October.08.2020
Introduction
The economic impact of COVID-19 will be far reaching. Governments around the globe are currently grappling with a balance between the protection of the health of their populations and limiting damage to their economies. Corporates that are over-burdened with debts will undoubtedly struggle to take advantage of market opportunities as global economies recover. The tools available to allow corporate entities to restructure their debts is an important factor in determining how an economy will emerge from COVID-19.
Lending in the corporate sector has increased to historical levels since the pandemic began, as many companies seek out debt in a bid to plug gaps in their balance sheets stemming from disruptions attributable to COVID-19. Forecasters at the EY Item Club have predicted that corporate debt will grow by more than 14% in 2020, compared to a 2% increase in 2019.[1] This surge in borrowing can partly be attributed to the series of UK government-backed loan schemes (BBLS, CBILS, CLBILS), with figures at the end of July indicating that accredited lenders had issued government guaranteed loans of more than £50bn to businesses that have been impacted by the pandemic.[2] Such debt has been advanced as follows: £34bn through the BBL scheme of loans up to £50,000; £12.7bn through the CBIL scheme of loans up to £5m; and £3.1bn through the CLBIL scheme of loans up to £200m. With respect to BBLS loans, the Office for Budget Responsibility has predicted that 40% of the £1.1m loans could default. With continuing uncertainty as to when the economy will return to normal, there should be increased focus on how to help companies that have taken on large amounts of debt in response to the economic disruption caused by COVID-19.
The Corporate Insolvency and Governance Act 2020 ("CIGA") and the speed with which the bill passed through the UK's legislature is therefore very welcome. CIGA introduced a number of temporary measures intended to support business in the UK through the financial consequences of the COVID-19 lockdown, together with permanent changes to the UK's restructuring and insolvency regime which will have an important role to play in the months and years to come as over-levered borrowers seek to deal with their debt.
The UK Government's stated purpose in enacting CIGA was to:
This note considers the new restructuring plan introduced by CIGA as a tool, and how it might be utilised by companies suffering financial distress as a result of COVID-19 and more generally.
The Rescue Culture and the Restructuring Plan
One of the most significant introductions of CIGA is the new restructuring plan (the "Restructuring Plan"), a new restructuring tool that significantly improves the UK's restructuring and insolvency legislation. The Cork Report[3] which was published in 1982 and led to the Insolvency Act 1986 concluded that insolvency legislation should encourage a "rescue culture", to restore a company back to profitability, which in the long term would be in the interests of all creditors. However, even after the adoption of the Enterprise Act 2000 which removed (except in certain limited circumstances, such as a "capital markets arrangement" e.g. a securitisation) the previous administrative receivership regime and introduced the administration regime, various deficiencies have remained in practice. In particular, the primary objective of administration (i.e. to rescue the company as a going concern) is in practice very rarely achieved, and instead administrators will seek to accomplish the secondary objective of bringing about a better result for creditors than would be possible if the company had gone straight into liquidation. Consequently, whilst businesses may be rescued, the company itself rarely survives and creditors are left with claims against the insolvent company. Moreover, company voluntary arrangements have been of limited use as a practical matter, in that they cannot be employed to alter the rights of secured creditors without their expressed consent, and as such have mostly found favour in limited circumstances. For example, company voluntary arrangements are often used to compromise landlord claims against companies with large lease portfolios, such as retail companies, or otherwise to restructure lease obligations. Complex financial restructurings have frequently been implemented through schemes of arrangement under Part 26 of the Companies Act 2006 (“Scheme”) (or a combination of restructuring tools) which itself has gaps compared to the restructuring tools available in other jurisdictions. CIGA therefore appears to have gone a long way in addressing some of the issues with the UK's existing insolvency and restructuring regime.
Recognising the success of Schemes in allowing companies to implement a financial restructuring, CIGA introduced the Restructuring Plan as an insert into the Companies Act 2006 (“CA 2006”) as the new Part 26A. The Explanatory Notes to CIGA states:
“The new restructuring plan procedure is intended to broadly follow the process for approving a scheme of arrangement (approval by creditors and sanction by the court), but it will additionally include the ability for the applicant to bind classes of creditors (and, if appropriate, members) to a restructuring plan, even where not all classes have voted in favour of it (known as cross-class cram down). Cross-class cram down must be sanctioned by the court and will be subject to meeting certain conditions. As is the case with Part 26 schemes, the court will always have absolute discretion over whether to sanction a restructuring plan. … While there are some differences between the new Part 26A and existing Part 26 (for example the ability to bind dissenting classes of creditors and members), the overall commonality between the two Parts is expected to enable the courts to draw on the existing body of Part 26 case law where appropriate.”
