U.K. Solvent Schemes of Arrangement Insurance Creditors and the Court Finally Bite Back
Author's Note:This article, confined to English law as at August 1, 2005 except where expressly stated otherwise, focuses cursorily on a few interesting aspects of Lewison J's July 21, 2005 decision in British Aviation Insurance Co. Ltd.  EWHC (Ch) 1621 ('BAIC' unless the context otherwise requires) downloadable from http://www.bailii.org/ew/cases/EWHC/Ch/2005/1621.html. This article's not-exhaustive paragraph [§] references, supplied for the reader's convenience, are to those of that decision. In that case, BAIC unsuccessfully petitioned the Companies Court under Companies Act 1985, s.425(2) to sanction a proposed 'solvent' scheme of arrangement, downloadable from http://www.baicsolventscheme.co.uk. The latest version of Companies Act 1985, ss.425-6 is downloadable from http://www.astorlaw.com/downloads. The author's own technical terms are defined at his Master Glossary v.3.2, downloadable from http://www.astorlaw.com/downloads.
Unless a particular statutory insolvency process (such as, for example, administration1 or liquidation2) has already descended upon it, every company 'liable to be wound up'3 under Companies Act 1985,4 whatever its business, is entitled in principle to volunteer to its chosen [§96] creditors such 'compromise or arrangement'5 as it pleases, and those creditors are entitled in principle to assent or dissent. The targets and details of each scheme are left entirely to the debtor's discretion, who is thus free—consistent with the sanctity of freedom of contract—to try to pick off its creditors as it chooses and prescribe in the scheme document matters such as proof procedure [§§22-23, 108], bar date [§22], disposition of insurance claims [§§24-29] and contractual releases [§31].
English company law (cf. company insolvency law, which is materially different) has long6 made it easy for a debtor company to proactively impose an arrangement on a dissenting minority provided the statutorily stipulated majority consents—75 percent by value, more than 50 percent by turnout either actually or by proxy at the requisite statutory meeting [§§38-44, 55-68, 116-117],7 assuming the insurer has managed to identify, locate and notify sufficient relevant creditors in the first place [§§34-37, 115]—and the court has then sanctioned the arrangement. Per Companies Act 1985, s.425(2) (so far as presently relevant):
If a majority in number representing three-fourths in value of the creditors or class of creditors... present and voting either in person or by proxy at the meeting, agree to any compromise or arrangement, the compromise or arrangement, if sanctioned by the court, is binding on all creditors or the class of creditors...and also on the company or, in the case of a company in the course of being wound up, on the liquidator and contributories of the company.
With the terminological gaucheness typical of English lawyers, such an arrangement, whether proposed or actual, is now known as a 'section 425 scheme'. The point about s.425(2) is not the proposing and majority acceptance of a debtor's scheme or even its sanctioning by the court, but its subsequent imposition on the entire non-assenting or dissenting minority.
BAIC Decision: A Reality Check for Insurers
When the proposing company, having had a successful statutory meeting, then petitions the court to sanction the approved scheme, opposing minority creditors then get their chance to persuade the judge to dismiss the petition notwithstanding the apparent majority vote [§§118, 142]. The BAIC case, in which they were successful, highlights the now-significant8 community of London insurers (and their impatient—and in BAIC's case, substantial9—corporate shareholders) grown weary of their own open-ended 'old year' [§21] U.S. asbestos, pollution and health-hazard (APH) and other insurance liabilities and proposing s.425 schemes, thitherto successfully both with creditors and the Companies Court. They have also presumably grown bored of spending or saving the premium paid in good faith by the insurance creditors adversely affected by the proposed scheme.
As well as selling conventional aviation-related insurance products, BAIC diversified into selling cover—nay, blank checks, viz., insurance cover unlimited in time and amount via 'occurrence'-wording insurance contracts—to U.S. assureds for APH liabilities [§§3, 6 and 8]. Relevant U.S. insurance creditors bought, in good faith, unlimited prospective coverage [§8]. BAIC's board and shareholders should have taken this simple fact more seriously. Apparently, BAIC was the first 'solvent' insurer s.425 scheme case to be opposed [§§46-52] by creditors [§2], all of them U.S. corporations [§45] (in relation to whom the company and its advisers self-evidently failed to do due diligence and to whom the proposed scheme was, self-evidently, not properly pre-sold10).
