Earlier this year, the English Court refused to sanction two Part 26A restructuring plans ("RPs") which sought to bind HMRC, the UK tax authority, into restructurings via "cross-class cram down". (See "Restructuring Plans 101" below for a description of the key features of this restructuring process.) In Great Annual Savings Company1 ("GAS"), one of the statutory conditions for cross-class cram down was not satisfied. In Nasmyth,2 both conditions were satisfied but the Court exercised its discretion to refuse sanction – the first time it has done so in these circumstances.
The Court recently sanctioned the cram down of HMRC in the Prezzo3 RP despite a request from HMRC for the Court to once again exercise its discretion to refuse sanction. Here, we look at the differences between the three RPs and key takeaways from each, including for future cases which do not involve HMRC.
1. “No worse off” test
In GAS, the company's valuation evidence showed only a marginally better outcome for HMRC in the RP than in the relevant alternative. The Court was not convinced by the strength of this evidence, questioning the independence and accuracy of the report and the weight that could be given to it in light of apparent gaps in the analysis. Ultimately, the Court was not persuaded on the balance of probabilities that HMRC would be no worse off under the RP than it would be in the relevant alternative, and found that Condition A was not met.
HMRC did not provide evidence supporting its argument that it would be worse off in the RP, as the Court has encouraged challenging creditors to do in other contested RPs. However, the Court confirmed that, even in the absence of competing evidence, it is not required to simply accept a company's evidence as correct.
2. Allocating the “restructuring surplus”
Even when both conditions for cross-class cram down are met, the Court has discretion to refuse sanction. One of the factors considered by the Court will be whether the "restructuring surplus", essentially the benefit of the restructuring, has been allocated fairly amongst the different classes. The Court considered this in both GAS and Prezzo against the backdrop of the leading case on this point, Re Virgin Active,4 where the Court held that significant weight should be given to the views of the "in-the-money" creditors, in contrast to those creditors who would be "out-of-the-money" in the relevant alternative.
The key question for the Court in GAS was whether the benefits of the RP were allocated fairly between the consenting and non-consenting creditors. The Court set out the following three factors to consider: (i) the existing rights of the creditors and how they would be treated in the relevant alternative; (ii) the additional contributions made by creditors to support the success of the RP (namely whether any additional risk was being incurred by making new money available; and (iii) if any class is disadvantaged under the RP when compared with the relevant alternative, whether this is justified.
In GAS, the position of the secured creditor was significantly improved when compared to the treatment of HMRC. The Court found that this was not justified, in particular given that the secured creditor was not providing any new money and was not subject to any greater degree of risk than other creditors. The company had essentially preferred one creditor over the others with no defensible rationale. The fact pattern in Prezzo was very different. The secured creditors provided significant amounts of new money, including an additional £2 million to fund an enhanced recovery for HMRC under the RP. Further, the return to HMRC was substantially greater than it had been in either GAS or Nasmyth. Ultimately, the Court found that almost all of the restructuring surplus was being allocated to HMRC and it declined to use its discretion to refuse sanction.
The statutory order of priority, which determines how the assets of an insolvent company should be distributed between classes of creditors in administration and insolvent liquidation, is a cornerstone of English insolvency law. HMRC benefits from a secondary preferential status, which ranks certain tax claims ahead of the claims of floating charge holders and unsecured creditors. In GAS, as well as HMRC being disadvantaged under the RP when compared with the secured creditor class, certain unsecured creditors were also intended to receive better treatment than HMRC under the RP, in a manner which was inconsistent with the statutory order of priority. The Court noted that deviating from the statutory order of priority can be a potential source of unfairness and reiterated that the distribution of the benefits of an RP is principally a matter for the "in-the-money" creditors to determine. In this case, the "in-the-money" creditors included HMRC and the Court was not convinced that the company had any good reason for deviating from the order of priority.
Prezzo also involved a deviation from the statutory order of priority: the shareholders were not impaired by the RP whilst the unsecured creditors received nothing. However, the shareholders were, with one exception, the same entities as the secured creditors and their retention of the equity was justified on the basis that the secured creditors were the key group of "in-the-money" creditors and made a material contribution to the restructuring via the provision of further funding.
In restructurings of leveraged financings, the ranking and waterfall provisions under the intercreditor agreement are likely to be a key consideration in considering the allocation of the restructuring surplus. This is especially so where the relevant alternative to the RP is an enforcement of security or another scenario which would result in the distribution of proceeds pursuant to the intercreditor waterfall. The guidance of the Court in relation to the statutory order of priority is likely to be relevant and helpful in such cases.
3. A genuine compromise?
An RP must involve a "compromise" or "arrangement" between the company and its creditors. The legislation does not define these terms. In the context of schemes of arrangement, they have been interpreted by the Court to require an element of "give-and-take" such that creditors need to receive at least some consideration in return for the compromise of their rights.
