The Precondition: Composition Proceeding Instead of Bankruptcy

A successful pre-pack transaction hinges on avoiding direct bankruptcy by initiating composition proceedings instead. In bankruptcy, business activities typically cease, and assets are administered by the bankruptcy office with the goal of liquidation. By contrast, a composition proceeding offers temporary protection from creditors, allowing the business to continue operations under the supervision of a court-appointed administrator (a debtor-in-possession model).

A composition moratorium (also called debt restructuring moratorium or administration) is initially granted provisionally for up to four months (extendable to eight months). To qualify, the company must present a plan outlining prospects for successful restructuring and secure liquidity for the composition period. Boards must monitor solvency closely and act early to ensure sufficient cash reserves for this process. Liquidity can be arranged through senior credit lines similar to US-style debtor-in-possession financings, but it is challenging to secure such arrangements on short notice.

Upon request, a court may even grant a so-called silent moratorium, allowing companies to keep the moratorium confidential. This is valuable for companies that need to carefully manage market (over-)reactions, as well as relationships with customers, suppliers, and employees.

Notably, Switzerland does not permit a single insolvency process for a whole corporate group. Hence, each group entity must consider and, if need be, initiate separate proceedings. At least, courts may appoint the same administrator across all entities to streamline coordination.

Implementing the Pre-Pack Solution: Providing A Lifeline to the Business

Unless the relevant business is housed already in a separate entity, a pre-pack transaction is usually implemented in two steps:

1.  Hive-Down: Relevant assets, liabilities, and contracts are transferred to a newly formed subsidiary (the pre-packing).

2.  Sale: The shares of this subsidiary are sold to a new owner in a share deal. Alternatively, a direct carve-out asset deal may be considered.

The transactions must be supported by the administrator and submitted to the court overseeing the composition moratorium for approval before implementation. This is particularly important to mitigate the risk of the transactions being voided as a result of claw-back claims in case of a later bankruptcy or if the composition moratorium ends with an assignment of assets to creditors for liquidation. Before approving a deal, the court will assess its fairness, ensuring it benefits creditors. A market test is not a strict legal requirement, but common in practice. This market testing typically occurs before signing and submission to the court, but it is possible (but rare) to conduct such post-signing (similar to a section 363 sale in the US).

The Swiss Supreme Court has clarified that creditors cannot appeal a court's decision to approve a pre-pack transaction, although seriously and obviously flawed court decisions may be null and void. As a result, due process, detailed disclosure, and experienced advisory support are critical to ensuring the validity of the court's approval.

If the moratorium is silent, the pre-pack can be implemented confidentially. However, given the complexity of such deals and the involvement of multiple stakeholders (e.g., employees and bidders), maintaining confidentiality may only be feasible for a limited time.

The Buyer's Perspective: Reaping the Benefits of a Pre-pack

From a buyer's perspective, pre-pack transactions offer opportunities, if the relevant risks are properly managed. In particular, reduced claw-back risks due to court oversight and the ability to acquire only the viable parts of the business are positive aspects.

For a bid to be attractive from an administrator (and court) perspective, a buyer should offer high deal certainty (fully funded transactions with limited conditions precedent are preferred) and a clear-cut exit minimizing post-closing entanglements (avoiding earn-outs, hold-backs, and specific post-closing undertakings). The buyer must be prepared to live with limited recourse, which can be mitigated through rigorous due diligence (also covering the initial carve-out of the business) and potentially warranty insurance. This is why the sell-side even under time pressure should allow for a proper due diligence process to avoid lower (or fewer) bids.

As distressed M&A continues to rise, the Swiss pre-pack offers a vital lifeline for businesses in financial difficulty and provides a path to restructuring with reduced risks for all parties – provided all players understand the intricacies of the process