It’s time for offshore jurisdictions to have cross-class cram downs in the restructuring toolkit

24 May 2021

Restructuring & Insolvency analysis: A plan within the new English Part 26A of the Companies Act 2006 (CA 2006), implemented by the Corporate Insolvency and Governance Act 2020, is a legislative amendment which introduces the concept of "cross-class cram downs".

This restructuring option is not yet available offshore. We believe that each of the offshore jurisdictions, the British Virgin Islands (BVI), Cayman Islands and Bermuda, should adopt the new English cross-class cram down provisions by way of their own legislative amendment in order to keep up with modern restructuring requirements. Written by Ian Mann, Asia managing partner, Harneys.

Scheme of arrangement

A scheme of arrangement is a court sanctioned compromise or arrangement between a company and its shareholders, or creditors. Originally introduced by the English Companies Act 1862, its modern iteration around the common law world has hardly changed, and therefore its durability is to be lauded. A scheme may affect mergers and amalgamations and may also alter shareholder or creditor rights. Schemes of arrangement are used to execute changes in the capital structure of a company. It is not a formal insolvency procedure, and is not recognised as a "collective insolvency proceeding" in and of itself; but is often used following an insolvency process, such as provisional liquidation, or in England, administration. In offshore jurisdictions, a scheme requires approval by at least 75% in value of each class of the members or creditors who vote on the scheme, being also at least a majority in number of each class. If the court sanctions the scheme, the scheme is binding on all affected members, creditors and the company. In short, it is presently the primary tool for offshore jurisdictions to restructure.

In a creditor scheme of arrangement, creditors must be divided into classes, depending on their rights and interests. Single class schemes may appear strategically appealing since they would mitigate the risk of minority veto. However, the courts have cautioned against single class schemes, since it is potentially unfair to creditors with different interests.

English case law: "Scheme" vs "Plan"

Clearly summarised by Mr Justice Zacaroli in Gategroup Guarantee Ltd, Re [2021] EWHC 304 (Ch), the material differences between a "scheme" and a "plan" under the English 2006 Act are:

under Part 26, the court may sanction a scheme only if both (i) a majority in number (ii) representing 75% by value of the creditors or class of creditors (or members) approve the scheme. In contrast, under Part 26A there is no numerosity requirement: a plan may be sanctioned under CA 2006, s 901F provided that creditors (or members) representing 75% by value of the creditors or class of creditors (or members) approve it
Part 26 applies irrespective of the financial state of the company. By CA 2006, s 901A, however, Part 26A applies only if the following two conditions are satisfied: (a) "the company has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern" and "the purpose of the compromise or arrangement is to eliminate, reduce or prevent, or mitigate the effect of, any of the financial difficulties mentioned in [(a)]"
under Part 26, a scheme consisting of more than one class of creditors (or members) may only be sanctioned if each of the classes approves the scheme by the requisite majorities. Under Part 26A, in contrast, CA 2006, s 901G provides that where two conditions are met, then the court may sanction the plan even if one or more classes fail to approve the plan by the requisite majority, and a dissenting class of voters cannot block the plan (a "cross-class cram-down"). The conditions are as follows:
- the court is satisfied that, if the compromise or arrangement were to be sanctioned under CA 2006, s 901F, none of the members of the dissenting class would be any worse off than they would be in the event of the relevant alternative (defined as "whatever the court considers would be most likely to occur in relation to the company if the compromise or arrangement were not sanctioned")
- [T]he compromise or arrangement has been agreed by a number representing 75% in value of a class of creditors or (as the case may be) of members, present and voting either in person or by proxy at the meeting summoned under CA 2006, s 901C, who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative

A scheme of arrangement’s greatest utility is to break the deadlock in negotiations, when a majority of the financial creditors are content to restructure the debt, but a minority are not amenable. The plan goes even further. Cross-class cram downs have the effect of massively changing the hold out position of any creditor since resisting the implementation of a plan does not rest on simply holding greater than 25% of the value of a class of debt as with a scheme.

Battleground for "Plans"

Earlier this year, we predicted that the battleground for plans will centre around competing valuations and whether the credible alternatives are acceptable. This has been borne out by the recent case of Virgin Active Holdings Ltd [2021] EWHC 1246 (Ch) before Mr Justice Snowden where a major issue was the valuation evidence of the plan companies’ business. The judge noted that:

"it is obviously important that the potential utility of Part 26A is not undermined by lengthy valuation disputes, but that the protection for dissenting creditors given by the 'no worse off' test (and the court’s general discretion) must be preserved."

The judge further cited the authors of Howard & Hedger: Restructuring Law and Practice:

"In many restructuring scenarios the valuation tension will be fully played out by the senior and junior creditors and in certain cases the equity. Each stakeholder will argue that the value (based on the four cases and the six valuation methodologies outlined above) breaks within their constituency, such that they should receive the equity ownership in the newco if there is a necessary conversion of their impaired debt as part of a balance sheet restructuring."

The offshore courts are experienced in examining valuation evidence in schemes of arrangement in any event. In particular, in an analogous and complementary discipline, the offshore courts (and practitioners) have experience in valuation disputes in the context of disputes concerning the fair value of shares following a privatisation of a formerly listed company, known as "s 238 disputes".

A plan could be imposed on one or more dissenting classes of senior creditor where approved by a class of junior creditor so long as it can establish that in the relevant alternative they would have a genuine economic interest in the company. A plan is similar in form and process to the existing offshore schemes of arrangement procedures and the offshore courts will likely benefit from well-established case law on the application of the scheme process. Undoubtedly, there will be cross border recognition issues with a plan that will have to be carefully considered.

BVI: Potential route to cross-class cram downs

In the BVI, under section 177 of the BVI Business Companies Act, there is in theory a route to cross-class cram downs save that (unlike the new English legislation) it is not express, there is no specific approval threshold and would be subject to wide discretion. To our knowledge it has never been used to avoid the numerosity test of a scheme and is more commonly used for share capital reorganisations. It was not drafted with the intention of cross-class cramming, rather it is an interesting anomaly. We do not therefore believe that it is presently fit for purpose viz cross-class cram downs. Neither of the Cayman Islands, nor Bermuda have anything similar to the BVI provision.

Conclusion

There is a danger that in the future other jurisdictions will adopt cross-class cram down legislation which will create difficulties for offshore jurisdictions where debtors need to use parallel schemes of arrangements. A parallel scheme of arrangement is simply the use of two or more inter-conditional schemes in the places that have jurisdiction over the debtor (often by reason of the place of incorporation of the debtor and/or the governing law of the debt). By sewing up the scheme compromise in both places, one ensures that dissentient creditors cannot take wrecking action. If part of the compromise involved cross-class cram downs, unless the concept exists offshore, the offshore part of the parallel scheme could include the same. This could prove detrimental, even fatal, to any restructuring. Offshore legislative amendment is therefore necessary to introduce the concept of the cross-class cram down.

This article was originally published in LexisPSL.