The new UK legislation for companies in financial difficulty represents a fundamental shift in approach to restructuring in Europe and adds an important new tool to the UK restructuring framework. The availability of a plan proposed under the new Part 26A of the Companies Act 2006 (a “Restructuring Plan”) will undoubtedly change how many distressed companies seek to address their financial difficulties. However, until case law is developed, there will remain considerable uncertainty as to how the Restructuring Plan will work in practice.
Below, Weil’s Business Finance and Restructuring team provides their key observations on the draft legislation which they expect will be the main focal points when the new law becomes effective.
- Since the onset of the financial crisis in 2008, the English scheme of arrangement under Part 26 of the Companies Act 2006 (a “Scheme”) has become the predominant restructuring procedure in Europe, with hundreds of domestic and foreign debtors accessing the flexible, predictable regime to reorganise their debts. However, while the Scheme has stolen the march on other restructuring processes across Europe, which in general remain under-utilised, it has always fallen short of its US counterpart, Chapter 11, in providing a complete solution for companies in distress.
- The Restructuring Plan seeks to address some of these issues and has the following key differences from the existing Scheme:
- (disenfranchisement) a company can apply to court to exclude from voting a class of creditors or shareholders who have no genuine economic interest in the company, but still bind those classes into the Restructuring Plan – this is a significant departure from the existing position, where the consent of “out of the money” creditors or shareholders is required to affect their rights or it is necessary for a Scheme to be coupled with a distressed sale of the business in order to leave those stakeholders behind;
- (cram down) a Restructuring Plan can be sanctioned notwithstanding that a class of creditors or shareholders have voted against it, provided that a class with a genuine economic interest has approved the Restructuring Plan and none of the dissenting class would be worse off than they would be in the event of the “relevant alternative” – on the face of it, this allows junior (or senior) stakeholders to be bound into a Restructuring Plan without their consent – i.e. to be “crammed down”, moving us towards the US model and providing companies in distress with a more comprehensive tool to address their financial difficulties;
- (conditions to access) broadly speaking, the company must be experiencing, or be likely to experience, financial difficulties and the purpose of the Restructuring Plan must be to eliminate or reduce those difficulties – this will narrow the universe of companies able to use a Restructuring Plan compared to a Scheme;
- (numerosity) in determining whether the requisite members in each class have voted in favour of the Restructuring Plan, only the value count is relevant – the Scheme “majority” by number threshold does not apply.
- Apart from these key differences, the Restructuring Plan regime is in large respects aligned with the existing Scheme process. The Restructuring Plan retains the convening hearing and sanction hearing procedure and we would expect matters of class constitution, use of Restructuring Plans for overseas companies and associated court jurisdiction to be broadly similar.
- In addition, the general expectation is that courts will refer to the long line of existing case law regarding Schemes when interpreting the Restructuring Plan provisions. However, the differences outlined above may well give rise to a new approach on some old issues.
2. DISENFRANCHISEMENT AND CROSS-CLASS CRAM DOWN
- The availability of the Restructuring Plan (in particular, the disenfranchisement and cross-class cram down provisions) is likely to lead to a change in the negotiating dynamics of many distressed situations, even if a Restructuring Plan and / or cram down is not ultimately used to implement a deal.
- As matters stand, a Scheme can only bind creditors within a class. As a result, the general approach taken by companies and the court is to take a broad view of class, in order to mitigate “hold out” risk.
- The ability to cram down dissenting classes in the new regime could incentivise a company to propose multiple smaller classes to try to ensure its Restructuring Plan succeeds – the opposite of the approach taken to class composition under a Scheme.
- However, the court may look to prevent companies from intentionally fracturing classes in order to exploit the new cram down mechanics, particularly where the dissenting creditors would have had the numbers to vote down the scheme if they were in the same class as consenting creditors. Certainly, the courts have previously held that where a person’s rights are sufficiently similar to another’s, they should be placed into the same class in a Scheme (see Re UDL Holdings).
Disenfranchisement – exclusion of classes who have no genuine economic interest
- As noted above, the first major shift under the Restructuring Plan regime is the apparent ability to alter (or even cancel) the rights of a completely out of the money class (which can be a creditor or shareholder class or indeed multiple classes) without allowing them to vote on the Restructuring Plan at all.
- This means a company can utilise a Restructuring Plan to cancel the claims of a junior creditor class without their consent and without the need to implement the additional, and often costly and complex, step of also transferring assets of the company to a new group with a reconstituted capital structure. The legislation even provides for consequential Companies Act amendments allowing the company to issue new shares while disapplying pre-emption rights to facilitate this type of transaction – see further below.
