Financially stressed companies often seek to agree significant changes of the terms of their debts with their lenders outside of a formal insolvency process. It is not unusual for borrowers to be able to persuade a majority of creditors to agree to radical amendments, often in the teeth of objection from minority creditors. This Client Alert highlights some recent key case law relating to the protection of dissenting creditors using the doctrine of minority oppression. It also discusses a more recent case, where a judge declined to use this doctrine.

This Client Alert highlights some recent key case law relating to the protection of dissenting creditors using the doctrine of minority oppression. It also discusses a more recent case, where a judge declined to use this doctrine.

Introduction
In the UK, market bonds or notes and even syndicated bank debts (which we will refer to collectively as “Notes”) often include a threshold percentage which, assuming the relevant majority of noteholders have consented, enables the issuer of debt to amend the terms of Notes. In recent years there have been two cases – Assénagon Asset Management SA v IBRC and Azevedo v Imcopa – which we discuss below and which examine the rights of Noteholders who do not agree to the proposed changes.

More recently there has been another decision – Myers v Kestrel Acquisitions Limited – which addresses the limits on the ability of Note issuers to vary the rights attaching to the Notes they have issued. Unlike Assénagon and Azevedo, which focused on arguments between the majority holders versus the minority holders, the key focus of Myers v Kestrel was whether issuers of debt have duties towards Noteholders when making amendments to Notes.

We have summarised the three recent key cases below and discuss the impact of these cases for borrowers seeking amendments to their debt terms.

What happened in Myers?
The Myers were the beneficial owners of Swift Advances PLC (“Swift”), a company involved in sub-prime lending. In 2004 they sold Swift to Kestrel Acquisitions Limited (“Kestrel”). Kestrel paid part of the price by issuing vendor loan notes (“VLNs”) to the Myers.

Kestrel funded the acquisition largely by issuing unsecured discounted loan notes (“DLNs”) to its indirect shareholders – Alchemy and Indigo.

The VLN instrument stated that the VLNs would rank equally with the DLNs and that Kestrel was required to amend the terms of the VLNs (without the VLN holders’ consent) to ensure they remained consistent with the terms of the DLNs.

Swift suffered financial difficulties. In 2007, 2008 and 2009, Kestrel issued further “follow-on” loan notes (“FONs”) to its indirect shareholders. Each time, Kestrel and its indirect shareholders amended the DLNs to postpone their maturity date and subordinate them to the FONs. Each time Kestrel amended the DLNs, it made the same amendment to the VLNs.

As a result, the VLNs were subordinated to the FONs to the tune of around £102 million and their maturity date was postponed by almost eight years.

The Myers claimed the amendments were invalid for three reasons:

• Kestrel and its indirect shareholders should have acted in good faith when amending the DLNs and (consequently) the VLNs, because the majority of a class was trying to bind the minority (the “minority oppression” argument).
• Kestrel should also have acted in good faith because it was exercising a contractual right to amend the loan notes without the Myers’ consent.
• The amendment was invalid because, by postponing the maturity date (potentially indefinitely), it was effectively extinguishing the Myers’ rights under the loan notes.

What did the court say?
The court rejected all three arguments.

It said there was no possible minority oppression here because the Myers were the only persons holding VLNs. Kestrel was the issuer of the VLNs, and its indirect shareholders held DLNs, an entirely separate security from the VLNs. Neither Kestrel nor its indirect shareholders were in the same class as the Myers. The Myers themselves were the entire class, so there was no “majority” who could have oppressed them.

It said Kestrel did not have to act in good faith when amending the VLNs. If Kestrel had had a choice over how to exercise its right (i.e. what kind of amendment to make), that would have been a different matter. However, Kestrel was only allowed (and, indeed, was required) to make the change it made, because it was required to ensure they remained aligned with the DLNs. It had no choice in the matter.

Finally, it said that merely postponing the maturity date of the VLNs did not extinguish the Myers’ rights. Swapping them for some other asset (e.g. shares) would have been unacceptable, but merely postponing repayment was permitted.

The court didn’t refer to either Assénagon or Azevedo, but we think it is important to consider the Myers case in the overall context of the case law relating to amendments of debt.

Who is oppressing whom?
In Assénagon, the High Court confirmed the long-standing principle that, when the majority holders of a security try to make an amendment that will also affect the minority, they must act in good faith. In that case, Anglo Irish Bank (“AIB”) allowed its bondholders to exchange their bonds for cash and/or new securities, provided they voted in favour of an amendment to the bond conditions varying the repayment amount. Those not voting in favour of the amendment would have their bonds cancelled for a nominal amount. One bondholder, who saw bonds with a face value of €17 million redeemed for only €170, challenged the amendment.

