Houst Limited's (the Company) restructuring plan (under Part 26A of the Companies Act 2006) (RP) was recently sanctioned at the High Court on 22 July 2022.
- It is the first use of an RP to help secure the future of an SME business in distress (circa. £9 million in debt – as opposed to the tens / hundreds of millions of debt, which RP and schemes of arrangement had exclusively restructured until now). The Court took a pragmatic approach to the level of detail and sophistication required to fit the circumstances and situation of the company (the proposed RP administrators' report taking the form of an 'estimated outcome statement', supported by evidence schedules, a well understood mid-market tool), suggesting an RP can be more flexible and appropriate for SMEs than first envisaged.
- It is also significant as the first occasion that the RP procedure has included the cross-class cram-down (CCCD) of HMRC, the dissenting secondary preferential creditor in this case. HMRC voted against the RP, but were 'crammed across' by the Bank (Clydesdale Bank plc) as the anchor creditor (the Bank formed the impaired 'in-the-money' class for the purposes of providing the anchor to facilitate the use of the CCCD power).
- Where HMRC have a blocking stake in any CVA as secondary preferential (crown preference) creditors, they have no such veto power in a RP. HMRC nonetheless refused to engage with the process on the basis that they were, on a policy level, not prepared to voluntarily compromise their crown preference status. If the RP is seen as a way to rid a group of a tax burden in this way, HMRC will likely have to meaningfully engage in future to avoid this precedent becoming cemented.
- HMRC could in theory have negotiated a better deal with the Company and instead tried to cram across the Bank – but they did not engage, and the Bank gained an uplift in recoveries on the basis that this was what it negotiated. With HMRC’s support, the CCCD power could however have been exercised so as to impose a different RP on the Bank instead. HMRC could have chosen to directly influence the balance of power in the RP, in so far as HMRC here amounted to 75% or more in value of a class of creditors – an interesting position for the ‘Tax Man’. Albeit the Bank held fixed and floating security – raising the possibility that the Bank could have refused to vote in favour and threatened to enforce its security in the face of HMRC driving the RP in a certain direction (there was no lock-up agreement). This RP class voting dynamic, of financial creditor v. HMRC (who will become the anchor creditor?) will likely come to dominate the mid-market RP space.
- Following the sanction of this RP, the restructuring industry could see an increase in the use of the tool in the mid-market (combined perhaps with the CIGA 2020 debtor in possession creditor moratorium), where costs have been the obvious barrier to date (at the very least as a means to try to reduce HMRC tax burdens post-pandemic without the need to use a pre-packaged administration process to break the existing corporate and capital structure).
- The Background
Operating in eight countries and employing 300 people via independent contractors, Houst and its Group specialises in providing property management services for short-term and holiday lettings. Due to the pandemic it experienced a significant reduction in demand.
The group was cash flow and balance sheet insolvent, caused by the impact of the Covid-19 pandemic on the travel and hospitality industry. The group was unable to service its current loan obligations to its financial creditor (Clydesdale Bank plc). Further, three of its creditor classes (including HMRC, a previous landlord and a former call centre provider), had presented statutory demands and were threatening to issue winding-up petitions.
Crown preference returned on 1 December 2020, meaning that certain debts owed to HMRC are included in a category of preferential debt.
The RP’s objective was to provide a capital injection to return the group to solvency and allow it to continue to trade. This included a minimum £500,000 cash injection from shareholders immediately (in return for the issue of new shares, leading to a dilution of existing shares to 5% of their existing equity), followed by a further £250,000 to be paid over three years. The only alternative to the RP was a pre-pack administration, returning materially less value to creditors.
- The Law
Introduced via CIGA 2020 as a new Part 26A of the Companies Act 2006, an RP is an ‘arrangement or compromise’ between the company and its creditors or shareholders which is proposed to ‘eliminate, reduce or prevent, or mitigate the effect of any financial difficulties’ which the company has encountered or is likely to encounter, and will affect the company’s ability to carry on business as a going concern. If sanctioned by the court, an RP will be binding on both relevant secured and unsecured creditors.
