Debt-to-Equity Swap in Israel

A debt-to-equity swap in Israel is a restructuring mechanism that converts outstanding debt obligations into equity shares in the debtor company, giving creditors an ownership stake in place of a monetary claim. Under Israel';s Insolvency and Economic Rehabilitation Law, this tool sits at the centre of modern corporate rescue proceedings. For creditors, it offers a path to value recovery when cash repayment is impossible; for debtors, it removes balance-sheet pressure and preserves the business as a going concern. This guide covers the legal framework, the procedural steps, the roles of key stakeholders, the costs and timelines involved, and the practical considerations that determine whether a swap succeeds or fails.

Israel';s primary insolvency statute is the Insolvency and Economic Rehabilitation Law, enacted to replace the older Companies Ordinance and Bankruptcy Ordinance provisions. The law introduced a rehabilitation-first philosophy, meaning courts and practitioners are expected to explore restructuring options before ordering liquidation. A debt-to-equity swap is one of the most significant tools within that philosophy.

The law distinguishes between two main proceedings relevant to swaps. The first is a rehabilitation arrangement under Part D of the statute, which allows a debtor company to propose a plan to its creditors and shareholders. The second is a creditor-driven arrangement, where a significant creditor or group of creditors initiates the process. In both cases, the District Court - sitting as an insolvency court - supervises the proceedings and must approve any plan that alters creditor rights or converts debt into equity.

The Companies Law also plays a role. Any issuance of new shares to creditors must comply with the Companies Law';s requirements on share allotment, shareholder approval, and pre-emption rights. A common mistake among foreign creditors is to focus exclusively on the insolvency statute while overlooking the corporate law mechanics that govern the actual share issuance. In practice, both bodies of law must be navigated simultaneously.

The Israel Securities Authority becomes relevant when the debtor is a publicly listed company. A swap that results in a creditor holding a significant stake in a public company may trigger disclosure obligations, mandatory tender offer rules, or prospectus requirements under the Securities Law. These layers add complexity and cost to swaps involving listed entities.

Not every distressed company is a suitable candidate for a debt-to-equity swap. The mechanism works best when the business has genuine operational value - meaning its going-concern worth exceeds its liquidation value - but its capital structure is unsustainable due to excessive leverage.

A swap can be initiated by the debtor company itself, by a trustee appointed by the court, or by creditors holding a qualifying threshold of the outstanding debt. Under the Insolvency and Economic Rehabilitation Law, a rehabilitation plan can be filed at the outset of proceedings or at any point before a liquidation order becomes final. The court appoints a rehabilitation trustee to assess the debtor';s affairs and report on the viability of proposed plans.

Creditors who hold security interests - such as floating charges or fixed charges over specific assets - occupy a privileged position. Secured creditors are generally not bound by a plan unless they vote in favour or the court exercises its cram-down power. The cram-down mechanism allows the court to approve a plan over the objection of a dissenting class of creditors, provided the plan meets specific fairness tests set out in the statute. This is a critical lever in debt-to-equity negotiations, because it prevents a single blocking creditor from derailing an otherwise viable restructuring.

Unsecured creditors, by contrast, vote as a class. A plan requires approval by a majority in number and at least two-thirds in value of the creditors voting in each class. If those thresholds are met and the court is satisfied that the plan is fair and feasible, it will sanction the arrangement, binding all creditors in the class - including dissenters.

Two practical scenarios illustrate the range of situations. In the first, a mid-sized Israeli technology company has accumulated bank debt it cannot service after a revenue shortfall. The bank, preferring to preserve the business rather than foreclose on limited assets, agrees to convert a portion of its loan into preference shares, retaining a debt tranche with revised terms. In the second, a real estate developer with multiple secured lenders faces insolvency. A consortium of bondholders proposes a plan that converts their bonds into ordinary shares, diluting existing shareholders to near-zero, and appoints new management. The court confirms the plan after finding that liquidation would yield less for creditors.

The process follows a structured sequence, and understanding each stage helps parties plan their timelines and resources accurately.

The first stage is filing for rehabilitation proceedings. The debtor or an eligible creditor files a petition with the District Court. The court may issue a stay of proceedings - a moratorium on enforcement actions - to give the debtor breathing room. This stay typically lasts an initial period of several months, with extensions possible at the court';s discretion.

The second stage is the appointment of a rehabilitation trustee. The trustee examines the debtor';s books, assets, liabilities, and business prospects. The trustee';s report is central to the court';s assessment of whether a rehabilitation plan is viable. Trustees are typically experienced insolvency practitioners or accountants approved by the court.

