Out of the Money – Still Untouched: The Absolute Priority Paradox in Swedish Reorganisations
This article examines how the 2022 Swedish Business Reorganisation Act (the “Act”) has affected the treatment of equity holders in business reorganisations. Although the Act sought to modernise Swedish restructuring practice by introducing cross-class cram down and the absolute priority rule, recent court and market practice show that the practical impact of these tools may be smaller than expected. By structuring reorganisation plans to leave shareholder rights untouched, debtors have succeeded in excluding equity holders from the group of “affected parties,” thereby avoiding the priority comparisons laid out in the Act and allowing out-of-the-money equity to stay intact despite creditor write-downs, undermining the reform’s policy goals.
Background: The Pre-2022 Framework
Under previous Swedish legislation, the tools available in business reorganisation proceedings for restructuring a debtor’s balance sheet were limited to write-downs of unsecured debt. With support from a sufficient majority of unsecured creditors, unsecured financial liabilities could be written down – down to a minimum of 25% of aggregate claims – with binding effect on all unsecured creditors. Shareholder rights could not be altered within the scope of a Swedish reorganisation process, and secured creditors were not entitled to vote in the write-down approval procedure.
This framework was often seen as unattractive to lenders, who would be required to take a haircut in a reorganisation while shareholders’ positions remained unaffected or even improved if the reorganisation succeeded. For creditors seeking to eliminate equity, forcing a bankruptcy or share pledge enforcement (if available) were the only viable options.
The 2022 Act: New Tools and Expectations
The 2022 Act introduced provisions allowing a court-approved reorganisation plan to become binding on all affected parties, including measures that affect the shares and share capital of the company (e.g., issuance of new shares). To the extent necessary for company law purposes, measures included in a court-approved reorganisation plan are given the same effect – and can be registered with the Swedish Companies Registrations Office – as if they had been resolved at a general meeting of shareholders.
Together with the cross-class cram down mechanism and the internationally recognised principles of absolute priority and “no creditor worse off” – all new concepts in Swedish law – the Act was expected to modernise Swedish reorganisation law by aligning the order of priority and waterfall of proceeds among stakeholders with bankruptcy principles. Under the Act, equity holders who are out of the money can be forced to accept dilution or even elimination of their stake in a debt-to-equity swap effected by cross-class cram down.
Plan Negotiation and Court Approval
The process for obtaining a court-approved reorganisation plan is conducted through court-led negotiations. Stakeholders who are to be affected (“affected parties”) are invited to negotiate and vote on the plan. Stakeholders are divided into classes, which may include creditors with secured claims, unsecured claims, subordinated claims, and shareholders. The Swedish government, if a creditor, is typically a separate class.
The plan is approved if a sufficient majority within all classes accept it, but certain classes can also be crammed down. Subject to safeguarding principles, the court may declare the plan legally binding by way of cram down if more than half of the classes approve it and:
- at least one approving class consists of secured creditors, or
- at least two classes consist of creditors who can expect payment in bankruptcy.
Safeguards include the “no creditor worse off” principle, equal treatment, and the absolute priority rule. The “no creditor worse off” principle means the plan cannot be approved if an affected party would be better off in bankruptcy. Equal treatment requires that stakeholders within the same class are treated pro rata. The absolute priority rule requires that dissenting classes are fully compensated if a lower-priority class receives any payment or retains any right under the plan.
The Absolute Priority Rule
The underlying principle of the absolute priority rule is to uphold the order of priority that would apply in the case of bankruptcy. Absent an exemption, the court cannot approve a cross-class cram down of a plan where equity retains value unless all creditors are paid in full. The Act allows deviations from the absolute priority rule (and equal treatment) only for extraordinary reasons, such as when shareholder involvement is necessary for a plan to pass. Preparatory works stress that exceptions should be rare, and that the principle of absolute priority should generally be upheld. The legislative intent was clearly for variation of shareholder rights to be the main rule when creditors are forced to accept a write-down.
Market and Court Practice: Excluding Shareholders
Despite this, market and court practice since the Act’s entry into force show that reorganisation plans adopted by way of cram down often leave shareholders’ rights intact. Courts have held that the absolute priority rule applies only to stakeholders who partake in the plan negotiations, i.e. the classes of “affected parties” whose rights are directly affected by the plan. By structuring plans so that no measures are directed at shareholders, debtors have effectively excluded shareholders from the group of affected parties, avoiding their inclusion as a voting class and the court’s comparison of economic outcomes under the absolute priority rule.
This approach is unsatisfactory from a systematic perspective. It is unclear why the legislation would allow deviations from the absolute priority rule only for extraordinary reasons, yet permit voluntary exclusion of shareholders on the basis that they are not expected to bear any downside from the reorganisation. Courts have nevertheless adopted this approach, and appeals to the Swedish Supreme Court have not been granted.
Conclusion: Unresolved Issues and Future Outlook
Despite the legislative intent, current practice undermines the rationale and intended effects of the Act’s tools for compromising equity. From the perspective of creditors, it appears reasonable that, in circumstances where debts must be compromised and no equity value remains due to the inability to satisfy obligations, equity and shareholders should, as a matter of principle, also be subject to impairment.
Whether this position is now settled under Swedish law remains uncertain. The Swedish Tax Agency has announced that it will cease appealing judgments where it is crammed into a write-down as an unsecured creditor on the basis that this contravenes the absolute priority rule. Guidance from the Court of Justice of the European Union could change the position, but so far, Swedish courts have not sought such preliminary rulings.
On a final, the efficiency and legal certainty of Swedish business reorganisations could likely benefit from concentrating such cases in a limited number of specialised courts. Specialisation would foster greater expertise, consistency, and predictability in the application of the law, contributing to a more coherent and reliable body of case law and helping to address current uncertainties and inconsistencies.
For creditors looking to be in control and maintain a possibility to get rid of equity investors in a distressed scenario, obtaining a pledge over the shares in the borrower from the outset will remain the most efficient strategy.
