The much anticipated judgement of Mr Justice Snowden in relation to a restructuring plan proposal (the “Plans”) made by Virgin Active Holdings Limited, Virgin Active Limited and Virgin Active Health Clubs Limited (the “Plan Companies”) was handed down on 12 May 2021.
In another blow to landlords following the judgment in the New Look CVA challenge also handed down this week, and despite significant legal challenges raised at both the convening hearing (which ran for 2 days) and the sanction hearing (which also ran to 4.5 over the early May bank holiday weekend) by a group of landlords (the “Landlord Group”), the Plans have been sanctioned and are now effective.
Whilst companies may feel emboldened to pursue CVAs following the court’s decision in New Look, Restructuring Plans may well be the company’s only valid restructuring choice if landlords have sufficient voting power to vote down a CVA so this decision is really important.
On the basis of the court’s judgment in Virgin Active, restructuring plans may be the preferred route in any event given the benefit of greater certainty the court’s sanction can deliver to a company compared to a CVA.
Whilst, from an insolvency perspective, the result in Virgin Active was not entirely surprising given the legislation’s aim to give priority to economic value and to “rescue” businesses the combination of these judgments will have sent a chill down landlords’ spines.
At the convening hearing the judge held that the threshold conditions of section 901A were met on the basis there was clear evidence that the Plan Companies were distressed (in this case as a consequence of the financial impact of the Covid-19 pandemic); that the purpose of the Plans was to address those difficulties; and that the Plans contained sufficient “give and take” to amount to a compromise with the relevant creditors.
He also accepted the division of the creditors into seven basic classes (the “Plan Creditors”). Those being unsecured creditors - made up of the Landlord Classes A-E and the General Property Creditors; and groups of secured creditors owed significant debts under various senior facility agreements.
The bulk of the discussion however at this hearing was in relation to the provision of certain confidential information which the two groups of separately represented landlord companies argued should have been provided (as part of the explanatory statement to be issued with notice of the creditors’ meeting) and was required in order for the creditors to be able to fully understand the Plans and what they were being asked to vote on.
Whilst Mr Justice Snowden felt that the explanatory statement didn’t need to be amended he encouraged the parties to agree that some of the confidential information sought should be provided to the professional advisors of any creditors, subject to agreement of acceptable terms of confidentiality.
The plan meetings were held on 29 March 2021. At those meetings the Plans were approved by the Secured Creditors and the Class A Landlords but none of the other classes voted in favour of the Plans by the requisite majority, or at all.
Whilst this oversimplifies the detailed nature of the legal arguments made during the sanction hearing, as a result of the support of the Secured Creditors and the Class A Landlords voting in favour of the Plans, there were two issues to be decided: Issue 1. The “no worse off” test; and Issue 2. whether the court should exercise its discretion to sanction the Plans.
Issue 1. Arguments
The “no worse off” test requires the court to identify what the most likely outcome would be if the Plans were not sanctioned; determine what that outcome would mean for the dissenting classes; and then comparing that to the outcome for the dissenting classes under the Plans. It did not have to be shown that the alternative outcome would definitely occur or was more likely than not.
Understandably, therefore, there was a significant amount of witness evidence heard at the sanction hearing (ten statements from five witnesses for the Plan Companies and seven statements from two witnesses for the Landlord Group) with some of that evidence being heard in private to maintain confidentiality.
There was also “expert” evidence from both sides dealing with the relevant alternative and methodology, which ultimately the judge found supported the conclusion of the Plan Companies that this was a trading administration.
The focus of the arguments made by the Landlord Group was on the way in which that conclusion had been reached. In particular, that the approach was designed to elevate shareholders above other stakeholders and to deny landlords any “negotiating leverage”. This was evidenced, according to the Landlord Group, by the failure of the Plan Companies to have undertaken a competitive marketing/sales process as part of the testing of their conclusion that a trading administration was the relevant alternative, thus depriving themselves, and the creditors as a whole, of any other possible alternative.
