Bond restructuring – overcoming structural bond impediments to effect a compromise
The use of a co-obligor structure is a clever artificial legal contrivance to transfer claims into a single entity which effects a compromise through a scheme of arrangement. With recent (but not necessarily pioneering) judicial approval by Mr Justice Zacaroli in the English High Court in the case of Re Gategroup Guarantee Limited, it is worth considering the use of co-obligor structures in more detail for use in offshore restructurings. It should be noted that the restructuring in that case was by way of a plan of arrangement under the new English Part 26A of the 2006 Act, implemented by the Corporate Governance and Insolvency Act 2020, where cross-class cram downs are available. This is not yet available offshore, but we will be blogging on whether it should be shortly.
The basic process is: (1) incorporate a newco, which then executes a deed of indemnity and contribution in favour of senior lenders and bondholders of the original obligor; (2) newco then proposes a restructuring plan to compromise those claims and all creditors’ claims against the original obligor; and (3) newco acquires right to compel the relevant obligors to “fund” the payment of the newco’s liabilities to bondholders or senior lenders.
It was argued before the judge that the incorporation of the newco and its assumption of liabilities under the deed were undertaken for the purpose of ensuring that there was an effective way in which the group could be restructured so that it could receive a very substantial injection of new money from the shareholders, enabling it to survive the unprecedented but hopefully temporary downturn caused by the Covid-19 pandemic.
The problem was that pursuant to their terms, the bonds could only be amended at a bondholders' meeting attended by bondholders collectively holding at least 66 per cent of the aggregate principal outstanding amount, by a resolution passed by at least 66 per cent of the votes cast. It was considered that, in view of the large number of bondholders each holding relatively small amounts, the quorum requirement under the terms of the bonds would make it practically impossible to effect an amendment pursuant to those terms. The issuer itself could not propose a plan because that would have constituted an event of default under the terms of the bonds, leading to potential acceleration and enforcement action.
While it might have been possible to mitigate the effect of that by applying for a moratorium, this would not have prevented cross-defaults occurring under contracts entered into by other group entities, thus imperilling the restructuring as a whole.
The newco had considered all possible alternatives, but none of them were realistically available. The structure had been chosen in order to overcome the practical reality that because of the quorum requirement in the bonds, their maturity cannot otherwise be extended, and if their maturity is not extended the Group will inevitably fall into an insolvency process within weeks. In other words, the co-obligor structure was necessary to overcome the structural impediment within the terms of the bonds, and the use of the newco avoided this problem.
InRe Gategroup, the Court endorsed the use of this form of co-obligor structure with a warning and noted that the use of such a structure could be “wholly objectionable… where it unfairly overrode legitimate interests of creditors pursuant to the contracts governing their relationship with the primary obligor companies or under the system of law, including relevant principles of insolvency law, which applies to the relationship between them”.
The newco had no assets other than the right to require other group companies to satisfy their obligations. Any right of contribution that it might have had against other group entities by reason of the performance of its obligations under an indemnity in a deed was illusory as it was deferred until all amounts payable by the obligors were paid in full. Accordingly, from the moment it entered into the deed, it was inevitable that the newco could never satisfy the liabilities it was assuming under it. That was addressed by a mechanism in a “Contribution Payment Agreement”, which entitled the newco to require the relevant Obligors to "fund" the payment of the newco’s liabilities by itself making payment directly to, respectively, the bondholders or the senior lenders.
Notwithstanding the artificiality of this arrangement, it created the following legal result: the newco is liable to the plan creditors, co-extensively with, among others, the issuer (in respect of the bonds). The plan amends the bonds and the senior loans, principally by extending their maturity dates, with the consequence that the newco's own liability in respect of the bonds and senior loans is postponed in the same way. The plan did not originally say in terms that the newco's liabilities were also to be amended. That was not fatal to the plan constituting an "arrangement", both because it is not a pre-requisite of an arrangement that it affects the rights of plan creditors against the newco and because in this case the amendment of plan creditors' rights against the other Group companies necessarily amends their rights against the newco’s. The plan was later amended to provide expressly that the plan creditors’ rights against newco were similarly compromised.
It was held that it is possible to envisage a case where the artificial structure is the only solution to enable a restructuring to be effected, all other possible alternatives having been explored and rejected for one or other reason of law or practicability; where the alternative is a value-destructive liquidation; and where the terms of the restructuring demonstrably benefit the affected creditors. In such a case, there would be a powerful argument that the artificiality of the structure should not prevent the company and its creditors being able to take advantage of the English scheme or plan jurisdiction.
Re Gategroup did not need to resolve the issues as to what would happen if a creditor purports to disclaim the relevant deed poll – the objection was subsequently withdrawn by a creditor and so the issue never arose.