The process to approve a restructuring plan involves an application to Court to summon a meeting of creditors or members (or classes of each), followed by a meeting and an application to Court to sanction the restructuring plan.
The RP must be passed by 75% or more in value of creditors (or class of creditors) or members (or class of members) present and voting of each such class. There is no numerosity requirement (a minimum number of creditors). Importantly, the RP allows for CCCD: which can occur where an RP is presented and even though one or more classes of creditors vote(s) against the RP, the court is willing to sanction the RP by seeing those creditors crammed down by the vote(s) of at least one class of in-the money but impaired (under the terms of the RP) creditors that votes for the RP. The CCCD procedure is only permitted where it is just and equitable for the court to sanction that cross-class procedure. In determining whether a class of creditors can be subject to CCCD, the court will consider the “relevant alternative” test. Here, the starting point will be the position the company would be in if the RP were not sanctioned (i.e. an immediate liquidation or pre-pack administration). This gives the court wide discretion as it sets a very low bar for the “no worse” off test under that relevant alternative, especially in relation to unsecured creditors, who in many cases, in a pre-pack administration or liquidation scenario would likely receive little or no recovery.
- The RP
The RP creditors were treated as follows (with our focus being on HMRC and the financial creditor):
- The Bank, as secured creditor (owed £2,800,000);
The Bank’s debt will be reduced to £750,000 from £2,800,000, of which £250,000 will be repaid within two weeks of the effective date, and the remainder repaid over three years (resulting in a dividend of approximately 27p/£). The Bank would have received a dividend of 7p/£ in the alternative pre-pack administration.
- HMRC, as secondary preferential (Crown Preference) creditor (owed £1,800,000):
The Company will make monthly contributions into certain funds, including a 'secondary preferential creditor payment fund': this would be funded at the rate of £12,000 per month for a year, and then £20,000 for a further two years. This will be used to fund a dividend payment to HMRC of 20p/£.
HMRC voted against the RP (despite the fact that they would gain more underneath it than in the relative alternative). The email position provided by HMRC in evidence is instructive as to the current rigidity of their policy following the re-introduction of Crown Preference – they will not agree to relinquish their preferential status:
“HMRC will not relinquish this status in order to provide a dividend to unsecured creditors. We appreciate that this may be problematic with regards to creditors of this category, and we understand that our dividend is likely to be less in liquidation. However, with the reinstatement of HMRC as a secondary preferential creditor at the end of 2020, this is a position we are not willing to compromise on and will insist this be honoured in all circumstances, regardless of whether this disadvantages unsecured creditors.”
HMRC could in theory have negotiated a better deal with the Company and instead tried to cram across the Bank – but they did not engage, and the Bank gained a negotiated uplift in recoveries. With HMRC’s support, the CCCD power could however have been exercised so as to impose a different RP on the Bank instead. HMRC could have chosen to directly influence the balance of power in the RP, in so far as HMRC here amounted to 75% or more in value of a class of creditors – an interesting position for the ‘Tax Man’.
In the alternative, HMRC would have recovered 15p/£. HMRC would have received the highest dividend in the pre-pack admin (versus the Bank's recovery of 7p/£). So, the RP materially deviated from the normal order of payment priority between creditors. The Court initially queried the acceptability of reversing the order of priority of payments to HMRC's disadvantage, and in favour of the Bank ("[t]his is not a case where the Company is dependent on the Bank to be able to continue trading".
Albeit the Bank held fixed and floating security – it is unclear as to why the Court did not raise the possibility in the alternative that the Bank could have refused to vote in favour and threatened to enforce its security in the face of HMRC driving the RP (there was no lock-up agreement).
