As noted in our previous article found here, the Plan provides for a significant injection of new capital into Adler Group S.A. and its subsidiaries (the “Group”) to facilitate the repayment of debts maturing in 2023 and 2024 (the “New Money”).  In addition, security will be granted to all noteholders, with the holders of notes maturing in 2024 being given priority over the other noteholders.  The holders of notes maturing in 2024 will also see the maturity date of their notes extended.  Unlike most of the restructuring plans previously considered by the English Courts which were designed to rescue the relevant plan companies as a going concern, the Plan contemplates that the Group’s business operations will be wound down and its assets sold by the end of 2026 in order to repay the Group’s debts in full.

The key findings of the Court were as follows:

• while noting the inherent uncertainty in predicting the future sale values of the Group’s assets, the Court preferred the valuation evidence of the Plan Company and found that the most likely outcome should the Plan be implemented was that noteholders would be paid in full.  The Court did not have to be satisfied that the AHG would definitely be paid in full;
• the Plan did not unfairly depart from the pari passu principle having regard to the Court’s finding that all noteholders would most likely be paid in full.  If the Group failed to achieve the forecasted sale values the next most likely outcome was that noteholders would take steps to enforce their rights including accelerating their debts and would be paid in accordance with the pari passu principle;
• although the Court was not satisfied that the Plan Company had clearly justified why shareholders should retain 77.5% of their equity under the Plan in circumstances where the Group was insolvent and no additional support had been provided by the shareholders, this was not a sufficient basis to refuse sanction of the Plan;
• the UK-incorporated Plan Company had been validly substituted as the issuer of the notes as a matter of German law, and therefore that the English Courts had jurisdiction in relation to the Plan (although we note that this issue is being litigated in Germany);
• the Court placed weight on the significant levels of support for the Plan amongst the noteholders; the requisite majority of creditors voted in favour of the Plan other than one class of 2029 noteholders, of whom 62% voted in favour of the Plan;
• it was not necessary for the Court to determine a dispute as to the validity of acceleration notices served by certain members of the AHG.

Set out below is a detailed summary of the Court’s reasoning in relation to the key issues in dispute.

Valuation dispute and the no worse off test

The Plan provides for the Group to conduct an orderly sale of its real estate assets over the period to the end of 2026 in order to repay the Group’s debts, including the New Money and the amounts owing pursuant to the notes. 

The principal factual dispute between the parties concerned the likely returns to noteholders under the Plan and in the relevant alternative, which the parties agreed would be an immediate formal insolvency of the Group (the “Relevant Alternative”).

The parties’ experts divided the Plan Company’s assets into two categories – the ‘yielding assets’, which comprise properties generating rental income, and the ‘development assets’, which comprise partially completed residential and commercial developments.

The Plan Company relied on expert evidence which, based on modelling of the German property market through to 2029, estimated that noteholders would receive returns of 100% under the Plan and 63% in the Relevant Alternative.  The lower return in the Relevant Alternative was primarily driven by an insolvency discount which the Plan Company asserted would inevitably be applied to the Group’s assets in the circumstances of a distressed sale in an insolvency process.  On its evidence, an insolvency discount of 25% would be applied to the yielding assets (based on an expert opinion as to the ordinary impact of an insolvency on the realisable value of income-generating real estates) and 23% to the development assets (an aggregated discount based on the individual characteristics of each development, such as its stage of construction).

The AHG, on the other hand, asserted that the Plan Company’s expert evidence overstated the value of the Group’s assets and, in fact, under the Plan, whilst the holders of the first four tranches of notes would recover 100%, the holders of the notes maturing in 2027 would recover only 44.8% and the holders of the notes maturing in 2029 (including the AHG) would recover only 10.6%, whereas in a formal insolvency noteholders would receive uniform returns of 57% (and therefore the AHG would be materially worse off under the Plan than in the Relevant Alternative).  The lower returns to later-dated noteholders would be driven by the fact that under the Plan, the proceeds of asset realisations would be applied to the notes in order of maturity.  The AHG also asserted that an appropriate insolvency discount would be 5% rather than 25%.

