The proposed schemes of arrangement for certain creditors of Boart Longyear Limited (BLY) - following very recent decisions in New South Wales at trial and now appellate level - are significant for restructuring and distressed investing professionals transacting in Australia. In particular, those decisions explore the principles for separation of affected creditors into classes, and highlight that different treatment of creditors in the same class does not of itself lead to division of those differently treated creditors into separate classes.
Need to know
The scheme proposed by BLY for its senior secured creditors involved one group of senior-ranking lenders (led by entities managed by Centerbridge) voting in the same class as another group of senior-ranking lenders (including entities managed by First Pacific) on whether to approve the scheme. This was despite the Centerbridge entities receiving different consideration under the scheme. First Pacific objected, contending that this different treatment ought to see Centerbridge vote in a separate class, which would then disable Centerbridge from cramming down First Pacific through the scheme. That objection was rejected at first instance and again on appeal.
From that outcome, a number of key lessons emerge:
- The focus of the Court's consideration when considering constitution of classes of creditors under a scheme is on legal rights of creditors against the target company and on legal treatment under the proposed scheme. Wider, commercial considerations for particular affected creditors do not play a part.
- Different treatment of some creditors in the same class does not of itself lead to those particular creditors being separated into their own class.
- When considering different treatment, comparing outcomes for both groups of creditors under the scheme against the liquidation counter-factual is critical. Compared to that liquidation counter-factual, the BLY scheme was shown to produce better outcomes for both Centerbridge and First Pacific. This was central to the Court's conclusion that those groups should vote in a single class.
- The considerations relevant to application of the test for separation of classes are context-specific and can be wide-ranging. An outline of those considerations is set out below in detail.
- Importantly, exclusion of First Pacific from negotiations of the Restructuring Support Agreement (RSA) was not a basis for the Court refusing to order that a meeting of creditors be convened to consider the proposed scheme.
- A decision on class voting arrangements at the first Court hearing does not preclude dissatisfied creditors from continuing to oppose the scheme at the second Court hearing (to finally approve the scheme, once voted on by creditors) - different treatment of creditors in a single class may well provide grounds for objecting to Court approval of scheme's class structure on the basis of wider fairness considerations.
All of those matters determined, the Court ordered meetings of BLY's creditors to be convened to consider the proposed schemes. Those meetings of creditors have since occurred, with the requisite majorities obtained. It will now be a matter for any opponents of the schemes to raise their challenges, on fairness grounds, at the second Court hearing, expected for 4 July 2017.
For those interested, greater detail follows below.
BLY defaulted on payments of interest to its debt holders on 1 April 2017. Absent a restructuring of its debt, BLY would be insolvent.
Centerbridge held nearly half of the ordinary shares in BLY, a significant portion of BLY's Senior Secured Notes (SSNs) and had also provided two term loans to BLY in October 2014 as part of a previous restructuring transaction. Another creditor, First Pacific, held 29% of the SSNs.
Following BLY’s default on interest payments under the SSNs, it entered into an RSA with several of its creditors, including Centerbridge. The RSA contemplated a restructuring of Centerbridge's term loans and the SSNs, together with a restructuring of Senior Unsecured Notes also on issue by BLY.
Broadly, BLY proposed two interdependent schemes with its creditors, being:
- Unsecured Creditors Scheme: this provided for the holders of notes under a 7% Senior Unsecured Notes Indenture and the holders of subordinate claims against BLY; and
- Secured Creditors Scheme: this provided for holders under a Senior Secured Notes Indenture (including First Pacific) and two Term Loans under Securities Agreements and creditors under the Restructuring Support Agreement (including Centerbridge).
Critically, the Secured Creditors Scheme would see:
- the term loans held by Centerbridge restructured, including by way of conversion of debts into substantial further equity in BLY; and
- the SSNs restructured by way of changes to repayment terms for those loans (with no conversion of those debts into equity in BLY).
The main tactical issue – division of classes
A scheme of arrangement is not binding on a class of a company’s creditors unless it has been agreed to by the requisite majority of creditors in that class (section 411(4)(a)(i) Corporations Act 2001 (Cth)).
In this case, it was clear that if SSN holders (First Pacific's interests) were treated as a separate class from term loan holders, then First Pacific had a sufficient percentage interest in the SSNs to block approval of the scheme at that separate class meeting. On the other hand, if the SSN holders and term loan holders (ie, Centerbridge) were treated as a single class, then Centerbridge, which committed to supporting to the scheme under the RSA, had a sufficient interest in the total SSN and term loan debt to deliver the required majority at a scheme meeting.
Test - When are separate class meetings ordered?
Creditors will not be put into a class when it would be impossible for them to consult together with a view to their common interest. The rationale for separating voters into different classes is to afford the parties justice by allowing for representation of the different interests of different creditors, which may differently affect their minds and their judgment on the proposed scheme.
The Court of Appeal has explained in the BLY decision that, in a creditors’ scheme concerning an insolvent entity, the Court asks three questions:
- What are the existing creditors’ legal rights and to what extent they are different?
- To what extent are those rights differently affected by the scheme?
