Converting Debt into Equity Interests or Shares in a Company

The mechanism for converting debt into equity interests or shares in a company (Debt-to-Equity Swap) is one of the most important strategic tools for restructuring financing and providing liquidity to companies operating in the Egyptian market.

This mechanism enables companies to reduce the burden of repaying principal and interest by converting their financial obligations towards creditors—whether founders, partners, banks, or international investors—into direct contributions to capital.

Whether the management of a local company is seeking to increase its registered capital or a foreign company is seeking to protect its investments in Egypt, understanding the precise legal and regulatory frameworks governing this procedure remains essential for achieving financial stability and avoiding invalidity or future disputes.

The Concept and Economic Importance of Debt Restructuring Through Equity

The process of converting debt into equity interests or shares involves settling a financial obligation owed by the company by issuing new shares in joint-stock companies or increasing the value or number of equity interests in limited liability companies in favour of the creditor.

The creditor is thereby transformed from a seller or lender holding a debt portfolio into a partner or shareholder holding equity rights.

From an economic and operational perspective, this arrangement achieves several objectives:

• Improving the Balance Sheet: Reducing the debt-to-equity ratio (Debt-to-Equity Ratio), thereby strengthening the company’s financial standing and increasing its future borrowing capacity.
• Protecting Cash Flows: Ending the depletion of cash allocated to repaying the principal amount of the debt and periodic interest.
• Redistributing Risk for Foreign Investors: Enabling an international creditor to restructure its relationship with the company and participate in profits and corporate governance instead of bearing the risk of payment default (Default Risk).

The Egyptian Legal Framework Governing the Conversion of Debt into Shares or Equity Interests

Transactions involving the conversion of debt into equity interests or shares in Egyptian companies are subject to an integrated legislative and regulatory framework intended to protect the rights of existing shareholders and ensure the validity of the debt and proof that it has arisen as an obligation of the company.

1. Companies Law No. 159 of 1981 and Its Executive Regulations

Law No. 159 of 1981 on Joint-Stock Companies, Partnerships Limited by Shares, and Limited Liability Companies regulates capital increases through debts that are due and payable. It requires the existence of monetary debts that are certain, due and payable, and recorded in the company’s documents and official financial accounts.

2. Capital Market Law No. 95 of 1992 and Its Executive Regulations

This Law applies to joint-stock companies, particularly companies whose shares are listed on the Egyptian Exchange or that transact through the Central Securities Depository and Registry Company (MCDR).

3. Investment Law No. 72 of 2017

The Law provides guarantees and incentives for foreign investors and institutions specialising in the modification of financing structures, while regulating the mechanisms for repatriating profits and capital abroad.

4. Instructions of the General Authority for Investment and Free Zones (GAFI)

GAFI’s instructions specify the documentary requirements and accounting reviews necessary for valuing debts, subscription by shareholders or creditors using their value, and completion of registration procedures in the Commercial Register.

5. Central Bank of Egypt (CBE) Regulations

These regulations apply where the creditor is a local or foreign bank or where the transaction involves debts denominated in a foreign currency that were transferred through the official banking system.

Conditions and Practical Procedures for Implementing the Transaction

Implementing the transaction requires compliance with precise legal and procedural requirements to ensure its smooth registration before the General Authority for Investment and Free Zones and the Commercial Register.

1. Substantive Conditions for Convertible Debt

• The Debt Must Be Certain and Due and Payable: Contingent debts, debts of an undetermined amount, or debts that are not yet due may not be converted unless the parties agree to accelerate their maturity in accordance with the law.
• Express Consent of the Creditor and the Company: A debt settlement and conversion agreement (Debt Conversion Agreement) must be concluded, clearly expressing the definitive intention of both parties.
• Financial Certification: An official report must be issued by the company’s auditor, who must be registered in the Register of Accountants and Auditors, confirming the validity and value of the debt recorded in the company’s books.

2. Implementation Procedures

• Preparing the Agreement to Convert Debt into Shares or Equity Interests: Drafting a detailed agreement specifying the amount of the valued debt, the price of each share or equity interest, any share premium, and the express release of the debt immediately upon completion of the capital increase.
• Convening and Holding the Extraordinary General Meeting (EGM): The meeting issues a resolution approving an increase in the authorised or issued capital by converting debts due to the creditor, with existing shareholders waiving their pre-emption rights where the creditor is not among the existing partners.
• Auditor’s Report: Preparing a report stating that the amount required for the increase has been recorded in the “Creditors for Capital Increase” account or the corresponding credit accounts in the books.
• Approval of the General Authority for Investment (GAFI): Submitting the general meeting minutes and financial reports to the General Authority for Investment for formal approval.
• Annotation in the Commercial Register: Recording the capital increase and amendments to the provisions of the preliminary agreement and the company’s articles of association, while updating the Companies Gazette.
• Registration with the Central Securities Depository and Registry Company (MCDR): For joint-stock companies, the shares are issued and their ownership is transferred to the creditor or investor through the central depository system.

Legal Risks and Common Mistakes

Procedural or substantive errors during the conversion of debt into equity interests or shares in a company may invalidate the capital increase or expose the company and the creditor to significant legal and tax risks.

