DeepOcean Restructuring Plan causes small waves

On 13 January, the High Court sanctioned the DeepOcean restructuring plan by exercising its discretion to apply cross-class cram down for the first time. In a reasoned judgment handed down on 28 January, Mr Justice Trower provided important guidance concerning the exercise of this cram down power. The case is also notable for the principle established at the convening hearing that it is not essential for a restructuring plan to seek to rescue a company as a going concern. 

The facts of the case were fairly straightforward, but at the same time atypical, in the sense that the plan was not intended to secure the survival of the plan companies or their business, but instead was designed to facilitate their solvent wind-down.  The specific circumstances on DeepOcean arguably made the judge's job a bit easier: if there was ever a case which obviously justified the use of the cram-down power, this was it.  As the eagerly awaited first application of cross-class cram-down, the decision is ground breaking, but, given the context of the restructuring plan, perhaps not surprising.  It also leaves untested some of the more difficult issues which might arise in a more typical (and more complex) rescue scenario.

In giving the order sought, the judge ran through the requirements for sanction, shedding much needed light on how the courts will be approaching cross-class cram down cases in the future.  In this briefing, we examine what the case tells us about restructuring plans, and importantly, what it does not.

What is a Restructuring Plan?

A restructuring plan is a new restructuring tool, introduced in 2020 by The Corporate Insolvency and Governance Act 2020.  It provides a company encountering financial difficulties with the ability to propose a compromise or arrangement with its creditors and members to restructure its affairs. The framework of the new restructuring plan is based very much on the scheme of arrangement procedure (which still remains available to companies wishing to restructure). Additionally, the new restructuring plan allows courts to sanction a plan that binds dissenting classes of creditors and members (rather than just minorities within a class), provided one in-the-money class votes for the plan, members of the dissenting class are no worse off than in the alternative scenario, and the plan is just and equitable. The process of binding dissenting classes in this way is called 'cross-class cram-down'. 

Click here for a more detailed analysis of the restructuring plan tool.

The DeepOcean Plan

Three companies within a loss-making division of the DeepOcean group, a subsea services provider, proposed interconditional restructuring plans which would implement solvent wind downs of the companies and provide their creditors, who would release their claims in full, with greater returns than they would have achieved in an insolvency.

At the plan meetings, the creditor voting threshold necessary to approve the plans, being 75% by value in each class, was met in respect of two of the plans but not achieved for the plan proposed by DeepOcean Subsea Cables Limited ("DSC"). Although 100% of the secured creditors voted in favour, only 64.6% by value of the unsecured creditor class did so. Accordingly, the plan could only be approved if the court exercised its power to apply cross-class cram down and sanction the scheme notwithstanding the dissent of the unsecured creditor class.

Cross-Class Cram Down

Under section 901G of the Companies Act 2006, the court is entitled to apply cross-class cram down if two conditions are satisfied:

• A. No members of the dissenting class would be any worse off under the plan than in the relevant alternative (ie. what would be most likely to occur to the company if the plan were not sanctioned). 
• B. The plan has been approved by a class of creditors who would receive a payment, or have a genuine economic interest in the company, in the relevant alternative. This condition was satisfied because the secured creditors had voted in favour of the plan. 

Relevant Alternative

For the purposes of cross-class cram-down, insolvency was determined to be the most likely outcome in the absence of the restructuring plans. The court therefore had no difficulty accepting that this constituted the "relevant alternative" under the legislation.

The judge noted that while "all incidents of the liability to the creditor" can be taken into account when considering whether the dissenting class is "any worse off" in the relevant alternative, including issues other than value such as timing of payments and the security of any covenant to pay, no such incidents arose on the straightforward facts of this particular case.

The financial consequences of this "relevant alternative" for all of the plan creditors were therefore straightforward: a cash distribution on a liquidation of the plan companies.  The judge treated the test of whether the dissenting class would be "any worse off" under the plan as a question of simple arithmetic, based on an uncontested entity priority model of the insolvency outcome.  On this basis, condition A was satisfied because the unsecured creditors would receive c.4% under the plan, rather than nil on insolvency. 

However, the judge acknowledged that in other cram-down cases a more complex "relevant alternative" may give rise to questions of complexity as to the financial consequences of that counter-factual for some or all plan creditors and therefore make the sanction decision more challenging.

The Court's Discretion

The Explanatory Notes to the Corporate Insolvency and Governance Act 2020 state¹ that "the court will still have an absolute discretion whether or not to sanction a restructuring plan, and may refuse sanction on the grounds that it would not be just and equitable to do so, even if the conditions [A and B] have been met".  

The judge interpreted this guidance as meaning that , where conditions A and B have been satisfied, a restructuring plan will already have a "fair wind behind it" or in other words, all other things being equal, satisfaction of conditions A and B is capable of justifying the application of cross-class cram down. He noted that the Explanatory Notes suggest that, where cram-down is in point and all the other necessary conditions for approval of the plan are met, the court's approach should be to consider whether a refusal to sanction is appropriate on the grounds that the restructuring plan is not just and equitable, rather than the more positive question of why justice and equity point to the plan being sanctioned.

The judge then discussed certain considerations that may assist the court with determining whether a refusal to sanction is appropriate on the grounds that the restructuring plan is not just an equitable.

