Overview

Unlike US Chapter 11 which is a court-led process with substantial transparency and documentation, the English courts’ role is more supervisory, and mostly used for deal implementation.

Many foreign companies choose the UK to restructure due to greater process certainty. This is due to many case law precedents since the GFC, with well-regarded courts, and a significant number of restructuring professionals and distressed investors based in the UK.

The widespread use of English law for finance contracts is another attraction, especially given the Rule in Gibbs – one of the oldest and most controversial pieces of English corporate law – which says that a foreign proceeding cannot vary English Law documents.

However, new revised European regimes prompted by EU minimum standards regulation are closing the gap amid some uncertainty on judgments recognition post Brexit.

To attract foreign restructurings, the English courts have taken a very commercial approach over the years. This included allowing innovative procedures pioneered by law firms, making it easier to engineer sufficient connection to the UK for foreign companies to use UK processes.

One of the main advantages of the UK over Chapter 11 is lower cost and speed. A disadvantage is lack of a worldwide stay, with secondary proceedings such as Chapter 15 often required. Unlike most processes in the EU and as seen with Chapter 11, there are no protections for new money in debtor-in-possession financings, no absolute priority rule, and no automatic moratoria.

English Scheme of Arrangement

The English Scheme is arguably the most used European Restructuring tool. However, it is not an insolvency procedure (still to be legally tested, some think otherwise), sitting in Part 26 of the Company’s Act 2006, rather than the 1986 insolvency act.

As well as being used to implement debt/equity swaps and facilitate creditor enforcement, Schemes can be used to lower contractual voting thresholds to implement corporation actions including takeovers, amend-and-extend and vary debt documents. The voting threshold of 75%, is lower than the typical 90% needed to substantively amend finance documents.

The process typically takes around six-to-eight weeks, after a filing is made with the courts.

Foreign companies must prove sufficient connection to the UK – this can be English law contracts and having the majority of creditors in the UK – no COMI is required. The court often requires expert evidence that foreign courts will recognise the scheme and its effects.

Creditors are split into classes of common interest – there is no hard and fast rule – but not all creditors may be entitled to vote. Only those which are deemed in-the-money are invited to vote, therefore junior creditors can be excluded, as long as their legal rights are not affected.

There is no strict cram down but dissenting minorities in a class can be bound if voting thresholds are met. A Scheme is often combined with a shift of the Scheme Company’s assets to a new creditor-owned company, leaving the SchemeCo and any remaining creditors behind.

The key test for a Scheme is to offer a better outcome for creditors than under an insolvency – also known as the ‘no-worse off’ test. Often a marketing exercise or a desktop valuation is undertaken to provide evidence of ‘where the value breaks’ to the court.

To provide notice to creditors, a Practice Statement Letter is released stating the background and reasons for the Scheme, outline the restructuring terms, suggested classes of creditors, reasons for the class splits, and their treatment.

Around three weeks later, there is a Convening Hearing where the court decides if conditions to hold a Scheme are met, approves class composition and convenes meetings. Notice of potential creditor challenges is normally indicated at this stage – but these are dealt with at the sanction hearing (the Judge may adjust the court timetable to allow time for evidence to be presented and heard).

Creditor meetings are held typically around 21-days after the convening hearing. Each class meeting requires a majority in number (numerosity test) and 75% in value to pass.

At the Sanction Hearing the presiding Judge has full discretion whether to sanction the scheme or not. He will hear challenges on the fairness of the scheme, class composition, jurisdiction, and its effectiveness. Once sanctioned the Scheme is binding on all creditors/shareholders whose rights are dealt with under the Scheme.

Note, not all financial creditors of a company must be subject to a scheme, just those affected by it. Often a Scheme will be done in conjunction with an asset sale/transfer to a NewCo owned by the scheme creditors to implement a debt/equity swap.

UK Restructuring Plan

Similar to the Scheme of Arrangement, the UK Restructuring Plan resides in the Companies Act 2006 (Part 26A), rather than the 1986 Insolvency Act. The primary driver for its introduction was Covid-19 and the need to protect businesses during the downturn.

The Restructuring Plan is a “compromise or arrangement” between the company and its creditors or members. There are two conditions to be satisfied:

1. 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
2. the purpose of the Restructuring Plan is to eliminate, reduce or prevent, or mitigate the effect of such financial difficulties.
   

Similar to the English Scheme, members are arranged into classes, with practice statement letters, convening and sanction hearings.

But the restructuring plan has the ability to bind dissenting unsecured creditors, similar to US Chapter 11 – a so-called cross class cram-down – as long as they would receive at least what they had under a relative alternative. This provides more room for valuation challenges than under a Scheme. The case law on this is evolving, with Virgin Active providing useful guidance. Our analysis on the VA judgment is here for clients.

In theory, junior creditors can also cram-up, as unlike US Chapter 11 (and EU minimum standards) there is no absolute priority rule (which means that junior creditors cannot be paid until seniors are repaid in full) allowing juniors to impose a plan on others if the relevant alternative conditions are met.

There are ipso facto rules, an idea borrowed from the US, which prevents suppliers from cancelling contracts. The new restructuring law can bind non-financial creditors such as landlords and could supplant CVAs to some extent. (More on CVAs later).

Unlike US Chapter 11, there is no automatic moratorium to protect against aggressive actions from financial creditors. There is a separate moratorium under the Insolvency 2002 Act, but it was watered down prior to its introduction and cannot bind financial creditors as capital market instruments are excluded, meaning that lenders can still accelerate their claims.

Company Voluntary Arrangements

These allow a company to agree a composition or arrangement with creditors (usually unsecured claims or trade creditors). CVAs are commonly used to restructure leases of underperforming properties, most notably in the retail and leisure sectors.

