The legal position on the Scheme of Arrangement: 19/04/09

The legal position on the Scheme of Arrangement: 19/04/09

The hearing on 9 April

Members of DAG with Edwin Coe attended a meeting in London with Mr Spellman of The Isle of Man Treasury (“IoMT”), Alix Partners and Herbert Smith a month ago. At that meeting, the Group was presented with facts and figures intended to suggest the Scheme was advantageous to all depositors in comparison to liquidation. It was suggested that the Scheme documents would reflect this view.

DAG was provided with a copy of the Scheme of Arrangement (the “Scheme”) late on Friday 3 April. The Explanatory Statement to the Scheme was not provided in its final form until 8 April, the day before the Scheme was considered by the Court. Worked examples of how the Scheme might operate were sent to the DAG as late as 7.00pm on the evening before the hearing. This clearly put creditors and the Court under considerable pressure to digest and understand the Scheme in a very limited timeframe.

Having considered the Scheme and the Explanatory Statement, DAG came to the conclusion that the Scheme was only of advantage to those depositors with lower deposits and of disadvantage to the remainder. DAG instructed its lawyers to oppose the Scheme in its current form.

A number of creditors attended the hearing in Douglas on 9 April in their individual capacities and the DAG was represented by Dominic Chambers QC of Lincoln’s Inn and local advocate Richard Halsall. The IoMT and the Bank were jointly represented by Richard Hacker QC also from London chambers. Despite opposition from a broad band of depositors but with some concessions on behalf of IoMT the Court gave permission to the Scheme proposers to put the Scheme to a vote of creditors on 19 May. The Court did not endorse the Scheme but was not persuaded that it was so defective that creditors could not take a view on it and vote.

The life companies did not oppose the Scheme. The DAG argued that the two classes, which had been put forward, by the IoMT and the Bank, were not sufficient. The IoMT conceded this point and there will be three classes;
• those who would not be protected under the Depositors’ Compensation Scheme (“DCS”),
• those who would be protected under the DCS for the full value of their scheme claims (either £50,000 or £20,000 as the case may be), and
• those who would be entitled to payments under the DCS but whose scheme claims exceed their entitlements to DCS payments (i.e. those who had deposits of more than £50,000 or £20,000 as the case may be).

Mr Hacker QC submitted that it was not part of the Court’s function at this stage of the process to form a view on the supposed deficiencies of the Scheme or how it could be improved. Neither was it for the Court to consider whether the Scheme was fair or unfair to one or other of the groups of depositors. He said that the IoMT could have made a different offer to depositors, for instance subrogating its rights until depositors had been paid 70p or 80p in the £ but had decided not to do so. The offer contained in the Scheme of Arrangement was the only offer available and if that offer was rejected then the Bank would be placed into liquidation. He also explained to the Deemster that classes were not a matter with which the Deemster should concern himself. Under the modern English procedure, creditors would all have been given notice of the hearing and would have been entitled to make full representations on the Scheme. That procedure was not being followed in this instance.

Mr Hacker said that he was not in Court to sell the Scheme, but nonetheless proceeded to list its perceived benefits. Chief among these in his view were accelerated receipt of payment for some depositors, certainty of timing, and the advantage of financial certainty under the Scheme as opposed to the DCS. He referred to a series of graphs, which had been produced the previous evening. DAG, in the short time it had available, showed to the Court that these were not accurate and IoMT agreed to revise these before circulation.

Dominic Chambers for the DAG said that he based his submissions on evidence that had been put forward by Michael Simpson, Allan Bell and others by way of affidavit and witness statement on previous hearings. This evidence had not been contradicted and it was sensible therefore to use it as the basis for a comparison between the Scheme of Arrangement and liquidation. Mr Chambers produced in the short time available to him graphs showing the relative advantages and disadvantages. He made the point that there appeared to be no material benefit to the Scheme for the majority of depositors. In particular there was no additional money in the Scheme for depositors over a liquidation unless total recoveries under a liquidation were to amount to less than 60p in the £. That, for the reasons stated below, was very unlikely to be the case.

The timing benefits which had been referred to by Mr Simpson at the previous hearings had now evaporated. The graphs provided by the IoMT were completely misleading as there was a fundamental error in them as to the timing of the payment of DCS top ups and dividends in liquidation.
Concerns raised by the IoMT about the DCS were baseless and flew in the face of what was elsewhere being said about the DCS by the Isle of Man and by banks on the island. The viability of the Isle of Man as an offshore banking centre depended upon the strength of the DCS, which was aggressively marketed by the banks on the island.

