A comparative review of restructuring processes in the United Kingdom, France and the United States

In summary

This article provides a comparative overview of the current state of the rules governing cramdown, absolute priority and priming transactions in France, the United Kingdom and the United States.

Discussion points

• In what circumstances the cross-class cramdown mechanism is available in France, the United Kingdom and the United States, and key areas of challenge
• Absolute priority rule is a key guardrail in the application of cramdown in chapter 11 bankruptcies and now French restructuring plans, but not adopted within the English restructuring plan process. This article contains a discussion of the nuances and differences this makes in practice
• A review of how prevalent liability management exercises (LMEs) are in the United States versus Europe
• Overview and analysis of the latest LME technology
• A prediction on future LME trends

Referenced in this article

• Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring frameworks
• French Ordinance 2021-1193
• Part 26A of UK Companies Act 2006
• US Bankruptcy Code
• Till v SCS Credit Corp
• Re Adler
• Re Smile Telecom
• Orpéa
• Unhycos

Introduction

The toolkit available to companies to restructure their financial liabilities has expanded exponentially over the past five years. Globally, there has been an increase in legislation designed to facilitate the rescue of companies as going concerns, a more liberal application of such laws to stressed and distressed companies and, in the United States in particular, an ever-expanding repertoire of contractual wizardry by which companies can find flexibility in existing covenant packages to restructure their capital structure outside of bankruptcy courts.

The increase in legal options and court-confirmed contractual flexibility of existing finance documents means that stressed and distressed companies have multiple options available to them to achieve a more sustainable balance sheet and plug liquidity gaps. On the one hand, the breadth of options provides such companies with a greater ability to resolve their over-leverage or liquidity constraints. On the other, it increases both risk and opportunity for those invested in, or looking to invest in, such structures.

This article compares and contrasts the current state of the rules governing cramdown, absolute priority and priming transactions in France, the United Kingdom and the United States, three of the most active jurisdictions for complex, cross-border restructurings at present.

Cramdown

The ability to bind dissenting creditors into a restructuring is a vital element of an effective restructuring process. Without it, debtors (and supportive creditors) are at risk of being held over a barrel by one or more minority creditors who threaten to block an otherwise well-supported proposal to negotiate enhanced returns in respect of their positions.

It used to be the case that English and most European restructuring processes only provided for the ability to bind dissenting creditors within a class. Against the backdrop of the EU directive on restructuring frameworks,^[1] the ability to cram down across-classes is now available in England and France (as well as many other jurisdictions in Europe) through their respective restructuring plan regimes.^[2] Meanwhile in the US, the ability to cram down across classes is a long-standing tenet of the Chapter 11 process. However, there are some key differences in the availability and application of this mechanism versus the European approaches.

United States

In the United States, confirmation of a Chapter 11 plan of reorganisation requires, among other things, that each class of claims either votes to accept the plan or be unimpaired. A creditor is ‘impaired’ under a plan if it alters a creditor’s legal, equitable or contractual rights.

To the extent that not every class votes in favour or is unimpaired, a plan may nevertheless be crammed down over the rejecting creditors’ votes (and existing shareholders) with the acceptance of at least one impaired consenting class, providing that the plan, with respect to each impaired dissenting class, does not discriminate unfairly and is fair and equitable.

A plan unfairly discriminates against a class of secured creditors if another class of equal rank in priority will receive greater value than the secured creditors under the plan, without reasonable justification.

A debtor can establish that a plan is fair and equitable with respect to a class of secured claims by showing that the plan provides for: the holders of such claims to retain liens equal to the value of their security interest and deferred payments totalling at least the present value of such holders’ interests in the estate; the sale of any collateral, free and clear, with liens previously attached to the collateral attaching to the proceeds of sale; or the realisation by the holders of the ‘indubitable equivalent’ of such claims. Whether a plan is fair and equitable is often hotly contested.

