Adler Successful Appeal: Court Wholeheartedly Embraces the Opportunity to Refine Nascent Restructuring Plan Jurisprudence

In the first Part 26A appeal decision since the inception of the restructuring plan in 2020, the Court of Appeal has set aside the restructuring plan sanction order that was granted to German real estate group, Adler.

Whilst this isn't the first time that a restructuring plan has been rejected by the court (see, for example, Hurricane), it was the Court of Appeal's first opportunity to scrutinise plan jurisprudence and, more specifically, the court's discretionary cross-class cram down power. Significantly, the judgment demonstrates that the checks and balances that are in place to safeguard against wrongful use of the "super scheme" are not without teeth. The decision also puts some much-needed flesh on the bones of how courts should use their cross-class cram down power, helping to boost restructuring certainty going forward.

What did Adler's restructuring plan seek to achieve and why was it appealed?

The Plan

Adler is a German property group, which owns a large number of rental properties. After a failed consent solicitation process to amend the terms and conditions of the group's senior unsecured notes (SUNs) under German law, the group launched an English restructuring plan with six classes of creditors (being the holders of six series of SUNs due 2024, 2025, January 2026, November 2026, 2027 and 2029).

In brief, the plan was intended to avoid an imminent insolvency of the group and instead permit a controlled wind-down, by:

• extending the maturity date of the 2024 notes by one year (whilst retaining the maturities of the other SUNs); and
• varying the terms of the SUNs to (i) permit and facilitate the raising of further indebtedness; and (ii) modify certain negative pledge covenants to permit the creation of security to secure the new money and the SUNs, giving priority to the 2024 noteholders ahead of the rest as compensation for extending their maturity.

The relevant alternative (i.e. whatever the court considers would be most likely to occur in relation to the company if the plan is not sanctioned) to the plan was a formal insolvency of the group, which would take place in England for the plan company and in Germany for the parent and the rest of the group.

The plan was approved by five out of six classes of creditors, with 37.72% of the 2029 noteholders class voting against. As a result, the court at first instance exercised cross-class cram down against the 2029 noteholders and sanctioned the plan. For more details on the plan itself, see our briefing on the first instance decision here.

Grounds of Appeal

An ad-hoc group of the 2029 noteholders appealed on eight grounds, which Snowden LJ (giving the Court of Appeal's judgment) categorised as follows:

1. That Leech J (the first instance judge) failed to appreciate that the plan departed from the pari passu principle that would apply in the relevant alternative, and that no good reason had been shown for this differential treatment (the pari passu principle states that all unsecured creditors participating in an insolvency process must share equally any available assets of the company, or any proceeds of sale from those assets, in proportion to the size of their admitted claims).
2. That Leech J wrongly (i) applied the rationality test derived from schemes of arrangement; and (ii) held that he did not need to investigate whether the plan could have been better or improved.
3. That significant weight was wrongly given to the fact that the plan had been approved by other classes of noteholders and a simple majority of 2029 noteholders when cross-class cram down was applied, and that satisfaction of the no worse off test was treated as a factor supporting the exercise of this discretionary power.
4. That the plan company's evidence on its "alternative case" (i.e. what would happen if the values of the group's properties were as stated in the appellants' valuation report rather than the company's) should not have been accepted, and that Leech J had been wrong not to accept that some of the SUNs had been accelerated under German law (which would have constituted an event of default under the SUNs).

The Court of Appeal opined on what it considered to be the "main grounds of appeal" (1 – 3 above) and declined to express any views on 4, which it said would involve a review of findings of fact and disputed issues of German law and wasn't necessary in the light of its other findings.

What does the appeal mean for restructuring plans going forward?

The judgment is significant in establishing that if the pari passu principle applies in the relevant alternative, creditors must be treated on a pari passu basis under the proposed restructuring plan, unless there is justification for a departure from this principle. Given that Parliament declined to legislate for a priority rule for the allocation of benefits of restructuring plans in the Corporate Insolvency and Governance Act 2020 – the US, for example, follows the absolute priority rule, which dictates that no junior creditors may recover until a senior class has recovered in full, and no senior class should recover more than it is owed – guidance on what restructuring plans can actually achieve (i.e. what deals can be struck and how the benefits of a restructuring can be divided up) is welcome.

