U.K.s Chapter 11 Plan Schemes of Arrangement

Journal Issue

Apr 2006

Column Name

European Update

Citation

ABI Journal, Vol. XXV, No. 3, p. 30, April 2006

Topic Tags

International Insolvency

Practice and Procedure

Journal HTML Content

Editor's
Note: Bankruptcy practitioners in Europe are often in the
fortunate position of being able to assist U.S. lawyers involved in
developing a chapter 11 plan by making use of similar methods of
compromising claims on the other side of the Atlantic. Very often,
this assistance occurs within the framework of two sets of parallel
proceedings with the shared objective of a deal that will bind all
relevant creditors (whether subject to U.S. jurisdiction or not).
Our article this month considers "schemes of arrangement,"
which for more than 100 years have played the role of a chapter 11 plan
in the United Kingdom and throughout the
Commonwealth.</blockquote> A scheme of arrangement under §425 of the
Companies Act of 1985 is a procedure under which a company may make
a compromise with its creditors or any class of them. Schemes have
been used in the United Kingdom (and in many other Commonwealth
jurisdictions) for many years. It is the nearest U.K. equivalent to a
chapter 11 plan. In this article, we consider how the
courts have approached challenging issues that have recently arisen
in two contexts where schemes are used: first, where they are used
as part of a financial restructuring to compromise bondholders; and
second, where they are used to shorten the run-off of solvent insurance
companies. A three-stage process exists for promoting a
scheme of arrangement: <blockquote> <blockquote>

