Session 10 RISA (Corporate Rescue Plans - Schemes of Arrangement)

What is a Scheme & what are its uses?

An arrangement or compromise between a company and its

creditors or members (or both)

• “Arrangement” is broadly construed - involves element of compromise.

• Concerns reorganisation of either the company’s debts or ownership

structure or member entitlements.

Key functions of a scheme

• Subject company is the proponent of the scheme and a scheme cannot be imposed upon it.

• Scheme imposes a change on a dissenting minority of stakeholders. (“Cramdown”)

• Court does not have the jurisdiction to engage with the scheme procedure if all affected stakeholders agree with the proposal.

All schemes serve one of two wide purposes:

• Preserving life of company at a time of financial distress via a form of debt restructuring.

• Adjusting company's ownership structure to rationalise, redirect or revitalise business.
  Statutory merger can have the same impact as a scheme.

Who takes part in the scheme?

• An arrangement can apply to the whole or only a subset of its creditors or members eg, where only one share class is restructured or omitting “out of the money” creditors from a debt restructuring.

• A scheme does not remove or restrict the powers of the company’s board.

• The scheme process can be used even where fiduciary duty claims may exist against directors.

Do Schemes provide protection from creditor action?

• No – a scheme filing does not create any form of moratorium or ring fence against creditor action.

• Protection used to be available by having a scheme procedure wrapped in a light-touch provisional liquidation.

• The Restructuring Officer regime now provides that protection and there

exists in the RO regime a mirror provision (s 91I) to the stand-alone

scheme provision (section 86).

• We are focusing on the longstanding (since 1961) scheme provision,

section 86.

What are the relevant laws related to schemes?

• Section 86 of Companies Act

• Order 102 rule 20 Grand Court Rules (important dont forget)

• Practice Direction No 2 of 2010 (sets out matters at the convening hearing and further provides procedural requirements for the following hearing)

In summary, what is required?

• Petition for sanction of scheme and summons for orders convening meeting(s).

• Affidavit detailing scheme, incl. affected parties and class composition.

• Affidavit on any relevant listing rules/regulatory requirements.

• Hearing of summons for convening meeting(s). (First hearing - where Court determines constitution of relevant classes for voting purposes - It will also dispatch notice of meeting if directed by the Court in the relevant jurisdiction )

• If Court grants order convening meeting(s), chairman’s affidavit post-meeting.

• Hearing of petition for sanction of scheme.

• Registration of Order with Registrar of Companies. (File if order is granted after petition filing)

Can you challenge a scheme?

• Any shareholder or creditor affected by proposed scheme can appear at the convening hearing and object to:

• class composition; or

• the propriety of the scheme. (rarer usually wrongdoing by directors)

• An objecting shareholder or creditor may object to the scheme being sanctioned at the final hearing, but should have compelling reasons eg:

• procedural irregularity or regulatory non-compliance;

• vote splitting; and / or

• manipulation.

Any person who has a substantial financial interest in the shares can appear and object

Steps Prior to Filing - Summary

• Formulating the arrangement and negotiating with key stakeholders.

• It is common in a creditors scheme, to sign up key creditors to a “Restructuring Support Agreement” (RSA) which binds them to vote in favor of the scheme.

• Determine the likely class composition – important.

• An affirmative vote is required from all classes, and unlike US Chapter 11 (and part 26a in UK), there is no cross-class cram down. (Process by which entire dissenting class of stakeholders can be cram downed in a scheme - No affirmative vote from all persons in a class)

Tests for determining class composition:

• “a class must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to vote together with respect to the common interest”: Sovereign Life Assurance

• “analysis (i) of the rights which are to be released or varied under the scheme and (ii) of the new rights (if any) which the scheme gives, by way of compromise or arrangement, to those whose rights are to be released or varied”: Re Hawk Insurance

• Stakeholders having different interests under a scheme is not the test.

• The test is whether the rights of the stakeholders are sufficiently similar that they can / should vote together.

• The Court will lean toward putting parties in the same class.

How class works in practice: examples

• Secured creditors - usually in a separate class with any residual claims in the unsecured creditor class (Ocean rig - Highland claimed that it should vote in its own class separate from the creditors - Court found that Highland’s security is valueless and that their vote was not material and could not vote in their own class)

• Shareholdings which carry privileges under a company’s articles might be placed in different classes.

• Creditors who were indirectly affected by sanctions on Russia were put in the same class as other creditors.

• Consent fees may be paid to creditors for entry into a RSA, but such different treatment may not amount to a material difference.

