English High Court approves latest fully contested restructuring plan: Adler group - PART TWO

In the second of two blog posts on the Adler group restructuring plan, we look at the court’s decision to sanction the scheme and the practical implications for future restructurings.

Key issues

Fair distribution – the pari passu problem

In order to decide whether to sanction the plan, the court had to decide (among other things) whether differential treatment of creditors under the plan was an unfair departure from the pari passu principle as a matter of English law. In other words, did it matter that under the plan the 2029 note holders would be subordinated in time to the other note holders?

It was accepted that, in the absence of the plan, the notes would be accelerated and paid on a pari passu basis. However, under the plan, all bar one series of notes would retain their original maturity dates, meaning that the 2029 note holders would bear the greatest risk of the plan failing.

The judge restated the fundamental importance of the pari passu principle, but confirmed that a plan may depart from the principle of equal treatment where there is good reason. In this case, the 2029 note holders were already subordinated in time from the moment they purchased the notes (which was likely reflected in the price paid). Therefore the plan proposed continuity rather than an indefensible departure from the core principle.

The court confirmed that its role was not to determine whether the plan was the ‘best plan’ that could be presented. The question was whether it was a plan that a reasonable creditor could approve, and that it was fair. The judge considered that the plan creditors were best placed to assess that. This was evidenced by the high voting turnout and margin by which each of the classes voted in favour (84% across the remaining five series of notes; 62% of the 2029 note holders, albeit that did not meet the statutory 75% threshold).

Key to the plan’s fairness in this regard was the fact that, should the plan fail (which, on a balance of probabilities, it was not likely to do), the default position would be a pari passu distribution. 

Interestingly, in relation to the high creditor approval rates of the plan, the 2029 note holders argued that this did not necessarily reflect the fairness of the plan because several of the note holders held notes in different series. On this issue the court made an important observation (consistent with previous guidance in the context of class composition in schemes of arrangement) that likely will be relevant to future creditor votes: where a creditor has a particular interest that goes beyond that of its class, that interest will only undermine their vote where it is both their predominant motivation in voting and adverse to that class’s interests.

Conflicting valuation evidence

With previous restructuring plans, judges have been clear that creditors who wish to oppose restructuring plans must ‘step up to the plate’ and produce their own evidence, not merely shouting from the sidelines.  With Adler, the court got exactly that. The court was required to hear full arguments with conflicting evidence, both on valuations and on the effect of the purported substitution of the issuer to an English Newco under German law. That valuation evidence was based on analytical models but required speculative analysis of the future state of the German property market. The court had no ‘crystal ball’, and could only evaluate the evidence as best as it could.

In an English restructuring plan, in order to invoke cross class cram down, the court must be satisfied that, if the plan were to be sanctioned, no member of the dissenting class would be 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 under the relevant alternative, 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 under the relevant alternative, 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 capitalised PIK interest). Preferring the Plan Company’s evidence, the judge adopted a methodical approach to evaluating the evidence, accepting on a balance of probabilities that that under the plan a 100% recovery was the most likely outcome and that a 10.6% recovery was the least likely outcome.

The court accepted the Plan Company’s evidence that the relevant alternative would result in an ‘insolvency discount’ on asset realisations 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 the relevant alternative of immediate liquidation. Significantly the court accepted there was a solid buffer as the group would need to recover £500m less than its forecast before creditors would be worse off compared with the relevant alternative.

Having concluded that the dissenting 2029 note holders would be no worse off and accepting the Plan Company’s German law evidence that the substitution of the issuer for an English Newco was valid to bring the plan within the English court’s jurisdiction, the court accepted the Plan Company’s expert evidence that on a balance of probabilities the plan would be recognised under both German and Luxembourg law. Therefore the court exercised its discretion to sanction the plan.

What are the key lessons for distressed companies and creditors?

The Adler group’s selection of the English restructuring plan as its tool of choice for restructuring German law governed debt is testament to the flexibility of the English restructuring plan and the expertise of the judiciary and professional advisers. The English court was able to deal with complex issues of law and a large volume of evidence in a very tight timeframe – the practice statement letter was sent out to relevant parties on 26 January 2023 and the plan was sanctioned on 12 April 2023, just over 11 weeks in total. 

The court drew on existing precedent to allow the staggered maturity dates to remain in place, demonstrating the importance and also the flexibility of the English pari passu principle in a restructuring context. However, the judge did note that it would not necessarily have reached the same decision on the pari passu issue had the plan not contemplated a full or significant recovery for the note holders.

The 2029 note holders did apply for permission to appeal the court’s decision, which was denied. It is unclear whether permission will be sought direct from the Court of Appeal. In the meantime, certain of the 2029 note holders have applied to the Frankfurt court for a declaration that the issuer substitution was invalid as a matter of German law, which if successful could undermine the efficacy of the English plan. As long as the German courts have not confirmed the recognition of a UK restructuring plan, be it in the Adler case or elsewhere, there is no certainty whether the arrangements made by such a plan are enforceable against dissenting creditors.

Finally, the position of the shareholders in the Adler restructuring is interesting from a comparative law perspective. The judge 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. Ultimately Mr Justice Leech 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 in US Chapter 11 proceedings, the same facts could have required shareholders to accept a write down of their equity stake where no new money was being provided. In England, it remains for the ‘in-the-money’ creditors to decide how to share the value of the restructuring plan, which may result in those creditors agreeing to shareholders retaining their equity stake, provided, of course, that the plan is fair.