This alert is up-to-date as at 26 June 2020

The Corporate Insolvency and Governance Bill 2020 received royal assent on 25 June 2020, and has now passed into law as the Corporate Insolvency and Governance Act 2020 (the "Act").

Alongside several other key updates, the Act introduces into the Companies Act 2006 a new “cross-class cram down” arrangement and reconstruction process (the “Plan”) as an additional tool to rescue financially distressed companies.

A summary of the important points on the proposed cross-class cram down procedure is as follows:

Key features

  • The Act introduces the Plan as a new restructuring tool available to companies which have, or are likely to encounter, financial difficulties that are, or are likely to, affect their ability to carry on trading as a going concern. There is no requirement that the company is technically insolvent before the Plan is entered into. An application to court in respect of this new process may be made by the company, any creditor or a member of the company. An application may also be made by a liquidator or administrator of the company.
  • Broadly, the Plan is similar in form and process to the existing scheme of arrangement procedure under Part 26 of the Companies Act 2006 (“Scheme”) and courts will likely benefit from well established case law on the application of the Scheme process. However, for creditors of a company, there is one major distinction between a Plan and a Scheme:
    • While a Scheme requires approval by at least 50% in number constituting 75% in value of each relevant class of creditors or members, as the case may be, present and voting either in person or by proxy in favour of the Scheme for it to proceed to sanction by the Court, the Plan allows the court discretion to sanction a Plan where a number representing 75% in value of the creditors or members, as the case may be, of each relevant class present and voting either in person or by proxy in favour of the Plan, even where there is a dissenting class (or classes) which binds that dissenting class (or classes) to the Plan (i.e. “crams them down”) where:
      1. no members of the dissenting class would be any worse off under the “relevant alternative” to the Plan; and
      2. at least one of the classes that has voted in favour of the Plan would receive payment, or have a genuine economic interest in the company if the relevant alternative was implemented.
    • For these purposes, the relevant alternative will be whatever the court considers most likely to occur if the Plan is not sanctioned by the court (for example, this might be an administration or liquidation or, potentially, could be an alternative Plan).
  • Save as above, the process for implementing a Plan is expected to follow that which applies for a Scheme:
    • the court orders, on application by an entitled party, that creditor/member meetings are to be summoned in such manner as the court directs;
    • every creditor or member of the company whose rights are affected by the compromise or arrangement must be permitted to participate in the meeting (this does not apply in relation to a class of creditors or members if the court is satisfied that none of the members of that class has a genuine economic interest in the company);
    • all parties summoned by notice to attend the meeting must be provided with a statement setting out the effect of the compromise or arrangement, there being specific requirements in relation to any material interests of the company's directors and debenture holders (where their rights are affected);
    • the meetings are convened to enable voting to take place on the Plan. To pass, the votes must comply with a) and b) above as well as satisfy the minimum voting threshold representing 75% in value of the creditors or class of creditors or members or class of members present and voting;
    • once approved in accordance with these requirements, an application must be made back to the court for sanction of the Plan; and
    • the Plan becomes effective, binding upon all creditors and members (including any dissenting class, where relevant, provided that the Court is satisfied under the "no worse off" and "no genuine economic interest" principles) upon delivery of the court's order sanctioning the Plan to the registrar (and, in the case of an overseas company, there is a requirement for publication in the Gazette).

Points to consider

  • We expect disputes around Plans to focus on "the relevant alternative" and business valuations to establish whether or not parties have a "genuine economic interest"

It seems highly likely that parties outside the senior creditor group will be concerned to ensure they maintain a seat at the table in any restructuring process which seeks to implement a restructuring against their interests. What is clear is that this new restructuring process enables a company to exclude creditors from the Plan provided the court is satisfied on the "no worse off" and "no genuine economic interest" principles set out in the new Part 26A. In practical terms, this means that creditors "at risk" of being excluded (i.e. "crammed down") must equip themselves speedily to challenge any attempt by a company to exclude them or else accept their fate.