The lack of information, or at least the failure of the Plan Companies to have allowed the unsecured creditors access to and as much time as the secured creditors to review any information, was another area of focus, with the contention made by the Landlord Group that both the process and the information were not sufficient to allow the court to consider and sanction the plan.
Issue 1. Decision
Mr Justice Snowden was critical of the apparent lack of urgency taken by the Landlord Group following the convening hearing to obtain the confidential information and their failure to have applied (as he directed they could and should) to the court if they felt any such information was lacking or to raise such issues at a pre-trial review which in fact they had agreed to vacate.
On the basis of the valuation evidence of the Plan Companies, and the witness evidence of the Landlord Group challenging that evidence, both rigorously tested by cross-examination, the judge concluded that it was appropriate and procedurally fair to proceed on the basis of the evidence before him. On that basis, he found that the relevant alternative was a trading administration as contended for by the Plan Companies. The judgment makes it clear that the court found the evidence of the Plan Companies’ experts was more persuasive, coupled with the fact there was no valuation report to counter it.
The judge also considered that the process undertaken by the Plan Companies and their advisors was sufficient and that there was no obligation to have undertaken a full market testing process, particularly where it was unclear how the Plan Companies might fund any such process and whether, in an uncertain market, this would be the correct approach. Therefore, reliance on the “desk-top” reports provided enough detail and certainty (both on valuation and non-valuation issues) to enable them to draw their conclusions as to the relevant alternative.
The judge also rejected a challenge by the Landlord Group to the Plan Companies’ evidence as to the likely outcomes for landlords in the relevant alternative, based on a report by Mason and Partners containing estimated rental values, on the basis that the Landlord Group could have produced its own evidence as to as to rental values to demonstrate they could get a better deal than in the relevant alternative, but had chosen not to.
The judge also rejected the argument that Class B landlords would be worse off in the relevant alternative on grounds that those landlords would be able to negotiate a better outcome in an administration than provided by the Plan, preferring the Plan Companies’ evidence as to the approach a Class B landlord would most likely take in an administration.
On that basis the judge concluded that if the Plans were sanctioned, creditors in a dissenting class would be no worse off than in the relevant alternative of administration (i.e. Class B-E Landlords) than under the Plans.
Issue 2. Arguments
Two related issues were the focus of legal argument in relation to this issue. Firstly, the treatment of creditors who are “out of the money” and secondly, the distribution of the “restructuring surplus” in light of the proposal that even the dissenting unsecured creditors would receive 120% of any estimated return under the relative alternative. The Plan Companies argued that this in itself should be sufficient to enable the Court to exercise its discretion and sanction the Plans.
The Landlord Group contended that simply satisfying the “no worse off” test shouldn’t mean that the Court automatically sanctioned the Plans.
Rather, the Landlord Group argued that because the Plans are designed to enable the Plan Companies to eventually trade profitably it is probable that the shares in those companies would increase in value giving substantial benefit to the shareholders who were to receive new equity. This was contrasted by the position in administration where their shares might be entirely worthless. The Landlord Group contended that it could not be fair, just or equitable for the restructuring surplus to be divided in this way where unsecured creditors, including the landlords, have enabled the survival of the Plan Companies as a result of releasing their claims under the Plans.
The Landlord Group also argued that they had been excluded from the negotiations as to the terms of the Plans and the provision of new money and that this should be a relevant consideration for the court in exercising its discretion.
There were also arguments made as to the level of votes cast, with the Plan Companies suggesting that the landlords had a different agenda as it was clear, they said, that voting in favour of the Plans was the most rational outcome from an economic perspective. The Landlord Group relied on the fact that the Plans were rejected by all of the Class B-E Landlords and a significant number of the General Property Creditors.
Issue 2. Decision
Whilst statute itself gives little guidance to the Court in exercising its discretion, Mr Justice Snowden confirmed that, as discussed in previous decisions (including his own) the power of the Court to exercise its discretion and “override the wishes of a class meeting, even if 100% of the class has voted against the plan” (i.e. the cross-class cram- down) is clear by the very nature of the power contemplated by the legislation .
