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Legacy industry debates ramifications of Scottish Lion ruling

Scottish judge Lord Glennie's comments on the fundamental issue of fairness effectively halted the Scottish Lion solvent scheme of arrangement and could block progress on schemes currently in the pipeline, according to industry experts.

The legacy market is digesting the outer house of the Scottish Court of Session's opinion that a single creditor's opposition is sufficient to derail a proposed solvent scheme of arrangement. Meanwhile, practitioners have begun debating the likely repercussions for solvent schemes both related to insurance and otherwise.

Two distinct camps are forming; there are those who see far-reaching ramifications for the entire solvent schemes of arrangement mechanism, and those who interpret Lord Glennie's ruling as a case-specific one that should warn the industry over the ingredients of such schemes.

The policyholders that opposed the Scottish Lion scheme on fairness and other grounds were ExxonMobil, Creditors Goodrich, Textron, ITT, and Zapata. They were represented by specialist law firm Covington and Burling which argued that, among other issues, the extensive and expensive occurrence-based coverage the insureds purchased through the London market are irreplaceable business assets.

The judge heard that replacement occurrence-based coverage is no longer available for the risks in question from any insurance market at any price. He concluded that this, and the objectors' other concerns, constituted a powerful argument "which cannot lightly be brushed aside".

Law firm Lovells pointed out that a close examination of the judgment "indicates that Lord Glennie did not completely rule out sanctioning a scheme of arrangement proposed by a solvent insurance (or reinsurance) company".

Instead, his emphasis is on the need for "other" considerations and for "supporting material justifying the [scheme]".

"Although Lord Glennie does not elaborate on these observations, they are arguably merely another illustration of - and consistent with - the fact-based 'case-by-case' approach to solvent schemes," Lovells said.

And Lovells also noted that Lord Glennie's comments are aligned with the UK Financial Services Authority (FSA)'s guidance on solvent schemes, which state that a substantially solvent company "should not treat policyholders any worse than the treatment they would receive from such a company in solvent run-off".

Seen in this context, Lord Glennie's ruling "does not appear to break new ground", Lovells concluded.

To further this argument, a market source told The Insurance Insider that a divide is forming between "schemes that are perceived [rightly or wrongly] as being somewhat aggressive and others which are not", and that creditors' as well as judges' reactions to them differ.

"In the end, the question is whether the creditors are willing to believe that they are going to be treated fairly and whether they see the scheme company as willing to share not only information but also a risk premium to reflect their loss of cover," the source said.

Meanwhile, Juliette Winter, director and general counsel of Ruxley Ventures, said she believes that solvent schemes remain "viable mechanisms to close out old legacy business", adding: "The ruling confirms that schemes should be viewed on a case-by-case basis and it is our objective to propose schemes that are acceptable to policyholders.

"An example of Ruxley's approach is the scheme proposed by its subsidiary City General that was sanctioned by the court in April. Great efforts were made to make the scheme process transparent and to engage with policyholders at an early stage," she said.

But the view of Addleshaw Goddard threw up a stark contrast. The law firm described the ruling as "groundbreaking" and warned that unless it "is overturned on appeal, it threatens the success of many other solvent schemes currently in the pipeline, and the future of solvent schemes generally".

By upholding the objections of the five dissenting US creditors, Lord Glennie's view has "enormous potential ramifications - it threatens the whole viability of solvent schemes of arrangement as a mechanism for effecting planned exits from the market, or specific sectors of it, and releasing capital for re-deployment elsewhere", the Addleshaw Goddard note explained.

And a market source speaking to The Insurance Insider agreed, opining that solvent schemes sitting in the pipeline at present will hold off until Scottish Lion is resolved, commenting: "Practically, I think we are stuck for the time being."

In his statement, Lord Glennie said that "in the present case" he saw no reason, aside from the wishes of the shareholders, why Scottish Lion should not continue with run-off.

"In a situation where the company is sound financially, why should one group of creditors who might wish to enter into a commutation agreement with the company be entitled to force other creditors to participate against their will?" Lord Glennie explained, adding: "If any of them wish to enter into a commutation agreement with the company, they can do so without the participation of any of the other creditors. But if they do not wish to do so, why should they not be left in a position in which they presently find themselves?"

Partner at PricewaterhouseCoopers (PwC) and Scottish Lion scheme adviser Dan Schwarzmann regards the 10 September judgment as applying to all solvent companies considering a scheme of arrangement, and has insisted that the decision will be appealed.

If Lord Glennie is right, Schwarzmann said the judgment indicates that a company "must be impaired before it can successfully propose a scheme", adding that: "The ramifications of this judgment are huge - this results in creditor democracy being replaced by a single creditor veto, which simply cannot be what was intended by the Companies Act."

Scottish Lion CEO Bill Bower agreed with Schwarzmann, concluding that a solvent entity looking to scheme could effectively become "a hostage of fortune to one creditor".

"Other schemes in the pipeline at the moment will be probably getting the views of their own counsel to consider whether that opinion would hold up in an English court. Anybody who has got anything coming up in terms of schemes will be looking very closely at this," Bower explained.

He added that the ruling has "opened up a question of law: certainly schemes of arrangement are a key tool for many industries - corporate restructuring, mergers and acquisitions and IPOs for example - and a wider consensus will be obtained as to whether or not this will apply in England, as different practitioners will have their view".

But London law firm Elborne Mitchell reasoned that the ruling is not quite as "draconian" as indicating that single creditors could veto proceedings, the decision will nevertheless "make things vastly more complicated and enable creditors to argue prejudice even if they are in the minority".

And Nigel Montgomery, a partner at law firm Sidley Austin, opined that while Lord Glennie's comments will be "persuasive" in an English court: "[The ruling] is not binding in England and is still part of an ongoing case. The judge has invited the parties to clarify the issues that are troubling him."

"I do believe that the English court has looked at this issue in BAIC and subsequent to the BAIC judgment there has been clear case law and precedent for what the English Court will accept in schemes and be willing to sanction.

"The fairness questions raised in the Scottish Court are not new; they need sensitive consideration and answering and they are likely to come up every time a solvent estimation scheme is proposed for an insurance company."

Montgomery added: "What's important in doing a scheme is not only the way in which the scheme documents and the vote process are constructed, but also how one reaches out to the creditors from the very beginning - the very first practice statement letter or even earlier. It is a question of approach as well as drafting."

The Scottish court has put the case out "By Order" to allow the parties a further opportunity to consider the decision.

The Insurance Insider understands that a case management conference has been scheduled for October, which will give both Scottish Lion and the scheme objectors the opportunity to consider the judgment and decide where to go from here.

"It is now for SL to bring forward to the adjourned second phase of the sanction hearing evidence of those elements which will be required to persuade the judge that their scheme does indeed, as they protest, contain other considerations and advantages for creditors which justify bending the will of the minority to the vote of the majority," Lovells commented.

And Addleshaw Goddard noted that the prospect "would seem to give the parties a chance to settle their differences, and perhaps allow the scheme to go ahead".

Anne Ware, a partner at Covington & Burling, told The Insurance Insider that the ruling "vindicated their concerns that the scheme had been inherently unfair to [their clients]".

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