English schemes of arrangement and restructuring plans are a particularly effective tool for debtors with creditors who are blocked under various sanctions regimes in their capital structures or who hold the debt through a blocked intermediary.
Debtors in this situation face greater execution risk when trying to undertake typical liability management transactions. Asset freezes may practically prevent sanctioned persons or persons who hold their debt through sanctioned persons from exercising their voting rights under debt instruments or receiving any allocations resulting from the liability management. Intermediaries involved in the debt instrument (trustees, paying agents) and often issuers may be prohibited from accepting those votes or allocating any distributions to such holders.
Equally, other creditors may be reticent or in fact restricted by sanctions from engaging in transactions which involve the property of sanctioned persons. Together, this leaves debtors with often insurmountable mountains to climb.
English schemes do not necessarily resolve all these issues and in certain cases licenses from sanctions authorities may still be needed to proceed with the vote on and/or implementation of the scheme. That said, English schemes of arrangement and restructuring plans provide for an effective mechanism for the debtors to have the restructuring approved and implemented effectively disregarding (or setting aside) the sanctioned holders. Typically, sanctioned holders will not be allowed to participate in the voting on the scheme and consideration attributable to sanctioned creditors under English schemes of arrangement and restructuring plans will be completely ring-fenced in a holding trust or escrow structure.
We examine the different tools debtors have successfully deployed to address such sanctions concerns, all while avoiding any unfavorable class or fairness rulings from the English courts.
Participation in Scheme or Plan Meetings
For a scheme or restructuring plan to be approved, debtors need to obtain the approval of 75% or more by value (plus, in respect of a scheme of arrangement only, a majority in number) of each class of creditor participating in the scheme or plan meeting (subject, in respect of restructuring plans only, to the cross-class cram-down feature). While there is no quorum requirement applicable to scheme or restructuring plan meetings, the meeting must be representative of the class and prohibiting sanctioned creditors from voting at scheme or plan meetings could undermine fair representation.
The issue is considered by courts on a case-by-case basis. For example, in Nostrum Oil & Gas, the court found it relevant that the sanctioned creditors had entered into a lock-up agreement with the debtor before becoming sanctioned, thus, showing their implicit consent to the scheme. The implicit consent of sanctioned creditors does not however appear essential to show fairness.
The VEON Holdings B.V. scheme and the SGB-Smit restructuring plan, among others, were approved by the English courts notwithstanding objections raised by sanctioned creditors who would have clearly voted against the restructurings if allowed to participate in the scheme or plan meetings:
- The court refused to reject the VEON Holdings B.V. scheme on grounds of unfair representation since the scheme was overwhelmingly approved by those who voted at the meeting.
- The SGB-Smit restructuring plan did not raise fair representation issues for the court since voter turnout was high despite the fact that sanctioned holders could not attend or vote at the plan meeting.
Participation in Scheme or Plan Meetings
For a scheme or restructuring plan to be approved, debtors need to obtain the approval of 75% or more by value (plus, in respect of a scheme of arrangement only, a majority in number) of each class of creditor participating in the scheme or plan meeting (subject, in respect of restructuring plans only, to the cross-class cram-down feature). While there is no quorum requirement applicable to scheme or restructuring plan meetings, the meeting must be representative of the class and prohibiting sanctioned creditors from voting at scheme or plan meetings could undermine fair representation.
The issue is considered by courts on a case-by-case basis. For example, in Nostrum Oil & Gas, the court found it relevant that the sanctioned creditors had entered into a lock-up agreement with the debtor before becoming sanctioned, thus, showing their implicit consent to the scheme. The implicit consent of sanctioned creditors does not however appear essential to show fairness.
The VEON Holdings B.V. scheme and the SGB-Smit restructuring plan, among others, were approved by the English courts notwithstanding objections raised by sanctioned creditors who would have clearly voted against the restructurings if allowed to participate in the scheme or plan meetings:
- The court refused to reject the VEON Holdings B.V. scheme on grounds of unfair representation since the scheme was overwhelmingly approved by those who voted at the meeting.
- The SGB-Smit restructuring plan did not raise fair representation issues for the court since voter turnout was high despite the fact that sanctioned holders could not attend or vote at the plan meeting.