- Does the difference in rights/treatment of rights make it impossible for the creditors to consider the scheme as one class?
From that point, the question of separation into classes involves achieving a balance between
- Giving each class the opportunity to veto a scheme to avoid oppression of the minority by the majority; and
- Supporting the underlying concept of decision by large majority.
To this extent, the Court will discount or disregard altogether the votes of creditors who, though entitled to vote at a meeting as a member of the class concerned, have such personal or special interests in supporting the proposals that their views cannot be regarded as fairly representative of the class in question. Prior to this, their votes can be tagged so as to avoid difficulty in identifying them.
Applying the test to the BLY scheme - a wide range of relevant factors
Having explained the principles, the Supreme Court then proceeded to consider a wide range of factors relevant to the proposed BLY scheme.
Commonalities between SSNs and the term loans
The Court reviewed the common features in respect of the SSNs and the Term Loan relevant to the three-question test set out above:
- The debts were issued and guaranteed by the same entities within the BLY Group;
- Creditors in respect of each category of debt face a common and imminent issue as to BLY’s insolvency; and
- Both SSN holders and Term Loan holders were party to complex security arrangements over common assets, so that in any insolvency of BLY, the SSN holders and the Term Loan holders would likely have to negotiate arrangements between themselves to allow the realisation of the securities in an insolvency.
The Court determined that these matters tend towards the treatment of the three groups of secured scheme creditors as a single class.
Differences between the SSNs and term loans that affected class separation
From that point, the Court considered the differences between the SSNs and the term loans to be relevant to the application of the class test:
- Under the scheme, there would be a change in BLY's interest payments on the SSN debt from cash to an option to pay interest in kind until December 2018, with retrospective effect to January 2017 and this did not apply to the Term Loan.
- The Court determined that this created practical difference because BLY would potentially have the capacity to pay interest after its solvency was restored by the scheme but would not need to for the SSN debt until December 2018. However, this was not alone determinative as it is outweighed by the commonality of their interests;
- Centerbridge’s right to nominate an additional director to BLY (it originally was entitled to four nominations, then five under the scheme).
- The Court determined this was likely to be of practical significance but did not make it impossible for them to consult with other scheme creditors.
Differences that were not relevant to class separation
The Court then determined that the following issues, raised by First Pacific, were not relevant to the class test:
- All of the interest due to SSN holders was secured, whereas part of the interest due to Centerbridge as Term Loan holder was unsecured, however, this did not make them different form[s] of creditor;
- Different maturity dates and extensions did not matter as neither SSN holders nor term loan creditors would have any real prospect of recovering the value of their notes on maturity because the BLY; companies are presently insolvent or close to insolvency;
- Both the SSN holders and the term loan creditors had a waiver of rights arising from any change of control event but even though the commercial interests of the two groups may be opposed in exercising these rights, this did not involve a different effect on their legal rights;
- Centerbridge received a right to additional equity arising under the Subscription Agreement and its associates had a right to equity in exchange for debt under the Unsecured Creditors Scheme which could reinforce the difference in those commercial interests. However, this did not prevent consultation as to their common interests.
First Pacific also argued that its exclusion from negotiations of the RSA with other major creditors and its making of counterproposals to BLY for an alternative restructuring were relevant to the Court's decision to make orders convening a meeting of creditors to consider the proposed scheme.
This argument was rejected, with the Court determining that its role at the first Court hearing did not involve securing individual creditors an opportunity to participate in negotiations with BLY as scheme proponent.
Collateral benefits - not something for the first court hearing
The prospect of Centerbridge obtaining a controlling shareholding and right to nominate directors to BLY’s board was potentially a collateral benefit relevant to application of the class test.
In this case, the Court determined that
- creditors can be excluded from voting if they receive additional benefits not available to other creditors;
- where the votes of interested creditors would be tagged, there is no need to exclude these creditors from voting as some or all of them can be disregarded at the second hearing;
- Centerbridge's votes were required to be tagged.
Consistent with established authority, however, the Court then determined that collateral benefits were something for consideration at the second hearing (where the Court considers whether to approve the scheme) and not for consideration at the first hearing (where the Court considers whether to convene the meeting).
The importance of disclosure to creditors
Before convening the meeting, the Court must consider whether the material provided to voters has sufficiently brought attention to any change in dominant commercial interests effected under the proposed scheme. This was important in the BLY proposal, given the different treatment of term loans and SSNs.
Initially, BLY did not provide any comprehensive analysis of the differences in outcomes for secured creditors who would receive equity (Centerbridge) and the other SSN holders. The proposed explanatory statement was, however, amended to include:
- the key terms of the SSN, TLA and TLB debts before and after the recapitalisation transactions;
- alterations to the maturity date of the SSN and term loan debts, the variation of the change of control trigger, the call schedule, the treatment and priority of security, the interest rate and manner of payment, interest payments date, and the provision of a guarantee; and
- the share issue and director nomination rights conferred on Centerbridge.
The Court was satisfied with this approach, and determined that there was no need to provide detailed information about Centerbridge itself and about its future intentions for BLY should the scheme be implemented.