This article considers the questions raised when a creditor of an Iraqi company proposes, or is asked, to convert its debt into equity. A debt for equity swap can relieve a struggling company of debt it cannot service and give the creditor an upside if the business recovers. It can also dilute existing shareholders, change control of the company and require regulatory approval. Whether a conversion is achievable depends on corporate procedures, regulatory constraints, valuation and the interests of the parties involved.
In many jurisdictions, debt for equity swaps are a routine restructuring tool, sometimes implemented through court-supervised procedures that can bind dissenting shareholders. In Iraq, a conversion is typically implemented through the ordinary corporate procedures for a capital increase, which require shareholder approval. This makes the existing shareholders’ cooperation central to the proposal.
The Companies Law No. 21 of 1997, as amended, governs capital increases, the issue of shares, contributions other than cash and amendments to the articles of association. The Iraqi Civil Code No. 40 of 1951 governs the extinction of debt through set-off or other means. Sector legislation, including the Banking Law No. 94 of 2004 for bank creditors, may restrict a creditor’s ability to hold equity. The Investment Law No. 13 of 2006, as amended, the Competition and Antitrust Law No. 14 of 2010 and the Income Tax Law No. 113 of 1982, as amended, may also be relevant.
Assessing whether conversion makes commercial sense
Before addressing legal mechanics, both the creditor and the company should consider whether conversion is the right solution:
- For the company. Conversion reduces debt and interest, improving cash flow and the balance sheet. It may help the company attract new funding or avoid insolvency. However, existing shareholders lose part of their ownership and control.
- For the creditor. Conversion replaces a fixed claim with an uncertain equity interest. The creditor may gain upside if the business recovers, but it ranks behind all creditors if the company fails. It may also take on governance responsibilities it did not expect.
- For other creditors. Conversion by one creditor improves the position of the remaining creditors by reducing competing claims.
A conversion is most likely to succeed where the business is viable but over-indebted, and where the creditor has the capacity and willingness to act as a shareholder.
Implementing the conversion through corporate procedures
A conversion is usually implemented as a capital increase in which the creditor subscribes for new shares and pays by setting off its existing claim. The following steps require attention:
- Shareholder approval. The general assembly must approve the capital increase and amendment of the articles, by the majority required under the Companies Law and the articles. Existing shareholders may have pre-emption rights that must be waived or respected.
- Nature of the contribution. The registry may treat a debt converted into share capital as a contribution other than cash, which may require valuation or verification under the Companies Law.
- Registration. The capital increase and new shareholding must be registered. Until registration, the creditor’s position as shareholder may not be recognised by third parties.
Corporate advice in Iraq can confirm the procedures the registry will apply to a conversion and the documents required.
Valuing the debt and the equity
Valuation is often the most contentious issue. The parties must agree how much equity the debt will buy. A creditor will argue that its claim should be valued at face value and the equity at a low value reflecting the company’s distress. Existing shareholders will argue the opposite. Independent valuation of the business can provide a basis for agreement and may be required to support the registry filing.
The parties should also consider whether all of the debt will be converted, or only part, with the balance rescheduled. A partial conversion may leave the company with sustainable debt while limiting dilution.
Checking regulatory restrictions
Certain creditors may be restricted from holding equity. Banks, for example, may be subject to limits on investments in non-financial companies under the Banking Law and Central Bank of Iraq instructions, and may need approval or be required to dispose of the shares within a defined period. Foreign creditors may face restrictions on owning shares in companies engaged in certain activities or holding certain assets.
The company’s own licences may also be affected. A change in shareholding may require approval from the investment commission or a sector regulator, and the competition authority may need to be notified if the creditor is a competitor. These approvals should be identified before the conversion is agreed. Commercial and regulatory advice in Iraq can help determine whether a bank creditor can lawfully take and hold the shares.
Addressing tax consequences
A conversion may have tax consequences for both parties. If the debt is converted at less than face value, the company may realise a gain on the extinguished portion, which may be taxable. The creditor may realise a loss, whose deductibility depends on the tax rules. Tax advisory services in Iraq can identify the likely treatment and help structure the conversion efficiently.
Agreeing governance after conversion
The creditor will become a shareholder and will want governance rights proportionate to its new stake, as well as protections such as information rights, reserved matters and exit rights. Existing shareholders will want to preserve their position. A new or amended shareholder agreement should be negotiated alongside the conversion, setting out board representation, decision-making and the terms on which the creditor may exit its investment.
Protecting the creditor before conversion completes
Conversion takes time. Between agreement and registration, the creditor has given up its right to enforce but has not yet become a registered shareholder. During that period, the company’s position may deteriorate, other creditors may enforce or shareholders may withdraw their cooperation. The creditor should seek protections for this interim period:
- Conditional release. The debt should be released only when the shares are registered, not on signature of the agreement.
- Interim covenants. The company should agree not to dispose of assets, incur new debt or make distributions before completion.
- Long-stop date. If conversion is not completed by a defined date, the creditor’s original claim should revive in full, with any standstill ending.
These protections ensure that the creditor is not left with neither a claim nor shares if the conversion fails.
Illustrative example. An Iraqi cement company owes a substantial amount to its main equipment supplier. The supplier offers to convert half the debt into a thirty per cent shareholding. The founding family initially resists but agrees after an independent valuation shows that the business cannot service its current debt. The conversion is implemented through a general assembly resolution, waiver of pre-emption rights, valuation of the contribution and registration. A new shareholder agreement gives the supplier one board seat, information rights and a put option after five years.
Conclusion & how Etihad Law Firm can help
A debt for equity swap can be an effective restructuring tool for an Iraqi company, but it requires shareholder cooperation, careful valuation, regulatory clearance and attention to tax and governance consequences. Addressing these questions early helps the parties determine whether conversion is achievable and on what terms.
Etihad Law Firm advises companies, shareholders and creditors on debt for equity proposals and broader restructurings in Iraq. We help clients assess, negotiate and implement conversions through the required corporate and regulatory procedures.