The present value of a secured claim has been the subject of considerable litigation following the US Supreme Court’s decision of Till v SCS Credit Corp, 541 U.S. 465 (2004), in which a plurality of the court found that the cramdown interest rate in a Chapter 13 case (involving an individual) should be set by reference to a ‘formula approach’, being the prime rate (ie, the daily published rate reflecting the amount a commercial bank should charge a creditworthy commercial borrower), plus a risk adjustment. Based on a footnote in the US Supreme Court’s ruling in Till, a number of US bankruptcy courts have adopted a two-step approach and will only employ the formula approach in the absence of an efficient market of applicable interest rates.^[3]

With respect to the indubitable equivalent of a secured claim, US bankruptcy courts generally find that a plan provides for the indubitable equivalent of a secured claim where the collateral securing the claim is transferred to such claimant. When the return of the collateral does not satisfy the secured claim, a plan may nevertheless satisfy the indubitable equivalent test when it provides a return of collateral and an unsecured claim in the amount of any deficiency on account of the secured claim amount.

Creditors frequently engage in valuation fights over the appropriate interest rate to use for deferred payments on account of secured claims and the value of collateral surrendered to secured creditors to dispute indubitable equivalency.

With respect to a class of unsecured creditors, as further described below, a debtor can establish that a plan is fair and equitable by demonstrating that, under the plan, either holders of claims in the unsecured class are being paid in the full amount of their allowed claim, or holders of claims or interests of junior priority are not receiving or retaining any property.

Importantly, under what is referred to as the best interest test,^[4] any dissenting creditor may defeat confirmation if they show that they would receive less under the plan than in a hypothetical liquidation. This is an individual creditor’s right that can be asserted even if a class votes in favour of the plan. To address the issue, Chapter 11 debtors almost always include in their disclosure statement accompanying a proposed plan an analysis with expert evidence demonstrating that the proposed Chapter 11 plan provides greater distributions to creditors than would be the case in a liquidation scenario, which typically employs a ‘fire sale’ analysis. While any creditor may contest the debtor’s conclusion and evidence by proffering competing evidence, such challenges are costly and very rarely successful.

France

While French law has provided for out-of-court proceedings for some time, including the pre-insolvency safeguard proceedings, seen as the French alternative to the English scheme of arrangement, Ordinance No. 2021-1193 of October 2021 introduced for the first time a new voting procedure for restructuring plans with classes of creditors and a cross-class cramdown mechanism. The mechanism is automatically applicable to companies in safeguard and reorganisation proceedings that, together with the companies they control, exceed the following thresholds: at least 250 employees and a turnover of at least €20 million or a turnover of €40 million. Underneath these thresholds, it is optional at the request of the debtor. Classes of creditors are automatic in all accelerated safeguard proceedings. Importantly, and significantly for a jurisdiction that has historically been considered as more debtor-friendly, in certain circumstances equity holders may be grouped into a class and can be subject to cross-class cramdown.

The introduction of these classes is most welcome as they replace creditors’ committees, which were criticised as insufficient to reflect the granularity of the interests of different creditors.^[5] Shareholders were subject to corporate law not bankruptcy law, so specific measures could not be imposed against the equity through the bankruptcy process, except in restructurings of very large cap companies (though the thresholds were so high that the measures were never actually applied).

Since October 2021, the court-appointed insolvency trustee divides creditors that are affected parties into classes that reflect a sufficient commonality of economic interest. The plan must be adopted by a vote of each class of creditors with a majority of two-thirds of the creditors voting.

Where all classes approve the plan, the Court must verify that the plan has been fairly adopted and does not unfairly affect dissenting creditors. For that, French law follows the US Bankruptcy Code in applying the best interest test^[6] (ie, no affected party having voted against the plan finds itself in a position that is less favourable within the plan than the position it would have had in the comparator scenario). However, there is a key difference: under French law, the comparator is not always liquidation, but can be whatever is a better alternative solution that might have been adopted in the absence of the plan.

The mention of a better alternative solution raises questions. Some authors have suggested that it could refer to, for instance, an alternative restructuring plan presented by a third party. However, this is not permissible, as French law expressly provides that only the debtor is allowed to present a plan in a safeguard. The better alternative test has already been challenged in court and is likely to give rise to many challenges on restructuring plans in the future. To avoid any undue delay to the passage of a restructuring plan, a challenge must be filed within a very short period of time after the vote.

