Advising an Ad Hoc Committee

Scope of the chapter

This chapter considers the common issues that arise for attorneys advising ad hoc committees.^[2] While the matters discussed in the other chapters of this publication will inevitably be brought to bear throughout an engagement, this chapter focuses on some of those issues from the attorney’s point of view.

As the topics in this chapter elaborate, the attorney will often find himself or herself needing to exercise as much skill and negotiation acumen managing the client (which invariably will comprise members with differing views, widely separated interests and even factions) as the client’s counterparties (which invariably will include other creditor groups, the debtor and, depending on the industry to which the debtor belongs, the regulator overseeing the debtor’s activities). The circumstance giving rise to an attorney being engaged by a committee is usually financial distress of a debtor. The debtor may have announced its intention to engage in negotiations with creditors because of an impending trigger event that it fears it may not be able to meet, or sometimes where the governing documents are ‘covenant-lite’, a trigger may not be imminent, and so the committee may have formed to put pressure on the debtor to address its financial issues.

These circumstances will mean different things to different investors; for some, such as distressed investment funds, their raison d’être may be to form committees in distressed situations, and so they will see it as an opportunity, while for others it will be viewed as a potential balance sheet loss requiring mitigation. Both types of investors (as well as all the others in between) will be eligible to (and, to bring a balance of views to the discussions, ideally should) join the committee. The attorney’s task will be to navigate around their diverging attitudes.

Backdrop to advising an ad hoc committee

Common interest

The attorney advising a committee will naturally seek a commonality of interest among its members. This commonality will provide a helpful point of reference for the attorney’s advice, negotiating strategy and recommendation for a restructuring solution. As aptly put in Sovereign Life Assurance Co v. Dodd,^[3] the touchstone for commonality of interest is 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’.

Classes in schemes of arrangement under Part 26 of the Companies Act 2006 (UK), and now the Part 26A restructuring plan, may be, depending on the circumstances, be helpful comparators. The concept of a class of creditors has been consistently given a broad, rather than narrow, construction so as to avoid ‘excessive fragmentation of classes lest a minority interest group be given a power of veto (or at least a disproportionate voice)’,^[4] the focus being on legal rights rather than collateral interests.^[5] The same rubric can be applied as a guide to finding commonality of interest in an ad hoc committee.

Thus, a commonality of interests is likely to exist in investors holding the same instrument, though it may not necessarily be so confined; it may exist among investors who hold a range of instruments. However, it is important that members of a committee are free, when required, to discuss all matters together, and thus, for reasons discussed here (such as complications arising out of private information and public trading) and in other chapters, it may not be practicable to combine these groups into the same committee, advised by the same attorney.

Conversely, at times, committee members’ interests may vary so widely as to make commonality of interest seem elusive. Factors that have the potential to divide committee members’ interests include the following (although not all of these differences would mean the members are not in a single class):

• diverging buy-in prices (e.g., some members may have been holders from the issue date, while others may have bought in at steep discounts);
• the presence of cross-holdings by some members (e.g., some members may hold positions in multiple parts of the debtor’s or its group’s capital structure);
• the presence of insurance cover for the investment, such as credit default swaps (the presence of which may dramatically alter a member’s objectives as regards its investment);
• varying degrees of reputational sensitivity among different members of the committee; and
• an appetite or capacity for different kinds of restructuring structures (e.g., depending on a member’s constitution or the kind of institution it is, it may not be able to invest new money or hold certain kinds of instruments (in this regard, an example is collateralised loan obligations – they are generally unable to hold equity) and individual tax issues may also inform the restructuring options proposed).

In addition, it is not uncommon to find that the composition of the committee and the size of members’ investments change regularly. These divergent interests can result in different attitudes as to what might comprise a satisfactory restructuring solution. The attorney will need to facilitate compromise and propose creative optionality accommodating all members.

