Co-op Bank Recapitalisation: Stage One and Its Timetable
Friday this week 29th November 2013 is the first key date in the long and complex process of saving the Bank from insolvency proceedings by recapitalising and demutualising it. The others are 11th December 2013 , the day of the Class Meetings to approve it and 16th December 2013, the date of the court hearing to finally approve it.
This post looks at that process, the legal mechanisms used to implement it and the timetable.
The Story So Far
In May this blog examined the Co-op Bank’s credit rating downgrade. That was the first public sign of the trouble to come.
In June, I looked at Plan A for a rescue of the Bank in the light of the £1.5bn shortfall identified by the PRA.
In September, hints of the likely demutualisation and indications of the Hedge funds’ demand for 100% ownership were addressed.
On 23rd October the scale of investor control was announced and later that month I shared my thoughts on the issue of the use of the name “co-operative” in that bank after it becomes 70% owned by stock market investors with follow up on Co-operatives UK’s response.
The Plan in Summary: A Reminder
The Co-operative Group will give 70% of the equity shares in the Bank to the senior bondholder (i.e. those with the highest priority claim – upper tier 2) in exchange for about £940m of the debt they hold plus a £125m cash injection into the bank. The Group will continue to hold the remaining 30% in return for providing £462m in a new Group bond and cash.
The lower ranked bondholders who are mainly retail investors on a smaller scale but who would have lost their whole investment if existing priorities of debt had been followed, will be offered new bonds with a choice between continuing their existing annual payments for 12 years with no capital sum or a lower annual payment plus a future capital sum. (See the FT Outline and Q & A)
The Legal Mechanisms Involved
Since this is a Law Blog, it might be useful to look at the legal basis and process for this crucial first stage of the recapitalisation plan for the Co-operative Bank PLC.
The detailed plans for the scheme can be found in a combination of the outline press release announcement and the detailed “nitty gritty” of the legal mechanism.
Why the Money is Needed:
Readers will remember that £1.5bn extra “common tier 1 Equity” is required by the bank as a result of the wide range of problems it has faced and the increased requirements imposed by the PRA and Bank of England for bank capital. The problems included the bad debt that Britannia brought, the bank’s excessive cost to income ratio, the money written off on IT schemes, and the compensation it is having to pay as a result of mis-selling PPI to its customers.
As the Summary section of the Bank Prospectus succinctly puts it:
“Para B.4b The capital shortfall is a result of continuing losses incurred by the Bank predominantly driven by impairment charges to the carrying value of the Bank’s loans, in particular corporate loans acquired as part of the merger with Britannia Building Society (Britannia) in 2009. Impairment charges for the six months ended 30 June 2013 were £496.0 million.
The Bank also has a high cost base relative to its revenue when compared with its peers. The Bank has an ageing IT platform that has suffered from under-investment in recent years and has failed to integrate Britannia into the Bank’s operations, resulting in significant cost duplications in front, middle and back office functions and a significant overlap in the branch network. In addition, the Bank’s revenues are impacted by it not having achieved sufficient penetration of its current account customer base and historically pricing certain of its products on terms more generous to customers than the market.”
– Page 8.
The recapitalisation plan will raise the £1.5bn in two ways:
A Liability Management Exercise in 2013 will contribute £1062m and
Another £333m – £170m by 30.06.2014 and another £163m by 31.12.2014 – will come from the Banking Group, the subsidiary of the Co-operative Group through which the Bank is held.
They are linked and conditional on each other but let’s look at the Liability Management Exercise today. The rest of the money only comes if that goes ahead and that question depends on a legal process. Let’s look at that.
The Liability Management Exercise: The Current Process
As the FT Outline and Q & A reported, the two main groups of securities (bonds or shares in the Bank) affected are:
5.555% perpetual subordinated bondholders – lower tier 2 (LT2) investors – hand over their £937m of debt plus £125m of new cash plus £38m of interest (£1100m in total) for 70% of the Bank’s ordinary shares. This Group includes the Hedge Funds and holders of 48% of these securities have signed up to a legal commitment to vote in favour of the Scheme in their meeting. So those votes are in the bag.
9.25% Preference Shares and 13% perpetual subordinated bonds – both mainly held by retail investors and lower in priority for payment than the other bonds. They would have been completely wiped out in the normal course of events but are offered £38m for their £60m. They can swap for either “Instalment Repayment Notes” which get 12 years of income with no capital at the end or “Final Repayment Notes” which give capital at the end of the 12 years but less income from interest in the meantime. If 75% of each of the two groups agree to swap by 29.11.13, they all get more than if that doesn’t happen. Their agreement to swap is taken as a vote for the Scheme. However, the whole scheme has to be agreed before anyone gets anything. If the financial incentive works, it will be known on 29.11.13 whether one or both of these groups have effectively voted in favour of the whole plan.
Legal Process and the Key Dates
This process involves a combination of legal agreement based on the common law of contract and procedures under the Companies Act 2006 to allow the imposition of what is agreed by a big enough majority on the minority.
Under the Law of Contract, agreement must be made with anyone who is to be legally bound by their promise. If people already have rights attached to their bonds or shares, Contract Law would require the agreement of each one of them before those rights were changed. Here the plan is to substantially change the rights of the holders of these securities. If each and every one of them had to agree, a tiny group could hold the rest to ransom and it would be impossibly complex to organise the arrangement.
To allow deals agreed through “creditor democracy”, Part 26 of the Companies Act 2006 provides a mechanism, now being used for the Bank Liability Management Exercise, to allow majorities to impose new terms on minorities. This requires court approval as well as special majorities in separate meetings of each sclass of creditors or members. Section 895 of the Act sets out the possible uses of the procedure for “a compromise or arrangement” between a company and its creditors or members or any class of them. In the case of the Co-op Bank, the Bondholders are creditors and the preference shareholders are members.
