Re Sunbird Business Services Limited

This was an application under Part 26 of the Companies Act 2006 for the court's sanction of a scheme of arrangement converting unsecured creditor debt into equity and enabling a rights issue. The court held that the explanatory statement and accompanying scheme documents were materially deficient and in one respect positively misleading. Key legal principles applied included the duty to provide information required by section 897 (in particular disclosure of directors' interests), the need to give creditors "such information as is reasonably necessary" to form a judgment (Practice Statement paras 14–15, and authorities such as Re Heron and Re Telewest), and the court's discretionary role at sanction to ensure fairness to dissentients.

The court identified multiple material defects: the initial explanatory statement omitted the directors' interests; an Addendum containing that information was circulated late and not in compliance with the convening order; there was no adequate liquidation/insolvency analysis or company-by-company financial detail; the valuation methodology and the identity and remit of the purported independent reviewer were inadequately disclosed; and the explanatory materials misstated the dilutive effect of the inter-conditional rights issue. The company also engaged in selective informal communications and lock-up agreements with some creditors. For these reasons the court declined to sanction the scheme.

Background and parties: Sunbird Business Services Limited (the Company) sought court sanction under Part 26 of the Companies Act 2006 of a scheme to convert about US$18.78 million of unsecured debt into A1 Ordinary Shares and to enable a contemporaneous US$3,000,000 rights issue, underwritten by an existing investor. The principal opponents were six Scheme Creditors (the Opposing Creditors), several of whom were related parties connected to the Company's former CFO, and one unconnected creditor (BRIL).

Nature of the application: The Company applied for sanction of the scheme and the Opposing Creditors objected that the information provided in the scheme document and explanatory statement (and the Addendum) was inadequate, misleading and thereby prevented an "intelligent and honest" creditor from reasonably approving the scheme.

Issues considered by the court:

• whether the explanatory statement complied with section 897 (including disclosure of material interests of directors);
• whether Scheme Creditors had been properly consulted and informed so as to enable a reasonable assessment of the scheme versus the alternative of liquidation (in particular adequacy of insolvency analysis and company-level financial data);
• whether the valuation methodology and any independent review were adequately disclosed; and
• whether the explanatory materials fairly and accurately described the dilutive effect of the linked rights issue and the consequences of not participating.

Court's reasoning and findings: The court accepted a purposive construction of section 897 permitting supplementation of an explanatory statement by a later addendum in appropriate cases, but held that where a material omission is made and remedied by a supplemental circular this must comply with the convening order (21 clear days) or a further court order; the Addendum here was circulated late and no further order was sought. Substantively, the explanatory materials lacked company-by-company balance sheet information, any quantified liquidation recovery analysis, and independent insolvency verification; the valuation methodology was expressed in highly general terms (median of five unidentified comparables with a 45–50% discount) and the identity and terms of the purported independent reviewer were withheld; the rights issue and underwriting arrangements were insufficiently explained and the circular misstated the post-rights-issue dilution for creditors. The Company had also conducted selective informal approaches and obtained lock-up agreements from some creditors while others did not receive the same information. The court concluded these defects meant the majority vote could not be relied upon and that a reasonable creditor could not have taken an informed decision.

Other observations: The judge discussed the increased use and risks of lock-up agreements, the statutory safeguards in the scheme process, and emphasised the court's duty not to "rubber-stamp" majority decisions where material oversight or unfairness exists.

The court refused to sanction the proposed scheme and dismissed the Company's application. Although section 897 may be read purposively so an explanatory statement can be supplemented, the Addendum was circulated late without a further court order and the scheme documents were materially inadequate or misleading (insufficient insolvency analysis, undisclosed/opaque valuation review, failure properly to disclose directors' interests, and misleading dilution figures). For these reasons the court could not be satisfied a reasonable creditor could have approved the Scheme.