Update on scheme of arrangement class composition principles (Re Codere Finance 2)

Update on scheme of arrangement class composition principles (Re Codere Finance 2)

Mrs Justice Falk in the Chancery Division held that a single meeting of scheme creditors should be convened despite the objection from Kyma Capital that the members of an ad hoc committee of creditors should be placed in a separate class to the other scheme creditors. Kyma had argued that the class was fractured because the ad hoc committee had been offered the right to subscribe for interim notes at a discount with a premium on the coupon, the payment of backstop fee on new notes issued pursuant to the scheme, the payment of a work fee and the reimbursement of the fees incurred by the ad hoc committee’s advisers. Written by Jonathan Akinluyi, associate at Skadden, Arps, Slate, Meagher & Flom (UK) LLP.

Falk J found that the interim notes (including discounts and backstop fees associated with them) and the advisers’ fees, were not relevant to class composition. Though the judge considered that the work fee was relevant to class composition and if the interim notes were in fact relevant to class composition, the scheme creditors could nevertheless still be grouped together as their rights were not so different, when considering that the likely alternative to the scheme was the Codere group entering liquidation.

What are the practical implications of this case?

The case provides helpful guidance to practitioners advising companies which are proposing schemes of arrangement on the proper formulation of creditor classes for voting. Matters that practitioners should be conscious of when advising an applicant scheme company including the following:

• the existing rights of the creditors and the impact of the terms of the scheme on such rights based on a careful analysis and application of class composition principles derived from the authorities including Sovereign Life Assurance v Dodd [1892] 2 QB 573 and Re Hawk Insurance Ltd [2002] BCC 300

• the inclusion of commercial terms in a lock-up agreement which binds creditors to vote in favour of a scheme may fracture the class even though they are purportedly not conditional upon the scheme being implemented but which are nevertheless arrangements that are commercially linked to the scheme such that they are properly construed as disguised consideration that is part of the scheme proposal, and which will likely affect the creditors’ decision to support the scheme by reference to the whole package of rights to which they are entitled

• the payment of fees to particular creditors in connection with a lock-up agreement should be on the basis of a genuine commercial reason independent of the scheme eg the payment of a backstop fee in exchange for underwriting the provision of new money, and the company should be able to adduce evidence in support of an argument that any payments are market-value, and

• the company must consider whether the cumulative effect of such fees or benefits may give rise to different arrangements between creditor groups, though this is not simply an aggregation of the benefits received as the consideration provided by those creditors in exchange for the benefit asserted is to be taken into account

What was the background?

The financial position of the Codere SA group, an international gaming operator in Latin America, Spain and Italy, deteriorated as a result of the coronavirus (COVID-19) pandemic, with venues being closed and major sporting events being cancelled.

The group’s liabilities, which benefitted from substantially the same guarantee and security package from a number of group companies, included two series of €500m and $US 300m notes (the ‘Existing Notes’) issued by Codere Finance 2 (UK) Limited (‘the Company’) and Codere Finance 2 (Luxembourg) SA (‘Codere Finance’), a €95m super senior RCF, a €50m super senior surety bond facility and €85m interim notes issued by Codere Finance in July 2020 to address the group’s imminent liquidity crisis (the ‘Interim Notes’).

The scheme was required to put the Codere group on a sustainable financial footing as the interim notes did not of themselves address the group’s cash flow issues long term. The terms of the scheme included:

• extending the maturity of the Existing Notes from 1 November 2021–1 November 2023

• increasing the interest rate on the Existing Notes, with Codere Finance able to elect to pay either entirely in cash or through a combination of cash and PIK interest

• amending the terms of the Existing Notes to permit Codere Finance to issue (offered pro rata to holders of the Existing Notes) a further €165m of new notes on the same terms as the Interim Notes, and

• using a portion of the proceeds of the new notes to repay the RCF

What did the court decide?

In response to Kyma’s arguments that the ad hoc committee members should be separated into another class, Falk J concluded that:

• the Interim Notes (including the associated discount and backstop) were not relevant to class composition because they were issued in exchange for the funds advanced for them by the relevant ad hoc committee members, rather than constituting any form of disguised consideration for the release or variation of rights as holders of Existing Notes under the scheme. The non-participation of one ad hoc committee member provided valuable evidence that they had been issued on commercial terms separately from the scheme, rather than as an incentive to secure support for the scheme

• the advisers’ fees were not relevant to class composition because the group had agreed to meet the fees well in advance of the execution of the lock-up agreement

• the work fee was, however, relevant, as it was calculated as a percentage of the Existing Notes, was paid to all ad hoc committee members pro rata to their holdings of Existing Notes, and payment was conditional on holders of 75% by value of the Existing Notes acceding to the lock-up ie the fees were thus an arrangement commercially linked to the scheme

Even if the Interim Notes and advisers’ fees should be taken into account, by reference to the likely alternative of a liquidation in the absence of the scheme, the differences between the rights of ad hoc committee members and other Scheme creditors was not so great that all Existing Note holders could not consult together with a view to their common interest.

Case details

• Court: Chancery Division

• Judge: Mrs Justice Falk

• Date of judgment: 14 September 2020

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