Case: Lehman Brothers International (Europe) (in administration)  EWHC 1980 (Ch), Hildyard J (27 July 2018)
The High Court sanctioned a complex scheme of arrangement (“Scheme") under the Companies Act 2006 (“CA 2006”) in relation to Lehman Brothers International (Europe) (“LBIE”). The Scheme had as its purpose the compromise of unresolved litigation so as to enable distribution of surplus funds remaining in the LBIE estate. The High Court examined issues relating to class composition, the fair representation of classes and the overall fairness of the Scheme.
This alert is relevant to companies in financial distress and their directors and creditors, as well as insolvency practitioners.
The Scheme affected the recoveries of creditors of, and shareholders in, LBIE. Key takeaways from the decision include:
1. Classes: a properly constituted class requires an assessment of legal rights (not commercial or other interests). A close association of creditors (e.g. where one member of a class is also a member of another class by virtue of a legal right) that may have a commercial incentive to vote in a certain manner cannot, in itself, fracture a class. However, had there been evidence of those creditors being considered “alter egos” of one another, the class may have fractured.
2. Voting in accordance with a ‘lock-up agreement’: where a lock-up agreement committed creditors within a class to one of two ways in which the class was invited to vote, that fact will not, itself, fracture a class, as it does not necessarily give the locked-up creditors different rights to the other members within the class.
3. Fair representation of a class (special interests): where creditors within a class have a special interest that influences their decision to vote in a certain way, unless the special interest is adverse to or opposes the interests of the remaining members of the class, it will not impugn fair class representation. Further, the Court held that the interest would need to be ‘the dominant or causative reason’ for the creditors to vote in a certain way.
4. Overall fairness of the scheme (consent fee): where one class of creditor receives a significant consent fee from creditors in other classes, payable upon the Scheme becoming effective, this will not, in itself, impugn the fairness of a Scheme. The Court’s approach was to ask if the other creditors received consideration for supporting the Scheme. In this case, the accelerated payment of the Surplus, in itself, was consideration. Further, the commercial assessment of the Scheme was clearly positive as the Scheme was approved by a significant majority of creditors who were not receiving a consent fee; and their commercial assessment of the Scheme could not be called into question.
LBIE, the main trading arm of the Lehman Group in Europe, had been in administration since September 2008. LBIE’s administration was so successful that it yielded financial resources sufficient to repay the provable claims of creditors in full but also, beyond that, to create a substantial surplus – approximately £6.6 billion in liquid assets and a potential of £1.2 – 1.7 billion in future realisations (the “Surplus”). While the order of priority had been decided in Waterfall I (outlined briefly below), a number of issues, including the calculation of certain interest entitlements, remained undecided. Each of the undecided issues affected the calculation of each class of creditors’ entitlement to the Surplus and was the subject of numerous ongoing court proceedings (the “Relevant Proceedings”). Until the Relevant Proceedings and any subsequent related appeals had concluded, the Surplus could not be distributed to the various stakeholders and therefore the administration could not be concluded. The Relevant Proceedings showed no prospect of early resolution; on the contrary, they were likely to continue in the Courts for many years, causing considerable delay to the distribution of the Surplus. This delay was disadvantageous to LBIE’s creditors – their claims were no longer accruing statutory interest as their provable debt claims had been discharged in full.
The Surplus Waterfall: Quick Reminder
By way of background, the UK Supreme Court (“UKSC”) had previously decided the order of priority for the Surplus distribution should be applied in satisfaction of the following:
- first, the statutory payment of interest in accordance with Rule 14.23 of the Insolvency (England & Wales) Rules 2016 (“IR 2016”), at the higher of 8% of provable debt or the rate applicable to the debt (i.e. the contractual rate);
- second, the payment of non-provable debt;
- third, the payment of subordinated debt; and
- fourth, LBIE’s sole shareholder, LB Holdings Intermediate 2 Ltd (“LBHI2”).
The Scheme was proposed by LBIE’s administrators under section 896(2)(d) of the CA 2006. The rationale of the Scheme was to facilitate and expedite the distribution of the Surplus which, for the reasons stated above, otherwise would have taken several years.
The Scheme provided an outline for the payment of the Surplus as follows:
- by ending the Relevant Proceedings and preventing any further challenges from creditors;
- by enabling the Higher Rate Creditors (as defined below) to choose to:
- accept a settlement premium of 8% + 2.5% and waive the right to certify for a higher rate (the “Settlement Premium”); or
- certify a higher rate for their interest claim than the Settlement Premium. LBIE could accept, reject or propose a counteroffer. Any resulting dispute would be resolved by an independent adjudicator, who had the power to make a binding and final decision; and
- by introducing a bar date, after which LBIE would be released from any subsequent claim.
