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Unfair prejudice and the ‘No worse off’ test – CVAs and Restructuring plans compared

After a flurry of recent decisions arising from clashes between three distressed high profile companies and their landlords, we reflect on the areas of dispute and the similar but distinct tests considered by the court in CVAs and the new restructuring plans respectively.

CVAs

Under section 6 of the Insolvency Act 1986 (IA86) creditors may challenge company voluntary arrangements (CVAs) on two grounds, namely where:

  1. the CVA unfairly prejudices the interests of a creditor, member or contributory of the company; and/or
  2. there has been some material irregularity at the meeting of the company or in relation to the relevant qualifying decision procedure.

Whether or not a CVA unfairly prejudices the interests of creditors has been the subject of a number of recent cases involving challenges to CVAs, particularly by landlords, including those in relation to New Look, Debenhams and Regis.

In assessing whether a CVA is unfair, the court will consider at a number of factors including:

  1. Whether or not there has been different treatment of classes of creditors;
  2. If there has been different treatment of classes of creditors, whether there is any prejudice caused by the treatment, as between the classes of creditors, and to what extent the different treatment can be justified;
  3. To what extent the outcome for creditors under the CVA would differ under a different arrangement, such as liquidation or administration;
  4. Whether the CVA infringes the IA86 requirements for preferential debts to be paid before unsecured debts;
  5. Whether there is a fair allocation of the assets available between secured and unsecured creditors;
  6. Whether other creditors in the same position as those objecting approved the CVA; and
  7. In the case of landlords, whether they are offered the option to terminate the lease and the extent of the modification proposed to the lease.

In the New Look, which involved a challenge to the CVA by a number of the compromised landlords, Zacaroli J found that the CVA did not unfairly prejudice the landlords’ interests; they would have been worse off in an administration of the company and the differential treatment of the landlords was justifiable as they were given the option to terminate their leases if they did not wish to accept the reduced rent under the CVA, which the judge noted was an option for the compromised landlords “to get off the bus”.

Shortly after the New Look decision was circulated, the same judge handed down his considerations as to the challenge to the Regis CVA by its compromised landlords.  By contrast to New Look (which remains subject to the CVA), the Regis challenge was more academic as its CVA had already been terminated when it entered administration in October 2019. Regis’ landlords claimed both unfair prejudice and material irregularity and sought that the nominees and supervisors of the CVA repay their fees to the company. The judge dismissed the majority of the landlords’ claims and declined to make an order that the nominees/supervisors repay their fees. The judge did however revoke the CVA on the basis that the treatment of a specific creditor as critical (resulting in that creditor being paid in full), in circumstances where there was insufficient evidence to justify that treatment, was unfairly prejudicial and found that the nominee had on that occasion “fallen below the standard required of a nominee”. However this single finding alone was insufficient to justify any order as to the repayment of the nominees’ fees.

Restructuring Plans

The Corporate Insolvency and Governance Act 2020 introduced the restructuring plan as a new insolvency tool. There is no direct equivalent to the ‘unfairness’ test which the court is required to consider when sanctioning a restructuring plan, however the court must consider whether it is just and equitable to sanction any plan.   Additionally, in cases where not all affected classes have agreed to the plan, the court has a  discretion to sanction a restructuring plan and impose it on dissenting classes (known as a ‘cross class cram down’) where it is satisfied that no creditors in a dissenting class would not be any worse off than they would be under the ‘relevant alternative’ – being whatever the court considers would be most likely to occur in relation to the company if the plan were not sanctioned.

When sanctioning the DeepOcean restructuring plan, the first plan to consider the use of cross class cram down, Trower J made several references to the court considering whether a plan was ‘just and equitable’ when considering whether to sanction the plan and set out the considerations which the court ought to have regard to.

Subsequently the Virgin Active restructuring plan, proposed in early 2021, was voted against by certain landlords and in certain classes of landlords the voting threshold of 75% was not met. When considering whether to nevertheless sanction the plan, Snowdon J considered the DeepOcean judgment, noting that there was no requirement in the legislation for the court to impose its own view on what is ‘just and equitable’ or ‘fair’. Instead, Snowdon J focused on considering the position if the plan were not sanctioned and the outcomes in the relevant alternative, which in the case of Virgin Active was found to be a trading administration, and concluded that the dissenting landlords would not be worse off under the plan than they would be in the hypothetical administration. Further, the dissenting landlords had not produced any financial evidence to suggest that they would achieve a better outcome in any relative alternative.

Comment

In light of the sensitive balance to be struck between affecting certain creditors’ rights against their wishes, and achieving a viable business rescue and restructure, when advising companies proposing CVAs or restructuring plans, insolvency professionals will as ever need to give careful consideration to how each class of creditor is classified and, more importantly, to the justification for treating some more favourably than others.  

The restructuring plan has already gained significant traction since its introduction last year and the advantage of the cross class cram down mechanism to impose a plan even where creditors (such as landlords) oppose it demonstrates its flexibility.  Its popularity in restructuring leasehold liabilities is set to increase, though the very detailed analysis required for the court to consider plans will mean that the costs may be disproportionate in all but the biggest cases – leaving the CVA the restructuring tool of choice for the majority, and an ongoing power struggle between tenants and landlords.  It is notable though that permission to appeal the New Look decision was granted so landlords may yet claw back some ground – watch this space…

For further information on this article, please contact Cathryn Butler, Amy Gallimore or another member of our Restructuring & Insolvency team.

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