• A company must apply to the court for permission to hold a
meeting of its creditors. This can be one meeting unless it is
felt that different classes of creditors have rights that are so
different that they cannot reasonably consult together with a
view to a common interest (the so-called "common-interest
test"). In that case, a separate meeting is held for each
class. • Meetings are then held, and each class must
vote in favour of the scheme by a simple majority in number and
75 percent in value. • The company then returns to
court for sanction of the scheme. The court must exercise its
discretion and be satisfied that the scheme is fair and such as
an intelligent and honest creditor voting in his own interest
might reasonably approve. </blockquote> </blockquote> It is
the responsibility of the applicant to determine the correct classes.
If the classes are incorrectly constituted, the court will not have the
jurisdiction to sanction the scheme at the third stage. The
common-interest test is a high hurdle, and many schemes proceed on
the basis of a single class. Because any class can block the scheme,
the concept is very different from class voting in a chapter 11
reorganisation plan. When sanctioned by the requisite majority
and the court, a scheme will bind all members and creditors,
regardless of whether they had notice. Bondholders and
Schemes The role of bondholders within U.K. restructurings
has increased dramatically over the past few years. This is because
of the increasing complexity in capital structures and the growth of
U.S.-based investors in European debt. When a company is in
financial difficulties, the ideal solution is a consensual
restructuring, but due to the varied interests of the stakeholders, most
"consensual" workouts will inevitably involve some sort of
cramdown or threat of cramdown. The starting point is that all
unsecured financial creditors should be treated equally, but there
will inevitably be those who try to extract more value by holding
out for a better deal. Schemes can provide for such a cramdown
mechanism, as there is no requirement for unanimity. Recent examples
of bondholder restructurings where a scheme has either been used or
threatened include Marconi, Drax, Telewest, British Energy and
MyTravel. Why Are Bondholders Different from Other
Creditors? The way in which bonds are typically held and
the type of investors who deal in bonds differentiate bondholders
from other creditors. This will have an impact on the way in which
negotiations are conducted with bondholders prior to launching the
scheme and potentially also the way in which bondholders are treated
under the scheme itself. Typically, bonds are widely held by a
varied group of investors who have different objectives in the
restructuring (for example, distressed-debt traders or bondholders
who bought at par). The bondholders may also have a weaker position
than some other stakeholder groups as their claims are likely to be
unsecured and will often be structurally subordinated. Bondholders'
positions in the negotiations may also be further affected as,
unlike banks, the bond-holders will have no ability to underwrite
new cash. Another important difference is that where a company
is dealing with bondholders, it cannot be certain of who its
creditors are or who they will be at each stage of the
restructuring. This is because bonds are often held in global form
and can usually be freely and publicly traded. Consequently, the company
will be negotiating with a changing creditor constituency during the
course of the restructuring. Are Bondholders Treated
Differently in a Scheme of Arrangement? Bondholder schemes
are likely to be an alternative to insolvency, so the starting point
for determining whether or not they are in the same class as other
bondholders or other groups of creditors will be their rights in a
hypothetical liquidation. Viewed in this way, all
bondholders are capable of being in the same class, even where they
hold different issues of bonds, with different maturity dates or
interest rates, or in different currencies. However, although in theory
bondholders may be likely to form just one class together with other
creditors, in practice some bondholders can be aggressive litigants
who play the class game in an attempt to extract value. In addition,
different bondholders may have collateral rights that could
potentially place them in a separate class. The way in which
agreements are reached with bondholders prior to launching the
scheme could also have an impact on whether or not bondholders form part
of the same class. Given the time and expense involved in launching
the scheme, once scheme proposals have been agreed upon, it is in
the interests of both the company and the creditors that a
significant number of creditors enter into voting agreements to
support the scheme. This will also help the company put in place
other elements of the restructuring during the court process by
giving it increased certainty that the scheme will be successful. The
court has recently confirmed that voting agreements entered into by
scheme creditors before the launch of a scheme do not necessarily
cause class issues if the scheme creditor would not have voted
differently in the absence of the agreement.2 A
similar issue could potentially also arise in relation to payment of the
fees incurred by some, but not all, creditors. It is common practice
for the legal fees and expenses of the bondholder committee to be
paid by the company being restructured. The courts have confirmed
that the payment of legal fees incurred by the bondholder committee
or other creditors involved in the restructuring process does not,
of itself, cause any class issues so long as the payment was not
made to "buy" the vote. Are Bondholders
"Creditors" in a Scheme? In a chapter 11 plan,
bondholders are counted as creditors in their own right and are
entitled to vote on the plan of reorganisation, even where the bonds
are held in global form and the depositary or trustee has legal title.
However, the position in England is more complicated. A
"creditor" for the purposes of a scheme of arrangement is
any person who has a pecuniary claim against the company, whether
present or contingent.3 Where the bonds are held in
global form, the depositary and/or the trustee are likely to be the
"creditors," depending on the working of the indenture or
trust deed. Legally, the underlying bondholders who have the
economic interest in the bonds are not actually creditors. In practice,
the depositary/trustee would only exercise its vote in accordance
with the wishes of the bondholders. This causes a further
difficulty where bondholders make up the vast majority of the
stakeholders being compromised under a scheme. The statutory voting
test for a scheme is that a majority in number representing
three-fourths in value of the creditors or a class of creditors
present and voting must vote in favour. While the bonds remain in
global form, this will result in the views of the underlying
bondholders counting toward the "at least three-fourths in
value" limb of the statutory test (as the trustee will exercise
its votes in accordance with their wishes), but not the "majority
in number" limb. The voting mechanics of a scheme will
need to address this issue. How it is addressed will depend on the
terms of the bonds, but it can often be time-consuming and
expensive. For example, one approach that has been used is to require
bondholders who wish to vote to convert their bonds into definitive
form. This will then give the bondholder a direct claim against the
company. While the English courts have in practice insisted
upon definitisation of bonds for voting purposes, we are aware of
schemes in other jurisdictions where the courts have been prepared
to look through the strict legal position and allow bondholders to
vote for their beneficial holdings. Conclusion

Although schemes have been used historically where bondholders or
other large creditor groups are being compromised in a
restructuring, there is an alternative means of cramming them down
under English law. This is a company voluntary arrangement (CVA), a
procedure under the English insolvency legislation (though there is
no requirement of insolvency) having similar effect to a scheme. 
Following changes in the law relating to CVAs, which came into force
in 2003, it is now possible to bind creditors that do not have
actual notice of the CVA proposals in the same way as a scheme. This
means that there is now the potential to use CVAs in more
complicated compromises. This was done last year when the U.K.
companies that made up the TXU Group successfully implemented two
separate sets of interlocking CVAs. As there is no requirement for
classes of creditors to vote separately in a CVA, it seems likely
that CVAs may prove more popular than schemes in the future.
 Insurance Schemes Insurance schemes are now a common
feature of the London insurance market. They allow insurance
companies with large numbers of expired policies to cut off
liabilities now, rather than wait decades for claims to emerge and be
paid in the ordinary course. In the typical solvent scheme, creditors
(i.e., policyholders) are given a deadline (called the bar
date) by which they must submit to the company all claims they may
have. This includes contingent claims, which are estimated according
to an actuarial methodology. There will then be a process whereby
the value of claims is agreed to or adjudicated by an independent
expert, and the company then pays everyone in full and is left with
no liability. BAIC On 21 July 2005, the solvent
scheme of arrangement proposed by British Aviation Insurance Co.
Limited (BAIC) became the first to be successfully challenged at a
sanction hearing.4 The insurance liabilities that BAIC was
seeking to accelerate included long-tail asbestos and pollution
liabilities under loss-occurrence policies, as well as reinsurance
liabilities. The primary challenge was that the court had no
jurisdiction to sanction the scheme as only one meeting of creditors
had been held, whereas creditors with accrued claims (who would be
paid in full) and creditors with contingent claims (who would have
their claims estimated) should have formed separate classes.

