UK Restructuring Plan Update: One further sanctioned case, one giant step forward

A week is often described as a long time in politics, and so also (it seems) with the restructuring market.

Last week, we saw significant strides forward with:

1. the long-anticipated court judgment addressing the creditor challenge to New Look’s CVA (see our commentary of that decision);
2. the belated sanction of Smile Telecom’s Restructuring Plan (showing the increasing value of this UK process for cross-border businesses); and
3. the judgment of Mr Justice Snowden in Virgin Active – the first contested ‘showdown’ of the new Restructuring Plan, pitting the power of “cross class cramdown” by the plan companies against its dissenting creditors.

These decisions demonstrate that the UK Restructuring Plan process or “Super Scheme” is finding increasing favour, with a growing number of larger and mid-market companies and shareholders all seeking to engage this flexible process to implement a whole host of outcomes providing operational flexibility, breathing space and a balance sheet reset.

Virgin Active Unpacked: CVA or Restructuring Plan?

One of the major new features of the Restructuring Plan process (that we have considered previously in our market updates) is the likely use of the Restructuring Plan as a “One Stop Shop”.

The Virgin Active case demonstrates very clearly that a Restructuring Plan can enable a company to propose one process with multiple creditors, both secured and unsecured, to achieve operational improvements alongside changes to the balance sheet. The case shows that, if desired, a restructuring can be completed within the existing corporate group (offering significant structural and operational benefits) making such a process attractive for new money providers. Injecting “new money” as part of this process can buy control of the equity in the plan companies and the restructuring terms.

While the Company Voluntary Arrangement (CVA) process is a familiar mechanism for businesses seeking to address significant unsecured or property leasehold liabilities, a frequent issue with its commercial / legal viability is an inability to bind secured creditors (as well as certain potential voting and classification issues, given that all unsecured creditors will vote together in a CVA). Unlike a CVA, a Restructuring Plan can be commenced with:

1. both secured and unsecured creditors (and bind both these classes to the Plan’s outcome);
2. the ability to classify different creditors flexibly according to their existing and pro-offered new rights;
3. the potential for cross-class cramdown (where one assenting creditor class that is genuinely affected and approves the plan can cram down other classes where such creditors can demonstrably be shown to be “no worse off” in that outcome than in the relevant alternative);
4. the ability for a plan company as a debtor in possession to launch a process swiftly and rapidly in the face of actual or upcoming financial or anticipated financial difficulties.

In light of this, it is not surprising that we have seen the application and adaptation of a Restructuring Plan process to a business which would previously have sought to engage in a collective negotiating process with creditors and landlords through a CVA. Where the CVA may have had significant tail risk following launch (for example the risk of many months of dealing with challenge litigation and the associated uncertainty) or simply not been viable based on the voting parameters of the CVA itself – this “tail risk” is potentially cured or reallocated in a Restructuring Plan.

Key Aspects of the Virgin Active Judgment

The facts of the case are well ventilated, with the finances of Virgin Active and current earnings suffering significantly as a result of COVID-19 and health club and gym closures. This allowed the plan companies to access the new Restructuring Plan process on the basis that they had encountered - or were likely to encounter - financial difficulties that affect or could affect its ability to continue as a going concern.

What followed was the promulgation of a Restructuring Plan, following out of court discussions and bilateral negotiations with creditor landlords across its UK, European and Asia-Pacific businesses, by three companies within the Virgin Active group (the Plan Companies).

The plans sought to restructure the Plan Companies' liabilities owed to seven classes of creditors, in the following broad constituents:

• secured creditors;
• existing landlords, split into classes A to E; and
• general property creditors, such as those to whom guarantee liabilities were owed.

Based on their current and historic operational performance and future proposed treatment, the Plan Companies categorised their operational liabilities into different classes. This resulted in differential treatment in the existing leasehold portfolio in order to achieve an operational restructuring of those leasehold premises and make the UK business more sustainable.

This leasehold/operational restructuring was part of an interwoven financial restructure pursuant to which valuable concessions were also sought from the group’s secured financial creditors – paving the way for an agreement with the group’s existing shareholders to make available new money for the business.