The Plan Company’s answer to the AHG was that, on 31 December 2024, a Loan to Value Ratio covenant of 87.5% would come into effect under the amended note terms and, if the value of the Group’s assets was in fact overstated to the extent claimed by the AHG, the Plan Company would immediately breach that LTV covenant, the noteholders would become entitled to accelerate their debts and pursue enforcement action as described below and would rank pari passu for any recoveries:

• if the Plan was sanctioned, the Group would carry out a corporate restructuring under which its real estate assets would be moved to a Luxembourg-registered intermediate holding company (“PropCo”) which would grant share pledges in favour of the noteholders;
• on the occurrence of an event of default, and in the absence of a willing third party purchaser, the noteholders would take steps to have the PropCo (the shares in which would have been pledged favour of the noteholders) sold by way of a credit bid to an SPV established on behalf of the secured creditors, such that the secured creditors would assume control of the Group;
• the secured creditors would act rationally so as to maximise their recoveries, by either continuing the orderly sell-down of the assets as contemplated by the Plan or finding a third-party buyer for the business;
• this enforcement strategy would avoid the asset price discounts which would arise in a formal insolvency.

The Plan Company’s evidence was that this enforcement strategy would result in a uniform return to noteholders of 74.6%, and therefore, even if the AHG’s evidence as to the Group’s asset values was correct, noteholders would still be better off than in the Relevant Alternative.

The AHG raised a significant number of criticisms of this enforcement mechanism, including that:

•     the prospects of a breach of the LTV covenant being triggered were illusory, because the Plan Company would continue to rely for the purposes of covenant reporting on valuation evidence prepared by the same valuers that it has relied on in the restructuring plan proceedings (i.e. there was no prospect the Plan Company would adopt the lower valuation evidence relied on by the AHG and thereby trigger a covenant breach); and

•     certain plan creditors with substantial holdings in the new capital and earlier-dated notes (both of which stood to receive payment prior to the 2029 notes under the Plan) would act to waive negative covenants which prevented the Group from selling assets at certain discounts to their Gross Asset Value, in order to allow those assets to be sold by the Group as promptly as possible to secure repayment of the earlier-dated debts, with the consequence that, by the time the LTV ratio covenant became effective on 31 December 2024, the Group would not have sufficient assets to enable noteholders to secure a return of 74.6% by way of an enforcement.

Ultimately, the Court preferred the expert evidence of the Plan Company and found that, notwithstanding the inherent uncertainty in predicting the future sale values of the Group’s assets, the most likely outcome under the Plan was that noteholders would receive payment in full (although the Court noted that this was “ambitious”)  and that the least likely outcome was that the holders of the 2029 notes would receive returns of only 10.6%.  The Court held that it did not have to be satisfied that the 2029 noteholders would definitely be paid in full but rather that this was the most likely of the alternatives presented to the Court. 

The Court also preferred the insolvency discounts relied on by the Plan Company and did not agree with the AHG’s criticisms of the noteholders’ enforcement rights under the Plan, including on the basis that:

•     there was no evidence before the Court that the Plan Company’s valuers would over-value the Group’s assets in order to avoid an LTV covenant breach;

•     it was unlikely that the Plan Company would seek to sell its assets at a steep discount (not least because its directors would incur personal liability were it to do so); and

•     having regard to the evidence before the Court as to the cross-holdings across the various tranches of notes, the Court did not accept that holders of earlier-dated notes would act to seek to maximise returns for the earlier-dated notes at the expense of returns on later dated notes.

Pari passu principle, differential treatment and the Court’s discretion to sanction the Plan

The AHG argued the Court should not exercise its discretion to sanction the Plan. By (i) preserving the staggered maturity of the notes notwithstanding the fact that the Plan was in reality a planned liquidation; and (ii) granting priority ranking to the 2024 noteholders and New Money providers, they argued that the Plan unfairly violated the pari passu principle, provided for differential treatment between creditors and changed the existing priorities between the noteholders.

