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THE ROLE OF THE COURT IN DEBT RESTRUCTURING

Published online by Cambridge University Press:  08 February 2018

Jennifer Payne
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Abstract

This paper examines the intervention of the law, and the role of the court, in debt restructuring, both in terms of imposing constraints on creditors and in seeking to ameliorate the potential abuses that can arise from such constraints. Three potential forms of abuse are examined: the imposition of a restructuring on dissenting creditors, which introduces the potential for wealth transfers between creditors; the imposition of a moratorium while a restructuring is negotiated, which might lead to misuse of the process by managers wishing to prop up companies which are not viable, or may allow managers of a viable business to “shake off” liabilities that it is capable of servicing; and the facilitation of rescue finance, which raises the potential for new creditors to be preferred at the expense of existing creditors. It is argued that the court's role in protecting creditors from these three forms of potential abuse is vital, although the nature of that role differs according to the form of abuse. Recent debt restructuring reform proposals in both the UK and the EU, which adopt distinct approaches to the role of the court in this process, are examined in the light of this discussion.

Keywords

debt restructuringminority oppressionmoratoriumrescue financeschemes of arrangement

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The Cambridge Law Journal , Volume 77 , Issue 1 , March 2018 , pp. 124 - 150
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Copyright © Cambridge Law Journal and Contributors 2018 

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Footnotes

*

Professor of Corporate Finance Law, University of Oxford and Fellow of Merton College, Oxford.

References

1 For a discussion of the distinction between financial and economic distress, see Baird, D.G., “Bankruptcy's Uncontested Axioms” (1998) 108 Yale L.J. 573 CrossRefGoogle Scholar.

2 See e.g. Shleifer, A. and Vishny, R., “Liquidation Values and Debt Capacity: A Market Equilibrium Approach” (1992) 42 J.Fin. 1343 CrossRefGoogle Scholar. There may also be other reasons why sales will not be possible, such as where the transfer of crucial assets to a new entity is not feasible. Outside these scenarios, sales can have some advantages over restructuring as they avoid the need for potentially costly bargaining between the company and its stakeholders.

3 Proposal for a Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures designed to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU, COM(2016) 723 final, 22 November 2016 (“Draft Directive”), recital 18 and Article 4(3); European Commission, Recommendation of 12 March 2014 on a new approach to business failure and insolvency, C (2014) 1500 final (“Restructuring Recommendation”), Recommendation no. 8.

4 Insolvency Service, A Review of the Corporate Insolvency Framework: A Consultation on Options for Reform, May 2016 (“Insolvency Service Consultation Paper, May 2016”) and see Insolvency Service, Summary of Responses – A Review of the Corporate Insolvency Framework, September 2016 (“Insolvency Service Summary of Responses, September 2016”).

5 S. Paterson, Rethinking the Role of the Law of Corporate Distress in the Twenty-First Century, LSE Law, Society and Economy Working Papers 27/2014, 16.

6 This is the term adopted by the UK Insolvency Service (see e.g. Insolvency Service Consultation Paper, May 2016, note 4 above, part 10), but other terms are also used to describe this form of financing. The European Commission uses the terms “interim financing” and “new financing”, and in the US the terms “debtor-in-possession” (DIP) financing or post-petition financing are used.

7 S. Chatterjee, U.S. Dhillon and G.G. Ramirez, “Resolution of Financial Distress: Debt Restructurings” (1996) 25 F.M. 5.

8 See e.g. Jackson, T., “Bankruptcy, Non-Bankruptcy Entitlements, and the Creditors’ Bargain” (1982) 91 Yale L.J. 857 CrossRefGoogle Scholar; Jackson, T.H. and Scott, R.E., “On the Nature of bankruptcy: An Essay on Bankruptcy Sharing and the Creditors’ Bargain” (1989) 75 Va.L.Rev. 155 CrossRefGoogle Scholar.

9 See UNCITRAL, Legislative Guide on Insolvency Law, Parts One and Two (New York 2004)Google Scholar, Recommendation 63.

10 See J. Payne and J. Sarra, “Tripping the Light Fantastic: A Comparative Analysis of the European Commission's Proposals for New and Interim Financing of Insolvent Businesses”, Part 2 (2018) International Insolvency Review (forthcoming).

11 See e.g. Draft Directive, Articles 16–17.

12 See Re Maxwell Communications Corporation plc. (No. 2) [1994] 1 All E.R. 737.

13 See Section VI.

14 For discussion, see Payne, J., “Debt Restructuring in English Law: Lessons from the US and the Need for Reform” (2014) 130 L.Q.R. 282 Google Scholar.