Lewison J's refusal to sanction BAIC's proposed s.425 scheme, thus upholding the rights of dissenting contingent creditors with thitherto unliquidated claims, has caused consternation among insurer-side lawyers and accountants. His decision is a welcome reality check in an increasingly questionable routine of U.K. insurers proposing s.425 schemes, which were then seemingly nodded through by insurance creditors and Companies Court judges.
A s.425 scheme is one of a number of English restructuring processes that U.S. lawyers find so confusing and English lawyers find so tiresome. An insurer's resort to a s.425 scheme has become fashionable only lately. Insurance companies until recently appear to have favoured extricating themselves from their own insurance liabilities by transferring them, under close regulatory supervision, to another fully accountable insurer via yet another statutory device presently called a 'business transfer'.11
Three self-explanatory types of s.425 scheme are now well established for insurers—viz., cut-off, reserving and hybrid. A considerable industry of lawyers and accountants now supports insurer schemes and other insurer restructuring devices. Indeed, some service providers now seek out and stalk insurers and reinsurers, proposing to some that they 'do a scheme', administration of which is a large source of revenue (from assets better spent paying creditors). Suspecting material short-changing of U.S. assureds on a material scale, some U.S. assured-side law firms have taken an interest in the contentious possibilities of s.425 schemes and sometimes contrive tenable challenges to them. The BAIC decision empowers and is likely to embolden them.
A key to a s.425 scheme is the court's sanction under Companies Act 1985, s.425(2) [§§69-76]. Petitions for sanction (and all other substantial company insolvency matters) are heard in the Companies Court,12 part of the High Court's Chancery Division.13 Insurance coverage disputes, on the other hand, are heard in the Commercial Court,14 part of the High Court's Queen's Bench Division.15 The Chancery16 and commercial17 bars are separate, distinct and different. A Companies Court judge who spent his barristerial career at the 'pure' chancery bar may never have encountered the intricacies and peculiarities [§86] of a complex insurance transaction or of running an insurance business. Indeed, he would never have been retained, and would rightly have declined, to handle any such case. Rather, he will be familiar with company managerial and structural problems such as shareholder disputes, director malfeasance, capital reductions and generic insolvencies.
Encountering for the first time the abstrusities of long-tail APH insurance in an insolvency context, he will not necessarily be as well placed to cut through the issues as a commercial barrister or judge. He may not be familiar with the business dynamics behind, or the insurance content of, specifically, an insurer's application to him to sanction a solvent scheme. Some Companies Court output specifically on insurance insolvency has been unsophisticated and misinformed (certainly in relation to the Lloyd's enterprise). To neutralise this cultural dysfunctionality and stop him being susceptible to merely vociferous rather than technically meritorious arguments, a specialist insurance insolvency court combining chancery and commercial expertise would be nice, but there are apparently no plans for one.
BAIC was seeking through a so-called 'solvent' [§§2, 7] s.425 scheme to amend its underlying insurance contracts. The magic label 'solvent' touted by it so ingenuously to creditors and the court—and which the court actually takes seriously [§82], perhaps somewhat naïvely—insinuates that it was able, ready and willing to pay all its relevant creditors 100 percent of what it actually owed them at whatever time in the future it naturally actually owed it. If so, why18 seek an accelerated exit, especially if its shareholders are prepared to support it indefinitely (which BAIC's were apparently prepared to do [§141(v)])?
But contingent insurance creditors—viz., those whose insurance contracts had not yet produced valid claims—were not to be paid 100 percent of their ultimate valid claims at all under BAIC's proposed 'solvent' scheme. Rather, they were to be paid 100 percent of the estimated amount of their actual but unliquidated [§89], or not actual but merely possible [§90], claims. Both types of liability were to be catalysed into actual present liabilities [§21] using an inherently uncertain 'estimation methodology' [§18, 24, 128]. By the methodology, BAIC thus sought to pay perhaps less than what it would ultimately have had to pay, for an estimate by definition is correct only—assuming the contingency ever happens in the first place—by coincidence (as the BAIC judge accepted [§§90, 141(iii), 142(ii)]).