When a restructuring plan is not approved by all classes of creditors, the court may apply cross-class cramdown if the following conditions are fulfilled:^[7]

• the plan has been approved:
  • by a majority of classes of which at least one is secured (or ranks higher than the unsecured one); or
  • by one class, which is not a class of equity holders, and which, on the basis of the enterprise value of the debtor, is ‘in the money’ (ie, can reasonably expect to be entitled to payment or interest in liquidation proceedings);
• the absolute priority rule is complied with (see further below); and
• it is only possible to apply a plan to a dissenting class of equity holders if:
• the debtor, alone or together with the companies it owns or control, exceeds the thresholds mentioned above;
• it is reasonable to assume, on the basis of the enterprise value of the debtor, that equity holders of a dissenting class would not be entitled to any payment or interest in liquidation proceedings;
• in the case of capital increase, a preference should be given to existing shareholders to subscribe; and
• no transfer of shares or rights held by equity holders is included (only forced dilution or changes to the rights of shares are possible).

The introduction of classes and the possibility of cross-class cramdown has facilitated the adoption of restructuring plans in France. The insolvency trustee in charge of setting up the classes can employ ingenuity to structure the classes to maximise the chances of a restructuring plan being adopted. In significant cases, it is customary to anticipate the formation of classes of creditors during amicable proceedings such as conciliation proceedings, to allow for the quick set up of the classes and the subsequent adoption of the plan in accelerated safeguard proceedings. The flexibility given to the insolvency trustee comes with a higher risk of disputes over the formation of classes, as in the Orpéa case, for instance. In theory, however, the short time available to deal with these disputes still allows a restructuring plan to be adopted within a reasonable timeframe. Plans adopted by cross-class cramdown have been challenged (Orpéa and Unhycos) but, to date, no challenge has been successful.

England and Wales

Eagerly awaited as one of the most significant additions to the UK restructuring toolkit in recent decades, the restructuring plan (contained in a new Part 26A of the Companies Act 2006) introduced the ability to effect the cross-class cramdown of dissenting classes of creditors or members.

A plan company may only request the court to exercise its cramdown powers if two conditions are met. First, the court is satisfied that none of the members of the dissenting class would be any worse off under the proposed plan than they would in the relevant alternative (the no worse off test). Second, the plan has the support of 75 per cent in value of a class of creditors present and voting who has a genuine economic interest in the plan company.^[8]

To satisfy the first condition, the relevant alternative must be identified. In most cases, the relevant alternative will be some form of insolvency (typically administration or liquidation). This is unsurprising given that a debtor seeking to restructure through a restructuring plan must satisfy the threshold requirement that it has encountered, or is likely to encounter, financial difficulties affecting its ability to carry on business as a going concern.^[9] However, there will be other instances where the relevant alternative is less clear-cut.^[10] This is in contrast to US Chapter 11 where the relevant comparator is always liquidation. While the plan company must propose what it considers the relevant alternative to be, ultimately the court must determine the scenario that is most likely to occur. The court is unafraid to challenge, or in some instances reject, the plan company’s proposition.

Identifying the correct relevant alternative is one of the most important aspects of the English restructuring plan because the relevant alternative (and accompanying valuation evidence) underpins several aspects of the restructuring plan through which creditors may have a plan imposed on them without their consent. One of those is cross-class cramdown and the need to satisfy the no worse off test. Another is the fact that a plan company can request the court not to call a meeting of a class of creditors if ‘none of the members of that class has a genuine economic interest in the company’^[11] (ie, are out of the money). For that reason, creditor challenges to cross-class cramdown frequently turn on competing alleged relevant alternatives, as well as valuation evidence relied on by the plan company.

In early cases, non-consenting creditors contested the valuation evidence presented by the plan company, but did not actually present any competing evidence of their own.^[12] Those creditors were criticised by opposing legal counsel as simply taking potshots. The courts agreed, and made clear in Smile,^[13] that if a non-consenting creditor wishes to contest the plan company’s valuation evidence, they should file expert evidence of their own and put forward formal arguments to assist the court – even though the courts have acknowledged subsequently in Great Annual Savings that it is not compulsory for an opposing party to produce its own expert evidence to raise a successful challenge.^[14]

Any serious challenge to a restructuring plan on the basis of valuation should thus ideally be supported by expert evidence and an alternative valuation report. Otherwise, the non-consenting creditor offers little basis on which the court may decline to adopt the plan company’s position and can expect the court to dismiss its challenges swiftly.

