MoFo Perspectives: The Part 26A Restructuring Plan – A Year On and Beyond

Howard Morris, Amrit Khosa, and Jai Mudhar discuss the Part 26A restructuring plan and the legal developments that have unfolded since its introduction.

This pragmatic and informative discussion is designed to equip our clients with the latest updates to help navigate the months ahead.

Transcript

Speaker: Welcome to MoFo Perspectives, a podcast by Morrison & Foerster, where we share the perspectives of our clients, colleagues, subject matter experts, and lawyers.

Howard Morris: Hello, and welcome to our podcast on the Part 26A Restructuring Plan. I’m Howard Morris, I head the business restructuring and insolvency group in Morrison & Foerster in London, and today I’m joined by my colleagues, Amrit Khosa and Jai Mudhar. The restructuring plan procedure was introduced in June 2020, into Part 26A of the Companies Act 2006 and by the Corporate Solvency and Governance Act of 2020. It is a welcome, flexible addition to the restructuring tool kit and incorporates the concept of a cross-class cram-down into English law, bringing the UK restructuring regime within a stone’s throw of the well-known U.S. chapter 11, and moving us closer to the paradigm endorsed by the World Bank. Since its introduction, there have been at least seven approved restructuring plan cases and in this podcast, we plan to take you on a tour detailing the key features of the restructuring plan and providing a brief analysis of the case law so far that has, without fail, begun to demonstrate the inherent flexibility of the restructuring plan procedure. A look at this as yet untested elements of the restructuring plan. And finally, whether the restructuring plan will get recognition across the European Union. Amrit, please introduce us to the restructuring plan.

Amrit Khosa: Sure, Howard. The restructuring plan offers companies the opportunity to deliver a financial and operational restructuring using a single process. The restructuring plan, much like a scheme of arrangement, requires court oversight and approval. In particular, there will be two hearings. The first hearing requires the court to examine class composition, jurisdictional issues, and confirm a date on which voting should take place. The second hearing, which takes place after the voting, is for the court to decide whether or not to sanction the restructuring plan. The restructuring plan, while similar to the scheme of arrangement, is distinguished by certain qualifying conditions and key features. The restructuring plan is available to companies on the satisfaction of two conditions, the first relating to financial difficulty. The company has, or is likely to encounter, financial difficulties that may affect its ability to carry on as a going concern. And, secondly, relating to the compromise, reducing the effect of the financial difficulty, the proposed compromise or arrangement is between the company and its creditors or members.

Amrit Khosa: And has the purpose of eliminating, reducing, preventing, or mitigating the effects of the financial difficulties. For a restructuring plan to be approved, it must be supported by at least 75% in value by each class that votes. The classes can comprise of creditors or members. There is no numerosity requirement as there is with schemes of arrangement, meaning there is no need for a majority of those voting in favor to achieve a valid yes vote. The most notable feature of the restructuring plan, as Howard has mentioned before, is the cross-class cram-down. Jai, the cross-class cram-down is well-known element of chapter 11. Would you introduce it?

Jai Mudhar: Sure. A cross-class cram-down is a mechanism that allows a restructuring proposal to be implemented even though an entire class of creditor votes against the relevant proposal. In the context of the U.S. chapter 11 process, a cram-down of a class of creditors is only permitted where the court deems the plan to be fair and equitable to the dissenting class and any more junior classes of creditors. And the claims of the dissenting class are to be paid in absolute priority to any more junior claims. With respect to the restructuring plan, there are two conditions that must be satisfied before the court considers it appropriate to exercise its discretion to sanction a plan. Amrit, I’ll pass it back to you to go through those key threshold conditions.

