How common law duties and obligations can limit majority power and protect minorities in a restructuring
October 2021 | SPECIAL REPORT: RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
October 2021 Issue
Readers will no doubt be familiar with Socimer and Braganza-style duties in relation to a contractual discretion, and the much-discussed but little-applied limitations on majority power imposed by Redwood and Assenagon. In this article, we consider how those duties may impact restructurings effected through contractual powers or amendments to those powers by majority amendment or consent, and the powers that the minority may have irrespective of a lack of a blocking position.
Exercise of contractual discretions – Socimer and Braganza
Since the Court of Appeal’s decision in Socimer International Bank (In Liquidation) v Standard Bank London in 2008, it has been clear that the exercise of a contractual discretion by the relevant contracting party can be subject to principles of reasonableness, meaning that the discretion cannot be exercised arbitrarily, capriciously or irrationally. When the Supreme Court considered this in Braganza v BP Shipping, it made it clear that the duty to exercise contractual discretions in this way was always subject to the context and exact wording of the contract in question, such as whether the contract was ‘relational’, the balance of power between the parties, and potential conflicts of interest for the decision maker. The Supreme Court also stated that a Braganza duty could not arise where a party had a unilateral right, rather than a discretion, under the contract.
These limitations restrict but do not remove the application of these duties to financial restructurings.
The facts of the Socimer case itself concerned two financial institutions (Socimer International Bank and Standard Bank) and arose because of a disputed valuation of Socimer’s investment portfolio by Standard Bank, following Socimer’s payment default. Alongside the more highly-publicised aspects of the case relating to the principles of good faith and exercise of discretions, the Court of Appeal spent some time considering how Standard Bank should have approached the discretionary valuation process, both in terms of procedure and outcome. Subsequent cases have treated similar ground – including a raft of cases considering valuations or close-out amounts for the purposes of claims in or out of on insolvent estate.
Abuse of majority power doctrines
Separately, but potentially relatedly, case law most recently dealing with exit consents has sought to limit the ability of a majority to exercise rights under a contract to the detriment of a minority.
English law has long recognised principles prohibiting abusive majority behaviour. It began to be applied in a financial restructuring context in British American Nickel v O’Brien where the court was asked to consider majority-approved amendments to security documents as part of a wider restructuring. The English court concluded that a majority using their amendment powers must act “for the benefit[…] of the class as a whole and not merely individual members”. The English High Court approved and expanded on this reasoning in Redwood Master Fund v. TD Bank Europe, where it was asked to consider the majority-approved amendment of a syndicated facility agreement that appeared to benefit lenders of the drawn facility to the detriment of the lenders of the undrawn facility. In fact, on the facts of the case, the court found that there was no reason to block the proposed amendment. The amendment was borrower-driven and the fact that there was some potential conflict between the majority and the minority was not sufficient; it would be practically impossible for parties to always exercise powers in a way which was for the benefit of all others.
A pair of cases – Azevedo v Incopa Importacao, Exportacao E Industria and Assenagon v IBRC – before the English courts in 2012 and 2013 brought these principles into sharper focus in the context of bondholders and restructurings. In Azevedo, a Brazilian soybean group sought to solicit consents from its bondholders – to amend the terms of the bonds, including to defer interest – in return for a consent fee. The English High Court concluded that the payment of a consent fee necessarily to some bondholders (the consenting ones) but not others (the dissenting ones) did not invalidate the amendment, including because under English law a consent fee did not constitute a bribe, so long as the consent fee and process was open and transparent, and equally available and payable to all bondholders if they so wished to consent. However, in Assenagon, the English High Court invalidated a majority-approved resolution to wipe out value in bonds (by granting the issuer the right to redeem at a very low value) where the consenting majority had exchanged their ‘old’ (and now value-less) bonds for new bonds as part of the exit consent package. In doing so, the judge recognised that making an exit consent offer to all members of the class was not sufficient where the offer was coercive and of no benefit to the class as a whole. Assenagon has since been considered, including in Cooperative Bank where the High Court was satisfied that a restructuring package was valid where minority dissenting holders were ‘dragged along’ rather than left behind, a decision reached in the context of a fear of a zero-recovery outcome in circumstances where the high-profile restructuring did not go ahead, and the bank collapsed.