- In order to exclude an out of the money class in this way, the company needs to demonstrate they have “no genuine economic interest in the company”. Exactly what this means, and how it is determined by the courts, remains to be seen. However, it seems likely that the court will read this to mean “no genuine economic interest in the company in the relevant alternative”. The court will then likely look to assess the estimated return for the disenfranchised class in the most likely alternative (rather than assessing whether there is some remote possibility of a return) – see further below.
- At a practical level, the decision to exclude a class from voting must be dealt with at the first court hearing (the “convening hearing”) and so where a company intends to disenfranchise a class from the outset:
- any practice statement letter (or equivalent notice to affected classes) is going to need to be issued further in advance and contain more information regarding valuation and the intention to exclude classes from voting; and
- it is possible that complex and lengthy valuation disputes arise at the convening hearing stage.
- It is hoped that, provided disenfranchised creditors / shareholders have been given the opportunity to appear at the convening hearing, the court’s decision at that point will be respected at the final court hearing (the “sanction hearing”), but this is not expressly stated in the legislation and the court will always have discretion to review the issue at the sanction hearing.
- In light of this, a company may choose to allow completely out of the money creditors or shareholders to vote on the Restructuring Plan, perhaps offering them a tip to incentivise the requisite majority to vote in favour, and if that vote is not achieved, defer any valuation fight to the sanction hearing as part of a cram down – see below.
Cram down – “no worse off” than the “relevant alternative”
- A company can seek to cram down a dissenting class that has voted on, but not approved, a Restructuring Plan. This could address both in the money classes as well as out of the money classes who were allowed to vote on the Restructuring Plan but did not approve it in their classes (i.e. this could include those who are completely out of the money and who were not disenfranchised at the convening hearing stage).
- To invoke the cross-class cram down provisions in the Restructuring Plan regime, the company must show that:
- none of the members of the dissenting class would be any “worse off” than they would be in the “relevant alternative”; and
- the Restructuring Plan has been approved by at least one class who would receive a payment under, or who have a genuine economic interest in, the “relevant alternative”.
- The court will have to determine the “relevant alternative” based on the evidence presented to it and this will be a highly fact specific exercise. It is likely that the courts will face significant difficulties determining the “relevant alternative” in a heavily contested Restructuring Plan where dissenting (and even supporting) classes put forward competing evidence to support their own positions. The courts may be placed in the difficult position of having to predict future outcomes based on competing evidence from self-interested parties.
- The class and fairness tests in relation to existing Schemes already place emphasis on the likely outcome in the absence of the proposed Scheme (the so called “comparator”), but the Restructuring Plan regime will likely bring these considerations into sharper focus in light of the ability to affect the rights of classes without their consent.
- In determining whether a crammed-down creditor is “no worse off”, there is considerable scope for complex disputes centred on valuation and comparison of entitlements, which may slow down the restructuring process.
- Dissenting creditors are likely to want to point to some form of going concern valuation or valuation premium that would otherwise arise in return for their support under any alternative (see for example the arguments in My Travel and IMO Carwash).
- In contrast, senior supporting creditors with enforcement rights may argue that the Restructuring Plan is the only deal they are prepared to accept and they would simply enforce without it.
- The issues will become even more complex if there is a new money need that only certain creditors are prepared to fund: what then is the relevant alternative and cost of the new money need?
Fairness under Restructuring Plans
- Ultimately, approval of the Restructuring Plan will be in the court’s discretion, and therefore it is likely that the court will need to develop a new (or expanded) fairness test to address the type of situation set out above where a dissenting class is being forced to accept a Restructuring Plan against its wishes.
- It does not seem that all of the fairness tests in relation to Schemes can be applied directly when assessing cross-class cram down (as the existing Scheme tests are designed to assess fairness within the classes rather than across them). Equally, it appears logical that those tests should continue to apply in terms of the analysis of fairness issues within each class, for example the impact of cross-holdings and ancillary interests of creditors within that class.
- Considerations that the court may take into account when deciding whether to sanction a Restructuring Plan that involves cram down, following satisfaction of the cram down conditions, might include:
- whether the dissenting class is getting a fair share of the scheme consideration;
- whether the terms to be imposed on the dissenting class are necessary to achieve the survival of the company as a going concern;
- the relative sizes of each class in terms of value; the extent to which the dissenting class supported / opposed the scheme; and
- whether any other class which is less well off than the dissenting class under the Restructuring Plan has nevertheless voted in favour of it.
