The Virgin Restructurings: Comparing the Australian and UK Experiences and Looking Ahead to Future Law Reform

By Scott Atkins (Norton Rose Fulbright) and Dr Kai Luck (Norton Rose Fulbright)

Context

Virgin Australia Holdings Limited (Virgin Australia) and Virgin Atlantic Airways Limited (Virgin Atlantic) are both currently undergoing simultaneous restructuring processes in Australia and the United Kingdom respectively. 

On 4 September 2020, creditors voted to approve 10 deeds of company arrangement (DOCAs) implementing the restructure of Virgin Australia and its subsidiaries.  Two days earlier, the English High Court approved a restructuring plan for Virgin Atlantic following the earlier endorsement of the plan by all relevant classes of creditors. 

Although the end result of a successful restructure is the same, the return for unsecured creditors in the Virgin Australia matter is estimated to be between nine and 13 cents in the dollar, compared to 80 pence in the pound in the Virgin Atlantic matter.  Nevertheless, it is important to avoid the automatic conclusion from these figures, without more, that the United Kingdom restructure process is more beneficial for creditors than the Australian process.

Indeed, a closer look at the restructurings reveals that the total unsecured claims falling within the scope of the DOCAs in the Virgin Australia matter is substantially higher than under the Virgin Atlantic restructuring plan (over AUD $6.7 billion compared to just over £50 million).  In the latter restructuring, other creditors, including those with operating leases over aircraft, will eventually be repaid in full and a significant number of secured and unsecured claims have been negotiated and compromised under separate bilateral agreements outside the restructuring plan altogether. 

This does not suggest that the United Kingdom process is more efficient than the Australian process, but rather that the nature of the claims dealt with in the restructurings is vastly different.  That said, the ability for a large quantum of claims to be negotiated in separate bilateral agreements with creditors in the Virgin Atlantic matter reflects the stronger rescue culture that exists in the United Kingdom compared to Australia.  Since the original adoption of the London Approach by the Bank of England in the 1970s as a guide for creditors in cooperating to investigate the prospect of an informal rescue, creditors in the United Kingdom have typically acted with greater collectivism in pursuit of the common objective of maximised returns from the restructure of a viable entity, while in Australia a dominant individualist creditor enforcement approach has prevailed.  This has resulted in a greater incidence of informal rescue in the United Kingdom, compared to the predominant use of formal insolvency processes in Australia, which more often than not result in the winding up of a company (whether under a DOCA or a liquidation) rather than a successful restructure. 

With the impending influx of new insolvency filings as the economic and financial impact of COVID-19 continues for companies across the globe, reforms of the kind introduced in the United Kingdom in June 2020 – including the restructuring plan used for the first time in the Virgin Atlantic matter – serve as a useful model for Australia and other nations to incentivise the rescue and restructure of viable companies and businesses.

Virgin Australia restructuring

On 20 April 2020, Virgin Australia and 40 of its subsidiaries entered voluntary administration under Part 5.3A of the Corporations Act 2001 (Cth) (Corporations Act). 

Across each of the entities, over 1.6 million creditors were owed almost AUD $14 billion, consisting of:

• 100 secured creditors with claims under a range of bank loans, letters of credit, bank guarantee facilities and aircraft finance and operating leases, collectively owed over AUD $3.7 billion;
• 6,500 unsecured bondholders owed over AUD $1.9 billion;
• Approximately 1.6 million customers owed AUD $600 million;
• 53 primarily airport landlords owed AUD $301.6 million up to the end of existing lease periods;
• Over 9,000 employees owed AUD $128.9 million;
• 1,457 other unsecured creditors owed AUD $448.1 million; and
• 40 inter-group related party creditors (primarily unsecured) owed AUD $6.85 billion.

In their report to creditors, the voluntary administrators referred to the ‘cash burn’ for Virgin Australia caused by COVID-19 related lock downs across Australia and internationally, which resulted in an overall loss before tax of $763.5 million in just four months from January to April 2020 and which would leave the Virgin entities with insufficient cash to continue operations past 30 June 2020.

