Partner Michael Barnett analyses the landmark bankruptcy case, involving the acquisition of £274 million of Russian securities, in England’s first “unsecured credit bid”.
Michael’s article was published in Solicitors Journal, 21 June 2023, and can be found here.
For the first time in the 150-year history of of bankruptcy law, an English court has approved the sale of assets by special administrators to a creditor who in turn waived their creditor’s claim in exchange. In Re Sova Capital Ltd  EWHC 452 (CH), Mr Justice Miles granted Sova Capital’s special administrators permission to sell the assets on such terms, in recognition of the administrators’ difficulty in selling off the assets in conventional fashion due to the impact of Western sanctions on Russia.
Despite the objections of another creditor, the judge found that the sale to Dominanta was “rational and honest”, noting the “challenging set of constraints” binding the administrators in achieving the best outcome for Sova Capital’s creditors. The judge noted that a distinction had to be drawn between Dominanta’s position as a creditor and its position as a bidder for Sova Capital’s assets.
The court concluded that the transaction should not be considered a distribution of assets and did not infringe the pari passu principle, as the creditor was acting as purchaser and not as creditor. In doing so, the judgment identified an approach by which administrators could potentially realise value to the benefit of the body of creditors where a cash sale to third parties is problematic.
Before the administration, Sova provided investment brokerage services to institutional and corporate clients, largely trading in the Russian market. Most of Sova’s financial assets were securities traded on the Moscow Stock Exchange (MOEX).
Following Russia’s invasion of Ukraine, the MOEX closed to certain countries, which severely impaired Sova’s liquidity and its ability to leverage or finance its Russian securities. This caused Sova to become cashflow insolvent. Accordingly, Sova was placed into administration and joint special administrators (JSAs) were appointed under the Investment Bank Special Administration Regulations 2011.
Multiple sanctions-related issues arose, from both Russia and Western countries, causing the JSAs to encounter serious difficulties in their search for a buyer for Sova’s Russian securities. The severely limited market that resulted from applicable restrictions and reductions in real values rendered the securities virtually illiquid in the JSAs’ hands. In light of these unusual circumstances and the absence of a viable alternative for selling the Russian securities, the JSAs entered into a transaction with Dominanta, a Russian entity and one of Sova’s largest unsecured creditors. The agreement involved transferring 71 of Sova’s most valuable Russian securities to Dominanta in return for the latter waiving its admitted claim of approximately £233m.
To ascertain the cash equivalent value of the transfer of securities in return for Dominanta waiving its claim, the JSAs presented a hypothetical ‘dividend bid model.” According to this model, a creditor such as Dominanta would receive an initial dividend from assets otherwise available to the estate. The creditor would then bid this dividend for a portion of the securities. Subsequently, the creditor would receive another dividend, representing its proportionate share of the amount paid into the estate during the previous bid. This process would continue until all the securities had been transferred, and the acquiring creditor’s claims were fully waived.
Based on this notional “dividend bid model” as the JSAs described it, the cash equivalent value to Sova’s estate for Dominanta waiving its claim, or bidding its dividend, could range from £117.3m to £144.9m. Conversely, the JSAs estimated the value (to Dominanta) of the 71 Russian securities as approximately £274m per their value on the MOEX at a chosen date. However, due to sanctions restrictions and the lack of access to the Russian Market, Sova and the JSAs were not in a position to realise anywhere near that (or any) amount for those securities.
Shortly after,another creditor, Mr Boris Zilbermints, made a bid for the securities. His bid comprised £120m in cash, and a waiver of his claim of approximately £20m in the administration. Mr Zilbermints contended that his offer was at least comparable and on its ‘low case’, better in price than the Dominanta transaction. The JSAs agreed that the price of Mr Zilbermints’ offer was comparable in terms of price. However, by the time of the application hearing, Dominanta had obtained all necessary government approvals, while Mr Zilbermints still had to seek and obtain not only the same approvals but additional consents involving the export of cash from Russia.
Against the above background, the JSAs applied to court for approval to enter the Dominanta transaction. Mr Zilbermints opposed the application on the grounds that it infringed the pari passu principle, which requires equal treatment of creditors, rather than one creditor benefitting at the expense of others as he alleged was the case here. He also submitted that the JSAs could not show that they had taken steps to achieve the best price reasonably obtainable for the securities and that, by making the Dominanta transaction conditional on the court’s approval, they had surrendered their discretion to the court; the court should not assume the task of exercising their discretion in their place.
Mr Justice Miles held that the court had not surrendered its discretion. Indeed, rather than throwing the decision over to the court because they could not decide how to act, the JSAs were asking the court to approve a course of action they had already decided upon. Moreover, it was appropriate to seek the court’s approval in unusual circumstances involving, among other features, a novel transaction for the court involving the transfer of assets in exchange for the waiver of a creditor’s claim.
The judge then turned to the heart of the case – whether the transactions complied with principles of insolvency law.
