The NSW Court of Appeal has considered whether different groups of secured creditors should be placed into separate classes for the purposes of voting on a proposed creditors’ scheme of arrangement. Partners Christopher Prestwich and Tom Highnam report.
How does it affect you?
- A creditors’ scheme of arrangement requires the agreement of certain majorities of each class of creditors which is present and voting.
- Creditors will only be divided into separate classes if their rights are so dissimilar that they cannot sensibly consult together with a view to their common interest.
- The fact that different groups of secured creditors may have different rights, or will be treated differently under the scheme, may not be sufficient to warrant those secured creditors being broken into different classes.
- In this case,1 the NSW Court of Appeal concluded that two groups of creditors (being the holders of secured notes and Term Loan A and B investors) constituted a single class even though the latter group stood to receive slightly preferential treatment under the scheme.
Schemes of arrangement are a key tool for implementing corporate restructures in distressed scenarios. A restructure may involve steps such as extending the maturity date of secured debt, amending the interest payable to lenders, introducing new debt tranches (potentially on a super senior basis) and converting debt to equity. Those are steps which under standard facility documentation will require the unanimous consent of all lenders. Unless unanimous consent can be obtained, a scheme of arrangement can become the only way of implementing a restructure against the wishes of a dissentient minority of secured creditors.
A scheme of arrangement must be agreed to by at least 75 per cent of each class of creditors by value and more than 50 per cent by number. When creditors are broken up into classes, each class is given the power to veto the scheme. The court has recognised that process undermines the basic approach of decision by majority. Accordingly, the test for determining whether there should be separate classes is a high one – different classes must be confined to those persons whose rights are so dissimilar as to make it impossible for them to consult together with a view to their common interest.
The Boart scheme provides a stark illustration of how important that question of whether there should be separate classes of creditors can be. First Pacific held 29 per cent of the secured notes that had been issued by Boart Longyear (BYL) and it opposed the scheme. If First Pacific could establish that the secured noteholders formed a separate class for voting purposes, it would have an effective right of veto. However, if the relevant class for voting purposes was to include the balance of the secured debt owed by BYL (being Term Loan A and Term Loan B debt), then First Pacific would not have a right of veto. Looking at the secured debt as a whole, three other secured creditors (Centerbridge, Ares and Ascribe) held a total of 78 per cent of the debt by value and had already bound themselves to vote in favour of the scheme.
A key part of the background to the proposed scheme was BYL’s financial position, described by the court as ‘parlous’. The evidence in the proceeding was that its debts totalled $779 million against an enterprise value of $267 million. The scheme, if implemented, would reduce its debt to $445 million. There was no other restructuring proposal on the table, and if the scheme was not implemented, it was expected that BYL would go into external administration.
In considering whether the senior noteholders should be a separate class for voting purposes (which would give First Pacific a right of veto), the court looked at the following questions:
- What are the rights that the existing creditors have against the company and to what extent are they different;
- To what extent are those rights affected differently by the scheme; and
- Does the difference in those rights, or the difference in the treatment of those rights, make it impossible for the creditors in question to consider the scheme as one class.
As to the existing rights of the senior noteholders on the one hand, and the other secured creditors on the other, there were certain differences. While they shared the same security, there were different priority rights (eg interest on the Term Loan A and Term Loan B was unsecured). The various instruments had different maturity dates and different interest rates. While each instrument had the same change of control rights (enabling them to demand repayment if there was a change of control), those rights were of more value to the senior noteholders than to the holders of other instruments (in which Centerbridge, which already owned 48 per cent of the equity, had a substantial interest). None of those interests were of a nature which caused the court to conclude that it would be impossible for the secured creditors to consult together with a view to their common interest.
The real controversy in the case was whether the difference in treatment of the different types of securityholders was such as to result in the court breaking them up into different classes. Key features of the proposed scheme and associated recapitalisation transaction were as follows:
- There was no write-off of the senior debt (the unsecured debt was to be written off under a separate scheme);
- BYL would have certain rights to pay interest on the secured notes in kind;
- In exchange for reducing the interest rate on the Term Loan A and Term Loan B facilities, the holders of those instruments would receive shares, such that Centerbridge would hold 56 per cent of the equity;
- The differing maturity dates of the secured instruments would all be moved to the end of 2022;
- Centerbridge, which was already able to appoint four of the nine directors, would be able to appoint a majority of directors; and
- The change of control clauses would be waived.
The court held that those differences in treatment were not of a nature to warrant the secured creditors being broken into different classes for the purposes of voting on the scheme. Critical to that analysis was the risk of imminent insolvency as the only apparent alternative to the scheme. The expert evidence in the case was that each group of secured creditors would receive a better return under the restructure to be effected by the scheme than they would in an external administration. Further, while Centerbridge, Ares and Ascribe would receive equity and First Pacific would not, the evidence suggested that equity would have no value. As explained above, secured debt of $445 million would remain outstanding even though the equity value was only $267 million.
The court concluded that there was no difference which would result in the different groups of secured creditors being unable to consult together with a view to their common interest at the creditors’ meeting. As such, there would be a single class for voting purposes. The court did, however, note that First Pacific would be entitled to raise the question of fairness at the second court hearing when the court would consider whether to approve the scheme.
- There are some distinctions that will result in different groups of creditors being in different classes for voting purposes. Secured and unsecured creditors will typically form separate classes;
- This case illustrates that as between secured creditors, even though there may be differences between their existing rights and differences in relation to how they would be treated under a scheme, they can still be treated as a single class for voting purposes;
- That will be a question of degree, to be considered on a case-by-case basis. Where a company is in severe financial distress, the only alternative to the restructure is an insolvency, and each group stands to receive a better return under the restructure, it is less likely that they will be broken into separate classes;
- It was important here that none of the secured creditors were being asked to take a haircut. The differences in treatment were more 'around the edges', for example, the issue of equity with no apparent value;
- How far those differences can be pushed without resulting in different voting classes will be an interesting question to be tested in future cases; and
- The overarching fairness requirement for obtaining court approval should not be forgotten.
- First Pacific Advisors LLC v Boart Longyear Ltd  NSWCA 116.