Schemes widened to compromise non-English debt

Schemes widened to compromise non-English debt

Can English schemes of arrangement be used to compromise non-English debt such as bonds governed by New York law with a non-exclusive jurisdiction clause in favour of New York of a foreign company?

Original news

Re Magyar Telecom BV [2013] EWHC 3800 (Ch), [2013] All ER (D) 20 (Dec)

The Companies Court sanctioned a scheme of arrangement in respect of a company, whose principal business was the operation of telecommunication services in Hungary, and whose principal liabilities arose under an issue of notes which were governed by the law of New York. The court held that the evidence established a sufficient connection with England and that the scheme would substantially achieve its purpose.

What did the court decide?

Mr Justice Richards decided that:

• an English scheme can compromise New York law governed bonds

• even though the governing law and exclusive jurisdiction clauses were not in favour of England (but rather New York), sufficient connection did exist because following the company's movement of its centre of main interests (COMI) to England, any insolvency process for the company would be undertaken under English law in England

• the Council Regulation EC No 44/2001 (the Judgments Regulation) does apply to schemes of insolvent companies

• the consent fee taken by certain creditors didn't create a separate class

• a scheme can release third parties (eg guarantors)

What issues were discussed by the court before reaching its decision?

Richards J discussed a number of issues before reaching his decision, including:

Global notes

The notes were held in global form and so note holders were not strictly speaking creditors until the notes were registered in their names (ie definitised). However, they were treated as contingent creditors (note creditors) for the purposes of the scheme, and so creditors for the purposes of the Companies Act 2006, s 899.

High level of support

The judge noted the high level of support for the scheme from the creditors— it was approved by a majority of more than 97% in number representing more than 99% in value of those voting on the scheme. There was a very high turn out at the meeting—326 note creditors (entitled in aggregate to almost 90% by value of the notes) attended and voted, which assured the court the class was well represented at the meeting.

Consent fee and classes

Some 70% of note creditors had signed a restructuring agreement, committing them to vote in favour of the scheme in return for a consent fee. That fee was small when compared to the claims of the creditors (0.25% of the note holding) and the opportunity to get the consent fee was available to all note creditors. On this basis, they formed one single class of creditors.

Expert evidence on recognition

The court noted the detailed expert evidence that:

•  it was reasonably likely the US courts would recognise and give effect to the scheme under the US Bankruptcy Code, chapter 15, notwithstanding it altered and replaced rights governed by New York law (though it was unclear how relevant the COMI shift would be to New York courts, and they may give effect to such a scheme even if COMI had not been moved, but Richards J did not have to decide that point)

• the courts of the Netherlands and Hungary would also recognise and give effect to the scheme

Release of guarantors

As well as affecting rights against the company, the scheme also released creditors' rights against a number of third party guarantor companies. This was not an extraneous feature but a commercially important part of the proposals and integral to them. There would be little point in proceeding with the proposed exchange of the existing notes for new notes and equity, while leaving the guarantees in place. Richards J applied the established principles to find that the variation or release of rights against third parties can properly form part of, or even in the right circumstances constitute, the proposals embodied in a scheme (see Re T and N (No 4) and Re Lehman Brothers International (Europe) (No 2) )

What is necessary for a 'sufficient connection'?

Richards J recognised that serious issues arose as to whether the court would consider it appropriate to sanction the scheme (because the company was registered in the Netherlands and the notes governed by New York law). They were sufficiently fundamental that the court might decline jurisdiction even if there were no opposition by any creditors to the scheme.

Richards J considered what factors may establish a sufficient connection with England and whether the scheme would satisfy its purpose, applying Re Drax and Re Rodenstock. He said that the requirement to show a connection with England and the need to show that the scheme, if approved, will have a substantial effect are not wholly separate questions but, if not aspects of the same question, at least closely related. The purpose of the scheme was to affect the rights of the note creditors under New York law by exchanging the existing notes for new notes and equity. He noted the following factors had been enough to establish a sufficient connection:

• creditors' claims governed by English law and subject to a non-exclusive jurisdiction clause in favour of England, as well as security documents, plus security included very substantial assets in England (as in Re Drax)

• rights of relevant creditors governed by English law and an exclusive or non exclusive jurisdiction clause (as in Re Rodenstock, Re Primacom and Re Vietnam Shipbuilding)

• substantial assets belonging to the company proposing the scheme could in an appropriate case provide the requisite connection, because the scheme if sanctioned would have the practical affect of preventing execution by the relevant creditors against those assets, save in accordance with the terms of the scheme