This is an entirely new approach in the UK to formal restructuring processes and we anticipate there will be many challenges in court by creditors who feel aggrieved at the prospect of being shut out of restructuring negotiations and unable to participate in the outcome of a successful company rescue. The "battle ground“ will centre around business valuations and the potential for alternative Plans being put before the court for consideration. Disputed valuations are common place in Chapter 11 proceedings in the US and, if our extensive experience in such proceedings is anything to go by, there seems every likelihood that mezzanine and junior creditors, and other creditors in the capital structure such as noteholders and bondholders, will seek to deploy aggressive litigation tactics to leverage their positions. This will all be a new experience in UK restructurings and any company contemplating a Plan will need to be ready for challenges in court should it be contemplating this new procedure and seeking to cram down certain classes of creditors or members.

The High Court has considered the question of valuation in the context of a Scheme in the IMO restructuring1. In proceedings, contrasting approaches were taken by the senior and junior lenders as to how a valuation should best be conducted. The senior lenders took an approach which was based on coming to a valuation that represented a realistic purchase price for the company, whereas the junior lenders' evidence sought to value the company on a going concern basis based on statistical projections of the company's performance. In evaluating these divergent methods of valuation the court was clear in its conclusion that the most appropriate benchmark for valuation in the context of a scheme is the sale price of a company, not its going concern value with Mr Justice Mann stating "the scheme companies have produced expert evidence which is comprehensible and relates to a real point - how much would a purchaser pay for the group now?". The more theoretical approach favoured by the junior lenders was rejected by the court.

The IMO restructuring provides a helpful indication as to how the court might approach the question of valuations in future Plans, however, valuation remains an art rather than a science and the law in this area has not yet had the opportunity to fully develop in the UK. How courts approach the question of the company’s valuation in the context of the proposed Plan versus the “relevant alternative” will be pivotal in how stakeholders approach the implementation of Plans.

  • What is the relevant alternative that the court should consider?

Should it be a simple choice between the Plan and insolvency or could the alternative be a zombie company limping along hoping for new funding or selling in a different market environment? It will be important for the company seeking to persuade the court of the appropriate relevant alternative in the circumstances to produce a realistic and evidenced estimated outcome statement in respect of possible administration or liquidation. As with valuation, this is another potential area for dispute with dissenting creditors who may produce a credible alternative estimated outcome statement.

  • The “hold out” position for a creditor to resist a Plan is different to a Scheme.

The nature of this cram down provision means that the “hold out” position for any creditor to resist implementation of a Plan is no longer assured by simply holding greater than 25% of the value of a class of debt as with a Scheme. Instead, the ability to resist a Plan will be based on competing valuations and a view of what the credible alternatives to the Plan are likely to be. Junior creditors' prospects in this regard may be further hindered by the IMO restructuring judgement which clearly established that a "hold out" position (whereby creditors might extract value from the company on the basis of their negotiating position) is not a "real economic interest" for the purposes of considering creditor rights in the context of a scheme. A further lesson for hold out creditors to take from the IMO restructuring is the importance of being well prepared to rebut any valuation evidence presented by senior lenders at the earliest opportunity.

  • The impact on junior creditors

The Plan has taken from junior creditors an important luxury they enjoyed under Schemes of being able to prevent a Scheme they did not deem favourable to their position merely by dissenting (irrespective of the commercial efficacy of the proposed Scheme). This ability provided junior creditors with a degree of leverage over the formation of any Scheme that they will not enjoy in respect of Plans. Where the company / senior lenders show that the junior creditors will not be placed in a worse economic position by the proposed Plan, the court can bind them notwithstanding their dissent.

In theory, it is also possible for a Plan to be imposed on one or more dissenting classes of senior creditor where approved by a class of junior creditor who can show that in the relevant alternative they would have a genuine economic interest in the company. The practical obstacle is likely to be proving that the dissenting senior creditor will be no worse off than in the relevant alternative but nonetheless the court will have the jurisdiction to sanction such a Plan if this can be shown.