Apparently, BAIC was and is actually solvent only in relation to its actual present APH liabilities (however quantified), and not necessarily in relation to its contingent future uncrystallised U.S. APH liabilities when and if they were eventually to become matured claims. If all the insurer's U.S. APH liabilities matured into claims right now, BAIC may be insolvent, which is probably what was really bothering its shareholders and its 'new business' creditors. In the case of an apparently solvent insurer with un-matured, undetermined U.S.-based APH liabilities, a 'solvent' scheme with an 'estimation methodology' to artificially precipitate contingent liabilities should be presumed, rebuttably, to be an elaborate sham to force premature commutations.
Shortchanging, Especially of U.S. Customers
Indeed, there are many ways in which the U.K. insurance industry—not noted for its transparency—may attempt to shortchange or otherwise swindle a U.S. corporate assured. It helps considerably that the typical U.S. assured's typical U.S. coverage lawyer is unlikely to have genuinely mastered the London insurance market's abstruse intricacies, and that his impeccably groomed bluster can be spotted instantly by a genuine expert. Further abetting a lousy deal for the customer, insurance regulators and his own London broker cannot always be trusted to loyally, diligently or timeously inform him of what is afoot or his recourse rights. Particularly craven emperors-with-no-clothes have been substantial U.S. corporate EquitasRe-assureds-at-Lloyd's, who, all too often misinformed and badly advised by their own supposedly expert lawyers, appear to have been now shortchanged by the Lloyd's enterprise to the tune of billions of dollars.19
English Insurance Insolvency Law Basics
To avoid finding himself materially disadvantaged if his London insurer does propose or enter a solvent or insolvent restructuring process, a U.S. claimant or commutant assured—assuming he has substantive20 and procedural21 coverage in the first place—must genuinely master relevant English (there is no such thing as British) corporate insurance insolvency law, gratuitously burdened as it is by such deliberately engineered multiplicities as (for example):
- statutorily prescribed, less22 or more23 consensual, corporate24 restructuring processes, viz., administration,25 administrative receivership,26 company voluntary arrangement,27 provisional liquidation,28 receivership,29 solvent s.425 scheme, insolvent s.425 scheme, and a bewildering variety of liquidation30 (a process also called 'winding up');
- insolvency guardians, viz., administrator, administrative receiver, liquidator, nominee, provisional liquidator, receiver, supervisor;
- insurance insolvency instruments, some of which apply to or exclude insurers and or reinsurers and or some components of the Lloyd's enterprise. It is highly questionable whether U.K. insurance regulators—the Treasury and the Financial Services Authority—genuinely understand the U.K. insurance industry's deep substantive or procedural detail, or (self-evidently) have anything remotely approaching the intellectual ability to regulate insurance insolvency coherently and succinctly.
What the BAIC Judge Didn't Like
Lewison J was ultimately persuaded to dismiss BAIC's sanction petition by arguments including (for example—the number of grounds on which he was dissatisfied indicates the potential complexity of the s.425 sanction process in general, and how thoroughly and delicately the proposing debtor must tread in covering relevant detail):
- procedural unfairness in the creditor meeting [§102 et seq.; 112]: The judge agreed with opposing IBNR creditors that their claims had been unfairly valued for purposes of the s.425(2) 75 percent value threshold [§§106, 110], that some voting had been rigged [§§103-4], and that the low turnout at the meeting favoured special-interest creditors [§§118-121].
- classes [§§57-64; 82-97]: Clearly creditors who share the same relevant common interests should be treated in a s.425 scheme similarly if not identically both procedurally (including in relation to creditor meetings) and substantively (including in relation to quantification and payouts under the scheme). Section 425(1) and (2) merely alluding to 'classes', it has been for Companies Court judges to ensure, in individual cases,31 correct classification and then fair treatment. The BAIC scheme proposed to group all scheme creditors into one class [§86]. The judge, dissenting [§§88 et seq.], acknowledged distinctions between actual and contingent creditors; matured claims and un-matured claims [§59]; liquidated and unliquidated quantum [§89]; accrued and IBNR [§§82-83; 91-92]; and gross creditors and (after relevant set-off) net creditors [§§61, 93]; but he was not persuaded there was any relevant distinction between direct assureds and reinsureds [§§94-95, but see §142(i)]. One ground for dismissing the sanction petition was that the single-class creditors meeting was improper because it did not properly take into account the class of accrued claimant vs. the class of IBNR claimant [§§92, 142(i)].
