Houst - Restructuring Plans march onwards: green light for cram across, is cram up next on the restructuring plan journey?

On 22 July 2022 and after the judge ordered a delay for more evidence, the English court sanctioned the restructuring plan proposed by Houst Limited (Houst). Houst is an SME that is concerned with the provision of property management services for short-term/holiday lets. Its business was badly affected by the Covid-19 pandemic, meaning it was both cash flow and balance sheet insolvent when proposing the plan.

The case is an interesting one because (i) it sees the first use of cram down with respect to the UK tax authority (HMRC); and (ii) it provides fascinating guidance on the interaction between the allocation of the ‘restructuring surplus’ and the order of priorities in the relevant alternative. It seems likely to embolden companies and creditors to seek more ‘creative’ deals under a restructuring plan.

Background

Houst’s creditors consisted of monies owed to (i) Clydesdale Bank (the Bank), (ii) HMRC, (iii) loannote holders, (iv) trade and critical suppliers, (v) a connected creditor, and (vi) customers. Houst submitted evidence (which was accepted by the court) that the most likely relevant alternative, should the restructuring plan not be successful, was a pre-pack administration. In that relevant alternative, only two creditors would receive any recovery: the Bank as a secured creditor (7p/£) and HMRC as a preferential creditor (15p/£).

The restructuring plan included the following:

• capital injection of £500,000 by certain existing shareholders, in return for the issue of new shares, leading to a dilution of existing shares to 5% of their existing equity;
• reduction of the Bank, HMRC and unsecured debt, leading to a dividend to those creditors over time of:
  • 27p/£ for the Bank (vs 7p/£ in the relevant alternative);
  • 20p/£ for HMRC (vs 15p/£ in the relevant alternative); and
  • 5p/£ for non-critical unsecured creditors (vs 0p/£ in the relevant alternative).
• loannote holders were to be given the option to convert their debt into pre-dilution equity or to participate in the cash dividend to unsecured creditors.

If Houst failed to make any of the regular contributions envisaged by the plan, the plan could be terminated by the plan administrators, in which case the rights of all creditors would revert to what they had been pre-plan.

Classes and votes

There were six classes: five classes of creditors which included the Bank in its own secured creditor class and HMRC in its own preferential creditor class (i.e. both were single member classes). The liabilities to customers were paid in full and therefore not included in the plan. The company had two classes of shares (ordinary shares and Series A preferential shares), which voted together in the restructuring plan as a single class. At the convening hearing the court was persuaded, taking a ‘degree of pragmatism’, that there was no need to fragment the shareholder class as all members were to be treated in a similar way under the plan and the differences were not so much as to make it impossible for them to consult together

All classes of creditors and the shareholder class voted in favour of the plan save for HMRC.  Cross-class cram down of HMRC was therefore needed to sanction the plan.

Cross-class cram down

Legislation prescribes two conditions to enable the court to exercise its discretion to cram down an entire class:

Condition A, namely that the dissenting class (here HMRC) would be ‘no worse off’ in the relevant alternative, was satisfied on the basis of the valuation evidence: 20p/£ for HMRC rather than 15p/£. No creditor challenged the valuation evidence and HMRC accepted in correspondence it would be better off under the plan than in the relevant alternative. 

Condition B, namely that the restructuring plan had been approved by a class with a genuine economic interest in the company in the relevant alternative. This was also satisfied through the Bank voting in favour of the plan. However, the court noted that the condition had been met by the votes of a class which had 100% consented. The judge considered Snowden J’s obiter remarks in Virgin Atlantic Airways Ltd [2020] EWHC 2376 (Ch), where he raised whether support of a fully consenting class whose arrangements could have been effected outside of a restructuring plan can be used as the assenting class for the purposes of cross-class cram down. The judge in Houst noted that any attempt to artificially create an in-the-money class for the purposes of activating cross-class cram down should be resisted. Here however, the court considered there was no reason in principle why a unanimous class, even of one creditor, could not be the assenting class, where as here the creditor was impaired by the plan and particularly where the creditor had not committed itself (e.g. through a lock-up agreement) to support the plan. On this basis the court was satisfied that Condition B was met.

In addition to Conditions A and B, the court needed to consider its general discretion to exercise cross-class cram down. Among the usual considerations (e.g. had all classes been represented properly), a key consideration in this case was the appropriate allocation of ‘the restructuring surplus’ (i.e. the incremental benefits generated from the restructuring). Here, the court picked up earlier points made in Re DeepOcean 1 UK Ltd [2021] EWHC 138 (Ch) that similar considerations apply as when considering the ‘horizontal comparator’ in CVAs: ‘the court is required to see whether the plan provides for differences in treatment of creditors inter se and, if so, whether the differences are justified.’

As part of this analysis, the court noted that a key reference point is the position of creditors in the relevant alternative. In particular, the court will look to see whether the priorities in the relevant alternative are reflected in the distributions proposed under the plan. However, unlike in US Chapter 11, a departure from the order of priorities would not be fatal to the plan as there is, intentionally, no ‘absolute priority rule’ in Part 26A. The court noted that it might be relevant to take account of the source of the benefits generated by the restructuring (e.g. whether they are derived from assets of the company or from new money).

