The economic impact of the COVID-19 pandemic led to a wave of creditor schemes of arrangement ("schemes") and restructuring plans ("RPs") in the second half of 2020, which shows no sign of abating in 2021. For the uninitiated, the scheme (a long-established tool) and the newer RP process are court led UK restructuring options that a company can use to bind a minority of creditors into a restructuring. An RP can also be used to "cram down" an entire dissenting creditor class into a deal where certain conditions are met. Both processes involve two Court hearings, which provide a natural forum for challenges from dissenting creditors but which, if any such challenges can be overcome, result in formal judicial approval of the restructuring. Unsurprisingly, more schemes and RPs have led to more challenges.
Behind the numbers, we can identify several pervasive reasons for the increasing number of creditor challenges:
1. "Pushing the boundaries" on jurisdiction
The appeal of schemes and RPs remains so strong that applicants have sought increasingly creative means to tick the box of "sufficient connection" to the UK − a necessity if the Court is to have jurisdiction to sanction a scheme or an RP. Changing the governing law of finance documents to English law, COMI-shifting and the accession of an English co-issuer/obligor under the debt documents are tried-and-tested routes to establish jurisdiction. However, the techniques pioneered in Swissport [see Swissport] and Gategroup [see Gategroup] were more novel and attracted opposition from creditors opposed to the restructuring (although in both cases the relevant challenges were dropped).
2. (Single) class issues
Allocating different levels of fees and overall scheme consideration to creditors within the same class is another contentious issue. A restructuring agreed with a company's major creditors under one or more debt instruments will typically be easier to implement if the creditors under those instruments can be divided into as few classes as the law permits.1 This objective can conflict with the need for the company to compensate for benefits received or services provided, such as via work fees for ad hoc creditor groups or co-ordinating committees, underwriting or backstop fees (and improved economics) for new money and early-bird consent fees. All of these must be carefully considered from a class perspective [see Codere and, outside of England, note also the Scottish scheme of Premier Oil, which was strongly opposed (and indeed appealed) by one creditor, including on the basis of perceived class issues]. The increasing influence of ad hoc groups of creditors ("AHGs") in restructurings has contributed to bringing class issues into sharp focus, with the Court (and dissenting creditors) particularly live to favourable treatment of the AHG that would prevent them from voting in the same class as non-AHG creditors.
3. Valuation difficulties
Uncertain operating conditions and volatile markets increase the likelihood of contrasting valuations and therefore disputes. Since early 2020, accountants and financial advisers have faced the extraordinary challenge of preparing valuations to support schemes and RPs for businesses which have been forced to curtail their operations in the context of an unprecedented global pandemic [see Swissport]. Notably, the challenge in Swissport was brought by a group of bondholders who were not scheme creditors, but who nevertheless claimed that they would lose out from the broader restructuring of which the scheme was a part. As the group withdrew its challenge at the outset of the sanction hearing, the Court did not need to rule on the standing of non-scheme creditors to make such arguments but did indicate that, whilst it is important for the Court to take into account the interests of affected parties, it "should do what it can to guard against the sanction hearing turning into an occasion on which a series of miscellaneous fairness points are ventilated, sometimes at great expense" (to use Mr Justice Trower's words). Challenges from non-scheme creditors and the Court's receptiveness to such challenges are issues to watch out for in future cases.
4. Market developments and dynamics
The greater number of cases, heightened publicity and legal analysis from the financial newswire services have no doubt contributed to a greater awareness amongst investors of the pressure points in schemes and RPs. Equally, a dearth of other opportunities in the distressed debt market may have encouraged, and continue to encourage, hedge funds to pursue more aggressive strategies.
As far as the restructuring and insolvency sector was concerned, the EU-UK Withdrawal Agreement represented a "no-deal" Brexit. However, the impact of Brexit on the use of schemes and RPs has been tempered by the fact that schemes were never a designated process under Annex A of the EU Recast Insolvency Regulation and therefore never benefitted from automatic recognition in the EU. As such, it was always necessary to find an alternative basis to satisfy the Court that a scheme (or an RP) would be recognised in key European jurisdictions. Whilst one potential such basis, the EU Recast Judgments Regulation, has fallen away, other paths to recognition will usually be available depending on the circumstances and jurisdictions in question. However, we expect more judicial scrutiny of the evidence put forward by companies on overseas recognition, and for this to be the subject of contention in more cases than it was before Brexit [see Gategroup].
