In our previous blog post, we examined the decision of the New South Wales Court of Appeal to uphold the composition of classes of creditors in the Boart Longyear restructuring by way of scheme of arrangement.
Following an extensive second court hearing to approve the schemes of arrangement (which involved multiple days of hearings, several adjournments, and a court-ordered mediation), amended versions of the Boart Longyear schemes have now been approved by the Australian courts.
The decision emphasises the importance of the court’s overall “fairness” discretion in approving a scheme, irrespective of whether classes of creditors have been properly constituted. Importantly, differential treatment within a class of creditors that may not be sufficient to justify the creation of a separate class may nonetheless create sufficient unfairness to cause the scheme to ultimately fail. Significantly, the court was clear in its final judgment that the schemes as initially drafted would not have passed the “fairness” test and would have been rejected.
Background – the schemes and the class composition decision
Schemes of arrangement in Australia require two separate court hearings to be implemented:
- The purpose of the first court hearing is to seek an order for the holding of meetings of the different classes of creditors to consider and approve the proposed scheme. Much like other jurisdictions, under Australian law, the proponent of the scheme is required to assign creditors to separate classes, and each class must vote in favour of the scheme for it to be implemented. The court will generally consider whether the proposed classes have been properly comprised at the first hearing. The court will generally not consider the detailed terms of the proposed scheme at the first hearing, unless there is something obviously and manifestly prejudicial or unfair to a particular creditor or class of creditors.
- The purpose of the second court hearing (assuming the scheme is approved by the requisite majority of each class of creditors voting in number and value) is for the court to finally approve the scheme. The court will generally consider the terms of the scheme in detail at this hearing, as well as any objections raised by dissenting creditors, and is required to exercise a general “fairness” discretion in determining whether to approve the scheme.
By way of reminder, Centerbridge Partners LP and associated entities (Centerbridge) held a significant proportion of Boart Longyear Limited’s (BLY) senior secured notes (Secured Notes), and all of BLY’s partially-secured Term Loan A (TLA) and Term Loan B (TLB) debt. Centerbridge was also BLY’s majority shareholder.
BLY proposed two separate schemes of arrangement (a Secured Creditors’ Scheme and an Unsecured Creditors’ Scheme) (Schemes), under which:
- a proportion of BLY’s unsecured notes (Unsecured Notes) (holders of which included Ares Management LP (Ares) and Ascribe II Investments LLC (Ascribe)) would be exchanged for equity in the recapitalised company (which would, subject to the Secured Creditors’ Scheme terms, dilute Centerbridge’s shareholding from 48.9% to 3.7%);
- the holders of the Secured Notes, and the TLA/TLB lender, were to vote in a single class of creditors;
- the maturity dates of the Secured Notes, TLA, and TLB were all to be extended to the same date (where the Secured Notes otherwise matured more than two years prior to the TLA and TLB);
- the interest rate payable on the TLA and TLB was reduced from 12% to 10%, in return for Centerbridge receiving 56% of the equity in the restructured BLY (where Centrebridge otherwise would hold only 3.7% of the equity following the implementation of the Unsecured Creditors’ Scheme);
- interest on all facilities was converted to payable in kind until December 2018 (where interest under the TLA and TLB was already payable in kind);
- all parties waived any rights in relation to a change of control event occurring as a result of the restructuring; and
- Centerbridge was given the right to appoint five of the nine directors of BLY (up from its existing right to appoint four directors).
In the face of opposition from First Pacific Advisors LLP (FPA), a holder of Secured Notes, and notwithstanding the potentially significant differences in treatment of the holders of Secured Notes and the TLA/TLB lender, the New South Wales Supreme Court and Court of Appeal upheld the decision to include the holders of the Secured Notes and the TLA/TLB lender in a single class of creditors. The court’s reasoning was examined in our previous post.
What happened next?
Shortly after the Court of Appeal’s decision, both Schemes were approved at the creditor meetings by the requisite majorities of the classes approved by the court.
Along with a dissenting shareholder, Snowside Pty Limited (Snowside), FPA objected to the approval of the Schemes at the second court hearing on a number of grounds, including that the Schemes unfairly benefited Centerbridge because it would:
- obtain an increased shareholding (from 3.7% under the Unsecured Creditors’ Scheme to 56% under the Secured Creditors’ Scheme) and ultimately take control of BLY;
- increase the number of directors it could appoint from 4 to 5;
- improve its priority ranking over the holders of Unsecured Notes in relation to the unsecured elements of the TLA and TLB; and
- in comparison to the holders of Secured Notes, suffer only a short extension of the maturity date of its debt.
The second court hearing for approval of the Schemes extended over four days and multiple adjournments, following which Black J ordered that the parties engage in mediation prior to the recommencement of the hearing. In doing so, his Honour made it clear that he was minded to decline to approve the Schemes as proposed on the fairness grounds articulated by FPA.
Following the court-ordered mediation, the parties reached a settlement agreement, which varied the terms of the Schemes in the following key respects:
- holders of Secured Notes would receive 4% of the equity in the restructured company;
- PIK interest would accrue on the Secured Notes at 12% from October 2016, instead of at 10% until 31 December 2016 with 12% thereafter;
- the Secured Notes could be redeemed according to prices set out in a new call schedule; and
- if the Secured Notes were accelerated as a result of an event of default, they would be repayable at par plus accrued but unpaid interest, with no premium payable.
