PPF updates guidance for restructuring and insolvency practitioners

Insurance umbrella. Concept of safety business.Since its inception in 2005, the PPF has been a welcome safety net for employees whose company pension scheme is in deficit and the sponsoring employer is on the verge of insolvency. The PPF’s major challenge has been preventing employers from deliberately engineering or recklessly creating such deficits in the pension scheme (to the benefit of other creditors) in the expectation that the PPF will simply pick up those liabilities without question. As the world of restructuring and insolvency continues to evolve in a challenging economic climate, the PFF has recently refreshed both its general guidance for restructuring and insolvency professionals and its (shorter) booklet on the PPF’s approach to employer restructuring.

This latest guidance sets out the key principles the PPF will consider in order to determine the eligibility for a scheme to enter the PPF on a restructuring plan, which has come under close scrutiny following the PPF’s role in the recent high-profile restructurings of Kodak, Monarch and Halcrow as well as the PPF’s criticism of the government’s proposals for the British Steel Pension Scheme. It is also a clear reminder to the industry that the PPF is not obligated to consider a restructuring proposal and will only do so if its key principles are met.

The PPF’s key principles to consider are:

  1. inevitability: the insolvency of the company must be inevitable (i.e. the employer will shortly become insolvent if a restructuring cannot take place);
  2. a significantly better outcome: the scheme will receive money or assets which are significantly better than it would have received otherwise through the ordinary insolvency of the employer;
  3. fairness: the offer to the pension scheme is fair in the light of what other creditors and shareholders will receive as part of the restructuring proposal. The example given in the guidance is that of an insolvent employer with £100m of bank debt and a £100m pension scheme deficit who offers the PPF £1m to take on the scheme. If the PPF takes on the pension scheme, the employer continues trading and the bank debt is more likely to be repaid, rather than being impaired in an insolvency process. If a similar situation were to happen, the PPF may seek to negotiate a contribution agreement with the bank reflecting the benefit to the bank of their enhanced chance of recovery;
  4. equity: the PPF will seek at least 10% equity in the restructured company for the scheme if future shareholders are not currently involved in the company (i.e. there is a third party acquisition of the business). If the current shareholders will continue to be involved in the company a 33% equity stake will be sought;
  5. the Pensions Regulator: the PPF will liaise with the Regulator to establish if a contribution notice or financial support direction from the Regulator would put the scheme in a better position than if it were adopted by the PPF;
  6. Regulated Apportionment Arrangements (“RAA”): on the rare occasion that an RAA is proposed, draft clearance must have been submitted to and considered by the Regulator;
  7. bank fees: such fees must be deemed reasonable by the PPF where the deal involves refinancing; and
  8. costs: the party seeking the restructuring pays the costs incurred by the PPF and the trustees in delivering the restructuring proposal (including legal fees and TUPE liabilities). The PPF provides standard form documents which it will expect to be used in deals.

Restructuring professionals seeking to ensure a smooth entry for an employer’s scheme into the PPF should take note of the criteria under which the PPF will take on a scheme and draft proposals accordingly. The overarching principle is that, in order for the PPF to participate, the employer’s pension scheme must be better off than it would be if the business was simply left to fail. The proposals must also carefully consider the risk of contribution notices and/or financial support directions being imposed by the Regulator.

Links to the guidance can be found here:

General guidance for restructuring and insolvency professionals; http://www.pensionprotectionfund.org.uk/DocumentLibrary/Documents/insolvency_guidance.pdf

The PPF approach to employer restructuring; http://www.pensionprotectionfund.org.uk/DocumentLibrary/Documents/Restructuring_and_Insolvency.pdf

“It’s Virtually Money!” Federal Judge Rules ”Bitcoins” Qualify as Money

bitcoinsIn the latest opinion to wrestle with the question of whether virtual currency should be considered money, Judge Alison Nathan in the U.S. District Court for the Southern District of New York found that for the purposes of a federal anti-money laundering statute, “bitcoins” qualify as money.

In United States v. Murgio, a group of defendants were charged with operating, and conspiring to operate, an unlicensed money transmitting business online.  The defendants were alleged to have attempted to shield the true nature of their bitcoin exchange business by operating through several front companies in order to convince financial institutions that their website was merely an association of individuals with common interests.