The court felt that, essentially, AIB and the majority holders were attempting to disenfranchise the minority. The court said this was a form of coercion “entirely at variance with the purpose for which majorities in a class are given power to bind minorities” and was “precisely that at which the principles restraining the abusive exercise of powers to bind minorities are aimed”.

Myers affirmed this principle. However, the key point is that, in Assénagon, although AIB (the issuer) instigated the amendment that prejudiced the minority, it was the majority bondholders who approved it. In Myers, by contrast, the issuer alone implemented the amendment. This was enough to break the minority oppression argument – there was no majority doing the oppressing.

Carrot or stick?
In Azevedo, a company offered its bondholders a cash payment if they voted for an amendment to postpone the maturity date of its bonds (a so-called “carrot payment”). One of the bondholders did not vote in favour and later claimed the cash payment. It argued the carrot payment was unlawful because the bondholders were not being treated equally.

The Court of Appeal said it was perfectly lawful to offer this kind of carrot payment. The court agreed that English insolvency law requires members of a single class to be treated equally (the “pari passu” principle). However, it said that there was no insolvency question in Azevedo and the pari passu principle could only be invoked using the bond instrument. As it turned out, there was a trust arrangement in place which required the trustee to hold all amounts it received on trust for the bondholders equally and rateably. However, no monies were ever paid to the trustee, so this requirement never arose and the pari passu principle never became relevant.

The disgruntled bondholder also argued that the payment was a bribe, but the court disagreed, noting that the payment was available to all bondholders and was not made in secret.

Azevedo was seen by the market as merely endorsing a practice already common in practice. The carrot payments contrasted with the aggressive coercion techniques in Assénagon, where bonds were expropriated for virtually no value (not standard commercial practice).

What Azevedo and Myers share, in common and with established case law, is that postponing the maturity date of bonds or notes does not fundamentally alter the holders’ rights. So, in Myers, subordinating the VLNs to the FONs and postponing their maturity date was within Kestrel’s powers, even though it did not need the VLN holders’ consent. However, exchanging bonds or notes for something entirely different (e.g. cash or shares) would not have been acceptable.

What are the implications?
To our frustration, Myers, Azevedo and Assénagon all dance around a similar campfire but their differences make them hard to reconcile in practice.

Minority oppression was not argued in Azevedo. The decision in Assénagon was not appealed. Myers is constrained to a rather particular arrangement that is unusual in practice, under which Kestrel’s powers to amend the DLNs essentially gave it free reign to amend the VLNs without consulting the VLN holders.

Azevedo and Assénagon, in particular, are hard to read together. It would appear the court is more sympathetic to inducing Noteholder consent using a “carrot” payment, but not the “stick” of a negative effect for dissenting holders, particularly where the “carrot” is not that significant in the context of the proposed deal.

We are keen to see how the English courts would react to other coercive techniques, such as ‘exit consents’ and ‘covenant-stripping’ techniques, often a feature of US capital markets practice.

It is difficult to draw any general principles from Myers. We can say quite confidently that it will not be possible to invoke an argument based on minority oppression where the issuer (or borrower) attempts to make an amendment to a debt instrument (where no creditor consent threshold is required), rather than an amendment that requires the majority noteholders’ consent. Because the issuer is the borrower, rather than a lender, it is not a member of the class of creditors and so logically cannot form part of the majority. However, terms that specifically allow a borrower to make amendments to debt instruments without creditors’ consent are unusual for understandable reasons.

The decision may, however, have implications for junior and mezzanine lenders where there is an intercreditor agreement between the two tranches, and that intercreditor agreement allows the senior lenders to “drag” the junior lenders into an amendment to conform the junior debt to corresponding amendment to the senior debt. This term is now rare in transactions but is not unheard of.

The decision in Myers makes it clear that minority oppression can occur only if the creditors take action that affects a minority in the same class. In Myers, the creditors under one set of Notes agreed to an amendment to their Notes that had a (seemingly calculated) knock-on effect on the creditors under a different set of Notes. However, because the affected creditors held a separate instrument, the court would not treat them as a single class with the creditors who were seeking the amendment. It was therefore not possible to argue minority oppression of one class against another.

In the senior-mezzanine lenders “drag” scenario described above, senior lenders might now argue, on the basis of Myers, that minority oppression arguments should not be used against them. It is also interesting to speculate how a court may consider minority oppression arguments where senior lenders make decisions that affect second lien lenders where the senior debt and second lien debt are documented in the same loan instrument. This is a not uncommon scenario and we can expect at some point to see minority oppression arguments ventilated in the courts in this context.