Cross-class Cram-downs: The applicability of the absolute priority rule in Singapore
Introduction
In 2016, a cross-class cram-down mechanism was introduced into the Singapore insolvency regime in the form of section 211H of the Companies Act (Cap 50) (“CA”), and subsequently, section 70 of the Insolvency Restructuring and Dissolution Act 2018 (“IRDA”).
This move was part of Singapore’s efforts to establish itself as an international hub for debt restructuring and insolvency-related issues.[1] In particular, the aim was to prevent schemes of arrangements or other rehabilitation mechanism from being stymied by a dissident class of creditors.[2] This is done via a ‘cram-down’ that allows a scheme to be successfully passed over the objections of a dissenting creditor class.
This article examines the introduction of the cram-down provisions in the Singapore legislation, as well as the embedded safeguards to protect the interests of the crammed down minority creditors. Given that the cross-class cram-down mechanism was largely adapted[3] from Chapter 11 of the US Bankruptcy Code[4] (“US Code”), this article will also discuss the differences between the relevant provisions in the US Code and the IRDA in relation to the absolute priority rule.
Section 70 of the IRDA
In recommending the implementation of the cram-down mechanism, the Insolvency Law Review Committee had rationalised that a small minority of creditors in a dissenting class should not be able to veto a scheme simply because they belong in a separate class, so as not to hold the entire scheme “ransom”.[5]
Specifically, Section 70(2) of the IRDA provides that the Court has the power to approve a compromise or arrangement and order that it be binding on the company and all classes of creditors meant to be bound by the arrangement if the three conditions under Section 70(3) of the IRDA are satisfied.[6] The statutory requirements are:
- A majority in number of creditors meant to be bound by the arrangement, who were present and voting at the relevant meeting approved the scheme;
- The majority above represents three-fourths in value of the creditors meant to be bound by the arrangement, who were present and voting at the relevant meeting; and
- The Court is satisfied that the arrangement does not discriminate unfairly between classes of creditors and is fair and equitable to each class of creditors.[7]
The first two conditions exist to ensure that the applicant possesses the requisite majority in valuation and number of creditors across the classes of creditors such that they would have succeeded in the scheme but for the dissenting class(es) of creditor. Without meeting this minimum threshold, the Court does not have the jurisdiction to exercise its power to cram-down.[8]
Substantively, the third condition of the subsection codifies the requirement that the proposed scheme be ‘fair and equitable’ between each class of creditors and provides that the scheme should not discriminate unfairly between classes. The former requirement is also known as the ‘absolute priority’ rule.[9] The IRDA sets out accordingly when an arrangement is not considered ‘fair and equitable’ in Section 70(4)[10].
The ‘Absolute Priority’ Rule – Establishing the pecking order of creditors
The absolute priority rule is a general insolvency principle governing the order of payment among creditors and shareholders in a corporate liquidation. In essence, the rule requires that the original priority and order of stakeholders be preserved. This means that a secured creditor for example, must be paid out before an unsecured one.
This principle of priority manifests itself in a two-part requirement under Section 70(4) of the IRDA. First, for a scheme to be considered ‘fair and equitable’ to a creditor, the creditor must not receive pursuant to the scheme, a lower amount than what was estimated to be received in an alternative arrangement (in most cases, a liquidation)[11].
Second, the dissenting creditors being crammed down upon must receive full payment of their claims before subordinate classes of creditors can be paid. The absolute priority rule operates separately for secured and unsecured creditors respectively as such:[12]
- Where the creditors in the dissenting class are secured creditors, they must either: (i) be provided deferred cash payments totalling the amount secured; (ii) be given a charge over the proceeds of their secured asset; or (iii) be entitled to the “indubitable equivalent” of the security they own.[13]
- When the creditors in each dissenting class are unsecured creditors, the terms of the scheme must either: (i) provide for the full repayment of the claims; or (ii) the scheme must not provide for any creditor or shareholder subordinate to the dissenting creditor to receive or retain any property of the company.[14]
As then Senior Minister Indranee Rajah[15] noted, the requirement for cramming down on dissenting creditors under the IRDA is worded similarly to the corresponding provision[16] in the US Code. Hence, US cases are likely to be instructive and of persuasive value to the Singapore courts in determining whether “adequate protection” has been achieved in cases. It would therefore be crucial to discuss cases where the courts in the US have evoked Section 1129(b) in relation to a plan of reorganisation.[17]
Cram-down provisions in the USA
Although similar, the cram-down provision in the US Code is worded slightly differently from the Singapore provisions in the IRDA. Section 1129(b) of the US Code sets out the same substantive requirement for a cram-down, with the omission of the words “of the company”[18] in Section 1129(b)(2)(B)(ii) of the US Code. The resulting difference will be addressed in the next section.