Looking ahead
Outside of a valuation or close-out context, relevant case law explaining the application of these principles in a restructuring and insolvency context remains relatively rare. However, we expect these issues may have increasing prominence as we see the next wave of contentious restructuring disputes, once the markets steady after the removal of government support to businesses.
For example, we anticipate the application of the Socimer and Braganza principles in a restructuring context, where one contracting party is being ‘leaned on’ or is incentivised to act in the interests of a third party – such as one to which it may sell its interests – and takes steps that are, on their face, against their own interests because they are facilitating the interests of that party. This sort of scenario will inevitably attract scrutiny and, quite possibly, challenge from the harmed contracting party, who may raise the conflict of interest and the lack of commercial rationale as a basis for arguing that discretionary contractual rights were not used for their proper purpose and that this brings the exercise of those rights into Socimer and Braganza territory.
We also expect to see majority abuse arguments raised, although the way that the English courts will approach majority abuse and minority discrimination arguments in less-extreme fact patterns than Assenagon remains unclear. A smart borrower or issuer with time on its side may look to deploy a ‘creep’ package of amendments and waivers which is step-by-step less egregious (but collectively very detrimental) rather than a single, obvious amendment or exit, leaving a minority to argue about overarching strategy and long-term positioning in any litigation on this point.
Parties should therefore remain mindful that their contractual powers may be significantly limited by something which is not written down in front of them, on the face of the contract itself. A defaulting borrower may find itself well able to seek to argue for the imposition of Socimer or Braganza duties on a lender, to fend off post-default behaviour and protect its position. Cross-lender attacks could arise on a similar basis. This is particularly where conflicts of interest across the structure give rise to argument that a party is wearing the wrong ‘hat’ when voting on any amendment, waiver or restructuring. For example, where a sponsor holds both equity and debt and is voting on debt amendments, or where lenders sit at different levels in the debt structure, and the proposal on the table suits one of those positions but not the other, arguments will arise that it is not acting in accordance with the principles in this article and considering the benefits to the ‘right’ class.
Further, a party may find a more fruitful line of attack exists where it is a minority in a class compared to a bilateral-only arrangement. As a matter of principle, Redwood or Assenagon-style arguments have wider application than Socimer or Braganza duties (whose existence can turn on the type of relationship), perhaps quite rightly reflecting the potential powerlessness of a minority without a blocking position.
And as a matter of practice?
How should parties approach this, where concerns as to the exercise of powers arise? One route is injunctive relief, seeking urgent relief from the English courts to hold the ring while any dispute is resolved (and then resolving that dispute as quickly as necessary). Parties should, of course, carefully consider the costs-undertaking downside of an injunction (such as the liability for the winning party’s costs, if the injunction was wrongly obtained), but also not be unnecessarily deterred if there is limited risk of such liability arising in the circumstances. Alternatively, a party can consider pre- or post-declaratory relief, asking the English courts to declare any amendment or waiver (or other action, as appropriate) invalid.
Fiona Huntriss and Neil Pigott are partners and Nick Turvey is counsel at Boies Schiller Flexner (UK) LLP. Ms Huntriss can be contacted on +44 (0)20 3908 0723 or by email: fhuntriss@bsfllp.com. Mr Pigott can be contacted on +44 (0)20 3908 0754 or by email: npigott@bsfllp.com. Mr Turvey can be contacted on +44 (0)20 3908 0800 or by email: nturvey@bsfllp.com.
© Financier Worldwide
BY
Fiona Huntriss, Neil Pigott and Nick Turvey
Boies Schiller Flexner (UK) LLP
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