Part 26A scheme – first ever cross-class cram down

The new scheme procedure in Part 26A of the Companies Act 2006 closely resembles the old scheme procedure under Part 26, the principal difference being that the court may still sanction a scheme even if the requisite statutory majority (ie, 75% by value of those voting) has not been achieved for one or more classes with an economic interest provided:

• Condition A: The court is satisfied that none of the dissenting classes are any worse off under the plan than they would be in the event of the “relevant alternative”, and
• Condition B: The plan has been agreed by another class of voters who have a genuine economic interest in the company in the relevant alternative

Conditions A and B

The relevant alternative is defined as whatever the court considers would be most likely to occur in relation to the company if the scheme were not sanctioned by the court. Even if Conditions A and B are satisfied the court still has a discretion not to sanction the scheme.

This has the effect that, unlike the earlier scheme of arrangement process, classes can be bound into a  scheme notwithstanding that the class has a genuine economic interest and more than 25% by value of those voting vote against the scheme (a “cross-class cram down”). 

At the convening hearing, the judge ordered creditors' meetings to consider the restructuring plan.

At the sanction hearing, it transpired that, in the case of one of the scheme companies, the requisite threshold of 75% had not been met for one of its classes of voters: only 64.6% in value of the unsecured creditors voting had voted in favour. Its secured creditors had however voted in favour. The judge was therefore required to consider first whether Conditions A and B were satisfied and, if so, whether the court should exercise its discretion to sanction the scheme.

Identifying the relevant alternative was similar to identifying the appropriate comparator for class purposes under a Part 26 scheme and the ‘vertical’ comparison test for unfair prejudice in relation to a CVA. In this case, this was entry of the scheme companies into formal insolvency proceedings.

Condition A was satisfied. While the starting point would normally be a comparison of the value of the likely dividend, the phrase 'any worse off’ was broad and could include issues such as timing and security of any covenant to pay. Condition B was also satisfied as the secured creditor class had voted by the statutory required majority in favour of the plan and they had a genuine economic interest in the relevant alternative.

As regards the court’s discretion:

• Even where cross-class cram down is required, the approach taken by the court when sanctioning a Part 26 scheme was the right starting point
• Where Conditions A and B were met, as set out in the legislation explanatory notes, the court should focus on the negative question of whether a refusal to sanction is appropriate on the just and equitable ground rather than on the more positive question of why justice and equity point to the plan being sanctioned
• In cases where members of the dissenting class were out of the money in the relevant alternative and their exclusion would have been achievable had a Part 26 scheme been proposed, receipt of any benefits under a proposed plan meant they were unlikely to have been treated in a manner which was not just and equitable
• The following further questions (being the classic formulation used in Part 26 cases) were material to the exercise of discretion to sanction:
  1. Whether the class was fairly represented by the meeting
  2. Whether the majority was coercing the minority in order to promote interests which were adverse to the class that they purported to represent, and whether the plan was a fair plan which a creditor could reasonably approve
  3. Whether there was any 'blot' or defect in the plan
• As regards (ii), it was significant that all other classes of creditor voted in favour of the plan by at least a very substantial majority. Although there was an obvious difference in treatment between the secured creditors and the unsecured creditors, this difference was justified because of the secured creditors’ security. Furthermore, the fact that the unsecured creditors would be out of the money in the relevant alternative and that the benefits they would receive under the plan would derive from other companies not the scheme company reduced the significance of the usual horizontal comparison.

This was cross-class cram down “light” in that there had been a low turnout in the dissenting class, the statutory majority in that class was nearly achieved, the sanction hearing was not contested and the dissenting class was “out of the money” in the relevant alternative. It certainly did not entail a “cram up” which from the explanatory notes to the legislation would appear to be possible under Part 26A. (ie, where a junior class receives payment notwithstanding a dissenting senior creditor has not been paid in full.) Nonetheless it is significant as being the first ever use of the cross-class cram down power.

In re DeepOcean 1 UK Ltd, Chancery Division first instance judgment