MyTravel – Bondholders fail to get their way

In a hearing on 24 November 2004, the Court ruled that the holders of certain subordinated convertible bonds issued by MyTravel Group plc could not prevent the company convening the meeting of shareholders and creditors necessary to review and approve a scheme of arrangement under section 425 of the Companies Act 1985 designed to facilitate the company's reconstruction.

Background

Use of section 425 requires a mixture of Court, shareholder and creditor involvement. The company proposing a compromise or arrangement under this section must first submit its proposals to the Court for leave to call meetings of creditors and/or shareholders. If three-fourths in value of each class of creditors and each class of members vote in favour of the proposals put to them, the company must then revisit the Court to obtain final sanction. The above hearing was the initial Court hearing in this process.

The bondholders in question held approximately £216m of bonds, originally due on 5 January 2004 but whose maturity had been extended by agreement until 5 January 2007. Under the terms of the trust deeds governing the rights of the bondholders, payment in respect of these bonds was subordinated in the event that an order was made or resolution passed for the company to be wound up.

The compromise proposed involved the transfer of the company's undertaking to a Newco. The company had initially offered the bondholders 8% of the equity in Newco, with existing shareholders receiving 4% and other lenders, who were collectively owed over £800m, the balance if the reconstruction could be agreed out of Court. The bondholders had rejected this offer. Under the proposal placed before the Court, the liability to the bondholders was to remain with the company. Bondholders could if they wished still exchange their bonds for Newco shares, but under this proposal the bondholders were collectively offered up to a maximum of only 2% of Newco's issued share capital.

Were the bondholders entitled to vote on the proposal?

The company's argument before the Court was that, since they would be subordinated to other creditors, the bondholders would receive nothing if the company went into liquidation. On the company's evidence, there would be a shortfall even to ordinary unsubordinated creditors of £435m. The company also submitted that, if reconstruction could not be achieved before mid-January 2005 at the latest, the indications were that the Civil Aviation Authority was likely to revoke its licence to fly, which would inevitably trigger formal insolvency. Therefore, the company argued that it was not obliged to include the bondholders amongst the creditors who must be consulted on, and who would vote on the proposals and any equity offered to the bondholders was in the nature of a gift.

Counsel for the company relied particularly on the case of In Re Tea Corporation [1904] 1 Ch 12 where a company already in liquidation was proposing a scheme under the then equivalent of section 425. There, the Court of Appeal had decided that preference shareholders who had an economic interest in the company's assets were entitled to vote, whereas the ordinary shareholders, who had no economic interest, were not.

The bondholders responded that whilst they might be subordinated on a liquidation, they currently still ranked pari passu with other creditors and retained a right to be consulted. They argued the circumstances of the Tea Corporation case were somewhat different from the present in that Tea Corporation was already in liquidation and the value of the assets had been agreed by all concerned, neither of which was the case here.

Nevertheless, Mr Justice Mann ruled in favour of the company on this issue, holding that as matters stood they had no real economic interest in the company notwithstanding that their bonds were not at this stage subordinated, since even if they were able to obtain judgment for their debt at this point they could never realistically recover the sum due to them. He was satisfied that the evidence showed that nothing would be available to the bondholders on a liquidation. Therefore the bondholders did not need to be consulted by the company.

The "Section 427" point

It initially looked likely that, despite this, the bondholders could still block the Court approval route on a technicality. The compromise first put by the company to the Court needed to make use of section 427 of the Companies Act 1985. It is this section which empowers a Court, where a compromise or arrangement has been proposed under section 425 for a scheme for the reconstruction of a company which involves the whole or any part of its undertaking being transferred to another company, to make an order sanctioning the transfer and allotting of shares by the transferee company.

Mr Justice Mann concluded from his review of existing case law that a scheme could only be a reconstruction for the purposes of section 427 where substantially the same shareholders were involved in both the old and new companies. This could not be the case where 100% of the shareholders in the old company were to be given just 4% of the shares in the new company. However, the company was able to present an alternative proposal which circumvented section 427.

What happens next?

The bondholders have announced an intention to attempt to overturn the decision in the Court of Appeal. In the meantime, however, the meetings of creditors and shareholders are due to take place on 13th December and, assuming the necessary majorities vote in favour, the company is due to return to Court for final sanction on 20th December.

Comment

Section 425 is increasingly regarded as a flexible tool in the restructuring world, particularly for large restructurings involving a need to compromise with various different creditors and shareholders. The fact that a three-quarters majority of creditors having an interest in the outcome may "cram down" dissenting creditors means that minority creditors or creditors with no economic interest in the outcome cannot hold the company to ransom, whilst the Court involvement is designed to ensure that this cram down mechanism nevertheless cannot be used unfairly to prejudice interested creditors.

Disadvantages of the section 425 process are that it remains somewhat cumbersome and expensive and the final outcome can never be certain at the outset. Thus companies may initially prefer, as did MyTravel, to explore an "out of Court" compromise route with the various interested parties, resorting to a Court route only in the event that a consensual compromise cannot be agreed. The bondholders' wish was clearly to block or at least delay the use of this Section 425 route, since they would then have been in a far superior position to negotiate their own terms in any further consensual restructuring put to them. However, the Court indicated here that it was not prepared to allow them to do this where they had no real economic interest in the company.

The fact that the bonds involved here were subordinated did make the company's task an easier one, since the bondholders were never likely to be able to persuade the court on the evidence that a liquidator would make sufficient recoveries to pay the ordinary unsubordinated creditors ranking above them in full, and therefore that there would be anything left for them.

Where a company has issued unsubordinated bonds, the bondholders' position is stronger. Even where a company's assets would be insufficient to repay secured creditors ranking above them, any liquidation would bring with it the possibility of actions against directors and to set aside antecedent transactions, any proceeds of which would flow to the ordinary unsecured creditors, including unsecured but unsubordinated bondholders. This would make it very difficult for any judge to be so convinced that ordinary unsecured creditors would receive nothing that it was appropriate to prevent them voting.

Therefore should this decision be upheld by the higher courts it can be argued that it would only be of real relevance to bondholders who were in some way subordinated to the other unsecureds. Nevertheless, the prospective loss of a negotiating position on future schemes of arrangement would certainly be likely to prove a deterrent to future bondholders proposing to take this type of bond, and may well produce nervousness in the bondholding community at large. This could make this source of finance less available, or at least more expensive to reflect the increased risk.

For further information, please contact Rita Lowe on +44 (0) 20 7367 2798 or at [email protected] or Simon Beale on +44 (0) 20 7367 2822 or at [email protected]