In understanding the cram-down mechanism in the US, the case of In re Philadelphia Newspapers, LLC [2010][19] is helpful in setting out the basic principles of a cram-down. The US Court of Appeals noted that the process of reducing secured claims to the present value of the collateral under Section 1129(b)(2)(A) of the US Code forces secured creditors to accept less than full value of their claims.[20] This required the court to assess whether the proposed treatment of the secured claims is “fair and equitable”.[21] The court further noted that as long as one of the three methods of providing for secured creditors is provided (see [10(a)] above for a near identical provision in IRDA), the requirements under the statute will be satisfied.
The absolute priority rule operates similarly with respect to unsecured creditors, who must be paid in full before the debtor[22] or the equity holders[23] can retain any property as part of a scheme. Further, if a holder of a senior claim receives less than full value for their claims, no junior unsecured creditors can receive any property under the plan[24].
In essence, the rule exists to ensure that any schemes of arrangement or reorganisation plans respect the existing chain of priority with regard to the company or individual’s debtors. Only if the priority is preserved can the scheme satisfy the requirements for cram-down under S 1129(b)(2) of the US Code, thereby preserving the rights of certain classes of creditors who may potentially suffer harm from collusive behaviours between shareholders (who rank lower in priority) and directors implementing schemes.
Differences in the cram-down provisions in Singapore and the US
As mentioned above, there exists a key difference in wording in Section 70(4)(b)(ii)(B) of the IRDA and that of S 1129(b)(2)(B) of the US Code. Specifically, for dissenting unsecured creditors, the persons subordinate in priority to the dissenting class must not receive or retain any property of the company[25] pursuant to the IRDA; whereas in the US, the holder of such a claim cannot receive or retain any property at all.
The addition of the phrase “of the company” in the IRDA was made to clarify the implication of the original mechanism in the US – that a pre-requisite to cramming down an unsecured creditors requires existing shareholders to divest their shareholding so as not to retain “any property”, unless all unsecured creditors are paid in full.[26] This was difficult to achieve in Singapore since there is no statutory mechanism designed to compulsorily divest shareholders of their shares under a scheme.[27] Therefore, the addition of the phrase eliminates the requirement that shareholders be divested of the shares in the case where unsecured creditors are to be crammed down.
This addendum to the provision was specifically highlighted by then Senior Minister Edwin Tong, noting that the cram-down provisions were “not concerned with adjustments to shareholder interests”[28], a consideration also noted when Ms Indranee Rajah introduced the cram-down provisions into the CA in 2017[29].
‘Cram-down’ Provisions in Singapore
At the time of writing, the Singapore court has yet to report a case which has invoked either Section 70 of the IRDA or the repealed Section 211H of the CA. Hence, the procedure relating to a successful cram-down is still subject to the court’s interpretation of the legislation.
Nevertheless, there are likely to be two consequences of removing the shareholder divestment requirement. First, this erodes the absolute priority rule envisaged in the US Code and runs the risk of junior creditors potentially being “squeezed out” by senior creditors and shareholders forcing a scheme by the manipulation of equity issuance. Second, the change runs contrary to the general principle of insolvency that creditors should be repaid in an insolvent company before the shareholders.
In spite of the difference diluting the concept of the absolute priority rule, it is maintained that there is no substantive reduction in the effectiveness of the cramming down provisions and the relevant statutory safeguards to protect minority creditors.
The main reason for this is the more stringent requirement captured under S 70(3)(b) of the IRDA requiring the majority to represent more than three-fourth in value of the creditors being bound by the scheme[30], as compared to the US Code’s requirement of a two-third majority in value.[31]. The increased majority threshold mitigates against the erosion of the absolute priority rule, leaving only the risks of oppressive behaviour in situations where junior creditors comprise of a relatively small proportion of the overall financing structure. This risk is further contained by the requirement that no dissenting class of creditors receive an amount lower than the Court’s estimate in the most likely scenario if the scheme does not take effect.[32]
In fact, the majority requirement may have overcompensated against the erosion of the absolute priority rule, which possibly explains the dearth of scheme of arrangement cases applying for cram-down in Singapore, since the original requirements in Section 1129(b)(2) of the US Code are already stringent as they stand.
In any event, the courts in the US have in recent years tended to allow for the retention of equity in debt reorganisations. In the US courts, a “new value” doctrine has seen some equity holders retain their shares in a Chapter 11 plan of reorganisation, although it further requires the shareholders to a substantial and essential contribution in exchange for their continued ownership of the debtor.[33] This runs in tandem with the revised provision in Singapore, allowing for potential cramming down actions to be taken without requiring shareholders to divest.
