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Upd@te Germany
16 June 2011
Restructuring Consulting Legal and Tax Consulting International Affairs Insolvency Administration Business Consultancy
Subjects: Scheme of Arrangement / IDW Standard S6

Mr Justice Briggs has handed down his judgment in Rodenstock GmbH, a case concerning a scheme of arrangement in an insolvency context. A scheme of arrangement is a mechanism under Part 26 of the English Companies Act 2006. It is a very versatile tool that enables creditor classes to implement far-reaching restructuring steps, for instance to alter the existing rights which creditors have against a company in exchange for new rights under the terms of the scheme. The essential features of a scheme are that the court convenes meeting(s) of creditors and if the creditors present and voting at the meeting(s) either in person or by proxy vote in favour of the scheme by a 75% majority in value and a simple majority in number, the scheme will proceed to the court sanction stage. The court then decides whether the scheme is fair and if so found and approved by the court, the scheme will bind all creditors of the company, even if they did not vote or if they objected to the scheme.
Whilst schemes of arrangement have been available under English law for more than a century, this case stands out as the fully reasoned judgment contains a very thorough and interesting analysis of the case law pertaining to the High Court’s international jurisdiction and how European and domestic insolvency laws as well as the concept of COMI sit with schemes of arrangement.

Frank Tschentscher
Attorney at Law in Germany
Solicitor (England and Wales)

Frank Tschentscher

High Court of Justice (Chancery Division) London (Justice Briggs), [2011] EWHC 1104 (Ch), “Rodenstock”

The facts that gave rise to the decision and the issues as regards the English Court's jurisdiction and ability to sanction the scheme were as follows:

Rodenstock is one of the leading manufacturers of ophthalmic lenses and spectacles frames. The company based in Munich was founded in 1877. It is incorporated in Germany and has its centre of main interests there. The company has a worldwide workforce of approximately 4,000 people and is represented in more than 80 countries with sales subsidiaries and distribution partners. It has no establishment or assets in the United Kingdom affected by the scheme.

Rodenstock had outstanding senior debt of approximately Euros 305 million, advanced under a facilities agreement expressed to be governed by English law and which contained an exclusive jurisdiction clause in favour of the courts of England. Although operationally sound and performing in line with its budget, the company struggled with its debt structure and ultimately breached its financial covenants in the second quarter of 2009. A series of successive waivers were put in place, pending the extended consideration and negotiations between the company and its creditors of restructuring proposals. However, those waivers could be terminated at the end of April 2011 and all parties felt that the company might be unable to avoid insolvency significantly beyond that date.

At a meeting of the scheme creditors on 6 December 2010, the finance creditors were given a presentation by their advisors of the options which were considered open to the company. In each of the four options considered, the creditors would enforce share pledges given in their favour. The proposals were rejected by the creditors because it was felt that the suggested enforcement action would lead to some kind of uncontrolled insolvency proceedings. There was then an impasse’ as no one restructuring option had the full support of all creditors and the company itself was not able to propose a restructuring which would obtain the unanimous support of the senior lenders. Ultimately, this lead to the scheme being proposed with the support of those senior lenders who had signed up or acceded to an agreement committing them to support the restructuring proposed to be implemented primarily through a scheme.

Key Terms of the Scheme of Arrangement
The purpose of the scheme was to bind the senior lenders to a variation of their rights under the terms of the existing senior facilities agreement sufficient to enable the company to implement a restructuring to enable it to avoid going into a German insolvency process at the end of April 2011. The essentials of the scheme comprised an amendment of the terms of the existing senior facilities agreement to permit a Euro 40 million new money facility to be provided to the company on a super senior basis as well as a debt to equity swap in respect of a 49% stake in the company in return for recommitting to its existing debt and providing the addition of facility. Although the application to the court to sanction the scheme of arrangement was unopposed at the court hearing itself, a small group of lenders did submit evidence opposing the scheme, mainly on grounds of jurisdiction. Whilst their objections were ultimately withdrawn just before the hearing, the judge recognised that the scheme gave rise to "serious questions of jurisdiction", not least because some of the issues could soon be the subject of other litigation at the European Court of Justice. The judge also accepted that any judicial guidance would be useful in relation to future schemes.

Exercise of English Court's jurisdiction – Case Law and Conditions
The main question for the court was whether the company was a company "liable to be wound up under the Insolvency Act". The court’s statutory power to sanction the scheme of arrangement is to be found in Part 26 of the Companies Act 2006. Section 895 of the 2006 Act provides that “company” means any company liable to be wound up under the provisions of the Insolvency Act 1986 and the question was whether that applied to Rodenstock. The court analysed the historic case law as to schemes carefully and found that although Rodenstock was a foreign entity, it was indeed "liable to be wound up" under the Insolvency Act 1986. As the learned judge held, the reference to the Insolvency Act 1986 in section 895 of the Companies Act 2006 was but a convenient phrase and designed to broaden rather than restrict the scope of the court’s jurisdiction in relation to schemes!