In GAS, the RP originally sought to compromise the claims of certain contingent creditors in full in return for payment of only £1. At the convening hearing, the Court queried whether this de minimis consideration would be sufficient to constitute a compromise or arrangement. GAS ultimately improved the returns to the contingent creditors to ensure that this would not become an obstacle. In Prezzo, the company sought to compromise in full the claims of a single class of unsecured creditors (comprising HMRC in respect of its non-preferential debt and other unsecured creditors), for zero consideration. It was accepted that this class was "out-of-the-money" in the relevant alternative and so the question was whether the same requirement for "give-and-take" applies in respect of "out-of-the-money" classes. The Court accepted that, because the cross-class cram down feature of the RP only requires each class to be no worse off in the RP than it would be in the relevant alternative (and not any better off), a zero return would satisfy this condition where a class would receive nothing in the relevant alternative. This is a welcome clarification.
4. Ability to cram down HMRC
Nasmyth, GAS and Prezzo are the first RPs to be actively challenged by HMRC. They follow the cram down of HMRC in Re Houst in 2021, where the Court criticised its lack of active opposition. Whilst refusing sanction in GAS and Nasmyth, the Court made clear that it remained possible "as a matter of principle" for HMRC to be crammed down.5 The Court did, however, note that this should be approached with caution, highlighting in Nasmyth that: (i) HMRC debts have a special status given their secondary preferential ranking in insolvency; (ii) HMRC is an "involuntary creditor" in that it does not choose to trade with companies as other creditors do; and (iii) approving that RP could open the flood gates to the use of RPs to cram down unpaid tax bills. In GAS, the Court also recognised HMRC's "critical public function". The Court noted similar points in Prezzo but was nonetheless comfortable sanctioning the RP, holding that this would not give companies a green light to use the RP as a tool to cram down their unpaid tax bills.
5. Lessons learned
Whilst the three decisions are, to a large extent, specific to their facts and most relevant to future RPs which seek to cram down HMRC, they also provide helpful clarification on several points with wider application.
Nasmyth offers guidance on parties' standing to challenge an RP. The relative alternative was a pre-packaged administration in which HMRC's returns would have been zero. Whilst HMRC was clearly "out-of-the-money", the Court recognised its ability to challenge the RP because it nonetheless had a legitimate interest in the outcome. In particular, if the RP were sanctioned, (i) HMRC would have remained a creditor of the company's subsidiaries and (ii) its success would have depended on HMRC agreeing to "time-to-pay" arrangements. Whilst this provides food for thought when considering the leverage of "out-of-the-money" creditors, the leading authority remains Re Virgin Active, where the Court made clear that little or no weight should be paid to the complaints of such creditors. Re Virgin Active was followed in both GAS and Prezzo.
Nasmyth also emphasises that a successful RP does not only require a company to satisfy the statutory conditions for cross-class cram down and has brought the Court's discretion into focus. GAS reinforces the statements in Virgin Active that the views of the "in-the-money" creditors are paramount in assessing whether the allocation of the restructuring surplus (and any divergence from the statutory order of priority) is fair. Finally, Prezzo underlines that the provision of new money will be key in justifying any such divergence and helpfully confirms that no consideration is required to be given to an "out-of-the-money" class in an RP.
Case Snapshots
Restructuring Plans 101
Restructuring plans under Part 26A of the Companies Act 2006 are court-supervised debtor-in-possession proceedings that permit a company to propose a compromise or arrangement with its creditors and/or shareholders and/or any class of them. Following their introduction in 2020, they are now an established part of the English restructuring landscape and offer a means by which the Court can order a compromise of debt obligations even if there are one or more dissenting classes of creditors (this power is referred to as "cross-class cram down"). Impacted creditors and shareholders must be separated into classes, in each case consisting of all persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest. Seventy-five per cent by value of those present and voting in each affected class with an economic interest in the company must vote in favour of the plan. Unlike for schemes of arrangement, there is no numerosity threshold and if the 75 per cent threshold cannot be reached in one (or more) class(es), the Court can nonetheless sanction the plan if it is satisfied that:
- Condition A: None of the members of the dissenting class would be worse off than under the "relevant alternative" (i.e. what would be most likely to occur if the RP were not sanctioned).
- Condition B: At least 75 per cent by value of a class of creditors that would receive a payment or have a genuine economic interest if the relevant alternative were pursued voted in favour of the plan.
1 Re Great Annual Savings Co Ltd [2023] EWHC 1141 (Ch).
2 Re Nasmyth Group Ltd [2023] EWHC 988 (Ch).
3 Re Prezzo Investco Ltd [2023] EWHC 1679 (Ch).
4 Re Virgin Active [2021] EWHC 1246 (Ch).
5 As previously seen in Re Houst [2022] EWHC 1941 (Ch) and as subsequently occurred in Prezzo.
N.B. Re Fitness First Clubs Ltd [2023] EWHC 1699 (Ch), a fourth RP involving HMRC, was sanctioned on 29 June 2023, shortly before Prezzo. This RP adopted a conservative approach to the treatment of tax claims and was supported by HMRC so is not considered in this article.
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