Virgin Active – out of the money creditors hold little sway

On 12 May 2021, the High Court sanctioned Virgin Active’s Part 26A restructuring plan which had been heavily contested by certain landlords. This is the third restructuring plan to use cross-class cramdown (first used in the DeepOcean Group and subsequently in Smile Telecoms), and the first to bind dissenting landlord classes to lease compromises.  The judgment may be seen as a further blow to landlords, following hot on the heels of the New Look judgment handed down on 10 May 2021 which reaffirmed the availability of the company voluntary arrangement for similar purpose.

The Restructuring Plans

The group proposed, and the Court sanctioned, three inter-conditional restructuring plans (the Restructuring Plans) for three Virgin Active companies:

• Virgin Active Limited (VAL),
• Virgin Active Holdings Limited (VAHL); and
• Virgin Active Health Clubs Limited (VAHCL) (together, the Plan Companies).

The Plan Companies are part of the Virgin Active group, an international health club operator.  As fitness clubs were shut during a large part of the Covid-19 pandemic, the business was severely impacted.  The Restructuring Plans were proposed with a total of twenty-one creditor classes (7 classes mirrored across the three Restructuring Plans):

• secured creditors under a senior facilities agreement of over £200 million;
• landlord creditors compromising 46 landlords with a total of 67 leases, subdivided into Classes A-E; and
• general property creditors, i.e. creditors who are not current landlords, but whose claims relate in various ways to properties which are or have in the past been occupied by the group (together, the Plan Creditors).

Similar to the custom in company voluntary arrangements, the landlords’ categorisation was broadly based on the profitability of their leases (category A being the most profitable and E being the most severely loss-making) with different terms applied as follows:

• Category A landlords – remaining largely untouched but with right to terminate in exchange for 120% of estimated administration returns;
• Category B landlords – similar to Category A but with rent arrears released;
• Category C landlords – rent arrears released; 50% rent reduction during a rent concession period; right to terminate in exchange for 120% of estimated administration returns; and
• Category D – E landlords – liabilities released and discharged in exchange for 120% of estimated administration returns.

The convening hearing

At the first court hearing (which sought an order to convene meetings to vote on the plan), an ad hoc group of landlords (as well as two individually represented landlords) appeared before the Court opposing the Restructuring Plans. They disputed:

• the urgency of the restructuring as held by the Plan Companies;
• the relevant alternative (see later);
• class composition, which they said they could only be satisfied on if further information was provided to them; and
• the “stark inequality” between allocation of losses and benefits between different stakeholders, with shareholders retaining shares in return for a relatively small equity injection and new money financing, and secured lenders suffering no debt write-down.

The Court convened the plan meetings but ordered disclosure of further information, including the group’s business plan, cashflow statements, 2019 financial statements, and basis for landlord categorisation.  In light of the commercial sensitivity of some of this information, disclosure was to be made to the landlords’ legal and financial advisers, subject to appropriate confidentiality undertakings, rather than to landlords themselves. The Court rejected the request for disclosure of the Deloitte model underpinning the relevant alternative analysis, on the basis that Deloitte has proprietary control of its model and that it was not clear how such a detailed, complicated working model could easily and practically be provided.

The Court fixed a tight timeline allowing for judgment to be handed down by the week commencing 10 May 2021, accepting the Plan Companies’ case for urgency but noting that the timetable was “as tight as could possibly be envisaged consistent with the need for procedural fairness”.

The votes

The outcomes by value of those voting were that the secured creditors and Class A landlords voted (near) unanimously in favour of the Restructuring Plans. All other creditor classes voted against the plans, in several cases unanimously.  In terms of overall value, the VAHL and VAL Restructuring Plans were each approved by 77% of Plan Creditors voting and the VAHCL Restructuring Plan was approved by approximately 72% of Plan Creditors voting.

Cross-class cram-down

Given the result, the Plan Companies requested the use of cross-class cram down to sanction the Restructuring Plans.

