Global | Publication | Q3 2023
Restructuring plans are on the march.
In the UK and in member states across the European Union, new restructuring procedures introduced to implement the 2019 EU Restructuring Directive are being tested and refined.
In this article, we focus on the UK restructuring plan and its use in the recent case of German property group, Adler (Re AGPS Bondco plc [2023] EWHC 916 (Ch)). The English Court faced the interplay between the English restructuring plan procedure, the Adler group's German law bonds and the substitution of a Luxembourg incorporated bond issuer with a newly formed English incorporated company. The cross-border issues considered in Adler are likely to arise often in today's global economy and should be considered closely by groups and their creditors contemplating using foreign restructuring procedures.
The UK restructuring plan under Part 26A of the (UK) Companies Act 2006 is a court-supervised restructuring procedure that is available to English companies and to foreign companies with a sufficient connection to England and Wales. The procedure is similar to the tried and tested scheme of arrangement (which has been in use for over a century), but includes a cross class cram down (i.e. an ability to cram dissenting classes of creditors into a deal that is supported by a majority in another class (or other classes), subject to the satisfaction of certain conditions).
A common technique used by foreign groups to land English jurisdiction is for the foreign group to incorporate an English subsidiary, which unilaterally undertakes, by way of contribution or substitution, the debt obligations that are to be the subject of the restructuring plan. The new (English) company then proposes the UK restructuring plan for the debt. When considering whether it has jurisdiction to sanction a restructuring plan, the English Court needs to be satisfied that it is not acting in vain and that the restructuring plan is likely to have substantial effect (i.e. be recognized) in relevant jurisdictions where the company carries on its business.
The Adler group has a substantial residential property portfolio in Germany. A key element of the group's funding originated from six series of German law governed unsecured loan notes issued by Adler Group S.A., a Luxembourg company, with maturity dates from 2024-2029, all of which were issued to qualified/professional investors. The six series of notes, amounting to €3.2bn in debt, had staggered maturity dates, but otherwise ranked pari passu with each other.
The group encountered financial difficulties and was facing a liquidity crisis as a series of separate notes, issued by Adler Real Estate AG (a German group company), was due to mature on 27 April 2023. The group was not in a position to make the payment.
Failure to pay the Adler Real Estate AG note holders would result in cross-defaults across the groups' financing arrangements. This in turn would require the directors to file for insolvency in Germany in order to avoid personal liability. It was accepted that if a restructuring of Adler's debt could not be achieved, formal insolvency proceedings (i.e. liquidation) would be the most likely outcome.
Following an unsuccessful attempt to restructure its debt using a contractual Consent Solicitation procedure under the German Bond Act (Schuldverschreibungsgesetz), the group proposed a restructuring plan. To bring the restructuring within the English court's jurisdiction, an English Newco, AGPS Bondco plc (the Plan Company), was incorporated and substituted as loan note issuer under contractual provisions.
The restructuring plan also involved the creation of a new special purpose vehicle (SPV), funded by participating creditors taking a pro rata equity stake. The SPV would hold a 22.5% equity state in the Luxembourg parent company, Adler Group SA. The remaining 77.5% equity stake would remain with the existing shareholders, who themselves were not required to inject new capital. Conversely, the new creditor funding would provide €937.5m of super senior secured funding to the group to allow the Adler Real Estate AG notes maturing on 27 April 2023 to be paid in full, as well as allowing the group to continue trading.
The restructuring plan also envisaged varying the terms of the notes that were due to mature in 2024 (extending the maturity to 2025) in exchange for second ranking security. All other notes would retain their existing, pre-plan maturity dates and would benefit from new, third ranking security. There would also be an interest payment holiday and a temporary swap to PIK interest.
The plan proposed that all note holders eventually would be paid in full, but the group would start divesting itself of assets with a view to liquidating the companies by 2027. The opposing note holders – those holding the longest dated bonds -- described the plan as a 'liquidation plan'.
