Court of Appeal Overturns Adler Restructuring Plan

The Court of Appeal (Nugee, Snowden LJJ and Sir Nicholas Patten) has overturned Leech J and set aside the sanction order in Adler.  In a humdinger of a judgment delivered by Snowden LJ, the Court of Appeal has restated and clarified much of the law on restructuring plans.  In summary:

• The flaw in the plan which ultimately persuaded the Court of Appeal to set aside the judge’s order was its divergence from pari passu treatment of creditors without justification.  The relevant alternative to the plan was a wind down in a German insolvency proceeding that would have accelerated the plan creditors’ notes of differing maturities and paid those notes pari passu.  The pari passu principle was a fundamental principle that equalised the risk of a shortfall amongst creditors with similar rights: [183]-[186].  The plan did not adhere to the treatment of noteholders’ rights in the relevant alternative and instead differed from that alternative by imposing staggered maturity dates that reflected (with one exception) pre-plan maturities.  The plan company had said that the preservation of staggered maturity dates reflected noteholders’ commercial expectations.  The Court of Appeal disagreed with this assessment because the relevant alternative was (as described) one in which the noteholders’ rights would have ranked pari passu, and this was a matter which the noteholders must have understood commercially because it followed from their rights and what they accepted to be the relevant alternative.  In the absence of a sufficient justification for diverging from the treatment of those rights in that relevant alternative, the plan could not be imposed on the dissenting class by means of a cross-class cramdown.  See [187]-[224].

• In reaching the above conclusion, the Court of Appeal affirmed the following propositions:

• • Part 26A shares the same two-stage class test as Part 26: [108]-[113].

• • Where there is no cross-class cram down in issue, Part 26A operates as Part 26 does.  The test to be applied at sanction is the rationality test: [114]-[116].

• • Where cross-class cram down is in issue, Part 26A requires a different test to be applied at sanction.  There are two-aspects: first, the test to be applied within an assenting class, i.e. to bind any minority within that class; secondly, the test to be applied in order to impose the plan on a dissenting class.   As to the no cross-class cram down scenario, the test is the rationality test.  As to the cross-class cram down scenario, the rationality test is not appropriate.  See [119] and [130]-[133].

• • Before setting out what test is appropriate in the case of a cross-class cram down, the Court of Appeal cleared away certain matters hitherto thought to inform that test:

• • • It is not appropriate (given the dissimilarity of rights between assenting and dissenting classes) for a judge to draw comfort from the views of the assenting class in order to impose the plan on the dissenting class: [124]-[128].  The judge can however place reliance on the views of a majority within the dissenting class, albeit not to a degree to undermine the statutory significance of the 75% threshold: [129]-[130].  In so holding, the Court of Appeal explained that contrary interpretations of ED&F and DeepOcean were wrong and not to be followed: [135]-[147].

• • • The satisfaction of the ‘no worse off’ as a jurisdictional matter entailed no presumption in favour of a cross-class cram down: [154].

• • In terms of the positive requirements of the test in the cross-class cram down scenario, it is appropriate for the court to consider the ‘horizontal comparator’, being a comparison of ‘the position of the class in question with the position of other creditors or classes of creditors (or members) if the restructuring goes ahead’: [149] and [156].  In this respect, the Court of Appeal approved of the statements in DeepOcean, Houst, GAS and also New Look (a CVA case) to that effect: [157]-[161].  This meant that where a plan differed in its treatment of certain creditors relative to the treatment of other creditors (and having regard to their rights in the relevant alternative) that treatment had to be for ‘good reason’ and justified on a ‘proper basis’: [164].  Examples of such justification included the payment of necessary trade creditors in full or priority treatment of finance creditors who introduced new money: [167]-[168] and [170].  (Although the Court of Appeal suggested certain elevation mechanism of the kind encountered in ED&F might be more debatable and ‘likely to be highly fact sensitive’ [169]).

