Restructuring plans were binding on dissenting creditors
Back in September 2020, Virgin Atlantic made history when it was the first company to enter into a compromise with its creditors using the new restructuring plan introduced in response to the financial effects of the Covid-19 pandemic. Now another Virgin company has made legal history in a case where a restructuring plan was used to compromise the rights of dissenting creditors where the company could show that those creditors were ‘out of the money’.
A restructuring plan involves a compromise or arrangement between a company and its creditors or members or any class of those creditors or members.
A plan can only be proposed by a company that has encountered (or is likely to encounter) financial difficulties affecting its ability to carry on business as a going concern. The purpose of the compromise proposed by the plan must be to eliminate, reduce or prevent, or mitigate the effect of the financial difficulties.
Crucially, a plan can be imposed on a dissenting class of creditors – known as ‘cross-class cram down’ – provided that:
- they would be no worse off than in the ‘relevant alternative’ – that is, whatever the court considers would be most likely to happen if the plan was not sanctioned; and
- the plan has been approved by at least one class of creditors who would receive a payment, or have a genuine economic interest in the company, in the ‘relevant alternative’.
In Re Virgin Active Holdings Limited  EWHC 1246 the relevant restructuring plans proposed compromises with the secured lenders, landlords and general property creditors of the Virgin Active group. In particular:
- for the secured lenders, there was no reduction in the principal owed to them but, amongst other things, maturity dates were to be extended, interest payments were to be deferred and financial covenants were to be relaxed; and
- for the landlords, who were divided into five sub-classes, they were to be offered different commercial terms in respect of arrears arising during the pandemic and future rent payments depending on the company’s assessment of the sites’ profitability. In particular, some landlords would only be offered lower rents, a small payment relating to arrears (based on 20% above the minimal amount they could expect to receive in an administration) or the ability to exercise a new break clause.
At the class meetings, the restructuring plans were approved by the secured creditors and one class of the landlords. But they were rejected by all the other classes of landlords and also by the general property creditors.
The court then had to decide whether or not to sanction the restructuring plans, exercising the ‘cross-class cram down’ to impose the plans on the dissenting creditors.
The court found that, when considering the ‘cross-class cram down’, it first had to identify the ‘relevant alternative’ – that is, what the most likely outcome would be if the plans were not sanctioned. It then had to determine what that outcome would mean for the dissenting classes and compare that to the outcome for those classes under the proposed restructuring plans.
In this case, the court found that the ‘relevant alternative’ was a trading administration. It also found that the value of the companies ‘broke’ with the secured creditors – that is the secured creditors, because of their security, would be entitled to the value of the company in a trading administration and the unsecured creditors would not be entitled to anything other than the prescribed part. So the unsecured creditors would be ‘out of the money’ in the relevant alternative. When comparing this to their position under the restructuring plans, the dissenting classes would be no worse off under those plans.
The court then had to decide whether to exercise its discretion to sanction the plans and impose the cross-class cram down. The judge found that there was no automatic presumption that a plan would be approved where the relevant conditions for cross-class cram down existed. As the value broke in the secured debt, it was for those creditors to decide how to divide up any value created by the restructuring and the dissenting vote of creditors who are ‘out of the money should not weigh heavily in the court’s decision to exercise discretion and sanction the plans.
On the facts of this case, including that the dissenting landlords had not produced their own evidence as to estimated rental values and had not given any evidence as to why they had voted against the plans, the court sanctioned the plans.
This case was the first time the restructuring plan regime had been used to compromise the rights of landlords. Whilst it has become common for company voluntary arrangements (CVAs) to be used to compromise the liabilities of companies with significant property portfolios, the restructuring plan offers the advantage of the cross-class cram down to deal with dissenting classes who may otherwise be able to block a CVA.
This decision highlights that it is the ‘in the money’ creditors who control the division of the company’s value, including as against creditors who are ‘out of the money’. So, unlike in the present case, landlords will need to submit robust valuation evidence to show not only that they are ‘in the money’ but also that they would be worse off under the plan than in the relevant alternative. However, this could be challenging for landlords, who will need information from the company to prepare that valuation and alternative assessment. And it will also be costly for them to obtain expert valuations at a time when they may be receiving little or no rent.
Was the buyer’s notice of warranty claim valid?
The High Court has again considered a notice of warranty claim given by a buyer post-completion, holding in this case that the notice met the relatively low threshold set by the required clause and rejecting the sellers’ argument that the claims were within the buyer’s knowledge and therefore excluded.
In MDW Holdings Ltd v Norvill  EWHC 1135 (Ch) the buyer acquired a target company from three sellers for around £3.5m. The target carried on a waste management business, which processed and disposed of various different kinds of wet waste.
In order to operate the business the target had been granted a consent to discharge trade effluent by Dwr Cymru Welsh Water (DCWW). That discharge consent was subject to various conditions including in relation to ongoing monitoring and record maintenance, and limits on the permitted levels of various substances in the discharged effluent.
As part of the sale process the buyer conducted a due diligence investigation which included various environmental due diligence enquiries. In their responses to those enquiries, the sellers stated amongst other things that “there are no outstanding investigations, enquiries, prosecution or enforcement actions” affecting the target and there was no enforcement action, conviction or pollution incident. When asked about “discharge consents, monitoring data and any breaches” and “Welsh Water sampling results”, the sellers responded to say they were “currently reviewing consent levels as Welsh Water agree they are too low”.
In fact, for over two years before completion the target had been involved in correspondence with DCWW in relation to breaches of its discharge consent and the provision of false data to DCWW. DCWW required remedial action to be taken by the target and an improvement plan had been agreed. However, sampling of the target’s waste continued to show that the levels of restricted contaminants were still well above the permitted thresholds and, as a result, DCWW had threatened prosecution of the target.
