On 29 June 2023, Mr Justice Michael Green in the High Court sanctioned a Part 26A restructuring plan proposed by First Clubs Limited (Fitness First), a wholly owned subsidiary of Maddox Holdings Limited, notwithstanding challenges from certain opposing creditors.
The court relied on its cross-class cram down power to impose the plan on the five creditor classes who had voted against it. The dissenting classes comprised landlords of premises at which Fitness First operates its gyms. The judgment reaffirms the following principles that govern the court’s treatment of restructuring plans:
- the directors of a company, rather than the creditors, are usually best placed to identify the correct relevant alternative; and
- in determining whether to exercise its discretion to sanction a restructuring plan, the court will attribute little weight to the views of opposing creditors who are ‘out of the money’ in the relevant alternative.
Fitness First encountered significant financial difficulties in recent years, in large part caused by the pandemic and subsequent changes in consumer habits. The group had been kept afloat by funding from its shareholders in recent years by way of debt and equity. However, the most recent funding (provided by Ms Best, the indirect shareholder of 75.08% of the company) was made conditional on the company restructuring its liabilities by 30 June 2023.
The plan proposed to restructure Fitness’ First’s liabilities as follows:
- Secured Creditor: liabilities owing to Ms Best (amounting to approximately £18.7 million) to be paid in full, though repayment dates extended to 31 December 2028, combined with a three-year interest waiver and a cap on guarantee obligations.
- HMRC: VAT liability owing to HMRC, a secondary preferential creditor, to be paid in full over a five-month period.
- Landlords: divided into six classes under the plan according to the relevant sites’ profitability and contribution to the business (Class A, Class B1, Class B2, Class B3, Class C and Class D). No rent reduction in respect of Class A, but a switch to monthly payments, and 100% of rent arrears to be paid. For Class B1 to Class D landlords, all outstanding rent arrears to be released and discharged in return for a payment of 120% of estimated return in administration. Class B1 to Class D all to suffer varying rent reductions but given break rights.
- General property creditors and business rates creditors: liabilities to be compromised in full for payment of 120% of estimated return in administration. All business rates referable to 28 day period following restructuring effective date to be paid in full.
The plan did not include or affect the company’s shareholders who would retain their rights.
The plan received 100% approval by the secured creditor, HMRC and the Class A landlords, and 99% approval from the general property creditors and business rates creditors. The plan was opposed by a Class B1 landlord and separately by four Class B2 landlords.
Conditions for cross-class cram down
The court may sanction a restructuring plan notwithstanding that it has not been approved by at least 75% by value of those present and voting either in person or by proxy of each class of creditors provided that two conditions are met:
- Condition A: the court is satisfied that if the restructuring plan were to be sanctioned, none of the members of the dissenting class would be any worse off than they would be in the event of the relevant alternative (the ‘no worse off’ test); and
- Condition B: the plan has been approved by a number representing 75% in value of at least one class of creditors present and voting either in person or by proxy, who would receive payment, or have a genuine economic interest in the company, in the event of the relevant alternative.
It was uncontroversial that Condition B was met by the approving vote of the secured creditor class. The issue at stake was whether Condition A, the no worse off test, was met. Opposing landlords challenged the company’s proposition that the relevant alternative was an administration. They argued that the company had not proved that it could not have survived outside of an insolvency process and that it could continue to trade utilising a £1.5 million facility that was still available to it. The opposing landlords also suggested that Fitness First, together with Ms Best, had artificially generated the circumstances by requiring the approval of a plan by 30 June, forcing the court’s hand given the proximity of this date to the sanction hearing.
The court rejected these arguments and held that Fitness First had correctly identified the relevant alternative as an administration with an accelerated M&A process. The idea that Fitness First could tide itself over its peak cash shortfalls was “unsustainable on the facts”, and the decision to restructure was a commercially rational one. This being so, it was not unreasonable for Ms Best to provide new funding subject to a condition that the company restructure its liabilities.
In coming to this conclusion, the court reaffirmed the principle that the directors of the company, being advised by professional advisers, are normally in the best position to identify the relevant alternative. The court also found that recoveries for all creditors under the plan would be either greater or obtained quicker under the plan than in the relevant alternative. Therefore, the court was satisfied that the statutory conditions to binding a dissenting class were satisfied.
The court turned its attention to whether it should, as a matter of discretion, sanction the plan.
The dissenting landlords argued that the plan did not represent a fair distribution of the restructuring benefits because the parent company was excluded from the plan altogether, and one of the landlord’s guarantee claim against that parent was being compromised. The court rejected these arguments. It was for the secured creditor as economic owner of the business to determine how to divide up any value or potential future benefits.
In addition, while the courts’ jurisdiction to compromise third party guarantees is established, such releases are ordinarily granted to prevent so called ricochet claims, that is where the guarantor, once it has made a payment, seeks payment from the principal debtor. Here, the guarantee claim could not lead to a ricochet claim because the shareholders ‘claim against the company was already compromised by the plan However, as the shareholder had no material assets other than its shares in the company the court held that in the relevant alternative the shareholder would be highly likely enter into an insolvency process and any guarantee claims would have no value. The compromise of the guarantee was necessary to ensure the group was not at risk of an uncompromised claim against an insolvent parent, to avoid disruption to the services provided by the parent company, and to avoid undermining the basis on which the group was intended to operate post-restructuring.
In any event, according to unchallenged valuation evidence put forward by the company, the dissenting landlords were ‘out of the money’ and “have no real entitlement to share in the restructuring surplus”. This meant that little weight should be afforded to their views on whether the court should exercise its discretion to sanction the plan. The court also clarified that in determining whether a creditor is ‘out of the money’ for these purposes, it must be evaluated whether the creditor has any genuine economic interest in the company itself in the event of insolvency. The prospect of recovery from a third-party guarantor cannot affect whether a creditor is in the money vis-à-vis the company.
The judgment is helpful in addressing the discretionary factors that the court will take into account when deciding whether to exercise its statutory power to bind dissenting classes of creditors. Echoing the Virgin Active decision (see our previous blog post here), the court reaffirmed that ‘out of the money’ creditors are unable to sustain a complaint that the distribution of the restructuring surplus are unfair, and that therefore little weight can be attributed to their views at the discretion stage.
Interestingly, this contrasts from the decision in Nasmyth (see our previous blog post here) that even ‘out of the money’ stakeholders could have a legitimate interest in opposing a restructuring plan and the court was entitled to take such views into account at the discretion stage.
The decision also makes clear that while the courts’ jurisdiction to release third party claims often arises to prevent ricochet claims, this is not the only circumstance in which the court is able to release such claims. Here, given the court ruled that the guarantee claim would be worthless in the relevant alternative (as the shareholder itself would also be in an insolvency), no issues such as “guarantee stripping” arose – distinguishing this case from cases in the context of company voluntary arrangements such as Miss Sixty and Powerhouse.
The decision also clarifies the test for determining whether a creditor is ‘out of the money’ for the purpose of exercising discretion, explaining that prospective claims against third parties are irrelevant when making this assessment.