The past year has demonstrated that creditors are alive to these points. There have now been several cases where non-consenting creditors have produced alternative valuation evidence that has been considered in detail by the courts.^[15] Tellingly, in none of those cases has the court preferred the opposing creditor’s valuation evidence to the plan company’s.^[16]

Valuation disputes in the context of English restructuring plans have the capacity to become even more complex than in Chapter 11 proceedings. Not only is there scope for dispute around the recoveries of creditors in the relevant alternative, but identifying the relevant alternative in the first place also represents a key line of attack. While the English courts have expressed concerns that restructurings are being drawn into complex valuation disputes under considerable time pressure,^[17] it seems inevitable that valuation evidence creates a risk of a ‘mini trial’, especially for opposed restructuring plans.

The position is similar in France: valuation disputes have already been brought and will probably be one of the main grounds to future challenges to cross-class cramdown.

Absolute priority rule

Due to cross-class cramdown’s potentially draconian effect, adequate guardrails are necessary around its application. As mentioned above, under US Chapter 11 a plan may only be imposed upon dissenting classes if it does not unfairly discriminate against the dissenting class and is fair and equitable. Part of the fair and equitable test in the context of the cramdown of unsecured creditors is an assessment of whether the absolute priority rule has been satisfied. The absolute priority rule in essence requires that no junior class of creditor recover until a senior class has recovered in full, and that no senior class should recover more than what it is owed (referred to as the corollary to the absolute priority rule).

This is a central tenet of Chapter 11 bankruptcies and is codified in section 1129(b)(2)(B) of the Bankruptcy Code. It follows that, under the absolute priority rule, equity holders may not receive any interest in the debtor or other distribution under the Chapter 11 plan unless and until all creditors have been paid in full, or voted to accept a plan that provides for distribution to equity holders.

Nevertheless, under the ‘new value’ exception to the absolute priority rule, equity holders may retain an interest in a debtor when they provide a contribution, often in the form of new capital, to the reorganisation, provided that such value is deemed substantial, necessary and reasonably equivalent to the value of the interest received in exchange. Whether such contribution is sufficient to satisfy the new value exception will often be contested by an unsecured creditors’ committee, particularly on issues as to whether the new value was adequately market tested and whether the interests are actually being granted on account of the new value or on account of their equity interests.

Additionally, a court may determine that a plan is fair and equitable without looking to the absolute priority rule if the dissenting class of claimants receives payment in the ‘allowed’ amounts of their claims. However, while the Bankruptcy Code dictates what is required to satisfy the fair and equitable requirements under the Bankruptcy Code, it does not follow that such requirements are likewise sufficient. Accordingly, it is an open question whether a court would, for instance, permit a recovery to equity where unsecured creditors were not receiving post-petition interest on their claims.

The position is similar under French law, in that the absolute priority rule exists as a check and balance on the application of the cross-class cramdown mechanism, but there is a derogation from this rule. The derogation stipulates that the court may decide to disregard the absolute priority rule, when it is necessary to achieve the objectives of the plan and if the plan does not excessively affect the rights or interests of the parties at stake. This exemption is specifically designed to allow partial payment to suppliers, equity holders and claims arising from the debtor’s tortious liability. Similar to the United States, according to French doctrine, to benefit from the derogatory rules, the equity holders would have to provide contribution to the restructuring.

The drafting of this derogation is sufficiently broad to give the court the ability to impose the plan without application of the absolute priority rule when needed. At the time of writing this article, this point has yet to be considered in the cases and so remains untested.

Under English law, there is no absolute priority rule applicable in the context of schemes of arrangements or restructuring plans. Therefore, in theory it is possible for junior-ranking creditors and existing shareholders to retain value even in circumstances where senior ranking creditors are taking a haircut on their debt. Where this is seen in its most acute form is where senior creditors to work with the sponsors to cram down other creditors whilst allowing the sponsors to keep their equity.

