Mr Justice Snowden’s recent judgment sanctioning the Virgin Active restructuring plans is significant for several reasons. Not only is it the first judgment to consider a challenge to the cram down power of the 2006 Companies Act, but it is only the third instance that the cross-class cram down mechanism has been used. It is also the first time it has been used to cram down classes of dissenting landlords.
The five-day sanction hearing at the High Court heard arguments around the tests which should be applied when considering whether to sanction a restructuring plan, as well as cross-examination of witnesses. It gives important guidance on how courts are likely to approach cram down in the restructuring plans that will follow in the future.
Background to the case
The Plans were designed by the three companies within Virgin Active (Plan Companies) to enable them to continue in existence and trade profitably by reducing the existing unsecured debt and the provision of new money. This also carried the possibility of the shares in the Plan Companies increasing in value from future trading, thereby potentially benefitting the shareholders.
The group’s leases were categorised into Classes A-E. All Class C-E leases were granted additional break rights to enable landlords to take back their properties.
However, an ad hoc group of landlords (AHG Landlords) argued that shareholders shouldn’t enjoy the possible benefits of the Plans and contended that a just and equitable division of the restructuring surplus would be equity to the landlords.
During the hearing, the Court considered the issue of unequal treatment potentially arising in relation to the Class A landlords and Excluded Creditors. The decisions for the treatment of those creditors and the commercial judgment underpinning them were not challenged by the AHG Landlords, and they didn’t question the differential treatment accorded to the Class B-E landlords and the general property creditors.
The Court acknowledged that there may be reasons to decline to exercise its discretion when sanctioning a plan discriminating between different classes of unsecured creditors. Nevertheless, it didn’t need to explore the boundaries of any such principle in this case.
In addition, when examining the differential treatment of the shareholders, the Court found that since the AHG Landlords would be out of the money, their objections to what the secured creditors had agreed with the Plan Companies in this respect carried no weight.
Important lessons for future restructurings
So, what can we learn from the Virgin Active situation? The Court’s approach to sanctioning a restructuring plan where one or more classes dissent is instructive for companies in similar situations in future:
- The proposed alternative scenario from the Plan Companies’ was not disputed when considering if Condition A for cram down (the ‘no worse off’ test) was needed. The Court accepted the Plan Companies’ evidence that, if the restructuring plans were to fail, they were most likely to enter administration followed by an accelerated business sale.
- There is no absolute obligation for market testing for a valuation and its use will depend on whether it is a practical necessity in the circumstances or likely to produce a reliable valuation.
- The Court emphasised the importance of not undermining the utility of Part 26A by lengthy valuation disputes, but also that the protection of dissenting creditors given by the ‘no worse off’ test must be preserved.
- In the absence of competing evidence being adduced by a party seeking to challenge the Plan Companies’ asserted likely outcomes, the Court is likely to accept the Plan Companies’ evidence.
- There is nothing inherently inappropriate with the shareholders providing new money, nor is it a requirement for the offer to advance new money to be made generally available to all creditors. It will depend on the facts and circumstances of each restructuring. In this instance, there was no competing evidence of an alternative solution or offer to provide new money from the AHG Landlords.
- At present, if Condition A (the ‘no worse off’ test) is satisfied, the Court seems likely to exercise its discretion to sanction, subject to any evidence about any collateral purpose of those voting in favour.
- Objections to the allocation of the restructuring surplus from a dissenting class that is ‘out of the money’ in the relevant alternative carry little or no weight.
- Where the battle is between equal ranking classes that are ‘in the money’, the Court is likely to look closely at two factors: whether the proposed compromise with the assenting class is a real compromise or a manipulation of the classes, and whether the dissenting class received a share of the enterprise’s value that was in some way proportionate to the compromise that they were being asked to make.
In finding against the AHG Landlords, the key factor in this case appears to be that the Court was satisfied that the dissenting landlords were out of the money in the relevant alternative.
In this regard, the Court noted that the business and assets in essence belong to creditors who would receive a distribution in the formal insolvency. It is up to the in the money creditors to determine how to divide up any of the restructuring surplus following the restructuring.
The Court also noted the frustration of the Plan Companies in trying to find a resolution with the landlords and their recognition that an alternative route such as a CVA may have resulted in the restructuring being blocked. In this regard, the Court didn’t consider that there was anything inappropriate in the Plan Companies choosing to utilise Part 26A rather than a CVA if it would more likely achieve the desired result of rescuing the companies in the interest of their stakeholders generally.
What next for cross-class cram downs?
Although not relevant in this case, the Court gave insight into the possible considerations where there are assenting and dissenting creditor classes which rank equally, and who would each be in the money in the relevant alternative. If this occurred, the Court would look closely at whether the proposed compromise with the assenting class was a real compromise, arrangement of their rights, or a manipulation of the classes.
It would also have to examine if the dissenting class received a share of the enterprise’s value preserved by the plan that was in some way proportionate or comparable to the compromise they were being asked to make. This latter requirement is likely to prove contentious in restructurings where the relevant alternative is not clear-cut.
The Plan Companies’ proposed relevant alternative scenario was not disputed in this instance. The Court accepted the Plan Companies’ evidence that, if the restructuring plans were to fail, they were most likely to enter into administration followed by an accelerated business sale. There may be future cases where there is a real possibility that the relevant alternative is a different restructuring proposal – however, this was not explored in the judgment.
In addition, the Court held that the landlords had no genuine economic interest in the relevant alternative to the Plans. In light of the dissenting landlord classes being out of the money, the Plan Companies could have relied on the disenfranchisement provision in section 901C(4) to publicise the Plans and compromise the landlords without inviting those classes to vote. This would have eliminated the need for cross-class cram down altogether.
Going forward, the Virgin Active judgment is likely to impact how restructuring plans are set out where the relevant alternative is insolvency, and any dissenting class is out of the money. In the money creditors appear to be in a strong position to drive through a restructuring with the company, without significant (if any) input from dissenting out of the money creditors.