In its written argument, the AHG acknowledged there are examples where restructuring plans, schemes and CVAs treat unsecured creditors differently but argued that this differential treatment should only apply where the purpose of the proposal was to rescue the company as a going concern.  Where the Plan was a “liquidation plan”, it was not appropriate to deviate from the settled legal position as to creditors’ treatment on liquidation.

Whilst acknowledging that the principle of pari passu distribution (which holds that in a liquidation, creditors should share equally in the assets of the insolvent company with distributions to be paid pro rata to their claims) was a fundamental principle of corporate insolvency law, the Court found that the Plan did not involve a departure from the pari passu principle.  If the Plan were implemented, it was likely that all noteholders, including the AHG, would be repaid in full.  This was significantly different from other restructuring plans, schemes of arrangement and CVA cases where it was accepted on all sides that creditors would not be repaid in full.  However, the Court acknowledged it might have been prepared to accept that the Plan departed from the pari passu principle had it accepted the AHG’s evidence that there would be a shortfall and differing returns to noteholders under the Plan.

The Court was also not satisfied that the Plan involved a departure from the pari passu principle even if the Group failed to achieve the valuations forecast by the Plan Company’s advisors.  In its view, the most likely outcome would be an acceleration of the notes, enforcement of the security and distribution of proceeds rateably to all noteholders (other than those given priority as discussed below).  Had payment been other than pari passu, the Court might have found the Plan to be unfair.  However, it accepted the Plan Company’s evidence in relation to this issue. 

Finally, the Court confirmed that the priority given to the 2024 notes did not mean that the Plan was so fundamentally flawed that the Court should refuse sanction. It was clear that the Court was able to sanction a scheme that had the effect of altering the priority of different classes of creditors (see for example Houst).  The issue for the Court was whether the priority given to the 2024 notes made the Plan unfair to the AHG.  As the priority was given to the 2024 noteholders (who, it was noted, already had temporal seniority) as a “quid pro quo” for the extension of the maturity date of the 2024 notes, the Court concluded that this was a good reason why an honest and intelligent person might approve the Plan notwithstanding the differential treatment.  

The Court accepted the Plan involved a greater risk for the 2029 noteholders than it did for the creditors holding earlier-dated notes and noted “it is possible (although, in my judgment, unlikely) that they might be worse off” than in the Relevant Alternative.  However, the Court determined it was not required to be satisfied that the 2029 noteholders would be paid in full before it could sanction the Plan.  Indeed, it found “it is not unfair to require the 2029 Plan Creditors to accept a greater level of risk than the other Plan Creditors” for a number of reasons, including the following:

• by preserving the staggered maturity dates of the notes, the Plan reflected the commercial risks which the AHG had taken on when purchasing the notes (although the Court did note that it had not received a compelling reason why the maturity dates should be preserved and why the noteholders had not agreed to harmonise them – which would have saved “a great deal time and intellectual effort”);

•     even if the Plan’s primary purpose failed, it was likely that the notes would be accelerated and the security enforced.  In that situation, the AHG were likely to recover more than if the Plan Company went into an immediate insolvency process.  In addition, in such an eventuality the Court was satisfied that the AHG would not be treated differentially and the pari passu principle would be respected;

•     it was unrealistic to think that the AHG would be unable to exercise their legal rights under the Plan to accelerate the 2029 Notes and even less realistic to assume that they would not attempt to do so;

•     the noteholders (including 62% of the 2029 noteholders, a number of which did not have holdings in the 2024 notes) had voted in favour of the Plan.  This was a relevant factor to which the Court attached weight.

Ultimately, the Court was persuaded by the Plan Company’s final argument:  “If the Plan works, he submitted, everyone is better off and the best judges of this are the Plan Creditors themselves, who voted by the requisite majority in every class for the Plan and by 62% in the dissenting class. Given the balance of risk, the right exercise of discretion is to give the management of the Group the opportunity to implement it”.

