Scheme of Arrangement: How the Vote Binds a Holdout

A syndicated or club facility lets the majority lenders waive a covenant or change most terms. The terms that go to the money are different. Extending the maturity, reducing the principal or the interest, or releasing the security commonly needs every lender. That protects each lender from being outvoted on what it is owed, and it also hands any single lender a veto. A holdout can block a refinancing everyone else supports, or hold out to be bought out at a better price than the others.

A scheme lets the statute do what the contract will not. It is a compromise or arrangement between the company and its creditors, or a class of them, that becomes binding on every member of each class once approved and sanctioned. It can also bind members, which is why schemes are used for takeovers as well as debt.

There are three stages. The company applies to the court for an order to call meetings, and the court considers at that point how creditors should be grouped. The classes meet and vote. The company returns to the court for sanction, where the court checks that the statutory majorities were reached, that the classes were properly drawn and that the scheme is one a fair-minded creditor could approve.

Classes are drawn by rights, not by interests. Creditors belong together if their rights against the company, both now and in the alternative the company faces if the scheme fails, are not so different that they cannot consult together in their common interest. Lenders with different security, ranking or currency may form separate classes. Draw too many classes and each becomes a veto; too few and the court may refuse to sanction. In practice the lenders who support a scheme usually also sign a standstill or lock-up while it is prepared, because the scheme itself does not stop a creditor from acting in the meantime.

A cinema chain, constructed for this page like every figure in it, owes US$150m under a term loan from six lenders. The loan matures in seven months, and the chain cannot refinance in time. The proposal extends maturity by three years in exchange for a higher margin and a cash sweep. The agreement requires every lender to consent to a maturity change. Lender F, holding US$8m, refuses unless it is repaid at par. The chain proposes a scheme with the six lenders as a single class, all voting.

The first line is the scheme doing its job: a small holdout is bound once the rest agree. The second shows why the headcount exists. Two large lenders cannot impose terms on four smaller ones, even with more than 75% of the debt. The third shows the value limb: one large lender's no can sink a scheme the majority by number supports. The percentages are of those present and voting, so a lender that stays away drops out of both counts. Under a UK restructuring plan there is no headcount, and the second line would pass on value.

Each market has a cheaper way to bind creditors by majority, and the difference is usually what happens to secured lenders. In Australia, a deed of company arrangement reached through voluntary administration binds unsecured creditors, but binds a secured creditor only if it voted for the deed. In New Zealand, a creditors' compromise under Part 14 binds by class vote without court sanction, with an objecting creditor able to apply to the court. In the UK, a company voluntary arrangement cannot affect a secured creditor's right to enforce its security without that creditor's agreement.

A scheme can put secured lenders in a class of their own and bind that class. That is why, in the UK and Australia, it is the tool for changing the terms of senior debt itself, and why the court's role in checking classes and fairness is heavier than in the alternatives.

DEFINED IN ONE PARAGRAPH → · MAJORITY LENDERS → · CREDITORS' COMPROMISE →

For a lender in a club or syndicate, the possibility of a scheme changes the negotiation before anyone files. A holdout's veto is worth less when the borrower can show the vote would pass, and the arithmetic of heads and value tells each lender how much its own vote counts. A credit officer recommending a vote compares the scheme's terms with the alternative the court will also look at, usually an insolvency in which the lender's recovery is lower and later.

For most mid-market borrowers with one or two banks, a scheme is not the route. Court hearings, explanatory statements and advisers cost more than a bilateral renegotiation, and a single bank can simply agree. Schemes belong where debt is spread across many holders, as in larger syndicated loans, private placements and bonds.

PROBLEM LOANS AND WORKOUT → · THE HAIRCUT →