This is a unique feature of English restructuring plans compared to US Chapter 11 and the French restructuring, but there are limits to its application.

Where the two statutory conditions for the exercise of the court’s discretion to exercise its cramdown powers mentioned above have been satisfied, the court still has the discretion to refuse to sanction a plan if it is not satisfied that the plan represents a fair distribution of the benefits of the restructuring. In determining whether the distribution has been fair, the English courts have referred back not to the absolute priority rule – which was deliberately excluded from the provisions of the English Companies Act 2006 setting out the restructuring plan regime – but rather back to the pari passu principle, which essentially requires that losses in an insolvency are borne rateably by all creditors.

This principle and its application in the context of restructuring plans was discussed at length in Re Adler, the first restructuring plan case to be successfully overturned by the UK Court of Appeal. There were facts specific to that case which made the pari passu principle particularly important, the discussion of which goes beyond the scope of this article. However, the general point is that where a class’s right of veto is removed (due to the application of the cross-class cramdown), after the decision in Re Adler the court will look at whether there is a difference in distribution of the benefits of the restructuring between those classes that have agreed to the plan and those that did not, and if so, whether those differences are justified. Note that the Adler Group has since been granted permission to appeal the Court of Appeal order at the UK Supreme Court.

This is an assessment that will be highly fact sensitive, and a lot will depend on whether the plan is subject to challenge. The courts have specifically avoided prescribing an exhaustive list of what would constitute justifiable or good reasons to depart from that rule. This means that there are no hard and fast rules to apply when structuring classes and their respective rights emerging from the plan, and one has to keep abreast of the latest jurisprudence as this is an area where debtors will continue to push the boundaries. However, drawing from the case law to date, generally, if a shareholder provides new money to facilitate the restructuring, that shareholder should be entitled to be repaid in priority to pre-existing creditors, and may also retain some equity as it represents the value created by the restructuring which it has contributed towards creating. Also, the roll-up of some or all of the existing debt of providers of new money has also been confirmed as reasonable in the ED&F Man^[18] and Aggregate Holdings restructuring plans.^[19]

LMEs

The term LME has come into common usage in the restructuring world over the past several years. The methods used to capture discount or inject new capital into the structure include strategies that may benefit one creditor group to the disadvantage of another where such advantaged and disadvantaged groups may previously have been the participants in the same financial instrument with the benefit of pari passu ranking and security protections. Such transactions are also sometimes referred to as ‘lender on lender violence’.

LME technology is an effective tool for companies with forthcoming maturities or over-levered balance sheets to obtain additional liquidity and sometimes allows existing lenders to exchange their existing instruments for new instruments that have longer dated maturities, enhanced legal terms (usually solely from the lenders’ perspective) and enhanced economic terms (often both for the company and the negotiating lenders).

While technology that all debtors and creditors and investors spend significant time considering, LMEs in Europe are presently few and far between. Those that do occur are not yet as far reaching as those in the United States. However, this trend is receiving significantly more attention from all stakeholders, especially given that European law governed credit documents commonly have a lower threshold for sacred rights than US law-governed credit documents do. The rhetoric in Europe has moved away from referring to an inability to legally implement (with particular focus on exit consent case law), to a more commercial rationale that Europe is a village and that the relationship dynamics on this side of the pond are such that coercive LME transactions are not viewed as just ‘a cost of business’ in the same way the US market does. However, small, specific asset drop-downs are being replaced with larger-scale transactions of significant strategic importance to the continuity of corporate structures. The growing use of this technology can be seen in recent transactions such as Stonegate (UK), Loparex (Netherlands), Ardagh (pan-European), Altice (France) and Hunkermoller (Netherlands).

