UK: Bondholders’ Opposition To Schemes Of Arrangement

In our March 2003 issue we reported on the failure of an informal committee of minority bondholders to put Colt Telecom Group plc into administration. Bondholders’ committees have continued to be active when issuing companies are in financial difficulties. In 2004 this resulted in two cases on schemes of arrangement.

A company can enter into an arrangement with all or any class of its creditors or members (ie shareholders) under section 425 of the Companies Act 1985. An application has to be made for a court order to summon a meeting of the relevant creditors or members. If a meeting is held and at least 3/4 in value of those present (in person or by proxy) agree to the proposed scheme, the sanction of the court is sought. If sanctioned, the scheme will bind all (or the relevant class) of the creditors or members (even if they did not attend the meeting or vote in favour), the company and any liquidator. The financial assistance prohibition in section 151 of the Act will not apply. Such schemes can be useful where minority creditors are unwilling to agree to proposals to restructure a company’s debt, although they can be comparatively cumbersome and costly.

Telewest applied to convene meetings of its creditors (principally bondholders) to put forward a scheme of arrangement as an alternative to a liquidation or administration. It was "heavily insolvent" with some bond issues in US dollars and others in £ sterling. All the bonds were to be cancelled, with the holders receiving new US dollar shares instead. The problem was the conversion rate chosen to convert the £ sterling claims into US dollars. The applications were opposed by an informal committee representing 15% of the sterling bondholders who thought the chosen rate was unfavourable to them.

They wanted a different exchange rate, or separate meetings of the dollar and sterling bondholders (as different classes of creditors). They failed and the meetings were held in June 2004. The scheme was sanctioned despite arguments of the sterling bondholders that the scheme was unfair as it departed from the pari passu principle of insolvency. The court held that the relevant test was whether it was a scheme which "an intelligent and honest man, a member of the class concerned and acting in respect of his interest might reasonably approve". It need not be the only fair scheme, nor even the best scheme, on which views could differ.

In the Mytravel case there was an additional time pressure. It risked having its CAA licences withdrawn (and ceasing to trade) unless it restructured its balance sheet by the end of 2004. It had negotiated a debt for equity swap with creditors under four sets of financing facilities. An informal committee of subordinated bondholders would not agree. Mytravel then proposed a scheme of arrangement to transfer its assets to a Newco with the large bulk of the financing facilities being converted into shares in Newco, but the bonds being left in Mytravel. Newco would offer to buy them in exchange for a lower percentage of shares than the bondholders had been offered previously.

The bondholders opposed the application to convene a meeting on the scheme in November 2004. In addition to section 425, the scheme needed to fall within section 427 (which deals with reconstructions) because of the proposed transfer of assets and liabilities. The bondholders said a reconstruction meant the shareholders in both the old and the new company should be the same, or substantially the same (which would not be the case). The court agreed and declined to order the meeting since the scheme could not fall within section 427.

The company had considered that the bondholders did not have sufficient interest in its assets to vote on the scheme because, in an insolvency, they would receive nothing due to the subordination terms in the bonds. The court held that the position in an insolvency was the correct basis. Given the situation, the bondholders would have had no economic interest and would not have had to have been invited to the scheme meeting (had it occurred).

Mytravel was unable to go ahead with their original proposal. Instead they successfully applied for a meeting to approve a scheme under section 425 to which the bondholders were not a party. The bondholders successfully appealed in December 2004 against the judge’s conclusion on their interest. However the company did not appeal against the earlier decision on reconstructions.

Although the amended scheme was sanctioned by the court, it is understood that a consensual refinancing deal was put in place instead. Whilst this practical way forward is presumably the better outcome for the company and its creditors, it is unfortunate as far as section 427 is concerned. Unless the original decision is overturned, it may make it difficult for debt to equity conversions to be sanctioned under section 427 in future.