In Part 1 of this post I explained the background to the Insolvency’s Services Consultation Paper and analysed the proposals for a new moratorium to promote business rescue. Part 2 of this post will analyse the cram-down proposals and rescue finance.
The Consultation Paper envisages a restructuring plan which would bind all creditors, including secured creditors, and would enable a cram-down of junior creditors even if (as a class) they vote against the plan, as long as they will not be worse off than in liquidation.
The Consultation Paper envisages a procedure very similar to that in a scheme, ie the creditors are to be divided into classes (‘grouped by similar rights or treatment’- para 9.15), the classes to be decided by the company but approved by the court. The creditors would then vote on the plan in classes and a second court hearing would be required to confirm the plan. The consultation offers the option of this plan as a standalone procedure, or as an extension of an existing procedure - with the Consultation Paper offering the CVA as an option for this purpose (para 9.14). The close structural adherence to the scheme pattern makes the latter option very odd. The CVA is not a good fit with this mechanism. Schemes are used far more often to effect these restructurings and there is already a rich and developed jurisprudence regarding issues such as the division of creditors into classes and the protection of minority creditors. The only significant advantage of CVAs at present, namely reduced costs and complexity due to a lack of compulsory court hearings and no class meetings, would in any case disappear under the proposed restructuring plan.
In general, the introduction of a cram-down option is to be welcomed. While other jurisdictions (eg US Chapter 11) allow restructurings to go ahead without the consent of entire classes, in the UK no single mechanism allows this to occur. The scheme of arrangement comes closest, but there the restructuring can only be imposed on dissenting creditors within a class; there is no possibility of a cram-down across classes unless the scheme is twinned with administration, and in practice this is the most valuable aspect of using the combined regime. Being able to facilitate a restructuring even where out of the money creditors dissent is undoubtedly valuable if you wish to promote business rescue (see eg Re MyTravel Group plc  EWHC 2741 (Ch);  EWCA Civ 1734).
There are two points about the proposed procedure that require thought, however. One relates to the voting requirements in class meetings. The suggested majority vote repeats the existing approval requirement for schemes, ie a majority in number representing 75% in value of the creditors or class of creditors (see Companies Act 2006, s 899(1)). The addition of the majority in number requirement (headcount test) is not found elsewhere in company law and has been heavily criticised, and indeed other jurisdictions have amended the approval test for schemes, removing the headcount requirement (for discussion see J Payne, Schemes of Arrangement (CUP, 2014) pp 61-68 and 184-187). This can prove a problem in both member and creditor schemes. For instance in bondholder schemes it is not clear whether the test applies to the individual bondholders or the trustee- if the latter then there can be difficulties applying the headcount test. The benefit of the headcount test (to protect small creditors) can best be dealt with in other ways, such as via the exercise of the court’s oversight in approving the plan.
Second, the court’s role in approving the plan is (rightly) recognised not to be a rubber stamping exercise. Broadly, the considerations set out in the Consultation Paper for the court to take into account at this point in time follow those that exist in schemes and which generally work well. There is an additional requirement, which operates in practice in existing schemes but which is made explicit here, namely that the plan is in the best interests of the creditors as a whole, in that it recognises the economic rights of ‘in the money’ creditors and all other creditors are no worse off than they would be following liquidation (para 9.20). This raises the issue of valuation, which the Consultation Paper tackles only very briefly (paras 9.33-9.35) and yet in practice has proved a very difficult issue (see eg Re Bluebrook Ltd  EWHC 2114 (Ch). The issue of valuation is so complex and so divisive that a greater level of statutory guidance on this issue would be potentially beneficial (as occurs in US Chapter 11). The minimum valuation test suggested in the Consultation Paper is a liquidation valuation, but it may well be the case that in practice a higher valuation mechanism (based on a going concern valuation, for example) will be more appropriate.
It is generally acknowledged that the lack of rescue finance in the UK is a potential problem for distressed companies, and the UK compares poorly to other jurisdictions, such as the US, in this regard. The 2009 consultation paper therefore included such proposals, although they were not taken forward at that time. The Government is having a second bite at this cherry. The intent is laudable. However, the difficulty with rescue finance is always finding a way to balance to company’s need for new finance and the new creditor’s incentives to lend and desire for protection against the need to protect existing creditors. The difficulty of these issues are acknowledged in the Consultation Paper which simply puts forward a series of ‘options that could be considered’, which are not intended to be exhaustive, and seeks views from interested parties on this issue (para 10.15).
Among the options put forward by the Consultation Paper is super-priority for rescue finance in administration expenses, something that was proposed in 2009 and which was generally felt to be likely to have a modest impact given that administration expenses are generally discharged in full. Another suggestion is the ability to override negative pledge clauses in certain circumstances in order to enable a distressed company to grant security for new finance. This would be available where the company has equity in charged assets, but the existing charge holder relies on a negative pledge clause to refuse to permit the granting of new security even though their indebtedness could be fully discharged by the proceeds of sale of the charged assets. The Consultation Paper offers as an alternative option the ability of the company to grant security to new lenders over company property already subject to charges, where that new security might rank as an additional but subordinate charge on the property, or possibly as a first charge on the property (where the existing holder does not object), and, further, where the assets against which the new charge is secured prove insufficient to discharge the amount owed, any shortfall would rank above preferential and floating charge holders.
Again, many of these ideas were advanced in 2009. The devil with such proposals is generally in the detail and not much detail is provided by the Consultation Paper. It will be important to demonstrate that existing creditors are protected which will require careful thought as to valuation, amongst other things. The negative pledge could be overridden where it is deemed that the current security holders’ indebtedness can be fully discharged from the sale of the assets. When and how would that valuation be performed and by whom? What level of court oversight would be involved? There is the potential for abuse where a snapshot view is taken in volatile market conditions. It is also worth considering the likely response of other creditors to these provisions. For example, trading creditors may be less willing to continue to trade with the company given that rescue finance will rank ahead of trading expenses.
The aim of this Consultation Paper is laudable and it would undoubtedly be valuable to create a standalone procedure to perform the role currently undertaken by the twinned mechanisms of schemes and administration. Other jurisdictions are developing this kind of regime and introducing such a procedure will help the UK to remain competitive in a global market. The idea of creating a UK debt restructuring mechanism with a cram-down and a moratorium is exactly right. Now it’s about ensuring that the details are correct too.
Jennifer Payne is Professor of Corporate Finance Law at the University of Oxford.