The recent sanction judgment gives important guidance on the way in which the court's discretion should be exercised when sanctioning a restructuring plan and considers whether it is necessary for opposing parties to provide valuation evidence of their own. 

Key takeaways from the judgment

No worse off test: expert evidence

• An opposing party is not required to produce its own expert evidence to raise a successful challenge to the valuation analysis put forward by the company proposing a plan. Given the likelihood of valuation disputes, proposers of plans will therefore need to consider the justification of assumptions made in valuation reports in detail to ensure the court can be satisfied, even if no alternative is put forward.  

Fairness: the distribution of the restructuring surplus

• The company should consider offering a share of any upside that there might be following the implementation of the restructuring plan to the in the money creditors (the restructuring surplus). 

Critical creditors

• The court was satisfied that the company should be free to decide who the critical creditors should be

The High Court has declined to sanction the Great Annual Savings Company restructuring plan (“GAS Plan”). This follows the rejection of a restructuring plan proposed by a company called Nasmyth. These are the first two cases in which the UK tax authority has taken an active role in opposing restructuring plans. Whilst the decision in Houst opened the door for SMEs to access this flexible tool and avoid formal insolvency by using the discretionary power to cram down HMRC, it seems the Court is exercising caution when considering whether to cram down HMRC and is likely to take into account the preferential status of HMRC in considering restructuring plans.

Whilst the decision is a disappointment to the Company, a number of the issues debated in the case will help the market more generally in advancing our understanding of this developing area of jurisprudence, especially in relation to how restructuring plans can (or cannot) be applied to SME trading entities.

The GAS Plan was the first “self-funding” plan which has been proposed – it did not require any new money to be injected into the company as it was expected to trade itself out of its difficulties in the event that the GAS Plan was implemented. At the meetings, the proposed plan received 100% support in 12 of the creditor classes, including three of the four “in the money” creditors. Those opposed were HMRC as an “in the money” creditor and certain other energy suppliers who were “out of the money”.

“No Worse Off” Test

A key issue of dispute between the parties was whether the court could be satisfied that none of the dissenting creditors would be any worse off under the proposed plan than they would otherwise be in the “relevant alternative” (i.e. the most likely scenario in the event the plan is not sanctioned) otherwise known as the “no worse off” test. 

In cases such as this one, where the relevant alternative involved an immediate insolvency process, disputes between stakeholders often focus on the appropriate value to ascribe to assets and liabilities in that insolvency process.   

In Re Smile Telecoms Holdings Ltd Snowden LJ was clear that a creditor wishing to oppose a plan based on a contention that the company’s valuation evidence as to the outcome for creditors in the relevant alternative was wrong should file expert evidence of its own. 

The relevant alternative provided HMRC with somewhere between nil and 4.7p/£ compared with 9.1p/£ under the GAS Plan. The position under the plan therefore was almost 100% better than that of the best-case scenario in an administration.

The court considered that its function in considering a restructuring plan is to scrutinise the company’s proposals which must include the possibility of scrutinising the valuation figures to determine whether the burden of proof is made out i.e. that on the balance of probabilities the dissenting creditor would be no worse off under the plan than under the relevant alternative.  

In a departure from previous scheme and restructuring plan case law, the court gave limited weight to the experience and expertise of both Cerberus Receivables Management Limited (CRM) and FRP Advisory Limited in the context of insolvency recoveries of similar energy brokers and to the examples provided to the court of the progress reports of administrations of such similar businesses.

Even accepting that HMRC may recover more or less in the relevant alternative, the court was not satisfied on the evidence provided by the company that HMRC would be no worse off under the GAS Plan and therefore the “no worse off” test was not satisfied.

Fairness/ Restructuring surplus

The main area for dispute in relation to the GAS Plan was the way in which the court must consider whether the plan is a fair one which a creditor could reasonably approve. The appropriate question is whether the plan provides a fair distribution of the benefits generated by the plan. 

Given the lack of cases to date, the court considered this question by reference to two academic articles[1] and particularly took into consideration: 

1. the existing rights of the creditors and thus how they would fall to be treated in the relevant alternative; 
2. what additional contributions they are expected to make to the success of the plan – and in particular whether they are taking on additional risk by making available “new money”; and 
3. if they are disadvantaged under the plan as compared to the relevant alternative, then whether the difference in treatment is justified.

The court also considered how creditors would fall to be treated in the relevant alternative.

In the present case, of the 15 creditor classes, only 4 were in the money, and of those, the major creditors were the Secured Creditor and HMRC. The Judge considered the interests of the Secured Creditor and HMRC should have been at the forefront of the distribution of the surplus. He said: 

“It is principally for them to determine how to divide up any value or potential future benefits which might be generated following implementation of the Plan.”

Without engagement from those parties, companies will struggle to attain the correct balance.

The key consideration was therefore who are the beneficiaries of the intended future growth and value creation. On a simplistic view under the proposed structure HMRC would receive a fixed compromise payment and the Secured Creditor could potentially be paid in full (depending on the future success of the business). However, the payment in full may never happen. Such risk was fundamentally predicated on the future success of the company. Nevertheless, the court took the view that the exclusion of HMRC from any share in the future benefits was unfair.

Conclusion

It would certainly seem the court will think very hard about whether to cram down HMRC in a restructuring plan, particularly where the debt is significant and where there is no potential for HMRC to share any benefits following implementation. Every case will depend on its own facts, however, this judgment is helpful in bringing further clarification to certain elements of the restructuring plan jurisdiction as it develops, namely

• the importance of supporting the assumptions made in the valuations in relation to the “no worse off test” and
• making sure that any significant in the money creditors share in some of the upside when considering the issue of fairness/discretion.  

As the plan was not sanctioned, Administrators have been appointed to the company.

Resource

1 - Dr Riz Mokal (“The Two Conditions for Part 26A Cram Down” (2020) 11 JIBL 730, and “The Court’s Discretion in Relation to the Pt 216A Cram Down” (2021) 1 JIBL 12), and by Professor Sarah Paterson of the London School of Economics “Judicial Discretion in Part 26A Restructuring Plan Procedures” (January 24, 2022), available here.