In line with earlier decisions and agreeing with the Plan Company, the Court confirmed that it did not have to be satisfied that the Plan was the best plan available or that it could not be fairer. 

Treatment of shareholders

Under the terms of the Plan, shareholders of the Group would retain 77.5% of the Group’s equity, with the other 22.5% to be granted to the New Money providers.  Shareholders would therefore be entitled to a 77.5% share of the restructuring surplus, which on the Plan Company’s evidence, would amount to €309 million.  The AHG criticised this aspect of the Plan as unfair on the basis that, in circumstances where the Group was insolvent, its creditors were its economic owners and therefore creditors should be entitled to the Group’s equity.

The Court noted that this aspect was its greatest concern with the Plan and it could see no reason why shareholders who had provided no support for the Plan and no additional funding should get any upside were the Plan to succeed.  However, the Court held that this concern was not sufficient to refuse sanction, not least because the New Money providers (who were the most affected by the retention of equity by shareholders) had negotiated a 22.5% rather than a 100% stake and there was no suggestion they took anything other than a commercially rational approach.  Further, there was no evidence that even if the New Money providers had negotiated a 100% stake, the AHG’s opposition to the Plan would have changed.  Overall, the possibility that shareholders would receive a windfall was not sufficient to justify putting the Plan Company into an insolvency process at the expense of the noteholders who had voted for the Plan¹.

Effectiveness of issuer substitution and the ‘sufficient connection’ test

A company can only access an English restructuring plan procedure if the company has a ‘sufficient connection’ to this jurisdiction.

On 11 January 2023, the UK-incorporated Plan Company was substituted as the issuer of the notes.  This was necessary because the notes are German-law governed and the original issuer of the notes, Adler Group S.A., is incorporated and has its centre of main interests (‘COMI’) in Luxembourg.  It had no relevant connection to England.  The substitution of the Plan Company as issuer was effected in order to create a sufficient connection with England to entitle the Plan Company to apply to the English Courts for an order sanctioning the restructuring plan.

The Court cited Re Codere Finance (UK) Ltd [2015] EWHC 3778 (Ch) which is to the effect that forum shopping of this kind is acceptable as long as it is undertaken in order to achieve the best possible outcome for creditors (which it was in this instance), rather than as an attempt to avoid debts.

The AHG argued that the substitution of the Plan Company as issuer of the notes was ineffective, because the issuer substitution clause in the note terms, pursuant to which the substitution was effected, was invalid as a matter of German law.  As a consequence, the English Courts did not have jurisdiction in relation to the Plan.

The AHG relied on §307 of the German Civil Code (the “BGB”), which forms part of the German law on standard contractual terms (and, in relation to bond terms, is a lex generalis, or a law of general application).  §307(1, sentence 2) of the BGB imposes transparency requirements on business contracts.  The AHG argued that in accordance with §307 of the BGB, the issuer substitution clause in the note terms was required to set out non-exhaustively the circumstances in which an issue substitution may be effected (which the clause did not do) to ensure that noteholders could clearly understand why a issuer substitution may occur.

The Plan Company argued that §307(1, sentence 2) of the BGB has no application to the note terms because of the existence of §3 of the German Act on Issues of Debt Securities (the “SchVG”), which applies specifically to notes and similar securities (and is therefore a lex specialis, or a law of specific application, in respect of the notes).  According to the Plan Company, §307(1, sentence 2) of the BGB is not capable of having any concurrent application to the note terms alongside §3 of the SchVG, and the issuer substitution clause in the note terms is compliant with §3 of the SchVG and is therefore legally valid.