The third stage is the preparation and filing of the rehabilitation plan. The plan document must specify the proposed treatment of each class of creditors, the terms of the debt-to-equity conversion, the valuation basis used to determine the conversion ratio, the new capital structure of the company, and any operational changes intended to restore viability. Valuation is often the most contested element. Creditors and debtors frequently engage separate financial advisers, and disputes over enterprise value directly affect how much equity each creditor class receives.

The fourth stage is the creditor vote. The court convenes a meeting of creditors, organised by class. Each class votes separately. The statutory thresholds - majority in number and two-thirds in value - must be met in each class for the plan to pass without a cram-down application.

The fifth stage is court sanction. Even if creditors approve the plan, the court must independently satisfy itself that the plan is fair, does not unfairly prejudice any creditor class, and is feasible. The court may impose conditions or require modifications before granting its order.

The sixth stage is implementation. Once sanctioned, the plan is executed. New shares are allotted to creditors, existing share registers are updated, and any required filings are made with the Israel Companies Registrar. If the debtor is publicly listed, the relevant disclosures are filed with the Tel Aviv Stock Exchange and the Israel Securities Authority.

The overall timeline from petition to implemented plan varies considerably. Straightforward cases with cooperative creditors can conclude in six to nine months. Complex multi-creditor restructurings, particularly those involving listed companies or contested valuations, routinely take twelve to twenty-four months or longer.

The conversion ratio - how much equity a creditor receives per unit of debt converted - is the economic heart of any debt-to-equity swap. Getting it right requires a credible valuation of the debtor company, and this is where most disputes arise.

Israeli courts and practitioners generally accept discounted cash flow analysis, comparable transaction multiples, and asset-based approaches as legitimate valuation methodologies. In practice, the chosen method depends on the nature of the business. A technology company with limited tangible assets but strong recurring revenue is best valued on a cash flow basis. A real estate company is more naturally valued by reference to its property portfolio.

A non-obvious requirement is that the valuation must reflect the going-concern value of the business after the restructuring, not its current distressed value. This distinction matters enormously. A company that is technically insolvent today may have substantial value once its debt burden is removed. Creditors who anchor their expectations to distressed asset prices often underestimate the equity they should receive.

The conversion ratio also determines the dilution suffered by existing shareholders. Under Israeli law, existing shareholders retain their shares unless the plan explicitly cancels or reduces them. In most significant restructurings, existing equity is heavily diluted or extinguished entirely, because the absolute priority rule - or its Israeli equivalent - requires that creditors be made whole before shareholders receive any value. Courts scrutinise plans that preserve shareholder value while creditors take losses.

Many creditors underestimate the tax implications of a swap. The conversion of debt into equity is a taxable event under Israeli tax law for both the debtor and the creditor in certain circumstances. The debtor may recognise a gain on debt forgiveness, and the creditor may recognise a loss on the extinguished debt. Tax advice from Israeli counsel is essential before finalising conversion terms, as structuring choices can significantly affect the net economic outcome.

If you are navigating a debt-to-equity transaction in Israel and need guidance on structuring the conversion terms or managing creditor negotiations, contact us at info@vlolawfirm.com. We can help structure the setup correctly the first time.

Secured creditors occupy a distinct position in Israeli insolvency proceedings, and their treatment in a debt-to-equity swap requires careful analysis.

A creditor holding a fixed charge over specific assets - such as a mortgage over real property - has priority over the proceeds of that asset. In a swap, the question is whether the secured creditor can be compelled to convert its secured claim into equity. The answer under Israeli law is nuanced. A secured creditor cannot generally be forced to give up its security without consent, but the cram-down mechanism allows the court to approve a plan that provides the secured creditor with the "indubitable equivalent" of its secured claim. If the court determines that equity in the restructured business is worth at least as much as the secured creditor';s claim, it may sanction the plan over the creditor';s objection.

Bondholders present a different set of challenges. Israeli companies frequently raise capital through bond issuances on the Tel Aviv Stock Exchange, and bondholder restructurings are a recurring feature of the local market. The Insolvency Law provides specific mechanisms for bondholder arrangements, including the appointment of a bondholder trustee who represents the collective interests of all bondholders. A debt-to-equity swap involving public bonds requires the bondholder trustee';s engagement and, in most cases, a bondholder meeting with its own voting thresholds.

A common mistake in bondholder swaps is failing to engage the trustee early. The trustee has fiduciary duties to bondholders and will scrutinise the plan independently. Debtors who present a plan without prior consultation often face delays and demands for improved terms.