The Class Composition of the Creditor Meetings
There were four Scheme meetings:
- a meeting of the creditors entitled to the payment of statutory interest on their provable debt at 8% (the “8% Creditors”) and of the creditors entitled to a specified contractual interest at a rate above 8% (the “Specified Interest Creditors”) who were voting together as one class;
- a meeting of the creditors that had a contractual discretion to determine their rate of interest as a result of being counterparties to an ISDA master agreement and who, therefore, may have been entitled to claim more than 8% (the “Higher Rate Creditors”);
- a meeting of an informal group of funds representing the interests of approximately 40% of the unsubordinated debt (the “Senior Creditor Group”); and
- a meeting of Wentworth Sons Sub-Debt S.á.r.l., a member of the Wentworth Group (as defined below), and which held the subordinated debt (the “Subordinated Creditor”).
The “Wentworth Group” included the Subordinated Creditor, creditors with senior claims (the “Wentworth Senior Creditors”) and a group of entities formed in a joint venture with LBHI2. The two largest creditors were the Senior Creditor Group and the Wentworth Group. Each of the Senior Creditor Group and the Wentworth Group held a blocking position in respect of the Scheme.
Properly Constituted Creditor Meetings
Association of the Wentworth Group
The class composition of the Scheme meetings was opposed by certain creditors. They argued that the entities comprising the Wentworth Group should be considered as one entity and therefore as one class due to their close connection. It followed, so the argument ran, that the entities comprising the Wentworth Group had a special interest in recoveries flowing to the Subordinated Creditor. Due to this interest, it was argued that the Wentworth Group should form a separate voting class.
However, in line with accepted case law on the issue, the court focused on the importance of separating legal rights from commercial interest. The court held that the close association and cross-holdings within the Wentworth Group was insufficient to “fracture” the class compositions. The court observed that if the companies were to be considered “alter egos” of one another, then this may have been decided differently; there was no such evidence brought before the court.
Consultation Rights on Adjudication
It was argued that the Subordinated Creditor’s consultation right in the Higher Rate Creditors’ certification process caused a class issue. The right of consultation arose as the Subordinated Creditor had an economic interest in the result of the certification and adjudication process in relation to the Higher Rate Creditors (since the lower the certification, the more funds would flow down to the Subordinated Creditor). The Higher Rate Creditors that were not a part of the Wentworth Group argued that this consultation right was adverse to their interests (and the Wentworth Group should, for this reason also, have its own voting class).
The terms of the Scheme initially gave the Subordinated Creditor the right to finally determine the amount of any counteroffer the Higher Rate Creditor would be entitled to. However, this right was ultimately curtailed in the final terms of the Scheme; the right became the right to consult only on the acceptance or rejection of the certification of the Higher Rate Creditors’ interest rate. The final decision remained with LBIE.
The High Court decided the curtailed consultation right was not adverse to the interest of the Higher Rate Creditors.
The Wentworth Group and the Senior Creditor Group entered into a lock-up agreement. Due to their respective blocking positions, the Scheme could not have succeeded unless they supported the terms of the Scheme.
The terms of the lock-up agreement were such that both the Wentworth Group and Senior Creditor Group would support the proposed Scheme but also accept the Settlement Premium in respect of all of their Higher Rate Claims.
Some opponents to the Scheme argued that the Wentworth Group and Senior Creditor Group’s acceptance of the Settlement Premium indicated their rights were different to other Higher Rate Creditors and it would therefore be “impossible for them to consult with a view to their common interest”.
Ultimately the High Court held that the lock-up agreement only committed the two groups to one of the two ways in which the Higher Rate Creditors’ class could vote and so did not give them different rights to other members within their respective classes.
Under the terms of a private settlement agreement entered into after the lock-up agreement, the Senior Creditor Group received a significant consent fee from the Wentworth Group, payable when the Scheme became effective. This fee was not being given to any other creditor. The High Court held that this issue did not relate to class composition, but to the fairness of the overall Scheme (which is described in more detail below).
