The Court of Appeal's decision will be particularly significant for companies, creditors and their advisers faced with putting together and seeking support for restructuring plans ("RPs") (under the Part 26A court procedure introduced into the Companies Act 2006 by the Corporate Insolvency and Governance Act 2020), especially where an attempt is made to cram down a class of dissenting creditors - the so-called "cross class cram down" feature of Part 26 - as part of the sanctioning of the RP by the court. It marks the first time that the sanctioning of a RP has been appealed (and successfully) and provides detailed and important commentary from a notable senior Chancery judge on how the court's discretion in cram down cases should be exercised.
Key takeaways from the decision
- when considering whether to exercise its discretion to sanction a RP which involves the "cram down" of a class of dissenting creditors - binding them to the RP despite them not approving the RP by the statutorily required 75% in value vote in favour of their class in attendance at the court meeting - adherence by the terms of the RP to the pari passu distribution to all unsecured creditors principle will be a paramount consideration for the court, any departure from which will require "a good reason".
- when deciding whether to sanction a RP with cram down, the application by the court of the so-called "rationality test" - is the RP one that "an intelligent and honest man, a member of the class concerned and acting in respect of his interest might reasonably approve" - needs modification from the way in which it is applied to classes in RPs or schemes without cram down. The test cannot be applied in the same way as it is where no cram down is involved, i.e., taking account of what may still be a simple majority level of voting in the dissenting class (albeit falling short of the statutory 75% threshold).
- while in the case of a scheme (with no possibility of cram down) the court does not need to consider whether a better or fairer compromise might have been proposed, in the case of a RP with cram down the position is different and this consideration can be relevant to the exercise by the court of its sanctioning discretion.
- the Part 26A jurisdiction does not entitle a court, when sanctioning a RP, to order the confiscation or cancellation of "out of the money" debt or equity for no consideration.
Background
Adler is a German property company that came under scrutiny and financial pressure in late 2021 and 2022, forcing it to enter into discussions with its creditors with a view to agreeing a restructuring of its debts, in particular a series of unsecured notes with maturities ranging from 2024 to 2029 (the "Notes"). Having failed to receive sufficient support for its restructuring proposals pursuant to a consent solicitation exercise, in 2023 it brought forward a RP to modify the terms of the Notes.
To do this Adler made use of an "issuer substitution" provision in the terms of the Notes under which the Notes became primary liabilities of a new UK incorporated Adler subsidiary, guaranteed by the Adler parent company. This tactic is not uncommon and was not an issue under appeal in this case; however,it is worth noting below what Snowden LJ had to say about it.
Coupon payments on the Notes would be suspended for two years, capitalised and increased, a new loan to value covenant inserted into the Notes, new money provided to pay off certain other Notes falling due and other expenses. In addition, the 2024 Notes would see their maturity date extended by a year but also, under the terms of an intercreditor agreement regulating the application of the proceeds of any enforcement of security to be granted in respect of the Notes, the 2024 Notes would rank ahead of the other series of Notes which would rank equally between themselves.
The various series of Notes voted on the RP in separate classes, each class approving the RP by the required 75% vote except for the 2029 Notes which only approved the RP by a 62.28% vote. In April 2023, the High Court, under some timing pressure, gave its sanction to the RP, exercising its jurisdiction to cram down the 2029 Notes and so binding them to the RP despite their lack of 75%+ approval.
Significantly, while indicating that they intended to seek leave to appeal the sanction ruling, the dissenting Noteholders did not ask for a stay in the sanction order becoming effective with the result that the company immediately filed the order with the registrar of companies so that the order and changes to the terms of the Notes to become effective on the same day as the sanction order was made.
The Pari Passu principle
This was the main issue in the appeal. By continuing in the RP the sequential payment of the different series of Notes, the RP departed from the pari passu (equal footing) basis on which all the Notes would be repaid in the most likely alternative for the company - referred to as the "relevant alternative" in Part 26A - if the RP was not approved (i.e., its liquidation).