- the estimation methodology [§§128, 142(ii)], which the judge found, somewhat half-heartedly, did not provide a 'clear basis for treating all creditors alike, and results in uncertainty' [§142(ii)]. 'No matter how usable and reasonable an estimate may be, the very fact that it is an estimate is likely to make an inaccurate forecast of the actual liabilities of policyholders' [§143].
- fundamental commercial unfairness [§143]: The judge held that it was 'unfair' for BAIC to dispossess assureds of the full benefit of their insurance. 'The Company is in the risk business; and they are not. This is not a case of an insolvent company to which quite different considerations apply. On the evidence presented to me, the Company is able to meet its liabilities under such policies as and when they fall due.' BAIC thus found itself impaled on its own averred 'solvency'.
U.S. assureds, and especially their specialist coverage lawyers, must become genuinely familiar with London insurance market finance, culture and mood, and set up early-warning systems to timely identify relevant scheming insurers and the genuine technical defects of their proposals. They must know intimately where the money is buried to pay their claims.
Nor did the judge care to prefer BAIC shareholders over even a minority of relevant creditors: 'The purpose of the scheme is to allow surplus funds to be returned to shareholders in preference to satisfying the legitimate claims of creditors... If individual policyholders wish to compound the Company's contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would...require them to do that which it is unreasonable to require them to do' [§143].
Supposedly solvent insurers should stop getting bored of their own 'long tail' U.S. APH insurance products taking many years [§15] to mature into very substantial claims. They were originally paid by their customers to be in this business for however long it takes and, if actually solvent, should continue to do so accordingly. The proposers of a scheme must do thorough and genuine due diligence on all categories of creditor, and must pre-sell the scheme to all creditors, not just to the statutory majority. U.S. creditor perceptions must be changed if the s.425 scheme is not to be seen as the first resort of the scoundrel insurer. Scheme promoters should particularly stop using the word 'solvent' in relation to contingent liabilities crystallised by an estimation methodology, however expertly contrived (stochastic, simulation or other techniques) [§17].
U.S. assureds, and especially their specialist coverage lawyers, must become genuinely familiar with London insurance market finance, culture and mood, and set up early-warning systems to timely identify relevant scheming insurers and the genuine technical defects of their proposals. They must know intimately where the money is buried to pay their claims. No less important financially, shareholders and bankruptcy trustees of U.S. corporate assureds who have been materially shortchanged in London—particularly at Lloyd's and Equitas Re—must be able to identify the corporation's own board's, lawyers' and brokers' misconduct that abetted and consummated the short-changing, and be prepared to bring a thoroughly reasoned suit against the miscreants for the difference, based on sound English law analysis of what the corporation should, could and would have got had the insurance asset been managed correctly. In short, U.S. assureds should stop throwing away their London insurance assets.
