff enforcement procedure as follows (where creditors from each single line are satisfied proportionately, and upon their full satisfaction, creditors from the consecutive line are to be satisfied with the remaining part of the property):

  1. claims on costs for attachments or enforcement procedures as well as for certain avoidance claims – over the value of the property for which these have been made;
  2. State claims on taxes for certain properties or motor vehicles – over the value of that property or vehicle, as well as claims on concession payments, interests and penalties under concession contracts;
  3. claims secured by a pledge or mortgage – over the value of the pledged or mortgaged properties;
  4. claims for which a right of retention is exercised – over the value of the retained property; where if such a claim is over costs for maintenance or improvement of the retained property, it shall be satisfied before the claims under (c);
  5. employees' claims under employment relationships and allowance claims; and
  6. state claims other than those for fines or penalties.

In the case of an insolvency proceeding, the following special ranking of claims applies:

  1. claims, secured by a pledge or mortgage or attachment – on the amount after realisation of the security asset;
  2. claims for which a right of retention is exercised – on the amount or value of the retained property;
  3. expenses for the insolvency proceeding;
  4. claims under employment relationships existing before the date of the judgment opening the insolvency proceedings;
  5. allowances due by the debtor to third parties by operation of law;
  6. public law claims of the state or municipality such as taxes, customs duties, fees, mandatory social-security contributions and others existing before the date of the judgment opening the insolvency proceedings;
  7. claims existing before the date of the judgment opening the insolvency proceedings that have not been paid on their maturity date;
  8. any remaining unsecured claims existing before the date of the judgment opening the insolvency proceedings;
  9. a legal or contractual interest under unsecured claims, due and payable after the date of the judgment opening the insolvency proceedings;
  10. claims under credits extended to the debtor by a shareholder;
  11. claims under gratuitous transaction; and
  12. creditors' expenses related to their involvement in the insolvency proceedings.

If the proceeds from turning the assets into cash in insolvency are not sufficient to satisfy all creditors within a certain rank, they are distributed on a pro rata basis.

The commencement of insolvency proceedings against a pledgor does not affect the enforcement of a registered pledge upon the pledged assets if the enforcement started before the opening of insolvency proceedings and if the collateral is identifiable within the debtor's estate. In addition, the commencement of insolvency proceedings against a debtor does not affect the enforcement proceedings of public debts if the enforcement started before the decision to open the insolvency proceedings.

Priority of claims

The Bulgarian Obligations and Contracts Act establishes the ranking of claims over a debtor's property in the case of a court-bailiff enforcement procedure as follows (where creditors from each single line are satisfied proportionately, and upon their full satisfaction, creditors from the consecutive line are to be satisfied with the remaining part of the property):

Jurisdiction

As a preliminary note, apart from the private international law regulations that Bulgaria applies as a member of the EU, it has a Private International Law Code from 2005 whose rules follow the private international law codifications of the major EU continental jurisdictions (mainly Belgium) and the EU Regulation existing at the time of the adoption of the code.

The possibility for foreign lenders to have a valid choice of court in arrangements with Bulgarian obligors, as well as the recognition and enforcement of foreign judgments in Bulgaria, depends on where the lender is from – when it concerns the validity of the jurisdictional agreement – and on the nationality of the court that rendered a judgment – when it concerns the recognition and enforcement of foreign judgments in Bulgaria. For counterparties from the EU, exclusive and non-exclusive choice of court as well as recognition and enforcement without exequatur procedure is permitted under the conditions and limitations of Regulation (EU) No. 1215/2012 of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the Brussels I Regulation Recast).

For counterparties from other EEA countries (Switzerland, Norway and Iceland), the Lugano Convention on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the Lugano Convention) applies. In particular, Bulgaria will apply the Lugano Convention when a court in a Lugano Convention country (that is not an EU Member State) is chosen, and when the recognition and enforcement of a judgment originating from a Lugano Convention country (that is not an EU Member State) is being sought in Bulgaria. The rules of this Convention are substantially similar to the Brussels I Regulation No. 44/2001 (repealed and replaced by the Brussels I Regulation Recast). The most notable differences under the Lugano Convention – as compared to the Brussels I Regulation Recast – are that recognition and enforcement in the former case is subject to an exequatur procedure (albeit a simple one) and choice-of-court agreements in the former case are not immune to 'torpedo' actions.

