Re Stronghold Insurance Company Limited  EWHC 2909 (Ch)
Mr Justice Hildyard, who continues to amass expertise on schemes of arrangements, recently ruled against convening a single meeting of creditors on a scheme of arrangement proposed by Stronghold Insurance Company Limited (Stronghold) (the Scheme). Hildyard J found that where the appropriate comparator to the scheme was a solvent run-off of the company, creditors with incurred but not reported (IBNR) claims had rights which were so uncertain and contingent that they could not form a single class of voters alongside creditors whose claims had accrued. Accordingly, two classes of creditors were appropriate for voting purposes. In delivering his judgment, Hildyard J also expressed some concern on how creditors were adhering to the Practice Statement on Schemes of Arrangement. He reminded creditors that unless they had good reasons for doing so, creditors should raise and properly develop and argue any concerns on class composition at the first court hearing and should not be tempted to reserve their position on class issues until the sanction hearing.
Stronghold is an insurance company with a long-tail business exposure, particularly in asbestos pollution and health hazard liabilities. It has been in run-off since 1985. Stronghold’s regulators, the PRA and the FCA (the Regulators), ruled that it no longer met the minimum capital requirements imposed by Directive 2009/138/EC (Solvency II) and requested that Stronghold produce an exit plan to end its run-off. Stronghold proposed the Scheme because a capital injection, sale, transfer or liquidation were all not considered viable or reasonably practicable. The purpose of the Scheme was to settle or compromise all of Stronghold’s outstanding obligations, known as a cut-off and estimation scheme. Trade creditors and creditors whose claims had been previously agreed but had not been paid were not included in the Scheme.
Stronghold submitted that the Scheme would provide creditors with a number of benefits that might not be available to those creditors in a liquidation, namely that the Scheme would use a market-driven estimation methodology in calculating claims and there was no assurance that a liquidator would adopt such an approach in assessing the correct amount for any liquidation proof.
In considering the Scheme, Hildyard J applied a two-stage test. The first stage focuses on rights: if there is no difference in the respective rights of creditors, the fact that they may have opposing commercial interests is irrelevant. This test requires consideration of (i) the rights of creditors in the absence of the scheme and (ii) any new rights creditors obtain from the scheme. The second stage considers an assessment of whether the differences in the rights of groups of creditors and their treatment under the scheme are so different as to make it impossible for them to consult together with a view to their common interest. In his judgment, Hildyard J referred to Re British Aviation Insurance Co Ltd  1 BCLC 665 (the BAIC case) which also considered whether accrued claims should be in the same class as IBNR claimants. In the BAIC case, Lewison J considered that when assessing whether all the policyholders should form a single class, the starting point was to identify the appropriate comparator: that is, what would be the alternative if the scheme does not proceed. The court noted that should an insurance company face imminent liquidation if a scheme does not proceed, IBNR claims would be estimated in accordance with the Insolvency Rules. Liquidators may well be open to discussion about a market-driven estimation model and interest among creditors may accordingly be sufficiently close to allow them to be in the same class. However, where the company is solvent and likely to remain so, the IBNR creditors may benefit from its continuance that they cannot be realistically be expected to discuss with other scheme creditors a scheme which offers an immediate advantage to those creditors but virtually none to them.
While noting that the evidence in this matter was somewhat ambivalent on whether liquidation or continued solvent run-off should be the appropriate comparator, the court concluded that the most likely alternative to the Scheme in the near and mid-term was that Stronghold would continue in solvent run-off. This was the appropriate comparator, particularly given that the Regulators had failed to determine what regulatory enforcement it would take to enforce Solvency II.
In the context of this comparator it was considered that the rights of policyholders with notified but outstanding claims were not the same as policyholders with IBNR claims. Hildyard J considered that given the basic fact that an IBNR claim was inherently (a) uncertain even as to its occurrence, as to the range of events that may give rise to an insurance liability and also to the range of magnitude of any exposure and (b) therefore likely also to be subject to much greater ranges in any estimation process, signified that any outstanding claim gives a scheme creditor a qualitatively different right from an IBNR claim and that this should be the prima facie position unless there was evidence that liquidation was imminent and the alternative to the scheme.
The court acknowledged that while there were a number of factors which might allow IBNR creditors and other creditors to still have a sufficient common interest to be able to vote in the same class, the court reached its decision that absent further guidance from the Regulators as to what they would do if the Scheme failed, a separate class of Scheme creditors “with predominantly IBNR claims” would be required.
While Hildyard J acknowledged that the court would retain some flexibility in considering the jurisdiction of schemes at the convening stage of the court process, the “inaccurate perception” that all issues affecting the jurisdiction of the court would be dealt with at the first stage was incorrect, and the fact a skeleton argument for the first hearing mentioned a particular jurisdiction issue does not mean the court is satisfied on jurisdiction. Further, he stressed that consideration on the fairness of the proposed scheme should be the principal focus of the sanction hearing and not the convening hearing.