A topic of increasing relevance in the realm of considering common interest of ad hoc committees has been the work fees (consent fees) payable to creditors in a scheme or restructuring plan. Judges in recent cases have expressed caution in relation to the arrangements, where some creditors receive high fees while others do not. The courts are keeping a close eye on these arrangements as they may ultimately be of a size and structure to fracture a class. The main concerns have been in relation to the transparency regarding calculation of the fee, and whether they disguise any other substantive benefits to the committees. In advising ad hoc committees, the attorney should be cautious of how fee arrangements in relation to schemes may be perceived, and if those arrangements could lead to fracturing the common interests of a class. Although differing interests may not destroy the integrity of the committee, occasionally a member may have an interest that is so divergent from that of the fundamental common interests of the committee that it is inappropriate for it to continue to be part of the committee. The engagement letter should contemplate such an occurrence and facilitate the exit of a member.

In a slightly different, but nevertheless relevant, context where the court was determining whether a vote should be counted, it observed in Re Jax Marine Pty Ltd:

Quite frequently it is necessary to discount, even to the point of discarding from consideration, the vote of a creditor who, although a member of the class, may have such personal or special interest as to render his view a self-centred view rather than a class-promoting view.^[6]

However, in most cases, there will be at least two threads for the attorney to return to in his or her search for commonality: the fact that the committee itself is the client (not the individual members comprising the committee), and the underlying rights attaching to the instruments in which the members are invested (as discussed further below).

The committee as the client

The attorney owes his or her duty to the committee rather than to any particular individual member of the committee. For the attorney whose appointment may have been ‘sponsored’ by one member of the committee, this can understandably give rise to difficulties, particularly if that member holds forth and its approach or objective is at odds with that of other members of the committee. This distinction was considered in detail in a sometimes scathing report issued by Harvey Miller as examiner in the case of FiberMark Inc in connection with the conduct of a law firm representing an unsecured creditor committee.^[7]

Two fundamental duties of an attorney to his or her client are the duty of confidentiality and the duty to disclose all information relevant to the client’s interests. These two duties have the potential to come into conflict with one other when multiple clients are being represented. In the case of a committee representation, it is essential, therefore, that the committee as an entity, not the individual members, engages the attorney.

Likewise, to resolve potential tensions around the duty of confidentiality on the one hand, and the duty of disclosure on the other, the engagement letter should set out any special arrangements. For example, it is common for members’ own information about their holdings, such as quantum and buy-in price, to be kept confidential. Another example is any special arrangements for dealing with private information so as to facilitate the committee’s continuing ability to trade. This is discussed in more detail in the section ‘Private information’, below, as well as elsewhere in this publication.

A committee engagement also ensures that legal professional privilege applies for the benefit of the committee, regardless of whether the committee’s membership changes from time to time.^[8]

Examining the rights attaching to the instruments

The obvious starting point in the attorney’s quest to understand the underlying rights attaching to the instruments to which the committee is party is to review the finance documents and any other contractual arrangements regarding those instruments (e.g., facility agreements, bond indentures, security documents, intercreditor agreements and possibly the debtor’s constitutional documents). This is not the place to discuss the provisions of these documents, but it is relevant to observe that these documents underpin the committee’s rights and, therefore, frame the negotiations and available restructuring options.

The finance documents (as well as the debtor’s centre of main interests and place of incorporation) will inform the broader context, such as what laws and jurisdictions govern the negotiations and the forum for determining resolution of disputes, what restructuring tools are available, the circumstances in which a formal insolvency process may be required or desirable, and other matters addressed in the other chapters of this publication, and whether attorneys in other jurisdictions should be called on to assist.

The committee and its counterparties

Rights between the class to which the committee belongs

Finance documents will also contain important terms regarding matters between the creditor class to which the committee belongs, such as how amendments to terms may be effected so as to bind a dissenting minority within the class, how and when an event of default may be invoked by the class, how security and guarantees may be enforced or released by the class, and how the trustee or agent is to be instructed on a matter or replaced by the class.

