Matalan: (Some) Additional Clarity on the Impact of English Schemes and Chapter 15 on CDS
The Situation: On August 11, 2020, a Credit Derivatives Determinations Committee for EMEA ("DC") unanimously determined that the Chapter 15 filing by British retailer Matalan triggered a Bankruptcy Credit Event under standard credit default swaps ("CDS").
The Result: The DC's decision diverged from its only prior decision (involving Thomas Cook) on whether a Chapter 15 petition constituted a Bankruptcy Credit Event.
Looking Ahead: The DC statements accompanying the Thomas Cook and Matalan determinations provide useful guidance regarding the factors the DC will consider in determining whether a Chapter 15 petition and, to a lesser degree, an English scheme constitutes a Bankruptcy Credit Event. However, given that the purpose and terms of each scheme can vary considerably and there is a discretion as to what relief, if any, a company will seek pursuant to Chapter 15, it remains the case that whether an English scheme or Chapter 15 will constitute a Bankruptcy Credit Event needs to be carefully considered on a case-by-case basis.
English Schemes, the New Restructuring Plan, and Chapter 15
The English scheme of arrangement is a long-established procedure that can be used to alter the rights of creditors. Companies that would otherwise be unable implement corporate actions due to unanimous consent requirements under their finance documents may be able to use schemes to effect such actions if: (i) they can obtain the support of a statutory majority (>50% in number and ≥75% in value of creditors voting in person or by proxy) of each affected class of creditors; and (ii) the scheme is sanctioned by the court.
In addition to the English scheme, the new UK restructuring plan or "super scheme" (which has an approval threshold of ≥75% in value of creditors voting in person or by proxy) will be a key feature of UK restructuring market going forward. Unlike the scheme, the restructuring plan can be used to impose a cross-class cramdown on any dissenting class of creditor that does not vote in favor of the plan (subject to the satisfaction of certain conditions). Schemes and the new restructuring plan are a product of the Company Act 2006, which is not a bankruptcy or insolvency law, and can be used by solvent and insolvent companies alike.
Chapter 15 was added to the U.S. Bankruptcy Code in 2005 in order to adopt into U.S. law the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law in 1997. Chapter 15 was primarily designed to promote the fair and efficient administration of cross-border insolvencies; however, it can be used to recognize foreign proceedings under not only insolvency laws but also laws (such as schemes of arrangement) relating to the adjustment of debts.
Thomas Cook Scheme and Chapter 15
In August 2019, Thomas Cook Group Plc ("Thomas Cook") proposed an English scheme of arrangement. The scheme was somewhat unusual in that it did not itself seek to implement a restructuring. Instead, it sought to, among other things, lower certain approval thresholds in its finance documents so that the company could more readily implement a restructuring outside of a scheme. As is common with English schemes, Thomas Cook sought recognition of the scheme in the United States pursuant to Chapter 15 in order to prevent any creditor from taking any steps to act in breach of the terms of the proposed scheme pending its approval. Thomas Cook's Chapter 15, however, was also unusual in that it sought to waive the automatic stay that automatically accompanies recognition of foreign main proceedings (and often accompanies foreign non-main proceedings).
Matalan Scheme and Chapter 15
Like Thomas Cook, Matalan Finance Plc ("Matalan") also proposed a scheme of arrangement. The key purpose of the scheme, which was proposed as part of a wider balance sheet restructuring of the company, was to amend the terms of the company's 9.5% second lien secured notes to defer cash interest to payment-in-kind interest. On July 27, 2020, the English court sanctioned the scheme, and two days later Matalan sought recognition of the scheme as a foreign main proceeding under Chapter 15. Matalan did not seek to waive the automatic stay that would apply if recognition of the scheme were granted in the Chapter 15 proceeding.
The Bankruptcy Credit Event DC Determinations
Following the Chapter 15 filings of both Thomas Cook and Matalan, the DC was asked to consider whether a Bankruptcy Credit Event had occurred for credit default swaps subject to ISDA's 2014 and updated 2003 Credit Derivatives Definitions ("2014 Definitions" and "2003 Definitions"). The primary analysis conducted by the DC in each case was under limb (d) of the definition of "Bankruptcy." As set forth below, an important modification was made to this provision when the 2014 Definitions were published.
a the Reference Entity … institutes or has instituted against it a proceeding seeking a judgment of insolvency or bankruptcy or any other similar relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights….
As a result, under the 2003 Definitions, any proceeding seeking relief under a bankruptcy or insolvency or similar law will trigger a Bankruptcy Credit Event. Under the 2014 Definitions, however, the relief sought must be similar to a judgment of insolvency or bankruptcy.