The first step is an application to the court to order class meetings of different groups of creditors and members. That was done for this Scheme on 18th November 2013 as planned and the Court ordered that the meetings be called on 11th December 2013 as had been intended all along. That meets the requirement of section 896 of the Companies Act 2006.
Under section 897 of the Companies Act 2006, a statement explaining the effect of the compromise or arrangement must be made available and with the creditors being involved about where it can be found. That has been done by the availability of the statement on the Co-op Group website which is referred to in the Court Order.
The Scheme meeting will be held at 10.am on 11th December 2013 at the Bloomsbury Holiday Inn. Although it is referred to as one meeting, there are separate class meetings and the necessary majority has to vote in favour of the Scheme at each of those meetings. If any meeting does not get the necessary majority the whole Scheme collapses. According to the document on the Co-op Group website, the votes by Preference Shareholders will be at 1.00pm, those of 13% Bondholders will be at 2.00pm and those for the 5.555% Bonds at 3.00pm.
In each case the vote will be on an Extraordinary Resolution. A majority in number representing 75% in value of each class of creditors or and class of members voting either in person or by proxy at the meeting called under section 896 must agree the Scheme – s 899(1). That means that there must be a simple majority of votes by people present at the meeting and voting (in person or by proxy) and that simple majority of voters must also hold between them 75% in value of the holdings of all those present and voting (again in person or by proxy).
In addition each of the three classes must vote in favour of the Scheme by that dual majority and if they don’t the court has no power to sanction the Scheme and it cannot go ahead – 899 (1) and Re Hellenic & General Trust Ltd  1 WLR 123.
If the meetings do pass the necessary resolutions by the necessary majority, the court may approve the Scheme so that it becomes binding on all those it affects whether or not they voted in favour of it s 899(1). As that wording suggests, the court has a discretion about whether or not to approve the Scheme. Even after approval by the correct majorities, it can refuse approval. However, the court will be unwilling to upset the Scheme on its own commercial assessment, especially if there is a large majority in favour of it in each class. That is because the test applied by the court is whether no honest and intelligent person among those affected by it could reasonably approve it and the more votes there are in favour the less likely that is – Re Equitable Life Assurance Society (No.2)  EWHC 140 (Ch). It is also the case that the existence of an adverse situation facing the company if the Scheme fails is a factor in favour of approving the Scheme at least of all the procedural rules have been followed – Scottish Lion Insurance Co Ltd  CSIH 6 at para 44 [LINK]. Given that the Scheme document indicates (at para 5) [link] that:
“If the Liability Management Exercise is not successfully implemented on or before 31 December 2013, the Bank therefore considers that the PRA would have a basis for determining that the Bank is failing, or is likely to fail, to satisfy its threshold conditions; that the power of the Resolution Authorities to exercise stabilisation powers under the Banking Act had arisen; and the Bank believes it is likely that the Bank would be subject to a resolution procedure under the Banking Act. The Bank therefore believes that there are only two realistic outcomes for the Bank, which are either its recapitalisation following successful implementation of the Liability Management Exercise or a failure of the Liability Management Exercise resulting in the Bank becoming subject to a resolution procedure under the Banking Act.”
The result of the votes at the class meetings will be announced on 12th December 2013.
The Court hearing to sanction the Scheme will be on 16th December 2013 and the result of the hearing will be announced “as soon as reasonably practicable” after the hearing.
I don’t have a crystal ball. However, key factors making it likely that the necessary majorities will be found and that the court will approve the Scheme are:
The retail investors – Preference Shares and 13% Notes
They get quite a good deal they can get more if they agree the swap by 29.11.13 instead of waiting till 6th December and to get the extra they have commit to vote for the Scheme. They are treated generously. They can still get 12 years of income or less income plus some capital instead of losing the whole investment. Arguably, anyone investing in a security labeled as bearing a 13% return should have understood how risky it was and preference shares are shares and not debt. However, the potential PR disaster of a lot of elderly individuals with faith in the Co-op Bank ( or previously Britannia) having their savings wiped out, the great work of Mark Taber and others on their behalf, and the relatively small value of their total investments in the scheme of things has saved their bacon – as long as the Scheme goes through. They should be very grateful.
The LT2 Bond Holders – 5.555% Notes
This group get 70% of the Bank in return for all their bonds plus some cash. Whether that is a good deal depends on how the bank fares in the future. Negatives for the value of the Bank’s shares include the recent blizzard of bad publicity and political mud slinging around Paul Flowers and the plethora of enquiries into the Bank, the Group and the regulators. That all means that the controversy will run and run. However, if the business plan works and the Bank’s performance improves with its new capital structure, the new shareholders and the Co-op Group could do quite well. More immediately, holders of 48% of this class of securities are locked into voting in favour of the deal.
Both groups have been party to the detailed negotiations to agree the Scheme and seem to welcome it. If the Scheme fails and the Bank goes into “Resolution” (i.e. special regime for banks with financial difficulties) all parties will be worse off than they would be under the Scheme. The creditors and preference shareholders will either be wiped out or suffer significant loss.
For the Co-op Group, the “cross default” that Len Wardle was reported as mentioning at the Co-op Group Half Yearly meeting might also arise. So there can be no doubt that agreement on this plan is also in the interests of the Co-operative Group and the whole co-operative movement.
We must hope that the Scheme is approved despite the demutualisation of the Bank that it will involve.