Importantly, the amended Schemes had the support of all voting Secured Note holders (including FPA) and TLA and TLB lenders (representing 99.63% of the debt under the Secured Creditor Scheme) and all voting Unsecured Note holders (representing 96.19% of the debt under the Unsecured Creditor Scheme).
The court’s decision to approve the amended schemes
At the second hearing, the court was required to consider:
- whether the proposed amendments to the Schemes were within the scope of the statutory power for the court to approve a scheme “subject to such alterations or conditions as it thinks fit”; and
- whether the original and amended Schemes met the “fairness” requirement.
The amendment issue
The court held that the proposed amendments to the Schemes were permitted by the statutory framework, as they represented a reasonable mechanism to implement a complex arrangement in the circumstances the parties found themselves in. Boart Longyear was near insolvent (if not already insolvent) and did not have the luxury of recommencing the restructuring from the beginning. The court accepted that the amendments to the Schemes were substantial and not in the reasonable contemplation of creditors at the time the Schemes were approved at the creditors’ meetings, but held that this factor was only relevant, not determinative.
The court placed considerable weight on the fact that all creditors affected by the amendments supported them.
The decision was upheld by the Court of Appeal, which held that there was no reason in the text or purpose of the legislation to confine the power to approve “amendments” to immaterial amendments only.
The fairness issue
It has long been established under Australian law that the court must consider the overall fairness of a scheme, even if all the technical requirements for implementation (such as creditor class composition and approval by creditor classes) have been met.
In comments made prior to the court-ordered mediation and in the judgment itself, the court made it clear that it agreed with various concerns raised by FPA in relation to the fairness of the originally proposed Schemes. In particular:
- notwithstanding that the equity was, at the present time, worthless or close to worthless, the equity to be issued to Centerbridge and to other Unsecured Note holders had real “option value”, because the value of the equity would increase (potentially substantially) if the mining environment or Boart Longyear’s performance improved;
- the conversion of interest payable under the Secured Notes to PIK at Boart Longyear’s option was potentially disadvantageous to Secured Note holders – the right to receive interest in cash now may well be preferable to a right to receive PIK interest at a later date at a higher rate, which would only be recoverable if Boart Longyear had capacity to pay it or security realisations were sufficient to cover it on insolvency;
- the waiver of Secured Note holders’ rights to accelerate on a change of control effectively allowed Centerbridge to take control of Boart Longyear – it was therefore to the commercial advantage of Centerbridge at the expense of Secured Note holders; and
- the changes in maturity dates for the Secured Notes and TLA/TLB represented a limited detriment to Secured Note holders, because Boart Longyear could not presently repay its debts and therefore the Secured Note holders would receive only a fraction of the debt on insolvency.
The following factors were considered relevant by the court to the exercise of its discretion as to whether to approve the original Schemes:
- the fact that every secured creditor who was not to receive equity under the original Schemes (i.e. every secured creditor other than Centerbridge, Ares and Ascribe) voted against the Secured Creditors’ Scheme; and
- the fact that the Secured Creditors’ Scheme was approved by a narrow margin (56.82% in number and 78.49% in value).
Ultimately, once the original Schemes were amended and presented to the court, given the overwhelming creditor support and the determination that they were not unfair, the court approved the amended Schemes.
These decisions are potentially the most significant in relation to schemes of arrangement in Australia in a number of years. The points addressed will be of great relevance to distressed companies and potential proponents of schemes of arrangement going forward.
Firstly, the approach taken by the court in Boart Longyear was novel and flexible, and ultimately ensured that the restructuring could be rescued. It is the first reported instance of a court-ordered mediation in the context of a scheme of arrangement in Australia. Without the unusual step of court-ordered mediation, or if the court had simply rejected the Schemes on fairness grounds or refused to exercise its discretion to approve the amended Schemes, it is likely that the Schemes would have failed and Boart Longyear would have entered formal insolvency.
The case also demonstrates the significance of the court’s overall “fairness” discretion in determining whether to approve a scheme. Importantly, differential treatment within a class of creditors that may not be sufficient to justify the creation of a separate class may nonetheless create sufficient unfairness to cause the scheme to ultimately fail at the second court hearing. Whilst the class composition decision may still potentially enable the development of restructuring plans that enable dissenting creditors to be included within a broader single creditor class in order to cram down those creditors and deny them a potential right of veto, the final judgment confirms that this is only achievable where an appropriate balance of fairness is struck and where any differential treatment can be objectively justified in the context of the scheme; something which the original Schemes manifestly failed to do.
Importantly, the court also held that shares can have “future option value”. Even if the equity is hopelessly underwater on current valuations, the court is permitted to take account of potential future increases in the value of the equity, and the benefit that may provide in the context of the terms of a scheme. Whilst this valuation evidence was not available at the time of the class composition decision, it is notable that a significant factor in the Court of Appeal’s decision to permit the proposed class composition was the fact that the shares would be of little value immediately post-restructuring. It remains to be seen how this potential inconsistency between the class composition decision and the final judgment may play out.
The courts in Australia have long adopted an approach whereby any class composition issues are sought to be determined at the first court hearing in order to avoid wasted time and cost if the court rejects a scheme on class composition grounds at the second hearing. As a result of the Boart Longyear litigation, it remains to be seen whether stakeholders may now seek to have issues of fairness ventilated at the first court hearing in order to avoid similar outcomes.