Adler - English Court Sanctions Contentious Restructuring Plan of German Real Estate Company

On 12 April 2023, the English High Court sanctioned a restructuring plan (the Plan) for Adler, a German real estate company. The Plan amends six separate series of senior unsecured German law-governed notes (the SUNs), originally issued by a Luxembourg entity. Using the new cross-class cram down mechanism (CCCD) available in the UK, the Plan will bind each class of voting SUNs, including a single class of dissenting holders (the 2029 Noteholders) of notes maturing in 2029 (the 2029 Notes).

This was a highly contentious Plan in which an ad hoc group of 2029 Noteholders (the Ad-Hoc Group) voted against the Plan and sought to challenge the Plan at Court. The Ad-Hoc Group argued that the Plan, if approved, would contravene the pari passu principle, a fundamental tenet of English insolvency law pursuant to which creditors of the same rank should receive equal treatment. Further, the Ad-Hoc Group argued that the Plan did not satisfy the “no worse off” test (NWO Test)¹ as the relevant alternative (a formal insolvency process) would, in its opinion, result in a greater return compared to the Plan.

Under the Plan, only the maturity of the 2024 notes was extended to 2025, with the maturity dates of all other notes (see further details below) unaffected. The Group intends to carry out an “asset disposal strategy” over a three-year period to generate sufficient cash to repay all of its creditors in full, compared to a return of 63c/€ in an insolvency. As the Group’s strategy is comparable to a liquidation, the Ad-Hoc Group argued that:

• Based on the Ad-Hoc Group’s valuation evidence, the Group’s asset disposal strategy would not result in a 100 percent return but would instead only generate a recovery for the 2029 Noteholders of 10.6c/€ – far less than what they would receive in a formal liquidation where each of the SUNs would be treated equally under the pari passu principle
• By repaying each series of SUNs on maturity under the Plan, the 2029 Notes were effectively time-subordinated to the remaining SUNs as they would be paid last (and also paid far less than the other SUNs).

Although the Court accepted that the Plan involved a greater risk for the 2029 Noteholders², the Court ultimately took the view that, despite the competing valuation evidence, it only needed to be satisfied that the 2029 Noteholders were “likely to recover” more under the Plan than they would if the Plan was not sanctioned. Furthermore, as the Court was satisfied that the SUNs would be repaid in full under the Plan (and, even if this were not to be the case, the estimated returns to the 2029 Noteholders under the Plan were still likely to be greater than the returns in an insolvency proceeding), paying the 2029 Notes on maturity was not a departure from the pari passu principle.

The case highlights the complexities of valuation challenges in the context of the new UK restructuring plan and provides helpful guidance as to how the English Court will seek to determine valuation disputes going forward.

Background

The Adler group (the Group) manages and develops residential real estate in Germany. The Group, with external debt of approximately €6 billion, encountered significant financial difficulties resulting from the downturn of the German real estate sector, as well as certain allegations of impropriety made against it.

Plan treatment and voting

The Plan Company was AGPS BondCo plc, an English company substituted as issuer of the SUNs in place of Adler Group S.A. (the Parent), a Luxembourg incorporated entity. The issuer substitution was implemented in accordance with the terms of the SUNs for the purpose of the company being eligible to propose the Plan³. The issuer substitution was challenged by the Ad-Hoc Group but was considered by the Court (aided by expert evidence) to be valid and effective.

For the purposes of voting on the Plan, each series of SUNs were placed into a separate class (which was considered to be a correct and justified approach, albeit “conservative”). Aside from the 2029 Noteholders, all other classes voted overwhelmingly in favour of the Plan:  

New Money Funding

The Plan will allow for the Group to incur €937 million of new money to refinance its existing debt (the New Money Funding). The plan creditors are entitled to participate in the New Money Funding pro rata to their holdings of the SUNs. Certain Group companies will additionally provide guarantees and security in respect of the New Money Funding, the SUNs and certain other third-party debt.

Under the terms of a new intercreditor agreement to be entered into as part of the Plan (the ICA), any enforcement proceeds will be distributed (a) first, in discharge of the New Money Funding, (b) second, in discharge of the 2024 Notes and certain other third-party debt (ranking equally), and (c) third, in discharge of the remaining SUNs. Importantly, if the SUNs end up in default again, the 2029 Noteholders can enforce under the ICA, with the enforcement proceeds being distributed in accordance with the ICA payment waterfall whereby the SUNs (aside from the 2024 Notes) will rank pari passu. This fallback option aided the Court in determining that the Plan was fair.

In relation to the priority granted to the providers of the New Money Funding under the ICA, the Court rejected the argument advanced by the Ad-Hoc Group that the purpose of the new money was to elevate the debt of the new money providers. The Court accepted that the new money was being provided for the benefit of the plan creditors and that the providers of such new money should be compensated accordingly.

