Much time is spent by MLAs and Sponsors negotiating the list of unanimous lender decisions in a leveraged finance syndicated facilities agreement. The Sponsor will be concerned that its portfolio company should not find itself "held to ransom" on a waiver request by a dissenting minority lender. On the other hand, lenders require certain fundamental transaction terms to be entrenched so that key decisions cannot be taken without them. Commonly, changes which would increase the facilities, reduce the margin or extend the final repayment date will require the consent of all lenders.
On more recent transactions the parties may have incorporated a "structural adjustment" clause to facilitate certain increases/changes in tranches/facilities being made without the requirement for unanimity, but even if that is the case, it would be unusual for this to alter the requirement for unanimity on an extension of the maturity of the original facilities.
Lenders need to be aware, however, that in reality any unanimous decisions mechanism is of limited protection, as demonstrated by numerous restructurings undertaken by companies over the last six years. This is down to the increasing use of the English scheme of arrangement ("scheme"), under which a decision taken by a majority in number representing 75% in value of each class of creditors who vote on the scheme will bind all creditors in the same class, even if the facilities agreement provides that the relevant decision requires unanimity. Schemes are often used precisely because they can be used to override minority lender opposition in this way.
What is a scheme of arrangement?
A creditor scheme is a compromise or arrangement under the Companies Act 2006 which is entered into by a company and its creditors (or any class or classes of its creditors).
To become legally binding a scheme requires approval by a majority in number representing 75% in value of each class of creditors who vote on the scheme, and the court must then sanction it.
Creditors to whom the scheme is to apply have to be divided into ‘classes’. While this may sound fairly straightforward, as we discuss later, the determination of voting classes can be a contentious issue.
Once sanctioned, a scheme will be binding upon those creditors and/or classes of creditor to whom it was proposed, irrespective of whether they voted in favour of it.
Unlike other forms of compromise such as a company voluntary arrangement, schemes can be used to bind both secured and unsecured creditors.
English schemes are not insolvency procedures, and a company does not need to be insolvent to commence the scheme process.
In addition, schemes fall outside the scope of international insolvency provisions such as the European Insolvency Regulation and the UNCITRAL Model Law on Cross-Border Insolvency. The benefit of this, particularly for overseas companies, is that provided the English courts are willing to accept jurisdiction (on which see more below), the company does not have to show that its centre of main interests (COMI) is in England before starting the process.
It is not surprising that we have seen a number of overseas companies using the English schemes process to restructure their debts because the English scheme is often considerably more flexible than the restructuring and insolvency regimes in their own jurisdiction.
What can schemes be used for?
Provided there is a "compromise" or "arrangement" between the company and the creditors, schemes can be a very flexible restructuring tool.
They can't be used to impose new obligations on creditors (so, for example, if there is to be a new money element, a lender cannot be forced to provide part of that new money), but existing contractual rights and obligations can be varied.
Although typically the scheme will provide for a certain part of the debt to be compromised, that doesn't have to be the case and we have seen a number of "amend and extend" schemes under which debt maturities have been extended, financial and other covenants rewritten and margins reset, but without any form of debt compromise.
Can a minority creditor oppose the scheme?
Schemes are a court-driven process. If the company considers that it has the requisite level of support to implement a scheme it will prepare the scheme document, consider what creditor classes are required and then apply to court for a convening hearing.
At the convening hearing the court will consider a number of matters and if satisfied it will order the meeting of the relevant classes of creditors to vote on the scheme. If the scheme meetings approve the scheme by the requisite majorities then the Court will be asked to make an order to sanction the scheme at a sanction hearing.
There are a number of procedural requirements that have to be met before a scheme can be sanctioned. A scheme can be challenged, typically either at the convening hearing or the sanction hearing, if it appears not to be satisfying the procedural requirements or if the scheme is considered not to be "fair". Some of the key requirements are considered in more detail below.
Under the Companies Act 2006 any company that is liable to be wound up in the UK, as provided for by the Insolvency Act 1986, can enter into a scheme. This obviously includes English incorporated companies, but it will also include overseas companies which can be wound up in England as unregistered companies.
Before accepting jurisdiction in the case of overseas companies, the English courts must be satisfied that there is a sufficient connection with England and Wales, that the scheme will have practical effect (so be recognised and enforceable in all relevant jurisdictions) and that there are creditors located in England and Wales who would benefit from the scheme.
The English courts have made it clear that sufficient connection can be established if the governing law of the loan agreement or other debt instrument to be affected by the scheme is English and the parties have submitted to the jurisdiction of the English courts. This has been upheld even where the governing law of the relevant debt instrument has been changed expressly for the purpose of taking advantage of the English scheme process (see for example Apcoa Parking (governing law of the loan agreement changed from German to English) and DTEK (governing law of notes changed from New York to English)). In neither case was the change of governing law expressed to be an all-lender decision (in contrast to the current form of LMA standard form for leveraged finance transactions).