15 See note 4 above.

16 Re Bluebrook Ltd. [2009] EWHC 2114 (Ch); [2010] 1 B.C.L.C. 338.

17 For discussion of how the court responds to this scenario see Section IV(B).

18 Ibid., Article 16(3). This is subject to fraud or bad faith being involved.

19 For further discussion, see Payne and Sarra, “Tripping the Light Fantastic”.

20 Ibid.

21 An alternative option would be to put in place a neutral third party (see e.g. Eidenmueller, H. and van Zwieten, K., “Restructuring the European Business Enterprise: The EU Commission Recommendation on a New Approach to Business Failure and Insolvency” (2015) 16 E.B.O.R. 625 Google Scholar). The difficulty with such a suggestion is that this would be a very expensive option if the third party is not in a repeat game with any player.

22 See e.g. Armour, J. and Mokal, R.J., “Reforming the Governance of Corporate Rescue: The Enterprise Act” (2003) 1 L.M.C.L.Q. 28 Google Scholar, at 36–37; Finch, V., “Insolvency Practitioners: The Avenues of Accountability” (2012) J.B.L. 645 Google Scholar.

23 For discussion, see Saltri III Ltd. v MD Mezzanine SA Sicar [2012] EWHC 3025 (Comm); [2013] 2 B.C.L.C. 217, at [25]–[26].

24 See e.g. the right of creditors to apply to the court to challenge the CVA on the ground of unfair prejudice or material irregularity: Insolvency Act 1986, s. 6.

25 See e.g. Draft Directive, Article 4(3), which envisages a limited role for “judicial or administrative” authorities, but acknowledges the need for oversight in order to protect minority creditors from oppression in certain situations (recital 19).

26 Re Bluebrook Ltd. [2009] EWHC 2114 (Ch); [2010] 1 B.C.L.C. 338.

27 Re BTR plc. [2000] 1 B.C.L.C. 740, 748, per Chadwick L.J.

28 Companies Act 2006, s. 896(1).

29 Re Telewest Communications plc. (No.1) [2004] EWHC 924 (Ch); [2004] B.C.C. 342, at [14].

30 Adequate notice is required, but what this means in practice will vary: see Re Indah Kiat International Finance Co. BV [2016] EWHC 246 (Ch); [2016] B.C.C. 418, at [29].

31 See Companies Act 2006, s. 897.

32 For the requirement that creditors and members meet in classes, see Companies Act 2006, s. 899(1).

33 Further, the courts have emphasised the need for creditors to be provided with sufficient information to decide whether to attend the convening hearing. See e.g. Re Van Gansewinkel Groep BV [2015] EWHC 2151 (Ch); [2016] 2 B.C.L.C. 138.

34 Re Indah Kiat International Finance Co. BV [2016] EWHC 246 (Ch); [2016] B.C.C. 418, at [40].

35 See Companies Act 2006, s. 899(1).

36 See e.g. Sovereign Life Assurance Co. v Dodd [1892] 2 Q.B. 573, 583. For discussion, see Payne, J., Schemes of Arrangement: Theory, Structure and Operation (Cambridge 2014)CrossRefGoogle Scholar, §2.3.2.

37 For recent examples, see e.g. Re Public Joint-Stock Company Commercial Bank “Privatbank” [2015] EWHC 3299 (Ch); Re Codere Finance (UK) Ltd. [2015] EWHC 3778 (Ch); Re Indah Kiat International Finance Co. BV [2016] EWHC 246 (Ch); [2016] B.C.C. 418.

38 See Moss, G., “ Hawk Triumphant: A Vindication of the Modern Approach to Classes in Section 425 Schemes” (2002) Insolv.Int. 41 Google Scholar, at 43.

39 See the discussion in Section VI(B) below.

40 See e.g. Re Hawk Insurance Co. Ltd. [2001] EWCA Civ 241; [2001] 2 B.C.L.C. 480. By contrast, where the company is solvent, this comparator is not likely to be appropriate: Re British Aviation Insurance Co. Ltd. [2005] EWHC 1621 (Ch); [2006] 1 B.C.L.C. 665.

41 Re Hawk Insurance Co. Ltd. [2001] EWCA Civ 241; [2001] 2 B.C.L.C. 480, cf. the approach adopted by Arden J. at first instance: [2001] B.C.C. 57.