Certain common LME structures:

• Dropdown (J. Crew, Revlon): the transfer of assets to entities that constitute non-guarantor restricted subsidiaries or unrestricted subsidiaries, against which additional liquidity is raised from lenders, noteholders or other third-party capital providers, including potentially the sponsor.
• Uptier/priming (Serta, TriMark, Boardriders): the insertion of priority tranches of debt (which may also include the uptiering of selected existing debt (a roll-up)) either within the existing credit structure through a re-tranching of the waterfall, or through a new debt facility that ‘primes’ the existing structure via a new senior intercreditor agreement. The new priority debt may be offered only to certain lenders within the capital structure, and excluding minority lenders, or it may be provided by new money financing sources (including the sponsor). If there is a roll-up component to the uptier transaction, the roll-up may include elevation of existing debt at differing exchange rates.
• Spin-off (Chewy, MyTheresa): use of dividend capacity to transfer valuable subsidiary equity to a private equity sponsor, either in full (rendering the subsidiary a sister company of the borrower and guarantors of the existing debt) or in part (rendering the subsidiary no longer wholly owned by the borrower and guarantors, which generally results in the subsidiary no longer being required to be a guarantor or subject to restrictive covenants).
• Double dip (At Home): subsidiary financings utilising a special purpose vehicle (SPV) structure, whereby lenders provide new money financing to the SPV (either a non-guarantor restricted subsidiary or an unrestricted subsidiary) that is also guaranteed by the existing restricted group, and the SPV then on-lends that new money to the existing restricted group through an intercompany loan, the result of which being that the lenders receive a ‘double dip’ against the assets of a restricted group via:
  • a pari passu secured guarantee from the restricted group of the loan from the lenders to the SPV; and
  • a pledge of the intercompany loan from the SPV to the restricted group, which is also secured on a pari passu basis.
• Pari plus (Trinseo, Alvaria): a variant of the dropdown and double dip transactions, in which valuable assets are dropped down into an unrestricted or non-guarantor restricted subsidiary, which borrows money and then on-lends the proceeds to the existing restricted group through a senior secured intercompany loan that is incremental to or pari passu with the existing first lien debt, the result of which being that the lenders are secured by a pledged pari passu secured claim plus the value of the dropped down assets (plus potential other guarantees from non-guarantor restricted subsidiaries).

Parties excluded from uptier transactions have filed litigation arguing that such transactions are not permissible, primarily based on breach of contract and fraudulent conveyance theories.

The structures noted above typically combine multiple aspects of a group’s covenants and combine basket flexibility to create large baskets of opportunity to put money to work on elevated terms versus those who do not participate. There are also many bells and whistles that can be added to the negotiated terms that can provide additional flexibility for the debtor, return/security for the participating creditors and risk/value reduction for the non-participating creditors.

Going forward, we see a continued trend towards expanding the quantum, variety and benefit of LME transactions. Nearly every LME deal being considered in the market there shows some advancement in the technology. Those transactions that develop the law furthest in the LME arena will be those in the most acute circumstances that require the deepest and most creative surgery to survive, and for which the risk/reward dynamic presents the most interesting opportunities.

Last, these structures are not just the reserve of those sponsors traditionally perceived as aggressive, but are being used by mainstream private equity shops and founder/family businesses to retain the hope value and optionality of the equity.

Conclusion

The addition of the cross-class cramdown tool that has been a mainstay of the US Chapter 11 process is a welcome addition to the English and French toolkit. The subtle but significant differences in the cross-class cramdown mechanism and its guardrails (including the absolute priority rule in the case of France and the United States) across the three regimes mean that there may be a compelling reason why in a particular case one regime may be preferable to another. The ever-expanding options that can be used to restructure international corporate groups with complex finance structures is incredibly exciting.

In a similar vein, LME technology in the US market is developing at break-neck speed, and is widely anticipated to filter into European situations, albeit likely more as a last port of call where sponsors have no other avenues open to them to achieve a sustainable structure in a time and cost efficient manner, or cannot afford to follow their own money and would face the possibility of scrutiny against their continued involvement where they are not financially or commercially contributing to the go forward business.

It is more important than ever for creditors to have the ability to follow their money into a range of securities, both debt and equity, and to be in the know and in the tent in order to make sure that a priming or dilutive solution is not implemented to their disadvantage, and to understand at the outset of their investments that the risks of non-pro rata treatment of small holders are increasing.

When looking at restructuring opportunities and options, the international nature of businesses and their finance structures now, more than ever, necessitates a multi-jurisdictional investigation of the laws and techniques available in all but the smallest structures.

Endnotes