Special Considerations for International Clients and Companies (International Investors)

For foreign companies, international financial institutions, and foreign law firms seeking Local Counsel in Egypt, the debt conversion process requires particular attention to several implementation considerations:

• Foreign Exchange Restrictions and Exchange Rates: If the debt was originally denominated in a foreign currency (USD/EUR), the applicable exchange rate must be expressly agreed upon to determine the Egyptian pound equivalent of the debt when it is converted into shares, thereby ensuring its accurate recording in the capital.
• Profit Repatriation Rules and Exit Rights (Exit Strategy): It must be ensured that the new shares or equity interests are registered in GAFI’s designated foreign investment form to ensure the lawful repatriation of profits abroad in the future.
• Regulatory Approvals for Strategic Sectors: Certain sectors, such as energy, telecommunications, and companies owning real estate in areas of the Sinai Peninsula, require prior security or regulatory approvals before ownership is transferred or shares are issued to foreign parties.
• Suitability of Governance Rules and Minority Rights: It must be ensured that shareholders’ agreements (Shareholders’ Agreements) include legal protection mechanisms when the investor is converted from a creditor into a shareholder, such as veto rights or tag-along/drag-along rights.

Commercial and Operational Effects on the Ownership and Management Structure

A creditor’s decision to become an owner in the company results in a fundamental change to its governance structure and decision-making mechanisms:

1. Redistribution of Voting Percentages: The ownership percentages of existing shareholders are reduced (Dilution), which may alter the majority required to adopt ordinary or extraordinary resolutions.
2. Board Representation: The conversion often enables the relevant creditor to obtain one or more seats on the board of directors of a joint-stock company or to participate actively in the management of a limited liability company.
3. Improved Financial Solvency and Creditworthiness: The conversion enables the company to conclude new commercial agreements and obtain better credit ratings from suppliers and banking institutions.

When Is the Involvement of a Specialist Lawyer or Local Counsel in Egypt Required?

Converting debt into equity interests or shares in a company requires precision that extends beyond merely preparing conventional meeting minutes. Engaging a lawyer specialising in investment and corporate law becomes essential in the following circumstances:

• Preparing and structuring the debt settlement and conversion agreement (Debt Conversion & Settlement Agreement) to avoid tax and regulatory gaps.
• Providing full supervision over drafting notices, convening, and authenticating extraordinary general meetings before the General Authority for Investment (GAFI).
• Coordinating with registered auditors and financial advisers to ensure precise consistency between the accounting figures and legal annotations.
• Representing a foreign investor or international law firm as Local Counsel to provide the highest level of legal protection and ensure compliance with foreign exchange legislation, competition laws, and merger and acquisition control regulations.

How Can Specialist Legal Support Assist?

El Rouby Law Firm provides comprehensive legal support to companies, financial institutions, and international investors to complete restructuring and financing transactions efficiently and professionally:

• Regulatory Compliance and Governance: Satisfying all formal requirements before GAFI, the Egyptian Exchange, the Central Securities Depository and Registry Company (MCDR), and the Central Bank.
• Legal Risk Management and Due Diligence: Reviewing debts, obligations, and company records to verify that the transaction is free from grounds of invalidity or tax exposure.
• Drafting Contracts and Financing Agreements: Preparing debt conversion agreements, amending incorporation documents and articles of association, and concluding shareholders’ agreements (SHA).
• Dispute Prevention and Negotiation: Negotiating on behalf of companies or creditors to develop amicable and innovative restructuring solutions and avoid bankruptcy or litigation proceedings.
• Procedural Safeguards and Legal Representation: Representing clients before all governmental and regulatory authorities, judicial bodies, and arbitration panels when any enforcement-related dispute arises.

Conclusion

The mechanism for converting debt into equity interests or shares in a company represents an advanced legal and financial solution for revitalising companies and promoting their growth in the Egyptian market. However, successful implementation remains contingent on strict compliance with legal procedures and obtaining the appropriate regulatory approvals.

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Frequently Asked Questions

Q1: May Any Debt Be Converted into Shares in a Company Under Egyptian Law?

A: Law No. 159 of 1981 requires the debt to be fixed, certain, due and payable, recorded in the company’s books, and evidenced by an official report issued by the company’s auditor registered in the Register of Accountants and Auditors.

Q2: Does Converting Debt into Shares Require the Approval of All Existing Shareholders?

A: A resolution must be issued by the extraordinary general meeting (EGM) with the majority prescribed by the Companies Law and the company’s articles of association, expressly providing for the existing shareholders’ waiver of their pre-emption rights in favour of the creditor.

Q3: How Are Foreign-Currency-Denominated Debts Treated When Converted into Shares?

A: The Egyptian pound equivalent of the debt is calculated based on the exchange rate announced by the Central Bank of Egypt on the date agreed upon in the settlement agreement or on the date of the extraordinary general meeting convened to increase the capital.

Q4: What Is the Position of the General Authority for Investment (GAFI) on Debt Conversion Transactions?

A: The General Authority for Investment requires the submission of the official minutes of the extraordinary general meeting, accompanied by the auditor’s report and approved financial statements showing the debt recorded in the company’s accounts, to approve the meeting and annotate the capital increase in the Commercial Register.

Q5: Does Converting Debt into Equity Give Rise to Any Tax Liabilities?

A: If the transaction is completed as a fully paid capital increase and duly recorded in the books in accordance with approved accounting principles, it is not treated as income subject to commercial profits tax. However, imprecise drafting may be interpreted as a debt waiver, potentially giving rise to a tax liability; specialist legal and financial advice is therefore required.