Given the trend towards using Schemes as a tool to vary, settle or ‘cram down’ creditor claims, this overview:

> describes what a Scheme is;

> summarises some of the problems which Schemes can be used to solve;

> highlights a number of practical traps for the unwary where a Scheme is proposed; and

> answers a number of questions which are often asked about Schemes.

What is a Scheme?A Scheme is a statutory procedure which permits a company to enter into an arrangement or compromise with its members or creditors (or any class of them) which, if approved by the requisite majority and then sanctioned by the court, will bind all of them, whether or not they voted in favour of what was proposed. The relevant law is found in Part 26 (Sections 895-901) of the Companies Act 2006.

A Scheme is not a formal insolvency process, although proposing a Scheme may trigger insolvency-related events of default. A company does not have to be insolvent, or facing imminent insolvency, before it can propose a Scheme and doing so does not result in the appointment of an insolvency official or in the powers of the company’s directors or shareholders being restricted in any way.

Topical issuesCreditor schemes of arrangement: an overview

The key statutory requirementsThe main statutory requirements where a Scheme is proposed are that:

> the relevant creditors must be sent an ‘explanatory statement’ (i) explaining the effect of the Scheme and (ii) setting out any material interests of the company’s directors;

> the Scheme has to be approved by those creditors or, if the Scheme involves more than one class of creditors, by each class of creditors, at meetings convened by the court for the purpose of considering the Scheme. A Scheme will be approved if it receives the support of a majority in number representing 75% in value of the creditors (or each class of creditors) present and voting at the relevant meeting, either in person or by proxy; and

> it must be sanctioned by the court at a formal ‘fairness’ hearing, and, following the hearing, an office copy of the court order must be delivered to the registrar of companies for registration, at which stage the Scheme becomes effective.

Schedule 1 sets out the Scheme process in greater detail.

Who can propose a Scheme?An English court’s jurisdiction to sanction a Scheme is very wide. A Scheme can be proposed by “any company liable to be wound up under the Insolvency Act 1986”. This test covers both companies incorporated under English law and foreign companies (as the latter may be wound up under the Insolvency Act as ‘unregistered companies’).

English courts will, however, generally only exercise their discretion to allow a foreign company to use the Scheme procedure if there is ‘sufficient connection’ with the United Kingdom. This test would generally be satisfied where the Scheme was proposed by an English company or where the liabilities to be compromised under the Scheme were governed by English law (potentially even if the governing law had been changed to English law in order to propose a Scheme, as occurred in the recent Apcoa and DTEK Schemes). There are, however, other ways in which the “sufficient connection” test can be satisfied, with the result that Schemes have been used in an increasing number of cases by foreign companies in order to compromise claims governed by New York law.

Schemes have recently been used by a number of European companies, including Spanish (Cortefiel, Metrovacesa, La Seda), Italian (Seat), German (Primacom, Rodenstock Telecolumbus), French (Zlomrex International) and Dutch companies (Magyar Telecom and Nef Telecom), as well as by companies in jurisdictions outside Europe including Kuwait, Vietnam and Singapore.

A Scheme of arrangement is not a new legal concept – they have been used for well over 100 years for a variety of purposes, including implementing takeovers and mergers – but they are increasingly being used by companies incorporated in England and elsewhere to deliver a range of debt restructuring solutions.

Putting Schemes into their commercial context

What can be proposed?

One key attraction of a Scheme is its flexibility, as the statutory requirement is simply that there should be some form of compromise or ‘arrangement’ between the company and its creditors. Judges have been careful not to define what amounts to an ‘arrangement’ for these purposes, so as not to impose a potential limit on the scope of Schemes.

