Restructuring Russian companies in England
September 2014 | EXPERT BRIEFING | BANKRUPTCY & RESTRUCTURING
Companies throughout Europe, North and South America and the Middle East are using English law to restructure in times of financial difficulties. English law provides more flexibility in the techniques used, and does not require the consent of all creditors. The process tends to be quick and efficient with a focus on restructuring (rather than liquidation). The English insolvency regime is accessible to non-English companies due to the English courts’ willingness to claim jurisdiction over the restructuring of a non-English company.
The economic sanctions imposed by the European Union and other jurisdictions on certain Russian individuals and entities as a response to the conflict in Ukraine may make the use of English insolvency laws more appealing and necessary to Russian companies. Russian companies which are owned by, conduct business with or are connected to sanctioned individuals or entities may experience a decrease in, or restrictions on carrying on, business and, as a result, face financial difficulties. Further, companies not connected to sanctioned individuals or entities but operating in Russia or affected by sectoral sanctions in Russia may also be impacted as international consumers, investors and lenders take a more cautious approach to doing business in Russia or with Russian companies.
Russian insolvency law
Russian insolvency law provides that a company’s management or beneficial owner must file a bankruptcy petition as soon as possible where: (i) the payment of one or more of the debts owed by the company would result in its inability to pay all other creditors’ claims in full; (ii) enforcement action against the company’s property will significantly complicate or render the continuation of its operations impossible; or (iii) the company fails a cash flow or balance sheet insolvency test.
If a company satisfies the formal insolvency criteria above, then in accordance with Russian law, insolvency proceedings must take place in Russia. Russian law unequivocally provides that any bankruptcy proceedings with respect to a Russian company must take place in the commercial court where the debtor is registered. At this stage, a Russian company would be unable to utilise English insolvency laws.
Further, a creditor may initiate bankruptcy proceedings against a Russian company where that company has been indebted to the creditor for a period of three months or longer and the aggregate amount of the claim is RUB 100,000 or more. It is, therefore, extremely important for a Russian company in financial difficulty to consider restructuring its debt at an early stage. There are two basic methods of restructuring a non-English company in England. First, shift the COMI of the company to England and enter into a pre-pack administration. Second, implement a scheme of arrangement.
EU Council Regulation No. 1346/2000 on insolvency proceedings (EU Regulation) came into force on 31 March 2002, providing uniform rules for the resolution of cross-border insolvencies in the EU. However, it can also apply to non-EU companies. Article 3(1) of the EU Regulation introduces the concept of a company’s centre of main interests (COMI). A company can only have one COMI and its location determines the jurisdiction and applicable insolvency laws. The legal presumption is that the location of a company’s registered office is its COMI and it is for the company to prove otherwise. As a company’s COMI is decisive in determining the applicable insolvency laws, many companies move their COMI to benefit from more favourable insolvency regimes. A Russian company can benefit from English insolvency laws if it moves its COMI to England. Having its registered office in England allows the English courts to assert jurisdiction over the insolvency proceedings. In Re Gallery Media Group (unreported), a Russian advertising company moved its COMI to England to facilitate its use of an English scheme of arrangement. The scheme was approved by the group’s creditors and sanctioned by the courts in May 2010. Using the scheme, Gallery Media was able to reduce the group’s total indebtedness from $342.2m to $100.3m.
Once a Russian company successfully shifts its COMI to England, it can then enter into a pre-packaged administration sale (pre-pack). The pre-pack process involves a company being put into administration and the administrators then selling the company or its assets in a sale that was agreed, with the administrator’s knowledge, prior to the company going into administration. The appeal of a pre-pack to a Russian company or any company is twofold. Firstly, the process is fast; the sale of all or part of the company can take place as early as the date of administration. Secondly, it is possible to transfer solvent parts of the business quickly and easily before the negative connotations that come with insolvency do irreparable harm to the business.
The efficiency of a pre-pack is evidenced in Re Hellas Telecommunications (Luxembourg) II SCA  EWHC 3199 (Ch), where a company in financial difficulty moved its COMI from Luxembourg to London and was then sold using the pre-pack process. The court concluded that the company successfully moved its COMI to England because, among other things, the company’s head offices were now in London, it had registered at Companies House as a foreign company and all negotiations with creditors were held in London (as opposed to Luxembourg). Prior to applying for administration, a buyer for the company was selected and the terms agreed. The buyer, in this instance, was linked to the creditors of the company. The application for administration was granted on 26 November 2009, with the sale of the company finalised the next day.