Amrit Khosa: Thanks, Jai. The cross-class cram-down mechanism may be used at the discretion of the court to cram down a class or indeed multiple classes of dissenting creditors. If, first, the dissenting creditors would be no worse off under the relevant alternative, which means the alternative most likely to occur if the restructuring plan was not sanctioned. This is commonly known as the “no worse off” test. And secondly, at least 75% by value of at least one class that would have a genuine economic interest in the relevant alternative votes in favor of the restructuring plan. The restructuring plan was first used by Virgin Atlantic in September 2020 when its restructuring plan was sanctioned by the English high court. And then again by the PizzaExpress Group. In both cases, the cross-class cram-down mechanism was not used. The use of a restructuring plan by the PizzaExpress Group was the first time the plan was used to implement a debt for equity swap. The restructuring plan, among other things, can disapply certain shareholder preemption rights, including the requirement to seek shareholder authority to allot an issue further shares. It can provide an avenue to deal with shareholders without the need for shareholder approval. In these cases, the court made clear that it would evaluate the restructuring plans in the same way it would a scheme of arrangement. The cross-class cram-down mechanism was first tested with the DeepOcean Group’s restructuring plans. Its use was uncontroversial. Jai, do you want to introduce the concepts that case law is shaping with respect to certain aspects of the restructuring plan?

Jai Mudhar: Sure. Thanks, Amrit. While we’ve just spoken about DeepOcean, it’s worth mentioning that it was the first case in which the restructuring plan was used to facilitate a solvent wind-down rather than a rescue. The court held the fact that the plans would have a mitigating effect on the severity of losses the creditors would otherwise sustain was sufficient to satisfy the requisite purpose test, which provides that the plan eliminate, reduce or prevent, or mitigate the effect of any financial difficulties. Let’s turn our attention to the case law surrounding the cross-class cram-down conditions. First, looking at the “no worse off” test, as Amrit mentioned, the court must be satisfied that the dissenting creditors would be no worse off in the relevant alternative. The “no worse off” test may be approached by, first identifying the alternative scenario that is most likely to occur, if the plan was not sanctioned. Second, by determining what would be the outcome or consequence of that alternative for members of that dissenting class. And third, by comparing that outcome and those consequences of the relevant alternative with the consequences for the members of the dissenting classes if the restructuring plan is sanctioned. In Virgin Active, Mr. Justice...

Jai Mudhar: Snowden stated that the exercise is inherently uncertain because it involves the court considering a hypothetical counterfactual, which may be subject to contingencies, and which will inevitably be based on assumptions, which are themselves uncertain. While the relevant alternative of a trading administration was not disputed in the Virgin Active case, helpful guidance was provided in respect to valuation, which we’ll come back to shortly. The Hurricane Energy restructuring plan was the first restructuring plan cram-down that was not sanctioned by the high court. It was not sanctioned on the basis that the “no worse off” test was not satisfied. There were two voting classes, a class of bondholders and shareholders, the latter of which, as Mr. Justice Zacaroli had stated in his convening judgment, had their rights affected by the plan and had a genuine economic interest in the company, even though the bondholders argued the shareholders were out of the money.

Jai Mudhar: The company said that the relevant alternative was the controlled wind-down of its operations and insolvency. Mr. Justice Zacaroli held that the most likely relevant alternative was that the company would continue to trade profitably in the short to medium term and the dissenting class, the shareholders, would not be “no worse off” in that alternative, as there was a realistic prospect of the company discharging its obligations to the bond holders, leaving assets with at least the potential for exploitation and value for the shareholders. So if there is a realistic prospect that dissenting creditors or shareholders could be better off in the counterfactual, which is a high bar, a company will fail to satisfy this test. Amrit, it was interesting that the court came to the conclusion it did in Hurricane, despite the existing management viewing the situation differently. Do you think we’ll see more of the court intervening and contemplating commercial decisions of management?

Amrit Khosa: That’s an interesting question, Jai. The court is always going to assess what the relevant alternative is. In Hurricane, management sought to deal with the maturing bonds by implementing a debt for equity restructuring. Existing shareholders would’ve seen their holding substantially reduced and voted against the plan. The court was critical of the company’s evidence regarding the relevant term to the structuring plan being an insolvent liquidation. The Hurricane business is simplistic in nature, and viability of the business largely depends on the oil price, which we all know to be extremely volatile. This creates a possibility of future profitability, which together with the lack of a burning platform led the court to conclude that shareholders should not immediately be deprived of their interests. There were a number of options available to Hurricane in the short to medium term, which could result in a better outcome for shareholders. So the “no worse off” test was not deemed satisfied. Stepping away from Hurricane, with the new plan, we are going to have a broad range of issues that come before the court. And there is less guidance in the legislation. This in itself will require the court to take a more interventionist approach. We also have judges with a great deal of restructuring experience and expertise. They’re using this to provide an approach to dealing with possible issues early in the development of the restructuring plan. Jai, I’ll pass it back to you to touch on valuations.