Notes Representative

The Plan provided for the appointment of a Notes Representative for each series of SUNs. The powers of the Notes Representative include the power, if instructed by more than 50 percent of noteholders, to waive all past and existing Events of Default (except in respect of non-payment) or to rescind the acceleration of any claims. The Notes Representative also has the power to enforce the rights of the noteholders following an Event of Default (including a security enforcement).

The appointment of the Notes Representative was challenged by the Ad-Hoc Group, but the Court found that the appointment of a Notes Representative was commonplace as a matter of German law and there was no evidence that the Notes Representative would exercise its powers in an oppressive or abusive way to the detriment of the noteholders.

Retention of equity by existing shareholders

In consideration of providing the New Money Funding, the relevant lenders were provided with a 22.5 percent equity interest in the Parent with existing equity retaining their 77.5 percent equity interest in the Group. In his judgment, Leech J commented that the retention of equity by the current shareholders of the Group was:  

“…the point on which I have had the greatest concerns about approving the Plan. I can see no obvious reason why the shareholders who have provided no support for the Plan and provide no additional funding should get the upside if the Plan succeeds.”

However, notwithstanding these clear hesitations, the Court decided that it was not appropriate to refuse to sanction the Plan on the basis that the existing equity were to retain a 77.5 percent equity interest in the Group. Ultimately, the Court determined that, given that the providers of the New Money Funding were most likely to be affected by the retention of equity, they had negotiated such terms and the Court could only assume that in doing so, they took a commercially rational approach which it would not be appropriate or typical for the Court to challenge.

Valuation disputes

To date, there have been relatively few challenges to debtor valuations in the context of schemes and restructuring plans. A large part of the judgment in Adler considered in detail the competing valuation evidence provided to the Court by the Parent and the Ad-Hoc Group. The Court noted that it did not have a “crystal ball” and that it could not be certain as to future value. It accepted that for the purposes of determining valuation disputes, ultimately it had to decide if the NWO Test had been satisfied, meaning that the Court had to be satisfied that the 2029 Noteholders were likely to recover more than they would if the Plan had not been sanctioned. In determining if the NWO Test was satisfied, the Court was required to consider the NWO Test on the balance of probabilities. In particular, Leech J held:

“I do not have to be satisfied…that the 2029 Plan Creditors would definitely be paid in full if the Plan were sanctioned but merely that this is the most likely of the alternatives presented to the Court.”

On the facts of the case, the Court was persuaded by the Parent, based on its valuation evidence, that it was more likely than not that if the Plan was approved, the 2029 Notes would be no worse off than in the relevant alternative (being an insolvent liquidation). The Court noted that even if the Plan failed in due course, it was likely that the 2029 Noteholders would also be better off than if the Parent were placed into an insolvency proceeding now.

Final thoughts

The Adler decision provides helpful additional guidance on restructuring plans. Most notably, in assessing the “no worse off” requirement to implement a CCCD, plan companies do not need to prove with absolute certainty that a restructuring plan will result in a better outcome than the relevant alternative. Instead, the test is satisfied on the balance of probabilities, which should be demonstrated with logical and sensible valuation evidence. The decision also reinforces the Court’s position that drawn-out valuation disputes should not undermine the restructuring process.

It is worth noting that, whilst adopting a conservative approach to class composition and splitting the SUNs into separate classes allowed for the CCCD to be used, the overwhelming support for the Plan (approximately 84 percent across all six classes) meant that a single-class plan would have still achieved the desired outcome without the CCCD having to be used⁶.

The substitution of the Plan Company in place of the Parent (which did not require consent under the finance documents) to establish the English law nexus was a novel element of this restructuring and there may have been a significant time and cost benefit of doing so. A governing law amendment would have required the consent of noteholders whilst adopting a co-obligor structure would have needed additional documentation. However, the ability to substitute issuers was a matter of German law and is uncommon in bond documents which are widely governed by New York and English law. Whether this feature is incorporated into bond terms by issuers over time (and is accepted by investors) remains to be seen.

Footnotes

1. In order to apply to cross-class cram down mechanism, the Court must be satisfied that the dissenting creditor class is no worse off under the plan than in the relevant alternative.
2. The Court did separately note that the risk of the 2029 Notes being paid last reflected the commercial risks assumed by the 2029 Noteholders when they purchased the notes to begin with.
3. Commonly, a “sufficient connection” to England and Wales would be established by changing the governing law of a finance document to English law, or implementing a co-obligor (or similar) structure whereby an English company becomes a co-obligor in respect of a foreign law-governed finance arrangement and is subject to the restructuring plan.
4. Aside from the maturity extension to the 2024 notes, the SUNs are receiving identical treatment under the Plan.
5. Including an LTV covenant to maintain and LTV of 87.5 percent until the end of 2024 and 85 percent thereafter, as well as certain restrictions on debt incurrence and dividend payments.
6. However, only 68.85 percent of noteholders entered into a lock-up agreement prior to the plan being launched, so it could be argued that the approach taken regarding class composition (which allowed for the dissenting class to be crammed down) was the safer option.