In passing CIGA, Parliament did not intend to introduce a completely novel procedure; however it recognised that adhering to the long-standing procedures and concepts of a Scheme will provide more certainty with respect to its implementation.
What is a Restructuring Plan?
A Restructuring Plan is defined under s901C of the CA 2006 as a "compromise or arrangement" between the company and (i) its creditors, or any class of them; or (ii) its members, or any class of them. As the language largely mirrors the provisions applicable to a Scheme, it was expected that the English courts would apply their interpretation of Schemes to Restructuring Plans. Indeed, it has been confirmed by Mr. Justice Trower in the Virgin[4] case that a “compromise or arrangement” should be interpreted in the same way as a Scheme and therefore should require an element of “give and take” (by way of example, Re Savoy Hotel Ltd[5] and Re Lehman Brothers International (Europe)[6].) Schemes have a long history and have been interpreted very widely to enable companies to take a broad range of actions, from simple "amend and extends" to the total overhaul of a company's capital structure through debt for equity swaps and other measures.
Conditions for a Restructuring Plan
There are two conditions that a company must satisfy in order to propose a Restructuring Plan. Namely, that:
As the Restructuring Plan is intended to provide an alternative to an insolvency, the company must be experiencing an element of financial distress. However, the test deviates from the requirements for the appointment of administrators, where the company must be unable, or likely to become unable, to pay its debts. In practice, addressing potential financial distress early is often an important factor in achieving a successful restructuring as waiting until the company is unable to pay its debts eliminates the options available and limits its ability to implement a restructuring. The forward-looking element of CIGA is therefore welcome. The fact that CIGA does not specify a particular timeline for looking forward to potential financial distress is likely to be helpful for debtors and creates additional flexibility. However, Mr. Justice Trower did not focus extensively on this requirement, presumably because the financial distress and purpose of the Restructuring Plan was evident from Virgin's financial state.
Who can propose a Restructuring Plan?
An application to court for permission to propose a plan may be made by the company, a creditor or a shareholder of the company, or an administrator or liquidator of the company. In practice, we expect that creditor applications may be difficult given that creditors may not have access to sufficient financial information regarding the company to be able to ensure the pre-conditions of financial distress are satisfied, nor will they necessarily have access to the information necessary to enable the formulation of a plan to be submitted to creditors for approval.
Moreover, if a Restructuring Plan is proposed by a hostile creditor, given that it is a prerequisite that the compromise or arrangement be between the company and its creditors or members or any class of them, the question arises as to whether a Restructuring Plan could be imposed upon the company without its consent. Whilst CIGA does include the ability to bind dissenting creditor groups through a "cram down", there is no ability to require the company to accept a hostile plan. It will therefore be interesting to see how this will play out in practice.
Requisite Majority
Like a Scheme, the court may sanction a Restructuring Plan that is approved by at least 75% by value of the creditors or class of creditors, or members or class of members present and voting. If the court sanctions the Restructuring Plan it will be binding on all such creditors or members and on the company.
Notably, CIGA omits the requirement that a majority in number of the relevant class of creditors and/or members vote in favour of the plan (which is a feature of Schemes). This arguably makes sense in the context of a company in financial distress where creditors representing the largest financial stake in a particular class should not be frustrated by creditors within the same class holding a minority financial stake simply because they form more than a majority in number.
The UK's legislature did have the opportunity to reconsider the thresholds for approval for a Restructuring Plan and earlier drafts of CIGA considered a 2/3 majority threshold. However, CIGA as enacted requires approval by 75% (by value) of those creditors/members of a relevant class present and voting. Given that this is a higher threshold than that required in other European jurisdictions, such as the proposed Dutch scheme, recently approved by Dutch parliament which requires a 2/3 majority. The UK restructuring market may see an increase in competition with European corporates choosing to implement restructuring through tools provided in other jurisdictions. This may be particularly relevant for debt issuers incorporated in the Netherlands that may have previously opted for a Scheme. For example, Hema the Dutch retailer has recently implemented a restructuring of its €600m senior secured floating rate notes, which first required a change of law of the notes from New York law to English law and the accession of a newly incorporated SPV in order to avail itself of the Scheme process.
