Episode #2: A Comparative Analysis: U.S. Chapter 11 v UK Restructuring Plans and Schemes of Arrangement (Chris Knight and Dania Slim)

Knight: Let’s jump straight in, starting with eligibility. We know that the Restructuring Plan (and, indeed, a UK Scheme of Arrangement) is available to UK companies, but also overseas companies with a “sufficient connection” with the UK. This is a low threshold test and, for schemes, has been established in a variety of ways—for instance, by a company having assets in England and Wales, or an establishment, place of business, or its centre of main interests in the UK, or on the basis that any obligations to be compromised by the Plan or Scheme are governed by English law. In addition, first, for a UK Restructuring Plan, but not a Scheme, the company will need to be insolvent or otherwise in financial distress and, second, in the case of a foreign company, the court will require evidence that the process (whether a Plan or Scheme) will be recognised by the courts in the jurisdiction of the overseas debtor (and so will be given effect there). These entry requirements are not particularly challenging. However, they are still more onerous than those for chapter 11, right Dania?

Slim: Correct. The threshold eligibility requirement for chapter 11 is extremely low. Similar to the requirements for a Restructuring Plan or Scheme of Arrangement, a foreign debtor looking to file for chapter 11 has to have a place of business or property in the United States. However, there is no minimum value requirement, so even having a minimal amount of funds in a U.S. bank account has been found to be enough to satisfy this test. But, unlike with the UK Restructuring Plan, chapter 11 has no requirement that the debtor be insolvent or in financial distress.

Knight: Let’s move on to the mechanics and approval process of the respective procedures. First, who actually gets to vote, Dania? With a Restructuring Plan, every creditor or shareholder affected by the plan must be permitted to vote. The exception is in respect of what we’ll call “super priority” creditors in the event the Plan commences within 12 weeks of a standalone moratorium ending. In such a case, these creditors (being ones owed moratorium debts or priority pre-moratorium debts) are not entitled to vote, but nor can they be compromised by the plan unless they consent.

Slim: For purposes of voting on a chapter 11 plan, broadly speaking, creditors will fall into one of three categories. If a creditor is going to be paid in full, then it does not get to vote because it is automatically presumed to have accepted the plan. On the flip side, if a creditor receives no recovery under the plan, then it also does not get to vote because it is automatically presumed to have rejected the plan. This leaves us with creditors that fall into the middle category—creditors that receive something less than a full recovery, whose legal or contractual rights are altered under the plan—these creditors are entitled to vote on the plan. In most cases, the vast majority of creditors will fall into this middle category.

Knight: Moving on to approvals, a Restructuring Plan requires approval by at least 75% in value of creditors. This is less burdensome that the UK Scheme of Arrangement test, which additionally requires approval by a majority in number of creditors or members in each class. How does this compare with U.S. chapter 11?

Slim: In the U.S., to have a fully consensual plan, all classes of creditors whose rights are being altered in some way and are receiving less than a full recovery must vote in favor of the plan. To do so, approval must be granted by not less than two-thirds in value and one-half in number of each impaired class. So while the two-thirds value threshold is lower than the UK Restructuring Plan’s 75% threshold, chapter 11 contains the additional numerosity requirement.

Knight: Now, presuming the requisite approval thresholds are met, that should ordinarily be sufficient for a plan to be approved in the UK and the U.S., subject to the ultimate discretion of the respective courts. The test to be satisfied in the UK is: Is the plan “just and equitable”?

Slim: And this conceptually, in part at least, aligns with the requirements in a U.S. chapter 11. Here, the courts must satisfy themselves of various requirements, including that the plan has been proposed in good faith, is feasible, is in the best interests of creditors, and not likely to be followed by liquidation or the need for further reorganization.

Knight: In a further similarity between the two processes, where the requisite approval thresholds are not met, cross-class cram down is possible, preventing hold-out creditors from blocking an otherwise viable plan. Of course, this has been a feature of U.S. chapter 11 for a long time, but has only recently (via CIGA) become part of the UK company restructuring landscape—this also marks one of the most fundamental differences between a UK Restructuring Plan, where cross-class cram down is possible, and UK Schemes of Arrangement, where it isn’t. We dealt with the two UK Restructuring Plan conditions in our first episode—specifically, first, the “worse off” test (which is similar to the “best interests” chapter 11 test), and, second, the requirement that at least one class of creditors who would receive a payment—or have a genuine economic interest in the company—in the event of the “relevant alternative” must have voted in favor of the plan. Dania, what about the position in the U.S.?

