Necessary financing for a hotel in trouble

It happens with some regularity: a hotel finds itself in financial trouble. The hotel urgently needs a financial injection to survive. Think of large debts incurred during the COVID-19 pandemic, necessary renovations of rooms, or simply financing to bridge a temporary liquidity shortfall.

Sometimes, hotel financing can be arranged by obtaining a bank loan. However, banks are no longer always eager to provide funding. The hotel is then quickly dependent on its shareholders. Shareholders can provide financing by granting loans or by injecting additional capital through their shares or the issuance of new shares. In these cases, the hotel company depends on the cooperation of its shareholders. But what happens when the shareholders cannot agree on the necessary financing? One shareholder blocks the process, refusing to provide funding and also unwilling to cooperate in the issuance of new shares to existing or new shareholders. What happens then?

In principle, a shareholder cannot be forced to provide financing against their will. Furthermore, shareholders are generally reluctant to provide loans, as they get nothing in return. Also, a shareholder is, in principle, allowed to vote against the issuance of new shares. However, this freedom of decision is not unlimited. Under certain circumstances, shareholders may be obliged to cooperate in a share issuance if the company is in serious financial distress and financing is needed to avoid bankruptcy. This is referred to as “emergency financing.” Emergency financing usually takes the form of a share issuance with new capital contributions.

Emergency Financing

Every shareholder is obliged to cooperate with the issuance of new shares if there is: (1) acute financial distress, (2) a deadlock in decision-making, and (3) a lack of alternatives. At the very least, the shareholder must tolerate the issuance of shares. This also applies to a shareholder who holds a controlling vote in the general meeting.

1. Financial distress

First, the emergency financing must be necessary for the company’s survival. Essentially, the emergency financing must prevent (potential) bankruptcy. In short, it must meet the financial needs of the company.

2. Deadlock in decision-making

Second, emergency financing can only occur when shareholders are unable to agree on the form of financing, thus preventing essential decisions from being made. The deadlock must obstruct the required financing.

3. No alternative options

Third, emergency financing cannot occur if there are other viable financing options. For example, a loan from an external lender or a loan from a shareholder. Sometimes such obligations are enforceable through a shareholders' agreement. This must be properly assessed. If there are no realistic alternatives, emergency financing may offer a solution. The idea is that, in the absence of financing, bankruptcy will render the shares worthless for all shareholders.

Consequences for Non-Participating Shareholders

The consequences of emergency financing are significant for shareholders who are unwilling or unable to participate in the share issuance. Their shareholding is usually significantly diluted. As a result, their voting power in the general meeting decreases. On the other hand, the value of their shares can remain stable, provided the new shares are issued at a fair price.

Court Proceedings

If the above three conditions are met, legal proceedings can be initiated to compel a blocking shareholder to cooperate with or tolerate the emergency financing. This can be done via preliminary relief proceedings or through the Enterprise Chamber (see the article "Family Hotel Disputes," published on August 24, 2022, for more information on the Enterprise Chamber). The court can impose various measures, such as suspending voting rights, assigning the authority to issue shares to a different body, or ordering general cooperation.

Protection against dilution

Because the consequences of emergency financing are far-reaching, shareholders may wonder whether they can protect themselves from negative impacts. The answer is that this is only possible to a limited extent. Sometimes shareholders include an “anti-dilution clause” in their shareholders' agreement. This clause might stipulate, for example, that a shareholder’s stake cannot fall below a certain percentage. This could limit the number of shares that can be issued. However, such protections are often ineffective. If a company is in such dire straits that bankruptcy is imminent, invoking an anti-dilution clause will likely be considered unacceptable.

Pitfalls

Even when all three requirements for emergency financing are met, the share issuance can still go wrong. In addition to meeting the requirements, the new shares must be issued at a fair value. Therefore, it is essential to conduct a proper valuation of the shares to determine a fair issue price. This ensures that the interests of non-participating shareholders are not unduly harmed. Furthermore, all corporate formalities for share issuance must be properly followed, including compliance with the company’s articles of association and required decisions by the correct corporate bodies. If these requirements are not met, there is a risk that the court may annul the resolution to issue new shares. This would mean, legally speaking, that the issuance never took place. Any actions taken based on the issuance would need to be undone. In practice, this is often problematic or even leads to bankruptcy, since the capital contributed may already have been used and cannot be refunded.

About the authors

If you are in a similar situation, or if you are a hotel entrepreneur seeking more information about an emergency financing procedure, do not hesitate to contact Berth Brouwer (berth.brouwer@actlegal-netherlands.com) or Floor van den Berg (floor.vandenberg@actlegal-netherlands.com) of the Corporate & Commercial Litigation team at act legal in Amsterdam.