If the Scheme was allowed to be put to the vote, Mr Chambers said that there should be three classes of creditors. What had been said by Mr Moss QC and Mr Hacker QC was not in this case correct. It was inappropriate for those with deposits, which were less than the DCS compensation limit to be in the same class as those who had deposits amounting to substantially more than the limit. Their respective interests were sufficiently different to mean that they could not effectively consult together. Mr Hacker had been incorrect in describing the rights to DCS payments as rights, which were personal to depositors, and not rights against the Bank. DCS rights derived from rights against the Bank and therefore fell to be considered when considering the composition of classes. If the Scheme were to go ahead with just two classes it was open to any aggrieved depositor at the sanction hearing to argue that the classes had been incorrectly constituted. If that were to be found to be the case then the Court would not be able to sanction the Scheme irrespective of whether or not it had been voted by the classes. It appeared to the DAG that that would be a substantial waste of time and money and that these issues should be dealt with earlier rather than later.

Mr Chambers said the starting point was that the Scheme was not making any more money available over and above what depositors would receive in a liquidation. He referred in particular to the affidavit made by Michael Simpson on 28 January 2009. Paragraph 8 of that affidavit set out the potential advantages of the Scheme, as they were perceived by Mr Simpson to be. If recoveries amounted to less than 60p in the £ then there would be some financial advantage in the Scheme of Arrangement but otherwise recoveries would be the same. The chances of that being the case were very small. The reasons for this were as follows:-

• The IoMT’s recovery of any money it puts into the Scheme begins at 60%. The IoMT refuses to move from that point. The IoMT appears to be very confident that recovery will be at least 60p in the £ and it is therefore confident that the majority of its money will not be used.
• Mr Simpson is confident or hopeful that the dividend will exceed 60p in the £ (see the final paragraph of his affidavit).
• The explanatory statement produced to the Court on 9 April had in it graphs dealing with three scenarios, a high, medium and low return. The low return scenario was based on an ultimate dividend which was not less than 60p in the £ (see explanatory note page 16).

Mr Chambers also referred to the third statement of Mr Lovett. Mr Lovett accepted that there would be no additional money under the Scheme. In paragraph 24 of his statement Mr Lovett states that depositors can expect the same final recovery under either a DCS or a Scheme. Paragraph 10 of Mr Simpson’s affidavit makes the same point. The same amount will be realised under a Scheme or liquidation.

Mr Chambers dealt then with the question of the timing of payouts under either a Scheme or under the DCS. He based his assumptions on Mr Simpson’s affidavit. Under a Scheme the creditors’ meeting would be on 19 May and thereafter the sanction hearing would be on or about 28 May. Under paragraph 7 of the Scheme, the Scheme would not be effective until it had been recognised in the courts of England and Wales. There was no estimate of how long this would take but a conservative view would be two weeks. This would take the effective date to 15 June at the earliest. The first dividend under the Scheme will be made 90 to 100 days after that. That would be some time after 20 September. Under the timetable provided for in the Scheme the second dividend would then be on 15 June 2010 and the third on 15 June 2011.

Top up funding under the Scheme from IoMT will replace payments under the DCS. Under the Scheme at the time of the first dividend, being in September or October 2009 depositors will be paid £20,000 out of £50,000 or the value of their DCS claim, whichever was lower, at the second dividend payment in June 2010 they will be paid a maximum of £35,000 out of a possible £50,000 and on the date of the third dividend payment in June 2011 they will receive up to the full value of their DCS claim.

Mr Chambers submitted to the Court that, under liquidation, a substantial body of creditors would receive their money more quickly and in a greater amount. He referred to Mr Simpson’s affidavit of 18 February and correspondence exhibited to that affidavit in which Mr Simpson requested information on the DCS from the FSC. The FSC’s response was dated 16 February 2009. In that letter it was estimated that the total amount to be paid out in the DCS would be in region of £210 million. The payment profile was based on a prudent view of what would happen.

