Converting bonds into equity under Belgian company law: a two-way approach
For a while now, bonds have been popular instruments to support the development and related financing needs of companies. This debt security is used to finance both current expenditure and long-term investments.
Under certain circumstances, it may be contemplated to convert bonds into equity. With regard to public limited liability companies (NV/SA), the Belgian legislator has provided for two separate mechanisms in the Belgian Companies’ Code (BCC) to that effect.1 One the one hand, the classic conversion of (convertible) bonds and, on the other hand, the – less known – substitution of (ordinary) bonds by shares pursuant to article 568, par. 1, 3° BCC. Each of these mechanisms serves its own purpose and is governed by a different set of rules.
With this two-way approach, the Belgian legislator aims to strike a fair balance between the interests of (i) the bondholder, (iii) the issuing NV/SA and (iii) the shareholders of the issuing NV/SA.
Conversion of (convertible) bonds into equity
Convertible bonds are considered as an attractive alternative to regular bank financing, as – in comparison – the interest rate applicable to convertible bonds is generally lower.
This is due to the fact that holders of convertible bonds have a conversion right (i.e. a right to become shareholder of the issuing NV/SA) in addition to their interest entitlements. Note however that NV/SA’s are free to alter the conversion right as they deem fit. E.g. a bondholder may be obliged to convert its bonds into shares upon the fulfilment of certain conditions (mandatory convertible bonds), or the conversion right may be granted to the NV/SA itself instead of the bondholder (reverse convertible bonds). Such alterations may have an impact on the applicable interest rate.
Holders of convertible bonds will generally exercise their conversion right when the underlying value of the bonds (i.e. the NV/SA) has increased (or is expected to increase) after the bond issuance, thereby enabling the bondholder to make a profit upon the potential sale of the shares it received as a result of the conversion.
Convertible bonds can be converted into shares of the NV/SA through a simple request by the relevant bondholder to the NV/SA in accordance with the bonds’ terms and conditions. The board of directors of the NV/SA will subsequently formalize (i) the conversion, (ii) the related capital increase, and (iii) the number of new shares issued, by virtue of a notarial deed. No approval of the general meeting of the NV/SA is required, as the general meeting already approved the conversion/capital increase at the occasion of the convertible bond issuance.
In conclusion, the issuance of convertible bonds is treated as a capital increase, subject to the actual exercise of the conversion right. Hence, all formalities and necessary approvals for the capital increase are complied with upfront (i.e. when issuing the convertible bonds).
Substitution of (ordinary) bonds by shares
Article 568, par. 1, 3° BCC offers an alternative mechanism to replace a NV/SA’s bonds by shares. This mechanism is structured as ultimate remedy to a situation of excessive indebtedness by allowing a company – under certain conditions – to substitute its (ordinary) bonds into equity. Note that this mechanism has been labeled a “substitution of bonds” by the Belgian legislator to clearly make the distinction with the “conversion of bonds” as discussed sub 2.
The substitution of bonds by shares is treated as a capital increase through the contribution in kind of a receivable. As (i) ordinary bonds can be issued through a simple decision from the board of directors of the NV/SA and (ii) an equity substitution is not presumed when issuing the bonds, both the general meeting of shareholders and the general meeting of bondholders will have to approve such substitution with a qualified majority.
Hence, all formalities and necessary approvals for the capital increase are complied with at the occasion of the substitution, in contrast to the conversion-mechanism which requires all relevant formalities to be complied with upfront.
In any event, current legislation provides the necessary flexibility for a NV/SA to tailor its bonds as its deems appropriate (e.g. the terms of the bond issuance can be determined with the utmost freedom). Furthermore, in the absence of a numerus-clausus principle, a NV/SA is free to issue various types of hybrid or sui generis-securities to meet its financing needs.
1 Note that Belgian private limited liability company’s (BVBA/SPRL) may not issue convertible bonds (only the issuance of ordinary bonds is currently allowed). This restriction will most likely be abolished as part of the upcoming modernisation of the BCC, which is currently being discussed within the Belgian Federal government.
For more information: F. JORENS, “Vennootschapsrechtelijke behandeling van (converteerbare) obligaties en mogelijkheden tot omzetting van obligaties in het kapitaal van de vennootschap”, TRV/RPS 2017/2, p. 143-152 (available in Dutch).