Corporate Restructuring

The appeal of English schemes of arrangement, coupled with recent case law supporting their use, has contributed to a significant increase in companies outside of the UK relying on this tool to address their financial difficulties. This has been most notable with respect to, but certainly has not been limited to, companies incorporated elsewhere in Europe. We believe the following factors will result in this trend continuing throughout 2014.

Jurisdictional Flexibility

In Europe, the opening of main insolvency proceedings is governed by the European Insolvency Regulation, which restricts this action to the country where a company has its center of main interests (or COMI). The COMI concept also is found in Chapter 15 of the U.S. Bankruptcy Code concerning the recognition of non-U.S. bankruptcy proceedings. However, because schemes are creatures of corporate rather than insolvency law, they are not governed by the European Insolvency Regulation ' and their use is not limited to companies that have their COMI in the United Kingdom. The essential requirements for a foreign company to be able to propose a scheme are that it is liable to be wound up under the UK Insolvency Act 1986 (which foreign companies are) and that it has a sufficient connection with England.

Governing Law Clauses

Recent case law has established that a scheme of a non-UK company can be implemented where the debts in question are governed by English law, and there is ample evidence to show that, if approved, the effect of the scheme would be recognized in the company's home jurisdiction. A good example is the decision in Re Rodenstock [2011] EWHC 1104, where a scheme was approved with respect to a German company that manufactured spectacles. Rodenstock had its COMI in Germany, no establishment in the UK and no assets in the UK It was held sufficient that the finance obligations that were being adjusted were governed by English law and subject to an exclusive jurisdiction clause in favor of the English courts. In Re Icopal [2013] EWHC 3469, scheme meetings were convened by the court where the applicant companies were incorporated in Delaware, France and Denmark respectively and all the debt was governed by English law. The cases to date have also demonstrated that the courts of foreign jurisdictions will recognize a process whereby an entity's contractual obligations are varied through a mechanism operating under and in accordance with the same system of law ' in this case, English law.

In In Re Magyar Telecom BV [2013] EWHC 3800, a Dutch company had issued bonds to finance business operations in Hungary, which were governed by New York law and subject to an exclusive jurisdiction clause in favor of the courts in New York. Prior to launching the scheme, the company had moved its COMI from Holland to the UK. On the evidence before the court, if a scheme could not be successfully implemented, the likely alternative would have been a winding up process in the UK, since the company's COMI was now there. Crucially also, the fact that the COMI had been moved to the UK meant it was likely that the U.S. courts would recognize the scheme (altering NY law governed obligations) under Chapter 15 of the U.S. Bankruptcy Code. These features were key in persuading the court to convene the scheme meetings.

To date, schemes have been successfully implemented for companies incorporated in, among others, Spain, Germany, Italy, Holland, Denmark, Bulgaria, Vietnam and Kuwait. Given the extensive use of English governing law clauses in international financings, schemes have the potential to be used even more broadly in the future.

Amend-and-Extend Transactions

Traditionally, schemes have been used to effect substantial balance sheet restructurings. Schemes involve two court hearings and bespoke drafting of the scheme documents following detailed negotiations; consequently, they have tended to be deployed in more complex situations. Recently, however, schemes have been used under more straightforward circumstances. A defining feature of the distressed European landscape since the global financial crisis began has been reluctance on the part of lenders to realize losses that otherwise can be avoided. This has led to what are sometimes called “amend-and-extend” transactions under which maturities are pushed out and other terms adjusted. This permits the company to postpone addressing what may be fundamental structural issues for the period of the extension with the hope that the economic environment will improve. Several European companies, including Spanish retailer Cortefiel and German roofing supplier Monier, successfully used schemes in 2012 and 2013 to obtain amend-and-extend agreements on their debt facilities.

No Creditor Consensus, No Problem

There appears to be an increasing appetite to use schemes in a broader set of financial circumstances to address the problem posed by holdout creditors. Finance agreements often require unanimity ' an often impossible threshold to achieve ' to amend key terms such as the amount of principal and maturity dates. When this happens the results can include deadlock, having to pay holdouts in accordance with the original terms or even the failure of the business. A scheme provides a method of binding a minority to a new deal. Recent authorities have also confirmed that the use of lock up agreements, whereby creditors agree in advance to vote in favor of a scheme, and the practice of offering modest consent payments as an incentive to creditors to commit to supporting a scheme are permissible and will not ordinarily give rise to class issues.