In the VEON case, it was established that low turnout at a scheme meeting resulting from the exclusion of sanctioned creditors is not in itself a reason to refuse to sanction a scheme. In that case, approximately 60% by value of one of the two classes of bonds was held by sanctioned creditors. Given the high proportion of sanctioned holders, there was a low turnout at the scheme meeting, with a turnout of only 31.8% of the total value of the claims. The court nonetheless held that the scheme was fair, citing the fact that the scheme was overwhelmingly approved by those at the meeting, and that all non-sanctioned creditors whose shares were held by the sanctioned National Settlement Depositary in Russia (but who were not personally subject to sanctions) voted in favor of the scheme.
In the VEON case, it was established that low turnout at a scheme meeting resulting from the exclusion of sanctioned creditors is not in itself a reason to refuse to sanction a scheme. In that case, approximately 60% by value of one of the two classes of bonds was held by sanctioned creditors. Given the high proportion of sanctioned holders, there was a low turnout at the scheme meeting, with a turnout of only 31.8% of the total value of the claims. The court nonetheless held that the scheme was fair, citing the fact that the scheme was overwhelmingly approved by those at the meeting, and that all non-sanctioned creditors whose shares were held by the sanctioned National Settlement Depositary in Russia (but who were not personally subject to sanctions) voted in favor of the scheme.
Optionality; Holding Trusts and Escrow Arrangements
Under schemes of arrangement, where no cross-class cram-down is available, debtors are incentivized to constitute a single class of creditors in order to ensure that consent thresholds are achieved. Helpfully, the English courts have held that there is no rule per se preventing sanctioned creditors from being grouped in the same class as non-sanctioned creditors. Under restructuring plans, we have not yet seen a case of sanctioned creditors being grouped together in a distinct class and being crammed down, but Norris J, in his sanctioning judgment for the SGB-Smit plan, suggested that this could be a perfectly legitimate use of the cross-class cram-down provisions of Part 26 of the Companies Act 2006.
The basic principle when determining class composition, is that a class must “be confined to those persons whose rights are not so dissimilar to make it impossible for them to consult together with a view to their common interest”.
The practical impact of a scheme or plan is often different for sanctioned creditors than non-sanctioned creditors because they are unable to enjoy the rights conferred by the restructuring as a result of their sanctions status. Schemes or plans are often structured to give creditors the chance to elect different options with respect to the consideration they will receive. Sanctions restrictions also deprive blocked creditors of that opportunity and under such schemes or plans, blocked creditors’ participation is purely passive and they receive a default option chosen by the debtor. Additionally, the restructuring consideration allocated to sanctioned creditors (including by default, if there is optionality) typically gets placed in a holding trust or with an escrow agent until such time as sanctions are lifted and it can be lawfully received.
The rules on optionality established in the Malaysian Airlines scheme may provide guidance and comfort to debtors in their dealings with sanctioned creditors. In the Malaysian Airlines case, the court did not fracture the creditor class or refuse to sanction the scheme on the grounds of fairness, where certain creditors were unable to make their own elections, since:
- all the scheme creditors were offered the same options and were entitled to exercise those subject to certain limitations driven by external factors rather than the debtor’s discretion; and
- all the scheme creditors who did not exercise their option (either at all or as a result of them not being able to do so in view of external factors) were treated the same – the default option applied to them automatically.
Companies restructuring debt with sanctioned creditors are therefore advised to make clear in their scheme or plan documents that any options are available to all creditors and to ensure that the same default option applies to all creditors that do not exercise their options, whether due to sanctions laws or otherwise.
As explained in Nostrum Oil & Gas, China Fortune Land Development and other cases, a difference in interests rather than a difference in rights does not warrant separating out sanctioned creditors into their own separate class or result in a scheme being deemed unfair. The court in China Fortune Land Development pointed out that sanctioned creditors who cannot exercise their rights to directly receive scheme consideration because of sanctions regulations should not constitute a separate class where their pro rata entitlement to the consideration is preserved, since they are not being left out in any way and are “in the same position as scheme creditors who have failed to provide evidence of their holding in time”.
The same treatment would apply to creditors who cannot exercise their rights to receive securities allocated pursuant to a scheme for other reasons specific to such creditor (including investment limitations, their status as retail investors etc.).
As mentioned above, newly issued securities or other economic benefits granted as consideration under a scheme or plan will typically be held in a holding trust in favor of sanctioned creditors or by an escrow agent to be distributed at the direction of the debtor, in each case, until the lifting of relevant sanctions or the expiry of a holding period. The use of such structures has not resulted in class fractures.
