Implementing Schemes of Arrangement and Overcoming Common Obstacles

By George Weru & Scott Andersen
Published in Cayman Funds Magazine, April 2012

Corporate insolvencies in offshore jurisdictions can involve complex disputes in respect of the rights of stakeholders with regards to company property, their statutory order of priority or the ranking of their claims. Liquidators can use schemes of arrangement to obtain a binding agreement whereby the rights of stakeholders are modified or adjusted so that there will be an ultimate financial benefit to stakeholders which could not otherwise have been obtained.

Schemes of arrangement are particularly appealing to liquidators where their adoption might avoid the need for costly litigation to resolve complex disputes amongst stakeholders. They can, for example, be used to achieve a compromise of rights where there are uncertainties regarding ranking of claims.

Overview of Schemes of Arrangement

A scheme of arrangement affords a mechanism for stakeholders in a company to approve a compromise or arrangement of their rights against the company in a specific manner according to the terms embodied in the scheme. Section 86 of the Cayman Islands Companies Law is the authority that broadly governs the process by which a scheme of arrangement is implemented.

If the proposals  achieve the requisite majorities  at meetings  of those stakeholders who qualify as members or as creditors of the company, voting in different classes constituted by the Court according to stakeholders’ rights, and if the Court sanctions the proposals, the scheme of arrangement is binding on all affected members or creditors, regardless of whether or how they exercised their right to vote on the proposals. The Cayman Islands Companies Law prescribes the requisite majorities for each class of members or creditors voting on the proposals as a majority in number of those who voted, representing seventy-five percent in value of those who voted.

Process for Implementing a Scheme of Arrangement

Usually, it will be a liquidator who will develop and put forward a scheme proposal, although creditors or investors may initiate a proposal to use a scheme of arrangement to bring a commercial resolution to disputes between stakeholders. Whether or not the proposal originated with the liquidator, the liquidator must expect to take on the responsibility of ensuring that the scheme properly embodies the formal terms of the proposals, and of providing stakeholders with all the information reasonable necessary to enable them to make an informed decision about the merits of the proposed scheme of arrangement.

The prudent liquidator will want to ascertain whether there is sufficient underlying stakeholder support to warrant progressing development of the proposed scheme. At that point, if he has not already done so, the prudent liquidator will engage specialist legal counsel to help to produce the necessary documents. It can be helpful for stakeholders to be circulated with a draft of the proposed scheme documentation comprising the Scheme itself and an explanatory memorandum. The purpose of the explanatory memorandum is to explain the effect of the scheme of arrangement on the company and those stakeholders whose rights are affected by it, and to provide stakeholders (or, more accurately, the persons with the ultimate economic interest) with all the information reasonably necessary to enable them to consider the merits of the Scheme. Such information should enable stakeholders both to understand how disputes relating to company property and obligations are proposed to be dealt with and enable stakeholders to consider how their own commercial interests will be affected by the scheme.

The Cayman Islands Companies Law provides for the Court to order the convening of court meetings at which stakeholders will vote on the scheme. It is at the hearing of the application for this order that the Court will consider the proposals for the constitution of the classes to consider the scheme. Correct constitution of the classes to consider the proposal is essential, because if the classes have not been correctly constituted the appropriate meetings will not have been convened and the Court will not have jurisdiction to sanction the scheme at the final hearing.

Stakeholders are constituted in separate meetings such as to ensure that each meeting consists of shareholders or creditors whose rights against the company which are to be released or varied under the scheme, or whose new rights against the company which the scheme gives in their place, are not so dissimilar as to make it impossible for them to consult together with a view to their common interest. The constituency of the classes is a major concern for the liquidator when assessing the proposed scheme, because failing to identify the correct classes will be fatal to the scheme being sanctioned by the Cayman Islands Court. It is also at this hearing that the liquidator must satisfy the Court that the scheme documentation provided to stakeholders will provide all the information reasonably necessary for a decision on the merits of the scheme.

Once it is satisfied on these matters, the Court will order that court meetings be convened for the stakeholders to consider, and vote on the scheme. A quorum of at least two human beings, each of whom is either a member or creditor who is attending in person (or their corporate representative), or a person who is attending as a proxy for a member or creditor, must be present at each of the court meetings. The persons with the ultimate economic interest may not be the same as the persons who, by virtue of having their names in the records of shareholder or creditor information, are the shareholders or creditors entitled to vote at the meetings.

The scheme must be approved at each of the court meetings by the requisite majorities (a majority in number of those voting, and seventy-five per cent in value of those voting), otherwise the proposed scheme will fail.

