Following the English High Court’s written reasons for sanctioning the Adler Group restructuring plan on April 21, 2023 (you can read our deep dive on this decision here), the English Court of Appeal overturned the High Court’s decision and sent a strong message regarding future Part 26A restructuring plans and, in particular, the cross-class cramdown regime. The Court of Appeal’s decision, which was handed down on January 23, 2024, represents the maiden voyage of Part 26A restructuring plans in the UK through the appellate process since the introduction of the device in 2020 (Bondco PLC v. Strategic Value Capital Solutions [2024] EWCA (Civ) 24).
Summary of the Adler Group Restructuring Plan
The Adler Group, a prominent German property group owning a rental property portfolio valued at approximately €8 billion, faced a myriad of liquidity challenges following the impact of ratings downgrades, regulatory/bondholder scrutiny, and short-selling pressure. The Adler Group had six series of unsecured notes maturing in 2024, 2025, 2026, 2027, 2028, and 2029 (“Notes”). The proposal (“Plan”), initially sanctioned by the High Court, included
- introducing €937 million of new senior secured debt to repay the Notes maturing on April 27, 2023, and the 2024 Notes, in exchange for a super-senior first-ranking lien and a 22.5 percent equity interest post-restructure;
- extending the maturity date of the 2024 Notes until July 31, 2025, in exchange for priority over other noteholders in terms of repayment (maturity of all other Notes to remain the same); and
- amending the remaining Notes to allow refinancing and receive a paid-in-kind (“PIK”) interest and a subordinated security interest.
An ad hoc group of 2029 noteholders (“AHG”) opposed the Plan, but the Plan was approved by five out of six classes of creditors (37.72 percent of the AHG voting against), and the High Court sanctioned the Plan, including a cross-class cramdown against the AHG. An appeal by the AHG was allowed on the basis of the following arguments:
- Pari passu principle. The first-instance judge failed to recognize the Plan’s departure from the pari passu principle that would apply in the relevant alternative.
- Rationality test. The rationality test used was derived from schemes of arrangement that did not require further investigations regarding improvements to the Plan.
- Incorrect weighting of factors. Too much weight was given to the “no worse off” test and the simple majority of the AHG approving the Plan.
Main Takeaways of the Court of Appeal’s Decision
Further Scrutiny of and Commentary on the Pari Passu Principle
The Court of Appeal’s finding that the restructuring plan violated the pari passu principle sends a loud message about the nonnegotiable nature of equitable creditor treatment and underscores the centrality of proportionate distributions. The Court of Appeal made clear that adherence to the pari passu principle is paramount to eliminate risks associated with sequential payments to creditors from an inadequate common fund of money, and that if the pari passu principle is applied in an alternative scenario to the restructuring plan, then it must also apply to the restructuring plan itself. Departure from this principle requires a robust justification, introducing a nuanced perspective on creditor treatment.
The Court of Appeal declared the Plan to be in violation of the pari passu principle, as it did not treat the AHG in the same way as the secured creditors and other noteholders. The Court of Appeal was not convinced that the reasons argued in favor of the Plan outweighed the inequality of the Plan. In particular, the Court of Appeal was concerned by the nature of the sequential payments under the Plan, which did not align with the essence of pari passu distribution.
This position by the Court of Appeal underscores the importance of equitable creditor treatment in the cross-class cramdown scenario and the importance of providing persuasive reasoning for any deviation from equal treatment.
The Horizontal Comparator Test over the Rationality Test
The Court of Appeal deviated from the “rationality test” used in schemes of arrangement and instead introduced the “horizontal comparator test,” while emphasizing the need for a more sophisticated comparison between dissenting and assenting classes of creditors in a restructuring context.
The horizontal comparator test demands a meticulous evaluation of how different classes should be treated relative to each other in the relevant alternative scenario. This shifts the focus from a broad rationality check, which entails a broad evaluation of creditors’ commercial judgment, to a more nuanced analysis focusing on the actual positioning of creditors. The Court of Appeal, in applying this test, considered whether a proposed plan is the “best” plan, evaluating whether a different formulation could be “fairer.” For instance, if a plan offers enhanced benefits to one class over another without a justifiable reason, it might be deemed inequitable.
The Court of Appeal’s move away from the rationality test shows that courts expect a much more thorough assessment of the treatment of each class of creditor to be undertaken, with the focus being on equality. This may, however, increase the scope for challenges on these grounds in future cases. This uncertainty may result in more secured creditors proposing solutions in a legal framework outside of the UK’s Part 26A regime in order to seek certainty and liquidity.
Other Takeaways
The Court of Appeal decision in the Adler Group case emphasizes the need for a fair court process, comprehensive evidence exchange, and sufficient time for valuation considerations. Genuine urgency is going to be accommodated, but the Court of Appeal decision underscores the need for a robust and transparent process nonetheless. As part of this, the Court of Appeal stressed the importance of comprehensive valuation evidence, signaling a potential move toward longer periods between convening and sanctions hearings.
The Court of Appeal also noted that a restructuring plan can impose a “haircut” on creditors, while also permitting shareholders to retain equity. The Court of Appeal clarified that, in an insolvency scenario, shareholders not being paid until creditors are paid in full is not necessarily a departure from the pari passu principle.
Conclusion
Beyond the specifics of the Adler Group case, this decision provides guidance that may be applied to other scenarios and across jurisdictions. What some readers may view as a useful framework for the approach to other complex restructuring proceedings, others may see as a treacherous shift away from what many commentators considered to be the more “commercial” and expedient position advocated for by the High Court in April 2023.
This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information.
