Cross Class Cramdown: First thoughts or last word?

As we reported previously here, the DeepOcean restructuring plan was the third plan to be sanctioned¹ under the new Part 26A of the Companies Act 2006 (CA 2006) and the first in which the court used the cross-class cram down mechanism when sanctioning a plan.

The new restructuring plan procedure (the Plan) under Part 26A CA 2006 is similar in many respects to the well-trodden scheme of arrangement process under Part 26 CA 2006 (the Scheme). However, the Plan also provides for the mouthful that is “cross-class cram down”: even where there are dissenting classes of creditors or shareholders (i.e. classes which do not reach the approval threshold of 75% in value of those voting), the court has discretion to sanction the Plan provided that the following conditions are met:

• Condition A: that, if the plan is sanctioned, none of the members of the dissenting class would be any worse off than they would be in the “relevant alternative” (meaning whatever the court considers most likely to occur if the plan is not sanctioned).
• Condition B: that the plan has been approved by at least one class of creditors or members who would have a genuine economic interest in the company in that relevant alternative.

DeepOcean

Further detail on the DeepOcean Group can be found in our previous piece, however, in short, the Group provides subsea services to offshore industries (primarily in the oil and gas and offshore renewables sectors). In the UK, the Group operates two businesses, one of which is a cable-laying and trenching (or CL&T) business. The CLT business is operated by three English group companies: DeepOcean 1 UK Limited (DO1), DeepOcean Subsea Cables Limited (DSC) and Enshore Subsea Limited (ES) (together the Plan Companies).

The CL&T business had consistently underperformed and had continuously relied on funding from the rest of the Group. The Group decided that it could no longer fund the CL&T business and the Plan Companies each proposed individual restructuring plans, the purpose of which was to achieve a solvent wind down of the Plan Companies’ activities.

Restructuring Plans

The restructuring plans for the Plan Companies were interconditional (meaning that if one did not become effective, none would), however the Plan Companies retained the discretion to waive that interconditionality with the consent of majority lenders. The Group engaged financial advisors to prepare valuations and an entity priority model. However, in each insolvency scenario modelled, unsecured creditors were shown to recover at best a nominal amount.

Four creditor classes were approved at the convening hearing:

• Secured lenders:  Each of the Plan Companies were party as borrowers and guarantors to a secured facilities agreement originally entered into in February 2013 (the Facilities Agreement) with a syndicate of lenders;
• A UK landlord;
• UK vessel owners;
• Certain other unsecured creditors.

Broadly, the Plans provided for:

• The provision of $15 million to enhance dividends payable to creditors other than the secured lenders;.

• The amendment and restatement of the Facilities Agreement, including an extension of the maturity of the facilities to February 2025.  In addition, the secured lenders would release their claims against and security over the Plan Companies, retaining claims against the other obligors under the Facilities Agreement.
• Claims of the UK vessel owners to be released in full, with the owners entitled to receive an amount equal to c.5.2% of claims;
• Claims of the UK landlord to be released in full, with the landlord entitled to recover its property and receive an amount equal to c.4% of claims;
• Claims of the remaining specified unsecured creditors to be released in full with an entitlement to receive an amount equal to c.4% of their claims against DOI and DSC and c.8.2% of their claims against ES.

Creditors’ meetings were held virtually on 6 January 2021. The plans in respect of DO1 and ES were approved by all creditor classes. However, 35.4% of the class of unsecured creditors (the Dissenting Creditors) voted against the restructuring plan in respect of DSC. 

In sanctioning the DSC Plan on 13 January, the Court therefore – for the first time – used its discretion in applying the cross-class cram down mechanism. 

Judgment

Perhaps sensing that a judicial “cliff-hanger” was just what a community of restructuring lawyers needed to get them through one of the bleaker Januarys on record, Trower J declined to deliver oral judgment at the end of the sanction hearing on 13 January. His written judgment, which found its way into our inboxes on 28 January, is nevertheless meaningful compensation. It gives a useful initial insight into the factors the courts will consider when exercising their cross-crass cram down powers in the future.

Trower J repeated the approach that the court generally follows when deciding whether or not to exercise its discretion to sanction a scheme of arrangement, summarised as a four-stage test in In Re Noble Group [2018] EWHC 3092 (Ch):

• the court must consider whether the provisions of the statute have been complied with;
• the court must consider whether the class was fairly represented by the meeting, and whether the majority was coercing the minority in order to promote interests which are adverse to the class that they purported to represent;
• the court must consider whether the scheme was a fair scheme which a creditor could reasonably approve; and
• the court must consider whether there is any “blot” or defect in the scheme.

Statutory requirements

Trower J had been satisfied at the convening hearing that the Plan Companies were companies within the meaning of Part 26A CA 2006, were liable to be wound up under the Insolvency Act 1986 and had met the financial threshold conditions set out in s.901A(2) and (3) CA 2006.  Nothing had changed since the convening hearing which affected those findings. The convening order had been complied with, the explanatory statement was comprehensive and no creditor had suggested that it failed to provide all the information reasonably required to make a decision. Class composition had been approved at the convening hearing and it was not appropriate in this case to revisit class composition at the sanction hearing. However, a warning was sounded, in relation to class composition: Trower J noted that whilst there was no question of artificiality in the creation of DSC’s classes, there might be “…some cross-class cram down cases in which there is artificiality in the creation of classes to ensure that the requirements of the section 901G condition B are satisfied”. Where that came to light during the sanction process, it might “ ….be a ground on which the court will be prepared to revisit the conclusion that it reached on classes at the convening hearing”. 