The learned judge noted: "It is apparent therefore that the Insolvency Act confers jurisdiction on the court to wind up both insolvent and solvent unregistered companies, with no express jurisdictional restriction referable to the company's place of incorporation, COMI or establishment."

He continued that the very broad provisions of the Insolvency Act 1986 did not give the court carte blanche to wind up foreign companies, regardless of the presence or absence of any connection with England. Rather, the court would only be prepared to exercise its jurisdiction on the basis that a sufficient connection to England and Wales was established. As the learned judge held: “On the contrary, there evolved three judge-made conditions for the making of a winding up order in relation to a foreign company namely:

i) that the company had a sufficiently close connection with England usually, but not invariably, in the form of assets within the jurisdiction;
ii) that there was a reasonable possibility of benefit accruing to creditors from the making of a winding up order; and
iii) that one or more persons interested in the distribution of assets were persons over whom the English court could exercise jurisdiction.

All of the above conditions were satisfied in Rodenstock. The Judge did not consider that the sufficient connection test was satisfied by reference to the lenders or customers situated in England alone. Rather, the court was satisfied by the choice of English law and exclusive English jurisdiction in the facilities agreement. This was not a case where a number of different creditors had, by separate agreements with the company, each happened to have chosen English law and/or jurisdiction to govern their individual relationships with the company.  It was a case where they collectively did so in a single agreement which regulated not merely their individual debtor-creditor relationships with the company but also the relationships between each of the lenders inter se and between them as a body and the company. Furthermore, the company had significant relationships with customers in England, generating total annual direct revenues for the company in the sum of Euro 4 million in addition to those generated from England by the company’s subsidiaries.

Counsel for the company also submitted that other factors fortified the connection, i.e. the restructuring had been devised and negotiated in England (this has been relied upon in the context of other recent restructurings, for example Wind Hellas) and the judge also considered whether the creditors' participation in the court convened meetings reinforced the connection. However, he concluded that neither of these factors added any real substance to the connection criteria.

The Effect of the EU Legislation
Having established the court’s international jurisdiction as a matter of case law, the court also considered carefully the combined effect of Council Regulation (EC) No 3046/2000 on insolvency proceedings (‘the Insolvency Regulation’) and Council Regulation (EC) No 44/2001 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (‘the Judgments Regulation’). After detailed analysis, the court took the view that neither the Insolvency Regulation nor the Judgments Regulation had narrowed the court’s jurisdiction in relation to the sanctioning of solvent schemes of arrangement, by impacting restrictively on the circumstances when a company was “liable to be wound up”. The judge noted that neither of the two Regulations appeared to have been directed at restricting the English court’s international jurisdiction in relation to solvent schemes, and given that subsequent English legislation had left the “liable to be wound up” wording intact, the judge found that on a purposive interpretation of those Regulations they were not intended to restrict the English court’s jurisdiction.

Effectiveness of the Scheme in Germany
Last but by no means least, the court considered whether the scheme of arrangement was going to be recognised in Germany. The English courts being satisfied as to the recognition and effectiveness of the scheme in Germany was crucial in this case and had the court concluded that recognition was unlikely, the probable outcome of the hearing would have been a dismissal of the scheme application.

The principal difficulty in that context was the decision of the German Court of Appeals (Oberlandesgericht) Celle in Equitable Life. In a decision which has not yet been confirmed by the German Federal Court, the Court of Appeals Celle found that a scheme in so far as it related to policies subject to German law and jurisdiction was not recognisable as an insolvency or comparable proceeding in accordance with the Council Regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings. It also held that a scheme was not a "judgment" pursuant to Article 32 of Council Regulation (EC) No 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments.

After careful analysis, the English court concluded that schemes in relation to solvent companies did fall within the scope of the Judgments Regulation. More importantly, however, the court considered two legal opinions prepared by a leading German professor on international private law and a retired senior judge of the arm of the German Supreme Court that would normally deal with insolvency and recognition issues. Although the two German law experts agreed that the scheme would be unlikely to enjoy automatic recognition of the sanction order in Germany, nevertheless they both considered that in practice a decision by the English court to sanction the scheme would be legally effective in Germany, because the German court would, pursuant to the Rome Convention, apply English law to the question of whether the senior lenders' rights against the company had been varied by the scheme.  Thus the English court held that, although there would be no automatic recognition of the scheme under the Judgments Regulation, the lenders' rights would be found to have been varied after a trial on the merits. 