After a two month public sale process, the administrators exercised their power of sale to enter into a binding sale contract with Bain Capital on 26 June 2020.  Under the contract, there were two sale alternatives: a transfer of all of the shares in Virgin Australia to Bain Capital subject to the approval of creditors and the execution of 10 DOCAs covering all entities in the Australian corporate group, or, failing such approval, a transfer of Virgin Australia’s business and assets to a new corporate structure under the control of Bain Capital and the liquidation of Virgin Australia and its subsidiaries.

As part of the sale, Bain Capital also provided AUD $125 million to enable Virgin Australia to continue to trade until the completion of the sale.

At the second meeting of creditors held on 4 September 2020, 99% of creditors attending (and 97% in value) resolved to approve the DOCA alternative. 

Under the 10 DOCAs, Bain Capital:

• Agrees to pay all employee entitlements in full;
• Assumes liability for all customer claims (by the issue and honouring of future travel vouchers);
• Agrees to pay AUD $447.2 million into a creditors’ trust for distribution to creditors, divided into four different pools;
• Assumes liability for an inter-group loan to the value of $150 million plus interest; and
• Assumes liability under certain major contracts and aircraft leases, including the primary Boeing 737 mainline fleet and the regional and charter fleet, that will remain on foot as part of Virgin Australia’s restructured and streamlined operations – with the remaining leases for ATR, Boeing 777, Airbus A330 and Tigerair Airbus A320 aircraft types discontinued (and those lessors left to claim as unsecured creditors).

The remaining inter-group claims are excluded from the scope of the DOCAs and will continue as part of the restructured Virgin Australia.

This is estimated to leave unsecured creditors (including secured parties claiming for the balance of their debts after deducting the value of the security held) with a return of between nine and 13 cents in the dollar, to be paid within six to nine months.  The asset sale alternative would have yielded a return of between four and seven cents in the dollar, while the alternative of a liquidation would have produced a maximum return of just one cent in the dollar (with the payment of the dividend in each case being delayed for up to three years). 

While a positive result compared to the alternatives, to get to this stage, the voluntary administrators had to make a number of applications to the Federal Court of Australia under section 447A of the Corporations Act seeking orders modifying the usual provisions that apply during voluntary administration.  These included orders:

• Extending the convening period for calling a second meeting of creditors by three months; and
• Exempting the administrators from the usual personal liability under sections 443A and 443B of the Corporations Act for ongoing rental payments and debts arising under future contracts entered into during the administration – including, in Virgin Australia’s case, those relating to airport leases and services, operations, ground staff, cargo, fuel, in-flight services, charters, maintenance, insurance, the issue of conditional credits to be used by customers and alliance partnerships with global airlines. 

Both sets of orders were made to enable the administrators to negotiate with interested parties for a sale of Virgin Australia (whether by way of a share transfer or an asset sale).  Those negotiations could not be progressed, and presented to creditors, within the usual tight 25 business day timeframe for calling a second meeting of creditors.  Without the exemption from personal liability, the administrators also would have had no incentive to pursue a restructure, knowing that they would incur personal liability for rental payments and new debts beyond the free assets of Virgin Australia and uncertain about when, or if, an interested buyer could be secured.    

Yet, while the relief obtained by the administrators ‘did the job’ in Virgin Australia itself, requiring administrators to apply for ad hoc relief in a particular matter, incurring significant court costs and without any certainty of the outcome, is not optimal. 

Greater certainty, efficiency and cost savings – and enhanced flexibility extending to orders binding dissenting secured creditors to a viable rescue plan – could be achieved in Australia through substantive law reform designed to incentivise a stronger corporate and business rescue framework under the Corporations Act.  The new restructuring tools tested for the first time in the Virgin Atlantic restructuring, discussed below, serve as a useful model for reform in Australia.    

Virgin Atlantic restructuring

The Virgin Atlantic restructuring is the first to take place under the new restructuring plan rescue alternative introduced in Part 26A of the Companies Act 2006 (UK) (Companies Act) with effect from 26 June 2020. 