Stay on Legal Proceedings

Since it is not a creature of insolvency law, the proposal of a scheme does not give rise to a moratorium to prevent creditors from taking action against the company to maximize their own recovery or to derail the scheme itself. Historically, this has been regarded as disadvantage because a scheme will take time to be negotiated and prepared, and a company in financial distress may be subject to legal action and even insolvency proceedings before a scheme can be implemented. However, in a recent English decision, an innovative development provided the company with the time necessary to implement a scheme. In Bluecrest Mercantile v. Vietnam Shipping Industry Group [2013] EWHC 1146, monies had fallen due under a facility entered into by a Vietnamese ship-building company, and two of the lenders sought summary judgment.

The company had no defense to the claim, but negotiations on a scheme were reasonably well advanced. The court used its inherent case management powers to grant a temporary stay of the lenders' claims to give the chance for a scheme to be developed and approved. The order also included protections for the lenders to help ensure that they would not be prejudiced in the event that other creditors sought to take action against the company. It will be interesting to monitor whether the grant of a stay becomes a relatively common feature of the scheme process.

Conclusion

As the eurozone crisis continues to linger and companies and investors seek to remedy financial distress, the use of schemes is expected to grow in European restructurings where there is significant English law-governed debt. Notwithstanding some recent changes to the formal insolvency processes in countries such as Spain and Germany, European borrowers should view the British legal system's unique tool as an additional aid in navigating the restructuring process.

Dominic McCahill is a London-based partner in the Corporate Restructuring practice of Skadden, Arps, Slate, Meagher & Flom LLP. He advises companies and creditors in corporate restructuring matters with an emphasis on cross-border situations. He may be reached at [email protected].

A scheme of arrangement is a tool of English corporate law that has been used in M&A and restructurings for decades. A company implementing a scheme has complete freedom to choose with which groups of shareholders and creditors to engage to achieve the desired commercial end. The longevity of schemes in English law also has allowed a broad and detailed body of case law to develop, which has engendered predictability without endangering the tool's flexibility.

In restructurings, schemes have been used to effect complex financial reorganizations tailored to the specific needs of the stakeholders. The amount of debt can be reduced with the pain shared generally in accordance with the participants' relative legal rights and other points of leverage. In the UK, schemes often are used instead of a formal insolvency process, and they can be employed to provide more innovative solutions in administrations and liquidations than insolvency legislation alone can accommodate.

A scheme involves two court hearings. At the first hearing, the court is asked to convene one or more meetings of creditors (and/or shareholders) to consider and to vote upon the scheme proposal. A key area of focus will be the composition of the class or classes of persons whose rights are to be altered. If the meetings are summoned and each class has approved the scheme by the requisite majority (a majority in number representing 75% in value of those attending the meeting and voting), a second court hearing takes place at which the court will sanction the scheme if it is satisfied that: 1) the statutory requirements have been met; 2) the class was fairly represented and the majority acted in good faith; and 3) the scheme is appropriate in the sense that it is such as an intelligent, honest person acting in respect of his own interest might reasonably approve.

The appeal of English schemes of arrangement, coupled with recent case law supporting their use, has contributed to a significant increase in companies outside of the UK relying on this tool to address their financial difficulties. This has been most notable with respect to, but certainly has not been limited to, companies incorporated elsewhere in Europe. We believe the following factors will result in this trend continuing throughout 2014.

Jurisdictional Flexibility

In Europe, the opening of main insolvency proceedings is governed by the European Insolvency Regulation, which restricts this action to the country where a company has its center of main interests (or COMI). The COMI concept also is found in Chapter 15 of the U.S. Bankruptcy Code concerning the recognition of non-U.S. bankruptcy proceedings. However, because schemes are creatures of corporate rather than insolvency law, they are not governed by the European Insolvency Regulation ' and their use is not limited to companies that have their COMI in the United Kingdom. The essential requirements for a foreign company to be able to propose a scheme are that it is liable to be wound up under the UK Insolvency Act 1986 (which foreign companies are) and that it has a sufficient connection with England.

Governing Law Clauses

Recent case law has established that a scheme of a non-UK company can be implemented where the debts in question are governed by English law, and there is ample evidence to show that, if approved, the effect of the scheme would be recognized in the company's home jurisdiction. A good example is the decision in Re Rodenstock [2011] EWHC 1104, where a scheme was approved with respect to a German company that manufactured spectacles. Rodenstock had its COMI in Germany, no establishment in the UK and no assets in the UK It was held sufficient that the finance obligations that were being adjusted were governed by English law and subject to an exclusive jurisdiction clause in favor of the English courts. In Re Icopal [2013] EWHC 3469, scheme meetings were convened by the court where the applicant companies were incorporated in Delaware, France and Denmark respectively and all the debt was governed by English law. The cases to date have also demonstrated that the courts of foreign jurisdictions will recognize a process whereby an entity's contractual obligations are varied through a mechanism operating under and in accordance with the same system of law ' in this case, English law.

