A New Era of Greater Scheme Scrutiny
Introduction
A scheme of arrangement (a “Scheme”) is a statutory procedure under Part 26 (sections 895-901 CA) of the UK Companies Act 2006. The purpose of a Scheme is to allow the company to reach agreement for a consensual restructuring with 75% of a certain class of its creditors, which agreement then binds all creditors in that class (even if they vote against the Scheme). In practice, it is used to implement any step in the restructuring process which requires unanimity from the relevant class of creditors. Court supervision of the process is limited to presiding over two separate hearings. In the first hearing, the English court (the “Court”) will consider procedural issues such as whether the classes have been properly composed, and at the second hearing the court will consider whether the classes were fairly represented, whether all statutory requirements were complied with, and whether, taken as a whole, the Scheme terms are reasonable and fair. If it is satisfied on these counts, then the Court may exercise its discretion to sanction the Scheme.
Schemes are established restructuring tools that have been used in the UK by many debtors (both domestic and foreign) as a means of implementing restructurings over the past decades. In recent years, we have seen an increase in the number of foreign debtors proposing a Scheme in the UK. These foreign debtors must overcome the jurisdictional hurdle of demonstrating to the court that: (a) it is a “company liable to be wound up” under the UK Insolvency Act 1986 (“IA 1986”), which includes foreign companies and (b) it has a “sufficient connection” to England. In addition, the Court will need to be satisfied that there is a reasonable likelihood that the sanction order would be recognized and given effect to in other relevant jurisdictions before it will exercise its discretion as to whether to accept jurisdiction.
After years of expansion of the Courts’ willingness to sanction Schemes of overseas companies (indeed some commentators have noted that the jurisdictional hurdle seems to represent a slippery slope that reached a low water mark in recent years), several recent cases suggest that a stricter approach may be applied in the future. In particular, we have seen a clear effort on the part of the Court in the past 12-24 months to stress that the Court will actively exercise its discretion whether or not to sanction a Scheme and will rigorously scrutinize the facts rather than acting as a rubber stamp. This shift has coincided with the appointment to the bench of Justice Snowden (“Snowden J”), a very experienced Scheme lawyer.
Schemes and EU Law
One of the topical legal issues that has arisen in the context of Scheme jurisdiction is the question of how (if at all), the EU regulation on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the “Judgments Regulation”) applies to Schemes (uncertainty arises because it is not clear that a sanction order is a “judgment” under the Judgments Regulation). To date, judges have avoided reaching a firm conclusion on this issue, instead having been satisfied on the facts of each case that even if the Judgments Regulation were to apply, one or more of the exceptions to the general rule applies. The general rule is that “persons domiciled in a Member State shall, whatever their nationality, be sued in the courts of that Member State” (the “Domicile Rule”).
The Courts have focused their attention on the following two exceptions: (i) Article 8, which states that “a person domiciled in a Member State may also be sued, where he is one of a number of defendants, in the courts for the place where any one of them is domiciled, provided the claims are so closely connected that it is expedient to hear and determine them together to avoid the risk of irreconcilable judgments resulting from separate proceedings” (the “Close Connection Exception”), and (ii) Article 25, which states “if the parties have agreed that a court or the courts of a Member State are to have jurisdiction to settle any disputes which have arisen or which may arise in connection with a particular legal relationship, that court or those courts shall have jurisdiction” (the “Submission to Jurisdiction Exception”). As noted above, to date the Courts have taken the view that there are two possibilities, either: (a) the Domicile Rule does not apply to Schemes; or (b) the Domicile Rule does apply to Schemes, but the Court can assume jurisdiction because either the Close Connection Exception or Submission to Jurisdiction Exception applies.
The Close Connection Exception has been the subject of much judicial debate recently. To rely on the Close Connection Exception, the debtor must establish that at least one Scheme creditor is domiciled in the UK and that it is expedient to hear the claim in the UK to avoid the risk of irreconcilable judgments. Two distinct approaches are now being taken by the Court in respect of the second limb of this exception.
Recent Caselaw: MetInvest vs VGG
In the recent case of MetInvest [2016] EWHC 79 (Ch), the judge held that if a single creditor is domiciled in the UK, this will mean that the Scheme will almost always be expedient, considering that its purpose is to bind all Scheme creditors to the same restructuring. This is referred to as the “MetInvest Approach”, and has been followed in subsequent cases such as Hibu [2016] EWHC 1921 (Ch)., where the judge held that there was no basis for imposing a precise threshold on the number or value of creditors who are required to be domiciled in the UK. In short, provided at least one single creditor is domiciled in the UK, it is expedient for the claim to be brought in England because it is important that all creditors should be bound by the Scheme.