An English restructuring plan requires two court hearings: a convening hearing (to convene meetings of creditors) and a sanction hearing (where the court will decide whether the plan can and should be sanctioned in order then to take effect in accordance with its terms). Given the imminent debt wall, the court in Adler agreed at the convening stage to defer questions on the validity (as a matter of German law) of the issuer substitution until the sanction hearing.
When the meetings of creditors were held, the holders of five series of notes overwhelmingly voted in favor of the plan. The note holders with notes maturing the latest in time (the 2029 note holders) voted against, with only 62% by value approving it, thus failing the English law initial threshold, which is 75% by value in each class.
Given one class of notes did not vote in favor of the plan, the Plan Company applied to court to have the plan sanctioned and the 2029 note holders crammed down under the statutory cross class cram down mechanism.
A key issue for the court was whether differential treatment of creditors under the plan was an unfair departure from the fundamental principle of pari passu distribution in insolvency (i.e. that creditors should be paid equally, pro rata and pari passu, with other creditors of the same class). In other words, was it fatal to the plan's sanction prospects that the 2029 note holders would be paid later than the other note holders?
Without the plan, all the notes would be accelerated and paid on a pari passu basis. Under the plan, however, all bar one series of notes would retain their original maturity dates. The practical effect was that the 2029 note holders would bear the greatest risk of the plan failing in the future.
The court confirmed that a plan may depart from the principle of equal treatment where there is good reason for it to do so. Here, the court recognized that the 2029 note holders were already subordinated in time from the moment they purchased the notes. Therefore the plan merely provided for continuity of the agreed structure.
Further, the court was clear that its role was not to determine whether the plan was the 'best plan' that could be proposed. The question was whether it was a plan that a reasonable creditor could approve, and that it was fair. The high voting turnout and margin by which each of the classes voted in favour (84% across the remaining five series of notes; even 62% of the 2029 note holders) is a relevant factor which may be taken into account in the exercise of the court's discretion. In any event, should the plan fail (which, on a balance of probabilities, the court concluded it was not likely to do), the default position would be a pari passu distribution.
With previous English restructuring plans, judges had been clear that creditors who wish to oppose restructuring plans, particularly on valuation, must 'step up to the plate' and produce their own evidence if they want their opposition to be taken seriously. With Adler, the court heard conflicting evidence both on valuation and on the effect of the purported substitution of the Luxembourg (original) issuer to an English Newco under German law.
The valuation evidence was based on analytical models but required speculative analysis of the future state of the German property market. In order to invoke the statutory cross class cram down mechanism, the court must be satisfied that no member of the dissenting class would be any worse off than they would be under the relevant alternative. In Adler's case, the relevant alternative was liquidation.
The Plan Company produced expert evidence that note holders would receive a 63% recovery in liquidation, and a 100% recovery under the plan. By contrast, the 2029 note holders produced their own expert evidence that a 56% recovery would be achieved in liquidation, and only a 10.6% recovery under the plan (on the basis that the 2029 note holders would be paid last, with the 10.6% comprising capitalized PIK interest). Preferring the Plan Company's evidence, the judge accepted that on a balance of probabilities, a 100% recovery was the most likely outcome and thus was in excess of the liquidation recovery.
The court also accepted the Plan Company's evidence that liquidation would result in an 'insolvency discount' on asset realizations of 23% of the group's development assets and 25% of its yielding assets. Crucially, the court accepted that even were the plan to fail, the 2029 note holders would be better off than in an immediate liquidation.
The dissenting 2029 note holders also argued that the substitution of the English Plan Company for the Luxembourg issuer was invalid as a matter of German law, the law that governed the bonds. The court therefore had to be satisfied that the substitution was valid as a matter of German law. Both parties submitted detailed expert evidence as to the validity of the substitution under German law.
German legal commentators take different views as to the prerequisites and validity of such substitution, which became apparent from the differing evidence presented to the court.