The court defined a “bitcoin” as an anonymous, decentralized form of electronic currency that exists entirely on the internet and not in physical form and that is used to purchase goods and services from any person that is willing to accept it as a form of payment (although it does not have the status of legal tender).

Because a violation of the statute at issue, 18 U.S.C. § 1960(a), requires the operation of “unlicensed money transmitting,” and the statute only defines money as including “funds,” the court had to determine whether bitcoins should be considered “funds” under the statute.  The court found that they should. For purposes of the statute, the court held, “funds” mean “pecuniary resources,” and bitcoins fall under that broad category because they are used as a medium of exchange and a means of payment.  The court also relied on another federal court’s earlier holding that bitcoins qualify as money because they can be easily purchased in exchange for ordinary currency, act as a denominator of value, and are used to conduct financial transactions.

This decision is in contrast to the only federal bankruptcy judge’s ruling on the value of bitcoins.  In In re Hashfast Technologies LLC, Judge Dennis Montali in the Bankruptcy Court for the Northern District of California refused to address whether bitcoins are currency or commodities for purposes of the fraudulent transfer provisions of the Bankruptcy Code.  Instead, the court found it “sufficient to determine that…bitcoin are not United States dollars.”  The court’s holding in Murgio also went against a Florida state court opinion that found that bitcoins differ from money in many important aspects.  For example, they are not a commonly used means of exchange and are not accepted by all merchants or service providers.  Further, the Florida court found, the value of bitcoins fluctuates widely and has been estimated to be eighteen times greater than the U.S. dollar.

Although Judge Montali in Hashfast Technologies found that bitcoins are not equivalent to dollars, no bankruptcy court has ruled one way or the other regarding the more general question addressed in Murgio—whether or not bitcoins should be viewed as money or funds.  If bankruptcy courts around the country choose to adopt the opinion of Judge Nathan in Murgio and hold that bitcoins are money, the impact on bankruptcy jurisprudence would be significant.  For example, if bitcoins are regularly viewed as money, they will need to be considered in the value of a debtor and its estate.  More time and resources may need to be invested in calculating an accurate value for bitcoins, if such a value is even calculable.  The impact of virtual currency on an ever-changing technology-focused world may make the debate over the value of bitcoins a likely candidate for consideration by more courts, including bankruptcy courts and courts of appeals, in the future.

ECB Launches Public Consultation on Guidance to Banks on Non-Performing Loans

Hundred euros sinkingThe European Central Bank (ECB) has launched a public consultation on its guidance to banks on handling non-performing loans (NPLs), which is open until 15 November 2016. The ECB has also published the first stocktake of national supervisory practices and legal frameworks concerning NPLs.

The draft NPL guidance to banks, which is available on the ECB Banking Supervision website, addresses recommendations regarding strategy, governance and operations, which are key to handling NPLs and sets out a number of best practices that the ECB has identified and that will constitute the ECB’s supervisory expectations going forward.

The NPL guidance is addressed to credit institutions within the meaning of Article 4(1) of Regulation (EU) 575/2013. It is therefore generally applicable to all significant institutions supervised directly under the Single Supervisory Mechanism, including their international subsidiaries. Therefore, the ECB is focusing on asset quality as the key priority for its banking supervision, which comprises of two main pillars – an asset quality review and a stress test. Following on from the comprehensive assessment the ECB has done recently, the ECB is now intensifying its supervisory attention and work on NPLs.

The NPL guidance is structured to follow the life cycle of NPL management.  The contents include the following chapters-
1. Introduction
2. NPL strategy
3. NPL governance and operations
4. Forbearance
5. NPL recognition
6. NPL provisioning and write-offs
7. Collateral valuations.