One of the two conditions for cram down under Part 26A is that none of the members of the class being crammed down "would be any worse off than they would be in the event of the relevant alternative". The dissenting Noteholders argued that the later maturity dates of their Notes under the RP when compared to their ranking equally for payment with all the other Notes in a liquidation, meant that the principle had been departed from and that they faced a greater risk that the managed wind down of the company's business and realisation of assets under the RP would not produce enough to pay them off in full as well as the earlier maturing Notes. There was no good or proper reason for this.
The sanction judge had recognized the importance of this concern but had concluded that, on the basis of valuation evidence and what was referred to as the company's "alternative case", the most likely outcome would be that the 2029 Notes would be paid out under the RP pari passu with all the other unsecured Notes. The "alternative case" was that as a result of the insertion of the loan to value covenant in the Notes, if the managed wind down was not working, the covenant would be breached and the 2029 Noteholders would be able to accelerate repayment of their Notes. While accepting that this still involved a greater potential risk for the 2029 Notes, the judge decided that it was not unfair to require those Notes to accept a greater level of risk that the earlier dated Notes.
Snowden LJ disagreed. The judge's finding, on the basis of forward-looking valuation predictions, that "on a balance of probabilities" it was likely that the 2029 Notes would be paid, failed to satisfy a requirement that the RP should not depart from the pari passu principle as regards the crammed down creditors. There was no good or proper reason evident to justify such a departure. The "alternative case" argument did not help either since by the time that enforcement occurred, it was quite possible that earlier dated Notes would have been paid out in full before payments could be made on the 2029 Notes.
Snowden LJ did, however, accept that giving the 2024 Notes ranking priority under the intercreditor agreement and security mentioned above, and so departing from the pari passu principle, could have been justified - on the basis that by deferring their maturity the holders of those Notes would be allowing the group a longer period in which to start the realisation of assets under its "managed" wind down.
Rationality test
Snowden LJ agreed that a judge could, when considering whether to impose cram down on a class have "some regard" to the level of support for the RP within the dissenting class short of the required 75% (#131, 208 from the judgment). However, this required great care and a court should not simply "apply some form of rationality test based on the level of voting in the assenting class or classes, or upon the overall value of claims voted in favour of the plan across the assenting and dissenting classes as a whole" (#134). Proper scrutiny of the representative nature, completeness of information and absence of extraneous motivating factors among those in the class approving the RP is required.
Specifically, "the exercise [of the judge's cram down discretion] cannot, however, properly be carried out merely by asking whether any dissenting creditor will be any worse off as a result of the [RP] than in the relevant alternative" (#160). Rather, the court must "inquire how the value sought to be preserved or generated by the [RP], over and above the relevant alternative, is to be allocated between [the] different creditor groups" (#160). This is what has been called the "fair distribution of the restructuring surplus" and involves analysis of the so-called "horizontal comparator - in this case, comparing the position and treatment in the RP of the 2029 Noteholders with that of the other classes of Noteholders.
Although the 2029 Notes class meeting had recorded a 62.28% vote in favour of the RP, on closer analysis it seemed that those investors holding only 2029 Notes represented a mere 3% of the €800 million 2029 Notes with many having either minimum or very small holdings. Snowden LJ commented that "on any view, that cannot be regarded as a representative cross-section of the class of 2029 Noteholders".
Is a better or fairer plan available?
The trial judge had rejected the 2029 Noteholders' argument that, in contrast to the usual position for scheme sanctions, when the exercise of cram down is being considered, the court should consider whether a better or fairer plan for distributing the restructuring surplus might have been proposed. Snowden LJ disagreed with that and approved previous statements by judges in a CVA case and a recent Part 26A case, that a consideration of the fairness of a RP's proposed allocation of the restructuring surplus among the different creditor classes should involve comparing the RP which the court is being asked to sanction against alternative arrangements or structures (#173-181).
Cancellation/confiscation of "retained" equity
The 2029 Noteholders lost their argument - both before the trial judge and on appeal - that the RP further departed from the pari passu principle by allowing the existing shareholders to retain their interest in the group even though they ranked behind the Noteholders. As Snowden LJ succinctly said: "the principle of pari passu distribution of assets in an insolvency does not require the shareholders to forfeit their shares" (#241).
