In one of the most significant decisions relating to schemes of arrangement in Australia in recent years, the New South Wales Court of Appeal has dismissed an appeal challenging the composition of classes of creditors in the Boart Longyear restructuring.
The decision significantly widens the extent to which creditors within the same voting class may be treated differently, both in terms of their existing rights and their rights under the proposed scheme. As a result, the decision may lead to greater flexibility for stakeholders and distressed companies seeking to devise restructuring plans via scheme of arrangement.Creditor schemes of arrangement are becoming more frequently used in Australia to deliver debt restructuring solutions, particularly in relation to large, complex structures.
Under Australian law, the proponent of the scheme is required to assign creditors to separate classes, and each class must vote in favour of the scheme for it to be implemented. The common law test for identifying whether particular creditors may be included in the same class is whether they hold rights that are not so dissimilar as to make it impossible for them to consult together with a view to their common interest.
Earlier this year, the New South Wales Supreme Court granted orders for the convening of creditor meetings for two schemes of arrangement in relation to Boart Longyear Limited (BLY). The decision was controversial, because it placed BLY’s term loan lender and secured noteholders in the same class of creditors, notwithstanding that those parties had significantly differing rights before the scheme and under the terms of the scheme itself.
The first instance decision was appealed by a holder of 29% of the secured notes on the grounds that the differences in creditors’ rights should have seen them placed into separate classes of creditors. The Court of Appeal has unanimously dismissed that appeal. The Court’s application of the common law test for identifying classes of creditors in a scheme has surprised many commentators, and has pushed the boundaries in terms of the level of differentiation that is permissible between creditors in the same class.
BLY is incorporated in Australia and listed on the ASX, but has its headquarters in Utah, USA. BLY recently devised a restructuring proposal that included two separate schemes of arrangement, comprising a “Secured Creditors’ Scheme” and an “Unsecured Creditors’ Scheme”.
Under the Secured Creditors’ Scheme, the holders of BLY’s senior secured notes (Secured Notes), and the holder of the secured Term Loan A (TLA) and Term Loan B (TLB) debt, were to vote in a single class of creditors. Centerbridge Partners LP and associated entities (Centerbridge) held a significant proportion of the Secured Notes and all of the TLA and TLB debt.
The terms of the proposed scheme include the following:
- the maturity dates of the Senior Notes, TLA and TLB were all to be extended to the same date;
- the interest rate payable on the TLA and TLB was reduced from 12% to 10%, in return for the lender receiving 56% of the equity in the restructured BLY;
- interest on all facilities was converted to payable in kind until December 2018 (though interest under the TLA and TLB was already payable in kind); and
- all parties waived any rights in relation to a change of control event occurring as a result of the restructuring.
First Pacific Advisors (FPA), which held 29% of the Secured Notes, objected to the holders of the Secured Notes and the TLA and TLB lender being treated as a single class of creditors. In particular, FPA noted several differences between the parties’ rights, which, it said, should have led to the respective instrument holders being placed in separate classes. In particular:
- whereas the Secured Notes were fully secured, the TLA and TLB debt was unsecured in respect of certain assets;
- the Secured Notes were due to expire before the TLA and TLB debt, but were now being extended to the same maturity date;
- whereas interest on the TLA and TLB debt was already payable in kind, the Secured Notes were being converted from interest payable in cash to interest payable in kind at BLY’s option;
- Centerbridge alone was receiving outright control of the restructured entity;
- the waiver of the change of control event right was to the advantage of Centerbridge and affected the Secured Note holders differently; and
- Centerbridge was given the right to appoint five directors to the board of BLY (an increase from its existing right to appoint four).
First instance decision
At first instance, the Court held that it was appropriate for Centerbridge and the other Secured Note holders to be placed in the same class of creditors, notwithstanding the differences in rights outlined above. In particular, this was because:
- all parties faced a “common and imminent issue” as to BLY’s insolvency – in the absence of the scheme, most of the differences, in particular as regards interest payments and maturity of the loans, would be irrelevant in practical terms; and
- the security arrangements were complex, and on insolvency, would require the parties to negotiate further to allow realization of the assets.
Court of Appeal decision
In upholding the first instance decision, the Court of Appeal identified two key issues:
The Equity Issue
The first issue was whether the waiver of change of control rights and the issuance of equity to Centerbridge, and the right to appoint directors given to Centerbridge, created separate creditor classes. The Court of Appeal held that they did not.
In relation to the waiver of change of control rights, the Court held that whilst this undoubtedly benefited Centerbridge, the right to call up the loans as a result of any change of control was likely to be of limited benefit given the likelihood that BLY would be unable to repay the loans and would be placed into liquidation.
The critical question was whether the grant of new equity to Centerbridge changed this position. The Court held that it did not, because:
- the Secured Note holders did not currently hold any shares in BLY;
- Centerbridge already had “de facto” control under its existing 48.9% holding, and the right to appoint four directors; and
- immediately after the restructuring, the shares in BLY were likely to be of little value and so Centerbridge would receive no “significant financial advantage”.
The Interest Issue
The second issue was whether the imposition of different interest payment regimes created separate creditor classes.
In holding that it did not, the Court used the comparator of an insolvent liquidation, and noted that terms that were more favourable to one creditor than another did not prevent them from consulting together, particularly in the context of imminent liquidation as the only alternative.
It is uncontroversial that a scheme of arrangement can include some differential treatment of creditors within the same class. However, the Boart Longyear scheme is unusual in that the differentiation in treatment of the Secured Note holders on the one hand, and the TLA and TLB lenders on the other, is more extensive than has been seen in any reported decision to date. The decision arguably introduces a degree of uncertainty into the application of the longstanding common law test for identifying classes of creditors.
However, the decision can also be seen as an example of the Court taking a purposive, flexible approach to restructurings by schemes of arrangement, and its reluctance to allow schemes to fail on technical class grounds. It should be noted that splitting the creditor classes as proposed by FPA would have resulted in the Secured Note holders effectively holding a right of veto, which could have prevented the scheme from proceeding.
Further, the Court’s decision relates only to the convening of creditor meetings for the purposes of voting on the proposed scheme. Under Australian law, the scheme is only finally sanctioned at a second court hearing (assuming all creditor classes vote in favour), and the Court retains a broad discretion to set aside a scheme on “fairness” grounds at the second hearing. In this case, we expect that the Court will closely examine the level of support for the scheme among the Secured Note holders in particular, and any widespread dissent may be factored into its final decision.
In the meantime, the decision may provide greater flexibility for stakeholders in distressed businesses in devising restructuring proposals. In particular, it opens the door for restructuring plans that enable potentially dissenting creditors to be included within a broader single creditor class, in order to cram down those creditors and deny them a potential right of veto.