Landlord creditors organised a formidable challenge, recognising early on that a Restructuring Plan would also have the following potential benefits for the Plan Companies:

1. the ability to seek an agreed and accelerated timetable to complete a restructuring based on the group’s anticipated liquidity profile (as the new money injection was conditional upon the success of the restructuring as a whole);
2. the ability to engage the “cross class cramdown” rules, subject to the satisfaction of the statutory protections set out in Section 901G of the Companies Act 2006 (and, therefore, for the restructuring outcome as a whole to be imposed by assenting creditors on dissenting creditors provided such creditors were, among other things, offered no worse terms than the most likely alternative outcome to the Restructuring Plans); and
3. the ability to attract new money into the business, albeit subject to conditions including the completion of the restructuring as a whole and the retention of 100% of the existing equity / control of the group.

Mr Justice Snowden found in favour of the Plan Companies, with the resulting effect that Virgin Active’s Restructuring Plan will be given legal effect and thus bind all affected creditors, notwithstanding that many of the Virgin Active Plan Companies’ proposed creditors voted against the individual treatment thereunder.

In considering the ability of the Court to sanction such a plan, using the cross-class cramdown provisions, and considering the fairness tests that the Court must be satisfied have been met, Mr Justice Snowden’s lengthy and detailed judgment essentially concluded that:

1. Each Plan Company had established that it had encountered financial difficulties that affected its ability to carry on business as a going concern and therefore the Part 26A eligibility conditions had been met.
2. That each plan should be considered as a genuine compromise or arrangement between the relevant Plan Company and certain of its creditors and that the purpose of such compromise was to eliminate, reduce or prevent, or mitigate the effect of, those financial difficulties.
3. On the facts and detailed evidence provided to the Court (and in the absence of detailed evidence from the objecting creditors as to any other relevant alternative) the relevant alternative to the Restructuring Plans would, in each case, be entry into administration followed by an accelerated sale of the businesses of the Plan Companies.
4. Given that the outcome of the creditors’ meetings had not satisfied the requisite statutory majorities in each class (i.e. 75%), if the plans were sanctioned and thereby imposed on dissenting creditor classes, that the treatment offered by the Plan Companies under the plans was sufficient to ensure that no member of a dissenting class would be any worse off than they would be in the relevant alternative.
5. The plans had been agreed by a number representing 75% in value of a class of creditors, present and voting of the Plan Companies, who would receive a payment, or have a genuine economic interest in the relevant alternative.
6. There should be no requirement imposed on a Plan Company seeking to promote a Restructuring Plan to necessarily market test the business and assets with a view to demonstrating the existence of a relevant alternative.
7. There were many similarities between schemes of arrangement pursuant to Part 26 of the Companies Act 2006, which ought to apply to Part 26A Restructuring Plans – including the approach on valuation, treatment of out-of-the-money creditors, and the court’s application of its discretion not to sanction a Part 26 scheme of arrangement and by analogy a Part 26A Restructuring Plan. The Court rejected the contention that there was more justification under a Part 26A Restructuring Plan than in a scheme of arrangement under Part 26 for the court to impose its own views of what is (or is not) “fair” or “just and equitable” – instead preferring to adopt the test outlined by Mr Justice Richards in Telewest in connection to fairness issues.

Lessons Learnt?

The fact that we now have a significant judgment handed down following adversarial arguments advanced by Virgin Active and its landlord creditors undoubtedly gives us some pointers as to how Restructuring Plans can and will be used, and who has control in a Super Scheme process.

It’s all about Valuation

The assessment of “genuine economic interest”, along with cross-class cram-down when that is in play, has put valuation at the heart of the court’s judicial scrutiny of any Restructuring Plan.

This also provides opportunities for competing valuations between classes of creditors who will likely have different interests in the outcome of such a valuation dispute. However a sustainable challenge on valuation will likely require creditors to adduce significant evidence to rebut the presumption that a plan company’s relevant alternative is the more likely outcome.