If, in accordance with our submissions, the Bank were liquidated according to the estimates provided by Mr Simpson, the Liquidator Provisional, it was envisaged that the first dividend would be in July of 2009 (i.e. two months earlier than the first payment under the Scheme). At this point 36% of the DCS entitlement would be paid out. A further distribution would be made on or about 30 October 2009 when a further 31% of the DCS entitlement would be expected to be distributed. The next distribution would be 31 May 2010 where a further 15% of the DCS entitlement would be paid out bringing the total to that date to 82%. Under the scenario envisaged by Mr Simpson the next distribution (at which the DCS liability would be discharged in full) would be in December 2010. Distributions under the Scheme of Arrangement were clearly inferior to this.

The graphs produced by the IoMT and the liquidator were wrong in that they misplaced the timing of the first dividend under a liquidation and replicated that error throughout the graphs. The real picture was very different.

Mr Chambers went on to examine the status of the £150 million, which had been set aside by IoMT for use in the DCS. This would the subject of some discussion. He said £70 million had been set aside for the payment to creditors of KSF IoM, and this left a further £80 million as yet unallocated of the money put into the DCS by the IoMT. He made a number of points in relation to these sums. The figure on which he and Mr Simpson and others had based their payment profiles was £70 million and not the £150 million which, as he saw it, the IoMT was obliged to make available. Even with the £70 million available for distribution in the DCS, the DCS and liquidation were on the face of it more advantageous than top up payments under the proposed Scheme.

Depositors will now appreciate that the DCS is not, as has been suggested, an absolute guarantee to depositors. It is a scheme that depends for it’s funding on the banking community in the Isle of Man contributing to its funds. If they do not do so then money is not available to meet the intentions of the DCS. Further in the event of further bank collapse monies in the DCS are spread more thinly to meet the claims of depositors in all collapsed banks. The immediate lack of funds in the DCS has necessitated IoMT intervention.

It was to be noted that the participating banks’ contributions to the DCS for the year, which had just passed, were underwritten by the IoMT which had undertaken to make a payment of £9.6 million into the DCS in the event that the Scheme had not been finalised or the Bank not put into liquidation by March 31 2009. The banks would contribute a similar amount for the current year and this therefore made the available cash about £20 million in addition to the £70 million set aside by the IoMT.

There were two main points to be made in relation to the £80 million, as yet unallocated portion of the money put into the DCS by the IoMT. The first was that this might and should be available to creditors of KSF. Even if this were not the case it represented a significant cushion in the DCS system in the very unlikely event that another bank were to fail. The failure of another bank would not therefore have an immediate impact on the £70 million set aside for the KSF depositors. The £80 million would need to be expended before a further bank collapse could impinge on the DCS payment schedule.

Alleged weaknesses in the DCS
As to the assertions by those who proposed the Scheme that the Scheme offered greater certainty than a liquidation and DCS payments, Mr Chambers said that this was baseless. First of all there was no evidence at all that there was a real possibility that a further bank would collapse. Of the thirty or so banks trading in the Isle of Man most were owned by large Spanish, British, or other European banks and had the full backing of their parents. Assuming a further bank was to fail in spite of this, there was of course the cushion of the £80 million voted through by the IoMT for the DCS and not yet allocated.
Mr Chambers said that all of the banks on the island and indeed the Isle of Man Government itself used the DCS system to market the Isle of Man as an offshore banking centre. He said it was politically and economically inconceivable the IoMT would permit the DCS to default on its promise that £50,000 of depositors’ money was safe. When the DCS limit had been increased Mr Bell had in the debate in the Tynwald given as the reason for the increase the need to give increased confidence to the market. The DCS was a big draw to investors in the Isle of Man. It would be a catastrophe if the Government were to allow it to fail. In fairness to Mr Bell he had made no mention at all of any flaws in the DCS system.

IoMT subrogation
At previous hearings the IoMT had said it would subrogate its rights as a creditor for £10 million owed to it by the Bank. It now appeared that the sum in question was only £2.8 million. While it could be seen that there was a potential advantage to creditors in the amount of 0.3p in the £ by this subrogation, Mr Chambers said this was insignificant and outweighed by other aspects of the Scheme and in particular the Treasury’s ability to claw back monies spent in top up payments once the 60p in the £ had been distributed to depositors. There was a certain amount of debate about the wording of the Scheme on this point and in particular paragraph 18.5.

Mr Hacker replied for the IoMT and the Bank. He conceded that there were errors in the graphs provided but argued about the affect of those errors on the graphs. He said that further graphs would be produced. Mr Hacker and Counsel for the FSC made certain points on the £80 million. It was also stated that the IoMT would not seek to recover 100% of its payments under the top up scheme once depositors had been paid 60p in the £. To the extent that the wording in the Scheme did not reflect that (and it did not) this would be amended and the amendments circulated.

