Following the English High Court’s written reasons for sanctioning the Adler Group restructuring plan on 21 April 2023 (you can see our deep dive on this decision here), the English Court of Appeal has overturned the High Court’s decision and sent a strong message regarding future Part 26A restructuring plans and, in particular, the cross-class cram down regime.

A quick summary of the Adler Group restructuring plan

The Adler Group, a prominent German property group, 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 (the “Notes”). The plan, initially sanctioned by the High Court, proposed to:

• introduce €937 million of new senior secured debt to repay the Notes maturing on 27 April 2023 and the 2024 Notes, in exchange for a super-senior first-ranking lien and a 22.5% equity interest post restructure;
• extend the maturity date of the 2024 Notes until 31 July 2025 in exchange for priority over other Noteholders in terms of repayment (maturity of all other Notes to remain the same); and
• amend the remaining Notes to allow refinancing and receive a PIK interest and a subordinated security interest,

(together, the “Plan”).

An ad hoc group of 2029 Noteholders (the “AHG”) opposed the Plan, which was approved by five out of six classes of creditors (37.72% of the AHG voting against). The High Court sanctioned the Plan, including a cross-class cram down in relation to the AHG class. An appeal by the AHG was allowed on the following basis:

• Pari passu: the first instance judge failed to recognise 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 which did not require further investigations regarding improvements to the Plan; and
• Incorrect weighting of factors: the AHG argued that too much weight was given to the “no worse off” test and the simple majority of the AHG approving the Plan.

Main takeaways from the Court of Appeal decision

Further scrutiny and commentary on the pari passu principle

The Court of Appeal’s finding that the restructuring plan violated this fundamental principle sends a loud message about the non-negotiable nature of equitable creditor treatment. The Court of Appeal makes 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 and cogent justification.

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 was not convinced that the reasons provided in favour 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.

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”.

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 to a more nuanced analysis. The Court, in applying this test, would consider whether a proposed plan is the “best” plan, evaluating if 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.

Other takeaways

The Court of Appeal emphasised the need for a fair court process, comprehensive evidence exchange and sufficient time for valuation considerations. Genuine urgency will be accommodated, but the Court of Appeal underscored the need for a robust and transparent process nonetheless.
The Court of Appeal also noted that a restructuring plan can impose a “haircut” on creditors while 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 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 from what many commentators considered to be the more “commercial” position taken by the High Court in April 2023.

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