Conclusion
Summarily, while the rule of absolute priority has been eroded during the porting over of the provisions from the US Code to the IRDA, sufficient statutory safeguards are still in place to ensure that creditors are not short-changed when a scheme is crammed down on them pursuant to Section 70 of the IRDA. The comparatively more stringent requisite majority requirement, as well as the test for unfair discrimination in the provision ensures that by preventing a small majority from vexatiously vetoing a reasonable scheme, the court does not cause prejudice to these creditors. Time will tell if the court will also give greater consideration to the absolute priority rule when granting a cram-down of creditors in the future.
If you have any IRDA-related or restructuring-related enquiries, please do not hesitate to contact Head of Restructuring & Insolvency Meiyen Tan by email [email protected] or mobile +65 9366 3179; and/or Partner Keith Han by email [email protected] or mobile +65 9436 8330.
[1] Committee to Strengthen Singapore as an International Centre for Debt Restructuring, Report of the Committee (Ministry of Law, 2016) (the 2016 Report).
[2] Insolvency Law Review Committee, Report of the Insolvency Law Review Committee (Ministry of Law, 2013).
[3] Singapore Parliamentary Debates, Official Report (10 March 2017), Vol 94 (Ms Indranee Rajah, Senior Minister of State for Finance).
[4] US Bankruptcy Code, 11 USC § 1126 and 1129.
[5] Committee to Strengthen Singapore as an International Centre for Debt Restructuring, Report of the Committee (Ministry of Law, 2016).
[6] Section 70(2) of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018).
[7] Section 70(3) of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018).
[8] Singapore Parliamentary Debates, Official Report (10 March 2017), Vol 94 (Mr Edwin Tong, then Marine Parade MP).
[9] Bank of Am. Nat. Tr. & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 469, 119 S. Ct. 1411, 1429, 143 L. Ed. 2d 607 (1999)
[10] Insolvency, Restructuring and Dissolution Act 2018 (“IRDA”) (Act 40 of 2018) s 70(4).
[11] Section 70(4)(a) of the Insolvency, Restructuring and Dissolution Act 2018 (“IRDA”) (Act 40 of 2018)
[12] Section 70(4)(b) of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018).
[13] Section 70(4)(b)(i) of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018).
[14] Section 70(4)(b)(ii) of the Insolvency, Restructuring and Dissolution Act 2018 (Act 40 of 2018).
[15] Singapore Parliamentary Debates, Official Report (10 March 2017), Vol 94 (Ms Indranee Rajah, Senior Minister of State for Finance).
[16] US Bankruptcy Code, 11 USC § 1129(a)-(b).
[17] More commonly used term in the United States to describe a scheme of arrangement.
[18] See supra note 14.
[19] In re Philadelphia Newspapers, LLC, 599 F.3d 298, 301 (3d Cir. 2010), as amended (May 7, 2010)
[20] The court in In re Philadelphia Newspapers, LLC noted an interesting tidbit that the term ‘cram-down’ originated from the thought that such an action was akin to a scheme being ‘crammed down the throats of objecting creditors’, citing Kham & Nate’s Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d 1351, 1359 (7th Cir.1990).
[21] See Supra note 19 at Pg. 305.
[22] In re Brown, 505 B.R. 638, 647 (E.D. Pa. 2014) at Pg. 642.
[23] In re NTP Marble, Inc., 491 B.R. 208 (Bankr. E.D. Pa. 2013) at Pg. 215.
[24]In re Idearc Inc., 423 B.R. 138, 170 (Bankr. N.D. Tex. 2009), subsequently aff’d sub nom. In re Idearc, Inc., 662 F.3d 315 (5th Cir. 2011) at Pg 170.
[25] Singapore Parliamentary Debates, Official Report (01 October 2018), Vol 94 (Mr Edwin Tong, Senior Minister of State for Law).
[26]Paul Apathy, Emmanuel Duncan Chua and Rowena White, ‘Singapore’s New “Omnibus” Insolvency, Restructuring and Dissolution Bill’, Law Gazette, January 2019 (accessed 06 January 2021).
[27] ibid.
[28] Singapore Parliamentary Debates, Official Report (01 October 2018), Vol 94 (Mr Edwin Tong, Senior Minister of State for Law).
[29] Singapore Parliamentary Debates, Official Report (10 March 2017), Vol 94 (Ms Indranee Rajah, Senior Minister of State for Finance).
[30] Section 70(3)(b) of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018).
[31] US Bankruptcy Code, 11 USC § 1129(a)-(b).
[32] Section 70(4)(a) of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018).
[33] Bank of Am. Nat. Tr. & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 469, 119 S. Ct. 1411, 1429, 143 L. Ed. 2d 607 (1999)