Thus, to justify constituting itself as a committee carrying some negotiating leverage, the group of investors will need to have a convincing blocking position, at least, on such matters as calling a default, amending principal terms or implementing a scheme of arrangement, and, ideally, it will have a comfortable majority of the class of creditors. Therefore, it may be desirable to locate additional holders and use the existing platform to galvanise them to join the committee. Often, this task is more difficult than it may sound, notwithstanding the obvious commercial interest for a creditor. Bonds are held through clearing systems where several intermediaries stand between the debtor and the ultimate beneficiary of the bond. Advertising on newswires (such as Debtwire or Reorg Research) or employing agencies that specialise in locating bondholders are some of the effective methods used to find holders.

Rights between the class to which the committee belongs and other constituencies

Finance documents are quite likely (especially if they are Loan Market Association (LMA), or similar, documents) to contain other terms regarding matters between, on the one hand, the class to which the committee belongs and, on the other hand, the other creditor classes, the debtor, the trustee or agent, and other relevant counterparties. The attorney should scour the documents to determine whether the finance documents give the class of creditors comprising the committee consent rights on any issues pertaining directly or indirectly to the restructuring. Likewise, the attorney should investigate whether the documents give other creditor groups or the debtor consent rights on such matters.

The trustee

Almost invariably, the committee, at the appropriate time, will need to establish a good working relationship with the trustee or agent of the class to which the committee belongs. This is particularly the case in those investments that require decisions to be made or actions to be taken by the class as against the debtor or another class, through an appointed trustee or agent.

The committee’s attorney will often initiate the contact via the trustee’s attorney. Thought will need to be given to the approach to take and the attorney will need to be receptive to signals indicating the incumbent trustee’s willingness and ability (or otherwise) to cooperate, and in a timely manner, with the committee’s objectives. It may be that the trustee or agent initially appointed by the class is not able or willing to assist in the restructuring. Particularly in aged transactions, the trustee or agent appointed may be located in departments of the arranging bank, which may not be staffed with restructuring specialists. It is not uncommon that committees look to replace the trustee or agent with a successor trustee or agent. It is also sometimes the case that the incumbent trustee resigns, preferring not to serve amid controversy. Owing to demand for skilled and commercial trustee and agency services, there have been some excellent recent entrants to the ‘successor trustee and agent’ market.

The committee’s attorney should be familiar with the indemnities and other protections already granted to the trustee by the class and be ready to negotiate with the trustee’s lawyer as regards any additional indemnities or other protections requested. For example, a trustee may be concerned about personal liability if a default is incorrectly invoked or in connection with litigation initiated by or against the committee.

In any event, depending on the types of finance documents involved, it may be that the committee’s attorney will need to request copies of the executed finance documents from the trustee. Publicly available bond prospectuses typically only include summaries of the principal finance terms, so it is vital to ensure the fully executed terms are reviewed in detail.

The regulator

If the debtor is regulated, it is also vital to understand the regulatory framework to which it and its business is subject. It may be advantageous, in cooperation with the debtor, to initiate a dialogue with the regulator at some point during the process to understand its priorities and assist in facilitating negotiations. An example is the latest restructuring of the Co-operative Bank, in which the Bank of England was involved in the negotiations – notwithstanding that it did not exercise its resolution powers under the Banking Act, its role as regulatory overseer being sufficient reason to involve it.

The debtor

Last, but certainly not least, at the appropriate time, the committee will need to initiate or respond to contact with the debtor. The overriding objective will be to influence the debtor’s restructuring plan. The debtor’s attitude to this contact will largely be influenced by whether a trigger is looming, as well as a myriad of other factors (such as whether it has engaged restructuring advisers; whether it has an urgent need for new money and its view as to the committee’s ability and willingness to provide it; whether it is located in a jurisdiction that encourages a consensual restructuring; or whether the debtor’s directors will be distracted by obligations imposed by local legislation to make a formal insolvency filing).

The attorney should consider what protections the committee should seek from the debtor, taking the stance that the committee’s very existence benefits the debtor. As further discussed below, seeking cost cover for the committee’s legal fees should be a priority. So, too, should a protocol on the debtor’s agreement to timely cleanse private information. Thought should also be given to methods of seeking the debtor’s indemnification for actions that might be taken against the committee in connection with the restructuring, on terms similar to the trustee’s indemnity in the finance documents. Although such an indemnity is not common nowadays, it should nevertheless be on the table, on the simple basis of ‘if you don’t ask, you don’t get’.