Jai Mudhar: Thanks, Amrit. Turning back quickly to the point on valuations. Valuations have always been an important aspect of restructuring, and will be important for establishing whether dissenting creditors would be no worse off in the relevant alternative. Valuation identifies the creditors who are in the money and those who are not. And Part 26A expressly provides that parties with no economic interest do not have the right to vote on a restructuring plan. In Virgin Active, the court expressed the view that the utility of the restructuring plan should not be undermined by lengthy disputes on valuation. Chapter 11 disputes on the question of valuation can be very time-consuming and costly. Ultimately, where the valuation of a company is disputed, competing valuation evidence of the alternative counterfactual should be provided to the court, as only evidence placed before the court will be assessed when considering the relevant restructuring plan. Howard, do you want to talk about genuine economic interest?

Howard Morris: Yes. Happily. The second condition of the cross-class cram-down requires that at least 75% by value of at least one class, that would have a genuine economic interest in the relevant alternative, vote in favor of the restructuring plan. It stands to reason that careful consideration will be given to the classes generally, with there being an incentive on the part of the company due to the availability of the cross-class cram-down mechanism to increase the number of voting classes to increase the chances of a favorable vote by a class. However, the court is very much alive to the issue of artificial classes being formed, and so scrutinizes the classes put forward the company very carefully. Referring again to Virgin Active’s restructuring plans, multiple dissenting classes of landlord were crammed down. All of these classes were shown not to have a genuine economic interest in the company’s relevant alternative scenario. Consequently, it was deemed that there was no reason them to be given a vote in the restructuring, and the court was able to look past the challenges from these classes of landlords.

Howard Morris: The cases to date have shown that the cross-class cram-down mechanism works as intended, but as well as meeting the necessary statutory conditions, companies need to ensure that overall approach to implementing a restructuring plan is fair. The court will not automatically rubber stamp a plan because the conditions were satisfied. The court jealously guards its ultimate discretion to try to sanction a plan. Now, discretion, this was highlighted recently in that Hurricane Energy case where Mr. Justice Zacaroli has said in his judgment that even if the cross-class cram-down conditions have been satisfied—and remember, he found that the first condition hadn’t been satisfied—he would’ve refused to exercise the court’s discretion to sanction the plan, as the company is profitable and will continue to be so for at least a year. The legislation provides little guidance on the fact as the court should consider when exercising its discretion to sanction a restructuring plan or decline to sanction using the cross-class cram-down. We’ve seen in the judgements of the DeepOcean and Virgin Active cases that care has been taken to not establish a test, which would thereby tend to fetter the discretion of the court.

Howard Morris: Another interesting point in the case of the Virgin Active restructuring plan relates to the shareholders who rank junior to the landlords. The shareholders will receive some value in the restructuring by retaining their shares, while the landlords have had their leasehold obligations compromised. In the alternative of an administration, shareholders would rank behind the landlords, who are just unsecured creditors, and their shares would be worthless. Any treatment that enables the shareholders to obtain value to the exclusion of unsecured creditors that rank ahead of them in the insolvency waterfall is contrary to the ordinary principles of insolvency law. Mr. Justice Snowden highlighted that a restructuring plan may provide that different treatment and substantial value be given to some, but not all creditors, who are out of the money as referred to in DeepOcean and creditors who are in the money should decide how the value and potential future value that the business and assets may have generated post restructuring should be divided.

Howard Morris: There may however, be limits in this principle. In this case, there were justifiable commercial reasons for allowing the shareholders to retain their equity, as the shareholders were providing new money on better terms than would otherwise have been available in the market. Now, this decision does not impute into English law the absolute priority rule. The absolute priority rule is enshrined in U.S. bankruptcy law and provides that junior creditors can’t be paid before all senior creditors are paid in full. Remember as mentioned the court acknowledged that there may be limits to the value out of the money creditors or shareholders may receive. We’ll have to watch this space to see how the limits on this develop. Let’s quickly consider now the possibility of a cross-class cram-up. Jai, your thoughts on this, please.