For cross-class cram-down to be available, the Court needs to be satisfied that the following three questions can be answered in the affirmative:

• Condition A: If the plan were to be sanctioned, would none of the members of the dissenting class be any worse off than they would be in the event of the relevant alternative?
• Condition B: Has the plan been approved by the requisite 75% in value of a class of creditors present and voting who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative?
• General discretion: In all circumstances, should the Court exercise its discretion to sanction the restructuring plan?

It was common ground that Condition B was satisfied by the approval of the Restructuring Plans by the secured creditors and by the Class A landlords.  The challenge of the ad hoc group of landlords (as well as two individually represented landlords)  centred on Condition A and the general discretion, but the Court was satisfied on each of these points, making the following key findings:

Condition A – no worse off

• The no worse-off test is approached by identifying the relevant alternative and determining what the outcome for creditors would be in that scenario.  
• The relevant alternative is that which is “most likely” to occur if the Plans were not sanctioned, it is not necessary to establish that it would definitely occur or even that it is more likely than not to occur.
• The relevant question for the Court is what is the relevant alternative now, when considering sanction, rather than what might have been possible had the company taken a different course of action at the outset (although this latter point may be relevant in considering the general discretion).
• To evidence valuation, there is no absolute obligation to market test and such market testing is not always more reliable than desktop valuations.
• The mere existence of a broad range in the valuation does not, without more, make it unreliable.
• The Court can only assess the evidence before it, and so creditors seeking to challenge valuation would be well advised to adduce their own competing evidence on the matter.

The Court’s discretion 

• In a scheme of arrangement, it is established law that the Court should be slow to differ from the vote at a class meeting. This is however not the case for a restructuring plan when cross-class cram down is sought.
• It is not the case (as had been suggested based on certain comments of Trower J in DeepOcean) that the test to be applied is that, provided Conditions A and B have been met, the plan should be sanctioned unless the Court considers it not just and equitable to do so.
• Similarly, Trower J’s comments that a plan which satisfies Conditions A and B “will have a fair wind behind it” should not be read as creating a presumption in favour of sanction.  
• The dissenting vote of out-of-the-money creditor classes should not weigh heavily or at all in the sanction decision, noting that the legislation allows for these creditors to be bound to a plan which compromises their claims without even being given the opportunity to vote at a class meeting. This is especially so where there is no evidence provided as to why they dissented.
• Similarly, the principle of fair allocation of the “restructuring surplus” (i.e. the value or potential future benefits which use of such business and assets might generate following the restructuring) is likely to only apply as between creditors with a genuine economic interest and not to out-of-the-money creditors.
• It is generally for those creditors with a genuine economic interest to determine how to divide up the restructuring surplus, although there may be reasons for a Court to refuse sanction of a plan that discriminated capriciously between different classes of equally out-of-the-money creditors.

Comment

The Virgin Active judgment has not been great news for landlords (along with the New Look judgment). Virgin Active brings the shiny new Restructuring Plan to the fore and (as many practitioners predicted) it is fit for purpose to address financial and operational liabilities in the same process. Of particular note is the acceptance of (arguably) modest valuation evidence and the clear guidance that the votes of genuinely out of the money creditors will not attach much weight at all (if any).  The restructuring community will be emboldened by this decision to find ever more creative ways to do more holistic restructuring of businesses in a single process.

For landlords the outlook remains that there is a choice of tools to potentially force adjustments to businesses with a large retail physical footprint. It is worth noting the Court’s comment that it did not consider it inappropriate for the Plan Companies to have chosen to utilise Part 26A, rather than a CVA (which may have given the landlords more negotiating leverage), so long as that appeared to the Plan Companies “more likely to achieve the desired result of rescuing the companies in the interest of their stakeholders generally”.

Landlords will hope that the eagerly awaited Regis judgment (coming soon) may redress the balance a little but the direction of travel seems clear.

On 14 May, the landlords in New Look were given permission to appeal the judgment to the Court of Appeal, with the judge noting that the points raised are of general relevance and not limited to the New Look CVA – so the last word there may not have been spoken. It remains to be seen whether the landlords in Virgin Active will also seek (and be given) permission to appeal.