Sova Capital – a “special” Special Administration

So[va] why is this case important?
 
The case of Re Sova Capital Limited (in special administration) [2023] EWHC 452 (Ch) generated and continues to generate interest in insolvency circles, rightly. Having acted on the case, we set out its key takeaways that Sova gives rise to (and leaves open, arguably), as we see it, for insolvency professionals. 
 
Sova provides, for the first time, authority for the use of ‘unsecured credit bids’, where an unsecured creditor can look to purchase assets of the estate in exchange for the waiver of its claim. What does this mean in practice?  
 
First, who are we to say?
 
For our part, DMH Stallard (Partners Matt Akers and Michael Lynch) acted for a creditor of Sova (“BZ”) who highlighted various concerns he had regarding the JSAs’ applications to obtain court approval for the unsecured credit bid transaction, its effect on him and other creditors and his treatment by the JSAs as a creditor and rival bidder. 
 
On 2 March 2023, Mr Justice Miles handed down judgment on the expedited applications made by David Philip Soden, Ian Colin Wormleighton and Stephen Browne of Teneo, as Special Administrators (“JSAs”) of Sova Capital Limited (in Special Administration) (“Sova”).   
 

Background and the decision

Why did the case come about?  Factual background
 
In short:

• the JSAs held a tranche of Sova’s assets (trapped Russian securities) effectively stuck in Russia due to EU, UK and US sanctions; 
• after Sova entered into Special Administration, the UBO of Sova, a Ukrainian sanctioned individual named Roman Avdeev, set up a company based in Russia called Dominanta;
• Dominanta proceeded to hoover-up various creditor positions, to the tune of $233 million;
• after discussions between Dominanta and the JSAs between July and September 2022, Dominanta made an offer to waive its claim in the administration for the transfer of securities it selected from the trapped Russian securities; 
• the creditors of Sova were made aware of this proposed transaction to purchase the trapped Russian securities in late September 2022.  BZ only found out in October 2022;
• the JSAs entered into agreements with Dominanta in early December 2022; and
• the JSAs sought permission of the court to ratify the two transactions with Sova in mid-December 2022. 

The purchase of the securities from Sova was by way of a waiver of Dominanta’s claim in the administration (i.e. an unsecured credit bid).  The purchase mechanism and its effect were at the heart of this case.
 
JSAs’ position
 
Under English and Welsh law, administrators are given wide latitude to sell assets.  In this case, the JSAs necessarily applied to court because the Judge hearing the original administration application indicated that the JSAs should return to court for directions if it related to sanctions.  Central to the JSAs’ applications were the various UK, US and EU sanctions that meant such assets were effectively stuck in Russia. Dominanta engaged with the JSAs for months leading up to the JSAs’ urgent applications and the JSAs, seeing an opportunity to sell some of Sova’s assets that otherwise might not have sold, applied to court for liberty to procure Sova to enter into the two transactions.  The JSAs’ position was somewhat understandable.
 
BZ’s position, as a creditor
 
So why did BZ, a creditor, file evidence to oppose the transactions, especially if, on the face of it, it would benefit unsecured creditors?  BZ, as a fellow unsecured creditor, was only informed of Dominanta’s proposal in October 2022.  Amongst other issues BZ raised with the Court regarding his concerns about the JSAs’ inadequate/poor marketing of the trapped Russian securities, BZ opposed the application on the basis that the transactions were, in effect, a distribution in specie[1] and, therefore, contrary to the pari passu principle[2]. 
 
So[va] what?
 
BZ’s fundamental issue with the JSAs’ transaction with Dominanta was that, from his perspective, Dominanta (putting aside the UBO of Dominanta was the architect of Sova and its demise) was going to benefit from: (i) the assets at a price that could be “flipped in Russia” (by a Russian entity) pretty quickly and for a substantial profit; and (ii)  in effect, a return of 117% on its claim in the Administration, as opposed to the other unsecured creditors receiving between 50.3% and 60.3%, on the JSAs’ own position.  The legal argument centred on whether Dominanta was receiving a distribution in specie[3] as an unsecured creditor to the detriment of other unsecured creditors who would receive substantially less.   
 
The Judgment (in brief)
 
The English High Court has taken a somewhat pragmatic and commercial view of the transactions, permitting the transactions by virtue of what he considered to be their proper characterisation.  Miles J. determined that the distribution of the securities by way of the credit bid was properly characterised as a sale, as opposed to a distribution. In doing so, he endorsed the JSAs’ “dividend bid model” which effectively involved using the proceeds from a notional distribution to purchase the securities.  Characterising the transactions as a sale (rather than a distribution) meant BZ's arguments fell away because the pari passu principle and other statutory protections did not apply. Though it enabled the Court to determine that no infringement of the pari passu principle and underlying statutory restrictions on distributions in specie were engaged, unhelpfully for practitioners, the legal rationale for this characterisation is rather, to coin another insolvency phrase, light-touch.   
 