The Court preferred the Plan Company’s expert evidence that issuer substitution clauses are generally permissible and effective as a matter of German law, that the issuer substitution clause is valid pursuant to §3 of the SchVG (which excludes the operation of §307(1, sentence 2) of the BGB in relation to the notes) and that, in fact, substitution clauses in the same form as that in the note terms are standard in the German market.  The Court also found that, to the extent that §307(1, sentence 2) of the BGB does apply to the note terms, that provision would be satisfied because the issuer substitution clause complies with §3 of the SchVG.

On 24 February 2023, a member of the AHG commenced proceedings in the Regional Court of Frankfurt am Main for a declaration that the substitution of the Plan Company as issuer was invalid and ineffective.  It is likely that proceeding will take some time to be resolved, and it remains to be seen whether the Frankfurt Court will reach a different conclusion as to the issuer substitution than the English Court and, if so, what relief will follow.

Acceleration of Notes

There was also a dispute between the parties as to the validity (as a matter of German law) of notices which a number of AHG members had issued on 10 and 13 March 2023, pursuant to which those AHG members purported to accelerate the maturity dates of their Notes.  The Court held that it was not required to determine this issue (and the Court would have been reluctant to decide a point of German law unless absolutely necessary) because the Plan could take effect whilst the dispute as to the validity of the notices is resolved either consensually or by a German Court, and if the German Court decides that the notices were valid and the AHG members’ debts have been duly accelerated, it will be open to the Plan Company to simply pay off the relevant AHG members.

What’s next?

On 25 April 2023, the Court heard and refused an application from the AHG for permission to appeal the sanctioning of the Plan. Notwithstanding that refusal, the AHG remain entitled to, and appear likely to, approach the Court of Appeal directly for permission to appeal.  The grounds on which the AHG are seeking to appeal the sanction appear to be narrow, and are concerned primarily with the fairness of the Plan (which is a matter for the trial judge’s discretion), however if previous experience on this matter is anything to go by we expect the AHG to continue to pursue a “root-and-branch attack” on the Plan whether in the English Court of Appeal or in the German courts.

Conclusion

As is typically the case with restructuring plans, the Court’s judgment in relation to the Adler restructuring is heavily dependent on the particular circumstances of the Plan.  Nevertheless, the judgment provides helpful insight into the ‘no worse off’ test and how the Court will treat various factors which are relevant to the question of whether the Court should exercise its discretion to sanction a restructuring plan.

Notably, the Court was prepared to accept that a range of outcomes might realistically follow the sanction of a plan (in this case, either the Plan’s successful execution or noteholders taking enforcement action following a breach of the LTV ratio covenant) and that the Court is not limited to undertaking a binary analysis of the most likely outcome under a plan as against the relevant alternative.  The Court, however, was unwilling to accept the AHG’s submissions as to the likelihood of the 2029 noteholders receiving returns of only 10.6% under the Plan, which demonstrates the difficulty for opposing noteholders to attack a plan on a valuation basis, given typically it will be the plan company which is in the best position to prove the value of its own assets.

In relation to future plans, it is noteworthy that the Court took a dim view of Adler’s shareholders retaining post-restructuring equity despite not contributing to the Plan, albeit (amongst all the other circumstances) this was not a sufficient reason for the Court to refuse sanction.

The fact that (a) the Group chose to use an English restructuring plan despite the development of similar restructuring tools in other European jurisdictions and (b) the Plan was sanctioned despite robust opposition from the AHG is likely to cement the position of England and Wales as an increasingly debtor-friendly jurisdiction for companies needing to restructure their debts, and well and truly puts to bed any remaining concerns about the impact of Brexit on the use of the English Courts to restructure the debts of European debtors.

References

1 Steinhoff International is currently in the process of implementing a restructuring plan through a Dutch WHOA (i.e. a Dutch Court restructuring procedure) and a parallel UK consensual restructuring.  The terms of the Steinhoff restructuring plan have recently been amended to allow existing shareholders to retain 20% of the economic interest in the restructured group.  It will be interesting to see what approach the Dutch Courts take to the retention of equity by shareholders under a restructuring plan.