1 See, generally, Insolvency Act 1986, Parts II and VII. Return to article
2 See generally Insolvency Act 1986, Parts IV to VII. Return to article
3 Companies Act s.425(6)(a). Return to article
4 Companies Act 1985, s.425(6)(a)'s scope provision—virtually identical to Joint Stock Companies Arrangements Act 1870, s.3—is an abomination of the statutory draftsman's duty to make law simple and intelligible. To simply apply s.425 to a 'company' merely as defined at ibid., s.735(1)(a) ('"company" means a company formed and registered under this Act, or an existing company') would of course have made life too easy, and may even have made the provision accessible to a layman. Return to article
5 Companies Act 1985, s.425(1). An 'arrangement' (ibid.) proposed, presumably voluntarily, by a 'company' (ibid.) and sanctioned by the court under ibid., s.425(2) is not to be confused with an Insolvency Act 1986, Part I so-called 'company voluntary arrangement'. Return to article
6 For Companies Act 1985, s.425 derivation, see for example Companies Act 1862, s.136; Joint Stock Companies Arrangements Act 1870, s.1; and more recently Companies Act 1948, s.206; Companies Act 1980, s.80. Also see Sovereign Life Assurance Co. v Dodd  2 QB 573. Return to article
7 Companies Act 1985, s.425(1):
Where a compromise or arrangement is proposed between a company and its creditors, or any class of them...the court may on the application of the company or any creditor...of it, or in the case of a company being wound up [or [in administration], of the liquidator or administrator], order a meeting of the creditors or class of creditors...to be summoned in such manner as the court directs. Return to article
8 The current list of insurers being run off under a solvent scheme makes for sobering reading. Insurers at various stages of solvent or insolvent restructuring presently include Andrew Weir Insurance Co. Ltd., Anglo American Insurance Co. Ltd., Aviation & General Insurance Co. Ltd., BAI (Run-off) Ltd., Bermuda Fire and Marine Insurance Co. Ltd., Black Sea and Baltic General Insurance Co. Ltd., Blackfriars Insurances Ltd., Bryanston Insurance Co. Ltd., Carolina Reinsurance Ltd. (Bermuda), Cavell Insurance Co. Ltd., Charter Reinsurance Co. Ltd., Chester Street Insurance Holdings Ltd. (formerly Iron Trades Holdings Ltd.), Colonia Insurance (Ireland) Ltd., Compagnie Européenne de Réassurances SA, Dai Ichi Kyoto Reinsurance Company SA, Dutch Aviation Pool, English and American Group plc, Figre Ltd., Folksam International Insurance Company (UK) Ltd., Fremont Insurance Company (UK) Ltd., Gordian Run-off (UK) Ltd. (formerly GIO UK Ltd), Hawk Insurance Co. Ltd., ICS Reinsurance Private Ltd., Independent Insurance Co. Ltd., Insurance Corporation of Singapore (UK) Ltd., Kobe Reinsurance SA, Korean Insurance Company (UK) Ltd., the KWELM companies, La Mutuelle Du Mans Assurances IARD, Lakewood Insurance Co. Ltd., Lion City Run-Off Private Ltd., London United Investments plc, Ludgate Insurance Co. Ltd., Mercantile & General Reinsurance Co. Ltd., Moorgate Insurance Co. Ltd. Municipal General Insurance Ltd., North Atlantic Insurance Co. Ltd., Oaklife Assurance Co. Ltd., OIC Run-Off Ltd. (formerly the Orion Insurance Company plc), Orion Pool Scheme, Panfinancial Insurance Co. Ltd., Paramount Insurance Co. Ltd., QBE Reinsurance (UK) Ltd., Quincy Mutual Fire Insurance Co. Ltd. (UK branch), RMCA Reinsurance Ltd., Scottish Eagle Insurance Co. Ltd., Scottish Lion Insurance Co. Ltd., Seven Continents Insurance Company (Bermuda), Southern American Insurance Company, Sphere Drake Insurance Ltd., St. Helen's Trust, Tanker Insurance Co. Ltd., Trinity Insurance Co. Ltd., Unione Italiana (UK) Reinsurance Co. Ltd. and United Standard Insurance Co. Ltd. The list suggests an abject failure of insurance regulation. Return to article
9 British Aviation Insurance Co. Ltd. is a private company owned by three major insurance companies, Royal & Sun Alliance Insurance Group plc, AVIVA plc and AXA Investment Mangers UK Holdings Ltd. [§1]. Return to article
10 Indeed, the BAIC decision has demoralised some London insurer-side lawyers—principally, self-evidently, those who have been taking creditor acquiescence and court sanction for granted—that the Companies Court will in the future not sanction insurers' solvent schemes at all, or at least not where the insurer's court application is opposed. But there is no reason why the court should not sanction a properly constructed, fair, rational solvent scheme, opposed or not, that has been properly explained and justified—'pre-sold'—to a thoroughly researched, well-briefed, well-treated and therefore well-disposed statutory majority. The BAIC case merely demonstrates how much insurer-side lawyers had lost the script. Return to article
