A scheme of arrangement is a tool of English corporate law that has been used in M&A and restructurings for decades. A company implementing a scheme has complete freedom to choose with which groups of shareholders and creditors to engage to achieve the desired commercial end. The longevity of schemes in English law also has allowed a broad and detailed body of case law to develop, which has engendered predictability without endangering the tool’s flexibility.
In restructurings, schemes have been used to effect complex financial reorganizations tailored to the specific needs of the stakeholders. The amount of debt can be reduced with the pain shared generally in accordance with the participants’ relative legal rights and other points of leverage. In the U.K., schemes often are used instead of a formal insolvency process, and they can be employed to provide more innovative solutions in administrations and liquidations than insolvency legislation can accommodate.
The appeal of English schemes of arrangement, coupled with recent case law supporting their use, has contributed to a significant increase in European companies outside of the U.K. relying on this tool to address their financial difficulties. We believe the following factors will result in this trend continuing into 2014.
Jurisdictional Flexibility. In Europe, the opening of insolvency proceedings is governed by the European Insolvency Regulation, which restricts this action to the country where a company has its center of main interests (or COMI). The COMI concept also is found in Chapter 15 of the U.S. Bankruptcy Code concerning the recognition of non-U.S. bankruptcy proceedings. However, because schemes are creatures of corporate rather than insolvency law, they are not governed by the European Insolvency Regulation — and their use is not limited to companies that have their COMI in the United Kingdom.
Governing Law Clauses. Recent case law has established that a scheme of a non-U.K. company can be implemented where the debts in question are governed by English law, and there is ample evidence to show that, if approved, the effect of the scheme would be recognized in the company’s home jurisdiction. To date, schemes have been successfully implemented for companies incorporated in Spain, Germany, Italy, the Netherlands, Denmark, Bulgaria and even Kuwait. Given the prevalent use of English law clauses in international financings, the scheme has the potential to be used even more broadly in the future.
Amend-and-Extend Transactions. Traditionally, schemes have been used to effect substantial balance sheet restructurings. Schemes involve two court hearings and bespoke drafting of the scheme documents following detailed negotiations; consequently, they have tended to be deployed in more complex situations. Recently, however, schemes have been used under straightforward circumstances. A defining feature of the distressed European landscape since the global financial crisis began has been a reluctance on the part of lenders to realize losses that otherwise can be avoided. This has led to what are sometimes called “amend-and-extend” transactions under which maturities are pushed out and other terms adjusted. This permits the company to postpone addressing what may be fundamental structural issues for the period of the extension with the hope that the economic environment will improve. Several European companies, including Spanish retailer Cortefiel and German roofing supplier Monier, successfully used schemes in 2012 and 2013 to obtain amend-and-extend agreements on their debt facilities.
No Creditor Consensus, No Problem. There appears to be an increasing appetite to use schemes in a broader set of financial circumstances to address the problem posed by holdout creditors. Finance agreements often require unanimity — an often impossible threshold to achieve — to amend key terms such as the amount of principal and maturity dates. When this happens the results can include deadlock, having to pay holdouts in accordance with the original terms or even the failure of the business. A scheme provides a method of binding a minority to a new deal.
Stay on Legal Proceedings. Since it is not a creature of insolvency law, the proposal of a scheme does not give rise to a moratorium to prevent creditors from taking action against the company to maximize their own recovery or to derail the scheme itself. In Bluecrest Mercantile BV v. Vietnam Shipbuilding Industry Group [2013] EWHC 1146 (Comm), a recent English High Court case on this issue, monies had come due under a facility, and two of the lenders sought summary judgment. The company had no defense to the claim, but negotiations on a scheme were reasonably well-advanced. The court used its inherent case management powers to grant a temporary stay to give the chance for a scheme to be developed and approved. It will be interesting to monitor whether the grant of a stay becomes a relatively common feature of the scheme process.
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As the eurozone crisis continues to linger and companies and investors seek to remedy financial distress, the use of schemes is expected to grow in European restructurings where there is significant English law-governed debt. Notwithstanding some recent changes to the formal insolvency processes in countries such as Spain and Germany, European borrowers should view the British legal system’s unique tool as an additional aid in navigating the restructuring process.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.
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* This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.