Schemes of Arrangement and Creditor Democracy as Instruments of Subjugation

Schemes of arrangement are often used for mergers, take-overs and reorganisation of both solvent and insolvent companies. Some widely reported recent take-overs effected by way of schemes include: Adecco SA’s offer for Spring Group; Apollo Global’s offer for BPP Holdings plc; Resolution Limited’s offer for Friends Provident Group; and Sinochem Corporation’s offer for Emerald Energy. The scheme is unfortunately a very complex procedure governed by a straightforward set of rules enshrined in the Companies Act 2006 (Part 26) and finely reduced to component parts in Buckley on Companies Act, 14th edition (“Buckley Test”).

“[I]t is for the [company] to propose the scheme, for the creditors by the necessary majority to agree to it and for the court to sanction it. It is the statute which gives binding force to the scheme when there has been a combination of these three acts:” (Kempe v. Ambassador Insurance Co [1998] 1 WLR 271 at 276 (PC).

“In exercising its power of sanction the court will see that……..the arrangement is such as an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonably approve:” Re National Bank [1966] 1 WLR 819 at 829.

[T]he court must be satisfied that it is a fair scheme:” Re Telewest Communications [2004] EWHC 1466 (Ch) at [21].

Where courts start talking of the need to secure the assent of the “majority” of creditors; what the hypothetical honest and reasonable man would do; and a “fair scheme,” it becomes certain that the arrangement is a compromise entangled with ambiguity. This is because of the complexity surrounding the ascertainment of majorities (by class, value and number of creditors voting); determining what a hypothetical reasonable man would do in an arena where everyone is entitled to further his own selfish interests; and determining the essential quality of a “fair scheme” in instances where shareholders would almost always be favoured (where the scheme is proposed by a solvent company) or a minority of creditors would almost always be disadvantaged where 75% of creditors (by value) have not so dissimilar interests. This is a depiction of creditor democracy on which the petition to the court to sanction a scheme of arrangement relies.

Given that different classes of creditors will always be treated differently in different circumstances (Assurance Co v PRG Powerhouse [2007] EWHC 1002 (Ch), the only logical (and straightforward) rule, in cases where the relevant question is one of the fairness of the scheme and not statutory construction, should be that courts ought to decide whether or not to sanction a scheme based on the circumstances of each case. This was the position adopted by Lord Glennie speaking for the Outer House of the Scottish Court of Session in Re Scottish Lion Insurance Company Limited [2009] CSOH 217. Since the company was still solvent, Lord Glennie contended that it was only fair (in the circumstances) that the company shows that the scheme was an expedient solution to a pertinent problem. In other words, it had to show that recourse was had to creditor democracy because “failure to agree would ruin it for all.” Lord Glennie’s judgment was the subject of much debate and deemed controversial in many quarters due to the fact that the learned Lord was deemed to have created a precedent to the effect that courts should deal with solvent and insolvent schemes of arrangement (and creditor democracy) differently. On January 29th of this year, the Inner House of the Court of Session held that Lord Glennie had erred in his interpretation of the Companies Act. It is interesting that there was little consideration of the fact that Lord Glennie might not have been as much concerned with the correctness of the procedure as he was with the fairness of the scheme. It is important to note that there is even hardly any established procedure enshrined in the Companies Act. Hence, the Inner House’s decision to overrule Lord Glennie was actually based on the fairness of the outcome and not the interpretation of the relevant statute. It therefore agreed that the fact that the company was solvent was a relevant (though not determinative) factor to be taken into account by the court when exercising its discretion. Equally, it was not prepared to hold that creditor democracy was conclusive and binding in all circumstances.

Thus, the importance of the company’s solvency, as well as the constitution of a class of creditors (Sovereign Life Assurance Company v Dodd [1892] 2QB 537) should logically depend on the circumstances of each case. In Re Hawk Insurance Co Ltd [2001] ECWA Civ 241, the Court of Appeal arrived at the conclusion that the scheme was fair based on a comparison with the alternative situation (insolvent liquidation) where the scheme was not sanctioned. This may be distinguished from Lehman Brothers International (Europe) (in administration) (No 2) [2009] EWHC 2141, where the question (sanctioning a scheme that extended to release rights held over property by a company) was clearly one of statutory construction and the question of the fairness of the scheme was secondary, if not relatively unimportant.

It is therefore important to ensure that a class or majority of creditors do not always rely on creditor democracy to subjugate other creditors. Lord Glennie was right in holding that the onus should always be on the petitioners applying for a scheme to be sanctioned to show that it should justifiably bind the minority of creditors against their will in the circumstances. The Inner House equally noted that the petitioners must show “the positive benefits of the scheme, as well as the soundness and robustness of the procedures it has put in place for valuing claims.” This is no doubt a lower standard of proof than Lord Glennie required. Thus, there is a looming danger that schemes of arrangement and creditor democracy may effectively become instruments of subjugation. One may only hope that the questions of valuation methodologies and the number of classes required for voting on relevant schemes would incite courts towards the rule of deciding in light of the circumstances and not any pre-established procedures of dealing with schemes which are entangled with so many ambiguities.