6. Cross-class cram down – (almost) unchartered territory
RPs are similar to schemes but one of their key distinctive features, namely the ability to implement restructuring proposals over the objections of a dissenting class of creditors on the basis of what is commonly described as a cross-class cram down ("CCCD"), remains largely untested. The two key conditions for the use of CCCD are that:
(a) the dissenting class be "no worse off" under the RP than in the "relevant alternative" (being the outcome the Court considers most likely if the RP is not sanctioned); and
(b) one of the supportive classes would have a "genuine economic interest" in the company in the "relevant alternative".
The Deepocean RP sanctioned in January 2021 was the first case to use CCCD. The Court provided helpful guidance, noting that the concept of "no worse off" in the context of Condition A is a broad one and confirming that a fully locked-up creditor class can constitute a supportive class for the purpose of Condition B (but warning against the artificial creation of supportive classes). Nonetheless, until a more extensive body of precedent develops and given the importance of the inherently uncertain question of valuation, there is room for ambiguity in the interpretation of these conditions. This may embolden dissenting creditor classes to contest CCCDs, particularly in the context of uncertain operating conditions and volatile markets during and immediately after the pandemic.
7. A wider use of Schemes and RPs?
Finally, in the Sunbird case, the Court was supportive of a practical approach to assessing the accuracy and completeness of the documents circulated to creditors in schemes proposed by smaller and medium sized companies. These comments are welcome insofar as they encourage the use of schemes, and by implication RPs, by companies "of all shapes and sizes" (to use Mr Justice Snowden's words). However, a note of caution should be sounded that dissenting creditors will scrutinise scheme documents closely and any corners cut could provide ammunition for challenges [see Sunbird].
The impact of creditor challenges
For all these potential catalysts, examples of schemes (or RPs) being derailed by creditor challenge remain few and far between. The first Sunbird scheme remains the only creditor scheme the Court has declined to sanction. In many schemes and RPs, the evidence shows that the failure of the process would result in an insolvency filing in the short to medium-term. In such circumstances, companies are often able to make a compelling case that any deficiencies identified by creditors (or by the Court) should not be fatal to the process and, by extension, the company [see Sunbird].
In several cases, creditors have communicated their opposition in the lead-up to a hearing, but have either withdrawn their challenge or chosen not to appear at the hearing to make their arguments before the Court. A recent example of this is the Gategroup RP [see Gategroup]. This may be due to a range of factors – for example, the company may decide to adjust the restructuring terms to head off the prospect of a contested hearing or the creditor may withdraw the challenge to avoid being characterised as a "hold-out" – a perception which many institutional investors are keen to avoid. Creditors may also be concerned at the costs implications of pursing a challenge, although the Court has made clear that there is usually a real prospect of a creditor recovering its reasonable costs of helpful and focused representation, fairly outlined in good time before a hearing.
The recent increase in creditor challenges is a trend which seems likely to continue. Nonetheless, we expect that the appeal of the UK scheme as a tried-and-tested restructuring technique and the power of cross‑class cram down will mean that schemes and RPs will remain attractive options for companies worldwide to implement financial restructurings in the months and years ahead.
- Restructuring involved two schemes:
- First scheme designed to facilitate the borrowing of a super senior facility to address a liquidity crisis, buying Swissport sufficient time to negotiate and implement a more comprehensive solution
- Second scheme used to bind creditors to the implementation steps which effected the restructuring
- To ensure the necessary "sufficient connection" to the UK, the schemes were proposed by Swissport Fuelling Limited ("SFL") – a group company incorporated in England but only a guarantor of the relevant financing, not the borrower or issuer as is traditionally the case. Ahead of the first scheme (which schemed loans only), SFL executed a contribution deed in favour of the borrowers pursuant to which it agreed to contribute to any amounts paid out on the debt by the borrowers. Ahead of the second scheme (which schemed both loans and notes), SFL executed a similar deed in favour of the bond issuer. Each deed created a "ricochet claim" whereby, in order to be effective, the schemes would need to release or vary the liabilities of the borrowers/bond issuer as well as the liabilities of SFL in its capacity as a guarantor
- Second scheme was challenged by an ad hoc group of senior unsecured noteholders ("SUNs"), including on the grounds that:
- the contribution deed was a sham
- the basis and result of the valuation of the Swissport group was incorrect
- SUN challenge was withdrawn at the sanction hearing but the Court nonetheless addressed their arguments, holding that:
- the contribution deed was not a sham and the technique was not intrinsically objectionable, so long as it is done with a view to achieving the best result for creditors as a whole
- Swissport's valuation evidence supported the decision to treat the SUNs as "out of the money" and the correct approach was to value the group on an "uncoordinated liquidation" basis as this was the most likely alternative to the scheme
- Provides guidance on whether fees often paid to AHGs under a scheme (or RP) are additional rights which could be sufficiently material to put them in a different class to creditors not entitled to them
