Despite the ongoing global pandemic, opportunities for stressed and distressed investments have not been as prolific as many expected. The window for entry into credits opened and closed more quickly than imagined. Nevertheless there have been several high-profile restructurings using the English scheme of arrangement. Of course, some of these were already in motion prior to the onset of the pandemic. A handful of these have sought to test the recently enacted insolvency regime, whilst others have tested more established legislative principles. This note highlights some of the key issues that have arisen in those transactions.
There has been much commentary on the new restructuring plan which is modelled on the existing scheme of arrangement but includes cross-class cram-down powers afforded under section 901G of the new Part26A of the Companies Act. Such flexibility draws on inspiration from Chapter 11 in the United States, and its omission from the UK restructuring toolkit until now has been seen as the scheme’s major limitation. The market waited eagerly in July 2020 when Virgin Atlantic went to court to sanction the restructuring plan and potentially avail itself of this new option. As three of the four creditor classes consented to the plan, there was potential to use the cram-down power on the fourth and final class, the trade creditors. The trade creditors eventually approved the plan, but certain trade creditors were excluded from the plan for logistical and commercial reasons. The judge agreed that the rationale for excluding some but not all of that class was reasonable.
PizzaExpress is the second company to make use of the restructuring plan and has structured the creditor classes under the scheme of arrangement to ensure that the cram-down mechanic is available. The group proposed three classes of creditors, namely the senior secured noteholders, the senior unsecured noteholders and PizzaExpress Financing 1 plc (the sole shareholder of the plan company, PizzaExpress Financing 2 plc). The liabilities owing to the shareholder are limited to intra-group loans. The creditors that provided the super senior money to the group earlier in 2020 do not feature as a scheme creditor, and such debt is not being compromised or impacted.
Whilst it is unusual for the shareholder to be included as a voting class (given that the court is not needed to release guarantors), the shareholder’s inclusion allows for a potential majority of classes to approve the plan and thus opens up the possibility of using the class cram-down, subject to the following conditions being satisfied:
At least one class that would have economic interest in an alternative scenario votes in favour of the plan.
Dissenting creditors are not any worse off under the plan than they would be under the most likely alternative the court considers most likely to occur.
The court is willing to sanction the plan.
In the case of PizzaExpress, if the senior secured creditors and the shareholders vote in favour of the plan, and the group evidences that the senior unsecured noteholders would be worse off under the alternative, then the cram-down is possible. Needless to say, if 75% of senior unsecured noteholders vote in favour of the plan there is no cram-down, but given that a much lower percentage signed the underlying lock-up agreement, it seems prudent to include such optionality.
As is always the case, determining the first two conditions relies heavily on robust valuations, which will continue to be a key aspect in restructurings under the new regime. Many companies will carry out a public auction to evidence fair market value of the group. For PizzaExpress (where the only eligible bid received for the group was from the senior secured noteholders), the independent report on returns in the event of administration (whether via a pre-pack sale or piecemeal realisation of assets) evidenced a zero return to the senior unsecured noteholders and the shareholder. The 1% of equity offered to the senior unsecureds under the plan is intended to show a better alternative and attempts to satisfy the second condition specified above.
Share Security Enforcement
As a contingency should the requisite consents not be achieved, PizzaExpress could implement a share pledge enforcement. On some recent transactions (including the Dutch retailer, Hema), this was the preferred route taken in conjunction with a UK scheme of arrangement (although had the new Dutch scheme been available, that route would have likely been preferable). The enforcement allowed the group to bind the junior noteholders after requisite voting levels for the junior consent solicitation and a scheme of arrangement were not reached. Such enforcement is typically effected through the distressed disposal regime in the intercreditor agreement. This is a useful tool, as it allows for the release of junior claims in cases where their consent has not been obtained for the proposed restructuring. The intercreditor agreement details how both borrowing and guarantee liabilities are dealt with so that even if the borrowing liability can be left behind in a holdco, the guarantee liabilities of subsidiaries subject to the sale can be released to ensure no such claims exist on completion of the sale. As has been well publicised, the ability to release such junior claims received extensive focus back in 2008-2009, resulting in various value safeguards being included in a new breed of intercreditors following the financial crisis to ensure that the junior creditors were treated fairly. Requiring disposals to be run by public auction or with a fairness opinion gives the necessary credibility to ascertaining fair market value and reduces risk of junior challenge.
One point that creditors may wish to consider when adopting the share pledge enforcement strategy is the identity of the security agent. Some traditional clearing banks in such role have adopted a conservative approach. Therefore, prior to enforcement action being taken, it may be prudent to replace the security agent to encourage a more flexible, commercial and precipitous approach. Both Hema and PizzaExpress have implemented such changes.
Whilst class composition in PizzaExpress (and in other recent names, such as Selecta) was fairly straightforward, that was far from the case in Codere, where Kyma Capital, a holder of 0.6% of the senior secured notes, argued that the ad hoc group of senior secured noteholders should be a separate and distinct class from the remaining noteholders by virtue of certain fees payable to the ad hoc group and an ability to provide the interim financing.
Ultimately the fees payable were not deemed enough to fracture a class, albeit there was great scrutiny across the fees and particularly on the work fee. In that case, the significant amount of work undertaken by the ad hoc group was cited as a factor in reaching such decision along with the fact that the group held inside information, which meant that it was restricted from trading and potentially suffered a loss in addition to undertaking risk. It is worth noting, however, that just because the fee had already been paid and was not dependent on the scheme being sanctioned did not mean it could be disregarded for the purposes of determining classes. The backstop fee was paid in exchange for the underwriting of the new notes, and that service is not provided for nothing. Advisor fees were seen as independent to the scheme and as such should not be taken into account, and the consent fee in itself presented a clear basis for splitting a class.
On the interim funding, it was concluded that interim notes were issued in exchange for funds advanced by the ad hoc group and were not deemed disguised consideration to release or vary rights under the scheme. There was no element of bounty on the notes, and this argument was strengthened by the fact that one significant member of the ad hoc group elected not to participate in the funding.
A key takeaway is that fees or benefits available should be assessed fairly and on a cumulative basis, and parties cannot rely on a simple aggregation of economics. Consideration must be given to what creditors provide in exchange for any benefit and the overall transaction. Taking into account cumulative benefits, what was received in return and the likely alternative of liquidation, the differences in rights between the ad hoc group and other noteholders were not so material as to fracture the class.
Schemes of arrangement continue to play a vital role in how stakeholders seek to restructure company balance sheets. With the exception of the cross-class cram-down, the themes that have arisen over the course of 2020 are not new, but they will continue to be key points of consideration, negotiation and debate in the future. The cram-down adds another layer to this dynamic and will result in even greater analysis and scrutiny of class composition. Given the potential benefits, it is likely to be increasingly seen in the coming months.