The NPL guidance recommends that banks with a high level of NPLs should establish an internal business strategy which needs to be combined with their future business plan and risk management framework to effectively manage and ultimately reduce their NPL portfolio in a credible, feasible and timely manner. The banks’ business strategies should include the setting of quantitative targets to reduce the NPL portfolio and a detailed implementation plan. Further, the NPL guidance recommends banks to put in place appropriate governance and operations structures to deliver an effective NPL reduction and workout. The strategy should be done by closely involving the banks’ management, setting up dedicated NPL workout units and establishing clear business policies which need to be linked to NPL reductions and workouts. Therefore, the NPL guidance provides for the banks’ short-term and long-term options and solutions with the aim of returning the exposure to a state of sustainable repayment. It further guides banks on how to measure impairment and write-offs in line with international recommendations. The NPL guidance outlines the policies, procedures and disclosures banks should adopt when valuing immovable property held as collateral for NPLs.

Currently, the NPL guidance is of a non-binding nature, but ECB will expect the banks to explain and substantiate any deviations upon supervisory request and any non-compliance may trigger supervisory measures. When implemented, banks will be expected to apply the NPL guidance proportionately and with appropriate urgency. The NPL guidance will be finalized following the consultation process and the final document will be published in the next few months.

However, the NPL guidance does not intend to substitute or supersede any applicable regulatory or accounting requirement or guidance from existing EU regulations or directives and their national transpositions or equivalent, or guidelines issued by the European Banking Authority. It should be noted that the NPL guidance is a supervisory tool with the aim of clarifying the supervisory expectations regarding NPL identification, management, measurement and write-offs in areas where existing regulations, directives or guidelines are not existing or do not provide clarity. Where binding laws, accounting rules and national regulations on the same topic exist, the banks should comply with those.

The ECB will hold a public hearing as part of this consultation at 15.00 CET on 7 November 2016, at its premises in Frankfurt. The hearing will be webcast on the ECB’s Banking Supervision website. Information on registering for the public hearing and on how to submit comments can also be found here. Following the public consultation the ECB will publish the received comments, together with responses and an assessment of the comments.

“Reasonably Equivalent Value” – – A Path Without Guideposts.

white guidepost isoleted with path“Reasonably equivalent value” – – part of the standard for evaluation of potential constructive fraudulent transfers – – is both subjective and imprecise. The words “equivalent value” require the court to make a subjective judgment whether consideration received in exchange for a transfer is worth the same as the consideration transferred by the debtor. And the considerations exchanged by the two parties are necessarily of differing characters. A transaction may involve the exchange of money for a tangible asset or for services. In that event, at least one side of the bargain has a recognized and relatively objective value. However, even in those instances, the court must make a subjective judgment as to the value of the non-monetary side of the transaction. It becomes even more complicated when both sides of the exchange are open to subjective conclusions as to their value.

A further complication comes from the addition of the modifier “reasonably” to the test applied. The court is not finished when it reaches its subjective conclusion regarding the value of the two sides of the exchange. The court must then decide how much of a difference in the relative values of the exchanged consideration is reasonable. Is a 10% difference “reasonably equivalent?” And if so, at what point does a greater variation cease to be “reasonably equivalent?”

The ultimate result of these three slippery words is that we are often left with an inconsistent landscape for decisions involving similar fact patterns. The courts struggle to apply the words of the statute and the variations in outcome leave us without any clear guidance. A prime example of this varying landscape involves cases where a trustee seeks to recover tuition payments made by a debtor parent on behalf of a child.

In DeGiacomo v. Sacred Heart University, Inc. (In re Palladino), Adv. Pro. No. 15-01126, 2016 Bankr. LEXIS 2938 (Bankr. Mass. Aug. 10, 2016), the debtor parents paid about $65,000 in college tuition on behalf of their adult daughter. The bankruptcy trustee sought to recover that amount from the college, arguing that the parents had no legal obligation to provide a college education for their daughter. The trustee also argued that any emotional benefit the debtors received as a result of the payment was not sufficiently “concrete” or “quantifiable” to qualify as “value” for purposes of the statute. In response, the college offered the testimony of the debtor mother that she felt obligated to pay tuition for her daughter and that she also felt a college education would help the daughter to become economically self-sufficient.

