Unfortunately, economic shocks generally lead to a wave of businesses needing to restructure their debts in order to continue trading as a going concern and avoid insolvency. By way of example, the 2008 financial crisis was a global phenomenon causing a liquidity crunch for businesses and precipitated large numbers of both restructurings and insolvencies. More recently we have endured the economic shock of the coronavirus pandemic. Legislators and governments worldwide have taken various measures, such as introducing a new regime for Schemes of Arrangement, in a bid to save businesses that would otherwise be viable from insolvency.
Here, Blake Morgan take a look at:
- the basic concept of a restructure;
- the original Scheme of Arrangement procedure in Part 26 Companies Act 2006 (Original Schemes) and its limitations;
- the new Scheme of Arrangement procedure in Part 26A Companies Act 2006 (New Schemes), its key features, and any implications for business owners in the jurisdiction of England and Wales.
It should be said at the outset that a Scheme of Arrangement is, relative to other mechanisms generally, a labour intensive and expensive process as it requires expert advice from a multitude of disciplines and multiple attendances at court for the court to sanction the Scheme of Arrangement. For those reasons, a Scheme is generally regarded as being a suitable option for large company complex restructuring’s for whom the cost of implementing the Scheme is reasonably proportionate to the business to be saved and worthwhile. It should further be noted that this article will focus on Schemes, with discussion of other mechanisms including: administration, Company Voluntary Arrangements (CVA’s), and work-out’s, being beyond the scope of this article.
The key questions to consider for an owner of a business in financial distress are:
- what is a restructuring?; and
- what does it entail?
In broad terms, a restructuring (in the present context) refers to a reorganisation of the debt and equity claims on a company so that it has a viable future and is not pushed into insolvency, perhaps alongside making operational changes. Effecting this reorganisation has various features including, most notably, that a deal needs to be arrived at with a company’s creditors and shareholders which will sufficiently satisfy a company’s creditors to postpone monies owed to them. This can be a controversial process as it impacts upon the stakeholders in the company.
A Scheme of Arrangement: the concept
A Scheme of Arrangement is a legal mechanism by which a company can effect a restructuring by way of coming to an “arrangement” with its creditors and/or members (shareholders). This “arrangement” is the deal as referenced above. For example, a company in financial distress may be unable to repay a loan to a senior lender. Here, for illustrative purposes, a typical restructuring option to take may be a ‘debt-for-equity’ swap, whereby the company’s creditors forego their debt claims against the company in exchange for receiving equity instead. This can be beneficial to the company as it:
- (i) means that what might be immediate or imminent debt or interest payment are averted;
- (ii) it can continue to trade; and
- (iii) is no longer on the brink of insolvency.
It can also be beneficial to the creditor as pushing the company into insolvency may be detrimental to the value of the company and mean the creditor does not recover sums owed to it anyway; converting its debt to equity allows it to maintain its interest and at some point in time, allow the company to return monies to it in its new capacity as a shareholder. However, in contrast to these potential benefits for the company and creditors, the debt-for-equity swap can be disastrous for shareholders prior to the restructure, whose stake will often be wiped out as a result of being diluted by the creditors taking a majority equity stake in the company (in exchange for foregoing their debt claims).
Schemes have been a tool in the various iterations of the Companies Acts for over a century, and Original Schemes were used as a popular tool to effect restructurings in England and Wales post the 2008 crisis.
Typical problems in Schemes of Arrangement: obtaining requisite approval
A general problem with Schemes of Arrangement is that a certain number of votes of each class of creditor and shareholder must be obtained in order to make the “arrangement” i.e. the plan proposal, pass.
Schemes would effectively be unworkable if a proposed “arrangement” required the unanimous approval of all creditors and shareholders. The entire premise of a Scheme is that the company needs to be restructured as its debts are no longer sustainable. Therefore, to come to any kind of arrangement, debt will have to be reduced meaning that inevitably a stakeholder (or various stakeholders) will not recover what it is owed from the company in full.
To address the fact it would be unrealistic to get unanimous stakeholder approval, the Original Scheme has a “cram down” mechanism. A cram down allows effective majority rule, where, provided certain numbers of a class approve the arrangement, this is binding on those dissenting in the class. However, one of the criticisms of the cram down of the “Original Schemes” has been that there was no mechanism to “cram down” dissenting whole classes.
The New Scheme
As a response to the coronavirus pandemic, the UK Government took the step of introducing the Corporate Governance and Insolvency Act 2020 (CIGA). Schedule 9 of that Act provided for the New Schemes.
The purpose of the New Schemes are to give a company the best chance it can to survive given the economic downturn caused by coronavirus.
A significant feature of the New Scheme is that an arrangement may be sanctioned by the court even where a whole class in question do not approve the arrangement to the required level. This is a “cross – class cram down”. Whereas the Original Scheme allowed dissenting creditors within a class to be crammed down (i.e. ignored), the New Scheme allows for an entire class of dissenting creditors to be crammed down in certain circumstances. This means that New Schemes are not entirely dependent on obtaining sufficient approval from stakeholders.
It should be noted that the courts’ powers per New Schemes are discretionary, and safeguards still exist for dissenting stakeholders. Most notably, the court will only sanction the Scheme of Arrangement upon satisfaction of the condition that it is satisfied that none of the members of the dissenting class would be any worse off than they would be in the event of the relevant alternative insolvency process (being the most likely event to occur in the absence of sanctioning the New Scheme). Additionally, the court also require that those approving the New Scheme constitute a number representing 75% in value of a class of creditors or (as the case may be) of members, present and voting either in person or by proxy, who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative.
Notwithstanding these safeguards for dissenting stakeholders, the New Scheme is a significant development and signifies the English and Welsh jurisdiction pivoting to a more ‘rescue – friendly’ approach to insolvency. Blake Morgan can advise on all forms of restructuring and disputes including Original and New Schemes.
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