The other view is that the Close Connection Exception requires an analysis of the number and value of the creditors domiciled in the UK. This test was developed in a case called VGG [2015] EWHC 2151 (Ch). and is referred to as the “VGG Approach”. On this approach, a certain “weight” in terms of number or value or both may be required for a Scheme to be considered expedient; although the exact requirements are unclear.
An Era of Closer Judicial Scrutiny
There has been judicial support for each of the MetInvest and VGG Approach in subsequent cases, and so although it is not possible (yet) to determine which will prevail in the long term, it is very clear that the judges are requiring fulsome disclosure from the debtor company in terms of establishing clear facts to demonstrate that they fall within the Close Connection Exception. In particular, the Courts expect the debtor to put evidence before the Court of the identities, holdings and domicile of the UK domiciled creditors.
By way of example, in the recent case of Global Garden Products (“GGP”)[2016] EWHC 1884 (Ch)., the debtor had initially filed in evidence a statement saying “I understand that scheme creditors holding at least 28.37% of the scheme claims by value and at least five by number are domiciled in the UK…”). Snowden J described this in his judgment as unsubstantiated and inadequate, and requested that further evidence be submitted to the Courts to justify precisely how many creditors were domiciled in England, and how such domicile was established. The case was adjourned whilst the debtor’s lawyers collated further evidence. The evidentiary bar that Snowden J set was surprisingly high. He goes into some detail in his judgment examining the connection between two of the UK incorporated Scheme creditors and the UK, for example noting where their central administration took place and whether discretionary decisions were taken by portfolio managers located in the UK. Ultimately, Snowden J held that the evidence before the Court was sufficient to demonstrate expediency under the Close Connection Exception, and on this basis he accepted jurisdiction. However, Snowden J’s thorough scrunity of the facts set the tone for a more rigorous approach to jurisdiction and expediency consideration.
In addition, Snowden J’s judgment in GPP includes further examples of the Courts requiring more detailed disclosure. For example, one of the issues Snowden J considered was whether the lock-up fee (in aggregate, €450,000) offered by GPP to its Scheme creditors would have had a material effect on the decision whether to support the scheme. Current case law suggests that a lock-up fee or other inducement needs to be sufficiently small so that it is unlikely to have a material effect on the decision of a creditor to support the Scheme, and must be offered to all Scheme creditors. Snowden J noted that insufficient evidence was provided to the Court in relation to the lock-up fee. He felt that it should have been proactively drawn to the Court’s attention as a potential class issue, but was prepared to waive the deficiency on this occasion. Nevertheless, Snowden J was explicit in providing a warning for future Scheme debtors, suggesting that a supplemental document should have been submitted to the Court detailing exactly how particular creditors would gain from the restructuring as a whole, as an aid to the Court’s analysis on this issue. He added that when considering fees, the price at which the debt had been acquired was relevant – for example, a 0.5% inducement fee might be material if a creditor had acquired the debt at a deep discount as it might represent a significant return on investment.
Schemes: The Future
Although we expect Schemes to continue to be used by foreign companies, certain judges (in particular Snowden J) have made some clear statements to caution that overseas companies will need to demonstrate robustly a sufficient connection and properly satisfy the procedural requirements before the Courts will exercise their discretion to sanction the Scheme. By way of further example, in the recent case of Indah Kiat {2016] EWHC 246 (Ch)., Snowden J held in a particularly damming judgment that: (a) 14 days’ notice of the convening hearing was inadequate given the complexity of the Scheme; (b) the company had failed to provide evidence of urgency; (c) inadequate disclosure had been given by the sole director of the company in his witness statement as to the identity of the supporting creditor; (d) the explanatory statement gave inadequate disclosure about alternatives to the Scheme, and (e) notice to Scheme creditors was inadequate. Judgments such as these serve as a serious warning to overseas debtors and their advisers that if they approach the Court with a request for it to sanction a Scheme, they should approach with caution and on the understanding that the Court will rigorously scrutinize the facts rather than conducting a rubber stamping exercise.
