R&I Insight H1’24 Wrap: Creditors Try to Regain Control; New 26A Guidance; Overseas Restructuring Tech Improves

In Europe, the first six months of 2024 have seen novel developments in creditor behavior as debtors enter into the financial difficulty zone. Creditors have turned to Cooperation Agreements to bolster their position and also sought to rely on Directors Duties to protect themselves from aggressive liability management exercises, or creditor-on-creditor violence.

The English law restructuring plan, or 26A, now four years old, has been extensively used by both large cap and SME debtors this year to restructure their financial obligations. As the boundaries of what is possible under a 26A is tested by plan companies, useful judgments in Aggregate, McDermott and also Adler (Court of Appeal) this year have provided guidance. Further, clarification around when security for costs can be obtained when a creditor challenges a 26A was provided in Consort Healthcare Tameside’s 26A.

Apart from 26A guidance, the English courts also provided useful precedent on breach of English law directors duties, wrongful trading and provided the first ever award for “misfeasance trading” in a claim against two directors of BHS.

The tricky issue of restructuring debt where sanctioned entities are involved was also addressed during the first half when administrators to VTB Capital, the U.K. arm of Russian lender VTB Bank, were granted an amended license from HM Treasury’s Office of Financial Sanctions in order to pursue an English scheme of arrangement.

Looking further afield in Europe in 2024, valuable lessons about how the new French Restructuring regime could be applied were learned from both Emeis (fka Orpea) and Casino, providing crucial insights to investors involved in Atos’ restructuring. The relatively new Dutch restructuring tool (WHOA) was used by Dutch football club SBV Vitesse Arnhem, amidst the odd scenario where one of the player’s fathers attempted to be appointed as restructuring expert.

Earlier this year, U.S. engineering group McDermott broke new ground by implementing its restructuring using an English restructuring plan under Part 26A of the U.K. Companies Act in tandem with an inter-conditional WHOA. These “parallel proceedings” were also accompanied by a chapter 15 recognition hearing in Houston, meaning three separate court jurisdictions were involved.

Finally, a biomedical business park in Istanbul, also used the WHOA to implement its restructuring. This is notable for being the first time a debtor has consensually changed the governing law of its debt from England and Wales to the Netherlands in order to rely solely on the WHOA restructuring tool, successfully sidestepping the so-called “Gibbs” rule.

This H1 2024 wrap collates the aforementioned new precedents or development in more detail below, and takes a look at how 26A have been used over the last four years.
 
Corporation Agreements - Agreements which aim at providing creditors with ways to collectively improve their bargaining power against a borrower, have featured in Europe recently. They stem from creditors needing to defend their investment where covenant protection is ambiguous or insufficient.

As borrowers of covenant-lite debt, issued during the low interest rate environment of 2019-2022, become financially distressed, creditors have experienced limited controls over borrowers acting in conjunction with their sponsors to remove value away from creditors’ remit.

Loose protections mean that borrowers have first-mover advantage when experiencing financial distress, allowing them to execute liability management exercises, or LMEs, which can damage the position of creditors. A company’s management and its sponsor are likely to be significantly aligned in their financial objectives for an LME or restructuring and are able to act quickly - with a united front to implement transactions that may catch creditors off-guard.

Furthermore, certain complicit lenders more experienced with LMEs and managing distressed scenarios, may move quickly in obtaining advantageous deals or lending arrangements with the borrower to the disadvantage of other lenders (creditor-on-creditor violence).

Directors Duties - Lenders to stressed borrowers have found themselves grasping for other means of control, where the covenant packages in lending documentation provide little control over a borrower’s actions. The obligations of a borrower’s management to abide by their duties to their company can, in certain circumstances, provide another means of power over a borrower company, where the borrower begins to act in an unfavorable way toward lenders.

The directors’ duties exist to ensure the responsible management and governance of a company, safeguarding the interests of shareholders, employees and other stakeholders. However, it is important to note that in most circumstances, a director owes their duties to the company they are appointed to, rather than separately to any third party. Altice France recently caused a huge stir among investors when it designated key media business subsidiaries as unrestricted subsidiaries, removing their value away from bondholder recourse, all without breaching the telecommunications company’s covenants.

Investors were left scrambling to find a way to control management, and among a lack of any lending documentation protection, some questioned whether they could find solace in the French law directors duties regime. Across Europe, directors’ duties are contained in the legislative (and common law) corporate regime of the incorporation jurisdiction of a debtor company and will bind the behavior of directors. These duties, however, are far less prescriptive than the covenant usually found in lending documentation. They are not specific in nature and are designed to provide general guidance to directors on how to behave responsibly.
 
Adler - CA - German real estate company Adler’s Part 26A restructuring plan, sanctioned last year, has become the first of its kind to be appealed, and subsequently overturned, in the English Court of Appeal. The Court of Appeal judgment clarifies and restates existing case law in relation to restructuring plans. The appeal was allowed for two main reasons:

(i) The plan had departed from the pari passu principle that would have applied in the company’s presented Relevant Alternative; and

(ii) Leech J had erred in exercising his discretion under sections 901F and 901G when sanctioning the plan.