As Mr Justice Snowden remarked in his sanction judgment, the Court’s role is not to validate that a relevant alternative will occur, merely that such relevant alternative may be considered by the court as being “the most likely”. If creditors who are out of the money on a plan valuation metric wish to successfully challenge a cramdown then it is likely that they will need to demonstrate that there is either a genuine likelihood that someone will pay more (within a realistic and credible time period) or that there are multiple equally likely alternatives. As we move to a more “Chapter-11 lite” restructuring process, we may well see dissenting creditors propose alternative restructuring plans which may be part of the evidence that a plan company’s relevant alternative is not the most likely outcome.

Information is Key

The Court in Virgin Active accepted that more information to creditors is likely needed where valuation is in dispute. Companies and their advisors will need to consider this carefully in their planning phase to identify what information can supplement the typical suite of information contained in the Explanatory Statement, whilst balancing the need to protect commercially sensitive information. And the need for expert valuation testimony and estimated outcome statements will require report providers to consider the target audience upfront when such analyses are commissioned and be prepared “to show their workings”.

Court Attitude

The Court’s attitude to challenge in recent cases is instructive. Mr Justice Snowden remarked in Virgin Active that it would be “unfortunate” if the Part 26A process was subject to frequent adversarial and contested processes (the costs of which can be significant). To the extent that Restructuring Plans begin to follow a format which has been tested by the Courts on significant issues, we predict that many Restructuring Plans will follow the format of Part 26 schemes of arrangement (i.e. as being substantially unopposed). Even in cases where value is in the “eye of the beholder”, with the prospect of cross-class cram-down being used as a “hammer blow” on dissenting out-of-the-money creditors (who argue that value is breaking in their debt) the Court will continue to have a role in shaping the timeline for such contested situations. The Courts appear so far to have recognised that the amount of such time available must ultimately be as short or long as the plan company’s liquidity profile, and it remains to be seen whether future skirmishes between senior / junior creditor groups will bring with it the prospect of rescue financing being made available.

Restructuring Surplus/Control

The Court in Virgin Active heard extensive debate on the potential for a “restructuring surplus” and the fair allocation of such a restructuring surplus amongst creditors based on pari passu or other principles. What appears to be the case so far is that new money, and concessions of creditors who are perceived to be “in the money” have great weight in determining the application of such a restructuring surplus. By contrast, the votes of out-of-the-money classes (and their views as to the appropriate distribution of post-restructuring rights) have been given relatively little weight by the Court. Which of course brings us back to the age old question of (current) valuation and where it is breaking.

What’s Next?

Nearly a year since the enactment of the Corporate Insolvency and Governance Act (the Act) and the introduction of the Part 26A Restructuring Plan process, the Super Scheme is here to stay. Such process offers an additional powerful tool for companies facing difficulties that require a coordinated restructuring outcome.

We would suggest that the Restructuring Plan will continue to have a number of adaptations. Potential further areas of expansion are likely to include:

• Restructuring Plans proposed as a genuine and credible alternative to an accelerated or “pre-packaged” administration. In particular given changes to connected parties rules.
• Restructuring Plans following on from an administration process, or the planning by administrators for an exit that might include a Restructuring Plan to achieve their highest and best purpose objective of corporate rescue. Such a scenario may also provide support for the business in an interim period through the imposition of the administration moratorium.
• Greater usage of the Restructuring Plan as a means of effective “liability management”, similar to how Part 26 schemes of arrangement have been used.
• Increasing assessment by boards/companies/sponsors/new money providers/restructuring professionals of the potential benefits of the Restructuring Plan processes against other existing restructuring (and insolvency) processes.

Given the powerful provisions contained in the Act for dealing with both secured and unsecured creditors, creditor cram-downs and cram-ups, and notwithstanding the introduction of far reaching insolvency and restructuring reforms in other jurisdictions, the Restructuring Plan is a powerful new tool in the arsenal that will need to be considered as part of contingency and implementation planning for any restructuring. Given the experience of the English courts with CVAs, pre-packs and schemes and Restructuring Plans, the Restructuring Plan will prove increasingly popular for companies looking to promote and successfully implement a restructuring proposal with wide applicability as a genuine restructuring solution.