Examples of how creditor Schemes have been used in practice

> Imposing new commercial terms: A Scheme can allow creditor claims, including those of secured creditors, to be varied, compromised (or, in some cases, effectively written off) without their individual consent;

> A fall-back if consent solicitation fails: A Scheme can be used as a fall-back option if a consent solicitation exercise does not achieve the necessary approval level;

> Assisting investment: If additional liquidity is required, a Scheme can provide a mechanism which allows existing shareholders or rescue investors to keep, or take, equity interests in the business, typically following a restructuring of the company’s financial indebtedness;

> Release of claims: A Scheme can include the release of claims against guarantors and third parties where they are closely connected to claims being compromised under the Scheme;

> Dealing with New York law claims: A number of Schemes, including Countrywide, Magyar Telecom, New World Resources, Wind Hellas and Zlomrex (Cognor) have compromised liabilities governed by New York law, highlighting the possibility that Schemes may offer a quicker and cheaper alternative to Chapter 11;

> Imposing a settlement: A Scheme can allow a company whose business is being hindered by the existence of significant contingent claims (such as litigation relating to industrial injuries) to reach a binding, court-approved compromise with potential claimants;

> Imposing a bar date: A Scheme can, as with the Card Protection Plan Scheme, be used by a company facing significant potential liabilities to impose a bar date by which claims must be made;

> Facilitating pre-pack sales to secured creditors: A Scheme can be used to address the cash leakage risk that arises on a pre-pack sale to a creditor-owned vehicle, where there are hold-out creditors who do not want to participate in the process; and

> A flexible alternative to liquidation: A Scheme can provide a more flexible means of returning assets to the company’s creditors than would be the case if a formal liquidation process was used, particularly where there are questions about contingent liabilities and/or identifying assets which could otherwise delay making payments to creditors.

How long does it take to get a Scheme approved?

This will depend on how long it takes to agree the commercial deal and to prepare the (often lengthy) Scheme documents. There are no statutory timing requirements, but, in practice there is usually a period of around five to six weeks between Scheme documents being posted to creditors and a Scheme becoming effective, although the period may be longer if there is a large creditor group which has not been involved in the negotiation of the Scheme.

10 frequently asked questions

What is meant by ‘creditor’ for the purposes of a Scheme?

The court has adopted a very wide interpretation of the term ‘creditor’, so de every person who has a quantifiable claim against the company, whether actual, contingent, unliquidated or prospective. This means that it may be possible to treat bondholders as creditors even where the trustee remains the legal owner of the bonds, if such bondholders are technically contingent creditors because they have a right to become the lender of record in certain specified circumstances. Key Cases: Re T&N Ltd and Re Castle Holdco 4 Limited (Countrywide).

What constitutes a class of creditors?

The original test was that a class “must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest”. Courts have, in applying this test, tended to treat all creditors as being capable of consulting together in a class unless it is possible to identify significant differences in their rights.

More recently, courts have adopted a ‘rights in, rights out’ test when reviewing class composition, looking first at a creditor’s existing rights (and, more specifically, at what those rights would really be worth if the Scheme was not approved), and then at what is being offered to that creditor under the Scheme. This has resulted, in several cases, in bondholders being treated as

members of the same class despite the fact that the bonds were denominated in different currencies and had different maturity dates. Key Cases: Sovereign Life Assurance Company v Dodd, Re Hawk Insurance Co Ltd, Re Telewest Communications plc and Re Co-operative Bank Plc.

Do all creditors in a class have to be included in the Scheme?

No. The court will sanction a Scheme that excludes certain creditors if it can be shown that there were good commercial reasons for doing so. It may, for example, not be desirable to include trade creditors in a Scheme so as to ensure continuity of supply, even though other unsecured claims are included. Key Cases: Re PT Garuda Indonesia and Affinion.

What amounts to a ‘compromise’ or ‘arrangement’?

For there to be a compromise or arrangement, the Scheme must include some element of ‘commercial give and take’. This is the rationale for the court’s refusal, to date, to sanction a Scheme which simply removed a party’s rights for no consideration. A ‘compromise’ and an ‘arrangement’ are, however, separate concepts. An arrangement need not involve a compromise or be confined to circumstances where there is a dispute or other difficulty. Key Case: Re NFU Development Trust Ltd.

Can creditors with no economic interest block a Scheme?