He went on to give his "provisional view" that "there is no jurisdiction under Part 26A to sanction a compulsory cancellation or transfer of shares in a debtor company for no consideration" (#258). The result is, in Snowden LJ's view, that the "two stage restructuring process" which is commonly utilized under schemes - under which the claims of the "in the money" creditors are transferred to a newly formed company which acquires the scheme company's business in return, leaving the shareholders and "out of the money" creditors who are not parties to the scheme behind in a shell company - cannot be avoided under Part 26A by simply confiscating the interests of those shareholders and creditors as a term of the RP. Critically, as with schemes, any RP needs to represent a "compromise or arrangement" which case law clearly shows must involve some element of "give and take" between the company and the parties to its scheme or RP (see #258-277).
Issuer substitution
As mentioned above, the company, in order to make use of the Part 26A restructuring procedure (which it needed to do, having failed with its consent solicitation), exercised its German law rights under the Notes to substitute a UK incorporated company as the issuer. This step in the restructuring was not contested by the 2029 Noteholders before the English courts (although it was in Germany) and so was not considered on appeal. Snowden LJ made a point of saying that "for the avoidance of doubt, and without expressing a view one way or the other, I would wish to make it clear that the fact that this judgment does not deal with this issue should not be taken as an endorsement of the technique for future cases." A cautionary note for future use of the procedure where there is creditor opposition to the restructuring proposals and so a possible first time review of it by the court?
Timing pressures on court time for RPs involving possible cram down
Snowden LJ pointed out in his judgment the particular timing pressures that litigation involving Part 26 A plans with cram down is likely to face. Companies must make relevant information underlying valuation evidence available in a timely manner and recognize that the court will be ready to order specific disclosure of key information if this does not happen. He went on to say that "it must also be emphasised that the court's willingness to decide cases quickly to assist companies in genuine and urgent financial difficulties must not be taken for granted or abused. ... [there must be] appropriate time [for the court] to hear the case and to deliver a reasoned decision, and ... time for the determination of any application for permission to appeal. If this is not done, the parties can have no complaint if the court decides to adjourn hearings and to take whatever time it requires to give its decision" (#65).
Did the 2029 Noteholders win?
Although the sanctioning of the RP was set aside by the Court of Appeal's (unanimous) judgment and the judgment records that counsel for the company accepted that "in that event, at least so far as English law is concerned [emphasis added], the alterations to the terms and conditions of the Notes effected by and under the Plan would be ineffective, and the parties would have to consider their respective positions in light of our judgment." and that the court was "content to hear the appeal on that basis" (#97), on the same day as the judgment was handed down Adler announced that it would be continuing on its restructuring path as planned.
Specifically, it noted that the amended Notes terms have formed the basis of its ongoing liabilities, and - a point to which Snowden LJ drew attention and found "surprising" - the appellants in April 2023 did not apply for the appeal to have a suspensive effect on the sanction order. It also said that the implementation of the restructuring in April 2023 was carried out in accordance with German law and "therefore the terms and conditions of the bonds remain valid regardless of the decision by the Court of Appeal to set aside the sanction order". It said that while it respects the Court of Appeal decision, that "has no impact on the Adler Group or the effective amendments to the bond terms."
Obviously, in this case there are conflict of law complexities - English and German law considerations - but another lesson from the judgment is also clear. As Snowden LJ said: "this may be yet a further example of the difficult issues that can arise when complex cases such as this are heard at the last minute under significant pressures of time. If similar circumstances arise in the future, such matters should be raised by the parties with the judge."
"I would allow the appeal and set aside the Judge's Order sanctioning the Plan. By adhering to a sequential payment of the different series of Notes, the Plan departed in a material respect and without justification, from the scheme of pari passu distribution of the assets of the Group to Noteholders that would have applied in the Relevant Alternative. In my judgment, the Judge erred in principle in his approach to the exercise of his discretion under sections 901F and 901G to impose the Plan on the dissenting class of 2029 Noteholders" Snowden LJ at #280 of his judgment.
https://www.bailii.org/ew/cases/EWCA/Civ/2024/24.pdf