Jai Mudhar: Well, while a cram-up is untested, it’s a theoretical possibility. Where appropriate supporting relevant alternative evidence can be prepared, there is a possibility for junior creditors to work with companies to impose a restructuring plan on dissenting senior creditors. While the cram-up is indeed a prospect, it may be practically hard to see, as senior creditors will likely have security and, accordingly, it would be difficult to see how they would not be worse off in the relevant alternative. So let’s see if we are ever find ourselves in a scenario where this might occur. Amrit, one of the drawbacks to the Corporate Solvency in Governance Act is that there was no mention of a dip like financing regime. What are the new money opportunities like with the restructuring plan?

Amrit Khosa: You’re spot-on. The Corporate Insolvency and Governance Act did not introduce a dip financing regime, meaning that any new funding must fit within the framework of the existing debt documentation. Approval for new priming debt, however, may be sought under the terms of the restructuring plan. So while the provision of new money is not entrained in law, the restructuring plan procedure allows for new money opportunities. Approximately 1.1 billion of new money has been made available in the last year or so. In the case of Virgin Active, as Howard mentioned, the existing shareholders provided new money. They provided 65 million. In the case of the Smile Telecoms restructuring plan, the super senior funding of $62 million was provided by Smile Telecoms minority shareholder. In both of these cases, the provision of funding resulted in the cram-down of certain creditors. I’m briefly going to touch on restructuring plans and company voluntary arrangements or CBAs.

Amrit Khosa: In Virgin Active, the restructuring plan was used instead of a CBA to compromise lease liabilities and, more generally, to implement a financial and operational restructuring. CBAs, which do not require much court involvement and in which all the unsecured creditors vote as a single class, have been used a lot in the recent past to deal with leases. Virgin Active was the first time the restructuring plan was used to compromise lease obligations. Landlords were placed in different classes and treated differently, with cross-class cram-down being used to implement the restructuring plan. The restructuring plan therefore provides a more flexible way for companies to tackle their unviable real estate portfolios over company voluntary arrangements. The court made clear that there is nothing inappropriate about companies making use of the restructuring plan over CBAs. In a scenario where a company wishes to propose a compromise that binds all unsecured creditors, a CBA should still be used. Interestingly, in a single class vote, creditors without an interest in leases can outvote landlords and enable the lease company to compromise its lease obligations. Since the Brexit transition period has ended, the recognition of restructuring and insolvency tools has been somewhat uncertain. Jai, do you want to give us an overview on the recognition of the restructuring plan across the EU?

Jai Mudhar: Sure. Without opening too big of a can of worms right now, as we could likely have a whole podcast on recognition, the Gate group decision somewhat unexpectedly effectively placed the restructuring plan and schemes of arrangement on different paths to recognition. A restructuring plan, as the law currently stands, is considered an insolvency proceeding. As such, in a pre Brexit state of play, it would’ve benefited from the EU insolvency regulation and automatic recognition across the member states. Now that the U.K. is not in the sphere of influence of the EU insolvency regulation, recognition of a restructuring plan will need to be obtained by using the relevant member states domestic laws approach to recognition or relying on another avenue, such as the own one regulation. A bit of a blow to the attractiveness of the restructuring plan, but not insurmountable.

Howard Morris: Jai, thanks. So tying everything together, what we’ve seen is we have an inherently flexible and powerful restructuring tool that companies can utilize. The courts are focused on the procedural fairness and evidence provided to the court by companies and the other parties, particularly when it comes to valuation evidence. Thirdly, the cross-class cram-down mechanism is available where the statutory conditions are met, but ultimately, the court maintains its discretion to sanction a restructuring plan. And perhaps fourthly, what we’re beginning to see emerge now is courts participating or getting involved in making commercial judgements about the future of a company, something which they have eschewed throughout English insolvency law in the past. That’s it from us today. Myself, Howard, Jai, and Amrit have been delighted to speak to you on this fascinating and large topic. If you have any questions, please do get in touch. We’d be very happy to answer them.

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