Can a construction company be restructured?

In the past few months, many Finnish construction companies have been forced to throw in the towel. Some of the largest victims of the current market conditions include Jukkatalo, Siklatilat, Sajucon, Puurakentajat Group and Lehto. In addition to these, several smaller construction companies and subcontractors for new construction production have gone bankrupt. The bankruptcy of Siklatilat was preceded by an unsuccessful corporate restructuring, and attempts are still ongoing to rescue Lehto’s parent company, Lehto Group, through restructuring proceedings.

The Finnish insolvency proceedings system consists of bankruptcy and restructuring proceedings. In both bankruptcy and restructuring proceedings, all monetary debts incurred before a certain date are subject to enforcement. Whereas in bankruptcy the creditors are paid out of the liquidation value of the debtor’s assets, in restructuring proceedings debts are paid out of the free cash flow generated by the debtor’s business.

In restructuring proceedings, the debtor retains control of its assets and, with certain exceptions, is allowed to continue to conduct its business as usual. Although restructuring proceedings allow for the restructuring and cutting of the debts – the amount of the debt is adjusted to the debtor’s future imputed free cash flow – it aims at a better outcome for creditors compared to bankruptcy. The positive cash flow generated by the debtor’s business must therefore, within a reasonable period of time (five to six years on average), exceed the liquidation value of its assets. From the perspective of the debtor, the owners and the employees, the benefits of restructuring compared to bankruptcy are obvious.

Amendments to the Restructuring of Enterprises Act aim to promote the fulfilment of the purpose of restructuring proceedings

In recent years, the Restructuring of Enterprises Act has been amended a few times. An amendment that entered into force in summer 2022 introduced, alongside the original restructuring proceedings (now known as ‘standard restructuring proceedings’), a procedure called ‘preventive restructuring proceedings’ with slightly less stringent commencement criteria as an alternative for companies that are still solvent but facing insolvency. 

The most recent amendment, which entered into force in June 2023, introduced in the Act the possibility to prematurely terminate any executory contracts where the debtor’s obligations are non-monetary. Such termination is subject to it being necessary for the fulfilment of the purpose of the restructuring proceedings. The notice period is not fixed: the contract only ends if and when the debtor’s restructuring programme is approved. Any compensation for premature termination is considered restructuring debt and can therefore be subject to debt arrangement.

The amendment described above is a significant exception to the general principles of restructuring proceedings. Ever since the concept of restructuring was introduced to Finnish legislation in the early 1990s, sanctity of contracts was adopted as a premiss in restructuring proceedings together with the idea that, with some very specific exceptions, restructuring only applies to the debtor’s monetary debts.

Do the amendments to the Restructuring of Enterprises Act affect the restructurability of construction companies?

Could bankruptcies of construction companies be avoided, at least in some cases, by means of restructuring proceedings? This seems plausible, at least in theory.

Firstly, restructuring proceedings allow for the rearrangement of the company’s liabilities. Restructuring can therefore be used to reduce financing costs that have become unsustainable in relation to the company’s business volume, or to reduce accounts payable, for example. Following the June 2023 amendment to restructuring legislation, restructuring now allows for the premature termination of building contracts and other similar executory contracts that have become unprofitable and for the debt arrangement of any subsequent compensation. On the other hand, the possibility of terminating such contracts may even encourage the counterparty to voluntarily renegotiate the contract. Restructuring could be a way of avoiding the loss of capital invested in a construction company and the loss of business value.

However, restructuring proceedings of construction companies have traditionally not been very common, and the prognosis for construction companies pursuing this option has generally not been positive: either the restructuring proceedings have failed before the conclusion of the restructuring programme or the company has not been able to observe said programme. Can we expect this to change as a result of the preventive restructuring proceedings launched in 2022 or the possibility of prematurely terminating executory contracts introduced in the Act in 2023?

The amendments have had valid goals. The preventive restructuring proceedings, which are based on the EU Insolvency Directive, aim at helping companies at risk of insolvency to enter the proceedings in good time, when the company’s liquidity situation is not yet critical and the dialogue with key creditors is better. The aim of the right to prematurely terminate executory contracts, which has been in force for a better part of a year, is to make it possible for the debtor company to withdraw from agreements that have become economically unsustainable. The amendment shows that the legislator is aware that non-monetary obligations may also become economically unsustainable and prevent the debtor from rehabilitating its viable business.

According to the latest information, however, only three applications for preventive restructuring proceedings were filed during an 18-month observation period. By way of comparison, a total of 306 restructuring proceedings were commenced in 2023, and the number of applications for restructuring proceedings was substantially higher. There is no information on whether the provision on the termination of executory contracts has been applied yet. However, as it only entered into force less than a year ago, it is unlikely that it has been largely applied yet, considering that, pursuant to said provision, the contract only terminates when the restructuring programme is approved.

A lower threshold for commencing restructuring proceedings and the possibility to rearrange executory contracts, such as building contracts, could, as such, help construction companies to restructure their operations. These factors do not, however, solve the main challenge related to the restructuring of construction companies – publicity.

The main challenge in restructuring a construction company is the publicity related to the proceedings

The difficulty with a construction company’s restructuring proceedings is largely related to how the information about the proceedings becoming public affects its ability to win new building contracts and to enter subcontracting agreements. Very few clients are willing to enter into a building works agreement with a company tainted by restructuring proceedings, regardless of whether the company is actually able to fulfil its obligations under such agreement. The drying up of the company’s order book will lead to the failure of the restructuring proceedings, even if these are started in good time when working capital is still available. The termination of unfavourable building contracts is not helpful, either, if the company is unable to win new contracts.

The bankruptcy of a construction company may have significant economic consequences for the client, both as regards the completion of the building works and potential guarantee issues. The clients’ sensitivity to risk with regard to construction companies subject to restructuring proceedings is therefore understandable. If we wish to effectively rehabilitate construction companies in financial difficulties instead of driving them to bankruptcy, there may be a need for a framework of voluntary arrangements that would allow to proactively seek a comprehensive arrangement of predetermined debts and contracts quickly, efficiently and without the stigmatised reputational damage of insolvency proceedings. Such a framework could prove useful also for companies in other industries facing financial difficulties, where the publicity received by the restructuring proceedings more or less means that the business activities dry up completely.

Among the tools currently in use, the accelerated restructuring proceedings could at least make it possible to avoid the uncertainty generally related to restructuring proceedings as it allows to quickly present to creditors and stakeholders with the contents of the restructuring programme and the measures to rehabilitate the debtor company. In fact, a company that abides by a restructuring programme and whose debt burden is controlled and adjusted to correspond to its business volume is likely to be a more reliable partner than a company that is quietly struggling with serious financial difficulties.

When a construction company is being rehabilitated, the significance that potential clients attach to the restructuring proceedings has a large impact. In order to avoid losses of value and unnecessary costs resulting from a bankruptcy, it would be good if the client party also critically assessed the impact that restructuring proceedings have on the actual ability of a construction company to fulfil its obligations under a building contract.