The English Scheme of Arrangement
The English scheme of arrangement (the “Scheme”) is an English Court supervised process which, amongst other things, requires: (a) an initial convening court hearing (the “Convening Hearing”); (b) a vote of creditors at a meeting where a statutory voting threshold of 75% by value and a majority in number of the creditors present and voting at the meeting must be met; and (c) a sanction court hearing (the “Sanction Hearing”).
Executive Summary
In recent times, the Scheme has become a popular cross-border restructuring mechanism for non-English incorporated companies and has gained national and international respect as an effective way to implement restructurings where there are dissenting creditors. At a sanction hearing on 29 November 2013, the English Court expanded the circumstances in which a Scheme may be used by foreign companies by sanctioning a scheme for Magyar Telecom B.V. (the “Company”) 1, a Dutch holding company, which sought to compromise notes governed by New York law and release third party guarantee rights (the “Magyar Scheme”).
The Magyar Scheme was closely followed by another scheme to restructure New York law governed notes issued by a French registered company, Zlomrex Internatinal Finances S.A., whose principal operating activities are carried out in Poland by its Polish holding company2. Â Apart from the commercial terms of the restructuring implemented by each scheme, the key points relating to both schemes are very similar, namely, both:
involve foreign companies that have issued notes governed by New York law documents which provide for the non-exclusive jurisdiction of the New York courts;
involve a shift to England of their centre of main interest (discussed further below) with the specific intention of taking advantage of the Scheme;
had very high support from creditors;
obtained expert evidence that the schemes would be recognised in the respective foreign jurisdictions and, most importantly, by the US Bankruptcy Court by way of Chapter 15 recognition;
involved the non-consensual release of third party rights;
included the option by the company (with the consent of the note trustee) to waive the requirement to obtain Chapter 15 recognition; and
set out that the alternatives to a scheme of arrangement were unattractive because they involved formal insolvency proceedings, were uncertain for creditors or were very expensive so as to make them prohibitive.
Background to the Magyar Scheme
In relation to the Magyar Scheme, the Company was incorporated and is registered in the Netherlands. Its principal business is the operation of telecommunication services in Hungary through an operating company based in Hungary. In December 2009, the Company issued €345 million 9.5% senior secured notes due in 2016 (the “Notes”). The Notes were issued pursuant to New York law governed documents and are subject to the non-exclusive jurisdiction of the New York courts. Guarantees in respect of the Company’s obligations under the Notes were provided by the Hungarian operating company, Invitel Távközlési Zrt, and other companies in the group.
The Notes are traded through Euroclear and Clearstream and are held in global form through the Bank of New York Depository (Nominees) Limited. The Company ran into financial difficulties and in June 2013, it defaulted on payment of interest of over €15.6 million. The group was unable to provide funding and, as such, the directors concluded that the debt of the Company had to be restructured otherwise the Company was at risk of becoming subject to an insolvency procedure.
Why Choose the Scheme?
In assessing the options available to the Company, the directors were keen to avoid a formal insolvency process (i.e. in Hungary, the Netherlands or in the US) in order to avoid the negative press which often goes hand-in-hand with such proceedings. In addition, the Dutch Akkoord (similar to the Scheme) was not an option because it can only be used to restructure unsecured debt. The Scheme was chosen because it is an English law process under the Companies’ Act 2006 and, most importantly, it is not an insolvency process.
Jurisdiction, COMI Shift and the Convening Hearing
An English Court has jurisdiction to sanction a Scheme in relation to a company where that company is liable to be wound up under the Insolvency Act 1986. The judge in the Magyar Scheme sanction hearing summarised it as follows: “The fact that a foreign company would not be wound up by the English court in the circumstances prevailing at the time of the scheme is not a bar to the court sanctioning the scheme, provided that there is sufficient connection with this jurisdiction”. The fact that English Courts can sanction a Scheme in respect of a foreign company where that company has sufficient connection to the English jurisdiction is not a new concept. There have been a number of cases where sufficient connection was found, including, amongst other things, where the relevant finance documents were subject to English law even if the company’s COMI was elsewhere.
The Magyar Scheme is the first time an English Court has had to consider whether to sanction a Scheme in respect of a foreign company where the underlying documents are governed by New York law and where the Scheme would result in the non-consensual release of creditors’ rights under certain guarantees. As such, in order to create a sufficient connection to the English jurisdiction and in anticipation of the Convening Hearing in October 2013 for permission to convene a meeting of creditors, the Company took steps from mid August 2013 to shift its Centre of Main Interest (“COMI”) to England by: opening a new office in England; sending notices to creditors; holding negotiation meetings with creditors in London and appointing directors based in England. The shift in COMI is important because within the EU, a company with its COMI in England must open its insolvency proceedings in England. As a result of the COMI migration, the judges at both the Convening and Sanction Hearings were satisfied that the English Courts had jurisdiction to sanction the Magyar Scheme, not so much because of the COMI migration created sufficient connection to the English Jurisdiction, but more so because any insolvency process for the Company would naturally be under English law in England. The judge at the Magyar Scheme sanction hearing said that this provided ” solid basis and background for a scheme under English law which altered contractual rights governed by a foreign law”. The Convening Hearing judge ordered that a meeting of creditors be held on 27 November 2013.
In addition to shifting COMI, the Company obtained expert evidence to demonstrate that it was likely that the Magyar Scheme would be recognised by the US Courts under Chapter 15 of the US Bankruptcy Code as well as by the Dutch and Hungarian Courts, notwithstanding that it sought to compromise rights governed by New York law.
