Introduction

A scheme of arrangement is a way to restructure a company’s debt, and it allows a company to enter into an arrangement or compromise with its creditors, or any class of its creditors. In Hong Kong, Part 13 of the Companies Ordinance (Cap. 622) regulates arrangements and compromises. The court may order meeting of creditors in relation to the arrangement or compromise proposed to be entered into and may thereafter sanction the arrangement or compromise if a majority in number representing at least 75% in value of the creditors or the class of creditors present and voting agree to such an arrangement or compromise.

In the UK, Part 26 of the Companies Act 2006 provides for the relevant provisions in relation to schemes of arrangement. Recently, in the English case of Port Finance Investment Limited [2021] EWHC 378 (Ch), the High Court restated the principles in relation to the variation of rights against third parties and class composition.

Background

Global Ports Holdings Plc (“GPH”), an English public limited company, and its subsidiaries (collectively, the “Group”) were hit hard by the Covid-19 pandemic, and the Group’s consolidated revenue declined by over 50%. The Group’s indebtedness included unsecured notes (the “Existing Notes”) issued by a directly owned subsidiary of GPH (the “Original Issuer”) and they were guaranteed by a subsidiary of the Original Issuer, hereinafter referred to as Ege Liman. Given the uncertainty caused by the Covid-19 pandemic, the Group considered it necessary for it to defer the interest payments on the Existing Notes in order to maintain its liquidity position and the Group did not see itself being able to repay the Existing Notes in full on their maturity or to find an alternative source of funding to refinance the Existing Notes. As a result, a scheme of arrangement with the principal objective to cancel and release the Existing Notes in consideration for the Existing Notes holders being given an entitlement to new notes (the “New Notes”) with an extended maturity date was proposed (the “Scheme”).

Among other things, under the Scheme, (i) the creditors could elect to have an opportunity to receive cash in lieu of part or all of the New Notes entitlements (the “Cash Option”); and (ii) any creditor who delivers a consent letter committing to vote in favour of the Scheme prior to an early bird deadline would be eligible to receive a cash fee amounting to 1% of the aggregate principal amount of the Existing Notes they held (the “Consent Fee”).

Variation of rights against third parties

The Scheme provided for the release of the creditors’ rights against the Original Issuer and guarantor, i.e. Ege Liman. The Court restated the trite law that a scheme of arrangement may include a mechanism providing for the release or variation of creditor’s rights against third parties such as guarantors. While an arrangement between a company and its creditors is an arrangement which deals with their rights inter se as debtor and creditor, it does not prevent the inclusion in the scheme of the release of contractual rights or rights of action against related third parties necessary to give effect to the arrangement for the disposition of the debts and liabilities of the company to the creditors. However, it excludes the rights of creditors over their own property which is held by the company for their benefit as opposed to their rights in the company’s own property held by them merely as security.

Class composition

The Court then moved on to consider whether the Consent Fee should have any impact on the class composition. A class of creditors is confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest, and the test is based on the similarity or dissimilarity of legal rights against the company but not on similarity or dissimilarity of interests not derived from such legal rights: Re UDL Holdings Ltd [2002] 1 HKC 172 at 184-5. In other words, individuals holding different views based on their own private interests not derived from their legal rights against the company is not a ground for calling separate meetings and the question is whether the rights which are to be released or varied under the scheme or the new rights which the scheme gives in their place are so different that the scheme must be treated as a compromise or arrangement with more than one class. In this regard, it is generally necessary to identify a comparator to the scheme.

In relation to the Consent Fee, which has become increasing common in a scheme of arrangement and which was one of the issues potentially relevant to the class question in the present case, the Court held that the mere fact that all creditors had the opportunity to qualify for a consent fee was not determinative of the class question. A consent fee will not fracture a class as long as it is made available to all scheme creditors and it does not induce creditors to commit to vote in favour of a scheme which they might otherwise reject. What is relevant is the size of the fee when compared to the predicted returns offered to all creditors under the scheme and the returns that creditors are predicted to make in a liquidation. In the present case, the quantum of the Consent Fee was assessed in light of the predicted returns to all creditors under the Scheme and in the absence of the Scheme. In the absence of the Scheme, following an orderly sale of assets, it was estimated that the Scheme creditors would recover between 59%-70% of the principal on the Existing Notes whilst under the Scheme, subject to the Cash Option, the Scheme creditors were expected to recover 100% of the principal on the Existing Notes, albeit at a later date. The Court held that a sub-division of the class of scheme creditors was not required having regard to the relatively high levels of return under both scenarios and the significant differential between the two estimated outcomes as an Existing Note holder who would otherwise have wished to vote against the Scheme to see some money sooner rather than later, would nevertheless be likely to be induced to vote in favour of the Scheme by the offer of a mere 1% right away.

Takeaway

The case discussed fundamental principles in relation to schemes of arrangements. As far as third parties are concerned, a scheme of arrangement may include a mechanism providing for the release or variation of creditor’s rights against them. In terms of class composition, the court, when exercising its judgment, will have regard to the most important commercial or financial issues which creditors have to weigh up when deciding whether to vote for or against the scheme.