#16696 - Pre Packs - Debt Restructuring

Overview:

• Comparing Chapter 11 under US law to Administration under English law

• Pre-packs

Collectivisation and Privatisation:

• Administration and Chapter 11 as collective insolvency procedures, aimed at solving the tragedy of the commons.

• Features:

  • Comprehensive moratorium under administration;

  • Automatic stay under Chapter 11;

  • Control through administrator under administration or debtor-in-possession under Chapter 11;

  • Creditors have information and voting rights under both administration and Chapter 11;

  • Plan of reorganisation;

  • Cross-class cramdowns are possible under Chapter 11; and

  • Administration can be used together with a CVA or a scheme.

Contrasting Chapter 11 and Administration:

• Control:

  • Chapter 11:

    • The debtor-in-possession remains in control;

    • Incumbent management;

    • Appointment of a trustee-in-bankruptcy is possible but rare; and

    • Appointment of an examiner is also possible (as in Lehman). He does not have the power to run the debtor’s business or to dispose of the debtor’s assets; he is merely charged with looking into the debtor’s affairs and determining what went wrong.

  • Administration:

    • An administrator comes into control (for large companies, a large partner-led team may come in from any one of the Big 4 accountants to perform the role of administrator);

    • The administrator is a qualified insolvency practitioners;

    • The administrator is given comprehensive management powers; and

    • Light-touch administration.

  • Does administration thus assume that management is somehow responsible for the plight of the company?

• Advantages and Disadvantages:

  • Chapter 11:

    • “Incumbent management knows best”;

    • Suppliers and customers can continue dealing with a group of people that they are familiar with;

    • For certain small companies such as a restaurant with a chef-owner, the owner is likely to be essential to the running of the company;

    • But fraud is much less likely to be discovered.

  • Administration:

    • The professional expertise of an external administrator;

    • A “fresh pair of eyes”;

    • Administrators are officers of the court, and is thus subject to certain requirements regarding fairness and neutrality;

    • But it might be disruptive to the debtor’s business.

• Post-petition financing:

  • Even after entering into a formal insolvency process, the debtor still needs an injection of cash to keep it functioning. How can the debtor possibly continue attracting financing when it is already in insolvency?

  • Chapter 11: Debtor-in-possession financing

    • Chapter 11 features an extremely attractive built-in mechanism for post-petition financing. The debtor-in-possession can continue to issue debt, beginning with unsecured debt with administration expense status. If that is not good enough to persuade lenders to lend to the debtor, the debtor-in-possession can apply to court to issue debts with even higher priority.

    • (1) Unsecured debt with administrative expense status; and, if not

    • (2) Unsecured debt with super-senior priority; and, if not

    • (3) Debt secured on unencumbered assets, or, if there are no longer any unencumbered assets available, then debt with a junior security interest over encumbered assets (n.b. this is only possible if value of the collateral is greater than that of the senior debt); and, if not

    • (4) Senior-secured debt with security over already-encumbered assets.

  • Administration:

    • Credit contracts entered into by the administrator take priority over: the fees and expenses of the administration; floating charges; but NOT fixed security.

    • This gives lenders a peace-of-mind to continue lending to the debtor.

  • Why the difference? Because administration is about “priming” the debtor for a pre-pack sale?

• Cramdowns:

  • If all classes accept the plan, we are then in the realm of S1129(a), Chapter 11. S1129(a) sets out the basic requirements that must be met for the court to confirm the plan.

  • If however there are dissenting classes, we are then in the realm of S1129(b), Chapter 11. S1129(b) is sets out further requirements (in addition to those in S1129(a)) that must be met before the court can confirm the plan against the wishes of the dissenting classes.

    • Cross-class cramdowns are possible.

    • Dissenting unsecured creditors = The “absolute priority” rule. Claims junior to the cramdown-ed class cannot get anything as well.

    • Dissenting secured creditors = They must retain their lien and receive deferred cash payments equal to the value of their collateral.

    • Dissenting equity-holders = They must receive their fixed liquidation preference, or the junior equity-holders must get nothing as well.

  • Administration + Scheme of arrangement:

    • It is possible to have cramdowns on dissenting creditors within a class.

