March 26, 2024

Adler: Court of Appeal sets aside sanction of a Restructuring Plan



In the first appeal of a restructuring plan under Part 26A Companies Act 2006, the English Court of Appeal unanimously set aside the first instance decision sanctioning the plan proposed by AGPS BondCo PLC, part of the Adler real estate group1.

The Court of Appeal addressed issues concerning the exercise of the cross-class cram-down power and the process and timetable for the conduct of restructuring plans where the Court is being asked to exercise that power. 

The proposed plan sought to amend indebtedness arising under six series of senior unsecured notes governed by German law, which matured on different dates through to 2029.  If the plan was implemented, the group intended to execute an orderly wind down and sale of its assets.  The relevant alternative to the plan was formal insolvency in which the claims of plan creditors would rank equally for payment.  However, with one exception, the terms of the plan preserved the notes' existing staggered maturity dates, thereby placing a materially greater risk of non-payment on the 2029 noteholders than it did on the holders of the notes with earlier maturity dates. 

In setting aside the sanction order, the Court of Appeal held that, in preserving the existing sequential maturity dates, the plan departed in a material respect from the pari passu principle of distribution that would have applied in the relevant alternative.The plan did not respect the pari passu principle because it involved a greater risk for the 2029 noteholders than for plan creditors holding earlier dated notes.  Given the existence of material risks that the group might fail to realise the sums forecast in the report prepared for the company, the payment of the different series of notes sequentially under the plan thus carried the risk that the group would pay the earlier dated notes in full, but would run out of money from realisations before being able to pay the 2029 notes.  Findings reached by the Court at first instance on the balance of probabilities (after consideration of competing evidence on future realisations) provided no assurance that sufficient sums would be realised under the plan to pay the noteholders in full. The sequential payments to creditors from a potentially inadequate common fund of money are not the same thing as a rateable distribution of that fund.

There was no good reason or proper basis for the adherence to sequential payments of the notes in accordance with their maturity dates.  The Court at first instance had wrongly concluded that it did not need to inquire as to whether the plan would have been fairer or could have been improved and therefore did not appreciate that the parties could easily have produced a fairer plan which eliminated this differential treatment by harmonising the dates.

The enhanced security given to the 2024 Noteholders in exchange for an extra year's extension of their loans was not a departure from the principle of pari passu distribution that was unfair to the 2029 Noteholders.

The Court at first instance had erred in the exercise of its discretion to cross-class cram down the dissenting class of 2029 noteholders.

Read more about the background to the plan and the first instance decision.

The decision

The application of the "rationality test" to a restructuring plan

When deciding whether to impose a scheme of arrangement upon the dissenting minority within a class, the Court does not impose its own view of the commercial merits of the scheme but instead asks a more limited question of whether the compromise or arrangement embodied in the scheme is one that an “intelligent and honest person, a member of the class concerned and acting in respect of its interest, might reasonably approve.”  This rationality test is based on a number of fundamental assumptions, namely:

  1. the class of creditors has been properly constituted, so that the majority and minority in the class have a commonality of commercial interests based on sufficient similarity of their rights;
  2. the majority in the class have not voted in favour of the scheme to promote some extraneous interest adverse to the interests of the class (for instance, if they have a cross-holding in another class); and
  3. the class has been properly consulted.

The Court of Appeal held that this rationality test can be applied within a class which assents to a proposed restructuring plan as the basis of the exercise of the Court's discretion to impose the plan on the dissenting minority within that class. However, when considering whether to exercise its discretion to impose the plan on dissenting classes, the Court cannot simply apply the same rationality test either: (i) within the dissenting class; or (ii) as regards the overall voting across the different classes.  The Court must engage with the underlying commercial issues.

Vertical and horizontal comparisons

These concepts (developed in scheme of arrangement and CVA challenge cases) can be modified and applied to the question of whether to impose the plan on dissenting classes. 

The "vertical comparison" compares the position of a particular class of creditors in the proposed plan with their position in the relevant alternative.  It is reflected in the jurisdictional requirement (known as Condition A) under which the cross-class cram-down power is not exercisable unless the Court is satisfied that the dissenting class will be no worse off than in the relevant alternative.  The Court of Appeal held that the satisfaction of Condition A creates no presumption in favour of sanctioning the plan.  Likewise the jurisdictional requirement that that the plan be approved by a class who would receive a payment or have a genuine economic interest in the company in the event of the relevant alternative (known as Condition B) creates no presumption in favour of sanction.

The "horizontal comparison" compares the position of the class in question with the position of other creditors or classes of creditors (or members) if the restructuring goes ahead. The Court of Appeal held that it is appropriate to conduct some form of horizontal comparison when deciding whether to sanction a plan where cross-class cram-down is engaged.