11 Under the now-obsolete Insurance Companies Act 1982, Sch. 2C, it was called a 'transfer of insurance business'. See now Financial Services and Markets Act 2000, Part VII 'business transfer'; Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 (SI 2001/3625); Financial Services and Markets Act 2000 (Control of Transfers of Business Done at Lloyd's) Order 2001 (SI 2001/3626) (note the draftsman's 'transfers of business' error in the last instrument, just one of many examples of current statutory draftsman sloppiness in the field of U.K. insurance regulation). Return to article
12 See generally Practice Direction—Applications Under the Companies Act 1985 and Other Legislation Relating to Companies, §1(1), definition of 'the Act' read with ibid., §§2(3) and 3. Return to article
13 See generally (for example) Chancery Division Guide 2002 at http://www.hmcourts-service.gov.uk/cms/1231.htm. Return to article
14 See generally (for example) Admiralty and Commercial Court Guide 2002 at http://www.hmcourts-service.gov.uk/publications/guidance/admiralcomm/index.htm. Return to article
15 See generally (for example) the Queen's Bench Guide 2000 at http://www.hmcourts-service.gov.uk/cms/1444.htm. Return to article
16 See for example the Chancery Bar Association at http://www.chba.org.uk. Return to article
17 See for example the Commercial Bar Association (COMBAR) at http://www.combar.com. Return to article
18 The author recently attended a talk about solvent schemes. The audience was mostly insurance company operatives. There was the usual background shuffling as the speakers droned on. A sepulchral hush descended when a speaker said words to the effect that 'there is some way to go before a solvent scheme is not perceived by policyholders as a quick dishonest fix for the insurer.' There is certainly a nervousness in the industry about customer perceptions of solvent schemes. Return to article
19 See for example R. J. Astor, "Lloyd's of London: The Curious Case of Equitas Re" (ABI Journal, Vol. 23, No. 8, October 2004, p. 32). The author estimates that potential malpractice claims by (solvent and insolvent) U.S. corporate EquitasRe-assureds-at-Lloyd's against their own U.S. insurance lawyers amount to around $4 billion, the sum by which the lawyers have, by failing to inform and advise fully on the Golden Rule, appear already to have abetted the Lloyd's enterprise and Equitas Re in materially shortchanging their clients in claims settlement deals. A typical retort exacerbating the lawyer's misconduct is that the client, demonstrably insufficiently informed and advised, has made a 'commercial decision' in accepting Equitas Re's offer. But only the fullest, most comprehensive, most expert advice, including Recourse Due Diligence(tm), will enable the client to make a genuinely commercial decision. ['Recourse Due Diligence'(tm) is a trademark owned by the author; all rights reserved.] Return to article
20 'Substantive coverage' deals with the insurance contract's express, implied and inherent provisions. Return to article
21 'Procedural coverage' addresses issues such as enforceability of the insurance contract in the first place (void, avoided, illegal, etc.), justiciability (time bar problems, etc.) and the assured's compliance with the insurance contract's relevant procedural requirements such as continuing utmost-good-faith disclosure, and sufficient compliance with relevant claims notification provisions. Return to article
22 For example, administration (Insolvency Act 1986, Part II), liquidation (ibid., Part IV). Return to article
23 For example, company voluntary arrangement (Insolvency Act 1986, Part I), scheme of arrangement (Companies Act 1985, s.425). Return to article
24 Insolvency processes for natural debtors include individual voluntary arrangement (Insolvency Act 1986, Part VIII; 'IVA') and bankruptcy (ibid., Part IX). In English law, 'bankruptcy' is not used in relation to an insolvent corporate person. Return to article
25 Insolvency Act 1986, Part II. Return to article
26 Insolvency Act 1986, Part III. Return to article
27 Insolvency Act 1986, Part I. Return to article
28 Insolvency Act 1986, s.135, etc. Return to article
29 Insolvency Act 1986, Part III. Return to article
30 See generally Insolvency Act 1986, Parts IV-V. Return to article
31 See particularly Re Hawk Insurance Co. Ltd.  EWCA Civ 241,  2 BCLC 480 (Court of Appeal) on appeal from ibid.  2 BCLC 480 (Arden J); Sovereign Life Assurance Co. v Dodd  2 QB 573. Return to article