Further, certain of the 2029 note holders had applied to the Frankfurt court for a declaration that the issuer substitution was invalid as a matter of German law. That litigation has the potential to undermine the English court's jurisdiction if the Frankfurt court rules that the substitution was invalid under German law and hence the English court lacked jurisdiction to sanction a restructuring plan.
Issuer substitution clauses are actually market standard in German bond issuances. They are found in the terms and conditions of many bonds issued by larger German companies. Usually a special purpose vehicle (SPV) (for example a Dutch entity) will serve as the financing vehicle with the parent company acting as guarantor under the notes. From time to time, such SPVs are replaced by other entities incorporated in other (generally, EU) jurisdictions.
Under German law, such a substitution would require the approval of the noteholders. In principle, that approval can be granted in advance in the notes themselves subject to terms and conditions. Such pre-approval clauses are also relevant to consent solicitations where noteholders are asked to provide their consent to a substitution of the issuer for restructuring purposes pursuant to the provisions of the German Bond Act. The German Bond Act explicitly allows for such substitution upon a vote of 75% of the votes cast at a noteholders' meeting.
Although preliminary legislative materials for the German Bond Act, as well as the draft Act (2008), did foresee certain required conditions for a substitution, the final version of the Act (2009) refrained from establishing any material conditions for such substitution. Hence, some commentators argue that it is permissible to include a substitution clause even without any conditions (or restrictions) in the terms and conditions.
It is widely acknowledged (and confirmed by German court judgments) that the enforceability of terms and conditions in bonds generally falls within the scope of civil law provisions for general business terms and conditions. If the required legal restrictions are not respected, the terms and conditions can be held invalid by a German court. German law follows the concept of consumer protection and provides limits on the use of certain terms and conditions. In particular, such terms must be clear, transparent and unambiguous. In commercial business transactions, the scope for using these terms and conditions is less restrictive than in consumer transactions. In addition, the general transparency regime is superseded by specific provisions of the German Bond Act pursuant to which the required level of transparency may reflect an investor's profile. The fact that the Adler notes were placed among professional investors who are deemed to have considerable experience in investments of such nature and that the particular substitution clause is based on market standard terms was raised by the Plan Company's expert witness.
A 2012 decision by the higher regional court in Frankfurt (OLG Frankfurt) also dealt with issuer substitution. It found that the substitution in that case could deviate from basic principles of contract law even where there was not a parent company guarantee. However, the Frankfurt court did not comment on the general enforceability of substitution clauses. The facts of that case deviate from the Adler case because in Adler a guarantee (which was not already in existence) was offered by the original issuer rather than its parent company. Although the Frankfurt court did not make any further determinations on the enforceability of the issuer substitution clause, it stated that, in general, a potential deviation from the principles of contract law may be permissible if compensated for. Therefore, some commentators take the view that such clauses may be valid if there is fair compensation.
An alternative view is that the economic basis of the noteholder's investment must not change as a result of the issuer substitution. In other words, where a change of the issuing debtor would lead to a significant change in the risk profile associated with the bonds, a noteholder's meeting would need to be convened. However, if, as in the Adler case, such substitution involves the original issuer assuming the function as a guarantor under the notes, it seems hard to argue that a higher risk is assumed since the noteholders would have the benefit of two obligors (i.e. the Plan company and the original issuer as guarantor). Hence, the noteholder's position would not fundamentally change.
An English Part 26A restructuring plan should be available to restructure German law governed debt. Unlike the rule in Gibbs under English law, German law does not provide that German contractual claims can only be discharged or amended in accordance with German law. Whether or not foreign laws (and restructuring procedures) are effective to amend German law governed debt is, from a German view, a question of jurisdiction.
Interestingly, both expert witnesses (prominent professors of German law), did not seem to have significant concerns over whether the Adler plan (i.e. involving the restructuring of German debt of an English company using an English procedure) would be recognized in Germany.
