Shareholders are a company's residual claimants – if a company is a cake, shareholders get the last slice after everyone else takes theirs. When a company goes bankrupt, there are no more leftovers, and, therefore, our bankruptcy laws generally wipe out shareholders.
Can companies that are in trouble, but perhaps not quite beyond repair, restructure even when there's still some value left over for equity? Arcan Resources Ltd. thinks that it can do so through a plan of arrangement. However, the plan requires building a consensus between debt and equity holders, a difficult task. And, if the plan does work, it exposes a procedural flaw in the plan of arrangement process.
A company's capital structure is the organization of claims against a company's assets. Secured creditors rank first, unsecured creditors second, and equity last. Prior to insolvency, creditors protect their rights contractually by putting limitations on a company's actions. To change a company's obligations, creditors must approve changes to the bond indenture. In insolvency, by definition, there is nothing left for equity. Since there's nothing left for them once everyone else has fed, they don't get to vote on reorganization, they merely get to challenge the fairness of the transaction in order to make sure that there really was no value left over . Under the Companies Creditors Arrangement Act (the CCAA), creditors usually meet with the insolvent debtor in advance to put together and vote on a plan of reorganization – a "pre-packaged" insolvency or "prepack" – to be approved by the court during a CCAA procedure.
While a CCAA procedure may be structured, orderly and may eventually turn a troubled company into a viable one, it's also costly, time consuming and can damage corporate value.
Arcan has about $325-million in debt, nine times its cash flow. Half of that debt is in the form of high yield convertible debentures coming due in 2016 and 2018. These debentures rank in priority above shareholders, but below Arcan's bank debt.
While Arcan can technically meet its obligations to its debtors, it likely can't do so for long, or in a way that encourages corporate growth. To solve this problem, Arcan began searching for potential suitors, both to buy assets but also to potentially buy the company. After conducting its search, the only option that emerged was the relatively new oil and gas company Aspenleaf Energy Ltd.
Aspenleaf put forward a complex plan. In brief, Aspenleaf's plan of arrangement involves taking over Arcan, assuming the bank debt, buying out the debentureholders for about $825 per $1,000 of their face value, and giving the shareholders a 90 per cent stake in a new company that owns about 12.5 per cent of Arcan.
What's obvious from Aspenleaf's plan is that it thinks that there isn't that much left over for shareholders. This is clear because, under Aspenleaf's plan, shareholders see their ownership interest reduced to just over 10 per cent. What looks like a raw deal for shareholders isn't: under CCAA – a likely eventual alternative to this plan – shareholders would get nothing. Similarly, this is likely better for shareholders than transforming the convertible debentures into equity, where the debentures' pricing formula – based on the volume weighted average price of the securities in the run up to conversion – risks an even larger dilution.
Aspenleaf doesn't think that there's enough value to pay debenture holders the entirety of their claim while still giving shareholders enough incentive to vote "yes" to the plan. So, while debenture holders are offered a premium over the market value of their claim, the plan offers them a discount on the face value of their bonds.
Aspenleaf's nominal plan of arrangement looks an awful lot like a prepack that's being done outside of the CCAA. The rub is that, unlike in a prepack, Aspenleaf needs to convince both debenture holders and equity to accept the plan of arrangement. In order to do so, it needs to slice the Arcan cake in a way that both debt and equity will agree to. Aspenleaf is hoping to build consensus by transferring some value from debenture holders to equity, still leaving debenture holders with more value than the market would give them, but less than the face value of their claim.
A group of convertible debenture holders, lead by Stornoway Portfolio Management, objects to the transaction on the grounds that the slice Aspenleaf wants them to take is too small. Indeed, Stornoway argues that anything less than 100 per cent of the face value of their claim is too little and is threatening to vote against the proposal.
The core of Stornoway's objection is based on the terms of the debentures and their rank in Arcan's capital structure. Stornoway is willing to vote down the deal to continue to be bound by the contractual terms of its debentures, which require an above-market price for early redemption, knowing that under a potential CCAA procedure, creditors must receive full value on their claims before shareholders receive anything. To receive less than face value outside of CCAA, Stornoway must value Aspenleaf's offer at more than their contractual claim. And Stornoway does not.
Aspenleaf's argument as to why debenture holders should accept is that the paper claim isn't worth the paper it's written on and that debenture holders should take the deal because it offers a premium over the market price. The debate between Stornoway and Aspenleaf is almost metaphysical – in Stornoway's contractual reality the debentures are worth one thing, in Aspenleaf's financial reality the debentures are worth another, and those two realities are incompatible with one another.
The debate between Stornoway and Aspenleaf will be settled by the debenture holder and shareholder vote. And this is how this fight should be settled. But, if the plan of arrangement regime is going to be used for borderline solvent companies, impaired and objecting creditors should be given similar dissent rights to shareholders under normal plans of arrangement.
Under Aspenleaf's plan of arrangement, creditors who vote no are not given dissent rights. This is a bit of legal arbitrage: the statutory requirements of a plan of arrangement only mandate dissent rights for shareholders, not creditors who aren't given dissent rights by either law or the debenture terms.
For transactions where debenture holders receive diminished value, the rules make little sense – in these situations, creditors taking a discount from face value are more likely to be denied fair value for their debentures than shareholders. Therefore, creditors should be given the same rights to have a court appraise their position as shareholders are under more typical plans.
The debate over who gets dissent rights is less metaphysical than the one over the value of the debentures. Stornoway believes that the priority rights of debenture holders to recover are being stomped on by Aspenleaf's offer. This isn't fully accurate – if they accept the proposal, debenture holders are simply selling their debentures for a price, not agreeing to compromise their priority. But the debenture holders are not just voting to modify the terms of their indenture, they are voting on the plan of arrangement, and should be given the same protections as dissenting shareholders.
That wouldn't just make the plan of arrangement useful for restructuring companies; it would also make it fairer.
Adrian Myers