Schemes of arrangement and why loan note investors should be wary of governing law amendment mechanisms
06 July 2015
In the matter of DTEK Finance B.V.  EWHC 1164 (Ch), 28 April 2015, a change in the governing law of loan notes from New York law to English law was sufficient to found jurisdiction for the English court to sanction a scheme of arrangement between a Dutch company and holders of loan notes issued by that company.
A company, DTEK Finance B.V. (DTEK), incorporated in the Netherlands, applied to have the English High Court sanction a proposed scheme of arrangement with the holders (Scheme Creditors, or Noteholders) of certain loan notes (the Notes) under the Companies Act 2006.
DTEK was part of a group of companies carrying on a vertically integrated energy business (including mining coal, generating power, and distributing and selling electricity), with its core customers located in the Ukraine. DTEK's core function was to raise finances for the group, which it in turn distributed to other group companies.
In line with that overall group structure, in 2010, DTEK had issued the Notes to the Noteholders, in the principal amount of USD 500 million (although USD 300 million had earlier been bought back by DTEK) bearing interest at a rate of 9.5%. DTEK had duly on-lent the proceeds of the Notes to other companies in the group, and it, in return, had taken certain guarantees from those group companies. The Notes, as originally issued, were governed by New York law.
The Notes were due to mature on 28 April 2015. However, as the maturity date approached, the wider group had encountered financial difficulties due to complications in the Ukraine: in particular, the devaluation of the Ukrainian currency, as the group received its revenue in the Ukrainian currency but serviced its borrowings in USD or EUR. As such, at the time of the hearing in April 2015, the group was in the process of undertaking a wide-ranging restructuring and party to on-going negotiations with lenders.
Regardless of the outcome of those negotiations, it was certain that DTEK would not have the funds to pay the Noteholders in full on the maturity date, such that, absent the approval of the scheme of arrangement in respect of the Notes, DTEK would default, which would in turn trigger defaults on the part of other group companies and thereby lead to insolvency proceedings.
DTEK was therefore seeking the English court's approval of a scheme of arrangement (the Scheme) with respect to the Notes, with the support of over 90% of the Noteholders. The Scheme was straightforward, involving DTEK acquiring and then cancelling Notes, and in return, issuing Noteholders with new notes for 80% of the par value of the Notes (with a 2018 maturity date and the same interest rate), and cash for the remaining 20% of the par value of the Notes.
While, ultimately, the court did not take any issue in exercising its discretion to sanction the Scheme itself, or with the due satisfaction of the statutory requirements, the key substantive issue of interest for determination was whether the court itself had the necessary jurisdiction to sanction the Scheme under the Companies Act 2006.
Rose J surveyed the applicable law, noting that the jurisdiction to sanction a scheme of arrangement under the Companies Act 2006 arose in respect of any company liable to be wound up under the Insolvency Act 1986. As a foreign company may be wound up as an unregistered company under that Act, jurisdiction would arise where the Court was satisfied that the relevant company had a "sufficient connection" with England (applying Re Drax Holdings  1 WLR 1049).
Authority demonstrates that a "sufficient connection" arises where English law is the governing law of the instruments to be compromised by the proposed scheme. In this case, the original governing law of the Notes was New York law – however, the governing law had very recently been changed from New York law to English law by a collective decision of the Noteholders. The terms of the Notes permitted changes to the governing law on a majority basis, and provided that such changes would bind all Noteholders (regardless of their agreement). As such, according to the originally-governing New York law, the governing law of the 2015 Notes was indeed successfully changed to English law.
The change of governing law had been approved by Noteholders on the express basis that it was being effected so as to create a link with the English court, in order to enable DTEK to seek approval from the English courts for a scheme of arrangement under the Companies Act (in the event that the 98% support threshold required for a voluntary exchange of the Notes was not met).
Applying Re APCOA Parking Holdings GmbH  EWHC 3849 (Ch), Rose J held that the connection created to the English court was no less "sufficient" because it was made for that express purpose shortly before the sanctioning of the Scheme. In particular, the Court observed that "part of the bargain that the Noteholders signed up to" was the mechanism to effect changes to the governing law (in accordance with the originally-governing New York law).
As such, the requisite sufficient connection was held to exist (supported by the fact that DTEK had also moved its centre of main interest to England and held significant assets in England) and, in light of additional expert legal opinions that the Scheme would be of practical effect in the Netherlands and other relevant jurisdictions it was ultimately duly sanctioned by the court.
The case is an interesting reminder that it is important not only to consider the selection of governing law, but also the mechanism for effecting any changes to that governing law, at the drafting and negotiation stage. It is clear that, in line with APCOA, the English courts (at least) will not look behind any such changes of governing law in a cynical or disapproving manner, even if the purpose of such changes is, in effect, to frustrate and deliberately override the fact that a requisite number of creditors (under the original governing law) have not given approval to a scheme of arrangement, and may attract companies to English schemes of arrangement in undertaking a restructuring. From a practical point of view, it is interesting to note DTEK's adoption of the judge's comments in Re APCOA in expressly notifying the Scheme Creditors of the purpose of the change of governing law and providing the requisite expert evidence to show that the Scheme would be of practical effect.
Note that the Brussels Regulation was not relevant as insolvency matters are excluded from its scope.