If the statutory majorities are attained at each of the court meetings, the scheme of arrangement is put forward to be sanctioned by the Court. The Court has discretion whether or not to sanction the scheme. It is at the hearing of the application for sanction that the Court will consider the fairness of the scheme, and this is the last opportunity for the Court to consider whether the scheme is inconsistent with Cayman Islands Law or whether there is any other reason why the Court would not have jurisdiction to sanction the scheme. At this hearing the Court will hear submissions on these or any other matters from any dissident stakeholder who objects to the scheme or from any third party who contends that they are affected by the scheme and who wants to persuade the Court that it should not sanction the scheme.

Once the scheme has been sanctioned by the Court and the Court’s order sanctioning the scheme has been delivered to the Registrar of Companies in the Cayman Islands for registration, the scheme will bind all stakeholders, including those who did not vote on the scheme and those who voted against the scheme. At that point the scheme takes effect and the liquidator or, if the scheme provides for the appointment of a scheme supervisor, the scheme supervisor, will begin to conduct the affairs of the company in line with the terms of the scheme.

Common Obstacles to be Overcome When Implementing a Scheme of Arrangement

Schemes of arrangement can be time consuming and cost intensive to implement, particularly where the compromises embodied in them are complicated and resolve a multitude of disputes which span a number of classes affected by the scheme. A liquidator proposing a scheme to compromise disputes of significant complexity will want to engage specialist legal counsel who will assist in identifying the disputes to be comprised and how they should be addressed, and with the analysis of stakeholders’ rights and the constitution of classes. Participation of counsel with the appropriate expertise will increase the chances that the proposed scheme will find the necessary support amongst stakeholders, and will be compliant with legal principles and so be acceptable to the Court. Some of the key considerations in developing the scheme are outlined below.

Consensus among Stakeholders

The implementation of a scheme of arrangement usually involves eliciting agreement amongst often diametrically opposed interest groups. The resolution of disputes amongst stakeholders may be assisted by negotiations and mediations which ultimately form the basis for a proposal which can be formalized into a scheme of arrangement. However, throughout the initial period beginning with the outset of negotiations and culminating in the voting at the meetings, there can be a significant risk that the requisite majorities will not approve the terms of the compromise. There may therefore be substantial uncertainty about whether the scheme will obtain the necessary approval from stakeholders until the court meetings have been held and stakeholder votes reckoned.

Even after the statutory majorities have been obtained, the proposals can be challenged by a dissentient stakeholder. If the Court is to exercise its discretion to sanction the scheme, the Court has to be satisfied at the hearing of the application for sanction that the scheme is one which the intelligent and honest stakeholder, acting reasonably as a member of the class concerned, could be satisfied was in the interests of their class. The Court has to be satisfied that the majorities were obtained by virtue of the stakeholders deciding that the scheme was in their interests as members of the relevant class, and that the minority have not been oppressed by the majority pushing through a proposal which was actually against the interests of persons in that particular class, because the proposal favours some other interest of the majority. In order to reduce the risk that the scheme fails because the Court is shown that the majority have been oppressing the minority, or on the basis of unfairness to the minority, the prudent liquidator will ensure that the scheme is formulated against the background of the principles of law by which the Court will assess the scheme. He will want to be confident that the proposals are not just dictated by the commercial considerations of the majority without any regard to the interests of the minority.

Evaluation of impact of Scheme on the Liquidation Estate

It may be important for the explanatory memorandum to include consideration of the impact of scheme on the recoveries of the estate as a whole. If the terms of the scheme may have negative implications for the assets, the liquidator should conduct an assessment of any potential or perceived negative implications on relevant property and appropriately disclose this to stakeholders in the explanatory memorandum, as part of the obligation to ensure that stakeholders have all of the information reasonably necessary to enable stakeholders to assess the merits of the scheme.

Recognition

The cross border nature of corporate insolvencies in the Cayman Islands may prompt a liquidator to seek foreign recognition of the scheme, once sanctioned by the Cayman Islands Court, so that the terms embodied within it can be imposed upon stakeholders whose domiciles are extraterritorial to the Cayman Islands. An application for recognition will require the foreign court to consider the scheme in the context of the applicable law within the relevant jurisdiction and, if appropriate, to accede to the terms becoming enforceable within that particular jurisdiction.

A liquidator who proposes to seek foreign recognition for the scheme may wish to seek legal advice in the relevant jurisdiction at an early stage, particularly before the convening hearing, so that an assessment of the legality of the scheme in that jurisdiction can be conducted. This will ensure that any legal anomalies are identified and resolved and the terms of the scheme can, if necessary, be appropriately modified so that foreign recognition of the scheme is attainable.

Conclusion

Schemes of arrangement are intensive for a liquidator to implement as the process is complex and can be fraught with obstacles. Scheme proposals which seek to resolve complex disputes amongst stakeholders necessitate development of unique schemes of arrangement and a prudent liquidator ought to seek assistance from professionals with suitable expertise and experience in this regard. This will enhance the viability of the scheme and equip the liquidator with the appropriate expertise and experience to identify and overcome potential obstacles.