Mr Hacker conceded that it was arguable that three classes were more appropriate than two and the Treasury conceded this pointed.
The Deemster deliberated for an hour and gave the judgment attached hereto allowing the meetings to be convened.

Transcript of the judgment can be found [here]
Transcript of the hearing can be found here

Events after 9 April
We have requested from the IoMT and the Liquidator Provisionally that certain things are done before the Scheme is circulated to creditors. In particular we requested that fresh graphs be produced and annexed to the explanatory statement which would offer creditors a clear comparison between the Scheme of Arrangement and liquidation. We also pointed out that the wording of paragraph 18.5 and its subparagraphs was at odds with the stated intention of the IoMT not to recover 100% of its outlay. We requested sight of these amendments in good time to comment upon them.

We have also asked for confirmation that the Liquidator Provisionally has made demand under the parental guarantee given by Kaupthing hf. We believe it important that Kaupthing hf’s obligation to make good the shortfall in the Bank’s ability to meet its liabilities should be crystallised before creditors compromise their claims against the Bank in any Scheme.
Thus far we have received no reply at all from the IoMT or the Liquidator Provisionally.

Press Release of Liquidator Provisionally dated 9 April
The press release on the Bank website is misleading. A court hearing in the Isle of Man is listed for 27 May not 25 May. The press release states that the Court at that hearing “will” sanction the Scheme at that hearing. More correctly the Court “may” sanction the Scheme at that hearing depending on what representations are made by any creditors or interested parties. Finally the press release states that 25 May will be the effective date of the Scheme. The effective date of the Scheme as defined by the Scheme documentation is the date on which the courts in England and Wales agree to recognise the moratorium under the Scheme. That is likely to be at least two weeks after 25 May. To date this press release has not been corrected.
Please find copy of letter sent to PWC highlighting the inaccuracies here

The DAG will open multiple phone lines on Monday 20th April to provide information on proxy voting and the latest legal position. These phone lines will be operated around the clock and will be located across the world in order to provide information for those depositors who are unable to access the Internet and who may not yet be aware of the disaster that occurred on 8th October 2009. KSFIOM DAG Telephone Helplines

We aim to ensure that the 8,000 plus depositors of KSFIOM who are not yet members of the DAG, are given the full version of events and motivations and not just the version that is being distributed by: Isle of Man Government; Isle of Man Government appointed Consultants, Alix Partners; Isle of Man Government appointed PR Company; Isle of Man Government owned media; and now the LP Price Waterhouse Cooper

Depositors of KSFIOM deserve the right to make an informed decision and the access to information provided by Edwin Coe.

What happens next?

You should receive a copy of the Scheme documentation during the next week. The draft put before the Court on April 9 was not clearly drafted and several of the key clauses were ambiguous. It remains to be seen whether the final version will be clearer. You should read the Scheme carefully before you decide whether to support the Scheme or to vote against it. You may appoint a proxy to vote for you and may either specify whether that vote will be for or against the Scheme or leave that decision to your proxy. Alternatively you may wish to attend and vote at the meeting.

Provisional Conclusions

The position of the DAG strategy team was, on legal advice, to oppose the proposed scheme of arrangement at the hearing on 9 April. It emerged at the hearing that, as a result of drafting errors in the scheme document, that which was apparently intended by the scheme proposers differed from that which actually appeared in the scheme document in several respects. After making allowance for these matters, notwithstanding that the promised amendments to the scheme have not yet been published, we remain opposed to the proposed scheme because no changes have been promised or offered that would alter our view.

Therefore our present position remains that we are opposed to the presently proposed scheme and could not commend it to members as being an acceptable alternative to liquidation and the DCS. Quite obviously neither of these alternatives satisfy the DAG mission, which remains (in keeping with what has been achieved in other jurisdictions and for other Kaupthing depositors) that of seeking 100% return of our deposits.
When the final scheme document is published with the voting papers, we will be publishing an explanation of how the scheme works and a calculator to show the likely returns under liquidation (including DCS) and to compare them with those under the proposed SoA.

