There are various routes which can be taken if your business gets into financial difficulty, some of which are designed to rescue the company and/or business and others which return value to the company’s creditors and result in the winding-up and dissolution of the company and business. For an overview of these procedures, please see Corporate insolvency: what are the options for your business?
Although a scheme of arrangement is not actually an insolvency procedure, it can be used to rescue an insolvent company and/or its business. Here, we explain the procedure and practical issues to be considered.
- What is a scheme of arrangement?
- Does a scheme of arrangement result in a moratorium?
- What is the effect of a scheme of arrangement on creditors and/or members?
- How long does it take to put in place a scheme of arrangement?
- Setting up a scheme of arrangement – the process
- Court considerations
- Lock-up agreements
- Enforceability of schemes of arrangement in other jurisdictions
- Advantages of a scheme of arrangement
- Disadvantages of a scheme of arrangement
What is a scheme of arrangement?
A scheme of arrangement is a court-approved agreement between a company and its shareholders or creditors. It is not actually an insolvency procedure and can be used by both solvent and insolvent companies to agree any issue or matter with its creditors and/or members. That said, schemes of arrangement are regularly used by insolvent companies to restructure debts or to agree a way forward with creditors in an effort to avoid formal insolvency.
In order to effect a scheme of arrangement, the scheme must receive approval from the relevant creditors and/or members and be sanctioned by the court. It is important to remember that the court will consider the scheme and the process used carefully; court approval of the scheme is not a foregone conclusion. The terms of the scheme of arrangement must therefore be reasonable, fair and legitimately aim for an agreement to be reached between the company and its creditors and/or members.
Does a scheme of arrangement result in a moratorium?
A scheme of arrangement does not automatically result in a moratorium preventing creditors from bringing any legal proceedings or other action against the company while the moratorium is in place. An automatic moratorium will apply, for example, if a company is placed into administration, or can be applied for under a new process introduced by the Corporate Insolvency and Governance Act 2020 (CIGA).
Schemes of arrangement can, however, be used as part of the administration process and in this way, a company can benefit from an automatic moratorium while preparing and agreeing the terms of the scheme of arrangement with its creditors and/or members.
What is the effect of a scheme of arrangement on creditors and/or members?
A scheme of arrangement, once effective, applies to all creditors and/or members of the relevant class or classes. This means that secured creditors are also bound by the scheme, unlike a company voluntary arrangement (CVA), with the result that debts owed to secured creditors may be cancelled or reduced without their unanimous consent.
How long does it take to put in place a scheme of arrangement?
The length of time that it will take to put in place a scheme of arrangement will depend on various factors, including the complexity of its terms, the effect of the scheme, whether multiple jurisdictions are involved and so on. A straightforward scheme of arrangement can be completed within two months, but others will take longer. Court dates should be booked as soon as possible and can be booked confidentially. Your legal advisors will be able to help with this.
Setting up a scheme of arrangement – the process
The process for putting a scheme of arrangement in place is set out in the Companies Act 2006. It is complex, requires the sanctioning of the court and must be put in place correctly. As such, it is crucial that appropriate professional advice is obtained if you are considering a scheme of arrangement.
A scheme can be proposed by the company, any creditor, any member or, if the company is insolvent, the liquidator or administrator. The basic steps are set out below, but additional processes may be required by law, for example, if the scheme is effecting a reduction of share capital.
- Preparation of the terms of the scheme by the applicant
- Claim form is issued in the Insolvency and Companies List of the High Court
In addition to the claim form, certain written information is also required to be filed at court, including statutory information about the company, the proposals for the scheme and a witness statement by one of the company’s directors, the liquidator or the administrator. It is important that all pertinent information is provided.
- Court hearing to convene a meeting of the relevant creditors and/or members (see Court considerations below)
The court will consider the information provided to it and if it considers that there is a likelihood of the scheme being approved, it will order the convening of a meeting of the relevant creditors and/or members for them to vote on the scheme.
- Company issues notice of meeting
The court will not prescribe the notice period required for the meeting of creditors and/or members but will consider the requirements set out in the company’s constitutional documents, such as its articles of association. Upon receiving the court order, the company must issue a notice of the meeting and provide an explanatory statement setting out the terms and effect of the scheme.
It is imperative that the company calls the meeting properly and that the explanatory statement includes as much information as possible to allow those voting to make an informed decision. The creditors and/or members must be notified of any change which arises after the explanatory statement has been issued and as a result, it is advisable for the company to avoid making any significant changes until the vote has been held.