• • In Adler, unlike cases of asserted different restructurings or a sales process, the relevant alternative was a wind down to be conducted in a German insolvency process: [163] and [166].  The assessment of the horizontal comparator was therefore relatively straightforward, and there was no good reason or proper basis for diverging from pari passu treatment.  A harmonisation of maturities under the plan would have achieved the objectives of the restructuring: [203].  The court was not precluded from this assessment by the principle in Part 26 that the court should not ask whether alternative scheme terms were ‘better’ than the scheme at hand.  Amicus was not authority to the contrary: [174]-[179].  Instead, at [180], the Court of Appeal said that approach articulated by Zacaroli J in New Look (at [196]) was to be preferred:

‘[I]n considering whether the allocation of assets is fair, the court is necessarily required to consider whether a different allocation would have been possible, so the principle adopted in scheme cases, against considering whether an alternative arrangement would have been fairer, needs to be modified.’

• • In rejecting the plan company’s case that there would ‘likely’ be payment in full in the future (such that the staggered maturities merely imposed a differential credit risk that would ‘likely’ come out in the wash), the Court of Appeal held, firstly, that the pari passu principle was concerned with the equalisation of risk and that judge had found that future payment was not risk free; and secondly, that any finding about what was ‘more likely’ or ‘likely’ as to future events was inherently uncertain.  The Court of Appeal said, at [195] and [196]:

‘The first mistake, again, was that the Judge’s findings as regards the likely outcome in the Alternative Case were necessarily forward-looking and were arrived at on the balance of probabilities.  They provided no certainty whatever that the predicted sequence of events would in fact occur.

…

But there was no logical basis for the Judge to assume that this was the only other alternative to success of the Plan.  It is entirely possible – indeed inherently likely – that neither BCG’s nor Knight Frank’s predictions would turn out to be 100% accurate, and that the asset values and realisations obtained might therefore fall somewhere between the two extremes that they identified.’

• The Court of Appeal rejected part of the appellant’s case on one of its grounds of appeal, namely that the plan was unfair because of the retention of equity by existing equity holders.  The appellant’s had submitted that the logical conclusion of ‘economic ownership’ in the hands of ‘in the money’ creditors as against ‘out of the money’ shareholders entitled the former to allocate value and that the retention of equity had to be specifically justified (which it had not been).  Although he expressed his conclusion as provisional ([258]), Snowden LJ explained (at [239]-[278]) that Richard Smith J’s view in Prezzo that creditors or members rights might be ‘zeroed’ for no consideration was wrong.  He said that ‘compromise’ or ‘arrangement’ had the same meaning in Part 26A as in Part 26, and that NFU barred an expropriation of rights, whether a forfeit or shares or debts for no consideration.  He said that the means to bind ‘out of the money’ members and creditors in s.901C were only that; a means to bind ‘out of the money’ members and creditors based on determinations made on the balance of probabilities.  The same did not imply or justify a removal of rights for no consideration.

• As to process at first instance, the Court of Appeal praised the judge’s effort in undertaking the expedited trial over three days with extended sitting hours and in delivering a prompt judgment at the request of the plan company.  The Court of Appeal was however critical of the process and has provided guidance as to how future case should be conducted: [55]-[65].  There are several points:

• • The court will always be prepared to act urgently in appropriate cases.

• • A distinction is however to be made between foreseeable restructuring timelines and those which arise from unforeseen events.  As to the former, such as apparent maturity deadlines in finance documents, if the plan company and creditors have not left sufficient time for the court to adjudicate on matters fairly in the event of disputes, the plan company and creditors can have no complaint if the court should adjourn the case to a longer hearing in order to take ‘whatever’ time it requires.

• • Jurisdictional matters should not in general be postponed to the sanction hearing and any practice that might be developing in that respect ‘is to be deprecated’.

• As to process on appeal, parties minded to appeal a sanction order should give consideration to a stay of delivery of the sanction order to the registrar of companies (thus postponing the plan coming into force) until after reasons for the judgment are given and permission to appeal is determined: [97].

• The Court of Appeal expressly reserved comment either way on the use of the issuer substitution device as a means to create jurisdiction for the English court.  It noted that ‘artificiality’ had not been alleged in Adler and therefore said nothing about that issue save that it regarded the question as open at appellate level: [33]-[34].

Tom Smith KC and Adam Al-Attar appeared for the appellants.

Daniel Bayfield KC, Ryan Perkins and Annabelle Wang appeared for the plan company.