A restructuring plan can be proposed in circumstances where a company has or is likely to encounter financial difficulties that will impact on its ability to continue as a going concern and the purpose of the plan is to eliminate, reduce, prevent or mitigate those difficulties (section 901A of the Companies Act).  A plan is notionally similar to a scheme of arrangement, but with a more flexible approval requirement.

Specifically, in contrast to the pre-existing formal rescue alternatives in the United Kingdom – a company voluntary arrangement, which is not binding on secured creditors without their consent, and a scheme of arrangement, which requires the approval of 75% in value and a majority in number of each class of creditors (similar to the position in Australia) – the new restructuring plan alternative adopts a ‘cross class cram down’.  This permits the court to approve a proposed plan even where one or more classes of creditors does not approve the plan by a 75% in value minimum threshold (with no requirement for the majority in number voting condition for a scheme to be met). 

In doing so, the court must be satisfied that dissenting creditors would not be ‘any worse off’ under the plan than the ‘most likely relevant alternative’ if the plan was not approved (typically liquidation) and that, on fairness grounds, it is appropriate to approve the plan (section 901F and 901G of the Companies Act).  Significantly, however, unlike the United States Chapter 11 process, there is no ‘absolute priority rule’, which requires the claims of a dissenting class of senior secured creditors to be satisfied in full before any junior classes of secured or unsecured creditors receive a distribution as a condition for the approval of a restructuring plan.

The ‘no worse off’ test provides greater flexibility than the United States rule – and the Australian ‘adequate protection’ test for secured creditors under a DOCA – in allowing the court to approve a restructuring plan, notwithstanding the opposition of one or more classes of secured creditors, where it is reasonably likely to result in the revival of a distressed company or its business. 

Under the Virgin Atlantic restructuring plan, there are four classes of creditors:

• Secured creditors owed US $280 million under a revolving credit facility;
• Creditors holding operating leases over 24 aircraft, with an aggregate liability of US $1.25 billion;
• Creditors with claims under various intellectual property licensing agreements and joint venture agreements, owed £400 million; and
• 162 trade creditors owed a total of approximately £51.67 million.

The plan was proposed in circumstances where:

• Virgin Atlantic was facing a significant liquidity crisis due to COVID-19;
• In the absence of the plan, Virgin Atlantic’s cash flow would drop to a critical level by the week of 21 September 2020 and would trigger the rights of bondholders to enforce their rights over the company’s landing and departure slots at Heathrow Airport;
• The company would run out of available free cash altogether in the week of 5 October 2020; and
• Virgin Atlantic would then face an orderly winding up (effected under an administration) likely to result in a return for unsecured creditors of between 10.5 pence to 21.4 pence in the pound, with the first dividend not being paid for several years at least.

On 14 July 2020, Virgin Atlantic sent a letter to all plan creditors advising of its intention to obtain a court order convening meetings of each class of creditors to consider and vote on the plan.  That court order was obtained on 4 August 2020. 

According to the terms of the plan:

• The secured creditors will have their security converted into a term loan facility, with a maturity date of 17 January 2026, an increase in the margin payable on the outstanding balance of the loan by 1% per annum, and various other covenant and repayment enhancements;
• Virgin Atlantic will only pay 15% of rent due to operating lease creditors until either 30 September 2021 or 31 December 2021 (depending on revenue achieved), with the balance capitalised for repayment, along with all future rent, in 48 equal instalments from 2022 to 2025;
• Creditors with claims under the licensing and joint venture agreements will have their claims capitalised in exchange for preference shares; and
• Trade creditors with claims relating to goods and services supplied up to 14 July 2020 will have those claims reduced and discharged by 20%, with the remaining 80% balance payable in nine cash instalments with interest accruing at the rate of 1% per annum.  Trade creditors supplying goods or services after that time will not have their claims compromised (intended to incentivise ongoing supply to Virgin Atlantic).

The 80 pence in the pound return for unsecured trade creditors is substantially higher than the winding up return estimated. 

Outside of the plan, there is also a significant injection of new capital, comprising a £200 million cash loan facility provided by Virgin Investments Limited (whose ultimate beneficial owner is Sir Richard Branson) and new third party secured debt financing of £170 million from global investment management firm Davidson Kempner Capital Management.  

