In July this year, 82 members of the E W Payne Pools successfully obtained approval for their schemes of arrangement with their creditors. This was not the first scheme put forward by a pool – there have been at least six previous pool schemes – it is, however, by some way the largest pool to have proposed a scheme.

The main purpose of the E W Payne scheme was to reduce dramatically the length of the run-off of the pools. Pools, such as the E W Payne Pools, can be notoriously difficult to run-off, the number of stakeholders compounding the normal issues and complexities faced by a company in run-off Schemes, however, provide a bespoke solution. The idiosyn-crasies of each pooling arrangement, which can raise problems for both the members of the pool and their creditors, can be addressed directly by the terms of the scheme proposal. The E W Payne Pools scheme provides a good example of both this versatility and the mechanism’s robustness for companies in run-off.

What Is a Scheme of Arrangement?

Before turning to the E W Payne scheme, it is helpful to recap more generally on what a scheme is and how it operates. A scheme of arrangement is a court-enforced binding agreement between a company and its creditors (or its shareholders, although this article will focus on creditor schemes only). This description, however, says nothing about the contents of a scheme. Indeed, the governing legislation, Part 26 of the Companies Act 2006 (the successor to sections 425 to 427 of the Companies Act 1985), is almost silent on what needs to go into a scheme. As with a contract, this means a scheme can be designed to address the needs of the parties. There are minimal legal limits to the content of a scheme, the main one being the oversight of the court. A scheme is a court-governed process (this is described in more detail below) and for it to become effective the court has to be satisfied that the arrangement is such “as an intelligent and honest man...acting in respect of his interest, might reasonably approve” (Plowman J in Re National Bank Ltd [1966] 1 WLR 819). In broad terms, this means that the court must be satisfied that a scheme is fair. Apart from this, there are very few limits on the contents of a scheme. It is for the parties involved – the company and the affected creditors – to agree the terms using the process set out in the legislation, which is described below.

There is a three stage process for implementing a scheme:

  • First, the person proposing the scheme, which is normally the company, must obtain the court’s permission to circulate the scheme proposal to the creditors. It does not need to be to all the creditors of the company, just those that are to be directly affected by the scheme. The court will also convene the meeting (or, in certain circumstances, meetings – a separate meeting must be convened for each class of creditors) for the creditors to vote on the proposal.
  • Secondly, the meeting (or meetings) to vote on the scheme must be held. To be successful, there must be a simple majority by number and more than 75% by value of the creditors who vote at each meeting voting in favour of the proposal.
  • Thirdly, the person proposing the scheme must obtain the court’s sanction of the scheme. This is when the court considers whether “an intelligent and honest man” would approve the proposal. Provided that the court’s approval is obtained, and a copy of the scheme is sent to the English Registrar of Companies, the scheme will become binding on both the company and its affected creditors.

Schemes for Insurance and Reinsurance Companies

Schemes began to be used in the insurance context by insolvent insurers and reinsurers as an alternative to the liquidation process. Then in the late 1990s they started to be used by solvent companies in run-off as a means to speeding it up. The majority of schemes proposed by solvent companies have been so-called “estimation” or “cut-off” schemes. The essential feature of such schemes is that a creditor’s contractual relationships with the company is brought to an early end. In return, the scheme provides a process for establishing the fair value of the creditor’s claims against the company, including claims that are not payable until some time in the future (ie notified outstandings and IBNR). This fair value is then paid to the creditor. The scheme removes the creditor’s and the company’s rights to begin litigation or arbitration proceedings to enforce their contractual rights. Instead, the scheme provides an agreement process, or if that fails, an expedited adjudication process, to establish the value of the creditor’s claims. This all takes place over a very short period, sometimes as little as a year. Without the scheme, the run-off – which may involve contracts with a long-tail – may take many decades.