The Court began by noting that “[e]thereal or emotional rewards, such as love and affection, do not qualify as value for purposes of defeating a constructive fraudulent conveyance claim.” However, the court found the trustee’s effort to completely dismiss the debtor mother’s testimony to be “overly rigid.” The court focused on the undisputed testimony that the mother believed that a college education would help make her daughter financially self-sufficient, a result that would be an economic benefit to the parents. The court accepted that evidence as “concrete and quantifiable enough” to provide value for fraudulent conveyance purposes.

The court also emphasized the notion of reasonable equivalence. The court found that future outcome and economic hindsight do not provide an appropriate standard for measurement, acknowledging that it is often difficult at the outset to know whether a particular payment “will turn out to have been ‘worth it.’” It accepted as reasonable the debtor’s testimony that she believed a college education would enhance the financial well-being of the child and thus confer an economic benefit. On that basis, the court dismissed the trustee’s complaint.

The DeGiacomo decision typifies the difficulty in applying the words “reasonably equivalent value.” The ruling necessarily turns on the court’s subjective judgment that the expenditures provided enough “concrete” and “quantifiable” value to avoid clawback as a fraudulent transfer. Another court presented with the same facts could as easily find that value absent or insufficient. And a reliance on the debtor’s expectations at the time of the transfer presents the risk of after-the-fact efforts to articulate a justifiable basis for a given decision.

The requirement of “reasonably equivalent value” presents another instance where one must necessarily rely on the judgment of the bankruptcy judge, based on evidence presented. The absence of objective guideposts provides an unavoidable risk, but also the opportunity for capable counsel to help provide a record to support their desired outcome.

Are you “special” enough to be validated?

Allegory of justiceThe presumption that courts normally validate dispositions by a company subject to a winding up petition if such dispositions are made in good faith and in the ordinary course of business has been called into question in the recent case of Express Electrical Distributors Ltd v Beavis and others [2016].  Whilst the court has discretion to validate a disposition, it was considered that the court must balance the interests of the recipient of the company’s property with the company’s other creditors and unless there are special circumstances justifying validation of a transaction, the pari passu principle must not be overridden.

The Legislation

As covered in our article of April last year section 127 of the Insolvency Act 1986 (“the Act”) provides that any disposition of a company’s property made after the commencement of a winding up (i.e. after the date of presentation of a winding up petition) is void unless a validation order is made in respect of that transaction.  This is to ensure the preservation of assets for the benefit of all the company’s creditors and to guard against the risk of preference of creditors, ensuring all unsecured creditors are treated equally and paid pari passu.

The Facts

Edge Electrical Limited (“Edge”) regularly received electrical goods from its supplier Express Electrical Distributors Limited (“Express”). Payment was due on the last day of the calendar month immediately following the calendar month in which delivery took place.  Edge generally paid for goods on the last permissible date under terms agreed between the parties, utilising the maximum credit to which it was entitled.  From November 2012, however, Edge began to pay late and this pattern continued for several months.  Following supplies made in April 2013 and after several attempts made by Express to contact Edge, a payment of £30,000 was made by Edge to Express on 29 May 2013.  Although at this date Express had supplied goods to Edge with a value in excess of £30,000, strictly speaking, nothing was due from Edge to Express until 2 days after the payment was made (i.e. on 31st May). Even then, invoices totalling only circa £25,000 were contractually due for payment – the balance of circa £5,000 was not due for payment until 30 June 2013.

On 22 May 2013, seven days prior to the payment being made to Express, another creditor of Edge had presented a winding up petition against it. Edge’s directors claimed not to have known about the petition at the time of making payment to Express.  A winding up order was ultimately made against Edge on 15 July 2013 and in accordance with s.129(2) of the Act, the winding up was deemed to have occurred on 22 May 2013.

The key question on the facts of this case was whether there should be validation of the payment of the £30,000 on the basis that such payment was necessary to secure the continued supply of goods from Express to Edge after 29 May 2013.

The Decision

The Court of Appeal upheld the decision of the District Judge not to grant a validation order in respect of all or part of the £30,000 payment. The court scrutinised the scope of its discretion to make a retrospective validation order and concluded that there needs to be “special circumstances” showing a benefit to the general body of creditors to justify overriding the pari passu principle.  Special circumstances may include, for example:

  1. A payment to secure the continued supply of goods necessary for completion of a profitable contract; or
  2. a transaction in the ordinary course of business that would assist in ultimately achieving a sale of the business as a going concern for the benefit of creditors.