Class Composition
Like a Scheme, a Restructuring Plan is between a company and its creditors or members or any class of them. CIGA does not provide any guidance as to how a court should determine class composition. Mr. Justice Trower considered whether the court should adopt the same test for class composition as used under a Scheme.[7] The long-established test for class composition entails identifying creditors or members whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interests as to whether or not to vote in favour of the Scheme. Creditors or members who satisfy this test should form the same class[8]. Mr. Justice Trower considered some of the differences between a Scheme and a Restructuring Plan but noted that the relevant parts of CIGA track exactly the legislation for a Scheme. He concluded that if parliament had anticipated a deviation from the long history of Schemes under Part 26 of the CA 2006 and its predecessor legislation, this would have at least been signalled in some way. Whilst there was no challenge to class composition in the Virgin case, Mr. Justice Trower acknowledged that a Restructuring Plan could be sanctioned by the court in circumstances that a Scheme could not (i.e. where a class of creditors or members votes against the Restructuring Plan), but recognised that the approach to classifying the group of creditors with whom other creditors should consult is broadly the same. The purpose of a meeting under a Restructuring Plan is to enable creditors with a genuine economic interest in the company to reach a collective conclusion on whether the company’s proposals for their variation of rights ought to be approved, and in essence this is the same purpose as a Scheme. It was acknowledged by Mr. Justice Trower that the cross-class cram down (discussed below) may provide an incentive for companies to increase the number of classes in a plan so that at least one “in the money” class votes in favour of the plan.
The test to be applied in relation to class composition under a Restructuring Plan is therefore a rights-based test. As Chadwick LJ said in Re Hawk Insurance Company Limited[9] the answer to the question of class composition will “depend upon analysis (i) of the rights which are to be released or varied under the scheme and (ii) of the new rights (if any) which the scheme gives, by way of compromise or arrangement, to those whose rights are to be released or varied”.
Dissenting Cross-Class Cram Down
One of the most welcome introductions of the new Restructuring Plan is the ability to cram down dissenting creditor classes. S901G of the CA 2006 states that the court may sanction a Restructuring Plan even when one or more of the classes do not vote in favour of it provided that:
1. the court is satisfied that none of the members of the dissenting class or classes would be any worse off under the plan than they would be in the event of the relevant alternative; and
2. at least one class (whether creditors or shareholders) who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative, has voted in favour.
The ability to cram down dissenting creditor/member classes is a positive development and addresses an aspect of Schemes which has often been cited as a weakness. The absence of such a cram-down mechanic has resulted in "hold-out" creditors negotiating a better deal for themselves outside of the Scheme. Moreover, Schemes have often been structured by debtors in negotiations with supportive creditors to minimise the number of classes to ensure that dissenting creditors remain within a large class and can be bound by the Scheme. This has led to numerous challenges to Scheme classes by creditors trying to assert that they are in a narrower class of creditors to frustrate the scheme. Many challenges to class composition have focused on the treatment of creditors in the Scheme, for instance, based on early lock-up fees being paid to creditors who agree to a lock-up agreement prior to the Scheme vote or underwriting fees paid to certain creditors (usually a creditors’ committee) who agree to backstop a new equity injection prior to the launch of the Scheme. The courts have generally refused to agree to adjust class composition where such payments are (i) available to all creditors within a particular class, and (ii) of de minimis in nature when compared to the overall value of the claims being compromised, such that the creditor would not reasonably be expected to vote differently in the Scheme as a consequence of such fees.[10]
However, as recognised by Mr. Justice Trower, debtors and creditors negotiating the terms of a restructuring may take a different view of creditor classes in relation to a Restructuring Plan. There may in future be an incentive to create more classes and therefore less focus on parity of treatment of creditors in order to place creditors in different classes that can be crammed down.
Interestingly, the Restructuring Plan in relation to the Virgin case was proposed even though three out of four of the creditor classes already had 100% of creditors locked-up and agreeing to the terms of the restructuring. The Restructuring Plan was, however, proposed with the intention of potentially invoking the cross-class cram down under s901(G) of the CA 2006 in the event the requisite majority of the fourth class of “Trade Plan Creditors” did not approve the plan. However, the fourth class approved the Restructuring Plan by the required 75% by value, and therefore Mr. Justice Snowden did not give judgement as to whether the court could have ordered a cross-class cram down in relation to that class under s901(G). Nor did he give judgment as to whether the court would have jurisdiction under s901(G) in circumstances where a Restructuring Plan was used, notwithstanding the fact that certain classes had agreed to the commercial terms of the deal.