42 See e.g. Re MyTravel Group plc. [2004] EWCA Civ 1734; [2005] 2 B.C.L.C. 123.

43 See e.g. Indah Kiat International Finance Co. BV [2016] EWHC 246 (Ch); [2016] B.C.C. 418.

44 Companies Act 2006, s. 899(1).

45 See e.g. Re Rodenstock GmbH [2011] EWHC 1104 (Ch); [2012] B.C.C. 459, discussed in Payne, J., “Cross Border Schemes of Arrangement and Forum Shopping” (2013) E.B.O.R. 563 Google Scholar.

46 Re British Aviation Insurance Co. Ltd. [2005] EWHC 1621 (Ch); [2006] 1 B.C.L.C. 665.

47 For a recent example of a court's refusal to sanction a scheme, see Puma Brandenburg Ltd. v Aralon Resources and Investment Company Ltd. and Nortrust Nominees Ltd. (18 May 2017, judgment 27/2017, Guernsey Court of Appeal).

48 Re Indah Kiat International Finance Co. BV [2016] EWHC 246 (Ch); [2016] B.C.C. 418.

49 Companies Act 2006, s.172(1).

50 West Mercia Safetywear Ltd. v Dodd [1988] B.C.L.C. 250.

51 Re Marconi Corp plc. [2003] EWHC 1083 (Ch).

52 A liquidation methodology was used in Re Tea Corporation [1904] 1 Ch. 12; Re Telewest Communications plc. [2004] EWHC 924 (Ch); [2004] B.C.C. 342; and in Re MyTravel Group plc. [2004] EWHC 2741 (Ch); [2005] 1 W.L.R. 2365; [2004] EWCA Civ 1734; [2005] 2 B.C.L.C. 123. In Re Bluebrook Ltd. [2009] EWHC 2114 (Ch); [2010] 1 B.C.L.C. 338, Mann J. valued the company on a going concern basis, although the judge's decision on this point should be treated with care, since the liquidation valuation was not argued before the court. Moreover, the judge did not state that the going concern basis was the correct valuation methodology to be applied whenever a debt restructuring of this kind occurs, merely that it was appropriate in the case before him.

53 See Crystal, M. and Mokal, R., “The Valuation of Distressed Companies: A Conceptual Framework” (2006) 3 Int.C.R. 63 Google Scholar (Part 1) and 123 (Part 2); Westbrook, J., “The Control of Wealth in Bankruptcy” (2004) 82(4) Tex.L.Rev. 795 Google Scholar.

54 There is some evidence that the English courts are starting to do this: Re Van Gansewinkel Groep BV [2015] EWHC 2151 (Ch); [2016] 2 B.C.L.C. 138, at [24].

55 See e.g. Crystal and Mokal, “The Valuation of Distressed Companies”.

56 See e.g. Westbrook, “The Control of Wealth”, p. 811.

57 See Baird, “Bankruptcy's Uncontested Axioms”, p.136.

58 Re Bluebrook Ltd. [2009] EWHC 2114 (Ch); [2010] 1 B.C.L.C. 338, at [49].

59 Insolvency Service, Consultation Paper, May 2016, Part 9.

60 Draft Directive, Article 10.

61 See Section IV(C) below.

62 Insolvency Service, Consultation Paper, May 2016, paras. 9.33–9.35.

63 Ibid., para. 9.20, cf. Draft Directive, Article 13. Respondents to the consultation highlighted the problems with this approach: Insolvency Service, Summary of Responses, September 2016, para. 4.10.

64 For discussion, see Section V(B) below.

65 Insolvency Act 1986, Sch. 1A, paras. 2–4.

66 A. Walters and S. Frisby, “Preliminary Report to the Insolvency Service into Outcomes in Company Voluntary Arrangements” (2011), available at <ssrn.com/abstract=1792402>. Professor Goode's interpretation of this study is that the small company moratorium is a “dead letter”: Goode, R., Principles of Corporate Insolvency Law, 4th ed. (London 2011), 410 Google Scholar.

67 Insolvency Act 1986, Sch. B1, para. 43.

68 For the list of factors that the court will take into account in this exercise, see Re Atlantic Computer Systems plc. [1992] Ch. 505, 542–44.