For non-EEA lenders from countries that are party to the Hague Convention of 30 June 2005 on Choice of Court Agreements (the Hague Convention), most notably UK lenders, the rules in that Convention apply (though they are only relevant to exclusive choice of court). The Hague Convention also contains rules relevant for the recognition and enforcement of judgments rendered by courts that have been chosen in accordance with its rules, subject to an exequatur procedure.

The recognition and enforcement of judgments rendered by other countries (non-EU countries, non-EEA countries and non-Hague Convention countries) is subject to a full exequatur procedure governed by the Bulgarian Private International Law Code. Choice-of-court agreements in favour of the courts of such third countries (non-EU countries, non-EEA countries and non-Hague Convention countries) should be considered valid for the purposes of the recognition and enforcement of foreign court judgments to the extent they do not overstep the exclusive jurisdiction of a Bulgarian courts and do not violate Bulgarian public policy. On the other hand, if the choice of court in favour of the courts of third countries is assessed when a Bulgarian court is determining its own jurisdictional competence to hear a dispute, it is not certain whether a Bulgarian court will uphold such choice if it is competent to hear the case on a jurisdictional ground under the Brussels I Regulation Recast and has been seized on the matter.

Bulgaria is a party to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards signed in New York on 10 June 1958 (the New York Convention) and Bulgarian courts should uphold arbitration agreements under the conditions of the New York Convention to the extent that the underlying dispute involves a proprietary claim or a matter that can be resolved by settlement under Bulgarian law. A foreign arbitral award rendered in a contracting state to the New York Convention should be recognised and enforced in Bulgaria under the conditions of the Convention, subject to an exequatur procedure.

Acquisitions of public companies

Mergers (including takeovers) and de-mergers (spin-offs and splits), share transfers and business (going concern) transfers in Bulgaria are regulated by the Bulgarian Commerce Act. However, where the target is a public company, the specific rules set forth in the Bulgarian Public Offering of Securities Act (POSA) must be observed. Further, takeover bids with respect to public companies are extensively regulated under Ordinance No. 13/2003 enacted by the Financial Supervision Commission (FSC) by delegation under the POSA.

Under the POSA, shares in a public company may be bought up to the threshold triggering a mandatory offer without initiating a bid procedure. Notification requirements only apply to smaller acquisitions. Generally, the FSC must be informed of the acquisition of voting rights in a public company directly or indirectly, provided that following the acquisition the voting rights of the acquirer reach or exceed 5 per cent or a multiple of 5 per cent of the total number of voting rights. There are certain exceptions as well as complex rules for notifications about certain acquisitions with analogous effect.

The thresholds triggering mandatory takeover bids include certain acquisitions of more than one-third of the voting rights, as well as acquisition of more that half of the voting rights and more than two-thirds of the voting rights. Exceeding certain thresholds may also trigger the right to launch a voluntary takeover bid.

Takeover bids in respect of shares in public companies (which may be joint-stock companies only) are supervised by the FSC, provided that the public companies:

The year in review

As to what should be expected in the near future, Bulgaria is expected to transpose the EU Restructuring Directive (EC) 2019/1023 soon, the deadline for which expired in July 2021. It is hoped that this will address the major drawback of the current pre-insolvency restructuring procedure that is practically impossible to commence. Thus, courts regularly hold that there is no 'threat of overindebtedness' (as a prerequisite for restructuring) but rather an actual overindebtedness requiring the opening of an insolvency proceeding. Introducing more flexible criteria to ensure commencement of the restructuring procedures may alleviate pressure on insolvency courts and allow borrowers a last chance to recover.

This would be highly relevant if we see a worsening of the M&A activities and a surge in restructurings in view of the continuing global presence of covid-19.

Outlook

In the near future, Bulgaria is expected to transpose the EU Restructuring Directive (EC) 2019/1023 soon, the deadline for which expired in July 2021. It is hoped that this will address the major drawback of the current pre-insolvency restructuring procedure that is practically impossible to commence. Currently, courts regularly hold that there is no 'threat of overindebtedness' (as a prerequisite for restructuring) but rather an actual overindebtedness requiring the opening of an insolvency proceeding. Introducing more flexible criteria to ensure commencement of the restructuring procedures may alleviate pressure on insolvency courts and allow borrowers a last chance to recover.

This would be highly relevant if we see a downturn in M&A activity and a surge in restructurings in view of the continuing global presence of covid-19.

Footnotes

1 Tsvetan Krumov, Milena Gabrovska and Kristina Lyubenova are attorneys-at-law at Schoenherr (in cooperation with law firm Stoyanov and Tsekova).

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