This depends on whether the rights of the relevant creditor are being changed. An out of the money junior creditor would still have the right to vote in a Scheme if their contractual rights were being altered, but they would not have the right to vote if their contractual rights were staying the same, but the proposed Scheme potentially prejudiced the value of those rights. It has, for example, been held that a class of junior bondholders (who would have received nothing in a formal insolvency process) could not vote on a Scheme which involved the transfer of the Scheme company’s business to senior creditors, as, while the transfer would crystallise their loss, leaving them with claims against a shell company, their legal rights would technically remain unchanged. They could, however, still object to the Scheme at the final fairness hearing, drawing the court’s attention to the Scheme’s impact on their position. Key cases: Re Tea Corpn Ltd, Re My Travel Group plc and IMO Car Wash.

What test will the court apply in deciding whether to sanction the Scheme?

The court needs to be satisfied that (i) the relevant statutory requirements have been complied with, (ii) the classes of creditors were properly identified, (iii) each class was fairly represented by those attending the court meeting, (iv) the statutory majority was acting bona fide in the interests of the class and (v) it would be reasonable to approve the Scheme. Key Case: Re Anglo-Continental Supply Co Ltd.

How does the court decide whether it is reasonable to approve the Scheme?

The court will ask whether the Scheme is one that an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonably approve. The question is not whether the Scheme is reasonable, but whether a creditor could reasonably have approved it. Courts have taken the view that it is not their role to second guess decisions made by creditors who are acting honestly, provided that they have had sufficient information and enough time to properly consider their options. Key Case: Re Dorman Long & Co Ltd.

Is the court’s sanction of the Scheme just a rubber-stamping exercise?

No. The court would not sanction a Scheme if there were technical irregularities, if it considered that those creditors approving the Scheme were unfairly pushing their special interests or if there was inherent unfairness in the Scheme. Key Case: Re BTR plc.

Is the court therefore likely to refuse to sanction the Scheme?

Again, no. “Unless something is glaringly wrong with the Scheme, the principle of creditor democracy ought to be respected”. Key Case: Re McCarthy & Stone.

Who can object to the Scheme?

Anyone affected by the Scheme is entitled to appear at the final court hearing to sanction the Scheme and can raise any objections at that hearing. Key Case: B.A.T. Industries plc v B.A.T. Reconstructions Ltd.

Pitfalls and risks – five points to watch out for

Classes

Creditors vote in classes, with class allocation being determined by reference to (i) a creditor’s existing rights against the Scheme company and (ii) the rights which that creditor would obtain under the Scheme. The fact that some creditors might have different commercial or economic interests is generally irrelevant for the purposes of class allocation, although this would be a consideration at the final ‘fairness’ hearing.

The first step in the Scheme process is therefore to decide whether there should be one class of creditors or whether (as there are significant differences in either their existing rights or their proposed rights under the Scheme) creditors should be placed into separate classes. If the class allocation is wrong, the court will not have jurisdiction to sanction the Scheme.

Obtaining a majority in number

The requirement to obtain the approval of a majority in number of each class can create an effective veto for smaller creditors where (for example) two large creditors hold 90% of the debt in a class, while the remaining 10% is held by a number of smaller creditors. A Scheme should therefore only be launched where it appears that the majority in number test should be satisfied, as well as the 75% in value test.

One possible option where the majority in number test may not be satisfied would be to split the debt, so that the two large holders in the example above would transfer part of their debt to affiliates or friendly parties. While this should ultimately address the majority in number problem (assuming that the debt is transferable and there are sufficient willing holders of that debt), splitting the debt in this manner could potentially, depending on the exact circumstances, support an argument at the sanctioning hearing that the larger creditors were not acting in good faith.

Confidentiality

Even if tight confidentiality is maintained, the main terms of the Scheme will normally become public, even before the actual Scheme documents are posted. This is because, except in exceptional cases, the court expects a ‘creditors’ issues’ letter to be sent out, before the formal process starts, to those creditors whose rights are likely to be impacted by the Scheme, setting out the broad commercial terms of the Scheme and describing how creditors will be classed for voting purposes.