Key takeaways from Adler:
 

• A company proposing a restructuring plan should be mindful of straying from the pari passu principle, especially when considering the different treatment of creditors, without justification.
   
• Notably, departure from the pari passu principle is acceptable where it is justifiable - for example if certain creditors provide additional consideration to the company, they can be treated more favorably.
   
• When the company asks the court to exercise cross-class cramdown, or CCCD, in the context of a Part 26A, it should consider alternative proposals from creditors that are relevant to the fairness of the Part 26A.
   
• The overall voting support for a plan is not relevant when deciding whether CCCD can be used to impose a plan on a dissenting class of creditors, so long as the 75% threshold is passed.
   
• The “rationality test” does not apply to a Part 26A where CCCD is being invoked, instead a court should identify “whether the plan provides for differences in treatment of creditors inter se and, if so, whether the differences are justified.”
   
• Retention of equity by shareholders of the parent company is permitted. It had been argued that this was a further departure from the pari passu distribution principle that would have applied in the Relevant Alternative and there was no justification for this, but Snowden LJ refused to accept this submission adding that the principle “does not require the shareholders of a company to forfeit their shares.”

The CA Judgment is subject to appeal to the Supreme Court.

Aggregate - The English High Court declined to sanction a Part 26A restructuring plan proposed by a subsidiary of German real estate group Aggregate or to approve amendments to the plan designed to neuter concerns that junior creditors were being wiped out for no consideration.

Instead, the court made an order under section 901C(4) of the Companies Act, 2006 to convene fresh creditor meetings excluding out-of-the-money subordinated creditors from a vote on the amended plan.

The key takeaways from the judgment are as follows:
 

• The decision affirms obiter reasoning in the Adler Court of Appeal judgment that the court has no power to sanction a confiscation or expropriation of rights for no compensation under Part 26A;

• For the purposes of the “Condition B” threshold test in section 901A of Companies Act, 2006, the proposal must “constitute a ‘compromise or arrangement’ for every class of creditor or member to whom it is directed.”

• The court has no power to subsequently amend a proposed plan that does not meet the threshold conditions in s901A; and

• The court declined to determine whether a s901C(4) order could retrospectively disenfranchise classes that are subsequently found to have no economic interest in the relevant alternative, thus allowing a plan to be sanctioned without an application for a cross-class cramdown.

McDermott - McDermott successfully used the 26A tool to compromise around $1 billion of unsecured claims held by Reficar (and other claimants) originating from an arbitration award. Reficar launched an in-court challenge to the plan, however that was unsuccessful.

Key takeaways from McDermott:
 

• A court can only exercise jurisdiction under a Part 26A if there is some sort of “compromise” between creditors and the plan company, however extremely small payments to disenfranchised creditors (0.2%) appear sufficient to pass this low threshold.

• Part 26A has developed a different approach than the "absolute priority" rule found in certain other regimes. The party entitled to the restructuring surplus should determine its distribution, however, where a restructuring surplus is made in a manner which is inconsistent with the absolute priority rule, enhanced scrutiny and challenge may be expected.

• Case law provides that the creditor being crammed down must be “no worse off” under the plan than in the “relevant alternative”. There is a burden on the plan company to prove that the relevant alternative is in fact the most likely scenario should the court decline to sanction the plan. One of the factors which the court will consider in terms of this burden is the behavior of challenging creditors in the lead up to a plan.

• When making his decision on McDermott’s Part 26A Plan, Mr Justice Richards noted that challenging creditor Reficar’s arguments about the relevant alternative were fatally undermined by its extraordinary conduct. The judge therefore felt it unnecessary to indulge Reficar by dealing with every single point it sought to raise in opposition to the Plan. Most of its points were viewed to have been severely undermined by its refusal to agree to the very deal that it sought.

• The Part 26A tool is able to compromise both claims that originate as debt claims, and claims stemming from arbitration or litigation awards.

• Regarding the some $152 million McDermott spent on the legal proceedings, the judge commented that there seems to be “something wrong with the restructuring industry… where the costs appear to be out of control.” The judge’s comments on fees must of course be balanced with the magnitude of the restructuring. The McDermott group comprised nearly 300 entities across the globe.

BHS - The English High Court ordered two directors of collapsed U.K. retailer British Home Stores, or BHS, to pay about £18 million for breach of directors’ duties and wrongful trading after a five-week trial in late 2023.

Justice Thomas Leech’s 533-page judgment is understood to be the largest ever award for wrongful trading in the U.K. and the first ever award for “misfeasance trading” brought under s.214 and s.212 of the Insolvency Act 1986, respectively.

The wrongful trading claim was brought by the joint liquidators of BHS and concerns the conduct of the directors who presided over what lead counsel for the liquidators described as “the disastrous final months of [BHS’] trading.”

Leech J found that two directors “either knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation,” yet continued to trade. Notably, the judge said that the case was a good example of “insolvency-deepening activity,” which occurs when directors of a distressed company undertake a risky transaction which, if it fails, would worsen and not improve the company’s insolvency.
 