Insolvency law principles
It was common ground between the parties that, as per The Public Trustee v Cooper  WTLR 901, 922, office-holders would be required to show that the proposed transaction was within their powers and they were exercising those powers rationally and honestly.
Mr Zilbermints contended that the transaction was outside the JSAs powers because it infringed the pari passu principle for the following reasons:
- The transaction was a distribution in specie of the securities to Dominanta in discharge of its claim in the administration. Dominanta was set to receive 117 per cent of the value of its claim by receiving the securities, while Sova’s other creditors were set to receive between 50% and 62 per cent.
- The JSAs were under a duty to transform Sova’s assets into cash by selling them before distributing the proceeds pari passu amongst Sova’s unsecured creditors (see further Rule 149 of the Investment Bank Special Administration (England and Wales) Rules 2011.
- If the securities could not be “readily or advantageously sold” (for cash), the JSAs were required to distribute them among Sova’s unsecured creditors pari passu.
- However, the securities could be sold for cash because the existence of Mr Zilbermints’ offer, which contained a cash element and was compliant with the pari passu
The JSAs disagreed that the transaction infringed the pari passu principle. The pari passu principle only applied to a distribution of assets, whereas the transaction was a sale, and this was evidenced from the legal mechanisms set out in the underlying transaction documents. The true substance of the transaction involved Dominanta acquiring the securities as buyer, not as creditor, albeit in consideration of a waiver of debt.
Agreeing with the JSAs submissions, Miles J held that the transaction was properly characterised as a sale rather than a distribution, noting that Mr Zilbermints’ argument “collapses the distinction between Dominanta’s position as creditor and its position as buyer.” The pari passu principle was concerned with equality of distribution, and did not apply to sales of assets, and therefore it had no relevant application to what was in fact a sale.
Mr Zilbermints’ objection, that Dominanta would ultimately receive securities worth more to it than the final dividend payable to other creditors, was an appeal to economic substance that ignored the legal steps taken to get there. It was irrelevant that a Russian purchaser could sell (Russian) securities for a higher value on the MOEX. While there were “starkly asymmetrical values for non-Russian and Russian owners of the Russian Securities… these arise from the various legal restrictions (Western and Russian) and not from any action or choice of the JSAs.” As such, the transaction was not a distribution in specie, infringing the pari passu principle.
The JSAs’ motives
The JSAs maintained that the transaction was for the best price reasonably obtainable, and relied on their endeavours to find a buyer, as evidenced in the application. Mr Zilbermints’ rival transaction required steps to comply with Russian regulatory requirements, where there was no guarantee they would yield the necessary approvals.
Mr Zilbermints contended that, even if the transaction did not infringe the pari passu principle, the JSAs were not acting rationally because the transaction did not achieve the best price reasonably obtainable. The MOEX valued the securities at approximately £274m and the JSAs had not fully explored a sale, for example by appointing an independent, unsanctioned Russian broker to market the securities among unsanctioned family offices in Russia. Mr Zilbermints’ offer itself, on one projection of its outcome, represented a higher price than the Dominanta transaction.
Concluding that the JSAs were exercising their powers rationally, Mr Justice Miles noted the “challenging set of constraints” in which they were operating. The rational exercise of the JSAs powers was demonstrated by their comparative assessment of the transaction and Mr Zilbermints’ offer. No issue had been taken with the use of their valuation methodology, and the transaction was also presented to, and supported by, Sova’s creditors in an indicative vote.
However, the judge was careful to note that he was not expressing (nor was he required to express) a view about whether the JSAs had in fact achieved the best price reasonably achievable – only that they had acted rationally and honestly in the exercise of their powers. Thus, permission was granted for the JSAs to proceed with the Dominanta transaction.
The courts had not considered the issue of a sale to a creditor involving the waiver of their claim in over 150 years of bankruptcy law. The facts of the present case were unique and are unlikely to be repeated, unless in the context of more sanction-related insolvencies.
However, the case does provide some support for office-holders to accept bids involving a waiver of a creditor’s claim. That may encourage creditors to bid their claim, part of it, or with a combination of cash, for assets of the insolvent estate. This may create a more competitive bidding process, ultimately increasing the value of realisations to the benefit of creditors.
Office holders will take care to ensure that transactions involving a waiver of a creditor’s claim are documented to reflect the legal reality of a sale, rather than a distribution. To reduce the risk of future challenges on that basis, the documented transaction should clearly set out the legal route whereby the value to other creditors of the waived claim can be clearly demonstrated.
The court in this instance was careful to note that a determination that the JSAs approach was rational and honest did not mean they had acted reasonably or that they had taken steps to obtain the best price reasonably obtainable. Office-holders should be conscious when deciding to accept a waiver of a creditor’s claim as consideration, to ensure that they are complying with their duty to obtain the best price reasonably obtainable.
The price of a creditor’s claim is not usually known until the conclusion of the insolvency process, which leave office-holders open to criticism and the transaction to a potential challenge, if the waiver of a creditor’s claims does not eventually achieve the best price that could reasonably have been obtained.
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