- Meeting of creditors and/or members to vote on the scheme
The meeting of the relevant class or classes of creditors and/or members will then be held in order that the scheme of arrangement can be voted on. To be approved, a majority in number who represent at least 75% in value of the relevant creditors and/or members who vote (in person or by proxy) must vote in favour of the scheme.
- Chairman’s report lodged at court
Following the meeting, a report by the chairman about the meeting will be lodged at court. In addition, witness statements are required confirming that notice of the meeting was correctly given.
- Court hearing to sanction the scheme (see Court considerations below)
- Filing of court order with the Companies Registrar
Assuming that the court sanctions the scheme of arrangement, it will take effect once the court order has been filed with the Registrar of Companies, unless the scheme provides that its terms will become effective on a future date. The person nominated in the scheme will then implement the proposals.
As explained in Setting up a scheme of arrangement – the process above, two court hearings are required in relation to a scheme of arrangement, the first being the hearing to convene the meeting of the relevant class of creditors and/or members and the second being the hearing to sanction the scheme of arrangement.
Court hearing to convene the meeting of the relevant class of creditors and/or members
At this hearing the court will consider:
- whether the suggested classes for voting purposes seem correct; and
- the likelihood of the scheme being approved; if the court does not think that there is any chance of approval being given by the creditors and/or members, it will not grant an order to convene the meeting.
It is possible to challenge a scheme of arrangement on certain grounds, such as that a class was constituted incorrectly. Therefore, it is vital that serious consideration is given to the classification of the creditors and/or members to minimise the risk of this occurring. To be in the same class, the class members must have similar (not necessarily identical) rights to each other in order that they can discuss the scheme terms and arrangements between themselves. Whether the classes are constituted correctly will depend on the individual scheme and the circumstances, although professional advisors can assist here.
Court hearing to sanction the scheme of arrangement
At this hearing, the court will consider whether:
- the approval by the creditors and/or members was reasonable. The scheme must be fair, but the court will not consider its commercial benefits. At this point, the court may decide not to sanction the scheme at all or to propose amendments to its terms;
- the relevant classes were represented fairly at the meeting. To determine this, the court will look at the numbers attending, the information provided and whether the attendees were sophisticated investors or not;
- the statutory majority at the meeting acted properly;
- there are any conditions attached to the scheme. If any conditions are still outstanding at this point, the court is less likely to sanction the scheme;
- the scheme complies with the legal requirements and process, including that the correct notice of the meeting was given, approval was given by the requisite majority and that the explanatory statement was properly provided;
- there are any jurisdictional issues (see Enforceability of schemes of arrangement in other jurisdictions below); and
- the scheme is actually required.
It is common for certain creditors to agree with the company, before the approval meeting, that they will vote in favour of the scheme. This provides the company with an element of certainty that the scheme will receive the necessary approval. To this end, companies are permitted to incentivise those creditors, although it should be remembered that this could have an impact on the class distinctions and possibly affect the ‘fairness’ of the scheme.
Enforceability of schemes of arrangement in other jurisdictions
It is possible for overseas companies to put in place a scheme of arrangement which has been sanctioned by the English courts, however, the court must be satisfied that there is a sufficient connection between the overseas company and England for it to have jurisdiction. Various legislation and regulations, which are beyond the scope of this note, apply in this situation and legal advice should be sought.
Advantages of a scheme of arrangement
- Once sanctioned by the court, a scheme of arrangement binds all creditors and/or members in the relevant class or classes, including secured creditors (unlike CVAs)
- Companies can continue to trade throughout the process
- Schemes of arrangement are less public than other insolvency procedures and so an insolvent company is less likely to suffer from negative publicity and a loss of reputation
- Overseas companies may be able to effect a valid scheme of arrangement (but see Disadvantages of a scheme of arrangement below)
- The purposes for which a scheme of arrangement can be used are extensive and can range from restructuring debt to dealing with demergers, acquisitions and reductions of capital. Both solvent and insolvent companies can use schemes of arrangement
- Contractual terms which require unanimous agreement on various issues may be superseded by lower approval thresholds in a scheme of arrangement
Disadvantages of a scheme of arrangement
- Because of the need to involve the courts and the statutory process involved, a scheme of arrangement can be expensive and ‘process heavy’
- Jurisdictions outside of England and Wales will not necessarily recognise the existence of a scheme of arrangement and so it may not be enforceable overseas
- A scheme of arrangement does not result in an automatic moratorium and so an insolvent company may be advised to enter into administration to provide it with the breathing space required to agree the terms of the scheme.