VTB Scheme - Administrators to VTB Capital, the U.K. arm of Russian lender VTB Bank, were granted an amended license from HM Treasury’s Office of Financial Sanctions in order to pursue an English scheme of arrangement.

VTB Capital was placed into administration by the High Court in December 2022. Although entirely solvent – with liabilities of $980 million and assets of $1.32 billion – the lender was unable to operate due to the effect of full blocking sanctions against Russia. VTB is ultimately controlled by the Russian state.

The joint administrators, having recovered £152.5 million from Euroclear and settled litigation in the English courts, now consider they have sufficient funds to pay creditors.

Accordingly, a scheme was prepared and sanctioned in order to effect a “quick and efficient” distribution to preferential and unsecured creditors and deal with issues arising from sanctioned creditors and assets stranded in Russia.
 
McDermott Parallel Proceedings - U.S. engineering group McDermott recently broke new ground by implementing its restructuring using an English restructuring plan under Part 26A of the U.K. Companies Act in tandem with an inter-conditional Dutch scheme known as wet homologatie onderhands akkoord, or WHOA.

These “parallel proceedings” were also accompanied by a chapter 15 recognition hearing in Houston, meaning three separate court jurisdictions were involved.

The cross-border processes enabled McDermott to secure a three-year maturity extension for secured creditors and extinguish $1.65 billion of unsecured debt by way of equitization.

Key takeaways:
 

• What is a parallel process? A parallel restructuring process is where two or more restructuring tools in different jurisdictions are used contemporaneously to enable multijurisdictional companies to restructure debt in a way that is recognised and effective in multiple jurisdictions.
   
• Why is it necessary for some Part 26A plan companies to use a parallel process? Using a parallel process in a second jurisdiction to implement a restructuring ensures that creditors in the jurisdiction of the secondary process will be bound by the restructuring. It can also allow foreign debt to be discharged under its own governing law.
   
• What are the key differences between a Dutch WHOA and an English Part 26A? We have highlighted company valuation methodology, voting and distress thresholds and class composition as key differences between the two processes.
   
• Do we expect to see more parallel restructurings in the future? Given how effective McDermott’s large-scale parallel process was, we envisage more companies opting to implement restructurings across multiple jurisdictions via similar methods in the future.

Reorg’s Legal Director, Shan Qureshi, spoke with law firm Freshfields’ Michael Broeders who acted as the restructuring expert in McDermott’s WHOA. Listen to the full conversation HERE.
 
As well as the WHOA used by McDermott, explained above, the tool was also used by:

Bio City Development Co. - This entity is the holding company of a biomedical business park in Istanbul, Turkey. The plan company used the proposal to address an $880 million maturity wall on a series of convertible bonds due in July, and transfer ownership to a purchaser, an existing bondholder. Bio City was advised by Clifford Chance on the deal.

The restructuring is notable for being the first time a debtor consensually changed the governing law of its debt from England and Wales to the Netherlands in order to rely solely on the WHOA restructuring tool, successfully sidestepping the so-called Gibbs rule.

The 1890 case of Antony Gibbs & Sons v La Société Industrielle et Commerciale des Métaux provides that debt governed by English law cannot be discharged by a foreign insolvency proceeding without creditor consent. Typically, this results in two parallel proceedings in the Netherlands (or elsewhere) and the U.K as most recently seen in the restructuring of engineering group McDermott (explained above).

Sources close to the deal said the restructuring is the most complex so far considered by the Dutch court without a parallel proceeding abroad. They also told Reorg that the WHOA was “orders of magnitude cheaper” than an English court process requiring two court hearings.

Vitesse - In April, the football club opened a Dutch WHOA procedure with a view to presenting a restructuring plan. The court also appointed a restructuring expert to negotiate a viable alternative to bankruptcy. However, a restructuring plan may not be viable if the club is not permitted to keep its license by the KNVB. In order to retain its license, Vitesse must present a balanced budget.

Absent a willing investor, the club was forced to present a budget to the KNVB on June 17 containing a multimillion-euro deficit. Current owner, U.S. private equity investor Common Group described this as a “massive unforced error” which will “jeopardize” the club’s license. Vitesse was relegated from the Dutch premier league (Eredivisie) in April after historic points deduction imposed by the Dutch football association, the KNVB. The club was docked points for providing incorrect information to banking partners and authorities investigating undisclosed links to sanctioned Russians.

Last year, an investigation by the Bureau of Investigative Journalism and the Guardian uncovered a complex network of loans between the club’s holding company and a series of companies which ultimately appeared to trace back to former Chelsea owner Roman Abramovich. Abramovich is currently subject to U.K. and EU sanctions.

As a result of relegation, the club said it expects a 42% drop in revenue to around €11 million, mostly due to the loss of TV rights. Last season, the club had a cost base of €27 million which it has since cut by €10 million. Vitesse has debt of about €18.9 million, of which €14.3 million is owed to Common Group.