Category: Information

Recently, there has been a trend towards using bonds as a new tool to raise finance. However, in many cases, investors, perhaps due to lack of experience or a reluctance to understand the situation, do not appreciate the true risks of investing in the bonds being offered. Laurynas Staniulis, Managing Partner of AVOCAD, talks more about this.

First of all, it should be understood that a bond is simply a debt security issued by a company or government. It is a document that gives the bondholder the right to call on the entity that issued the bond at the end of the bond period. The entity that issued the bond is obliged to repay the money invested. In other words, the bondholder and the issuing entity have an elementary loan relationship.

Today, we see a trend towards bonds with very high yields and relatively short duration. In fact, borrowing at such a price means that, for one reason or another, traditional means of financing, such as loans from financial institutions or investment funds, are not available. The reasons for this may be varied, but the fact remains that probably no entity will borrow at 15% when banks are lending at an average interest rate of 8-10%.

Also, looking at the current trend in bonds, we see that the bonds that are being distributed are generally not secured by collateralised real estate, but rather by a pledge of the shares of the company that issued the bond as collateral. In terms of whether such collateral provides real protection, one would have to say probably not. Since, if shares are pledged, it is likely that the issuer does not have any assets pledged or that those assets are already pledged. This means that if the worst case scenario does occur and the entity is unable to redeem the bonds, the claims of the bondholders would only be met after the claims of the mortgage lender have been met, and only then, if there is anything left over, would it be the bondholders. I would therefore probably not be very far wrong in saying that such bonds are, in essence, simply a loan without any additional security for the bondholder.

Another point to note is that bonds are often placed to refinance an existing bond issue, while the source of redemption of the new bond is a future planned bond issue. This pattern of short-term high-yield bonds implies that the bonds are not issued to finance a new activity that would directly result in a redemption source, but rather to temporarily balance cash flows, to build equity or the like.  

However, from today's perspective, can we say that when the bonds mature, the issuer will have the ability to refinance them and, if necessary, service even more expensive bonds? Probably not, which leads to the view that the bonds issued simply reflect the issuers' belief in a positive market development. But the "what if" question remains unanswered.

Sometimes the answer to this question can be deduced, albeit indirectly, from the assessment of the issuer. If the issuer is a project company that is part of a large group of companies, and the bonds are not redeemed by the "parent" company, we may consider that the "parent" company is aware of the risks of the project and is not prepared to fulfil its obligations to the bondholders at any cost. Obviously, this is only an assumption and one would like to believe that if the issuer is unable to meet its obligations, there would be a consolidation of the Group's forces to redeem the bonds. However, the reluctance to formally commit leaves the question open.

In summary, bonds are not a new way of raising funds and are certainly not a threat in themselves. Bonds, like any other investment, involve risks that each investor has to assess individually according to his or her risk appetite. However, in any case, investing in bonds should not only be based on a careful assessment of the issuer or the collateral, but also on an understanding of the objectives of the bond.

Today, "I'll sue" can often seem like a good way of clarifying a relationship and, at the same time, solving a problem. Although most people are already aware of this, it is sometimes not fully appreciated that, invariably, at the end of the litigation, the losing party not only does not recover the costs of the litigation, but also has to pay for the legal costs of the lawyer of his opponent. Thus, it can often be really expensive to deal with the relationship in this way. This is the classic situation of the end of a legal dispute between two private parties, which is determined by the loser pays principle, often referred to in case law.

However, the court is always dealing with the question of the reasonableness of such costs: when a litigant claims tens of thousands of euros in legal costs, the court does not always agree - it is a very case-by-case decision. What about cases involving a public authority that uses its own lawyers? Are costs not always payable if you lose? Dainius Antanaitis, attorney at law at AVOCAD, explains more about this.

It should be understood that when a court finds that costs are unjustified, the unsuccessful party is not obliged to pay them. However, the law does not provide for a list of cases in which costs may be declared unreasonable. The unreasonableness of costs shall be determined on a case-by-case basis. For example, in a case concerning the division of property (which can be practically any other type of case, including business disputes), the costs will usually be calculated in proportion to the amount of the successful claims. I.e. if you are claiming €100,000 from your spouse and the court awards you €70,000, the costs here would be shared in a similar proportion. Here, 70% of the costs would be paid to the court. Your lawyer's costs should be reimbursed by the other party. Of course, this is a very crude example and the situations in practice are usually much more complex, but the basic calculation would be something like this.