  • The US Experience

Company valuation is a driving factor in Chapter 11 proceedings under the US Bankruptcy Code. Amongst other things, the valuation determines the right of a company to use its own cash during a Chapter 11 case, the right of a secured creditor to be paid interest, and the right of a secured or unsecured creditor to challenge a Chapter 11 plan. As valuation is so key to many stakeholders' positions it is often a hotly contested issue before the US Bankruptcy Courts.

Brown Rudnick is poised to bring this wealth of knowledge and expertise gained in the US context to its clients grappling with the new English-law Plan. In particular, we expect this experience will provide us with a unique viewpoint when: (1) assisting clients in preparing Plans and in developing strategies to deal with dissenting junior creditors; and in (2) assisting junior creditors to challenge a Plan and retain a seat at the restructuring table in order to recoup some value from the process and avoid being crammed down by the court.

  • The “Ipso Facto” provisions in the Act also apply to Plans

With a clear and significant nod to legislators’ desire to encourage the rescue culture, the separate protections that the Act creates (please see previous Brown Rudnick alert dated 5 June 2020) to prevent suppliers from relying on any term in the supply contract purporting to entitle them to terminate based on the counterparty’s insolvency also apply to Plans. This means that from the moment the court convenes meetings of the creditors to vote on a Plan, suppliers of services cannot terminate their contracts and this will apply to both new contracts as well as those contracts that have been entered into prior to the Act passing into law.

  • Interaction between the Plan and the new moratorium provisions

One of the other new measures the Act introduces is a moratorium available to companies to enable their rescue as a going concern (the “Rescue Moratorium”). The initial period of the Rescue Moratorium provides protection from creditors for 20 business days. Importantly in the context of a Plan, the Rescue Moratorium can be used as a prelude to a Plan, offering breathing room for the company to take the necessary steps involved. It is in the court’s discretion to extend the Rescue Moratorium period for a further 20 business days where a Plan is proposed to allow for implementation.
It should be noted however, that the Act provides certain relevant creditors cannot be “crammed down” in any proposed Plan. This category includes creditors in respect of any new debt incurred by a company during
a Rescue Moratorium. The court will not sanction any Plan dealing with these creditors unless their consent has been obtained.

  • Cross border considerations

We anticipate that the Plan is likely to become the “go to” restructuring tool for many companies who can find sufficient connection with this jurisdiction to utilise it. As with Schemes, the Plan will not technically be an insolvency process and therefore discussions around the ability of EU companies with English law financing arrangements to utilise it on Centre of Main Interest grounds should be straightforward. However, recognition of the Plan within the EU after the Brexit transition date will presumably be mired in uncertainty, with companies most likely needing to rely on comity in a post-Brexit world. At least the route to recognition of Plans in the US seems more certain as is easy to see how the same arguments and features that have led to Schemes being consistently recognised under the US Chapter 15 process2 could equally be deployed for Plans. Further, the English courts, with their swift, commercial approach, system of precedent and wealth of case law around Schemes, should add to the attractions for companies seeking to restructure over the coming years.

Conclusions

This new process represents a fundamental shift in the policy and principles which have been the cornerstone of UK insolvency legislation for generations and, for the well advised, it presents myriad opportunities. At Brown Rudnick we are well placed to help clients capitalise on these changes, leveraging off decades of experience in dealing with similar issues arising in some of the largest US bankruptcies, combined with our specialist UK practitioners.

The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick
LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP. Specific legal
advice depends on the facts of each situation and may vary from situation to situation. Information contained
in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and
it does not establish a lawyer-client relationship.

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1 Re Bluebrook Limited and other companies (IMO) [2009] EWHC 2114

2 Schemes have been consistently recognised under Chapter 15 by US courts in many significant restructurings, including (amongst others) Avanti Communications Group PLC, Syncreon Group, Noble Group and Nyrstar Group.