• the presence of a sufficient number of creditors in England subject to the personal jurisdiction of the court might also supply the necessary connection, as those creditors would be bound to act in accordance with the scheme, both within and outside the jurisdiction

Here, steps were taken less than three months before the application to convene the meeting of creditors to move the COMI from the Netherlands to England. It is well-know that schemes of foreign companies benefit from the lower threshold test of sufficient connection, rather than the higher COMI test. Richards J found that the significance of moving COMI to England was not so much in the establishment in the abstract of a connection between the company and England but, on the basis that any insolvency process for the company would be undertaken under English law in England, providing a solid basis and background for a scheme under English law which altered contractual rights governed by a foreign law—ie the only practical alternative to the scheme or some other restructuring would be a formal insolvency process which would proceed under English law in the English courts.

In circumstances where the practical alternative to the scheme is an insolvency process in, say, England, there is an obvious logic in treating a scheme approved under English law as effective to alter the rights of creditors, even though those rights are governed by the law of a different country. In the event of an insolvency process, the rights of the creditors to recover against the assets of the company would be governed by the insolvency law and recognition would be likely given to a scheme approved in the course of the insolvency process just as it would be given to the insolvency process itself.

When does the Judgments Regulation apply?

It is generally accepted that the purpose of the Judgments Regulation, art 1.2(b) is to enable the Judgments Regulation and the EC Regulation on Insolvency (EC) 1346/2000 (the EC Regulation) to dovetail almost completely with each other (see the Schlosser Report cited by Briggs J in Re Rodenstock). Schemes are not currently listed in the annexes to the EC Regulation (though there is some debate as to whether they should be added—see Reforms to EC Regulation on Insolvency 1346/2000).

An application to sanction a scheme of arrangement is a civil and commercial matter for the purposes of the Judgments Regulation, art 1.1 and, at least in the absence of formal insolvency proceedings, does not fall within the exclusion contained in the Judgments Regulation, art 1.2(b) (see Re Rodenstock).

As schemes of arrangements are not insolvency proceedings falling within the EC Regulation and the purpose of the Judgments Regulation, art 1.2(b) is to enable the Judgments Regulation and the EC Regulation to dovetail, it logically follows that the exclusion in art 1.2(b) does not extend to a scheme of arrangement involving an insolvent company, at least unless the company is the subject of an insolvency proceeding falling within the EC Regulation. In other words, an order sanctioning a scheme between an insolvent company and creditors is subject to the Judgments Regulation, at least if the company is not subject to insolvency proceedings to which the EC Regulation applies.

Richards J was satisfied that there was evidence that the company was insolvent and would only cease to be so if the scheme was sanctioned or another restructuring was agreed. Therefore, the order sanctioning the scheme would be entitled to recognition and enforcement under chapter III of the Judgments Regulation.

Richards J also considered whether chapter II of the Judgments Regulation applied on the basis that an application to sanction a scheme involves persons domiciled in a member state being 'sued'. However here, the exception in art 6 applies (enabling a person domiciled in a member state to be sued, where he is one of a number of defendants, in the courts for the place where any of the defendants is domiciled, provided that 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). A number of the note creditors were domiciled in England and therefore, if chapter II applied, note creditors domiciled in other member states may be 'sued' in England.

What did the US courts decide on chapter 15?

The scheme contained a condition that it would not become effective unless the company obtained a recognition order from the US Bankruptcy Court under chapter 15, though this condition could be waived by the company with the prior written consent of the note trustee.

One week after the UK sanction hearing, the US Bankruptcy Court gave a recognition order recognising the English scheme as a foreign main proceeding.

What does this mean in practice?

This is a helpful extension of the circumstances in which an English scheme can be used to compromise debt of foreign companies, highlighting the flexible nature of schemes.

Expert evidence that the scheme will be recognised in other key jurisdictions will be crucial and Richards J said it would be best if such expert reports were truly independent and provided by experts unconnected with the law firms engaged in the scheme (here the US and Hungarian law opinions were provided by the local offices of the law firm acting for the company), especially where there is no opposition to the case.

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About the author:
Kathy specialises in restructuring and cross-border insolvency. She qualified as a solicitor in 1995 and has since worked for Weil Gotshal & Manges and Freshfields. Kathy has worked on some of the largest restructuring cases in the last decade, including Worldcom, Parmalat, Enron and Eurotunnel.