What does this mean?
 
For Officeholders?
 
To a large extent, this decision fits into a long line of decisions with Courts supporting the statutory purpose of Administrations/Special Administrations.  However, this case is a legal first where unsecured creditors can now, effectively, ‘credit bid’ for assets in the insolvent estate. 
 
The judgment does not, problematically, give guidance as to when an unsecured credit bid structure might be permissible (effectively characterised as a sale) or whether the court’s sanction is required (likely not).  Miles J. was clear, however, that administrators do need to determine properly that the bid represents the best price reasonably obtainable for the assets in question.  The critical problem for officeholders is two-fold: (i) is the asset that may be subject to an unsecured credit bid achieving the best price reasonably obtainable; and (ii) does the transaction represent, in effect, a sale/disposal (and not a distribution in specie[4]) to that creditor?  Another critical element argued by BZ was whether the other unsecured creditors are treated unfairly by the sale.  This was rather ‘side-stepped’ by the court in Sova on the basis that, as it’s a sale, the rest of the issues fell away.    
 
The result is this: where officeholders do look to use this new ‘realisation tool’, they will need to assess valuations properly – clear marketing is preferable (this should not be a surprise) – and take legal advice (a lawyer would say this!) on the same.   In this case, ultimately, the court appears to have accepted the JSAs’ arguments that urgency was required, over and above what was arguably a rather weak marketing exercise. 
 
For creditors
 
Arguably, the Sova case means unsecured creditors can now, effectively, ‘credit bid’ for assets in the insolvent estate; as stated above, the Sova case permitted the transfer of securities to an unsecured creditor by means of its waiver of their claim in the administration. 

Secured creditors have been able to utilise credit bidding (more commonly in the US) for some time.  Where a secured creditor is left with an unsecured element or where you have an unsecured creditor interested in the assets, the Sova decision ostensibly provides: (a) another method for officeholders to realise assets; and (b) an opportunity for creditors to utilise value out of an otherwise unfavourable position.
 
For lawyers
 
Reading the decision after listening to the various legal arguments raised, one had the impression that Miles J. sidestepped the issues raised by BZ.  Dominanta, an unsecured creditor, objectively has received a greater benefit/return from the court-approved transactions, leaving the other unsecured creditors with a better but not equal return.  And there is the rub.  This case may be used as a precedent for ‘credit bids’ for unsecured creditors, outside of the court’s confines (i.e. without court approval), but it comes with a health warning. 

The critical characterisation of the ‘unsecured credit bid’ as a sale or disposal, as opposed to a distribution to a creditor, is not explained fully.  Oddly, the court agreed both with the arguments raised by the JSAs and with the arguments raised by BZ.  It was a practical judgment, borne of necessity.  However, the judgment fails to provide clear working parameters for the legal advisers and, consequently, officeholders. It could allow for mechanisms whereby larger unsecured creditors use sophisticated transfer mechanisms to purchase (via disposal) positions, leaving them in a better position than the remaining smaller creditors. 
 
So[va] far, so[va] good (or bad)?   
 
It’s difficult to envisage unsecured credit bids being utilised wholesale across the market.  This is particularly so when the leading judgment, Sova, does not provide any detail as to when such a tool can be used.  However, there is a real risk that, in certain circumstances, officeholders may attempt to rely on this case or be impressed upon (by a creditor) to rely on this case.  Ultimately, Sova has left an unsatisfactory opening in the market and it is likely that this will not be the first case that lands before the courts dealing with determining distributions versus disposals.
 
Conclusion – a tempered pari passu position
 
In a world where economic strains cross jurisdictions, on the one hand it is good to see the English courts being practical and flexible in its approach.  Conversely and arguably, Sova opens the door to unsecured creditors being put into two different groups, those that can trade in “disposals” and those that are left behind.  It’s still pari passu but it’s been, arguably, tempered.  Watch this legal space.    
 
[1] “A distribution in specie occurs where a company makes a distribution of an identified non- cash asset, without first declaring an amount in cash. Distributions in specie fall under section 845 of Companies Act 2006 (CA 2006). Most commonly, such assets may be property or machinery or the benefit of a debt” – ACCA Global Technical Factsheet, Oct. 2021, page 1.