Turning to cross-class cram down requirements (i.e. conditions A and B outlined above), Trower J considered:

Condition A

Identifying the “relevant alternative” for a plan was similar to identifying the appropriate comparator for class purposes in the context of a Scheme. It is also an exercise the court might carry out when applying a vertical comparison for the purposes of an unfair prejudice challenge to a CVA. Though Trower J acknowledged that there may be cases in which identification of the relevant alternative is complex, that was not the case here: the court had already concluded that insolvency of the Plan Companies was the likely outcome if the plans were not sanctioned.

In determining whether the dissenting class would be “any worse off”, Trower J explained that the starting point should be a comparison between the value of the likely dividend for the dissenting class in the relevant alternative and what would happen were the plan in fact sanctioned. However, Trower J went on to acknowledge that he phrase “any worse off” is a broad concept which “appears to contemplate the need to take into account the impact of the restructuring plan on all incidents of the liability to the creditor concerned, including matters such as timing and the security of any covenant to pay”.

In this case, it was clear that the Dissenting Creditors would receive nothing in the relevant alternative of liquidation, whereas under the plan they would make a recovery of c.4%.

Condition B

The only other class voting on the DSC plan, the secured creditors, had approved the plan. They would be “in the money” in the relevant alternative, as they would make a recovery on an insolvency of DSC. They therefore had a genuine economic interest and Condition B was therefore satisfied.

Discretion

Although the traditional approach taken by the court when considering whether to sanction a Scheme would in many respects be equally applicable to the consideration of a Plan, there were necessary differences. The approach, in relation to the sanction of a scheme, that the court would “be slow to differ from the meeting”, was clearly inappropriate for a Plan with a dissenting class. Trower J considered the explanatory notes to the Corporate Insolvency and Governance Act 2020 (by which the new Part 26A CA 2006 was introduced), which he said indicated that a company seeking sanction of a Plan in the face of a dissenting class will “have a fair wind behind it” where conditions A and B are met and that “all things being equal, satisfaction of conditions A and B is capable of justifying an override of the views of a dissenting class”. The benefits to be received by the Dissenting Creditors, combined with the fact that they would receive nothing in the relevant alternative, was a “powerful pointer” towards sanction.

Turnout

In Trower J’s view, a low turnout in a dissenting class could affect the weight to be given to the fact that more than 25% of those voting, voted against the plan. The turnout at the meeting for the class of Dissenting Creditors was c.35%, which was unsurprising given that this was a class consisting of trade creditors.

Trower J also considered the turnout and voting of the equivalent classes of unsecured “Other Creditors” for the other two Plan Companies: in aggregate across the three plans, just under 84% in value of the Other Creditors had approved the plans. The DSC plan did not propose differential treatment of its Other Creditors than proposed by the other Plan Companies. The aggregate majority therefore supported the conclusion that it was open to an honest and intelligent man to vote in favour of the DSC plan.

Horizontal comparison

Trower J explained that, in his view, it was appropriate to look at questions of horizontal comparability in the context of a cross-class cram down, given that a cram down will remove a dissenting class’ right of veto. In particular the court “ …will be concerned to ascertain whether there has been a fair distribution of the benefits of the restructuring…between those classes who have agreed the restructuring plan and those who have not”. There were no concerns here; the obvious differential treatment between secured creditors and the Dissenting Creditors was justified. The exclusion of other trade creditors from the plan was justifiable for commercial reasons. The approximately 4% recoveries to be received by the Dissenting Creditors (who otherwise would be out of the money) would be funded from other companies within the Group. Hence it was unarguable that there were other assets from which they could derive benefit in the absence of the plan.

Trower J was also satisfied that there was no other “blot” on the plan.

The judgment is therefore an interesting initial insight into the factors that the court will consider in exercising its cross-class cram down discretion. However, this was a straightforward test case: neither class composition nor the relevant alternative were contested, the existence of near-identical, albeit approving, classes in the case of the other Plan Companies provided a useful basis for considering how an honest and intelligent man would vote, and the Dissenting Creditors would otherwise plainly have been out of the money.

The sanction of restructuring plans where some or all of those (or other) factors are in issue will be the real test of the process. When that test comes, we expect the key elements of the process to require and receive material scrutiny to be valuation issues in computing the “relevant alternative”, evaluation of creditor rights and balancing the need for pragmatism against adopting the overly legalistic approach that often clouds the introduction of new legislation. We see each of these matters as being challenges that the English judicial system is more than capable of passing with flying colours.

Authored by Joe Bannister and Luke Hiller-Addis

¹ In the matter Of Deepocean I Uk Limited and In the matter Of Deepocean Subsea Cables Limited and In the matter Of Enshore Subsea Limited [2021] EWHC 138 (Ch)