Other evidence of sufficient jurisdiction would include having assets in England and Wales, or shifting COMI to this jurisdiction (see for example the schemes for Magyar and DTEK, both Dutch companies which shifted COMI to England).
It is essential to identify the classes of creditor at the earliest opportunity – if junior or dissenting creditors form a separate class this would greatly increase their negotiating power, and the possibility that they may be able to defeat the scheme.
However, the court will not simply approve classes based on the view taken by the company. On 18 September Debtwire reported that in relation to the scheme currently being proposed by Stemcor Mr Justice Snowden had required Apollo Capital Management, a senior creditor under the current structure, to form a class on its own rather than having a single class comprised of all senior creditors. We will have to wait until the decision is formally released to see the basis on which this change in classes was required, but it provides a timely reminder that a company cannot get over the issue of dissenting creditors simply by putting them into a class with other creditors it knows will approve the scheme.
Creditors whose rights are not affected by the arrangements to be put in place by the scheme - whether because their rights are not altered or because they have no 'economic interest' in the company - can be left out of the scheme process.
Creditors will be treated as in the same class for the purpose of the scheme jurisdiction if their rights are not so dissimilar as to make it impossible for them to consult together for the purpose of considering the scheme proposal. Rights don't have to be identical, they just have to be sufficiently similar.
This "similar rights" test is a question of both law and fact, and recent cases have clarified that:
what has to be looked at is each creditor's rights against the company, not its rights against the other creditors;and
rights should not be confused with economic interest (although this latter point might be taken into account when the court assess the fairness of the scheme).
The class issue is of particular interest when looked at in the context of a unitranche structure. As between themselves the unitranche lenders will have a clear idea of who ranks where in terms of claims against the company and who is in the driving seat in terms of the decision-making process. But, if the transaction has been structured as a single tranche loan agreement with the inter-lender sharing and voting position set out behind the scenes in a document to which the company is not party (especially if there is no reference to this issue in the intercreditor agreement to which the company is party), there has to be a risk that the lenders – whatever their own view of their ranking – will be placed in a single class for voting purposes. That could result in the "senior" lender being allocated into the same class as the "junior" lender who may well be able to approve or block the proposed scheme as they see fit; not a happy outcome for the senior lender.
Even if the court is satisfied that it has jurisdiction and all procedural steps have been complied with, it has a discretion not to sanction a scheme unless that scheme is "fair".
The basic test is whether "the [scheme] proposal is such that an intelligent and honest man, a member of the class concerned, acting in respect of his interests might reasonably approve".
On the issue of reasonableness, the Court will not substitute its own views for those of the meeting. The Court's stance is that the class members are themselves much better judges of what is to their commercial advantage than the Court can be, if those class members:
- are acting on sufficient information;
- have sufficient time to consider the proposals; and
- are acting honestly.
On the other hand it will not "rubber stamp" the class members' decision. The test is "Could the class members reasonably have approved the scheme?".
Sanction will rarely be refused in circumstances where the class members interested in the company's property have overwhelmingly voted in favour of the scheme. It is nonetheless a possibility, particularly if at the sanction hearing a disgruntled class member opposes the application and demonstrates to the Court the unreasonableness and unfairness of the scheme proposed in respect of him individually, or if the Court believes that the rest of the class were influenced by some ulterior motive. That said, it is notoriously difficult to challenge a scheme unless it is manifestly unfair (note, for instance, the unsuccessful challenge by the junior creditors on IMO Car Wash, and by a minority of the senior creditors on the most recent Apcoa scheme.)
The Court will need to be satisfied that there has been a sufficiently high turnout of creditors/members voting in each class. The requisite majorities only refer to a majority in number representing 75% in value of those voting in person or by proxy. This means that theoretically, a sole lender who is the only lender voting, would satisfy the required majority resulting in a scheme which "could" bind all other lenders. For this reason, the manner in which the meeting was advertised (and therefore, the manner in which creditors were given the "opportunity" to vote) together with the actual turnout achieved, will both be of relevance and should be disclosed to the Court at the sanction hearing.
In appropriate cases, if the Court is not entirely satisfied with the substance of the scheme or the procedure leading to the application for sanction, it may make limited changes to the scheme or require the giving of undertakings as a condition of giving its sanction.
English schemes are a very useful and flexible tool allowing a company and its creditors to restructure indebtedness without the company having to enter a formal insolvency process. However, the statutory voting thresholds mean that terms which as a matter of contract under the facilities agreement cannot be changed without "all lender" consent can in fact be amended without a dissenting creditors' consent if a scheme were to be implemented which has sufficient support from other creditors.