Introduction
With levels of distressed debt and corporate bankruptcies on the rise, it is quite timely that we revisit the interesting intersection of English law distressed debt, U.S. bankruptcy proceedings (in particular, under Chapter 11 of the U.S. Bankruptcy Code) and the century-old Rule in Gibbs in the context of cross-border restructurings.
Under English law, a formal insolvency procedure is often the only alternative for a debt issuer in financial difficulties that is not able to restructure successfully on a consensual basis. If an issuer has assets in the United States, instead of commencing a formal restructuring or insolvency procedure under English law, it may opt for effecting a restructuring of its debt using Chapter 11 bankruptcy proceedings. A very recent example is Cineworld Group, which had issued English law debt instruments. In late 2022, Cineworld Group and certain of its affiliates filed petitions for relief under Chapter 11 in the U.S. Bankruptcy Court for the Southern District of Texas. The company recently emerged from Chapter 11 bankruptcy with a plan of reorganisation that cut its global debt by approximately US$4.53 billion.
U.S. Chapter 11 proceedings
“Chapter 11” of title 11 of the United States Code (the U.S. Bankruptcy Code) provides for a reorganisation or structured liquidation process controlled by the debtor-in-possession under U.S. federal law.
The commencement of a Chapter 11 case creates an “estate” comprising all legal or equitable interests of the debtor in property as of the commencement of the case, including tangible and intangible property, wherever located, as well as causes of action. A Chapter 11 filing also immediately triggers an “automatic stay”, a broad statutory injunction that operates to enjoin most creditors from pursuing actions or exercising remedies to recover against a debtor and its property.
Chapter 11 plans (of reorganisation or liquidation) set forth how creditors’ claims will be treated by a debtor’s estate. Under a Chapter 11 plan, creditors and shareholders are divided into classes of holders sharing substantially similar claims or interests. Although Chapter 11 provides an opportunity to significantly restructure debts, Chapter 11 debtors are subject to the “absolute priority rule”, which provides that creditors with higher priority must be paid in full before creditors of lower priority receive any distribution from the bankruptcy estate. Accordingly, absent consent, secured claims must be paid in full from collateral before general unsecured creditors receive any recovery. Similarly, absent consent, equity holders cannot receive any distribution until all creditors have received payment in full on account of their allowed claims. A Chapter 11 debtor emerges from bankruptcy protection when its confirmed plan becomes effective, after which the debtor may resume operating without court oversight.
The U.S. Bankruptcy Code provides that a bankruptcy court may take jurisdiction over a debtor and its “estate” if the debtor has property in the United States. There is no requirement that a debtor be organised in the United States to avail itself of Chapter 11 protection. If a non-U.S. entity with minimal contacts with the United States files for bankruptcy protection in the United States, whether foreign courts will recognise and enforce the effect of the Chapter 11 may not be certain. As a practical matter, however, the risk of violating the automatic stay and being held in contempt of a U.S. court has proven effective at deterring financial institutions and other parties who do business in the United States from attacking a Chapter 11 debtor or its property in foreign jurisdictions, irrespective of foreign recognition.
Where there are material foreign creditors that do not do business in the United States, or where the debtor desires maximum certainty that the effect of a Chapter 11 plan will be respected, obtaining foreign recognition of a Chapter 11 case may be prudent.
In certain jurisdictions – such as those that, as a matter of local law, do not recognise foreign judgments – issues regarding recognition (and enforcement) of the U.S. Bankruptcy Code and orders of a U.S. bankruptcy court may present unique issues.
Recognition of U.S. bankruptcy proceedings under English law
Cross-border recognition of formal insolvency/bankruptcy proceedings is complex and achieved in several different ways depending on the fact pattern, particularly as between the United States and the UK. One of the reasons for this is the Rule in Gibbs, which must be carefully navigated in cross-border restructurings. The Rule refers to the principle outlined in Anthony Gibbs & Sons v. La Société Industrielle et Commerciale des Metaux [1890] 25 QBD 399 and is authority for the proposition that, absent agreement of the creditor, debt obligations governed by English law cannot be compromised or discharged by foreign insolvency proceedings.
There is an exception to the Rule in Gibbs, highlighted in Re OJSC International Bank of Azerbaijan [2019] Bus. L.R. 1130, which applies where the relevant creditor submits to the foreign insolvency proceedings. In the context of English law bonds constituted by a trust, if the bond trustee and/or bondholders have submitted to Chapter 11 bankruptcy proceedings (through participation in the insolvency process, which can happen in a variety of ways such as by filing a claim in respect of their bond debt with the relevant U.S. bankruptcy court, participating in discussions on the plan of reorganisation including creditor committee appointment and voting on the plan of reorganisation), the exception to the Rule in Gibbs applies. As a result, confirmation of a plan of reorganisation in accordance with the U.S. Bankruptcy Code will be effective to compromise the English law bonds pursuant to the terms of the confirmed plan of reorganisation without further recognition in the UK.