Snowden LJ also took the opportunity to correct some wrong turns in relation to several other strands of Part 26A jurisprudence that have been developing through the first instance decisions:

Cross-Class Cram Down

• Divergence from the scheme of arrangement "rationality" test: When cross-class cram down is engaged in a restructuring plan, it is not appropriate to apply the rationality test that is typically used in a scheme of arrangement to confirm whether it is "fair" to impose a scheme upon a dissenting minority within a class (i.e. whether the scheme is one that "an intelligent and honest man, a member of the class concerned and acting in respect of its interest, might reasonably approve"). In a scheme context, this question is usually answered by looking to the number of votes in favour at each class meeting: a greater majority in favour indicates a stronger likelihood that the scheme is in the interests of such class. This is not appropriate in a restructuring plan context when cross-class cram down is at play, because there is no commonality of commercial interest between the assenting and dissenting classes. Therefore, the overall level of support for a plan in the assenting class(es) is not a relevant factor to be taken into account when considering whether it is fair to cram down a dissenting class that has different commercial interests (and ED&F Man should not be considered authority for this proposition), nor is the overall level of support across assenting and dissenting classes as a whole.
• Vertical and horizontal comparisons ensure fairness: In place of the scheme of arrangement rationality test, the vertical and horizontal comparisons typically undertaken in challenges to CVAs on the grounds of unfair prejudice should be applied to restructuring plans to assess whether it is fair to cram down dissenting classes. The vertical comparison compares the position of a class of creditors under the restructuring proposal to their position in the relevant alternative, and the horizontal comparison compares the position of a class with the position of other creditors or classes if the restructuring is implemented. Whilst the vertical comparison is effectively codified in the no worse off test set out in section 901G(1) of Part 26A, the horizontal comparison requires consideration of how the benefits of the restructuring are to be allocated between different creditor groups. In this regard, the Court of Appeal noted that the horizontal comparison will be more straightforward in cases (like Adler) where the relevant alternative is a formal insolvency as opposed to, for example, a different restructuring or sale process. The relevant alternative is by definition fact-specific and the company's and its directors' views and opinions on what would be the most likely outcome if the plan being promulgated fails will still bear significant weight.
• Further enquiries as to fairness: When considering whether the distribution of the benefits of the restructuring is fair for the purposes of cross-class cram down, the court should consider whether a different allocation or structure would have been possible. In this regard, Snowden looked to CVA jurisprudence once more and endorsed the view of Zacaroli J in New Look, as well as Adam Johnson J in GAS, in holding that Amicus Finance is not authority for the proposition that the court need not ask whether a fairer or improved plan might have been available in a cross-class cram down context.
• No "fair wind" despite satisfaction of cross-class cram down conditions: Rejecting the proposition that originated in DeepOcean, the Court of Appeal established that even if conditions A and B of section 901G of Part 26A are satisfied (i.e. the requirement that (i) no dissenting classes are any worse off than in the relevant alternative; and (ii) the plan has been approved by at least one class of "in the money" creditors), there is no presumption that the court's discretion to apply cross-class cram down will be exercised.
• If the pari passu principle applies in the relevant alternative, creditors must be treated pari passu under the proposed restructuring plan (unless departure from the rule is justified): This means that the pari passu principle should typically be adhered to in any restructuring plan where the relevant alternative is formal insolvency (like Adler), unless there is justification for departing from the rule. There is not an exhaustive list of "good" reasons to justify departing from the pari passu principle in circumstances where creditors would be treated pari passu in the relevant alternative. However, by way of example, Snowden LJ suggested that creditors who provide some additional benefit to achieve the restructuring might merit some priority, and the payment in full of business critical trade creditors or employees might also be justifiable (noting that each case will be fact-specific).

Structuring

• There must be some "give and take": Contrary to the decision in Prezzo, Snowden LJ (noting that it was not strictly necessary to decide this point of principle but that it was his "provisional" view) stated that a Part 26A plan requires some form of consideration to be provided to "out of the money" creditors, and that it cannot be used to extinguish claims or confiscate shares for no consideration.