It should not be presumed that a validation order will normally be made even in respect of a disposition made in good faith in the ordinary course of business without knowledge of the outstanding winding up petition.

The facts of the case that we commented on in April 2015 can be distinguished on the basis that here, the petitioner had made numerous references to the possibility that he might present a winding up petition and as such, it was difficult to accept that Edge’s directors had no idea that a winding up petition had been served.  Furthermore, on the facts, there was evidence that the payment may not have been made in good faith and could have been an attempt to prefer because:

  1. payment was made much more quickly than in the months immediately preceding the payment and earlier than strictly required by the supply contracts (two days earlier in respect of circa £25,000 and one month and one day earlier in respect of circa £5,000);
  2. the goods to which the payment related had already been supplied and as such, the payment did nothing more than put Express in a better position than Edge’s other pre-petition creditors; and
  3. the benefit of making the payment had not been fully explained by Express or Edge.


This case highlights the need for companies in financial difficulty to monitor closely any creditor threats and treat these with more care than they may have done previously. Proceeding with transactions (even in the ordinary course of business) in ignorance of such threats, spurious or genuine, risks transactions becoming void if a winding up order is made at a later date.  Any parties entering into contracts with companies in distress may also wish to carry out regular insolvency checks against those companies.  Special circumstances should be demonstrated that benefit creditors and justify a departure from the pari passu principle – for example, that the payment was to ensure continued supply of goods to the Company which:

  1. ultimately led to a going concern sale of the Company rather than a forced sale; or
  2. led to the completion of a profitable contract; or
  3. resulted in the position of the unsecured creditors improving.

Ultimately, parties transact at their own risk where a winding up petition is outstanding.

Gibraltar Court Recognises Chapter 11 Bankruptcy as a Foreign Main Proceeding

Flag of Gibraltar sticking in american banknotes.(series)Peabody Energy Corporation is one of the biggest energy companies in the world. Its main business is coal mining and it conducts extensive operations in the United States and in Australia. Peabody had been hit by declining coal prices both for thermal coal and also for metallurgical coal used for steel making, especially due to the declining demand from China.

On 13 April 2016, Peabody filed for Chapter 11 bankruptcy protection in the Bankruptcy Court of the Eastern district of Missouri. This had the effect of staying the enforcement of debts due by the Corporation and its subsidiaries (“the Group). One of its subsidiaries is Peabody Holding (Gibraltar) Limited (“Holdings”), a company incorporated in Gibraltar whose shares are held by two Delaware companies, also part of the Group and which also filed for Chapter 11.

The Group in Chapter 11 entered an agreement with a syndicate of lenders to provide the Group with working capital. The agreement is titled ‘Superpriority Secured Debtor-In-Possession Credit Agreement’. The agreement enables the lenders to obtain super priority over all other secured lenders to the Group. The agreement is vital for the ability of the Group to continue in business and Holdings was pivotal to the agreement by owning the assets over which security would be granted to the syndicate.

Holdings applied to the Supreme Court of Gibraltar for recognition of the United States bankruptcy proceedings as the main insolvency proceedings for the purposes of the Insolvencies (Cross Border Insolvencies) Regulations 2014, which is the Gibraltarian legislation giving effect to the UNCITRAL model law on cross border insolvency.

A “foreign main proceeding” is defined as “a foreign proceeding taking place in the country where the debtor has the centre of his main interests.”  Regulation 21 provides that a foreign main proceeding will govern the execution against the debtor’s property within Gibraltar and any right to transfer, encumber or otherwise dispose of any property in the debtor within Gibraltar. Therefore, establishing the centre of main interest (“COMI”) of Holdings was the key issue.

The Court heard evidence that Holdings was incorporated in Gibraltar for fiscal purposes and is properly administered in Gibraltar as required by Gibraltar Law. Its head office functions are coordinated and driven strategically from St Louis, Missouri where Peabody Energy Corporation is headquartered and this is because it forms part of a much larger business headed by the Corporation.