• A liquidator used a scheme to avoid uneconomic process of determining post-liquidation interest entitlements. (eurobank corporation ex)

Evidence Required: Example 1: Debt Restructuring

• Affidavit exhibits:

• the scheme document and explanatory statement; and

• the proposed timetable, place and time of meeting; all of which must give creditors sufficient information and sufficient time to consider / seek advice.

• A liquidation analysis of accountants which concludes that the scheme is a significantly better outcome for creditors than an official liquidation. (Consider restructuring as early as possible because a liquidation is value destroying)

• Rationale for class composition. (why are certain creditors in certain classes - supporting evidence)

• Evidence of the terms of any RSA entered into.

• Evidence of the meeting being properly held, requisite majorities met.

Example 2: Take-private Scheme

• Affidavit exhibits same information as debt restructuring (see example 1).

• Summary of the scheme proposal, including evidence of price being at significant premium to current and historic trading price.

• Rationale for the composition of classes.

• Undertakings by offeror and concert parties that they will abstain from voting, but be bound by the scheme.

• Details of the relevant listing rules and compliance with them.

• Evidence of the meeting being properly held, requisite majorities met.

• Capital reduction application (separate petition, issued pursuant to s.15 Companies Act) to cancel the scheme shares.

Voting Thresholds - Background

• Until Act amendments, vote in respect of members’ schemes and creditors schemes needed to satisfy 2 majority requirements: (i) value majority; and (ii) headcount majority.

• Headcount test - problematic in shareholder schemes.

• English and Cayman common law differed in this respect.

• 2022 amendments to the Companies Act abolished the headcount test for member schemes.

• Creditor schemes continue to require both the value and headcount majorities to be satisfied.

Tests Applied by the Court - At the convening hearing:

• Is what is proposed an arrangement (Re SIIC Medical Science)?

• Does the supporting affidavit describe the purpose and effect of the scheme, and proposed timeline for convening and holding the meeting, allowing the Court to determine whether an EGM should be convened and the appropriate class composition?

• Does the affidavit set out all relevant listing rules and practice (O.102, r.20)?

• Is the information contained in the scheme documentation sufficient to allow a stakeholder to make an informed decision on whether to accept the proposal (Re XL Capital Limited)?

Tests Applied by the Court - At the sanction hearing:

• The meeting was properly convened and conducted.

• The resolutions were passed by the requisite majority (dual majority for creditor schemes).

• Each class was fairly represented at the meeting.

• Approval of the scheme was “objectively reasonable”.

• No blot - there is no reason why the court should decline to exercise its discretion to sanction the scheme.

• Court not acting in vain – internationally enforceable.

Parallel Schemes, Recognition & Compromise of Foreign Debt - Importance of enforceability

• Enforceability of a Cayman scheme in foreign jurisdictions is a question relevant to the exercise of discretion to sanction the scheme in Cayman.

• The Court doesn’t need absolute certainty in order to sanction the scheme, just credible evidence that it will be enforceable.

• There are instances in which creditors exist in jurisdictions who do not submit to the jurisdiction of the Cayman court, albeit that may not prevent the Court from sanctioning the scheme. (ex: Freeman fintech 2021 - creditor in macow unresponsive to scheme proposal - Court looked at minor amount of Macow creditor debt claims - Sanctioned the scheme in the instance, but had to look at the amount of the creditors debt there.)

Example 1: Hong Kong (Parallel Schemes, Recognition, & Compromise of Foreign Debt)

• Prior to 2019 - common practice to have parallel schemes – one in the place of incorporation (Cayman) and another in Hong Kong, the jurisdiction in which the assets and creditors were situated.

• This practice fell out of favor with the HK judiciary.

• The expense of parallel schemes was considered not to be in the best interests of creditors (Da Yu Financial Holdings [2019]).

• It is now more common for a scheme to be sanctioned in Cayman jurisdiction and recognised in HK.

Example 2: United States (Parallel Schemes, Recognition, & Compromise of Foreign Debt)

• Common for Cayman schemes to be recognised via Chapter 15 of the US Bankruptcy Code (ie, effective in compromising US law governed debt).

• In Rare Earth [2022] HK Court of First Instance declined to recognise a scheme in HK. Judge found that US law did not permit compromise of US debt by a foreign scheme where the foreign proceedings are in the place of the debtor’s center of main interest (COMI).

• Uncertainty was cleared up by the Modern Land [2022] ruling in the US, which affirmed that a Cayman scheme recognised through Chapter 15 would compromise US debt.

Example 3: United Kingdom (Parallel Schemes, Recognition, & Compromise of Foreign Debt)

• Where there are substantial UK creditors, the section 86 scheme will not be effective in overcoming the Re Gibbs principle - that a debt can only be compromised by the jurisdiction which governs the debt.