Corporate Restructuring and Insolvency: Administration Pursuant to Section 8 of the Insolvency Act 1986: Two Recent Cases of Interest to the US

The Meaning of Insolvency ó A Message to US High-Yield Investors and Acquirers of Distressed Debt in Europe

In Re Colt Telecom Group Plc [2002] EWHC 2815, the English Court has sent a clear message to US high-yield investors and acquirers of distressed debt that when considering the meaning of insolvency for the purposes of an English administration, it will not tolerate "shaky, tentative and speculative" arguments as to the financial health of companies.

Colt carried out business through its trading subsidiaries. Its business comprised the provision of advance telecommunications services to corporate and government customers across Europe (totalling £2.6 billion as at 30 September 2002). Its assets consisted primarily of cash held by it and investments in its subsidiaries comprising shareholdings in, and long term funding to, those subsidiaries. Its liabilities consisted principally of its indebtedness under 9 series of Notes issued by it between 1996 and 1999. Its business had also been funded by raising equity capital totalling more than £2 billion, the most recent being approximately £500 million in December 2001.

The Petitioners, Highberry Limited (an English company incorporated in November 2001) and its affiliate Highberry LLC (a Delaware Corporation incorporated in September 2002) were hedge funds which formed part of the US Elliott Associates group, specialising in the taking of short positions in company shares and acquiring debt securities at a discount in the hope of a rise in price.

At the time of the Petition, Highberry held approximately 7% in value of the Notes. There was no indication of any support for the Petition from the holders of the remaining 93%.

The Petition was considered to be unusual in that Highberry's principal argument was that Colt was or was likely to become insolvent notwithstanding that it was a constituent member of FTSE mid-250 index and had a market capitalisation of £550 million, not to mention its net assets of £977 million. In addition, the various series of Notes issued by Colt were not in default and did not fall for repayment until the period 2005 to 2009. In their proposals, Highberry relied upon a dramatic fall in the Colt share price since the year 2000 and its substantial operating losses and negative cash-flows.

The object of the proposed administration was purportedly to achieve a restructuring through a transfer of value of the company from the shareholders to the bondholders either by a debt for equity conversion or by payment out of Colt's cash or both. Highberry had made an initial approach to Colt suggesting a 100% payment of the face value of the Notes, even though repayment of capital was some years away and Highberry had obviously bought the Notes at a discount. The Court considered that Highberry was "after a large and quick profit" and it was accepted that companies associated with the Elliott group had taken short positions in the shares of Colt.

Colt submitted that it believed the Petition to be part of a strategy to make a speculative profit from Highberry's acquisition of Notes at a discounted price and also from their (or their affiliated companies') short position in Colt's shares and that Highberry was seeking to achieve the profit by forcing an unjustified transfer of value from shareholders to Note holders.

Highberry had previously brought a fair amount of pressure to bear upon Colt such as by sending letters to each Colt director at home threatening an investigation into the directors' conduct and, by implication, wrongful trading proceedings.

Against that background, the Court had to determine six issues:

Must a Petitioner prove that the company is "likely to be unable to pay its debts" within section 8(1)(a) IA 1986, on a balance of probabilities or is it sufficient for it to prove that there is a real prospect of that being so? According to the Judge, the meaning of the word "likely" is in effect "more likely than not". In other words, where a Petitioner alleges that a company is likely to become unable to pay its debts, the Petitioner must show that this is more probable than not. A company should not be put into administration where there is only a "real prospect" of insolvency, and the Judge did not consider in this case that insolvency had been proved on the "real prospect" test in any event. The Judge stated: "To put a company into administration is a serious matter. Creditors, as well as the company itself, can...