Additionally, a substantial number of creditors were not included within the scope of the plan at all, including:

• Lessors and lenders with claims amounting to almost US $1 billion under various aircraft lease arrangements;
• Bondholders with security rights over the Heathrow airport slots; and
• Trade creditors who provide ‘goods or services which are essential’ to Virgin Atlantic’s ‘ability to operate safely and/or continue as a going concern’. 

For each of these creditors, Virgin Atlantic has negotiated direct bilateral agreements.

On 25 August 2020, the first three classes of creditors approved the plan by 100% in value, while the trade creditors (107 of 162 attending to vote) approved it by 99.24% in value. 

The restructuring plan was then sanctioned by the court on 2 September 2020, with Justice Snowden finding that, in light of the clear creditor consensus and the absence of any other adverse fairness or justice considerations, it was appropriate to approve the plan. 

Ultimately, it was not necessary for the court to resort to the cross-class cram down process.  However, the fact remains that in other cases, the cram down provides the required flexibility for the court to be able to endorse a restructuring plan that, while restricting the immediate enforcement rights of one or more classes of creditors, will still be in the long-term interests of all creditors and may also serve the broader public interest via the revival of a businesses in an important industry or sector.  This is critical in enhancing the prospect of a successful restructure and moving away from an individualist creditor enforcement culture. 

Importantly, it is also possible, as an incident of the recent reforms, for a restructuring plan to be combined with a new pre-formal insolvency rescue moratorium introduced in Part A1 of the Insolvency Act 1986 (UK).  This enables directors to apply to the court for an initial 20 business day enforcement moratorium, which can be extended for a further 20 business days without creditor consent or indefinitely with creditor consent, while a restructure is negotiated.  An application requires the appointment of an expert monitor who must form the view that it is likely a moratorium would result in the rescue of the company or its business as a going concern.  The moratorium is broad-based and extends to the enforcement of claims by landlords and secured creditors.

The enforcement moratorium is important in preventing major secured creditors, suppliers and landlords from enforcing their strict rights during restructuring negotiations and withdrawing critical assets that may be used by a distressed entity with a realistic prospect of a return to viable trade in a restructuring.  

Again, the enforcement moratorium was not required in the Virgin Atlantic matter, as the restructuring negotiations had the support of existing creditors, but is an important tool in other cases.  A similar moratorium is not currently available in Australia.

Key takeaway

The new restructuring plan alternative for a restructuring in the United Kingdom provides considerable flexibility needed to maximise the prospect of a successful corporate or business rescue attempt.  The Virgin Atlantic restructure was able to proceed without needing to resort to the new cross-class cram down and pre-formal insolvency moratorium provisions introduced as part of the June 2020 reforms in the United Kingdom.  In itself, this reflects the well-developed collectivist creditor enforcement culture in the United Kingdom, which resulted in the majority of outstanding claims in the Virgin Atlantic matter being negotiated in separate bilateral agreements outside the terms of the restructuring plan sanctioned by creditors and the court.    

However, the same level of creditor cooperation cannot be assumed in other matters and the enhanced flexibility of the new restructuring tools will be useful in preventing dissenting creditors from dictating whether a rescue proceeds or not. 

The Virgin Australia restructuring has taken place under a voluntary administration process that has significant limitations.  While the administrators were able to obtain court orders dispensing with a number of key restrictions that limit the likelihood of a successful restructure, guaranteed legislative measures present a better model than ad hoc, expensive, time consuming court applications. 

Going forward, it is suggested that Australia would benefit from introducing similar laws to those adopted in the United Kingdom to incentivise corporate and business rescue.  Indeed, provision for a restructuring plan alternative with a cross-class cram down mechanism to bind dissenting classes of creditors and an enforcement moratorium while a company investigates an informal restructure will in time help to create a far stronger collectivist enforcement culture among creditors in Australia, enhancing the prospect of a higher incidence of corporate and business rescue than under the existing voluntary administration process.