Challenging schemes of arrangement: Recent case analysis

Published: 21/6/2021

Although the recent spate of decisions might give the opposite impression, fully-argued challenges to schemes of arrangement (and, now, restructuring plans) are relatively unusual.

Opposition to the scheme or plan may often be expressed when creditors are first informed about the proposals, or even at the first (convening) hearing, but it is only in a minority of cases that concerted opposition continues to the second (sanction) hearing. 

There has been much commentary and analysis on the decision in Re Virgin Active Holdings Limited [2021] EWHC 1246 (Ch), in which a challenge by landlords to a restructuring plan was rejected by Snowden J (and the cram-down of the landlords approved). The Virgin Active judgment coincided with equally significant judgments in relation to the CVA challenges in Re New Look and Regis UK, and has therefore rightly commanded most attention, but there have been other recent decisions in relation to scheme challenges which are of considerable interest.  

Proper consultation with scheme creditors: Re ALL Scheme Limited [2021] EWHC 1401 (Ch)

The majority of schemes that come before the English courts are compromises between the scheme company and a sophisticated and well-advised group of financial creditors (banks and bondholders), in which the terms of the scheme have been shaped by negotiations between the company and creditors. In such cases, the court will generally assume that the creditors are better judges of the merits of the proposed scheme than the court and will therefore be slow to look behind the creditors’ approval of the scheme (See Re Telewest Communications plc (No.2) [2005] 1 BCLC 772 at [22] per David Richards J). Accordingly, where the scheme before the court has been approved by the statutory majority, the court will not generally consider whether that scheme is the only fair scheme, or even the best scheme that could have been proposed.

The circumstances of the scheme that came before Miles J on 19 May 2021 were rather different. ALL Scheme Limited was part of the Amigo group (the “Group”), which offered loans to borrowers who were unable to borrow from mainstream lenders. The Group faced significant liabilities in respect of redress claims from borrowers who had entered into inappropriate loan arrangements, and their guarantors, and it sought to compromise those redress liabilities by way of the scheme. The Group’s position was that, if the scheme were not approved, the main operating company in the Group would likely go into administration.

The scheme was approved by c.95% of the redress creditors who voted (albeit that the turnout was c.8.7% of the total class). Despite this ostensibly high level of creditor support, at the sanction hearing the scheme was opposed by the Financial Conduct Authority (as the company’s regulator). The FCA raised a number of concerns about the scheme, but its overarching objection was that the scheme did not strike a fair balance between redress creditors (who were subject to a 90% reduction of their claims) and shareholders, which retained their economic interest in the group (in circumstances in which the value of their shares had increased by c.250% since the announcement of the scheme). 

Miles J refused to sanction the scheme, holding that the redress creditors were likely to have low levels of financial literacy, and that it was very unlikely that they would have any knowledge or experience of the “esoteric processes” of schemes of arrangement or corporate reorganisation. The Group had not paid for professional advisors to represent the redress creditors or advise them on the scheme (As has been done in other cases involving vulnerable creditors, e.g. Re Cape plc [2006] EWHC 1446 (Ch)).

Although the facts of the case are relatively unusual, the judgment includes many points of interest and general application, including the following:

  • The general rule that the court will defer to the views of the creditors or members who have approved a scheme is predicated on the assumption that the creditors or members have been properly informed and consulted in relation to the terms of the scheme. Where fair, full and adequate information has not been given, the court is unlikely to be able to place any reliance on the vote in favour of the scheme [102 (viii) – (ix)]
  • In a scheme where creditors’ claims are to be compromised but the existing shareholders are to retain a material stake in the restructured company, the company should provide a detailed statement of the assumptions and methodology underlying any valuations which are said to justify the treatment of shareholders, so that creditors can reasonably assess whether the allocation of losses between creditors and shareholders is appropriate and fair [102(xi)].
  • The scheme circular in this case had given creditors the impression—which Miles J held to be false—that if this particular scheme was not passed, an insolvency would be automatic and imminent. The creditors (given their lack of financial experience) were unlikely to have understood that the options were not as binary as suggested by the Group, and the explanatory statement to the scheme had been insufficient to inform them about the scheme and the relevant alternatives [132-133; 138].
  • As a result of the company’s failure properly to inform and consult with creditors, the court could not properly place any reliance on the approval of the scheme by the creditors meeting, and it therefore declined to sanction it [138-142].  

One interesting and unusual aspect of the ALL Scheme Ltd case is that the court rejected the evidence of the directors that, if the scheme were not sanctioned, the alternative was likely to be that relevant Group companies would go into administration. Miles J held that there was no evidence that the Group was facing an imminent, or even medium-term, cashflow crisis [85]. That being the case, and given that the share price indicated that the market perceived that there was substantial surplus value in the Group, he noted that it seemed improbable that the directors would simply force the Group into insolvency without carefully assessing alternative restructuring proposals [87] (As at the date of this article, the judge appears to have been right; no insolvency proceedings have been commenced). Indeed, he held that they would be duty-bound to do so [92]. The company’s assessments of the costs and time that would be required for an alternative restructuring were dismissed as “extremely pessimistic” [96].

It is common for scheme companies and their advisors to present the scheme as the only viable solution for the company’s financial difficulties, and the choice for scheme creditors as a starkly binary one. In many cases, of course, that may be true—and in others, the creditors will in any event be capable of forming their own view and entering into meaningful negotiation with the company. Nonetheless, the ALL Scheme Ltd judgment shows that directors should be careful to ensure that they do not succumb to the temptation to overstate the position in that regard, and that they have clear evidence to support their view of the relevant alternatives. Furthermore, the court’s directions as to the information that should be given to creditors in the explanatory statement, in a case where shareholders are to retain an economic interest in the company [102(xi)], appear to apply irrespective of the sophistication of the creditor group. 

Recognition of schemes in the EU: Re DTEK Energy BV [2021] EWHC 1551 (Ch)

A further case which those interested in this area should note is Re DTEK Energy

Enyo Law was involved in the case and is unable to comment further, but the judgment of Sir Alastair Norris considers (in particular): (i) the test of whether a proposed scheme will be substantially effective in key jurisdictions where the scheme company has liabilities or assets; (ii) the effect of Brexit on the court’s approach to that test; and (iii) how the court should deal with conflicting evidence of foreign law as regards the effectiveness of the scheme abroad (see, in particular, paragraphs [41-46] of the judgment).

Conclusion

Schemes and plans remain a dynamic and developing area of law, and we will no doubt see further decisions of interest as the effects of the pandemic on the global economy are worked through, and as the limits of the restructuring plan are tested. Challenging these processes is rarely straightforward, not least because judges (understandably) take very seriously the evidence of the debtor’s management about the catastrophic consequences of the scheme or plan not being approved. In that respect Re ALL Scheme Limited stands out from the general run of cases. Although it is also a decision founded on specific and unusual facts, it includes some points which may be of use to future challengers. 

The best advice to any such potential challengers remains to seek specialist advice as soon as possible upon learning of the proposal, so as to maximise both their leverage and their chances of identifying and exploiting weaknesses in the scheme or plan.

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