Valuation

At an early stage, the attorney will need to form an understanding of where the value breaks in the debtor’s capital structure, probably working with members of the committee to do so and often with the assistance of an external financial adviser. This information will inform the attorney of the committee’s negotiating approach, as well as restructuring structures available.

Valuation will be on a ‘forced sale’ basis if that is counterfactual to the restructuring proposal. However, a second valuation is often prepared on the basis of a ‘going concern’ as this assists in establishing the ‘high-water mark’ of where value breaks. In Re T&N Ltd and others (No. 3),^[9] the court said:

In considering the rights of creditors which are to be affected by the scheme, it is essential to identify the correct comparator. In the case of rights against an insolvent company, where the scheme is proposed as an alternative to an insolvent liquidation, it is their rights as creditors in an insolvent liquidation of the company. . . . Those rights may be very different from the creditors’ rights against a company which is solvent and will continue in business. In the latter case the creditors’ rights against the company as a continuing entity are the appropriate comparator.

The correct valuation is of critical importance. In English law, the issue is particularly acute because a class of creditor (or shareholder) that emphatically falls below where the value breaks will be regarded as having no economic interest in the debtor and, therefore, generally will not be entitled to vote on a restructuring proposal (such as a scheme of arrangement, although that would not be the case in a company voluntary arrangement, which has been used infrequently for restructurings).^[10] Thus, ‘out-of-the-money’ creditors will have little or no influence over the process (as discussed below).

If, on the basis of the correct valuation, the committee is ‘in the money’, it is likely to be more advantageous to agitate for a consensual restructuring solution and outside a formal insolvency process, as this will elicit most value. Conversely, if the committee is out of the money, it will be using whatever ‘nuisance’ or ‘hold-out’ value tactics it may have in an effort to extract value. This hold-out value usually manifests itself in the assertion of a claim that, because of the debtor’s desire to avoid costly delays, will meet with a settlement offer. The tactics available to an out-of-the-money committee depend on the facts, but the attorney should consider the appropriateness of challenging the valuation itself. The very question of valuation is often a matter of potential litigation, with those alleged to be out of the money arguing that a higher valuation (with or without a different valuation methodology) should prevail over lower valuations presented by other constituencies.

The introduction of the new Part 26A to the UK Companies Act 2006 has brought a further emphasis to the topic of valuation, and the type of valuation evidence being relied on by creditors, as well as enabling out-of-the-money creditors to be excluded from voting on a restructuring plan under Section 901C(3) of the Act. The cross-class cramdown provisions operate to allow, in theory, for a single class to approve a restructuring plan. Other classes, who vote against the plan, are then compelled to accept the restructuring so long as they receive at least what they would have got in the likely alternative to the restructuring plan.

In Re Smile Telecoms Holdings Ltd,^[11] competing valuation reports of the creditors became the context in which Mr Justice Miles reaffirmed that a creditor’s genuine economic interest in a company is determined by referring to the relevant alternative for the company were the plan not sanctioned. In the Smile Telecoms case, a creditor class was excluded from voting on the plan because its members lacked a genuine economic interest. They had not presented alternative valuation evidence at the initial convening hearing to prove they had an economic interest. The case illustrates the importance of valuations for working out who are the creditors entitled to vote and for gauging, in the context of cramdown, the likely relevant alternative, the counterfactual for the debtor against which the judgment will be made as to whether the class it is proposed be crammed down, will be no worse off by being compelled to accept the restructuring plan. If a creditor class is no worse off in the relevant alternative than if the plan is sanctioned, then that class may be crammed down even if it votes against the restructuring plan.