Slim: Well, in chapter 11, a plan can be crammed down if two requirements are satisfied: First, the plan cannot discriminate unfairly against any non-consenting class. A plan discriminates unfairly if, for example, a class of equal rank in priority receives greater value than the non-consenting class without a reasonable justification. Second, the plan has to be fair and equitable with respect to each non-consenting class.

Knight: And is there any further guidance on this “fair and equitable” requirement?

Slim: Yes, and the test is different for secured and unsecured classes of creditors. For secured creditors, a plan is fair and equitable if one of three things is satisfied. The secured creditor must either retain the lien securing its claim and receive deferred cash payments totalling at least the allowed amount of its secured claim; or the secured creditor must receive a lien on the proceeds of the sale of its collateral, subject to its right to purchase the property by credit bidding its secured claim. The third option is for the secured creditor to receive the “indubitable equivalent” of the value of its claim.

With respect to unsecured creditors, a plan is fair and equitable if one of two things are satisfied. Each unsecured creditor must receive property having a present value equal to the allowed amount of its claim. Alternatively, the holder of any junior claim or interest must not receive or retain any distributions under the plan—this is also known as the “absolute priority rule.” Effectively, this means that a plan cannot be crammed down on unsecured creditors unless shareholders (who are in a lower ranking class) receive no distributions. This “absolute priority rule” is not a feature in the UK. That said, given that a UK court may decline to sanction a plan if it does not find it to be “just and equitable,” this may very well bring in to consideration absolute priority principles.

Knight: Thanks, Dania. So, whereas, historically, chapter 11 may have been viewed favourably because of cross-class cram down, that this ability now exists in respect of a UK Restructuring Plan has resulted in a levelling of the playing field here.

Let’s now turn to the effect and scope of the respective processes, starting with the moratorium or automatic stay. In neither a UK Plan or Scheme is there the concept of an automatic moratorium. Now, by virtue of CIGA, a freestanding moratorium is available, and this can be combined with a Restructuring Plan; however, not only is the moratorium time limited to an initial period of 20 days (albeit this is extendable), but it is also subject to some quite significant exceptions, in particular it won’t affect the obligation to pay bank loan debts, and it will not override Cape Town creditor’s remedies. How does this compare with U.S. chapter 11, Dania?

Slim: Here, there is a meaningful difference between the two regimes. In contrast to the UK position, U.S. chapter 11 has an automatic stay. This is significant because first, the stay is very broad in scope, prohibiting many acts against the company or its assets, including the exercise of contractual termination rights; second, the automatic stay is long in duration remaining in place for the entire case unless the court grants relief, and finally, the automatic stay has limited exceptions. So, the automatic stay offers a debtor greater protections than the UK moratorium.

Knight: What about the interplay between the Cape Town Convention and the automatic stay?

Slim: Well, as we know, the U.S. is a signatory to the Cape Town Convention, but has not elected either Alternative A or B. Rather, Section 1110 of the U.S. Bankruptcy Code applies, which closely tracks Alternative A and, indeed, is what Alternative A was based on. Via Section 1110, aircraft creditors are granted special status in bankruptcy cases. Notwithstanding the automatic stay, aircraft creditors are permitted to repossess their aircraft, and enforce their other rights, unless the debtor elects, within a specified period of time, to cure existing defaults and perform its contractual obligations.

Section 1110, however, only applies to U.S. carriers. In chapter 11 cases involving foreign carriers, U.S. bankruptcy courts have not been called upon to apply Alternative A because consensual creditor agreements (or PBH stipulations) have been reached in the recent chapter 11 cases that have eliminated the need for creditors to enforce their Cape Town rights. But, hypothetically speaking, if a foreign airline were to file for chapter 11 and its primary insolvency jurisdiction has elected alternative A, then it is likely that a creditor or lessor seeking to invoke alternative A will first need to seek relief from the automatic stay or permission from the U.S. bankruptcy court before it can exercise remedies.