- Codere sought to convene a meeting of a single class of creditors, which was challenged by a creditor on the basis that the noteholders should be divided into two classes: noteholders which were members of the AHG and noteholders which were not
- Creditor argued that the AHG had been offered additional rights to other noteholders, including the opportunity to participate in the interim notes issued prior to the scheme and certain fees, including work and backstop fees
- Court considered each additional right afforded to the AHG and held that:
- participating in the interim notes issued prior to the scheme was not a "new right", nor was there an element of "bounty" - it was a separate arrangement, rather than a benefit conferred on the AHG as part of the price for agreeing to the overall restructuring
- backstop fees were payable in exchange for a commercial service, at a market level and were insufficiently material to fracture the class
- consent fees were available to all noteholders and low enough that they were unlikely to exert any material impact on voting decisions
- payment of the AHG adviser fees was independent of the scheme
- the work fee was insufficiently material to fracture the class, although the Court expressed unease with work fees on the basis that they could be viewed as disguised consideration
- rights given to one group of creditors and not another should be considered cumulatively
- rights offered to the AHG were not materially different to those offered to the broader noteholder such as to fracture the class
- RP convening hearing judgment providing important guidance on:
- how a deed poll and contribution payment agreement can be used to create a "sufficient connection" to the UK in the context of an RP (or a scheme)
- jurisdiction uncertainties in light of Brexit
- class issues, in the context of an RP involving bonds and bank debt
- To create the necessary "sufficient connection" to the UK and ensure that the relevant liabilities could be the subject of an RP, Gategroup incorporated a new English company which assumed obligations to the RP creditors and contribution obligations to the original obligors under a deed poll, and entered into a separate contribution payment agreement with the original obligors
- One creditor challenged the RP prior to the convening hearing on various grounds. The creditor withdrew its challenge before the hearing but the Court nonetheless addressed its arguments and held that:
- there was no inherent obstacle to the deed poll structure from a mechanical or jurisdictional perspective but the artificiality of the structure may be relevant to the Court's discretion to sanction the RP
- the RP was within its jurisdiction (despite the bonds being subject to an exclusive Swiss jurisdiction clause) as it fell within the bankruptcy exclusion under the Lugano Convention. An RP – unlike a scheme – can be characterised as an insolvency proceeding, not least because it requires the company to be in "financial difficulties" and the RP to eliminate, reduce or prevent, or mitigate the effect of, those financial difficulties
- Looking through their rights against the RP company and in light of their different existing rights against their own obligors and treatment under the RP, the Court held that the bonds and bank debt should vote in two separate classes rather than the single class proposed by Gategroup due to material differences in their treatment under the RP
- Provides useful guidance on how a company proposing a scheme (or indeed an RP) should engage with its creditors
- Creditors argued that that the information provided within scheme documents was "wholly inadequate and insufficient"
- Court refused to sanction the first scheme application citing "paucity of information", as the scheme failed to meet the requirement for fair process. It was also relevant that the company's dealings with its creditors resulted in an inequality of information amongst creditors, in particular prejudicing those whom "the directors clearly felt were irrelevant or would be an obstacle to their plans"
- Notably, no letter was issued to creditors ahead of the first scheme convening hearing as required by the Court's Practice Statement on schemes and RPs. In Flint/Colouroz, the Court emphasised the importance of issuing a practice statement letter to creditors in good time ahead of the convening hearing. In that case, Mr Justice Snowden found the period given to creditors to review the practice statement letter to be inadequate but allowed the company to proceed towards a creditor meeting on the condition that creditors were given more time if they wished to apply to vary or discharge the convening order
- Court emphasised its role is not merely procedural; schemes should not be used as a mechanism to force compromise from dissenting creditors
- Court expressed concerns over lock-up fees and the influence they may have over creditors' decision making processes
- A second scheme with the same creditors was sanctioned despite original dissenting creditors repeating concerns regarding defects and omissions in the scheme documents and questioning the impact of the scheme on the company's viability
- Court noted that "accuracy and completeness" of scheme documents "is an essential safeguard" for creditors but sometimes perfection is not always obtainable and, in this case, was not material to the creditors' decision making. Court recognised the need to take a practical approach when assessing the adequacy and appropriateness of the information provided. The absence of any new challenge(rs) to the second scheme assisted Mr Justice Snowden in his decision
1 This may not be true in every restructuring and the Court will keep a watchful eye out for the "gerrymandering" of classes in RPs to artificially create dissenting classes which can be crammed down by in-the-money approving classes.
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