DAG Analysis SoA v’s Liquidation/DCS

Our analysis is predicated to a certain extent on two key assumptions. The first of these is that the DCS, on which the Isle of Man continues to rely to promote its banking system, is not as flawed as advocates for the IoMT have sought to indicate in court. The second assumption is that all relevant parties are basing their figures on recoveries of more than 60p in the £ and it is reasonable therefore to assume that recoveries will be more than 60p in the £. If either of those assumptions are not correct then it may be that our initial analysis is not correct. To that extent depositors have been left in an invidious position because the Treasury, the FSC and the Liquidator Provisionally have not disclosed a great deal of information and have kept their cards very close to their chests.

When we receive the final documentation, DAG will endeavour to produce a more in depth analysis, in consultation with our lawyers, which we intend to place on this page. We will subject the revised graphs in the explanatory statement to close scrutiny. Any such analysis must however be read with a note of caution, in that we ultimately we rely on figures and assumptions provided by Mr Simpson – we do not have access to the Bank’s data room. Ultimately depositors must make up their own minds.
The Treasury has indicated that it will not negotiate further and that depositors can take or leave the deal which is on offer. The DAG continue to believe that depositors should strive for full recovery of their deposits and that if the Isle of Man is to retain its credibility as a banking centre it must ensure that compensation provided is adequate. It is very clear to the DAG that the Isle of Man government wants the Scheme to go through and does not want liquidation. For the Scheme to come into effect, the three classes of depositors must each vote for the Scheme by a majority with 75% by value of those voting in each class.

The DAG continue to believe that if the IoMT believe that depositors are united and will oppose the Scheme if it is not improved, it should be possible to obtain more favourable terms. To that end the DAG will provide the names over the next two weeks of DAG proxies who you may choose to nominate to vote on your behalf. Provided that you do not instruct the proxy to vote in a particular way, the starting point, unless the scheme changes before that time, will be that the DAG proxy will vote according to the position currently taken by DAG (at present, against). This process will ensure that depositors can optimise the collective pressure they can exert. The DAG is not in favour of appointing Mr Simpson as a proxy.

At the hearing on 9 April the life companies stated to the Court that they wanted the Scheme to go forward to a vote. The DAG is in discussion with the life companies and would hope to find some common ground with them in the forthcoming weeks. The life companies speak for some £200 million to £300 million and are in the third class of depositors (i.e. the class of depositors whose deposits exceed their DCS entitlement). While they account for a large percentage by value, they have only a few votes.
The DAG urges all depositors to take their rights to vote on the Scheme of Arrangement. A Scheme of Arrangement is a compromise with the Bank and if it goes through it will be binding upon all creditors.

KSFIOM DAG started raising funds back in late November 2008 and since then we have received donations to the bank account and via Paypal from approximately 500 different depositors. This has enabled us to retain leading legal advisers and PR/lobbyists to ensure that our viewpoint is heard in the courts, through politicians and political bodies such as the Treasury Select Committee and through the media. However over 1400 depositors put forward their names in support of our legal representation, and whilst some have already given generously and others will have donated in other ways (eg to the IT fund and to individuals before December) we do need everyone to give whatever they can afford to keep the cause alive in the next few important weeks. If the other 900 people keen to support our legal objectives could donate as much as possible to the DAG fund that would give us what we need to retain our legal advisers during this vital next stage of the proceedings. Please also: those who have already donated, give again if you possibly can. We do recognise that not everyone can do this but please donate whatever you can to help.

Ahead of the vote regarding the Scheme of Arrangement we need to continue to put pressure on all the relevant authorities to promote the return of 100% of our money. We will continue to do this as cost-effectively as possible but there is no doubt that very fact that we have been able to employ professional services in these areas has influenced IOM strategy to date and although we have yet to achieve our over-riding objective, there is no doubt that everyone involved knows what we want and also knows that we will not give up until justice prevails.
A big thank you to all those who have contributed, your generosity is not only appreciated, it is having a real impact on the proceedings. Please give as little or as much as you can to help us make the most of the very small window we have remaining to try to force the IOM Government to do the right thing.
To Contribute Click here

At the following links we will shortly upload some of the recent correspondence sent out by Edwin Coe. You will appreciate we are not able to disclose all correspondence that has been sent to the numerous parties involved, as is also the case with some of the correspondence sent out by Bell Pottinger, but we would like to assure you that the team are following each and every considerable action.
Most recent correspondence sent to FSA:
Most recent correspondence sent to FSC:
Most recent correspondence sent to John Spellman:
Further correspondence sent to PWC:

We will update this page as and when we receive further information in relation to the proposed Scheme.


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