Fair Representation of Classes at the Meetings
The main point of contention in relation to fair class representation arose in relation to the Higher Rate Creditor meeting. The Wentworth Senior Creditors, as described above, had a special interest in voting in favour of the Scheme. Their vote was required for the Scheme to be sanctioned. Thus, if it could be concluded that the Higher Rate Creditor meeting was not fairly represented due to the special interest of the Wentworth Senior Creditors, their vote may have been disregarded or discounted. The High Court, however, held that “the mere fact that the majority creditors have a special interest in supporting the scheme does not, without more, entail that the class was not fairly represented”. To impugn class representation, any special interest would need to be adverse to, or even oppose, the interests of the remaining members of the class. Further, there must be a “strong and direct link” between the adverse interest and the voting decision; much like in Re Apcoa, where Hildyard J suggested the “but for” test was useful for demonstrating a causal link. In the present case, the special interest was simply an additional reason for, not the “dominant or causative reason”, voting in favour of the Scheme; and, therefore, the special interest did not undermine the representation of the class.
A point arising from the judgment was that, even if the representation was impugned, it would be wrong to simply disregard the votes of the Wentworth Senior Creditors, whose main purpose in voting in favour of the Scheme was to expedite the payment of the Surplus.
Overall Fairness of the Scheme
The general test in assessing the fairness of the Scheme is “whether the arrangement is such that an intelligent and honest man, a member of the class concerned and acting in respect of his interest might reasonably approve”. Given the complexity and opposing views of some creditors, Hildyard felt “more anxious scrutiny of what appears to be the minority position” was required.
One of the primary objections to the fairness of the Scheme concerned the adjudication process.
The first objection under this category was that the adjudicator should not be faced simply with the choice of either the amount certified or LBIE’s counteroffer or, if no counteroffer is made, the statutory minimum of 8%. The objecting creditor argued that the adjudicator should be free to award another sum and to hold an oral hearing and should also be required to give brief reasons for his or her decision.
Although the judge acknowledged that “some would think [the suggestion] an overall improvement”, the court’s function was to determine whether the adjudication process as proposed was a blot on the Scheme putting it “beyond the pale of fairness”. In the judge’s view, it was not (and he took it that his view had been confirmed by the large numbers voting in favour of the Scheme). The process as offered in the Scheme would reduce the length and complexity of the adjudication (consistent with the overall purpose of the Scheme) and would also reduce the risk of excessively high certifications. On the issue of the absence of oral hearings, the judge had asked for confirmation that the three nominated adjudicators were comfortable with that and they had all responded in the affirmative. Their responses carried considerable weight for the judge.
The second objection was that the certifying creditor should be able to take the matter to court if the adjudicator made a manifest error, or an error of law, or had reached a conclusion that no reasonable adjudicator could have reached. The judge accepted that any “substitute for legal recourse to the Courts should be robust, satisfactory and justified”. However, the Scheme expressly provided that it did not exclude any mandatory rights of appeal under general law. The choice between the various rates available was also not likely to give rise to any coherent claim of manifest error, and the need to determine a point of law was unlikely. “In the round”, the judge was persuaded that the certification and adjudication process was not, even with the limited involvement of the Subordinated Creditor, unfair and was justified by reference to the fundamental purpose of the Scheme.
Consultation Right of the Subordinated Creditor
A group of the Higher Rate Creditors argued that the consultation right of the Subordinated Creditor was unfair. However, it was decided that the right of the Subordinated Creditor to consult was simply that – a right of consultation and not a right to “dictate”. Further, the Subordinated Creditor was under a strict obligation to keep any relevant information received through the consultation confidential. The court also observed that the right of consultation was not dissimilar to the right of creditors outside the Scheme, given by the IR 2016, to inspect or challenge proofs lodged by other creditors.
The judge held that the consent fee was a private agreement between the Wentworth Group and the Senior Creditor Group. It could not be argued that other creditors did not receive consideration for supporting the Scheme, as the accelerated payment of the Surplus was, in itself, consideration. Further, the commercial assessment of the Scheme was clearly positive, as the Scheme was approved by a significant majority of creditors who were not receiving a consent fee; and their commercial assessment of the Scheme could not be called into question.
After careful assessment, it was concluded that there was “no unfairness such that the court should decline to give its sanction to the Scheme”.
This judgment serves as a valuable reminder of the key legal issues, tests applicable and juridical approach when proposing a Scheme. It affirms the robust and pragmatic approach to class composition, fair representation of the classes and fairness of the scheme.
In short, creditor classes will not be fractured unless strict legal rights materially diverge. And a Scheme will not be unfair merely because of special interests of members to support its terms.
Nevertheless, the detailed and deeply considered judgment again shows that the court will rigorously put to the test the question of whether the proposed Scheme is genuinely fair and appropriate. In its lengthy and detailed decision, the High Court has again affirmed that the process for sanctioning a Scheme is not merely a box ticking exercise.