The questions before the DC under the 2003 Definitions were fairly straightforward in connection with the Thomas Cook and Matalan Chapter 15 filings. The filing of a Chapter 15 petition commences a proceeding seeking relief under a bankruptcy law (the U.S. Bankruptcy Code) and triggers a Bankruptcy Credit Event under the 2003 Definitions.
The questions under the 2014 Definitions were far more complex. The key issue in each case was whether the relief sought was "similar" to that of a "judgment of insolvency or bankruptcy."
In considering the Thomas Cook case, the DC placed great emphasis on the fact that the company did not seek a stay of proceedings in the United States and that the Chapter 15 petition did not otherwise seek to compromise creditor rights independent of the scheme. On this basis, the DC considered that the relief sought in the United States was limited and did not constitute relief "similar" to that of a judgment of insolvency or bankruptcy. Thus, it concluded that a Bankruptcy Credit Event had not been triggered under the 2014 Definitions. The DC noted in the statement accompanying its decision that the case involved unusual facts and was "not necessarily indicative of how the DC would approach chapter 15 filings in general."
As foreshadowed, the DC indeed reached the opposite conclusion in connection with Matalan's (more typical) Chapter 15 filing. It determined that Matalan's Chapter 15 had triggered a Bankruptcy Credit Event under the 2014 Definitions, as it sought additional consequences affecting creditor rights (including the automatic stay) that, combined with the effect of the scheme itself, would constitute "similar relief" to a judgment under bankruptcy or insolvency law.
Can an English Scheme Itself Constitute a Bankruptcy Credit Event?
DC determinations in recent years have provided insight regarding which types of proceedings are likely to trigger Bankruptcy Credit Events under the 2014 Definitions. We now have evidence that a Brazilian RJ plan, a Dutch moratorium, an Italian concordato con riserva, or a French sauvegarde can constitute "similar relief," but a Spanish preconcurso likely will not. We have less clarity in connection with English schemes.
The DC did not directly address whether the Matalan scheme itself constituted a Bankruptcy Credit Event (and Thomas Cook's scheme was never implemented). However, the DC has effectively acknowledged that a one-size-fits-all approach cannot be taken in respect of English schemes. Limb (c) of the Bankruptcy definition specifically relates to schemes, providing that a Bankruptcy Credit Event will occur if the Reference Entity "makes a general assignment, arrangement, scheme or composition with or for the benefit of its creditors generally."
However, in many situations, a scheme is not an arrangement with or for the benefit of its creditors generally. As in the case of Matalan, a company that has multiple outstanding financial obligations and implements a scheme that impacts only certain of those obligations would be unlikely to constitute a scheme or arrangement with its creditors generally. Accordingly, the question as to whether an English scheme will constitute a Bankruptcy Credit Event pursuant to limb (c) needs to be considered on the facts of each case.
A Bankruptcy Credit Event could also arise in connection with a scheme under limb (b) of the Bankruptcy definition on the basis that the reference entity "becomes insolvent or is unable to pay its debts or fails or admits in writing in a judicial proceeding … or filing, its inability generally to pay its debts as they call due." While many scheme applications will include an admission that a default or insolvency is imminent if relief is not granted, as illustrated by Thomas Cook and Matalan, that will not always be the case.
Can an English Scheme Itself Constitute a Restructuring Credit Event?
Whether or not a scheme will trigger a Restructuring Credit Event will also depend on the specific facts and circumstances of the scheme. The DC was asked to consider whether the Matalan scheme gave rise to a Restructuring Credit Event but deemed such a decision unnecessary following the bankruptcy determination. Given that the scheme involved a deferral of interest (one of the enumerated types of events that may constitute a restructuring) that was binding on all holders of the second lien notes, the key question for the DC would have been whether the modification resulted from a deterioration in the creditworthiness or financial condition of the company. This consideration is always fact-intensive and adds an element of uncertainty to all restructuring determinations.
Four Key Takeaways
- Together, the Thomas Cook and Matalan determinations provide important guidance regarding the factors a DC is likely to consider in deciding whether a Chapter 15 filing seeks "similar relief" to a judgment of insolvency or bankruptcy and thus triggers a Bankruptcy Credit Event under Section 4.2(d) of the 2014 Definitions.
- The DC decisions are less instructive regarding when an English scheme will constitute a scheme or arrangement with or for the benefit of its creditors generally and thus trigger a Bankruptcy Credit Event under Section 4.2(c) of the 2014 Definitions.
- Consideration of whether an English scheme or U.S. Chapter 15 is likely to trigger a Bankruptcy Credit Event or Restructuring Credit Event under the 2014 Definitions requires thoughtful analysis and will largely depend on the facts and circumstances of each case.
- The growing usage of schemes, and now super schemes, is likely to significantly impact the CDS market over the coming years, and we should expect many of such schemes to be crafted with CDS implications in mind.
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