In the matter of Bluebrook Ltd and others,^[12] the debtors had initiated negotiations with both senior and mezzanine creditors, but ultimately proposed a scheme of arrangement with the senior creditors only. The scheme involved the transfer of the business to a new group of companies owned primarily by the senior creditors. This new group would assume almost all outstanding senior debt, leaving the mezzanine debt at the original debtor, which was now without any assets. The mezzanine creditors were not invited to vote on the scheme. The mezzanine creditors petitioned the court to exercise its discretion to refuse to sanction the scheme on the ground that it was unfairly prejudicial to them. The debtor responded by arguing that it was not unfair because valuations showed that the value broke in the senior debt, and so the mezzanine debt was effectively worthless. The court agreed with the company that the mezzanine creditors did not have an economic interest that could be prejudiced, and for this reason (among others) sanctioned the scheme.^[13]

Other tactics for a committee that is potentially out of the money typically include other litigation options. For example, the attorney should investigate claims that might be brought against the directors of the debtor (e.g., for their part in contributing to the debtor’s circumstances that have resulted in the necessity to restructure the debtor). The tactics and degree of aggression that are ultimately decided on will depend on a full assessment of the merits of the case, including the costs of seeing through the disruption. One factor in English litigation (unlike US litigation) that will have a large bearing on tactics is the general rule that the losing party will be liable to pay the legal costs of the winning party, as well as its own. The attorney should also consider the merits of threatening to petition the debtor for insolvency (with the consequential value destruction for the fulcrum class of creditor that such an eventuality will be likely to bring). An alternative approach may be for the committee to offer to buy out the more senior debt and provide new capital, thereby protecting their investment.

Private information

English attorney rules of practice do not prevent an attorney in possession of information of the type regulated by the laws relating to insider trading and certain industry guidelines^[14] (generically, private information) from representing a person who wishes to trade a regulated instrument and who would be unable to do so if it came into possession of such private information. The issue is resolved by requiring the attorney not to disclose, directly or indirectly, the private information to the client. This approach should specifically be agreed by the committee and this is usually done in the engagement letter, expressed as a waiver of the attorney’s disclosure obligations. Other chapters of this publication discuss the issue of private information in detail, but from the point of view of the attorney, it is worthwhile examining two consequences.

First, the English rules of practice facilitate the attorney receiving private information and acting as an information barrier to the committee. The attorney will use the private information in its negotiations with the debtor’s advisers, using its professional judgement as to whether and on what terms it might recommend disclosure to the committee. The attorney will invariably enter into discussions with the debtor’s advisers prior to any dissemination to the committee, with a view to agreeing the timing of public dissemination.

Second, the attorney must take care not to inadvertently disseminate private information to the committee. Doing so will, at the very least, cause a bondholder to be unable to continue trading in the bonds, for fear of criminal or civil liability, until the information is publicly disseminated (referred to in the industry as being cleansed). Private information can even include terms in loan agreements that are not publicly known, such as covenant levels, terms of waivers granted by lenders, detailed terms of defaults and cross defaults. It can also include information about performance obtained from the debtor during negotiations with the lenders. Similar issues may also arise in the context of representing a committee of lenders, particularly where the committee has appointed a steering committee or coordinating committee to lead discussions with the debtor. The difference in the case of a bondholder committee and a lender committee is the regulatory backdrop. In the United Kingdom, loans are not regarded as regulated instruments subject to the Regulation (EU) No. 596/2014 on market abuse. However, the LMA’s guidelines on transparency and the use of information in the secondary loan market, as discussed in detail in Chapter 9 have prescribed best practice for loan market participants to abide by.

Finally, the attorney will need to give consideration to any laws of other jurisdictions regulating the use of information that might be relevant to each member of the committee.^[15]

Engagement letter

The attorney’s letter of engagement with the committee should set out the scope of the attorney’s services and the other terms on which the committee engages the attorney. It can also be a helpful place in which to include a short description of the function and objectives of the committee and any by-laws or detailed terms governing matters pertaining to the conduct of the committee.

Terms of attorney’s representation

The engagement letter should limit the liability of the attorney, prescribe the information that shall be regarded as confidential (and, therefore, not subject to dissemination among the members) and set out the basis for the attorney’s fees and how they are to be shared among the members.