Foreign creditors - particularly funds holding Israeli corporate bonds - must also consider the interaction between Israeli insolvency law and the law of their home jurisdiction. A creditor incorporated in a foreign jurisdiction may face questions about whether the Israeli court';s order is enforceable against assets held abroad, or whether the creditor';s home jurisdiction recognises the Israeli proceedings. Israel is not a signatory to the UNCITRAL Model Law on Cross-Border Insolvency, so cross-border recognition depends on bilateral arrangements and the domestic law of the relevant foreign jurisdiction.

A debt-to-equity swap in Israel involves several layers of cost that parties should anticipate from the outset.

Court and filing costs are relatively modest compared to professional fees. The dominant cost categories are legal fees, financial advisory fees, and the trustee';s remuneration. In a complex restructuring, total professional fees can reach significant sums, particularly when multiple creditor classes retain separate advisers.

Legal fees for debtor-side counsel in a mid-sized restructuring typically start from the low tens of thousands of USD and can rise substantially in contested proceedings. Creditor-side legal fees depend on the creditor';s level of involvement. A lead creditor driving the process will incur costs comparable to the debtor; a passive creditor voting on a plan will incur far less.

Financial advisory fees for valuation work and financial modelling are a significant additional item. Independent valuers are often required by the court or by creditor committees, and their fees are charged to the estate or allocated among the parties by agreement.

The rehabilitation trustee';s remuneration is set by the court and is typically calculated as a percentage of the assets under administration, subject to a cap. This cost is borne by the debtor';s estate and reduces the pool available to creditors.

Hidden costs include the management time diverted from running the business during proceedings, the reputational effects of public insolvency filings, and the cost of any operational restructuring that accompanies the financial restructuring. Many debtors underestimate the internal resource burden of a restructuring process that can last a year or more.

Practical planning tips for parties entering a swap process include the following. Engage Israeli legal and financial advisers before filing, not after. Conduct a preliminary valuation to understand the realistic conversion ratio before approaching creditors. Map the creditor classes carefully, because the voting dynamics depend on how claims are classified. Consider whether a pre-packaged arrangement - where creditor support is secured before the formal filing - is feasible, as it can dramatically shorten the court process.

What happens to existing shareholders when a debt-to-equity swap is approved in Israel?

Existing shareholders are not automatically eliminated, but in most significant restructurings they suffer severe dilution or complete extinguishment of their equity. Israeli insolvency law applies a priority principle under which creditors must receive full value before shareholders retain anything. If the company';s enterprise value is less than its total debt, existing shareholders receive nothing. The rehabilitation plan must specify the treatment of existing shares, and the court will not sanction a plan that preserves shareholder value at the expense of creditors. Shareholders do have the right to object to the plan and to be heard by the court, but objections are rarely successful when the company is genuinely insolvent.

How long does a debt-to-equity swap process typically take in Israel, and what drives the timeline?

The timeline ranges from roughly six months for a straightforward, consensual restructuring to two years or more for a contested multi-creditor case. The main drivers of delay are valuation disputes, disagreements between creditor classes, the complexity of the company';s capital structure, and the volume of litigation that accompanies contested proceedings. Pre-packaged arrangements, where creditor support is secured before the formal filing, can compress the timeline significantly. Court scheduling also plays a role - Israeli District Courts handling insolvency matters have busy dockets, and hearing dates may be set weeks or months apart. Parties who invest in pre-filing preparation and creditor alignment consistently achieve faster outcomes.

Can a foreign creditor participate in an Israeli debt-to-equity swap, and are there any restrictions?

Foreign creditors can participate fully in Israeli insolvency proceedings and are entitled to vote on rehabilitation plans on the same basis as Israeli creditors. There are no nationality restrictions on holding equity in an Israeli private company. However, foreign creditors should be aware of several practical issues. First, Israeli court orders may not automatically be enforceable against assets held in foreign jurisdictions, requiring separate recognition proceedings. Second, the tax treatment of the swap in the creditor';s home jurisdiction may differ from the Israeli treatment, creating a need for coordinated cross-border tax advice. Third, foreign creditors holding significant stakes in Israeli companies in regulated sectors - such as banking, telecommunications, or defence - may require regulatory approvals before the share allotment is completed.

A debt-to-equity swap in Israel is a powerful restructuring instrument, but it demands careful legal, financial, and strategic preparation. The Insolvency and Economic Rehabilitation Law provides a coherent framework, and Israeli courts have developed meaningful experience in supervising complex arrangements. Success depends on credible valuation, early creditor engagement, and precise navigation of both insolvency and corporate law requirements.

VLO Law Firms advises international clients on bankruptcy and insolvency matters in Israel. We can assist with structuring debt-to-equity swaps, advising creditors and debtors on rehabilitation plans, managing creditor negotiations, and coordinating cross-border insolvency issues. To request a consultation, contact: info@vlolawfirm.com