Comments
The Rodenstock-decision has been eagerly awaited in Germany as the company is a very high profile organization. This is the second successful scheme of arrangement for a German company, following the Tele Columbus restructuring in December 2010. Whilst this represents a further example of how the English scheme of arrangement has proved to be a useful mechanism for restructuring, it also highlights the need for the current German restructuring reforms to come into effect, so that a similar offering can be made in Germany to deal with companies in financial difficulty. It is very likely that the High Court's decision will clear the way for further restructurings of German companies via a scheme of arrangement. The Equitable Life scheme, whilst a significant decision, must be seen in context. Equitable Life had entered into a scheme of arrangement under which its liabilities would be run-off in the ordinary course albeit subject to the scheme terms) and was very different to the scheme proposed in relation to Rodenstock. It seems very unlikely, therefore, that a challenge of the Rodenstock-scheme on the same grounds could be successful.

Frank Tschentscher, Attorney at Law in Germany, Solicitor (England and Wales)

Does the IDW standard S 6 correspond to the provisions of jurisprudence?

In order to avoid negative legal consequences in case of the failure of restructuring efforts (e. g. avoidance claims according to sec. 133 para. 1 of the German Insolvency Code), the supervision of restructuring efforts by creditors depends generally on the preparation or the assessment of the restructuring concept by external third parties. Background of this is the corresponding jurisprudence of the German Supreme Court according to which the assessment of the capability of being restructured of companies is to be based on the opinion of an independent expert with experience in this branch.

Guido Koch
Dipl.-Kaufmann (certified business accountant/MBA equivalent)
Tax Consultant
Chartered Accountant

Guido Koch

The German institute for auditors (IDW = Institut für Wirtschaftsprüfer) had already passed a common standard  (FAR 1/1991) for the preparation and the assessment of restructuring concepts in 1991, according to which restructuring concepts must contain a thorough analysis of past data, a description of factors for the crisis and of the restructuring measures including a general approach for the restructured company as well as a so-called integrated prospective financial planning. The principles for auditors outlined in FAR 1/1991 have become widely accepted as general standard for the branch and were also recognized as standard for restructuring concepts (lastly Higher Regional Court Cologne 2009).

In 2009, the IDW further developed FAR 1/1991 to standard S6. Essential amendments to FAR 1/1991 comprise the introduction of the “step by step concept”, according to which in case of financial distress a prognosis concerning the continued existence of the company (first step) must be preceded by the actual restructuring assessment (second step) and an explicit examination of a possible obligation to file an insolvency of the company to be restructured must be performed.

Additionally, the term “capability of being restructured” was defined anew and now requires the reestablishment of competitiveness and the further capability of the affected company to be continued. In contrast, the confirmation of the capability of being restructured of a company had been considered sufficient according to FAR 1/1991, if exclusively “positive net current assets” were predicted during the planning period (as a rule for the current and next business year). Regarding the economic requirements concerning the capability of being restructured, standard S 6 exceeds its predecessor FAR 1/1991 and thus presents a further development and an advancement of the generally accepted economic principles for the preparation and examination of restructuring concepts.

Nonetheless, in recent times different parties had expressed their doubts that S6 could be accepted as the new standard for the examination and assessment of restructuring concepts. The reason was given that the concepts of IDW S6 do not correspond completely to the requirements of jurisprudence regarding restructuring concepts (cp. Pohl in ZInsO 6/2011 “Can IDW S6 become market standard?”). The main point of criticism is that according to S6 the expert must only decide, if “the company can be regarded as being capable of being restructured according to the assumptions and conditions of the concept”. A statement of the expert concerning the probability of the occurrence of the conditions required for the capability of being restructured is not requested by the S6 standard. This collides with the prerequisites of jurisprudence, which require an explicit statement of the expert concerning the objectively established capability of being restructured. In order to produce an expert opinion corresponding to the prerequisites of jurisprudence, an explicit assessment of the probability of the assumptions subject of the concept must therefore be effected.

This criticism was received differently by the creditors. Partially, an explicit confirmation of the capability of being restructured is meanwhile requested on the basis of the wording of jurisprudence.  It shall hereby be noted that the criticism is not related to the economic concept of IDW S6, which presents a further development of the generally accepted - especially also by jurisprudence – standards of FAR 1/1991. Insofar IDW S6 still represents the market standard. Therefore, it will ultimately be up to the creditor to decide in each case, if an explicit  statement concerning the capability of being restructured by the expert with quantification of the probability of occurrence of the assumptions made in the respective individual case is necessary to avoid negative legal consequences.

Guido Koch, Dipl.-Kaufmann (certified business accountant/MBA equivalent), Tax Consultant, Chartered Accountant

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