Thomas Cook Group Plc’s (Thomas Cook) recent attempt at a restructuring and its ultimate downfall received numerous headlines. As the world’s oldest travel company spiraled toward a liquidation, the inner workings of the restructuring process were illuminated for all to see. In the midst of a complex scheme of arrangement, a drag-along restructuring tool implemented under English law, the credit default swap (CDS) product was yet again critically important.
Kramer Levin advised buyers of CDS protection and made a number of submissions to the International Swaps and Derivatives Association’s Credit Derivatives Determinations Committee (DC) addressing the issues detailed below. This article highlights the main issues presented by the nature of the Thomas Cook restructuring and the takeaways resulting from the outcome.
Faced with a challenging business environment in the travel industry, a worsening liquidity position and other adverse economic conditions, Thomas Cook sought to implement a debt reorganization that, among other things, would have seen the conversion of over GBP 1.6 billion of debt into equity over the objection, and without the consent, of certain creditors. The proposed transaction also involved a capital injection by the company’s largest shareholders and certain of its core lending banks. However, the company did not have sufficient support from its bondholders to effectuate this debt reorganization under the terms of its existing indentures. Instead, the company sought to make various amendments to its indentures via a scheme of arrangement under the UK Companies Act 2006 (Scheme) that would then clear the path for the company’s debt-for-equity swap.
Thomas Cook’s 2022 and 2023 notes (Notes) were governed by New York law and subject to the jurisdiction of New York courts. This created the risk that the company’s proposed scheme of arrangement would be challenged in the United States, which ultimately could have prevented the completion of the debt reorganization. Thomas Cook therefore filed a Chapter 15 petition (Chapter 15) seeking recognition of the Scheme (a foreign proceeding) by the U.S. bankruptcy courts.
Thomas Cook (somewhat atypically) went to great lengths to avoid the imposition of an automatic stay in connection with its Chapter 15 filing. The company primarily sought for the Scheme to be recognized as a “foreign non-main proceeding,” which does not entail the imposition of the automatic stay, a rather interesting approach given that the company’s center of main interests was in the UK. In the alternative (i.e., if the Scheme was recognized as a foreign main proceeding), the company asked the court not to impose the automatic stay.
CDS at Play
The DC considered whether the Scheme and the Chapter 15 filing amounted to a Bankruptcy Credit Event under one of the prongs of the Bankruptcy definition in both the 2014 and 2003 Credit Derivatives Definitions. The 2003 and 2014 Definitions slightly differ in that respect, but in a relatively significant way.
Bankruptcy Credit Event
Section 4.2 of the 2014 Credit Derivatives Definitions (Definitions) states that the following events constitute a Bankruptcy Credit Event:
“… (d) the Reference Entity … institutes or has instituted against it a proceeding seeking a judgment of insolvency or bankruptcy or any other similar relief under any bankruptcy or insolvency law or other law affecting creditors’ rights …”
In previous determinations in respect of insolvency-type proceedings under European law,1 the DC focused on characteristics of the relief that would typically be obtained in the context of a bankruptcy or insolvency proceeding in the applicable jurisdiction of the Reference Entity. The DC then made a determination as to whether the relief sought in the insolvency proceeding under review was sufficiently similar to justify a Bankruptcy Credit Event determination. In virtually all of those cases, the ability of the Reference Entity to avail itself of a sufficiently broad automatic stay played a significant role. Other factors, such as mandatory acceleration of debt instruments, the appointment of a court-appointed representative having some control over the management of the Reference Entity and the overall duration of the proceeding, were also relevant.
Applying those factors to the Scheme and the Chapter 15, the DC noted that the company had sought to avoid an automatic stay, and that the relief sought via the Scheme and Chapter 15 did not show many (if any) of the characteristics the DC had determined to be probative in prior cases.
The DC also considered whether it should instead focus on the ultimate combined effect of the Scheme and the Chapter 15 proceeding, rather than on the immediate impairment of creditors’ rights. Taking that view, the ultimate effect of the overall reorganization would be analogous to a U.S. bankruptcy court order approving a debt-to-equity conversion under a Chapter 11 plan of reorganization. Indeed, in order for a foreign proceeding to be entitled to recognition under Chapter 15, it must be commenced for the “purpose of reorganization or liquidation” (i.e., relief that is arguably similar to the relief afforded in proceedings seeking a judgment of insolvency or bankruptcy). 11 U.S.C. §§ 101(23). This begs the question of whether the DC misinterpreted Section 4.2 of the Definitions or whether the Chapter 15 proceeding was appropriately commenced in the first place. If the Scheme was simply commenced for the purpose of amending Thomas Cook’s debt documents (and not for the purpose of reorganization or liquidation), the Chapter 15 requirements would not have been satisfied.
The DC elected not to take this approach. The DC emphasized that the relief provided by the Scheme and the Chapter 15 was limited in nature, primarily because it did not implicate any automatic stay but rather merely sought to extend the territory in which the outcome of the Scheme would be enforceable.