The Magyar Scheme Compromise and Meeting of Creditors
The Magyar Scheme provided that creditors (i.e. the noteholders) were required to give up their rights under the Notes, including any rights they had against guarantees which had been issued by the Company and other group companies in respect of the Notes. In exchange, creditors would: (a) be issued with new notes with an aggregate nominal value of ‚¬155m; (b) own 100% of the equity interest in a new company, which would in turn hold 49% of the share capital of the Company, thereby giving an indirect interest of approximately 49% in the Hungarian operating company; and (c) have the right to participate in a modified reverse Dutch auction whereby they could sell a pro rata portion of their new notes in return for cash. Interestingly, the new notes and the equity shares in the newly created company were “stapled” together into units and listed on the Luxembourg Stock Exchange so that it is not possible to trade the new notes or the equity shares separately meaning that the interests of the holders of debt and equity would be more closely aligned.
Attendance at the meeting of creditors, which was held on 27 November 2013, was very high and the Magyar Scheme was approved by a majority of more than 97% in number representing more than 99% in value of those voting. It is worth noting that each individual creditor had the right to vote in person despite the fact that the Notes were held in global form because under the documentation, the Notes could be registered in the names of the creditors and as such they were contingent creditors under English law for the purposes of the Magyar Scheme.
The next step before implementing the terms of restructuring would be for the Company to get the Magyar Scheme approved by the English Court at the Sanction Hearing.
Court Sanctions the Magyar Scheme
Generally, an English Court will not make an order which is not capable of achieving the desired result. Accordingly, the court will have to be satisfied that the Scheme is reasonably likely to achieve its purpose. The overwhelming support from creditors, the lack of challenge to the Magyar Scheme at the Sanction Hearing and the expert evidence presented to show that it was likely that the Magyar Scheme would be recognised by the US, Dutch and Hungarian courts played a big role in satisfying the judge that the purpose of the Magyar Scheme was likely to be achieved.
In addition, given that the COMI of the Company had been migrated to England, the alternative option would have been to put the Company into an English insolvency proceeding. The judge at the Magyar Scheme sanction hearing said: “As the only practical alternative to the restructuring proposed in the scheme or some other restructuring would be a formal insolvency process for the company, it follows that the insolvency would proceed under English law and in the English Courts… and “In circumstances where the practical alternative to the scheme is an insolvency process in, say, England, there was an obvious logic in treating a scheme approved under English law as effective to alter the rights of creditors, even though those rights are governed by the law of a different country. In the event of an insolvency process, the rights of the creditors to recover against the assets of the company would be governed by the insolvency law and recognition would be likely given to a scheme approved in the course of the insolvency process just as it would be given to the insolvency process itself….
Recognition in Europe under the Judgments Regulation
During the course of his judgment, the judge at the Magyar Scheme sanction hearing stated that Schemes of solvent companies, being a civil and commercial matter, were capable of being recognised across the EU (except Denmark) under the Judgments Regulation3. The judge also considered that Schemes between an insolvent company and creditors are capable of being recognised pursuant to the Judgments Regulation, at least if the company is not subject to insolvency proceedings to which the Insolvency Regulation4 applies. However, the question as to whether a Scheme proposed in respect of an insolvent company in a formal insolvency proceedings to which the Insolvency Regulations apply, would receive recognition under the Judgments Regulation, was left open.
US Chapter 15 Recognition
The US Bankruptcy Court issued an order on 11 December 2013 recognising the Magyar Scheme under Chapter 15 of the US Bankruptcy Code. The order also provided for the Magyar Scheme to have full force and effect in the US. Following this, on 12 December 2013 the Company implemented the restructuring set out in the Magyar Scheme (including the release of the creditors’ rights under guarantees provided by companies within the group in respect of the Notes). The US judge took comfort from his conclusion that the Scheme procedure was fair and sufficiently protected the creditors’ best interests.
Conclusion
The Magyar Scheme is significant for a number of reasons but mostly because it confirms clearly that a variation or release of rights of third parties who are not themselves proposing the Scheme can form part of the Scheme and be approved by the US Bankruptcy Court. Although the non-consensual release of third party rights in the context of a Scheme is not entirely a new point, this case provides significant comfort that a Scheme can be used to restructure Notes which are governed by New York law and provides a clear indication that the New York courts will, in the right circumstances, recognise and give effect to non-consensual releases of rights against third parties.
Finally, there is now clarity that Schemes in relation to solvent and insolvent companies are capable of being recognised within the EU under the Judgments Regulations where, at least for now, the company is not subject to an insolvency process which falls within the ambit of the Insolvency Regulations.
It should be noted however that both the Magyar Scheme and the ZIF Scheme received high levels of creditor support and, where there are no objections, the court has to rely on counsel representing the company. In addition, the judge in the Magyar Scheme pointed out that although expert evidence on foreign law recognition of the Magyar Scheme was given by partners (in Hungary and New York) of the same law firm representing the Company, it would be preferable if such reports were provided by experts unconnected with law firms that are professionally engaged in the scheme – especially in cases where there is no creditor opposition.
Notes
Magyar Telecom B.V., Re [2013] EWHC 3800 (Ch).
Zlomrex International Finance S.A., Re [2013] EWHC 3866 (Ch) – note that this is the convening hearing judgment. The scheme was sanctioned on 14 January 2014 and the judgment is not yet available.
Council Regulation (EC) 44/2001 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters.
Council Regulation (EC) 1346/2000 on insolvency proceedings.