In In Re Magyar Telecom BV [2013] EWHC 3800, a Dutch company had issued bonds to finance business operations in Hungary, which were governed by New York law and subject to an exclusive jurisdiction clause in favor of the courts in New York. Prior to launching the scheme, the company had moved its COMI from Holland to the UK. On the evidence before the court, if a scheme could not be successfully implemented, the likely alternative would have been a winding up process in the UK, since the company's COMI was now there. Crucially also, the fact that the COMI had been moved to the UK meant it was likely that the U.S. courts would recognize the scheme (altering NY law governed obligations) under Chapter 15 of the U.S. Bankruptcy Code. These features were key in persuading the court to convene the scheme meetings.

To date, schemes have been successfully implemented for companies incorporated in, among others, Spain, Germany, Italy, Holland, Denmark, Bulgaria, Vietnam and Kuwait. Given the extensive use of English governing law clauses in international financings, schemes have the potential to be used even more broadly in the future.

Amend-and-Extend Transactions

Traditionally, schemes have been used to effect substantial balance sheet restructurings. Schemes involve two court hearings and bespoke drafting of the scheme documents following detailed negotiations; consequently, they have tended to be deployed in more complex situations. Recently, however, schemes have been used under more straightforward circumstances. A defining feature of the distressed European landscape since the global financial crisis began has been reluctance on the part of lenders to realize losses that otherwise can be avoided. This has led to what are sometimes called “amend-and-extend” transactions under which maturities are pushed out and other terms adjusted. This permits the company to postpone addressing what may be fundamental structural issues for the period of the extension with the hope that the economic environment will improve. Several European companies, including Spanish retailer Cortefiel and German roofing supplier Monier, successfully used schemes in 2012 and 2013 to obtain amend-and-extend agreements on their debt facilities.

No Creditor Consensus, No Problem

There appears to be an increasing appetite to use schemes in a broader set of financial circumstances to address the problem posed by holdout creditors. Finance agreements often require unanimity ' an often impossible threshold to achieve ' to amend key terms such as the amount of principal and maturity dates. When this happens the results can include deadlock, having to pay holdouts in accordance with the original terms or even the failure of the business. A scheme provides a method of binding a minority to a new deal. Recent authorities have also confirmed that the use of lock up agreements, whereby creditors agree in advance to vote in favor of a scheme, and the practice of offering modest consent payments as an incentive to creditors to commit to supporting a scheme are permissible and will not ordinarily give rise to class issues.

Stay on Legal Proceedings

Since it is not a creature of insolvency law, the proposal of a scheme does not give rise to a moratorium to prevent creditors from taking action against the company to maximize their own recovery or to derail the scheme itself. Historically, this has been regarded as disadvantage because a scheme will take time to be negotiated and prepared, and a company in financial distress may be subject to legal action and even insolvency proceedings before a scheme can be implemented. However, in a recent English decision, an innovative development provided the company with the time necessary to implement a scheme. In Bluecrest Mercantile v. Vietnam Shipping Industry Group [2013] EWHC 1146, monies had fallen due under a facility entered into by a Vietnamese ship-building company, and two of the lenders sought summary judgment.

The company had no defense to the claim, but negotiations on a scheme were reasonably well advanced. The court used its inherent case management powers to grant a temporary stay of the lenders' claims to give the chance for a scheme to be developed and approved. The order also included protections for the lenders to help ensure that they would not be prejudiced in the event that other creditors sought to take action against the company. It will be interesting to monitor whether the grant of a stay becomes a relatively common feature of the scheme process.

Conclusion

As the eurozone crisis continues to linger and companies and investors seek to remedy financial distress, the use of schemes is expected to grow in European restructurings where there is significant English law-governed debt. Notwithstanding some recent changes to the formal insolvency processes in countries such as Spain and Germany, European borrowers should view the British legal system's unique tool as an additional aid in navigating the restructuring process.

Dominic McCahill is a London-based partner in the Corporate Restructuring practice of Skadden, Arps, Slate, Meagher & Flom LLP. He advises companies and creditors in corporate restructuring matters with an emphasis on cross-border situations. He may be reached at [email protected].