Until recently, there were two key rescue procedures which a company could use to reach a compromise with its creditors, namely company voluntary arrangements (CVAs) and general schemes of arrangement under Part 26 of the Companies Act 2006 (General Schemes):
- CVAs enable companies (if they have sufficient creditor backing) to compromise the debts of unsecured creditors – for example, by providing that unsecured creditors will only receive a portion of the amounts owed to them, to be paid in scheduled instalments.
- General Schemes are wider in scope than CVAs and enable compromises to be reached with some or all of a company’s creditors and/or members (again, provided that sufficient backing is obtained from each affected class of creditors and/or members).
Towards the end of June 2020, the Companies Act 2006 was amended to introduce a potentially significant new rescue procedure, namely restructuring schemes for companies in financial difficulty (Part 26A Schemes). This new rescue procedure was introduced alongside a number of other changes to the insolvency regime designed to support businesses adversely affected by COVID-19, as part of the Corporate Insolvency and Governance Act 2020. We summarised those other changes in our article here.
Cross class cram downs
The distinguishing feature of the new Part 26A Scheme is that it does not necessarily require the approval of all affected classes of creditors and/or members. It is possible for a Part 26A Scheme to come into effect even if some affected classes of creditors and/or members do not vote in favour of the scheme (i.e. the classes of creditors and/or members which vote in favour of the scheme may be able to ‘cram down’ the dissenting classes). The greater flexibility of these new restructuring schemes bears some similarities to the US Chapter 11 bankruptcy process, and the UK Government hopes that it will facilitate the rescue of businesses which have multiple classes of creditors and/or shareholders with divergent interests.
The scope of what can be achieved using the new restructuring scheme is currently unclear; a Part 26A Scheme requires court approval, and the courts are expected to develop limits regarding its use over time. The most likely applications of the Part 26A Scheme include the cram down of unsecured creditors (particularly where they are ‘out of the money’) and the cram down of shareholders (for example, by diluting/’washing out’ particular classes of shareholders in circumstances where lenders are prepared to take equity as part of the rescue package).
It is also possible (depending on how the courts interpret the legislation) that the new restructuring scheme could be used in ‘cram up’ plans – for example, to restructure secured debt without the consent of the relevant secured lenders. Depending on the circumstances, cram up plans might involve resetting events of default or adjusting interest rates against the wishes of affected lenders.
Companies which have encountered or are likely to encounter financial difficulty
A Part 26A Scheme may only be proposed in relation to a company which has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern. The purpose of the scheme must be to eliminate, reduce or prevent, or mitigate the effect of, any of those financial difficulties.
It is worth noting that a Part 26A Scheme can be used to address anticipated financial difficulties, as long as those difficulties are likely to arise and may affect the company’s ability to carry on business as a going concern. A Part 26A Scheme must be planned for sufficiently in advance, given the need to hold meetings of the affected classes of creditors/members and the requirement for court approval. It is unclear how proximate the financial difficulties will need to be in order for a court to approve a Part 26A Scheme.
Seeking the approval of affected classes of creditors and/or members
A proposed Part 26A Scheme must be submitted for the approval of each class of creditors and/or shareholders whose rights would be affected by the proposed scheme. It is not necessary to seek the approval of any class which has no genuine economic interest in the company.
An initial court hearing will be held in order to identify how many distinct classes of creditors and/or members there are. Each class holds a separate meeting to vote on the proposed scheme. A class will have approved the proposed scheme if 75% in value of its members present at the meeting (in person or by proxy) vote in favour of the scheme. If that acceptance threshold is not achieved, then that class is a dissenting class.
At least one class of affected creditors and/or members must approve the proposed scheme in order for a court to sanction it. Where there are one or more dissenting classes, then it is still possible for the court to decide to sanction the scheme, provided that the following two conditions are met:
- First, the court must be satisfied that no member of a dissenting class would be any worse off as a result of the scheme being sanctioned when compared against whatever alternative scenario the court considers is most likely to arise if the scheme is not sanctioned (the “relevant alternative scenario”). If the dissenting class decides to contest the proposed scheme before the court, then the court may be required to consider competing submissions and expert evidence regarding the economic position of the dissenting class if the rescue plan proceeds, relative to their likely economic position in the relevant alternative scenario.
- Second, at least one class of creditors or shareholders which is ‘in the money’ must have voted in favour of the scheme. This means that there must be at least one approving class of creditors or members which would, even in the relevant alternative scenario which is likely to apply if the scheme is not sanctioned, still receive a payment or otherwise retain a genuine economic interest in the company. The implication is that the scheme must be sufficiently attractive to the approving class(es) that they prefer it to the relevant alternative scenario.
Even where those two conditions are satisfied, the court will still consider whether the proposed scheme is fair and reasonable before sanctioning it. It remains to be seen what factors may persuade a court to refuse to sanction a scheme in circumstances where there are some dissenting classes.
The identification of distinct classes of creditors and/or members may well prove to be a contentious area. There is a risk that some parties may attempt to ‘game’ the voting process by moving likely dissenters into classes where their votes will be outweighed by the proponents of the scheme. Alternatively, an attempt could be made to isolate likely dissenters within their own distinct class, in order to prevent them from blocking the 75% approval threshold being reached by the proponents of the scheme.