Further, guidance as to how the discretion should be exercised is also provided by the explanatory notes that the Department of BEIS prepared in relation to the introduction of Part 26A so that the “cross-class cram down” can be used if the “no worse off” test has been met, subject to the court’s absolute discretion. That doesn’t mean that it should be and “The approach cannot be any less rigorous because one class has voted against a plan than where all classes have voted in favour”.
The judge considered that on the evidence the value “broke” with the Secured Creditors who, by reason of their security, would be entitled to the value of the business of the Plan Companies in the relevant alternative, where the unsecured creditors would not be entitled to anything other than the prescribed part. It was therefore for the Secured Creditors to determine what value they attributed to the new money provided by shareholders and consequently what their rights should be.
In his view therefore, and on the basis of the arguments raised by the Landlord Group who didn’t challenge the differing treatment of unsecured creditors, but objected rather to what they considered to be favourable treatment of the Shareholders, as the landlords would be out of the money their objections should carry no weight.
As to whether the landlords had been excluded, whilst they may not have been at the forefront of any considerations of the Plan Companies that wasn’t inappropriate and shouldn’t prevent the Court from sanctioning the Plans.
Additionally, the value attributable to the finance contributed to the Plan Companies by the shareholders far outweighed any benefit gained from the compromised claims of all of the Landlord Classes and the General Property Creditors.
The judge also considered whether the cross-class-cram down can be used in what is referred to as the horizontal comparison – i.e. where some creditors who would otherwise be “out of the money” are given some additional value under the plans but others are not. He found that on the facts of this case there was sound commercial rationale for any differential treatment, but made it clear that there could be scenarios where that was not the case such that the Court could decline to sanction any plan.
Mr Justice Snowden then finally turned to the voting. He noted that despite the large amount of evidence generally and the extensive submissions on this point there was no evidence from the Landlord Group as to why they voted against the Plans and accordingly he attributed little weight to the voting numbers of the dissenting classes given the overwhelming support of the Secured Creditors and Class A Landlords and of Class B Landlords of which 11 of 17 voted in favour.
Accordingly, the judge held that in all the circumstances he should exercise his discretion to sanction the Plans .
With other companies already making proposals for restructuring plans, and with the potential lifting of the various legislative restrictions currently protecting tenants at the end of next month, it is very likely that we have only seen the start of the rise of this new tool available to companies seeking to avoid insolvency.
It is clear that those creditors “in the money” are able to decide how the value of the business of the proposed plan company should be divided, including as against those creditors who are “out of the money”, which will be of major concern for landlords. This is a product of both the restructuring plan legislation and an extension of the case law on schemes of arrangement.
The key issue for landlords therefore, is to show that they are “in the money”, such that their interests should be properly included within any plan proposal and to ensure they are able to participate in the creditors’ meeting giving landlords the opportunity to vote against the plan if appropriate, even if the cross-class cram-down would then be relied upon. Evidence of that will need to be produced at the convening hearing stage to argue this where necessary and it will be critical for landlords to focus on it as soon as a plan is launched, so it has as much time as possible in what will be an extremely tight timetable. If landlords are excluded from the creditors’ meetings the company can avoid needing to satisfy the conditions for cross-class cram-down as a pre-requisite to the court’s sanction.
Any creditor will need compelling valuation evidence in order to challenge the evidence put forward by the plan companies, in relation to the relevant alternative and where the value breaks, as well as satisfying the “no worse off” test if cross-class cram-down is engaged.
Encouraged by this and the New Look decision, how far companies will now go in modifying leases remains to be seen. It is noticeable that the Virgin Active plans took on board many of the same principles (for example around break rights and market rent) as have been applied in CVAs. Whilst in New Look the modification of terms was not seen as a matter for the court, the judge did comment that terms need to be as fair as possible to landlords, otherwise landlords would choose to exercise their right to terminate. The same can be said for plans which go too far; landlords may vote with their feet.
Collaboration between landlords, as well as between landlords and their corporate tenants to try to achieve an acceptable consensus as part of any restructuring, is more important than ever as this might achieve an acceptable outcome, but could also be key to the evidence and resource necessary in any challenge.