In an interesting judgment, Judge Jack held that  Holdings’ COMI was in St Louis, Missouri and he directed that the Chapter 11 proceedings be treated as foreign main proceedings.

This was the first time that the Supreme Court of Gibraltar had been asked to consider an application by a Gibraltarian company in Chapter 11.  A similar case recently came before the English Court to  consider who can be  recognised as  “foreign representatives” under the Cross-Border Insolvency Regulations 2006 in the case of Re 19 Entertainment Limited, about an English company in Chapter 11. See our earlier post:
English Court decides who can be a foreign representative under Cross-Border Insolvency Regulations 2006

Teenagers And The D.C. Circuit Agree: Internet Service Is A Utility – Will Bankruptcy Courts Follow?

Businessman holds modern technology in handsThe topic of net neutrality has continued to be at the forefront of public discourse over recent years.  This is the result of the FCC’s repeated attempts to impose regulations designed to protect consumers while at the same time telecom companies seek to control their product and the services they provide without what they contend is burdensome regulation. This summer, in U.S. Telecommunication Association v. FCC, the D.C. Circuit Court of Appeals dealt a blow to the telecom industry when it upheld a FCC declaration that broadband internet is a telecommunication service—essentially a public utility.  Many speculate that this decision will have a broad impact (good and bad) on internet service providers in both the short and long term.  A less considered aspect of the D.C. Circuit’s ruling is how it will be applied in the bankruptcy context.

Section 366 of the Bankruptcy Code establishes safeguards for debtors when it comes to their use of public utilities.  Under Section 366, essential utility providers are prohibited from discontinuing service upon the filing of a bankruptcy petition.  Instead, the debtor is required to provide adequate assurance of payment within short order, and if the debtor complies, the utility provider must continue service.  The Bankruptcy Code does not define what a “utility” is, but the legislative history provides some insight, noting that section 366 “is intended to cover utilities that have some special position with respect to the debtor, such as an electric company, gas supplier, or telephone company that is a monopoly in the area so that the debtor cannot easily obtain comparable service from another utility.”

Bankruptcy courts have not strictly interpreted the monopoly reference in the legislative history and have continued to hold that telephone service is a utility even after the industry has been deregulated.  In the context of cable television, rather than looking to the monopoly requirement, the Fifth Circuit Court of Appeals in Darby v. Time Warner, 470 F.3d 573, 574 (5th Cir. 2006), held that the relevant analysis was whether the provider stands in a “special positon with respect to the [debtor] such that it is a utility within the meaning of the statute.”  There the Fifth Circuit held that cable television providers did not stand in a special position with respect to the debtor and further that cable television service was not a necessity and therefore not a utility under Section 366.

We have no doubt that individual debtors will begin to test whether they can claim internet service is a utility, relying principally on the D.C. Circuit’s ruling.  However, based on the Fifth Circuit’s analysis, it is entirely conceivable that bankruptcy courts will be reluctant to extend utility status to broadband internet service providers in individual bankruptcies, as it is difficult to find that internet service is a necessity.  However, in the corporate chapter 11 context, one can easily envision a scenario where broadband internet service is necessary for a debtor to continue operating its business, for example, in the e-commerce arena or simply to connect its internal computer systems.  In these circumstances, courts have already allowed debtors to consider internet service a utility under Section 366.  The D.C. Circuit’s recent opinion in U.S. Telecommunication Association v. FCC will now provide further support for commercial debtors to claim that internet service is a utility in the event that a provider dissents.

Financial services and not-for-profit firms should consider new PPF proposals on insolvency risk scorecards

Compressing pensionThe Pension Protection Fund (PPF) is reviewing its insolvency risk model with Experian. The proposals being considered are particularly relevant to the financial services and charity sectors. It is proposed they be introduced from 2018/2019 (and will not be part of the draft levy rules and levy estimate for 2017/18, which we expect will contain few changes).