The situation is slightly different when a private dispute involves public authorities, which have a relatively large pool of lawyers. If the public authority uses its own lawyers, the losing party does not have to pay for such legal costs. However, each institution has quite clear specificities and, for example, the lawyers of the State Planning and Building Inspectorate will not necessarily be well versed in the specifics of, say, non-pecuniary damage. Thus, in such cases, the institution may decide to hire a lawyer. Of course, this is done at the expense of the institution or, in other words, at the expense of taxpayers.

At the end of September, the Supreme Court of Lithuania issued a ruling which, among other issues, addressed the request of a public authority to pay the costs of the law firm it hired. Here, the Court noted that when deciding on the question of the award of representation costs in favour of an institution, the court must make a comprehensive assessment of whether the use of a lawyer was necessary in the light of the institution's internal administrative capacity and the nature of the case. In determining the nature of the case, account must be taken of the novelty of the legal issue raised in the case, the volume and complexity of the case. The totality of all three criteria is necessarily taken into account. It must be acknowledged that judges may see the same situation quite differently and, therefore, being principled and fair in their perception of justice, they decide on costs on the basis of their own internal conviction, which does not always coincide with that of different judges.

In the opinion of the Supreme Court of Lithuania, it is necessary to assess whether the lawyers of the institution involved in the case do not have sufficient capacity and competence to properly represent the institution in court due to the specificity, complexity or scope of the case. If, in the court's assessment, such capacity is lacking, the services and costs of the lawyer are considered reasonable and, if the institution successfully defends itself in court, the unsuccessful party must pay those costs. However, if the court were to find that the institution was able to pursue the case with the resources at its disposal and that the hiring of a lawyer was an excessive expense, even if the institution were to win the case, the costs would not be reimbursed to the State budget, as the losing party would not have to pay them.   

This is the third time the suppliers have called - their invoice has been sitting unpaid for two months. And there is more than one such invoice. And where are the salary payments? You decide not to pick up the phone. Will that solve the problem? Hardly. But the money is gone and you don't know where to get it from, and the pile of unpaid bills on your desk keeps growing. You contact your lawyers, they assess the situation and then smile uncomfortably and say: "It's a very bad situation, you've waited too long. It looks like you will have to declare bankruptcy."

So when is it time to declare bankruptcy? Is it too early? What are the main criteria? Egidijus Langys, partner at AVOCAD, talks more about this.

What is assessed when deciding whether to declare bankruptcy?

It should be understood that a company with €100 in outstanding liabilities will certainly not be declared insolvent, even though today's legal framework would formally allow it. Thus, the criteria for assessing a company's insolvency are still relevant in court.

Assessing a company's insolvency looks at its balance sheet and liquidity ratios (balance sheet and liquidity tests), as well as its viability - in simple terms, what the company's future prospects are for meeting its obligations.

Insolvency is most often equated with a lack of working capital - delays in financing day-to-day operations, meeting creditors, paying wages, etc. It is a test of liquidity - the extent to which a company is able to operate and meet its obligations. 

The balance sheet test reveals the ratio of a company's liabilities to its assets and, importantly, the extent to which liabilities exceed assets.

The last criterion is the viability of the company, which shows how well the company is able to operate and generate profits. Case law elaborates on this criterion:

• the causes of the company's insolvency problems;
• the economic and commercial activities carried out by the legal person;
• the prospects of the business, the expected income (profit) and whether it will enable the company to meet its future debts to creditors;
• how many employees are working in the company (headcount turnover), etc.

The absence of commercial activities or the fact that the commercial activities envisaged will clearly prevent the legal persons from meeting their debts in the future raises doubts as to the viability of the company.

When is it time to declare bankruptcy?

There is always the risk that a manager will initiate insolvency proceedings prematurely. This can happen if only formal assessment criteria are assessed, if there is no experience or practice, if bad practice or examples are followed, if immediate reliance is placed on advice from oneself or from colleagues who have supposedly "been there".

Without legal advice, this situation will involve the company in legal proceedings. Filing for bankruptcy prematurely and not being declared bankrupt by the court could damage the company's business reputation, damage the company's image with its business partners, and put the company on the list of unreliable companies, even though the company is solvent and the manager has made a mistake about the company's insolvency.

Of course, it can happen that a company's insolvency process can be initiated too late. Managers often overestimate their capabilities and believe that certain circumstances will not affect the viability of the company, think that they have made a lot of effort, that the company is struggling but is still in business, and are late in applying to the court for insolvency proceedings, or do not apply at all. However, if the manager's efforts have been insignificant and the company is unable to continue to operate, the manager will face serious consequences for failing to comply with the obligation to initiate insolvency proceedings.