In Nostrum Oil & Gas, the scheme consideration was placed in a holding trust structure, the terms of which held that the scheme consideration would transfer to the debtor if not claimed by the sanctioned persons within 60 days of the earlier of sanctions being lifted or the end of the 125-year perpetuity period. The court ruled that this was fair, since it did not place the sanctioned persons “at any greater disadvantage than the constraints they already face under the sanctions legislation”.
The same treatment would apply to creditors who cannot exercise their rights to receive securities allocated pursuant to a scheme for other reasons specific to such creditor (including investment limitations, their status as retail investors etc.).
As mentioned above, newly issued securities or other economic benefits granted as consideration under a scheme or plan will typically be held in a holding trust in favor of sanctioned creditors or by an escrow agent to be distributed at the direction of the debtor, in each case, until the lifting of relevant sanctions or the expiry of a holding period. The use of such structures has not resulted in class fractures.
In Nostrum Oil & Gas, the scheme consideration was placed in a holding trust structure, the terms of which held that the scheme consideration would transfer to the debtor if not claimed by the sanctioned persons within 60 days of the earlier of sanctions being lifted or the end of the 125-year perpetuity period. The court ruled that this was fair, since it did not place the sanctioned persons “at any greater disadvantage than the constraints they already face under the sanctions legislation”.
This test is a broad one and has led to the sanctioning of schemes with holding trusts constituted on terms which are increasingly restrictive from the perspective of sanctioned persons. For example, in the Hilding Anders case, the court sanctioned a scheme where newly issued shares were transferred to a holding trust for just up to six months, after which the new shares (if unclaimed) were extinguished.
Disenfranchisement Under Debt Instruments
In the VEON Holdings B.V. scheme, the debtor amended the voting terms of its bonds (surviving post scheme) so that to the extent that any bondholders are prohibited by any applicable law or regulation in exercising voting rights in relation to the bonds, for example, if they are sanctioned persons, the bonds held by such persons were excluded from calculating the principal amount of the bonds for the purpose of determining quorum and other requirements in connection with bondholder meetings.
At the convening hearing, the court held that while this amendment may give rise to fairness concerns to be considered at the sanction stage of the scheme, it does not give rise to a class issue. At the sanction hearing, the judge did not raise any fairness concerns regarding the amendment.
It is notable that in the SGB-Smit restructuring plan, the sanctioned plan creditor negotiated the inclusion of the following language in the debt instrument subject to the plan:
“No amendment or waiver in relation to a matter set out in Clause 43.3 (All Lender Matters) may be effected which affects or could reasonably be expected to affect the rights or obligations of a Lender whose Commitments are excluded and whose status is disregarded, in each case pursuant to paragraph (c) of Clause 43.8 (Excluded Commitments), in a way different from any other Lender in the same class as such Lender (disregarding for this purpose any effect that results specifically from the fact that such Lender is a Sanctions Disqualified Person).”
The purpose of this provision is to ensure that any lender who is not entitled to vote at lender meetings (including because such lender is a sanctioned person) cannot be adversely affected by amendments that otherwise require unanimous lender consent and are approved by other lenders who are able to vote; however, the provision merely requires the amendments to apply universally to all creditors without singling out disenfranchised creditors rather than adopting a much more general and potentially limiting approach prohibiting any changes having an “adverse effect”.
The development is very welcome by debtors with sanctioned persons in their capital structure since it can be used to ensure that post-restructuring, and in respect of any debts surviving the restructuring, they are able to achieve applicable minimum participation and consent thresholds when engaging in future liability management transactions.
In summary, English schemes of arrangement and restructuring plans can be used by debtors to effectively restructure their debt without requiring the active participation of sanctioned persons. They can also be used to extricate sanctioned persons from their creditor populations or disenfranchise sanctioned persons from exercising voting rights in relation to their debt instruments going forward, provided that the principle of fair representation is upheld and sanctioned creditors are not placed under any greater disadvantage than the constraints they already face under sanctions legislation.
A scheme of arrangement in relation to VTB Capital PLC (in administration) has been launched at the time of publication and the convening hearing is expected on July 1. This scheme is expected to discuss and develop the law on the treatment of sanctioned creditors under English law schemes.
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