Even though it is an insolvency process, the company doesn’t need to be insolvent – it just has to be at ‘risk of insolvency.’ Unlike Schemes and RP, it is not a court process, the courts will not be involved unless a CVA is challenged.

A CVA is implemented under the supervision of an Insolvency Practitioner (IP). Directors remain in control, but the IP will assist in preparing the CVA and issues an opinion whether it has a reasonable prospect of being approved/implemented.

The IP will issue a statement of affairs, nominees report and voting forms, with 14-days’ notice required to be given for creditors.

Under a CVA there is a single class of creditors, but different groups of creditors within this class can be treated differently. For example, in rent reducing CVAs, landlords can be bracketed into different groups with varying rental payment options.

At least three-quarters by value of those responding must vote in favour for it to pass, with at least 50% of total value admitted to vote. If passed the CVA binds all unsecured creditors that were entitled to vote.

A CVA cannot compromise senior creditors, and their permission may be needed and/or a Scheme required if their debt is to be restructured or its terms altered.

Challenges must be filed within 28-days. To succeed, it must be shown that there is either a material irregularity in the procedure, such as failure to supply sufficient information, and/or the CVA unfairly prejudices the interests of a creditor. They will need to prove the CVA is unfair, and to evaluate this the court will normally compare the challengers’ position with other creditors and other classes of creditors.

Creditor Challenges

Significant case law exists over the past decade for challenges to English Schemes. For English Schemes the court has discretion not to sanction on the grounds of “fairness.” The key test is whether an honest and intelligent member of such a class must reasonably approve the scheme.

The rise of ad hoc creditor groups and their use of backstop and work fees has led to creditor challenges if they should be treated as a separate class. Known as fracturing a class, most notably (unsuccessfully) challenged by Akshay Shah in Codere – this judgment gives a lot of latitude for ad hoc groups to claim fees.

Junior creditors, not subject to Scheme’s have regularly challenged at Sanction Stage. The Swissport case showed difficulties for out-of-the money creditors successfully making challenges – the ruling referring back to the failed MyTravel Scheme challenge in 2004.

UK Restructuring Plans are newer, so have less precedents, but Virgin Active (the first cram down challenge) guided that similar to English Schemes, out-of-the-money creditors should not be able to abuse the RP process.

As the late Robin Dicker QC acting for the landlords said at VA’s convening hearing colourfully said: “if you are not sitting at the table, that is because you are lunch.”

A UK Restructuring plan can still be sanctioned by the court where one or more classes do not vote in favour of the plan if:

A. None of the dissenting class would be worse off in the relevant alternative and;

B. The plan is approved by at least one class of creditors with a genuine economic interest in the relevant alternative

Justice Trower on DeepOcean said that if Conditions A and B were satisfied it will have a ‘fair wind behind it.’ Justice Snowden, however, said in Virgin Active that “He was certainly not saying that satisfaction of Conditions A and B would, of themselves, be sufficient in all cases.”

He added: “it is obviously important the potential utility of Part 26A [UK Plans] is not undermined by lengthy valuation disputes but that the protection for dissenting creditors given by the “no worse-off test” (and the courts general discretion) must be preserved.”

Under Virgin Active, landlord challenges to the categorisation of leases and calculation of relevant alternative were dismissed by Snowden. He gave short shrift to their arguments that VA could have submitted a better alternative plan – sticking to assessing what was presented before the court. The main takeaway is that successful future challenges are likely to need fully funded alternatives from challengers and substantive valuation evidence.

New Look last May, provides the most useful case law for CVA challenges. New Look’s Landlords launched a challenge to their CVA as ‘unfair and prejudicial’. It was heard around the same time as Virgin Active, with the two judges mindful of the precedents.

Justice Zacaroli looked at the vertical (or no worse off) and horizontal (honest and intelligent man) comparators, stressing the importance a statutory majority should share sufficiently similar rights with the minority it seeks to bind. 

He suggested that the courts might look at alternative allocations and any restructuring surplus, the nature and extent of different treatment for creditors, and “a finding of unfair prejudice ought not to be precluded merely because the same result might have been achieved in a part 26A [UK Restructuring] plan”.

Potential Changes

On 21 June the UK Insolvency Service published its interim report on the 2020 Act, covering restructuring plans, stand-alone moratorium and ipso facto clauses. It said:

• Restructuring plans are seen as too costly and time-consuming, especially for SMEs
• Costs of challenging a restructuring plan are seen as excessive, reducing protections for dissenting creditors;
• Greater disclosure and transparency requirements are needed, and:
• Giving restructuring plans expressed extra-territorial effect – as similar to US Chapter 11, RPs could have a wider (potentially global) reach beyond the UK – this would reduce costs and create greater certainty
  

With some restructuring plans costing £2m to £10m depending on company size, there is an urgent need to streamline the processes and documentation. This could involve the use of less costly courts and widen the number of Judges able to sanction plans, and dispensing with the convening hearing for SMEs, said one advisor involved in the consultation.

The UK has launched a public consultation (closes on 22 September) to extend recognition and enforcement of insolvency-related judgments and/or adopt the UNCITRAL Model Law on Enterprise Group insolvency. This should assist in dealing with inbound requests for recognition.

• It stops short of suggesting the adoption of UNCITRAL Judgments Model Law – which means Gibbs is safe (for now) – the release hints of future public consultations
• Enterprise Group Model Law allows for management and coordination of corporate group insolvencies, while respecting that each company remains a separate legal entity
• Would facilitate the recognition and enforcement of foreign insolvency-related judgments, via the Model Law’s Article X provision

Kirkland & Ellis have provided a good explainer. We will be providing an update on this and potential changes to the UK Restructuring Plan in the coming days.