69 Royal Trust Bank v Buchler [1989] B.C.L.C. 130, 135.

70 See e.g. Funding Corp Block Discounting Ltd. v Lexi Holdings plc. [2008] EWHC 985 (Ch); [2008] 2 B.C.L.C. 596.

71 Insolvency Service, Encouraging Company Rescue – A Consultation, June 2009; Insolvency Service, Encouraging Company Rescue – Summary of Responses, November 2009; Insolvency Service, Proposals for a Restructuring Moratorium – A Consultation, July 2010.

72 Insolvency Service, Proposals for a Restructuring Moratorium – Summary of Responses, May 2011, 5.

73 Bluecrest Mercantile NV v Vietnam Shipbuilding Industry Group [2013] EWHC 1146 (Comm).

74 Insolvency Service Summary of Responses, September 2016, para. 2.1.

75 Insolvency Service Consultation Paper, May 2016, Part 7.

76 Ibid., para. 7.10.

77 See 11 USC § 365(e). For discussion, see Lehman Brothers Financing Inc v BNY Corporate Trustee Services Ltd. 422 BR 407 (Bankr SDNY, 2011).

78 See e.g. The Insolvency (Protection of Essential Supplies) Order 2015, SI 2015/989, which seeks to ensure the continuity of supply of utilities and IT goods and services to insolvent businesses.

79 The European Commission's proposal also contains proposals in this regard: Draft Directive, Article 7.

80 See Insolvency Service Consultation Paper, May 2016, Part 8.

81 Ibid., paras. 7.35–7.36.

82 Ibid., para. 7.18.

83 Ibid., para. 7.22.

84 Ibid., para. 7.43.

85 Ibid., para. 7.15.

86 Ibid., para. 7.25.

87 Insolvency Service Consultation Paper, May 2016, para. 8.13.

88 See Insolvency Service, Summary of Responses, para. 3.7.

89 See Insolvency Service Consultation Paper, May 2016, para. 7.46.

90 The special protection currently granted to financial contracts under English law may be seen in Part VII of Companies Act 1989, the Financial Markets and Services (Settlement Finality) Regulations 2001, Financial Collateral Arrangements (No. 2) Regulations.

91 See e.g. 11 USC § 365(e)(1).

92 Draft Directive, Article 6.

93 Ibid., recital 18.

94 See e.g. Dahiya, S., John, K., Puri, M. and Ramirez, G., “Debtor-in-Possession Financing and Bankruptcy Resolution: Empirical Evidence” (2003) 69 Journal of Financial Economics 259 CrossRefGoogle Scholar.

95 Insolvency Service Consultation Paper, May 2016, Part 10.

96 Draft Directive, Articles 16–17.

97 See World Bank, Doing Business Report, 2017, para. 2.7.7.

98 Draft Directive, Article 16(2). For an analysis, see Payne and Sarra, “Tripping the Light Fantastic”.

99 Insolvency Service Consultation Paper, May 2016, para. 10.15.

100 See e.g. Insolvency Service, Encouraging Company Rescue – A Consultation, June 2009; Report of the Insolvency Law Review Committee, Insolvency Law and Practice (Cmnd. 8558, 1982)); Company Law Review, Modern Company Law for a Competitive Economy – Final Report, URN 01/943, 2001.

101 Ibid., paras. 10.19–10.20.

102 Ibid., para. 10.21.

103 Ibid., para. 10.22.

104 In re Health Diagnostic Laboratory Inc. (2015) WL 4915621 (Bankr. Ct. E.D. Virginia); Credit Alliance Corp. v Dunning-Ray Ins. Agency Inc. (In re Blumer) (1986) 66 B.R. 109, 113 (9th Cir. Bank. Appeal Panel).

105 In re Sonora Desert Dairy LLC et al. (2015) WL65301 (US Bankruptcy Appellate Panel 9th Cir.); M Bank Dallas, NA v O'Connor (1987) 808 F. 2d 1393 (10th Cir.).

106 In re Sonora Desert Dairy LLC et al. (2015) WL65301 (US Bankruptcy Appellate Panel 9th Cir.).

107 Pistole v Mellor (In re Mellor) (1984) 734 F. 2d 1396, 1400 (9th Cir.); In re Health Diagnostic Laboratory Inc. (2015) WL 4915621 (Bankr. Ct. E.D. Virginia).

108 In re Sonora Desert Dairy LLC et al. (2015) WL65301 (US Bankruptcy Appellate Panel 9th Cir.) at 11.

109 See UNCITRAL, Legislative Guide on Insolvency Law, Parts One and Two, Recommendation 63.

110 Insolvency Service, Summary of Responses, para. 5.2.