Sharing professional advisers’ fees and expenses is one of the obvious practical advantages of forming a committee. The terms of sharing can vary, but the most common and perhaps the fairest fee structure is for each member’s contribution to be prorated according to the size of its holding. Invariably, members’ liability for fees will be on a several (not joint and several) basis. To maintain confidentiality of members’ holdings, each member’s invoice should be sent to that member alone (so as to prevent members being able to deduce the holdings of other members).

The method and cut-off dates for determining the contributions of members who change positions, and members who leave or join the committee, should also be addressed. For example, should new members only be liable for fees and expenses incurred after the date of joining, or should their contribution be backdated to the commencement of the committee (so that existing members are given credit)?

Additionally, the committee should use the very existence of the committee to negotiate with the debtor to pay the committee’s legal fees. The rationale for this is that the committee’s formation is for the debtor’s benefit; absent the committee’s cooperation in the restructuring talks, the debtor would be at risk of an event of default being invoked, with the consequential risk of commencement of insolvency proceedings.

By-laws for the conduct of the committee

By-laws can be annexed to the engagement letter. They will generally be as facilitative as possible, so as to allow holders to join and leave and to trade their positions (except in the period preceding a vote because, at such times, there is usually a lock-up arrangement in place within the committee). New members should sign a joinder to the engagement letter and by-laws as a condition of joining. There may be terms requiring a member leaving the committee to require the assignee (if any) to accede to the engagement terms so as to give some stability to the group.

There may be some actions meriting a formal vote by the committee (e.g., instructing the attorney to initiate litigation or to commence a significant piece of work over a certain threshold of cost, expelling a member or changing the composition of the steering committee). The voting terms may be by simple or special majority, and by vote of hands or size of holding. Vote by holding is more common, as it is usually perceived to be fairer to give a bigger voice to members most invested in the situation and the engagement. Provision may be made so that, as regards other matters, the attorney may act on the instructions of the steering committee.

Depending on the number of members in the committee, a steering committee of selected members may be chosen. The steering committee will have authority to make decisions that bind the entire committee. Members of the steering committee may be selected simply on the basis that they have the most holdings, or they may be selected based on their resources, availability or experience. The powers of the steering committee to bind all members must be set out clearly. It may be appropriate to include a provision in the by-laws requiring a member of the steering committee to maintain a minimum holding, coupled with a requirement to notify the other members if a member reduces his or her holdings.

Establishing a member’s holding

The attorney should require proof of a member’s holding, either at the time a member joins the committee or in advance of a vote being cast. Depending on the type of instrument held, establishing proof may require the assistance of the trustee or legal account holder. Further, if a member holds its interest other than by way of legal title (e.g., by sub-participation), the attorney will need to consider the implications, particularly when a formal vote by the class is required and may need to assist in elevating the member’s holding to legal title.

Publicity

Members of an ad hoc committee might want to keep their participation in such a group confidential for fear of negative press coverage. This is particularly true when the situation is high-profile or politically sensitive and the committee’s common aim is to use a blocking minority to hold out for a better deal. In these types of situations, the members will not want to be seen to be frustrating the rescue of a company. It is imperative, therefore, that any adviser gauges each member’s appetite for press coverage and the topic is expressly addressed in any engagement letter. An adviser may also want to anonymise the group in future marketing publications.

Fiduciary duty and proper standards of conduct

The engagement letter should take the opportunity expressly to exclude any fiduciary relationship among the members of the committee to one another, or among the committee members to other members of the class to which the committee may belong.

Over and above any question of fiduciary duty, the attorney should always bear in mind that the committee members are likely to be subject to standards of conduct by their regulator. In the United Kingdom, the Financial Conduct Authority’s Principles 1 and 5 will be relevant, obliging market participants to conduct themselves with integrity and to observe proper standards of market conduct.

Termination

There may be circumstances mid-engagement in which the attorney may wish to terminate the engagement. The engagement letter should include circumstances in which the attorney reserves his or her right to do so, being sure to comply with any regulatory code of conduct applicable to the attorney.

Notes