Taking the above factors into account, the English Court ultimately exercised its discretion to sanction the Adler plan, holding that the substitution complied with the substitution clause in the notes and was valid under and complied with the German Bond Act.
The 2029 note holders applied for permission to appeal the court's decision, which was denied by the judge at first instance. Leave to appeal may be sought direct from the Court of Appeal.
Little to nothing is currently known as to the status and progress of the note holders' pending litigation in Frankfurt where they are seeking an order that the issuer substitution is invalid. It is reported to have been initiated by one of the dissenting 2029 note holders in spring 2023. However, under typical civil procedural standards and procedures, it is likely to be some months before a first judgment is issued. A potential appeal may then be lodged in the weeks following that judgment.
If the Frankfurt court finds that the issuer substitution was invalid, it follows that the restructuring of the German law governed debt pursuant to the plan may not be recognized in Germany notwithstanding its sanction by the English court. This creates uncertainty, of course. Practically speaking, however, it is unclear on what basis the elements of the restructuring plan already implemented could be unwound, or the losses that the dissenting creditors could successfully claim they have suffered remedied. In any event, a German judgment finding that the substitution was invalid may have significant implications for this and future cases.
More generally, it has not yet been determined by the German courts whether UK Part 26A restructuring plans of German debtors and/or German debt are capable of recognition in Germany following the UK's departure from the European Union. In the case of an English restructuring plan that modifies English debt, the Rome I conflict of laws principles could provide some assistance to recognition, although the position is not free from doubt as a matter of German law. If a Part 26A plan can be considered an 'insolvency proceeding' within the scope of Sec. 343 of the German Insolvency Code, then recognition would be available under that route (and this was the position agreed by the experts in Adler).
Recognition is potentially a political issue as well as a legal one. EU lawmakers and the European Court of Justice have worked for many years to create a common legal framework for determining jurisdiction in insolvency and restructuring proceedings, based on the principle that a debtor's centre of its main interests (or COMI) should be the jurisdiction in which the main restructuring or insolvency proceedings are carried out. Recognition in the EU of UK Part 26A restructuring plans as insolvency proceedings in the case of a foreign debtor with a 'sufficient connection' to England and Wales, but with its COMI in the EU, would create a divergence from the EU's COMI-based approach.
Finally, the treatment of shareholders in the Plan was also interesting and of greatest concern to the English court. The court was uncomfortable with the shareholders retaining a 77.5% equity stake in the group despite their unwillingness to inject further capital. Clearly, this could lead to a windfall for the existing shareholders despite them taking on no additional risk by providing new capital. In the end, the court concluded that the new money providers had commercially and rationally negotiated the new SPV's 22.5% equity stake in the group and those creditors were best placed to judge whether the 77.5% retention was fair. The judge considered the retained equity stake was "not so unfair" that he should refuse to sanction the plan (emphasis added).
In other jurisdictions, most notably under the absolute priority rule under US Chapter 11, the same facts might have required equity being wiped out under the plan in order to cram down the 2029 notes. In England and Wales, it remains for the 'in-the-money' creditors to decide how to share the value (or "restructuring surplus") remaining following implementation of the restructuring plan, which may result in those creditors agreeing to shareholders retaining their equity stake, provided, of course, that the plan is otherwise fair. Similarly, the German equivalent to the UK Part 26A restructuring plan, the StaRUG, allows for exceptions to be made from the absolute priority rule in order to enable flexible solutions.
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While country risk cannot be avoided in cross-border transactions entirely, it can be effectively mitigated through careful transaction structuring and tailored contractual protections.
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Miranda Cole, Julien Haverals and Emma Clarke of our Brussels/ London offices are the authors of a chapter on procedural issues in merger control that has been published in the third edition of the Global Competition Review’s The Guide to Life Sciences. This covers a number of significant procedural developments that have affected merger review of life sciences transactions.
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