The key issue for the Court is to identify whether the plan provides for differences in treatment of different classes of creditors and if so, whether those differences can be justified. An obvious reference point is the position of creditors in the relevant alternative. The Court must inquire how the restructuring surplus (that is, the value sought to be preserved or generated by the plan, over and above the relevant alternative) is allocated between assenting and dissenting creditor groups. This concept is sometimes described as the "fair distribution on the restructuring surplus." 

Pari passu distribution

In this case, the horizonal comparison was simplified as, in the relevant alternative, all plan creditors would be unsecured and rank equally for pari passu distributions and the plan was designed simply to achieve a more advantageous distribution in a wind down controlled by management than would be the case in a formal insolvency2. 

The Court of Appeal noted that, where creditors would rank equally for pari passu distribution in the relevant alternative, the Court will normally approve a plan which replicates that distribution in respect of the restructuring surplus. Departure from principle of pari passu distribution is permissible and can be approved provided that there is good reason or proper basis for that departure.

The Court of Appeal declined to provide an exhaustive list of criteria but commented that departure from the pari passu principle is likely to be justifiable in respect of:

  • Creditors which provide some additional benefit or accommodation to assist the achievement of the purposes of the restructuring in the interests of creditors as a whole receiving some priority or proportionately enhanced share of the benefits. For example, creditors which provide new money to avoid an immediate cash flow insolvency and provide a breathing space for the debtor to restructure in the interests of creditors generally should be entitled to receive full repayment of that new money in priority to the pre-existing creditors. However, there might be no such justification for the elevation of existing debt if: the opportunity to provide new money was not available on an equal and non-coercive basis to all creditors; the new money was provided on more expensive terms than the company could have obtained in the market from third parties; or the extent to which the existing debt was elevated was disproportionate to the extra benefits provided by the new money.Such cases are likely to be highly fact sensitive.
  • The exclusion of the claims of trade creditors or employees from the ambit of the plan. The usual reason is that the continued supply of goods and services by those creditors is regarded as essential for the beneficial continuation of the company's business under the plan.
Fairer plan

When considering the fair distribution of the restructuring surplus, the Court should consider whether the proposed plan could be fairer or could be improved.

Compromise or arrangement

The Court of Appeal expressly disapproved the comments in Re Prezzo Investco Limited3 that there is no jurisdictional requirement to provide any consideration at all to an out of the money class in a Part 26A plan.  The Court of Appeal said that the fact that the same reference to a "compromise or arrangement" appears in both Part 26 and Part 26A indicates that the same meaning should be given to that phrase in both Parts. There is the same jurisdictional requirement of "give and take" between the company and the plan creditors and there cannot be "a confiscation or expropriation" of rights for no compensation.  However, it would be sufficient to provide a "small payment" in order to satisfy the jurisdictional requirements of a compromise or arrangement.

Retention of equity by the shareholders of the parent company

The principle of pari passu distribution of assets in an insolvency does not require the shareholders of a company to forfeit their shares. The only relevant principle is that there should be no distribution of assets to shareholders until all creditors have been paid in full. 

The Court of Appeal also expressed the provisional view that there is no jurisdiction under Part 26A Companies Act 2006 to sanction a compulsory cancellation of the shares in the debtor company (or the extinction of creditor claims) for no consideration.

Procedural issues

The Court of Appeal noted that the requirements for the exercise of the cross-class cram-down power are increasingly leading to complex valuation disputes which the Court must resolve under considerable time pressure.  Sometimes this is driven by external factors which are largely outside the control of the parties.  However, in other cases, time pressures appear to be the result of the parties, either by oversight or design, running matters to the wire.  The Court’s willingness to decide cases quickly to assist companies in genuine and urgent financial difficulties must not be taken for granted or abused. 

Sufficient time for the proper conduct of a contested plan must be factored into the timetable, including: complying fully with the Practice Statement; giving interested parties sufficient time to prepare for hearings; giving the court appropriate time to hear the case and deliver reasoned judgment; and permitting time for determination of any application for permission to appeal.If this is not done, the parties will have no complaint if the Court decides to adjourn hearings and take whatever time it requires to make its decision.

In order to prevent undue delay and expense, the plan company must (subject to confidentiality undertakings) make available in a timely manner the relevant material that underlies the valuations upon which it relies.  The parties and their advisers and experts must also cooperate to focus and narrow the issues for decision so that sanction hearings are confined to manageable proportions.If sensible agreement is not forthcoming, the Court should exercise its power to order specific disclosure of key information and its other case management powers robustly.

1  Re AGPS BondCo PLC [2024] EWCA Civ 24

The Court of Appeal noted that the horizontal comparison was therefore far more straightforward than where, for example: the relevant alternative was a different restructuring or sale process, rather than a formal insolvency; where the plan creditors have different priority rankings of secured or unsecured debts; or where the company proposed a complex restructuring of its debts in order to continue trading after the plan was implemented. 

3  [2023] EWHC 1679 (Ch)

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