But none of the correspondence between the target and DCWW concerning breaches of the target’s discharge consent was disclosed to the buyer.
When the buyer subsequently brought a claim against the sellers for breach of the environmental warranties contained in the sale agreement, the court was asked to decide various issues including:
- The disclosure issue: had the sellers disclosed the relevant matters giving rise to the breaches of warranty to the buyer in the disclosure letter? The disclosure letter contained a letter which appeared to show a breach of consent caused by a pump malfunction. But the judge said that letter did not constitute disclosure of the history of non-compliance, or the provision of false data to DCWW, or the warnings of the possibility of prosecution. So it did not exonerate the sellers from liability for breach of warranty.
- The notice issue: did the buyer’s notice of its warranty claim contain the information required by the agreement? The agreement said that a notice had to summarise “the nature of the Claim (in so far as it is known to the Buyer) and, so far as is reasonably practicable, the amount claimed…”. Here, the judge noted that “every notification clause turns on its own individual wording”. In this case, he found that the notification requirement in the agreement set a low threshold. There was no requirement to set out the specific grounds of the claim, or reasonable detail of the matters giving rise to the breach or how the amount claimed had been calculated. The judge found that the buyer had given notice of its claim. The buyer had stated a figure for the amount claimed in its initial letter which had then been revised in a subsequent letter. The buyer had also made it clear that what was being claimed was the reduction in value of the target’s shares caused by the relevant breaches of warranty. Having regard to the available evidence the judge found that, as required by the agreement, the buyer had indeed summarised the amount claimed so far as was reasonably practicable at the time.
- The timing issue: was the buyer’s claim time-barred? The agreement contained a contractual limitation under which notice of a warranty claim had to be given to the sellers within two years of completion. But it also provided that this limitation (and the others in the agreement) would not apply where the relevant claim was caused by the “dishonesty, fraud, wilful misconduct or wilful concealment of the sellers”. The judge said that if he was wrong on the notice issue referred to above, it would not matter as the breaches of warranty had arisen out of the fraud, dishonesty and wilful concealment of the sellers. This meant that the various contractual limitations, including the requirement to give notice within two years and the requirements as to the content of that notice, did not apply.
- The knowledge issue: was the buyer unable to claim because it already knew about the relevant matters? The agreement said the sellers were not liable for a claim where the buyer had actual knowledge of the relevant matter or circumstance giving rise to the claim and went on to name seven individuals whose knowledge was imputed to the buyer for this purpose. The judge said that although one of the individuals named in the agreement had some knowledge of historic “one-off” breaches by the target, she did not know about a number of key matters, including that the breaches were ongoing right up to completion, that the discharge consent was likely to be revoked, that DCWW had made a threat of prosecution and that the target had repeatedly and deliberately given false data to DCWW to conceal the extent of its breaches of the discharge consent. Accordingly, the buyer’s knowledge did not prevent it from bringing a claim.
As a result, the court found the sellers were liable for the various breaches of warranty and were unable to rely on the contractual defences which they had put forward.
This case is a useful analysis of the practical operation of various contractual limitations commonly included in sale agreements. It is a reminder that the facts of a case must be viewed against the specific language used in the relevant agreement so that, for example, a notice meeting the relatively low requirements of the clause in this case may not be sufficient to comply with stricter requirements set out in a notification clause in another agreement.
Post-Brexit changes to UK market abuse regime
The Financial Services Act 2021 (FSA2021) received Royal Assent on 29 April 2021. This is the first piece of primary legislation relating to financial services to be passed since the UK left the EU. Amongst other things it makes certain changes to the UK’s retained version (UK MAR) of the EU Market Abuse regime (EU MAR).
Changes introduced by FSA2021 include:
- Notifying the market of transactions by PDMRs: EU MAR required “persons discharging managerial responsibilities” (PDMRs) and “persons closely associated” with them to notify both the company and the FCA of their transactions in the company’s securities within three business days of the transaction. The company is also required to notify any such transaction to the market within the same timescale – i.e. within three business days of the transaction taking place. This can be a difficult obligation for the company to satisfy if, for example, it only receives notice from the PDMR late on the third business day. So FSA2021 will amend UK MAR so that the notification by the company must instead be made within two “working days” of receiving notification from the PDMR. “Working days” for this purpose excludes bank holidays in England and Wales. This change will come into force on 29 June 2021.
- Maintaining insider lists: EU MAR provides that insider lists (i.e. lists of all those persons with inside information relating to a company) must be maintained by all listed companies “or any person acting on their behalf or on their account”. This led to some confusion about exactly who had to maintain a list: could it be done either by the company or someone acting for them, or did they each have to maintain their own list? The FSA2021 will amend UK MAR to clarify that both listed companies and those acting on their behalf or account must maintain insider lists. Again, this change will come into force on 29 June 2021.
- Increased criminal penalties: FSA2021 has also increased the maximum terms of imprisonment for certain criminal market abuse offences. The current penalty for insider dealing is a maximum of seven years. However, this is less than the maximum sentence for fraud (10 years) which is considered a comparable economic crime. This led to concerns that insider dealing could be perceived as a lesser offence, thereby increasing the likelihood of market abuse. So FSA2021 will increase the maximum sentence for insider dealing to 10 years to put it on an equivalent footing with fraud. For similar reasons, the maximum sentence for market manipulation will also be increased from seven to 10 years. A date for when these changes will come into force has not yet been set.
These are the first post-Brexit changes to the UK’s financial services regime. Whilst they are not particularly significant, they mark the beginning of a divergence between the UK and the EU when it comes to market abuse with the UK acting to “fix” perceived defects in the EU regime.
*Article first published in Accountancy Daily