Pools and Their Run-Off

Pools are group of insurers and reinsurers that come together to write business as a unit. The acceptance and administration of the business is commonly undertaken by a pool manager on behalf of the insurers/reinsurers, all of whom participate in the business in agreed shares. This seems straight-forward, but the structure of pools can be extremely complex. For instance, it is not unusual for one or more of the pool members to front a risk and then reinsure the risk into the pool. On some pools different pool members would front different types of risk while on certain risks all the pool members would write the risk directly. In addition, there may be pool-wide reinsurance arrangements. This can lead to a dizzyingly complex web of interlinking liabilities between the pool members themselves and between them and non-pool members. This can be made even more complicated when a pool goes into run-off because, over time, pool members may consolidate, transfer books of business or even become insolvent. Simply keeping track of who owes what to whom in those circumstances can be a significant (and probably expensive) challenge to whoever is managing the run-off.

The bespoke nature of the scheme process makes them well-suited for dealing with the complexities of pools in run-off. Schemes can be designed to clarify and then unravel the web of liabilities and cross-liabilities that make up the run-off of many pools. The E W Payne Pools scheme is a good example of their potential.

The E W Payne Pools

E W Payne Limited, formed in 1919 by Ernest William Payne, was widely known in London and throughout the international insurance industry as a specialist reinsurance broker. In parallel with its broking activities, from the early 1960s to the mid 1980s E W Payne set up a number of pools. The pools were designed to provide the pool participants with a spread of risks across what was known as E W Payne United Kingdom Excess of Loss Account. Participating reinsurers provided reinsurance cover to the E W Payne United Kingdom Excess of Loss Account in proportions agreed at the beginning of each year. Different proportions would be agreed for each class of business. Any one risk subscribed to by the pool would be underwritten by all the participants participating in that pool on that relevant class at the time the risk was written.

E W Payne did not fix the terms of any of the business declared to the pool. Each declaration was led and rated by a lead underwriter before the business was written by the pool. It was common for the portion of the risk underwritten by the E W Payne pools to be very small.

The make-up of the pools would vary from year to year; the pool participants would change and/or their share of the risks written would vary. Often there were extremely large numbers of participants on each pool in any one year. For instance, there were on average 100 participants on the Excess of Loss Pool No 1 (the largest of the four pools affected by the schemes) per underwriting year. As the Pools themselves were generally writing a small percentage of a risk, which was then shared between a large number of participants, who each took a small proportion of that small risk, it meant that each participant would often be writing a small share of a small share of any one risk.

The Scheme Proposal

The Pools have been in run-off for over 20 years and it was predicted that it could take a further 20 years to complete the run-off. The fact that so many companies participated on the pools, and that many of those participants had only a small share of any one risk, gave rise to obvious difficulties for the companies and their creditors, in particular in the presentation and collection of a large number of very small claims. The main driving force behind the scheme was the streamlining of the administration and collection of these small claims. The high-volume, low value nature of individual exposures added to the administrative costs for both the pool members and their creditors and created an added incentive for them both to reach a settlement.

The schemes – there was one scheme per participant – included a number of noteworthy aspects. For example, they provided for the payment of contingent liabilities regardless of whether a creditor formally submitted its claim. Most other schemes have either paid such creditors nothing at all or paid them only their agreed paid losses if they failed to submit a claim. Further, the schemes used an extremely simplified methodology for calculating IBNR claims for different types of risk, rather than a complicated estimation methodology. These aspects fit the particular circumstances of the E W Payne pools. They grew out of the extensive consultation process with both the creditors and the proponent companies leading up to the formal proposal of the scheme.

Conclusion

In summary, there are lessons to be learnt from the E W Payne schemes. First, that the consultation undertaken in advance of the scheme with creditors and the scheme companies is absolutely key to the scheme’s success. And secondly the scheme proposal must be designed to be a genuine compromise between the scheme companies and their creditors; one size does not need to fit all. It also highlights that the flexibility of the scheme process makes it well-suited to addressing the complexities of a pool in run-off. The success of the E W Payne scheme project is likely to open the door to the increased use of schemes to unravel the web of the run-off of very large pools.