The Scheme of Arrangement (“a Scheme”) process can be somewhat cumbersome and expensive. However, in the absence of a formal corporate restructuring procedure, it is often the most practical way to facilitate the rescue of distressed companies.
The regulatory structure covering Schemes of Arrangement is set out in section 179A of the Business Companies Act 2004. The legislation is very similar to that which has operated in the United Kingdom, Hong Kong and a number of other common law jurisdictions for a number of years and consequently much case law is equally applicable to all those jurisdictions.
Why Schemes Are Used To Restructure Distressed Companies
In the BVI, absent implementation of the sections of the 2003 Insolvency Act that relate to Administration, there is no formal corporate restructuring process providing a moratorium to protect a financially distressed company from its creditors whilst efforts are made to restructure it.
Indeed, sometimes it is necessary to create the moratorium by asking the Court to appoint provisional liquidators who then usually participate in the scheme process.
In broad terms, the process starts when a company in financial difficulties engages professional advisors (usually its solicitors and an insolvency practitioner) to put together a proposal to be presented to the company’s creditors and shareholders. The proposal will usually seek to compromise the company’s debts, more often than not with a view to the business continuing to operate, often under new ownership. A compromise usually means creditors being prepared to accept less than the amount they are owed, in full and final settlement of any claims they have against the company – often known as a “haircut”.
In most situations, the alternative to a Scheme is the liquidation of the company, in which case it is likely that the return will be significantly less, (in fact, in many liquidations there is no return whatsoever), than would be the case if a Scheme is accepted.
The process is however substantially driven by the Court, particularly in its early stages which has significant cost implications. Therefore, in practical terms, a company needs to be of a certain critical mass before it is cost effective to consider a Scheme. Once a proposal has been formulated by the company and its professional advisors, it must be presented to the shareholders and creditors. However, before this can be done, it is necessary to obtain the Court ‘s sanction to meetings of the respective classes of creditors and shareholders being convened.
This sets out the background to the company’s affairs explaining the reasons for the difficulties faced by the company and will be sent to all those who are entitled to vote at any meetings of any classes. It will contain statutory information relating to the company, its accounting history, but more importantly will focus on the company’s proposals for resolving its financial difficulties including any change in the control of the company that may come about as a result of the acceptance of the Scheme.
The document will also set out the terms and conditions governing the operation of the Scheme, creditors’ classes, issues relating to the meetings of creditors and shareholders, distributions – in other words the nuts and bolts of how the Scheme will work.
The effect of the Composite document is to ensure that prior to attending at and/or voting on the Scheme, creditors are provided with all the necessary information, in an easily understandable format, (or as understandable as it can be), to enable them to make an informed decision on whether to accept or reject the proposal.
The Court will review this document in some detail prior to sanctioning the convening of the meeting. In particular, the Court will be anxious to ensure that the document properly explains the reasons and purposes behind the Scheme and contains all the necessary provisions to enable the creditors to make a reasoned decision on the Scheme and for it to proceed if creditors agree.
At the respective meetings, it is necessary for a majority of 75% in value and 50% in number to approve the proposed scheme. It is important to appreciate that this majority must be achieved at the meeting of every class of creditors and shareholders which is held.
Meetings of Classes
The issue of classes has been dealt with extensively by the Courts of various jurisdictions. The crucial issue is to establish whether or not persons within a particular class have similar legal rights against the company.
One of the problems with classes has been that traditionally it is for the advisors to the company to decide upon how the classes are to be constituted. This decision is made at the point in time before the initial application is made to the Court for sanction to convene the meetings of creditors and shareholders.
Unfortunately, constituting classes is not always as straightforward as it might seem and failure to get this right at the start has often resulted in creditors and shareholders in various classes, meeting and approving the Scheme but then at the final hurdle, that is the sanction hearing before the Court, it is decided that the classes have been incorrectly constituted. If the classes have not been properly constituted, the Court has no jurisdiction to consider the application further and the Scheme will then automatically fail. That means that there is often a considerable waste of time, effort and costs in bringing a Scheme to fruition.
However, in recent years following a practice direction in the UK which has been tacitly accepted in other jurisdictions, (Oxford Properties and Finance Limited), there is scope for an application to be made at an early date, that is prior the application to convene the meetings, for the Court to consider whether or not the classes of creditors and shareholders for whom meetings have been called, have been properly constituted.
Chairman Of The Meeting
The identity of the chairman of the meeting is set out in the Court order convening the meeting. Sometimes it will be a director of the company, but if a provisional liquidator has been appointed, then he will be the chairman of the meeting.
His role is to properly conduct the meeting and then report the outcome of the meeting to the Court.
The main issue which he has to address is that of the valuation of creditors’ claims for the purposes of voting at the meeting. In this respect, he has to be particularly careful. Any misstep at this time could be raised subsequently at the sanction hearing and, in certain circumstances, could result in the Court rejecting a Scheme which has been accepted by the creditors and shareholders in the respective meetings.
Assuming that the necessary majorities are achieved at the respective meetings of the different classes of creditors and shareholders it is then necessary for the chairman of the meeting to report to the Court on the outcome of the various meetings. A further hearing, known as the Sanction Hearing, is then held, at which the Court will give its final approval to the Scheme being implemented.
The Sanction Hearing
The Sanction Hearing is not a rubber stamp. The Court will consider whether or not the necessary statutory requirements have been met and in particular whether or not classes of creditors have being properly constituted, always assuming of course that this issue has not previously been addressed. It will need to be satisfied that each class has been fairly represented and has voted bona fide in the genuine interests of the class and that there has been no coercion for members of a particular class to vote in a particular way.
It will also want to be satisfied that the Scheme as proposed and accepted by creditors is fair and reasonable in the circumstances and that there were no irregularities at the meeting.
The final approval of the Scheme is achieved when the Court order arising from the Sanction Hearing is filed with the Registry of Corporate Affairs.
The role of the scheme administrator is to then implement the provisions of the Scheme. Once the scheme is implemented and completed the scheme administrator will then file a notice with the Registry of Corporate Affairs stating that the Scheme has been concluded.
Compromising Debts in Other Jurisdictions
One issue that often arises is in relation to debts of a BVI company that have been incurred in a different jurisdiction.
If for example a BVI company has incurred debts in Hong Kong, a not uncommon occurrence, can it compromise those debts by entering into a Scheme in the BVI. The answer is NO! The Hong Kong debts are not compromised and the creditor is free to take action against the company and its assets in Hong Kong or other countries where those assets may be situated. In these circumstances the usual course of action is to propose a parallel scheme in the other jurisdiction – in this example Hong Kong – to compromise those debts.