It’s true that “the Early Bird Catches the Worm”…But Be Cautious on Locking-Up: Snowden refuses to sanction the recent scheme application of Sunbird.

As we enter the final quarter of what has been a tumultuous year, the UK restructuring market has been open as usual for companies and creditors seeking to use the flexible restructuring implementation process of a Part 26 scheme of arrangement or the latest and greatest restructuring process now found in Part 26A of the Companies Act, a Restructuring Plan or Super Scheme as we like to dub it.

Recent cases have demonstrated the remarkable flexibilities of the processes which come at a time when other European jurisdictions have made similar changes to expand the toolkit with the new Dutch WHOA scheme process becoming law only this week.

We focus in this short piece on a key issue which has affected recent cases – in getting that critical early bird support from stakeholders via support agreements and / or ad hoc committees, do the process benefits of having these arrangements outweigh a potential outcome that could give rise to a successful challenge? We briefly review this issue in the context of a short judgment from Snowden J in Sunbird, and which of course follows hot on the heels of Falk J’s judgment in Codere.

So what was Sunbird all about?

Sunbird, an office space solutions provider, had its recent application for a scheme of arrangement. The Sunbird Scheme designed to rebalance the company’s debt/equity profile comprehensively rejected by Snowden J – despite the fact that creditors representing 87% by value and 80% by number voted in favour of the Sunbird Scheme.

Manifest Defects

In summary, Snowden J found various manifest defects in the promulgation of the Sunbird Scheme, including:

• a general paucity of information available to creditors in the run up to the creditors’ meeting;
• the fact that some creditors had received information that was not available to others (particularly those creditors who it was thought might oppose the Scheme);
• an absence of verifiable valuation methodologies in relation to fundamental aspects of the restructuring;
• a failure to disclose certain director interests; and
• failure to provide creditors with sufficient time to consider additional information disclosures.

Sunbird’s process and informational deficiencies were, in the aggregate, sufficient to persuade the judge not to sanction the Sunbird Scheme. The case is a sobering reminder that the court does not simply rubber stamp a positive vote by creditors and makes it clear that, to avoid the ire of the court, the optimal approach is for “…the scheme company to provide creditors with as much information as early as possible, and in as concise and comprehensible form as possible…”

Watch-Out for those Lock-Ups

As is often the case with a Snowden J judgment, there’s a sting in the tail that stakeholders, particularly ad hoc noteholder committees (that are often critical to the development of a rapid and well-supported restructuring), should take note of.

It has become commonplace in the design and execution of restructurings, where stakeholder management consents and support is vital to design ‘lock-up’ agreements and permit the formalisation or recognition of ad hoc or coordinating committees as a way of providing direction and momentum in a restructuring e.g. identifying lifeline providers who are often providing fresh money and giving certainty to debtors and boards who must make the ultimate decision to launch such processes as against any other alternatives. Ultimately, it lets a company determine early in the process whether it is worth proceeding.

Snowden J, building on a trend that our team is following closely in the case law, highlighted “serious concerns” regarding the widespread use of lock-up arrangements in schemes, including:

1. Payment of Lock-up / Other Fees – whilst not a new issue, the courts are becoming increasingly focused on whether: (i) payment of such fees could result in separate classes; and (ii) the court can rely on a majority vote comprised of locked-up creditors in receipt of a fee. Similar concerns were echoed by Falk J in the recent scheme judgment of Codere. The judge queried, on a challenge by Kyma Capital, whether the whole package of fees and incentives on offer to the ad hoc committee really could be left out from the class composition analysis and whether the solution that some legal teams are adopting, by trying to delink payment of fees from the approval of the scheme, was sufficient.


2. Provision of Information – Snowden J articulated a concern (albeit not part of the decision of the case) that the use of lock-up arrangements can result in a mismatched and sometimes inconsistent provision of information to creditors i.e. creditors bind themselves at different times, when different information is available and some creditors may consider themselves unable to change their mind because of the possible receipt of a lock-up fee. AHCs and scheme companies should think carefully about the nature and timing of information provided to locked-up creditors / non-locked-up creditors. In order to structure around some of these concerns, we recommend designing proper information protocols (especially where there are numerous stakeholders with divergent interests and commercial drivers), developed terms sheets, so that it can be demonstrated that creditors know what they are signing up to and the inclusion a set of negotiated exit opportunities for creditors from the lock-up.

Snowden and “Super Schemes”

The court’s sharpening focus on lock-up arrangements in the context of ‘traditional’ schemes and its effect on class composition tempts one to look at whether it’s better to use a Super Scheme. The rationale is that locked-up creditor classes can, in theory, cram-down non-locked-up creditor classes using a Super Scheme.

It is not typical in a traditional scheme to include a class that is already 100% bound to vote in favour of the scheme proposals – and so the question is whether the courts will allow such an approach in a Super Scheme, where the purpose, ultimately, is to cram-down those non-locked-up creditor classes that do not vote in favour of the Super Scheme. To date, there are only two relevant examples of Super Schemes on which the market can glean a court approach – the successfully sanctioned restructuring plan of Virgin Atlantic and the ongoing restructuring plan process of Pizza Express.

Snowden J did not provide a direct answer on this point in the recent restructuring plan of Virgin Atlantic (as the non-locked up trade creditors voted sufficiently in favour of the Super Scheme) nor did Trower J at the earlier convening hearing. However, it is clear that the judiciary is thinking carefully about such tactics. Scheme stakeholders should consider whether: (i) there are alternative structures to locking-up; or (ii) the classes can be structured so that a minority of the participants in an otherwise supportive class are not ‘locked-up’ / do not vote in favour of the Super Scheme.

For a dedicated article considering the new Super Scheme, please refer to our recent article, written by partners David Manson and David Ampaw. Cases like Sunbird also appear to offer further guidance to both Part 26 and Part 26A restructuring processes as it is clear from these judgments that the judiciary themselves feel that the principles relevant to a Part 26 scheme are, in the main, equally applicable to a Part 26A Super Scheme.

Our View

The Sunbird Scheme is not, of itself, a ground-breaking scheme judgment. However, its obiter comments are very much in line with the direction of travel: there is an increasing appetite on the part of the scheme judges, not just Snowden J to scrutinise lock-up arrangements, benefits and structures. This is perhaps not surprising given the increased activism of market participants in ensuring the boundaries of such structures are continually tested. Despite the ultimate result in Codere, recent cases are likely to provide further ammunition to sophisticated opposing creditors (prepared for a fight) to exploit these concerns and mount a challenge.