The Rules of the Game have changed

The rules of the game have changed for people participating in schemes of arrangement, whether as creditors or as managers, according to Paul Murray of EMB. 


Although much has already been written about last year’s BAIC (British Aviation Insurance Company) judgment, I do not believe that the market has yet grasped the full significance for those involved in schemes of arrangement.

Press discussion about BAIC concentrated initially on whether it spelt the death knell for solvent schemes of arrangement and then on certain specific technical matters: the number of classes for voting; the time before the bar date; and the applicability of the reversion to run-off clause.

A much less publicised aspect of the solvent schemes issue, which deserves more attention than it has received, relates to how creditors’ claims are valued for voting purposes. The rules governing this aspect have changed radically in the past year and people need to understand them to take full advantage of what continues to be a well used and valuable run-off tool.

Why the rules are changing
Let’s begin with a reminder of why valuations, especially those relating to IBNRs, were a key concern in the BAIC scheme. Judge Lewison’s comments go to the heart of understanding the new practices that are now required:

“The real problem is that the votes of the policyholders with IBNR claims have to be estimated using sophisticated and controversial actuarial techniques,” he declared.

“In such a case it seems to me that the court must be especially wary of simply waving through a vote in which so many of the dissentients have had a nominal value placed on their claims.”

“The attribution of $1 to IBNR claims effectively means that the Company has treated the probability of an actual claim arising as being virtually nil….to disallow IBNR claims (by valuing at a nominal $1) on the basis that they were uncertain or unreliable is not, to my mind, valuing them at all.”

The courts are not alone in taking renewed interest in this subject. The FSA also have expectations of how schemes should proceed. The basic principle is that vote valuation needs to be more than just fair; it needs to be seen to be fair. The upshot is that in future schemes must have either:
• An independent chairman who values the votes; or
• An independent adjudicator who comments on the valuation process, including the result of the vote, whose views can be taken into account by the court at the sanction hearing.

More bureaucracy?
The new arrangements will be seen by some people as just another layer of bureaucracy and cost, but I would urge a much more positive view. Up to now some creditors have opposed schemes on principle, regardless of their individual merits, because of their deep-seated feelings of mistrust. Anything that increases the confidence of creditors in the process is to be welcomed.

In the past it has been too easy to push through schemes in a way that may have appeared to be unfair. Whether or not this perception was accurate is not the issue. Under the new regime, schemes must be like Caesar’s wife: beyond reproach. It is in everyone’s interests for them to command widespread buy-in so that they can proceed smoothly and in a timely manner whilst reducing legal and other frictional costs, whilst getting payments to creditors as quickly as possible.

In view of this need for transparent fairness, it is no longer appropriate for companies behind schemes of arrangements (and who, by definition, are hoping to benefit from their implementation) to have the job of valuing the votes without any independent overview. Even where they have acted as fairly as possible, the obvious conflict of interest could give rise to doubts about the legitimacy of their valuations. Independent vote adjudication, in contrast, encourages confidence.

New role for vote adjudicators
Given the pivotal role of vote adjudicators, the rules by which they operate are of critical importance. The system is too young for any particular approach to have become dominant, but here are some initial thoughts. They are based partly on logical analysis, but above all on my own experiences as a vote adjudicator, where I have needed to think through all the issues.

The starting point has to be the imperative for unquestioned fairness so that matters can advance with minimum fuss and avoiding any likelihood of legal challenge. An early question that the adjudicator has to consider is, which vote valuations do you adjudicate? Do you consider them all or just the ones in dispute?

The initial pragmatic answer may be to concentrate on the disputed ones only, but it is almost certainly wrong. Imagine a hypothetical, but not totally far-fetched scenario where all the accepted votes are in favour, whilst all the contested ones are against.

It may be that the adjudicator concludes that there are good arguments to reduce the large ‘Against’ votes. Even so, to ensure a fair voting process, I would contend that the accepted ‘For’ votes should also be considered to check that their valuations stand up, with the same rigour, to the methodologies used to assess the opposing votes; you might find inconsistencies. Either way, the vote adjudicator must be seen to be doing the right thing.

Limits of vote adjudicator’s knowledge
Another important question on which we do not yet have a consensus is whether or not the adjudicator should know which creditors are for or against a particular scheme (or instead simply know the submitted vote values). The knee-jerk response may be against the adjudicator having this knowledge in view of the understandable desire to strengthen the guarantee of impartiality. Once again, however, I would argue against this initial reaction.

Giving the adjudicator free access to this knowledge has a number of advantages. If it becomes obvious to them that the outcome of a vote is not in doubt, they can save everyone’s time and money. A quicker, yet fair adjudication can help to bring certainty sooner, whether that is through the payment of scheme claims or through abandoning the scheme. Of course, the adjudicator must still use a consistent methodology, but they do not need to turn every stone to get the value of each vote to the last dollar or pound. If, on the other hand, the outcome looks like being close, they may apply additional rigour, especially to large creditors with the potential to determine the result.

Timing of announcement
The new approach makes it less likely that the result of the voting will be announced at the scheme creditors’ meeting(s). The adjudicator should apply the same thoroughness to votes received just before the meeting(s) or at the meeting(s) as to those that decide in advance. There is no merit in cutting corners just to meet a particular deadline.

Other things the adjudicator has to consider:
• Have all creditors allowed for discounting if required under the scheme rules?
• Do submitted agreed losses & outstanding claims agree with the scheme company’s books?
• If it is unclear whether certain policies were actually placed with the scheme company, should votes in relation to these policies be counted or should they be excluded? The ideal solution is to wait until the validity of each claim has been resolved before adding up the votes, but time and information constraints may make this impractical. In such circumstances it is probably best for the adjudicator to err on the side of caution. This means avoiding a situation where a scheme goes through on the basis of decisions that may be open to this sort of dispute. To do this, I would recommend that all such votes may need to be included or all excluded, depending on which is most prudent with regard to the value of the vote.

Implications for creditors
So where does all this leave individual creditors faced with a solvent scheme?

First and foremost, be aware of the issues raised in this article. Whatever your views about them, you need to understand the chairman’s approach to the whole process and be comfortable with it. While the values given to claims for voting purposes may well differ from the value for payment (when creditors may decide to provide more detailed information), clearly the value for voting is crucial in helping to determine whether the scheme goes ahead or not.

Other points to bear in mind:
• Provide information to back up submitted agreed paids and outstanding claims;
• Explain the rationale behind any IBNR claimed (with reference to the type of business covered by the contracts in question);
• If the IBNR claimed is large (particularly in relation to the size of outstanding claims), fully explain the reasons why you expect these further claims and if available, provide an independent actuarial report;
• If the Scheme expects claims to be discounted, allow for this;
• If you believe your contracts will need relatively more IBNR than other creditors’, explain why. The Chairman will need to treat all creditors fairly and will need a good reason to allow you relatively more IBNR.

Although BAIC has been nothing like the setback for solvent schemes that some predicted at the time, it does act as something of a wake-up call. It is a warning to companies not to be complacent when implementing schemes. Winning the confidence of creditors is critical. It will make it a happier experience all round. 

This article appeared in Run-off Business Magazine in June 2006