The cross-class cram down will no doubt create its own area for challenge. In particular, we would expect that the cross-class cram down will result in an increase in valuation disputes with dissenting creditors seeking to demonstrate that the consideration they receive in the Restructuring Plan is less than they would receive in a “relevant alternative”. For these purposes, the court will have to be satisfied that the relevant alternative presented by the company is the most likely alternative to the Restructuring Plan. In most cases we would expect that the company would seek to demonstrate the relevant alternative as being an administration or liquidation of the company. However, any dissenting creditors may seek to argue that in the event the Restructuring Plan were to fail, the relevant alternative is likely to be the proposal by the company of a different Restructuring Plan. This may however be deal specific as, if the company provides evidence that it will not agree to such alternative Restructuring Plan, any dissenting creditor may have difficulty satisfying the court that there is a viable alternative.
Disenfranchisement of “Out of the Money” Creditors / Members
Notably, s901C(4) of the CA 2006 permits the exclusion of a class of creditors or members from the requirement to convene a meeting if the court is satisfied that no person within that class has a "genuine economic interest" in the company. This differs significantly from Schemes, which will further enable debtors to ensure that any potential hold out classes have no standing to object to the Restructuring Plan.
Powers of the Court to facilitate reconstruction or amalgamation
In the context of leveraged finance transactions, a Scheme has been employed to implement a "Transfer Scheme" whereby senior creditors use a Scheme to roll over their debt into a newco whilst at the same time the senior lenders (through a share pledge enforcement or through a sale by an appointed administrators) transfer the group to newco and any junior debt and guarantees can be released using the release mechanics in the intercreditor agreement. It seems that the wide powers provided under section 901 of the CA 2006 would enable the court to facilitate a "Transfer Scheme" without the need to use an enforcement procedure under the senior debt documents. Whilst helpful, where an intercreditor is drafted correctly and allows for a release of junior claims, it may be preferable to use a tried and tested restructuring method rather than using the novel Restructuring Plan in this way.
Debt for Equity Swaps using a Restructuring Plan
A debt for equity swap is a key feature of many restructurings using a Scheme. However, the need to obtain the consent of existing shareholders to implement the debt for equity swap, (i.e. in order to disapply pre-emption rights) could act as a hurdle to any Scheme. This was seen in relation to the proposed restructuring of Afren plc in 2015 where the company proposed two alternate Scheme plans, one which would be implemented if approved by shareholders and a second that would be implemented if shareholders did not approve. CIGA seeks to avoid this issue by introducing a disapplication of pre-emption rights relating to the allotment of equity securities that is carried out as part of a Restructuring Plan sanctioned by the court.
Conclusion
Following the first successful Restructuring Plan in respect of Virgin and a second being proposed by the Pizza Express group at the time of writing, we expect to see many more corporates seeking to implement financial restructurings through a Restructuring Plan. The English courts have a history of pragmatism and flexibility when considering Schemes under Part 26 of the CA 2006. It is clear this history will be an asset to the UK restructuring market and to corporates seeking to deal with the potentially crippling effects of COVID-19 and burdensome debt loads. However, we will no doubt see new law being developed in the English courts over the coming months and years and new boundaries being drawn, particularly with respect to the ability to cram down dissenting classes and to disenfranchise out of the money creditors.
[1] https://www.ey.com/ItemClub
[3] Report of the Review Committee on Insolvency Law and Practice (1982) Cmnd 8558
[4] [2020] EWHC 2191 (Ch)
[5] [1981] Ch 351, 359
[6] [2019] BCC 115 at [64])
[7]For more information see our note on class composition in relation to schemes of arrangement https://www.orrick.com/en/Insights/2016/08/English-Law-Schemes-of-Arrangement-Class-Composition#:~:text=The%20issue%20of%20class%20composition,or%20class%20of%20members%20voting.)
[8] This rule is found in Re Hawk Insurance Co Ltd [2001] EWCA Civ 241 and codified in a Practice Statement on 15 April 2002
[9] [2002] BCC 300 at [30]
[10] Re Telewest Communications [2004] BCC 342