Debt restructuring mechanisms have been under scrutiny in recent years. The EU Commission put forward a proposal for the introduction of a directive dealing with restructuring in November 2016, the UK Insolvency Service published a Consultation Paper outlining proposals for change regarding restructuring mechanisms in the UK in May 2016 and there have even been reform proposals put forward regarding US Chapter 11, sometimes regarded as the “gold standard” of debt restructuring mechanisms (see http://commission.abi.org/full-report). These proposals all aim to ensure effective mechanisms are in place to enable financially distressed companies to restructure and trade out of their difficulties, rather than go into liquidation.
A debt restructuring can be beneficial for companies, who need to be able to reshape their capital structures if they are no longer fit for purpose. It can also be beneficial for creditors and other stakeholders in the company, if it allows a company to continue and flourish rather than fail. Creating an effective debt restructuring regime is a valuable goal and one that should be pursued, but the intervention of the law to facilitate debt restructuring creates potential dangers, particularly for existing creditors of the company, and the role of the court in mitigating these dangers has sometimes been overlooked or misunderstood. This paper, forthcoming in the Cambridge Law Journal, examines the role of the court in the restructuring process and argues that the court should be at the centre of a debt restructuring regime.
There are three different issues that raise concerns for creditors in a debt restructuring that are discussed in this paper. The first is the imposition of a restructuring on dissenting creditors, which introduces the potential for abuse of the dissenting minority, and, in particular, for wealth transfers between creditors. Second is the imposition of a moratorium while a restructuring is negotiated, which might lead to misuse of the process by managers wishing to prop up companies that are not viable, or may allow managers of a viable business to ‘shake off’ liabilities that it is capable of servicing. Third, the introduction of provisions designed to encourage the financing of financially distressed companies, particularly those that prefer the providers of new finance to existing creditors, raises concerns for existing creditors regarding the level of their protection. The court can, and should, have a role in overseeing these constraints on creditors’ rights and ensuring an appropriate balance is maintained between the desire to rescue the company and the need to protect minority creditors.
There are different approaches to the involvement of the court in debt restructuring. In the US, for example, Chapter 11 of the Bankruptcy Code relies heavily on the role of the court, whereas the 2016 EU draft Directive regarding restructuring processes aims to minimise court involvement. In the UK, court oversight is already well developed in relation to the first issue, namely the danger of wealth transfers as a result of the imposition of a restructuring on dissenting creditors, particularly where the restructuring takes place by way of a scheme of arrangement. However, the English court has relatively little role to play in the second and third issues to date because these have not yet been significantly developed in the UK. This may be set to change. The UK Insolvency Service’s reform proposals will, if implemented, make significant changes to all three areas, expanding the extent to which debt restructuring proposals can be imposed on dissenting creditors, widening and expanding the reach of the moratorium, and introducing provisions encouraging rescue financing. There are reasons to doubt whether the law’s intervention in all these areas should be welcomed. This is not merely a matter of policy. Even if the law’s intervention is successful in other jurisdictions, such as the US, different institutional arrangements and legal frameworks in the UK may mean that the transposition of such provisions should be resisted. Nevertheless, if these proposals do go ahead, it is clear that they will entail significant additional constraints on creditors’ rights.
The current role of the English court is key to avoiding creditor oppression in a restructuring. The court has a role in ensuring that the procedural requirements for the restructuring are satisfied, and in particular that safeguards designed to protect creditors are met. The role goes further than this, however. The court may well be called upon to consider whether the restructuring should go forward even where the procedural requirements have been satisfied, as can occur at the sanctioning stage of schemes of arrangement at present, or to mediate between the interests of an individual creditor and the interests of the creditors as a whole, for example where a creditor seeks to assert its rights despite the existence of a stay. In order to ensure adequate creditor protection, the starting point must be that, as a minimum, creditors should not be made worse off following a reorganisation than they would be if the reorganisation were not to occur. This, however, requires a difficult assessment both as to what that alternative might be, and how the company is to be valued in that eventuality, and also what “worse off” means in this context, for example whether this requirement is satisfied where a creditor’s security is overridden but they are offered periodic cash payments instead. The English courts have made some progress in answering these questions, but more is needed, particularly if the Insolvency Service’s 2016 proposals are implemented. This paper analyses these issues and suggests how these matters should be dealt with by the English courts in the future.
Jennifer Payne, Professor of Corporate Finance Law, University of Oxford and Fellow and tutor of Merton College, Oxford.