European Union: European Distressed Debt And Restructuring: Year-in-Review

DEVELOPMENTS IN RESTRUCTURING PLANS

Throughout 2022, the Part 26A restructuring plan (the "Plan") has continued to be a popular tool for restructurings in Europe. We have highlighted below our key takeaways from judgments over the past 12 months, looking in particular at the continued popularity of the "cross-class cram-down", the first use of the "cram-out mechanism" and the recent departure from "absolute priority" in Re Houst Ltd.

CROSS-CLASS CRAM-DOWN

• In June 2020, the Corporate Insolvency and Governance Act 2020 (CIGA) introduced a "cross-class cram-down" mechanism, inspired by US Chapter 11 proceedings, in the form of the Part 26A restructuring plan. This enables stakeholders to "cram down" dissenting classes, provided that (i) at least one class that would receive a payment or would have a genuine economic interest in the context of the relevant alternative votes to approve the plan and (ii) no member of a dissenting class would be worse off under the restructuring plan than under the relevant alternative.
• In 2022, the "cross-class cram-down" has remained an attractive feature of the Plan. It has been used in two out of three Plans sanctioned in 2022 (ED&F Man and Houst). Selection of the relevant alternative and valuation evidence presented by the company and opposing stakeholders play a critical role in the likelihood of sanction, particularly where the use of the cram-down power is contemplated.

CRAM-OUT MECHANISM

• 2022 saw the first use of the "cram-out mechanism" (Smile Telecoms). Creditors or members whose rights are affected by the Plan must be permitted to participate in a class meeting. A Plan company can petition the court to exclude out-of-the-money stakeholders (i.e., those who do not have a genuine economic interest in the company under the relevant alternative). Given the draconian consequences of exclusion, the court has indicated that it needs to be "entirely satisfied" that it is appropriate to use the "cram-out mechanism" (Smile Telecoms). This reinforces the need for strong valuation evidence supplied in a timely manner. 
• In Smile Telecoms the court permitted the "cramout" and convened a single class meeting, as it was satisfied that the excluded classes were "well out of the money" and this was "not a marginal case". Further, the valuation evidence was provided to all the interested parties in sufficient time (one month prior to the convening hearing) and was analysed at length by their advisers. Objections were raised by one excluded creditor about the decision made on class composition, but the court refused to revisit the decision at the sanction hearing, as the creditor had neither sought to appeal the convening decision nor appeared at the sanction hearing.

DEPARTURE FROM ABSOLUTE PRIORITY

• In Houst, the court departed from the statutory order of priority under the relevant alternative (a pre-pack administration), permitting under-secured bank lender claims to jump ahead of HMRC's claims as a preferential creditor. Under the relevant alternative, the recipient of the largest dividend would have been HMRC (15p/£) versus 7p/£ for a bank lender. The remainder of the bank lending would have ranked as an unsecured claim. Under the plan, although HMRC's net return would increase (to 20p/£), the bank lender would also receive significantly more than their fixed charge security would otherwise have yielded (27p/£, including 20p/£ for their under-secured debt, while ordinary unsecured creditors would only receive 5p/£). This illustrates a key difference

"[I]f a creditor or member wishes to oppose a scheme or plan based upon a contention that the company's valuation evidence as to the outcome for creditors or members in the relevant alternative is wrong, they must stop shouting from the spectators' seats and step up to the plate."

— In the Matter of Re Smile Telecoms Holdings Limited [2022] EWHC 740 (Ch), §53

• The applicability of this development to other cases should be viewed cautiously, as Houst turned on its facts. Among the factors the court considered when sanctioning the plan were: (i) the Plan offered the opportunity of continued trading and an enhanced dividend to HMRC; (ii) benefits to be received by new shareholders under the Plan were justified, as the new capital they injected was imperative for the solvent rescue of the company; (iii) HMRC did not attend the sanction hearing or present any arguments against sanctioning, nor did they seek to negotiate with other parties; and (iv) the assets which would have been available in the event of the company's administration were applied in a manner consistent with the order of priority in administration.

LENDER-ON-LENDER VIOLENCE: WILL IT COME TO EUROPE?

Lender-on-lender violence refers to a type of liability management transaction through which a company gives an advantage to a subset of creditors at the expense of another subset. These "priming" deals enable the participating creditors, post-execution, to have some form of priority ranking relative to non-participating creditors. A company may be able to reduce the overall principal amount of debt outstanding, reduce the interest burden, manage an upcoming maturity or avoid an impending financial covenant default. Liability management can be considered both from an offensive and defensive perspective within many capital structures.

These transactions have become commonplace in the US market but are yet to be widely used in Europe, where such deals are more challenging to execute due to differences in the market standards for documentary terms and legal frameworks. Such deals are potentially less attractive in Europe given the existence of well-trodden alternative means of execution, such as by way of a scheme of arrangement. As macroeconomic pressure continues to apply to companies through rising inflation, increasing interest rates, supply chain disruption and geopolitical instability, we expect to see an increase in the number of distressed European companies seeking more bespoke refinancing techniques. For instance, BC Partners' portfolio company Keter Group B.V. reportedly considered carrying out an amend-to-extend of its English debt through an "exit consent" in October 2022 (see details below). This was the first prominent example in recent history of a company proposing an uptiering transaction under English law governed documents.

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