Background to Sova and the Special Administration
Sova Capital Limited (in special administration) ("Sova") is an FCA authorised investment broker. It provided investment brokerage services to institutional clients, mostly trading in the Russian market. As the result of market turmoil following the Russian invasion of Ukraine, Sova suffered a liquidity crisis and its directors applied for Sova to be placed into special administration pursuant to the Investment Bank Special Administration Regulations 2011 (the "IBSA Regulations") by order of the English Court. Sova had several £billion of assets under management across its CASS arrangements (both client monies and client assets) and its house portfolio. The IBSA Regulations were enacted to provide a modified insolvency regime for investment firms such as Sova, following the lessons learned from the Lehman administration.
Background to the Transaction
As an investment broker in the Russian market, 87% of Sova's investment portfolio comprised securities held in depositaries in Russia ("Russian Securities"), many of which were traded on the Moscow Stock Exchange ("MOEX"). As a result of UK, EU and US sanctions and Russian counter-sanctions imposed since the invasion of Ukraine, the Special Administrators were unable to realise the Russian Securities on a normal basis. The closure of MOEX to residents (including Sova) of countries Russia has designated "hostile" means Sova could only trade the Russian Securities on an over-the-counter basis, with either a Russian buyer or a non-Russian buyer. Any Russian buyer would need to be permitted to transact under Western sanctions and also required Russian government approval to transact, while any cash received by Sova in Russia required Russian central bank approval for repatriation to the UK. A sale of the Russian Securities to a non-Russian buyer in a hostile jurisdiction would have been extremely challenging. This meant that while the Russian Securities proposed to be sold had a nominal face-value of £274m, the Court accepted that it was "unreal" that Sova could, in practice, realise anything like that value.
As such, following a marketing process, the Special Administrators sought approval to enter into transactions with one of its largest unsecured creditors ("Dominanta") for a sale of certain of its valuable trapped Russian assets, in exchange for a release of that creditor's £233m claim against Sova (the "Transaction"). The Special Administrators also received a separate bid from another creditor ("BZ"), who as part of a consortium offered £125m cash and waiver of claims worth £20m (the "BZ Offer"), and contested the application. The Alternative Offer was considered to be reasonably comparable to the other offer received; however had considerable deliverability risks including third party approvals.
Credit-bid style transactions
“Credit bid” is a well-recognised construct in US restructurings, where it is mandated under US bankruptcy legislation. It essentially expressly contemplates a creditor making a bid of all or part of its debt, to buy an asset; the debt is released in consideration of acquiring the asset. The phrase is used occasionally in restructuring in other territories for transactions that have a similar economic effect and the phrase is used as a short hand in the market, but the concept of the “credit bid” does not exist in those terms in UK legislation. Secured creditors frequently enter into transactions with UK office-holders structured as having a cash value, but with the payment set-off or netted from the resulting recoveries they would make as a secured creditor, to produce the same economic effect. The structure was accepted in the Court as being unprecedented in an unsecured context. While Mr Justice Miles notably did not use the term ‘credit bid’ in his judgment, he provided detailed guidance in relation to the methodology used to construct and value such a transaction.
Pari passu
A key focus of the Court's judgment was the pari passu principle. This is a principle of insolvency law embodying the "fundamental principle of equality", which requires that "the distribution among unsecured creditors of assets available in an insolvent estate should be equal". The Court heard argument that the Transaction represented an unequal distribution to Dominanta which violated the pari passu principle. However, Mr Justice Miles confirmed the approach of the English Court is to review the legal substance of transactions (as opposed to economic effect). Analysing the legal substance of the Transaction, the Court concluded that the Transaction involved a sale, not a distribution. More particularly the transaction valued Dominanta’s offer not at its nominal value, but at its dividend. Therefore for that, and other, reasons the pari passu principle was not engaged.
Sanctions
As noted above, the case required complex navigation of the evolving US, UK, EU, and Russian sanction regimes. One of the key issues for the Court was whether there was a real risk that the Transaction could breach applicable sanctions law. In his judgment, Mr Justice Miles made reference to the detailed analysis of sanctions undertaken by the Special Administrators with the assistance of legal advice, concluding that the Transaction complied with Western sanctions. This aspect formed a crucial part of the Transaction. The Court concluded that there was no realistic risk that the Transaction would infringe UK sanctions, and that it did not infringe US or EU sanctions.
Conclusion
This morning's judgment is the first Court approval of an unsecured “credit bid” type transaction in the English Courts. It represents a bespoke and innovative solution for Sova's estate, creating a pathway for the Special Administrators to unlock value in the face of complex sanctions for its highly illiquid trapped Russian estate, thereby materially improving recoveries for Sova's unsecured creditors. We are pleased to have fielded a multi discipline team featuring our leading insolvency, litigation, and sanctions expertise (across EU, US, UK, and Russian sanctions) to deliver this solution for our clients.
Authored by Robert Peel, Camilla Eliott Lockhart, Tom Astle