While the need for an automatic stay may be consistent with prior DC determinations, the outcome in Thomas Cook raises a number of questions for protection buyers. In the event the reorganization had been successful, bondholders would have been left with equity in the reorganized entity and CDS protection buyers would not have been able to collect on their CDS contracts. This would be a highly unsatisfactory outcome for protection buyers. Moreover, had the Scheme been fully implemented and minority creditors forced into a debt-to-equity swap, a related Restructuring Credit Event could have ultimately triggered the CDS contracts. However, even in such a scenario, available debt necessary to settle the CDS contracts via the auction would have vanished, similarly hurting protection buyers and potentially resulting in a windfall for CDS protection sellers.
The DC then considered Thomas Cook’s Chapter 15 filing in the context of the 2003 Credit Derivatives Definitions. Critically, the formulation of Section 4.2(d) under the 2003 Definitions is subtly different:
“the Reference Entity … institutes or has instituted against it a proceeding seeking a judgment of insolvency or bankruptcy or any other similar relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights …”
Under the 2003 Definitions, the DC determined that the Chapter 15 need only seek “any other relief,” provided that such relief was sought under a bankruptcy law. As Chapter 15 exists under the U.S. Bankruptcy Code, the DC determined that any relief, irrespective of its effect, would suffice. On that basis, the DC determined that a Bankruptcy Credit Event had occurred.
Failure to Pay
Indentures governing the Notes issued by Thomas Cook (the Indentures) contained a number of events of default. One such event would occur where Thomas Cook:
“commences a voluntary case under any applicable Bankruptcy Law or any other case to be adjudicated bankrupt or insolvency, or files for or has been granted a moratorium on payment of its debts, or files for bankruptcy or is declared bankrupt” (emphasis added)
Because the occurrence of this event of default would specifically result in an automatic acceleration of the Notes under the Indentures, a market participant requested that the DC determine that a Failure to Pay Credit Event had occurred upon the expiration of the three-business-day grace period, as provided in the Credit Derivatives Definitions.
In considering that request, the DC questioned whether the mere commencement of a Chapter 15 case was sufficient to cause a default under the Indentures, or whether the Indentures required such Chapter 15 case to seek an adjudication of bankruptcy or insolvency in order for its commencement to constitute an event of default.
The DC noted that New York courts often apply the “rule of the last antecedent,” according to which a limiting clause or phrase ordinarily modifies the clause or phrase that it immediately follows. Applying this rule, the DC determined that under the Indentures, a voluntary case under a Bankruptcy Law alone was a bankruptcy event of default without the additional requirement that such case seek an adjudication of bankruptcy or insolvency. The DC therefore determined that a Failure to Pay Credit Event had occurred because Thomas Cook voluntarily commenced a Chapter 15 case under Bankruptcy Law; it was irrelevant that Thomas Cook did not seek an adjudication of bankruptcy or insolvency.
It is instructive to consider how the DC arrived at its determination of the existence of a Failure to Pay Credit Event. The DC considered policy implications. It took advice from colleagues on the Americas DC. U.S. legal advice with respect to rules of contractual construction under New York law. Ultimately, the DC based its decision on a plain read of the Indentures under well-established New York law.
The DC’s approach here is evidence that the DC prefers predictable outcomes based on standard principles — where clear, literal interpretations of contractual provisions are determinative — irrespective of policy arguments. The determination request submitted by the market participant clearly identified the applicable rule of contractual construction. This, among other things, shows the benefit of allowing market participants to substantiate their requests with relevant legal arguments, a process that has recently been questioned by the DC.
Sept. 20, 2019, CDS Contracts
Thomas Cook ultimately filed for liquidation on Sept. 23, 2019. This filing gave rise to a Bankruptcy Credit Event under both the 2003 and 2014 Definitions. However, contracts expiring on Sept. 20, 2019 (a roll date for the CDS contract) would not have been triggered by this credit event. The Failure to Pay Credit Event, on the other hand, occurred three business days after the date of the Chapter 15 filing, on Sept. 20, 2019. For buyers of CDS protection that expired on Sept. 20, 2019, the Failure to Pay Credit Event was therefore critical to their monetizing their CDS contracts (a significant value given the final price of 10.125 in the CDS auction).
Thomas Cook sheds additional light on how the DC might evaluate reorganization proceedings that do not result in the adjudication of bankruptcy or insolvency. It indicates that the DC is unlikely to focus on the ultimate combined effect of a reorganization proceeding, but that the DC will instead focus on the immediate effect of the impairment of creditors’ rights of action as in prior cases. From a policy perspective, it is questionable whether this approach is the most appropriate, particularly where the outcome of the reorganization would be very similar to what would have happened in a U.S. Chapter 11 bankruptcy proceeding. However, unless the Bankruptcy Credit Event is clarified or amended in a future iteration of the Credit Derivatives Definitions, this is unlikely to change.
From a DC process perspective, many market participants have debated the DC’s willingness to interpret provisions included in the debt documentation of a Reference Entity since the Dec. 21, 2017, credit event request in the Windstream case. Of course, there are many distinctions that can be drawn between Thomas Cook and Windstream. For instance, unlike Windstream, Thomas Cook had not openly and publicly disputed the alleged event of default prior to the time the DC’s determination was made. Also, in Thomas Cook the DC determined that it could resolve the interpretation issue without findings of fact. Nevertheless, Thomas Cook shows that the DC will engage in some amount of analysis where it is argued that a breach of covenant leading to the acceleration of the debt occurred.
1 See DC statements in Astaldi, Abengoa, Isolux and Portugal Telecom.
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