Commercially sensitive terms

Key agreements will normally need to be put on display for inspection by Scheme creditors. This would normally include the terms of any amended finance document which does not form part of the Explanatory Statement. It is therefore necessary to consider whether there are any sensitivities about (for example) the disclosure of financial covenants or covenants imposing a timetable for a disposal process and, if so, whether such provisions need to be included in a document to be made available for inspection.

Recognition by other courts

The court will not generally make any order which has no substantial effect. It will therefore need to be satisfied, on the basis of expert evidence, that a Scheme proposed by a foreign company will be recognised in the jurisdiction where the debtor company is domiciled. The court’s concern is that, in the absence of such recognition, creditors might simply ignore the Scheme and pursue an action against the debtor or its assets outside the United Kingdom. Schedule 2 illustrates those European jurisdictions in respect of which such expert evidence has been provided to date.

In addition, if the Scheme compromises claims governed by New York law, or there is a significant proportion of creditors located in the United States, it may be necessary to have the Scheme recognised in the United States pursuant to Chapter 15 of the U.S. Bankruptcy Code. If such recognition is needed, the Scheme documents may provide for the appointment of an ‘authorised representative’ of the Scheme company, who would be given the power to make any Chapter 15 application.

One final question – what about CVAs?

A Company Voluntary Arrangement or CVA, like a Scheme, can be used to implement an agreed contractual restructuring, imposing an agreed solution on any hold-out creditors. While Schemes are sometimes seen as being more complex and costly solutions than CVAs, there are many occasions (such as when dealing with secured claims or with the liabilities of certain foreign companies) where a CVA is simply not an option.

Compromise or arrangement proposed under Part 26 of the Companies Act 2006 between the company and its creditors and/or members (or any class of them). Proposed by the company, any creditor, member, liquidator or administrator. No statutory objectives – adaptable.

Letter sent to prospective Scheme creditors notifying them of the Scheme and letting them know which class it is proposed they will be in for voting purposes.

Application for leave to convene meetings made to court by issuing a Part 8 claim form. Supported by a witness statement setting out certain statutory information, giving details of the Scheme and meetings and sufficient evidence to enable the court to give directions as to the composition of classes.

Hearing before Registrar held to convene meetings of the appropriate classes of creditors. The function of the court at this stage is ‘emphatically not’ to consider the merits or fairness of the proposed Scheme. Notice of meeting sent by post or, less frequently, advertised. Must include Scheme details and explanatory statement setting out the effect of the proposed Scheme.

Meeting(s) held and Scheme is voted on. Must be approved by statutory majority of each relevant class: > being a majority in number; and > representing 75% in value of those persons present and voting (in person or by proxy) in each relevant class.

Binds all creditors, irrespective of whether they voted in favour or not.

If the Scheme is approved by the meetings, an application is made to court for a hearing to sanction the Scheme.

At the final sanction hearing, the duty of court (Re Anglo-Continental Supply Co Ltd) is to consider whether: (i) the relevant statutory requirements have been complied with, (ii) the classes of creditors were properly identified, (iii) each class was fairly represented by those attending the court meeting, (iv) the statutory majority was acting bona fide in the interests of the class, and (v) it would be reasonable to approve the Scheme.

If the Scheme is sanctioned by the court, then the sanctioning order is delivered to Companies House and, on delivery, the Scheme becomes binding on all relevant creditors and the company.

Schedule 1: Outline of procedure

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Key contacts

Richard Hodgson Partner, London Tel: +44 20 7456 3797 richard.hodgson@linklaters.com

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Richard Bussell Partner, London Tel: +44 20 7456 4672 richard.bussell@linklaters.com

Tony Bugg Partner, London Global Head of Restructuring and Insolvency Tel: +44 20 7456 4470 tony.bugg@linklaters.com

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Bruce Bell Partner, London Tel: +44 20 7456 3545 bruce.bell@linklaters.com

Schedule 2: Map illustrating the extent of Scheme recognition

Expert evidence has been presented to the English courts that those jurisdictions in countries which are coloured dark pink would recognise Schemes. The fact that a country is not coloured dark pink on this map does not necessarily mean that a Scheme would not be recognised there – it may just be that the point has not yet been considered in a reported case relating to that jurisdiction.

September 2015