In summary, the PPF is considering:

  • Using credit ratings and industry-specific scoring for regulated financial services providers. In the PPF’s experience, the current model is less reliable for financial services providers, as there is limited correlation between the PPF’s scoring and ratings agency data.
  • Using information from the Charity Commission to adjust the not-for-profit scorecard. The model has worked less well for not-for-profit companies and makes use of data on companies which are not actually sponsoring employers.
  • Changes to how companies who submit small accounts are reflected in the scoring. Again, the model has worked less well for smaller companies.
  • How to integrate scores on ultimate parent companies, which are based on ratings, with scores on unrated subsidiaries. These changes are expected to impact only a small proportion of employers.
  • Changes to reflect the new FRS102 accounting standard. The PPF will analyse the effects on the first 500 DB sponsors which file on an FRS102 basis for the first time in 2016 and consider alterations to the scorecards in light of this analysis.

Other areas which the PPF expects to consider include investment risk and certifying deficit reductions, contingent assets and asset-backed funding structures. The PPF also suggests – briefly – that it is considering simplification for smaller pension plans.

A formal consultation is expected at the end of 2016/early 2017. However, any firm or pension plan that has encountered problems with the current PPF model can contact the PPF to ask if their issue is going to be considered as part of the forthcoming consultation. The PPF welcomes comments on its approach by email to information@ppf.gsi.gov.uk.

Firms in the financial services and charity sectors should pay particular attention to the scope of the changes outlined by the PPF. As any “substantial” changes would likely be with us for at least three years (until the PPF’s next triennial review of its framework), we suggest all firms and pension plans with an interest should be poised to react to the consultation when it arrives. Be warned, however, that the PPF’s consultations are rarely short – parity with “War and Peace” springs to mind!

Football Transfer Spending- high risk leading to high reward?

flamy symbolAt the closing of the summer transfer window on 31 August, it was announced that the Premier League had splurged a record-breaking £1.165 billion on player transfers. To put that in context, that is roughly equivalent to the GDP of the Central African Republic but was spent by 20 English clubs in a two month period.

It is widely believed that this 35% increase in spending (up from £859m in 2015) is due to the new £5bn three-year TV deal, whereby each Premier League club is due to receive between £30m to £50m for the 2016-17 season. This increased revenue and spending suggests two things: (i) that the rewards of being in the Premier League are higher than ever; and (ii) clubs are spending record levels of money in order to secure their place and achieve the biggest slice of what is on offer.

So what about the non-Premier League clubs? Historically, football clubs have been very insolvency-prone. Since 1992, R3 estimates that an alarming 46% of Football League clubs have been through some form of formal insolvency process. Delving into some of the financials, the reasons become apparent. Unsurprisingly, the way to get promoted to a higher league and to share in the higher rewards is to have the best players. The best players demand the highest wages. Clubs are therefore spending a disproportionately high percentage of their turnover on wages. In the 2014/15 season, Championship clubs (the second tier of English football) spent an average of 99% of their turnover on player wages (down from 106% in 2013/14). The comparable figure for the Premier League is 63%. Whilst financial controls are being brought in for clubs in Leagues 1 and 2 (the third and fourth tiers of English football), capping the percentage of turnover that can be spent on wages to 60% and 55% respectively, no such cap currently exists for the Championship.

On any basis, such wage expenditure will cause lower league clubs to have cash-flow issues. If clubs get promoted, then the rewards may justify the increased risk, but given that the figures above were an average across the Championship and only 3 clubs can get promoted to the Premier League each season, only a small proportion of the clubs will receive the rewards. If clubs do enter a formal insolvency process, then this often leads to a downward spiral, as the Football League imposes penal points deductions on clubs that enter administration. This may lead to relegation, which in itself causes more financial hardship (just ask a Portsmouth fan).

Whilst there has not been a high-profile insolvency of a football league club for over two years, it is clear that clubs are still in financial difficulty. Just last season, Northampton Town and Bolton Wanderers were the subject of winding up petitions, both brought by HMRC. The petitions were only avoided after a change of ownership of both clubs, with the petition debt being paid as part of the deal to buy each club. It is therefore apparent that the financial rewards on offer within English football are still resulting in clubs raising the financial risks in order to try to get their hands on the rewards.