Notwithstanding this, UK company law and applicable regulations must still be complied with where the debtor is incorporated in England. Consequently, where the Chapter 11 plan anticipates actions such as the allotment of shares as part of a debt for equity swap concerning the shares in an English incorporated company, either shareholder and other consents will be required or use of a UK legal process in parallel to implement this, such as a Restructuring Plan (described below) or pre-pack administration.
Where the exception to the Rule in Gibbs does not apply, confirmation by the U.S. bankruptcy court of the Chapter 11 plan of reorganisation will not be effective to compromise English law-governed debt obligations without further steps to implement it under English law, and the bond trustee may seek to recover its debt claim (on behalf of bondholders) under English law by pursuing its ordinary remedies, subject to the risk of violating the automatic stay and contempt of court risk. One of the most effective routes to recognition of the Chapter 11 plan of reorganisation under English law may be to effect a parallel scheme of arrangement, such as a restructuring plan under Part 26A of the Companies Act 2006 (the Restructuring Plan). However, a “one size fits all” approach may not work when selecting the legal process for implementation purposes in the UK, which must be assessed in each case. For example, for listed companies, a Restructuring Plan cannot override the Listing Rules’ requirement for cash share issuances to be on a pre-emptive basis, resulting in the need for shareholder approval or cancellation of the listing by the FCA, neither of which will necessarily be forthcoming, which could mean a Restructuring Plan is not suitable. In Cineworld’s case, a Restructuring Plan was not used, though a pre-pack administration was used to implement a debt for equity swap in relation to one section of the debt stack.
The Restructuring Plan is based on the scheme of arrangement or scheme, which has been successfully used for many years in the UK as a restructuring tool. A Restructuring Plan is a court-supervised process which leaves the debtor in possession and can deliver adaptable outcomes, including debt restructures and debt for equity swaps. It does not, however, involve the application of a worldwide moratorium, though it is possible (in certain circumstances) to apply to stay proceedings and a separate parallel moratorium process may be available in the form of the Part A1 Moratorium under the Insolvency Act 1986.
Key new features of the Restructuring Plan include (a) the absence of a numerosity test (75% in value of each class voting in favour being sufficient), subject to cross-creditor cram down, (b) the requirement of a genuine economic interest which can permit the exclusion of “out of the money” creditors from voting, and (c) cross-creditor cram down. While some elements have similarities with the Chapter 11 process, there are differences in that with Restructuring Plans, (i) the absolute priority rule does not apply, (ii) “debtor-in-possession” financing is not available, and (iii) creditor objections occur at the convening hearing and on sanction, as opposed to the regular hearings on creditor objections throughout the Chapter 11 process.
Plans for reform in the UK?
In the context of the Rule in Gibbs, there are plans for reform, including the UNCITRAL Model Law on the Recognition and Enforcement of Insolvency-Related Judgments, which provides a framework for the recognition and enforcement of insolvency-related judgments originating from foreign jurisdictions. However, in July 2023 the UK government decided to undertake further work to determine how legal certainty can be maintained, and thus has not yet implemented this UNCITRAL Model Law.
If adopted in the UK, the UNCITRAL Model Law could have the effect of undermining the Rule in Gibbs by providing for English courts’ recognition and enforcement of foreign courts’ insolvency-related judgments regarding contracts governed by English law. Other reform in the shape of the UNCITRAL Model Law on Group Insolvencies is to be implemented at the earliest opportunity in England. This UNCITRAL Model Law provides a formal framework for cross-border group insolvencies. The status of Restructuring Plans as “insolvency related proceedings” for this purpose is to be determined by the courts in each jurisdiction on a case-by-case basis.
In conclusion, unless new legislation is enacted in the UK that modifies or overturns the Rule in Gibbs, the English law principle of freedom of contract and its applicability in the context of restructuring and insolvency proceedings (subject to applicable exclusions) is here to stay, for now at least.
What of “Chapter 15” recognition?
Although the Rule in Gibbs casts doubt on whether English courts will recognise modifications to the rights of parties to English law contracts effected under the U.S. Bankruptcy Code, a similar issue does not arise when it comes to recognising the effect of modifications of New York law governed debt pursuant to an English scheme of arrangement. The United States has adopted the UNCITRAL Model Law on Cross-Border Insolvency 1997 in the form of Chapter 15 of the U.S. Bankruptcy Code. A Chapter 15 recognition proceeding provides non-U.S. companies in foreign restructuring or insolvency proceedings with the means to protect their U.S.-located assets from enforcement proceedings or direct appropriation by individual creditors.
Where such recognition is granted by the U.S. bankruptcy court, Chapter 15 provides for an automatic stay that protects the debtor’s U.S.-based assets.
In essence, if a U.S. bankruptcy court recognises a UK scheme of arrangement as a “foreign main proceeding”, Chapter 15 provides for a stay in the United States where the debtor’s “centre of main interests” is located in the UK.
In-depth 2023-258