The judge decided that the question of whether creditors' rights were
similar was to be answered by reference to a reasonable comparator
– i.e., what would creditors' rights be outside the
proposed scheme as compared to their rights under the scheme?
 The company argued that if the company were to be wound up,
contingent creditors would have their claims estimated and therefore
all creditors would be treated similarly under the scheme. However,
the judge found that winding up (whether solvent or insolvent) was
not a realistic alternative to a scheme for BAIC. He said that the
risk of BAIC going into wind-up mode was remote and theoretical, as
it had a very healthy balance sheet and shareholders who would support
it for reputational reasons. Therefore, the only realistic comparator
was a solvent run-off. Applying that comparator, the judge found
that the two types of creditors had interests that were sufficiently
different in that they had no common interest at all and should form
separate classes. He therefore had no jurisdiction to sanction the
scheme. The judge went further and commented, obiter,
that if he had had jurisdiction, he would still not have sanctioned
the scheme as the company was able to meet its liabilities, and it
was unfair for those insureds with contingent claims to have their
insured risk compulsorily retransferred to them. BAIC was in the
risk business; direct policyholders were not. Subsequent
Developments There was some concern in the run-off industry
over what impact the BAIC decision would have upon future solvent
schemes. New schemes were initially put on hold pending an appeal,
but the decision is now not to be appealed. The next solvent
scheme hearing came in September 2005, when the Court of Session in
Scotland (where the law on schemes is largely the same as in England)
sanctioned a solvent scheme for M&G. Lord Clarke was referred
specifically to BAIC but declined to follow it, both as to class
constitution and as to fairness. The most significant
development following BAIC has come in the joint cases of Scottish
Eagle Insurance Company Limited and La Mutuelle Du Mans Assurances
IARD (MMA). In both cases, a single meeting of creditors was held, but
Mr. Justice Evans-Lombe sanctioned both schemes on 28 Oct., albeit
on different bases. In the case of Scottish Eagle, he held that the
BAIC analysis allowed a single meeting to be held because it was
demonstrable that it would be a realistic alternative for Scottish
Eagle to be placed into solvent liquidation. For MMA, he held that
this could not be said, but that there must be cases, MMA plainly
being one, where the nature of the claims was very different from
the insurance business that the BAIC judge examined. He held that the
court must be able to say that the claims are so similar that,
although there could not reasonably be a prospect of a solvent
liquidation, nonetheless accrued and contingent claims were so
similar, in the nature of the calculation required to arrive at
quantification, that creditors were able to consult together with a
view to their common interest. Perhaps significantly, the major
difference from BAIC was that no creditors opposed sanction of the
MMA scheme. Future Developments Insurance
companies thinking of proposing schemes can rest easy that the
courts have not rigidly applied the decision in BAIC. However, the
schemes that have subsequently succeeded have done so on the basis
of distinguishing BAIC rather than challenging it. A scheme on
similar facts to BAIC will be the next big test for this
increasingly popular exit option. <blockquote>

<blockquote>  </blockquote></blockquote><hr><h3>Footnotes</h3>1
Contributing authors were Neil Golding, Catherine Derrick and Craig
Montgomery in London. 2 Re Telewest Communications Plc
(No.1) [2004] B.C.C. 342. 3 Midland Coal, Coke and Iron
Co. [1895] 1 Ch 267 4 Re British Aviation Insurance Co.
Ltd. [2005] EWHC 1621 (Ch).

Journal Authors

Sandy Shandro

Journal Date

Saturday, April 1, 2006 - 12:00

Bankruptcy Rule

2006

none