Practical and Procedural Issues

• Dangers of a compressed timetable: Echoing the commentary of several other judges, Snowden LJ noted that time pressures put on the court process by the parties themselves (by oversight or intentionally) can (i) result in creditors not receiving adequate notice of the plan or having time to obtain or understand the valuation evidence; (ii) negatively impact expert evidence; or (iii) tempt parties to request certain issues to be pushed to the sanction hearing (which should not be encouraged). Whilst emphasizing the court's flexibility in times of genuine urgency, Snowden LJ warned that "it is important that the Court is not taken for granted and its willingness to assist must not be abused". As a result, plan companies must make valuation evidence available in a timely manner, and parties / advisers should cooperate and delineate the issues at play in order to make sanction hearings more manageable. Reassuringly for English and foreign companies alike, however, it was reiterated that the court is willing to "decide cases quickly to assist companies in genuine and urgent financial difficulties."
• Appeal process: If a restructuring plan is to be appealed in the future, thought should be given to whether a stay is required, or whether delivery of the sanction order to Companies House (which is the trigger for the plan to become binding) should be delayed until the application for permission to appeal has been decided. In Adler's case, this wasn't established prior to the appeal, and now the parties must work through the implications of the plan being rendered ineffective under English law (albeit Adler's announcement, released shortly after the judgment was handed down, states (perhaps surprisingly) that the Court of Appeal's decision has no effect on its previously implemented restructuring, which while facilitated by the consents achieved pursuant to the restructuring plan (prior to the appeal being allowed) has been implemented by foreign law instruments, so watch this space).

Whilst both of these points were obiter in Adler and do not create a binding precedent for judges considering restructuring plans going forward, these comments will likely be persuasive in future cases.

Have any questions been left undecided?

Despite offering a wealth of guidance on restructuring plans, and the cross-class cram down power in particular, it looks as if the jury is still out on a number of issues, including:

• Use of the co-obligor structure: The jurisdiction of the English court has frequently been engaged using a newly-incorporated English company as a substitute obligor / co-obligor of debt owed by a foreign company in recent years. However, Snowden LJ, echoing Zacaroli J's comments in Gategroup Guarantee, made it clear that the judgment did not endorse the technique for future cases (despite it not being subject to appeal in this case). There remains therefore a question over whether, and in what circumstances, the court might consider its use to be inappropriate in a future case.
• Treatment of equity: Whilst it is clear that it is up to creditors to decide how the benefits of the restructuring are allocated (and it is for the court to decide whether such allocation should be sanctioned), the question of what price shareholders must contribute in order to retain a share of the equity where more junior creditors are being compromised remains up for discussion.

Like the practical and procedural points raised above, both of these points were also obiter in Adler (but will likely be persuasive in future cases).

Does this have wider implications for forum shopping to the UK?

We do not expect this judgment to deter German, or indeed other foreign companies, from seeking to restructure in the UK. A key draw for foreign companies looking to forum shop to the UK is the certainty of the English process, and the predictability and speed of the English courts. This case strengthens that appeal by improving certainty. Whilst it is true that various jurisdictions have recently introduced new restructuring tools into their legislation, as with the English restructuring plan, the practical application of these tools is still being tested. The volume of Part 26A cases going through the English courts is such that restructuring plan jurisprudence (which was bolstered at the outset by existing scheme jurisprudence) is developing more rapidly than in other jurisdictions with fewer cases coming before the courts. The Court of Appeal's statement on its willingness to assist companies in genuine and urgent financial difficulties must also not be overlooked: the English court is clearly open for business.

Dr Karsten Raupach, restructuring partner (Munich), says:

"None of the grounds to overturn the Adler plan related to jurisdiction, so the decision should not impact the basis upon which a foreign company might seek a plan. The fact remains that the UK is still attractive from a procedural perspective (e.g. the speed of the courts, decades worth of helpful scheme jurisprudence and the quality of the judiciary) and that is difficult to replicate quickly in other jurisdictions."

Drew Sainsbury, restructuring partner (London), says:

"We welcome this decision, which offers some crucial guidance on the parameters of the court's discretionary cross-class cram down power and provides helpful instruction on what kind of restructurings can be achieved by way of a Part 26A restructuring plan. It will have an impact on many in-flight restructurings, and will be a key judgment for any debtor seeking to use a restructuring plan in the future."

Author: Charlotte Evans, Expertise Lawyer