    • Cross-class cramdowns are however not possible.

    • Overcoming the above limitation through pre-packed assets transfers, thereby leaving junior debtors behind?

• UK Reform Proposals:

  • BEIS, Insolvency and Corporate Governance: Government Response (26 August 2018).

  • Two additional standalone mechanisms.

  • Restructuring moratorium:

    • For solvent, but prospectively insolvent companies.

    • The company must not have been in administration (or any insolvency proceedings) for past 12 months.

    • For a duration of 28 days, extendable thereafter.

    • A debtor-in-possession system, but with an additional “monitor”. The monitor — a qualified insolvency practitioner — ensures the eligibility conditions have been met.

  • Restructuring plan procedure:

    • Similar to a scheme of arrangement.

    • Possibility of cross-class cramdowns, but subject to a weaker version of the US’s absolute priority rule.

    • It is weaker because English courts can still confirm the plan even if the rule is not met, so long as the plan is “fair and equitable”.

    • The “best interests of the creditors test” = The dissenting creditors must receive at least as much as they would under the next best alternative (which, under English law, is administration).

• EU Reform Proposals:

  • COM (2016) 723 (final): Proposal for a Directive on preventive restructuring frameworks. This features—

    • A moratorium;

    • Debtor-in-possession governance;

    • Cross-class cramdowns; and

    • An (optional) debtor-in-possession financing facility.

  • Should the harmonisation of insolvency and restructuring law be a priority for the EU after Brexit?

    • Absence of harmonisation = Diversity = The Menu Approach, with a multitude of options of debtor companies.

    • Harmonisation = One single choice = That system damn well better be good.

Switching from Collectivisation to Privatisation:

• Secured creditors take control of the process.

• Pre-arranged sale of the business occurs immediately on the appointment of an administrator.

• Chapter 11: The sale has to be sanctioned by the court.

• Unsecured creditors do not have a say in this; their prior approval is not required.

• Collaboration between corporate insiders and senior secured creditors.

• Empirical analysis: Despite the risk of opportunism on the part of corporate insiders and senior secured creditors, privatisation is beneficial for all the parties concerned overall, even the unsecured creditors who do not have a say in this.

Pre-packs:

• Statement of Insolvency Practice, No. 16:

  • Pre-pack = “Arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator, and the administrator effects the sale immediately on, or shortly after, his appointment.”

• There used to questions regarding the validity and legality of pre-packs.

• Pre-Enterprise Act 2002:

  • Re T&D Industries plc: An administrator can dispose of the assets of the company without the leave of the court and prior to the approval of his proposals by the company’s creditors.

• Post-Enterprise Act 2002:

  • Transbus International Ltd (in liquidation): Administrators are permitted to sell the assets of the company in advance of their proposals being approved by creditors.

  • DKLL Solicitors v HMRC: Even a majority (unsecured) creditor does not have a veto on the implementation of the administrator’s proposals.

    • This is an actual pre-pack case.

    • This case steadfastly confirms the legality of pre-packs.

• Requires the consent of:

  • Holders of fixed security:

    • Paras 70-73, Schedule B1, Insolvency Act 1986: The collateral can only be sold with the consent of the secured creditor or by court order.

    • The secured creditors must therefore be involved in the pre-pack, and must consent to the pre-pack.

  • Holder of a qualifying floating charge:

    • The holder of a qualifying floating charge must be the one to appoint an administrator; or

    • He must agree to not interfere with the company’s appointment of an administrator.

• Concerns: Frisby (2007) and the Graham Report (2014)

  • No market exposure, and hence the possibility of a sale below market price.

    • Insufficient marketing;

    • Insufficient valuation; and

    • No incentive to negotiate for a consideration that is any higher than the nominal value of the secured debt + any fees or expenses.

  • No transparency or involvement of unsecured creditors.

    • But this secrey is necessary in order to retain confidence in the debtor’s business.

    • Customers, suppliers, employees, and unsecured creditors are too often surprised by a “done deal”.

  • No consideration is given to the future viability of the business emerging from a pre-pack sale.

    • C.f. The “feasibility test” under Chapter 11.

  • Minimal court...