Ruling confirms majority noteholder should not be disenfranchised from voting
The English High Court held that it had jurisdiction in a cross-border dispute involving the Norske Skog group (Norske Skog), and confirmed that a majority noteholder did not “control” the debtor companies and was therefore not excluded from being part of the “instructing group”. The case also confirms the ability of the English courts to rule in relation to issues of both New York law and English law. These rulings reassured observers active in European leveraged finance transactions, who have long believed that courts should interpret and approach this suite of contracts in exactly this way.
In 2015, Norske Skog, a large Norwegian group of manufacturing companies engaged in the paper industry, issued senior secured notes (the Notes) pursuant to a New York law governed indenture. As is typical with leveraged finance structures, the company also entered into an intercreditor agreement (ICA) governed by English law. The ICA allows the flexibility for multiple secured creditor classes under various instruments to benefit from the security. Further, the ICA governs the relative priority of such creditors and other liabilities, as well as the ability to instruct the security agent in case of a default scenario.
Norske Skog defaulted on the Notes in July 2017. Subsequently, in December 2017, some of the entities in Norske Skog’s group filed for insolvency. The security agent and trustee of the Notes sought directions from the court regarding enforcement action to sell the shares in one of the group’s entities, in a public sale process. The majority noteholder expressed an intention to bid in the public sale.
Issues for the court
The English High Court was asked to rule on two issues:
- Whether the indenture should be read to dis-allow the majority noteholder from instructing the security agent to take enforcement action, when the noteholder held a 51% interest in the Notes and was also alleged by a minority noteholder to have “de facto control” over Norske Skog
- Whether the English court had jurisdiction when the ICA had an exclusive English jurisdiction clause but the indenture had a New York jurisdiction clause
Was the noteholder disenfranchised from counting towards the instructing group?
On 8 March 2018, Mann J held that the majority noteholder did not control Norske Skog for the purposes of the indenture. The relevant provision (often referred to as the disenfranchisement provision) requires that any notes owned by Norske Skog or any entity that controls Norske Skog will be eliminated from the numerator and denominator when calculating whether noteholders have met any voting threshold. The minority noteholder argued that the majority noteholder had control by virtue of: (a) the majority noteholder’s 51% holding of the debt; and (b) the majority noteholder’s “overwhelming influence” over the affairs of Norske Skog. The court rejected both arguments and held that the majority noteholder was entitled to instruct the security agent. The court subsequently ordered that the minority noteholder pay the security agent’s and majority noteholder’s costs on an indemnity basis.
- 51% holding – Mann J noted that the parties did not intend to exclude a creditor whose holding exceeded 50%, even in a distressed situation and even if the debt was secured by a share pledge. Otherwise, this would lead to “an absurd conclusion” that “makes no commercial sense.” It would be illogical for a creditor who has the majority interest to suddenly lose “the power to have influence” “… at the very moment when it matters the most (when there is a repayment problem)”.
- De facto control – Mann J noted that the majority noteholder’s actions were not sufficiently “pervasive” to give the majority noteholder a relevant degree of control, and that everything the majority noteholder had done was “done in its interest as a creditor… and to further its interests as a creditor under the very documentation which includes the ‘control’ provision.” The judge also found that the evidence did not demonstrate shadow directorship, since there was no showing “that the directors were ever, in any meaningful way, accustomed to act on the instructions of” the majority noteholder. Based on these reasons, and taking all of the facts into consideration, the judge found that there was no “de facto control”.
Did the English court have jurisdiction?
On 19 February 2018, Mann J held that the dispute fell within the ICA’s jurisdiction clause and therefore the English court had jurisdiction. While interpretation of the indenture’s disenfranchisement provision was a necessary step, the dispute still arose “out of or in connection with” the ICA.
Mann J’s rulings are welcomed and anticipated, reflecting an interpretation of the provisions of a typical leveraged finance structure consistent with commercial expectations. The case demonstrates that a noteholder’s majority holding, participation in arms’-length negotiations during a restructuring, and interest in the public sales process as a future bidder are not, individually or taken together, sufficient to amount to control requiring disenfranchisement. In contrast to the evidence at hand, the judge indicated (without ruling on the points) that either or both of the following elements might be sufficient to show control, absent actual shareholding:
- Contractual right to control
- Shadow control that is both pervasive and analogous to the acts of a controlling shareholder (as opposed to the actions of a creditor)
By analogy, the same analysis should apply in an English scheme of arrangement, a Companies Act 2006 restructuring tool used frequently to de-lever the exact sort of finance structures used in this case. A majority note holding could be considered in the context of class composition and ultimate fairness, but should not lead to disenfranchisement for voting purposes.
The case is also a useful illustration of the willingness and capacity of courts to apply a foreign jurisdiction’s law when necessary to reach a conclusion on one or more elements of a dispute. In typical European leveraged finance arrangements involving high yield bonds, this will often be key if any dispute arises. For example:
- New York law governed indentures often allow actions, or qualify the ability to take an action, based on what is allowed under the English law ICA (e.g., releasing security or guarantees in certain situations, or instructing the security agent).
- English law governed ICAs, in turn, often qualify the ability to take an action based on what is allowed in the underlying senior secured debt instruments (which could include the indenture and any senior credit facility).
- An increasing number of European term loan Bs include New York law governed bond-style incurrence covenants, while the rest of the document (whether cov-lite or just a loan wrapper) is governed by English law.