- It is also possible that the courts will develop a “horizontal” fairness principle, similar to that found in the current CVA regime, where the allocation of creditors to different classes and / or differential treatment between the classes (whose rights in the “relevant alternative” are substantially similar) will only be permitted if their differential treatment under the Restructuring Plan is justified in order to achieve the purpose of the Restructuring Plan.
- It is worth noting that the Restructuring Plan regime does not include an absolute priority rule like that found under the Chapter 11 regime (as was suggested in the Government’s 2018 consultation response). This would seem to allow flexibility for a company to offer “tips” to junior / out of the money classes in order to obtain sufficient support for its Restructuring Plan.
3. EQUITY CRAM DOWN AND COUNTER-PROPOSALS
- It appears possible for a creditor class to “cram down” shareholders in a Restructuring Plan, and the new legislation proposes ancillary amendments to the Companies Act which could facilitate this (e.g. by disapplying the requirement for shareholder approval to issue new shares and shareholder pre-emption rights). This may be particularly useful in the public company context where the existing shareholder base is disparate or disengaged.
- if a sufficient proportion of shareholders do not like the proposed Restructuring Plan, they could take steps to change the board of directors in order to cause the company to reject the proposal – it is likely that the rule in Re Savoy will apply in relation to Restructuring Plans, meaning the court will not sanction a Restructuring Plan that has not been approved by the company (of course, this risk could be mitigated if the company is able to be placed in administration and the administrators support the Restructuring Plan); and
- practically, it will be difficult, if not impossible, to implement a Restructuring Plan that aims to compromise the rights of shareholders in a foreign company, as the courts of the foreign country are unlikely to recognise an English court order purporting to affect shareholder rights – such rights are normally determined by the law of incorporation of the company.
- The same issues will apply in relation to creditor-led counter-proposals (notwithstanding the suggestion in the Government’s 2018 consultation response that creditors would have the ability to make and implement counter-proposals).
4. SENIOR CREDITOR “CRAM-UP”
- While much of the focus on the new legislation has been on how a Restructuring Plan might be used to cram down junior creditors and equity, it is also possible to use a Restructuring Plan to “cram up” senior creditors.
- In practice, it will be difficult to “cram up” senior secured creditors if they are able to enforce their security over the company’s assets.
- Although a new statutory moratorium is proposed to operate alongside the Restructuring Plan, it appears to have some severe limitations in its current form (e.g. it does not apply to bond issuers), and is unlikely to apply to many complex leveraged structures.
- Therefore in most situations it will be necessary to involve the senior secured creditors in the formulation of, and support for, the Restructuring Plan.
- However, so called “super senior” lenders may be in a different position. This is because those lenders, who generally provide small super priority working capital facilities at the top of highly leveraged structures, typically cede control of enforcement of security for several months under intercreditor arrangements with the senior secured class, and so they may not have the “defence” of security enforcement available to them.
- Where a senior creditor “cram up” is contemplated similar complexities and lengthy disputes may also arise in relation to the “relevant alternative” (in particular, whether an alternative restructuring may be the most likely alternative), the “no worse off” test (in particular, valuation of the consideration given to the senior creditors) and the overall fairness of the proposed restructuring, as noted above.
- Senior creditors who might otherwise have received payment under the relevant alternative but are instead being rolled over will argue that they are being exposed to continued credit risk and an adverse net present value under their Restructuring Plan consideration. The Company will argue that they are being compensated by the coupon on that roll over, giving rise to potentially difficult issues for the courts to resolve. As we have seen in the US, these issues are not straightforward to resolve, and can lead to substantial litigation.
- In our view, the introduction of the new Restructuring Plan will bring about a fundamental change to the way companies and creditors across Europe, and beyond, approach many distressed situations. There is, however, considerable uncertainty as to how the courts will develop principles of class and fairness under the new regime, and how they will approach the complex valuation issues that they will inevitably face.
- When coupled with the apparent limitations of the proposed new moratorium, it is possible that this uncertainty means we will continue to see pre-pack administrations and share pledge enforcement sales being used in combination with existing Schemes and / or Restructuring Plans to address dissenting shareholder and junior creditor classes, at least in the short term.
- However, it seems clear that the existence of the Restructuring Plan will change the negotiating dynamics in many distressed situations from the outset, and that, over time, the new regime will challenge the existing Scheme for primacy in the European restructuring space.