Recharacterization: It’s The Substance Of The Transaction That Matters

Trending TodayWhen should debt be recharacterized as equity? The answer to this question will have an enormous impact upon expected recovery in bankruptcy since equity does not begin to get paid until all prior classes of claims are paid in full. In a recent unpublished opinion, the Fourth Circuit Court of Appeals provided some guidance on when and in what circumstances recharacterization is appropriate. The Court’s decision also serves as warning to purchasers of debt that they may not be able to hide behind the original debt transaction in a recharacterization fight.

In PEM Entities, LLC v. Province Grand Old Liberty, LLC (No. 15-1669), the Debtor Province Grande Old Liberty, LLC (the “Debtor”) borrowed approximately $6.5 million from a bank (the “Loan”). The Debtor subsequently defaulted on the Loan and the lender instituted foreclosure proceedings. In order to settle the foreclosure action, the Debtor, its principal and other related entities entered into a settlement agreement with the lender. Under the settlement, the lender sold the $6.5 million Loan to PEM Entities, LLC (“PEM”) for approximately $1.2m. PEM was owned by insiders of the Debtor.

There were a number of interesting, and to the Court unsettling, facts surrounding the settlement, including.

  • PEM did not sign the settlement agreement and was not involved in the negotiations. Instead, the lender understood that the Debtor’s principals had the authority to bind PEM.
  • Even though PEM was not a party to the settlement agreement, the agreement bound the lender to sell the loan to PEM.
  • The agreement was purported to be “in settlement of the Loan.”
  • PEM contributed only $300,000 towards the purchase price, and PEM financed the remaining amounts, including by borrowing $292,000 from the lender.
  • Some of the financing required by PEM to purchase the loan was secured by the Debtor’s property, and the financing was partially paid back by the Debtor.
  • Following the settlement, the Debtor transferred approximately $202,000 to PEM and PEM thereafter “re-advanced” $50,000 to the Debtor for operating expenses.

The Debtor subsequently filed bankruptcy and scheduled PEM with a $7,000,000 claim, including principal and accrued interest. Two creditors of the Debtor filed an adversary proceeding seeking to equitably subordinate and/or recharacterize PEM’s claim. The bankruptcy court granted summary judgment in favor of the creditors, holding that PEM’s loan purchase was a settlement and satisfaction of the Loan and recharacterized the $300,000 portion of the purchase price as an equity investment in the Debtor. The court rendered PEM’s $7,000,000 claim void. The district court affirmed on appeal, and the Fourth Circuit affirmed the district court’s judgment.

In its ruling, the Court applied an eleven factor test (the Dornier factors) to the question of whether to recharacterize PEM’s debt. In its analysis, the Court agreed with the lower courts that the following factors supporting recharacterization: (1) the naming of the settlement agreement and the fact that it was entered into “in settlement of the Loan”; (2) the fact that the Debtor’s principals negotiated the settlement agreement on behalf of PEM; (3) the lack of any payment schedules, actual interest payments or a ledger for the financial transactions between the Debtor and PEM; (4) the Debtor’s partial payment of the loan purchase; (5) the Debtor’s total reliance on PEM for its operating expenses; (6) the identity of interests between the Debtor and PFM; and (7) the securing of PEM’s debt by the Debtor’s property.

The Court rejected PEM’s argument that the bankruptcy court considered the wrong transaction. Specifically, PEM argued that the bankruptcy court should have applied the Dornier factors to the inception of the Loan rather than the later settlement agreement. The Court noted that the bankruptcy court must look beyond “form to substance” in recharacterization claims. In this case, the “substance of the transaction” was the settlement agreement, and not the inception of the Loan, since the settlement agreement gave rise to PEM’s claims. The Court found that there was ample evidence that the Debtor had “used PEM as an extension of itself to complete, what was, in effect, a satisfaction” of the Loan.

The Fourth Circuit’s decision was certainly not surprising. PEM’s purchase of the Loan had numerous troublesome elements, all of which supported recharacterization. Nonetheless, the Court’s rejection of PEM’s argument that the bankruptcy court should have looked at the inception of the Loan itself, rather than the settlement agreement, should serve as a wake-up call to parties that the courts will look at the substance of a transaction in a recharacterization fight. Purchasers of claims cannot defend a recharacterization claim by arguing that the underlying claim is debt. Instead, they will need to show that the economic substance of their purchase should not be recharacterized.