Some distressed companies may be reluctant to shift COMI. For example, a Russian company may not want to shift COMI as there might be tax and reputational benefits associated with having its COMI in Russia. Fortunately, the English courts’ continuously flexible approach to company restructurings has minimised the importance of COMI shifting. Russian companies can now keep their COMI in Russia whilst having access to the English insolvency regime.
Schemes of arrangement
The most popular weapon in the English insolvency armoury is the scheme of arrangement. A scheme of arrangement is a statutory procedure, governed by Part 26 of the Companies Act 2006, which allows a company to enter into an arrangement or compromise with its creditors or shareholders (or any class of them). Schemes of arrangement have proved to be a popular restructuring tool for English and non-English companies because they fall outside the scope of the EU Regulation. The EU Regulation applies to collective insolvency proceedings listed in Annex A of the EU Regulation. However, a scheme of arrangement is not considered to be a formal insolvency process and is not listed in Annex A. Consequently, companies with their COMI and establishment outside England can still use schemes of arrangement. Schemes of arrangement appeal to companies wishing to avoid the stigma of insolvency but are nevertheless in need of restructuring. Further, a scheme can be used even when insolvency is not in prospect. A scheme can be used during takeovers, demergers, to overcome objections by minority shareholders or lenders, or to allow a company to reorganise its equity and debt.
Once a scheme is proposed, an application is made to the court for an order that a meeting of the relevant creditors or shareholders be held to seek approval for the scheme. A scheme is approved when more than 50 percent in number and 75 percent by value of each class approve it. After a scheme is approved by the relevant class of shareholders or creditors, the company must seek the court’s approval. The court has discretion whether to approve a proposed scheme. Once a scheme is approved by the court, it binds all creditors and shareholders to which it applies. Essentially, the scheme allows a majority of the shareholders or creditors in each class to bind the minority in that class.
The difficulty for a Russian company trying to implement an English scheme of arrangement arises where it has Russian creditors who refuse to be bound by the proposed scheme and reject the English court’s jurisdiction. There is no treaty or reciprocity agreement between Russia and England requiring Russian courts to recognise and enforce English judgements. A Russian creditor could still initiate insolvency proceedings in Russia and refuse to adhere to the terms of a scheme. The Russian courts will then have discretion to recognise the scheme or continue with insolvency proceedings. An English scheme of arrangement is, therefore, best used by a Russian company in agreement with all of its creditors or with creditors unlikely to reject the English court’s jurisdiction. It can also be applied where Russian corporate structures contain offshore holding companies located in jurisdictions which recognise English court judgments.
If a Russian company can gain creditor support to apply for a scheme of arrangement then the English scheme procedure is potentially accessible to it. English courts are willing to approve a scheme in respect of a foreign company provided there is a “sufficiently close connection with England and Wales which may, but does not necessarily have to, consist of assets within the jurisdiction”, as per Knox J in Re Real Estate Development Co .
The courts have taken a liberal view as to what constitutes a sufficient connection. In September 2013, the High Court sanctioned a scheme of arrangement for Vinashin, a Vietnamese company. The courts established jurisdiction on the basis that the loans to be restructured under the proposed scheme were governed by English law. Interestingly, Vinashin opted for the English scheme procedure because of the uncertainties associated with the application of Vietnamese law.
Generally, distressed companies are becoming less constrained by national boundaries. As companies continue to operate globally and choose laws outside their own jurisdiction to govern their agreements, it seems likely that they will continue to try and enforce their right to choose the laws that govern their restructuring and insolvency proceedings. The Russian court system is widely criticised for being susceptible to political and other external pressures. Therefore, Russian companies, especially those with foreign creditors, may be drawn to the consistency and impartiality offered by the English courts. It should be possible, for example, for a Russian corporate group to restructure its debt portfolio using a scheme of arrangement where its only nexus to England is a facility agreement governed by English law. The possibility of a Russian court not recognising or enforcing an English scheme as it applies directly to a Russian company complicates matters but is not an insurmountable hurdle if the company works with its creditors to develop a restructuring plan that works for all parties or determines that any non-Russian dissenting creditors are unlikely to challenge the scheme in the Russian courts. Shifting COMI may practically be more difficult for a Russian company to achieve. However, whether it is through shifting their COMI or establishing a sufficient connection to England for the purposes of a scheme of arrangement, Russian companies can evidently benefit from the flexibility of English insolvency laws.
Amanda Jennings is a partner and Sonia Namutebi is a trainee at Morgan Lewis. Ms Jennings can be contacted on +44 (0)20 3201 5599 or by email: firstname.lastname@example.org.
© Financier Worldwide
Amanda Jennings and Sonia Namutebi