Horizontal Comparison

By analogy with one of the fairness tests used in company voluntary arrangement (CVA) challenges, the court carried out a "horizontal comparison", which tests the fairness of differential treatment between creditors under the plans.  Horizontal comparability assesses whether the forecast additional benefits achievable by implementing the plan (the restructuring surplus) have been fairly distributed between the creditor classes. Here, the court concluded that the differential treatment of creditor classes was entirely justified by the fact that one class was secured and the other was not (and had no prospect of receiving any return under the relevant alternative). Moreover, the improved return of the unsecured creditors under the plan occurred as a result of contributions made by entities within the wider DeepOcean group, who were entitled to allocate such funds in any way they saw fit. 

Excluded Creditors

The judge also noted DSC's excluded creditors as a category of creditors who had been treated differently from the secured and unsecured creditors under the plan.  In this case, the judge remained satisfied, as he was at the convening hearing, that there were good commercial reasons for excluding those creditors and that although there had been some creditor complaints about their selection, these points were not pursued at the sanction hearing.

Other Sanction Requirements

Financial Difficulties Requirements

Under s901A(1) of the Companies Act 2006, the “financial difficulties” which a company proposing a plan must have encountered or be likely to encounter, and the effects of which the plan must at least mitigate, are those which could affect the company’s “ability to carry out business as a going concern”. At the convening hearing, the question arose whether the mitigation requirement would be satisfied when, as here, a plan would bring about a solvent wind down of a company, rather than increase its chances of being rescued. 

As noted above, the judge held that a broad interpretation of the legislation was appropriate and that mitigating the effects of financial difficulties could be achieved by lessening their impact on creditors, for example by providing them with a higher dividend in a winding up than they would receive in the absence of the plan. The purpose of a restructuring plan can be wider than just seeking to rescue the company as a going concern.

Creditors Fairly Represented at their Plan Meetings

The court accepted that restructuring plans are an incremental development of schemes of arrangement and followed the earlier Virgin Atlantic decision that case law familiar in a scheme context ought also to be applied (with any necessary modifications) to restructuring plans. As part of this approach, the court must consider whether creditors were fairly represented at their respective plan meetings. The court held there were no concerns here.  Although turnout among the dissenting class was relatively low, this was to be expected because the class members were primarily trade creditors who did not have high value claims. Consequently, the low turnout did not undermine the conclusion that the vote was representative.  Interestingly, in contrast to a scheme, the low turnout at the meeting of the dissenting class was identified as a reason to give less weight to the fact that more than 25% by value of those present and voting voted against the plan.  

The "Intelligent and Honest Man" Test

Drawing again from schemes of arrangement case law, the court noted that more than 99% by value of all DSC plan creditors had voted in favour of the plan, which might suggest that the plan was one which  "an intelligent and honest man, acting in respect of his own interests, might reasonably approve".   However, as the deal for secured creditors was very different from that for the dissenting class, the judge thought this metric was of no great significance in assessing the justice of the plan as a whole.  Of greater relevance was the fact that the two other DeepOcean plans were approved by their unsecured creditors who would receive the same percentage return under those plans as the dissenting DSC creditors.  They were not all placed in the same class as they were creditors of different companies.  However, if one aggregated these classes, just under 84% by value had voted in favour of what amounted to the same deal economically.  It followed that it would have been open to an intelligent and honest man to vote in favour of the plan. 

Comment

While DeepOcean is notable as the first cross-class cram down decision and provides some welcome guidance on the court's approach to restructuring plans, important questions still remain.

One area to watch is the "horizontal comparison" test.  The judge in DeepOcean imported this test from the consideration of unfair prejudice in the context of CVAs. However, on CVAs, that test is used only to compare differential treatment between unsecured creditors because, by definition, CVAs cannot compromise secured creditors' rights without their consent. The judge in DeepOcean noted that he was satisfied with the difference in treatment of plan creditors on the basis that one class was secured and the other was not. However, the facts of the case did not require him to provide further guidance on how the horizontal comparison test might apply when assessing whether a plan is "just and equitable" in a cross class cram down scenario where there are, for example, multiple secured as well as unsecured classes of creditors.  Nor was the judge required to consider, for instance, whether and how differences other than entitlement (or not) to security should be taken into account, or if it would be appropriate to consider what any excluded creditors might be receiving outside of the plan.

Another issue ripe for future review is the related point of how, in a more typical restructuring plan scenario involving rescue, the restructuring surplus should be justly and equitably allocated. This point did not really arise in DeepOcean partly because the plan companies never intended to continue as a going concern and partly because the "restructuring surplus" was provided by other members of the DeepOcean group for whom it was beneficial that the plan companies avoid an insolvency.  In those circumstances, the judge concluded that the dissenting class could not complain about the choice made by those other group companies to apportion the contribution in such manner as they saw fit.  Nevertheless, there are some comments in the DeepOcean judgment which, if applied to restructuring plans more generally, might suggest that where a dissenting class is out-of-the money in an insolvency relevant alternative, then anything they receive under the plan must be just and equitable because it is more than nothing.  This might be too hasty a conclusion because it would put too heavy a reliance upon Condition A (no worse off) and insufficient weight on what "just and equitable" should mean in this context.

Similarly, a plan involving a more difficult counter-factual analysis or a different value break, particularly if argued by dissenting creditors with a proposal for an alternative distribution of value, may challenge the court to engage more deeply on commercial issues than it was required to do on DeepOcean and has been required to do in the past when deciding whether to sanction schemes of arrangement.  

These points (and others) remain to be tested in future cases.  As we write, the Gategroup restructuring plan is before the courts, and although it does not involve another cross-class cram down, it is likely to provide further valuable guidance on restructuring plans.

1. At paragraph 192