Knight: In terms of scope of the processes, these are broadly similar; a Plan, Scheme and chapter 11 process each permit the debtor to compromise secured and unsecured creditors, as well as shareholders. In addition, operational restructuring can be achieved via all processes. This would include the sale of all or part of the debtor’s assets, paying certain classes of claims, exiting financing arrangements, and undergoing a capital restructuring. However, some may argue that U.S. chapter 11 offers a greater degree of debtor flexibility here, right, Dania?

Slim: That’s right, Chris. With respect to unexpired leases and executory contracts (in other words, contracts with material obligations remaining on both sides), the debtor can reject or, put another way, decide that it does not want to continue performing its obligations under, these agreements. The creditor, of course, will have a claim for its breach of contract damages. The debtor can also assign these executory contracts and unexpired leases notwithstanding anti-assignment provisions. Additionally, so-called ipso facto clauses—clauses that purport to give parties the right to terminate agreements as a result of the bankruptcy filing—are unenforceable.

Knight: In contrast, there is no specific regime for the treatment of contracts under a UK Plan or Scheme. That said, in respect of a UK Restructuring Plan, a company may compromise non-financial contracts within its plan. In addition, ipso facto clauses will not be able to be relied upon, albeit in a supply of goods and services contract context only. This is narrower than the U.S. chapter 11 termination clause reliance prohibition, which relates to all executory contracts (subject to carve-outs).

Pivoting to post-petition financing—what is this Dania?

Slim: Most debtors enter bankruptcy with limited access to cash or recognizing that they may need financing at some point during the bankruptcy case or to exit bankruptcy. Most debtors will turn to their existing lenders first. However, if a debtor’s existing lenders are unwilling to provide additional financing, then the debtor will look to third-party lenders. Usually, third-party lenders are unwilling to provide a so-called “dip loan” or “debtor-in-possession loan” unless the lender receives a senior lien on the debtor's access. But the U.S. bankruptcy court allows the court to request, at a debtor’s request, the dip lender a priming lien. In other words, a lien that will be superior in ranking to the lien of existing lenders. This is a tool that is not available in the UK or in most other jurisdictions. So, when a company is considering chapter 11 versus other alternatives, this may be an important consideration. In fact, if the company approaches lenders prior to filing, lenders may be unwilling to provide dip financing unless the case is filed in the U.S. or into jurisdiction that offers them similar protections.

Knight: And a quick word on cost and timing differences between the procedures, Dania?

Slim: Well, there is no one-size-fits-all answer here. In general, a chapter 11 process may run a few months to over a year, and costs will likely be significant, particularly in large, complex restructurings. However, the increasingly common pre-pack or pre-arranged chapter 11, whereby a plan has been negotiated or pre-agreed with creditors before the filing, should be less time consuming and costly than a free fall case.

Knight: As for the UK processes (which are often analogous to pre-arranged cases in the U.S.), these will likely be significantly cheaper and quicker than a free-fall chapter 11 process, although when compared to a pre-pack or pre-arranged chapter 11 procedure, the time/cost differential may not be materially different. Of course, this is only a generalisation, and Restructuring Plan time and cost could itself increase significantly in complicated cases, particularly if cross-class cram-down has to be utilised.

Drawing the various strands together, Dania, what is your overarching assessment of U.S. chapter 11 versus the UK processes, and in particular the UK Restructuring Plan?

Slim: In short, the UK Restructuring Plan, as well as the ipso facto ban and standalone moratorium provisions, all as implemented by CIGA, are welcome additions to the UK restructuring landscape and, in fact, there are now many similarities with US chapter 11 – for example: both are debtor-in-possession procedures, both can be used to compromise secured creditors, unsecured creditors and shareholders; cross-class cram down may be used in both, and both processes should broadly be recognised cross-border. There are also differences, for example as to eligibility, the automatic stay, the treatment of contracts, and the ability to prime existing lenders. Costs and timing may also be greater in a US chapter 11. All these factors, and more, will need to be weighed by a debtor in determining where and how best to proceed. On a practical note, let’s also remember that chapter 11 is tried and tested, and debtors and creditors take significant comfort from this. What the new UK Restructuring Plan does is to afford debtors another option. Only time will tell as to how widespread its use will be.

Knight: Well, everybody, that’s all we have time for. We hope that you have enjoyed this and if so, please give it a big thumbs up on whatever media platform you have listened to it on! Dania, it’s been a pleasure.

Slim: Thanks Chris. This was fun and for anyone listening who would like more detail on any of the topics discussed, please don’t hesitate to reach out.