As well as informal arrangements there are legal frameworks whereby all creditors are required to compromise liabilities if a majority agrees to do so. These can be invaluable in rescuing a company.
In this article Stuart Tait looks at formal mechanisms that require all creditors to support a restructuring that a majority have agreed to. They can be an invaluable tool for company survival.
The COVID pandemic and lockdown have left companies with liabilities from periods of restricted trade. This may leave otherwise profitable businesses with an overhang of legacy liabilities. The pandemic is just one example and companies may be feeling the impact a variety of issues, such as supply chain problems, labour supply or liabilities arising from discontinuation of certain business lines or adaption of the core business for new circumstances.
These liabilities should not be a millstone on a business. In relation to rental liabilities, the government introduced a framework to arbitrate between landlords and tenants to achieve an equitable allocation of losses ahead of landlords having the right to forfeit. For other creditors, a less formal approach has been taken. The key tool of creditor pressure, the winding up petition was heavily restricted during the height of the pandemic and while these restrictions have been relaxed somewhat, they have not returned to previous levels of use.
At the same time the government has introduced new tools to protect companies from creditor action while compromises are sought to balance the impact of losses suffered. These tools are now starting to be used as we return to business as usual and will give companies multiple options for dealing with creditors.
What tools are available when reaching agreements with creditors?
It will always be better to reach agreement with individual creditors. A consensual compromise will always be more cost effective and less risk of impact on trading relationships going forward. As such, this approach should always be prioritised.
However, it may not be possible to reach agreement with all creditors and it is not fair that the most supportive creditors should bear the pain while holdouts are not affected. Here there are a number of statutory tools to protect companies from creditor action and to impose a compromise on non-supportive creditors.
Protection will come primarily from the new statutory moratorium where a business is protected from creditor action while subject to oversight from professional monitors. This addresses one challenge faced by the restructuring tools below, which did not grant protection against creditor action during the period that the process was being undertaken. This alone however would not achieve a compromise of creditors which cram down dissenters.
The key tools for achieving creditor compromises are:
- Company Voluntary Arrangement or CVA
- Scheme of arrangement
- Restructuring Plan
- Pre-packaged administration
In this article we will give a brief overview of these tools then compare when each might be appropriate.
What is a Company Voluntary Arrangement (CVA )?
CVAs are probably the best known creditor compromise tool. They have had significant use in recent years in seeking to address rent liabilities, particular in the retail and casual dining sectors. A high profile example is Debenhams, which was challenged by landlords as being unfair, largely unsuccessfully although some modifications were made.
The key features of a CVA are:
- Compromise by a company with all of its unsecured creditors – a CVA cannot compromise secured creditors such as banks or preferential creditors. Preferential creditors were recently extended to include HMRC claims for VAT and PAYE which increases the relevance of this issue.
- All creditors vote together in a single class, approval of 75% by value of the creditors voting is required. Connected parties can vote but if more than 50% of unconnected creditors vote against, the proposal will fail.
- While all creditors are in a single class, there is no requirement to treat all creditors equally. Some creditors may have very limited compromises imposed on them, while others will have a more substantial impact on them.
- The CVA will proceed without court sanction unless a creditor seeks to oppose during a 28 day challenge period. Challenge can be on the basis of procedural irregularity or unfair prejudice, where the creditor is treated worse than they would be in the alternative scenario (typically insolvency) or where certain creditors have been treated unfairly compared with others.
To learn more about CVAs please read our article here.
What are Schemes of Arrangement?
A Scheme of Arrangement is similar to a CVA in that it allows a majority of creditors to impose a cram down on a dissenting minority. However there are differences in terms of the process required and the nature of creditors that can be compromised which mean that schemes have typically been used in the context of large scale financial restructurings, compared to the wider use of CVAs.
Key features of Schemes of Arrangement are:
- Compromise by company with specific class or classes of creditors. Does not need to be all creditors and the company can select who it wishes to compromise. Classes must comprise creditors with similar rights to be able to consider and vote together (eg secured and unsecured creditors would be separate classes).
- Unlike a CVA, a scheme can be used to compromise secured creditors.
- Approval threshold is 75% by value and 50% by number in each class voting. Multiple classes will mean that each class has a blocking right.
- Unlike CVA where courts not automatically involved, two court hearings are required. One hearing is required to approve class selection and convening creditor meetings; a second to sanction the scheme after creditor approval. This adds a layer of cost which has limited the usage of schemes to larger cases.
- Dissenting creditors can challenge the scheme at either hearing, class issues should be dealt with at convening while issues of fairness will be considered at sanction.
What is the Restructuring Plan?
The Restructuring Plan was introduced in mid-2020 as part of the government’s package of measures to assist businesses in dealing with the pandemic. This is a relatively new tool but has already seen use by well-known brands like Virgin Atlantic and Virgin Active. In some ways the Plan is a hybrid of the CVA and the Scheme, having the flexibility of the former and the ability to deal with secured creditors of the latter.
However, the Plan goes further and has the potential to become the leading restructuring tool across the large corporate and mid markets.
Key features of a Restructuring Plan are:
- It is similar to a Scheme, the company selects classes and each class votes with an approval threshold of 75% by value.
- Court hearings are required to convene the meetings and sanction the Plan.
- Unlike a Scheme however, approval of all classes is not required. Provided that one class with an economic interest has approved, the court can be asked to sanction on the basis that dissenting classes are not being treated worse than they would be in the alternative scenario. This requires evidence of financial distress and what the relevant alternative would be, but allows for differential treatment of different groups in the way CVAs have allowed.
What is a pre-pack administration?
A more radical tool for releasing a company from legacy liabilities where creditor agreement is not forthcoming is a pre-pack administration. We consider pre-packs in more detail elsewhere but in summary this allows a company in financial distress to dispose of assets to a purchaser through a sale by an insolvency practitioner.
Click here to read more about company administation.
The purchaser can elect what liabilities it wishes to discharge in order to preserve the value of the business and its trading relationships, while leaving behind legacy liabilities. While not strictly a creditor compromise we include this here as an alternative mechanism and one that can be used to prevail upon creditors to reach a consensual compromise.
Pre-packs are controversial tools and have been made subject to increased regulation. However, they remain an important and valuable tool in the arsenal of a company in financial distress to protect value in the business.
To read more about "pre-packaged" sales in administration, click here.
Comparison of CVAs, Schemes and Plans
We have touched upon some of the key similarities and differences between the three statutory compromise tools. Which is most appropriate will depend on the circumstances but some key considerations are:
- Cost – CVAs are well established and well understood in the market. The documentation is relatively simple to produce and there is no automatic right for court hearings. In most cases the CVA will be the most cost-effective tool to use. The Restructuring Plan is relatively new but there is a real push by the courts and the restructuring industry to broaden the use of this tool. This may lead quickly to the cost associated with a Restructuring Plan reducing, while it will have other benefits over a CVA.
- Secured and preferential creditors – while a CVA cannot deal with secured creditors, it will often be possible to link a CVA to a consensual restructuring of secured debt. Where this is not possible (eg where there is a broad and diverse secured creditor base) or where there are significant preferential creditors, a Restructuring Plan may be better.
- Challenge risk – landlords are showing an increasing willingness to challenge CVAs as unfair. This can introduce material uncertainty over an extended period of time while the challenge is heard, and can erode the cost advantage that a CVA has over a Plan. A Plan on the other hand is structured to deliver certainty more quickly and given the level of court oversight, expensive contested creditor challenges seem less likely.
Our Restructuring Advisory team have the required expertise and experience to assist you with restructuring challenges you may face. Please contact us if you would like to discuss any aspect of this article or series.