In this case, the order of priority under the plan was different from what would be the order in the relevant alternative (the prepack). This is because:

• the Bank was due to receive a significantly higher increase on its dividend (recall: the Bank in a prepack would receive 7p/£, compared to 27p/£ under the plan);
• HMRC would receive a smaller proportional (but still enhanced) benefit from the plan (a dividend of 20p/£ compared to 15p/£); and  
• unsecured creditors (other than HMRC) would receive a dividend under the plan, when they would expect to receive nothing in a prepack.

Houst argued that this allocation of the restructuring surplus was appropriate as it represented the minimum recovery that the Bank was prepared to tolerate to support the plan and the unsecured creditors were potential future trading partners or funders of the business. The court called this a weak basis for depriving HMRC of the priority it would have in the relevant alternative. Indeed, the plan could have been imposed on the Bank if HMRC had supported it – flipping it round with HMRC being the approving class to cram down the plan on the Bank. However, overall the court overrode these considerations, given that:

• the restructuring surplus would be principally generated from the capital injection by the new members;
• the only creditor that was disadvantaged, in that they stood to receive a smaller share (as in proportion) of the distributions then they would have been entitled to in the relevant alternative was HMRC, which is a sophisticated creditor that had declined to actively oppose the plan; and
• HMRC still stood to receive an increased dividend if the plan was sanctioned than in the relevant alternative and in the absence of any submissions from HMRC on the point, the court could assume that it would prefer to receive more tax rather than less.

On this basis, given the binary nature of the choice available to the court, the court sanctioned the plan and applied cross-class cram down.

Comment 

The judgment itself is a short and pithy read pulling together and summarising existing plan and scheme case law. It is recommended bedtime, beachtime or anytime reading for all English restructuring lawyers! Here are our takeaways:

• This is the first time that a restructuring plan has been used to cram down HMRC. If as a matter of policy they continue to be unwilling to engage in such processes on the basis that they are not prepared to relinquish their preferential status (as they intimated to the court in an email), it is unlikely to be the last time. 
• Houst confirms how the restructuring plan can be used for “cram across” as between competing classes. The next (and much talked about) question on the development of restructuring plans is how courts will react to the question of “cramming up”, namely where a junior creditor is the approving class and that approval is used to cross-class cram down a more senior creditor class.
• The case leaves underfunded defined benefit pension schemes as one of the few remaining typical restructuring stakeholders yet to be crammed down – perhaps a more challenging stakeholder given the effect of the Pensions Scheme Act 2021, which potentially imposes liability on those who seek to restructure to the detriment of pensioners.
• The case highlights the difference between CVAs and restructuring plans – in a CVA HMRC could not have been subject to cram down as a CVA cannot bind secured and preferential creditors without their consent. (Of course, where HMRC does not rank as preferential creditor, liabilities owing to it can be part of a CVA process, as demonstrated by the football CVA cases such as HMRC v Portsmouth City Football Club Limited (in administration) and others [2010] EWHC 2013 (Ch).) Similarly, given that there is no ability to cross-class cram down in a scheme of arrangement, HMRC as class of its own could have blocked the restructuring. There is no such limitation in a restructuring plan, possibly making the use of the plan more attractive to companies.
• Whether the court would have exercised its discretion to sanction the restructuring plan in a situation where HMRC’s dividend uplift was even narrower is up for debate, though clearly would leave greater room for valuation disputes, if HMRC chose to engage in them. In such a situation, the scale of uplift for other creditors compared with that of HMRC’s may seem unfair given its position in the order of priorities. However, there is no set rule on this point and it will remain subject to the discretion of the court. While – unlike the US - there is no absolute priority rule (as expressly acknowledged by the court in this case), the court will clearly still focus on the order of priorities in the relevant alternative in determining whether the allocation of any restructuring surplus is fair and therefore whether to use its discretion to sanction a plan and utilise cross-class cram down.
• The case provides helpful precedent that confirms that, in the appropriate circumstances, cram down can be achieved through a class of creditors that fully consents to the restructuring voting in favour of the plan.
• The case is an example of how amendments to the rights of shareholders can be achieved through restructuring plans (here existing preference shares were converted into ordinary shares and diluted), which builds on the first case to include shareholders and amend their rights, which we acted on earlier this year (Re ED&F Man Holdings Limited [2022] EWHC 687 (Ch) - see our blog post here).
• The case reinforces a key message from Re Smile Telecoms Holdings Ltd [2022] EWHC 740 (see our blog post here): if a creditor wishes to challenge a plan, it must actively attend the hearing and submit evidence. It will not do to object from the sidelines. The outcome of this case may prompt HMRC to engage more with future plans, as for example the Financial Conduct Authority has done in relation to consumer credit schemes following similar observations by Zacaroli J in response to concerns it expressed by correspondence in Re Instant Cash Loans [2019] EWHC 2795 (Ch).
• The case showed that the court is willing to be pragmatic when it comes to SMEs accessing the restructuring plan given the level of valuation evidence is unlikely to be to the same level of sophistication as when larger companies access the restructuring plan.