However, the Court nonetheless sanctioned the RP despite HMRC's status as a preferential creditor effectively being stripped from it – this was because deviating from the normal order of priority of payment in a formal insolvency would not itself defeat an RP given that there is, by design, no ‘absolute priority rule’ in the RP process (which would have provided that, like in Chapter 11 in the USA, a dissenting senior creditor is always to be paid ahead of a dissenting junior creditor). To that end, the Court thought it relevant to take account of the source of the benefits to be created by the financial restructuring (e.g. whether they stem from current assets of the company or from injections of new money that wouldn’t arrive absent the sanction of the RP):
a) the restructuring was funded by capital injection by the new shareholders;
b) HMRC was viewed as "a sophisticated creditor" who had failed to formally oppose the RP. After the case of Re Smile Telecoms Holdings Ltd  EWHC 740: it now seems quite clear that if an impacted creditor wants to challenge an RP, they are required to attend the sanction hearing, submitting argument and evidence. Passive objection is not enough; and
c) HMRC still stood to receive an increased dividend if the RP was sanctioned than in the relevant alternative and, given there were no submissions from HMRC, the Court could assume HMRC preferred to recover more tax, not less.
- Trade creditors;
5p/£ for non-critical unsecured creditors (as opposed to 0p/£ in the relevant alternative)
- Convertible loan note holders; and
This class were given the option to convert their debt into pre-dilution equity or to instead participate in the cash dividend to unsecured creditors
- A connected company creditor (they would receive nothing).
- The Mid-Market RP: RP X Moratorium
The Houst Limited RP is proof of concept. However, costs remain undisclosed, and it remains to be seen whether this was a pyrrhic victory for the company side advisors and whether the normally significant fees can in reality be curtailed by a more 'commoditised' CVA-esque process.
There is not a definitive reason why RPs must always be expensive. RPs for SMEs, as the Houst RP shows, ought to be far simpler than those for larger companies comprised of complex cross-border capital and corporate structures. R3 (the Association of Business Recovery Professionals) is producing an RP precedent with SMEs in mind which goes to this point. An RP for an SME is also likely to involve fewer classes of creditors, perhaps only single classes of each of secured, preferential and unsecured creditors, enabling the process to be more efficient and faster. Whilst an RP formatted during a moratorium does involve the need to appoint a Monitor, in comparison, a CVA could in fact be costlier due to the need for both a Nominee and Supervisor. In addition, whilst the Court in Houst did delay sanction by a week to request certain further valuation detail from the Company, the Court took a pragmatic approach to the level of detail and sophistication required to fit the circumstances and situation of the company (the proposed RP administrators' report appeared to take the form of an 'estimated outcome statement', supported by schedules of evidence, a well understood mid-market tool), again suggesting an RP can be more flexible, and more appropriate for SMEs than first envisaged.
If this 'mid-market' RP model takes hold, there will undoubtedly evolve a practice of combining the RP with the new moratorium procedure introduced under CIGA2020, enabling additional time for the company (and its creditors) to prepare an RP. Albeit this was not required in Houst, down to effective management of what was a small stakeholder body in the context of a relatively simple RP. This is the moratorium procedure for companies needing protection from creditors whilst the company considers a rescue plan (e.g. and RP) designed to facilitate the rescue of the company (the entity itself) as a going concern.
The moratorium is initially 20 business days, but can be extended (not earlier than 15 business days in to the initial period) for a further 20 business days without creditor consent, or for up to one year with creditor consent or by way of Court application. It allows for a payment holiday for the majority of pre-moratorium debt, and the company will be protected from legal or enforcement action and actions by trade creditors or landlords (such as forfeiture). It doesn’t generally cover financial debt (debts or other liabilities arising under a financial services contract (including lending (and factoring and financing of commercial transactions) or financial leasing)), which must continue to be paid throughout.
Prior to the launch of the Houst RP, three of its creditor classes (including HMRC, a previous landlord and a former call centre provider) had presented statutory demands and were threatening to issue winding-up petitions. If the winding-up petitions had been presented, it would have been too late to use the 'out of court' filing process for the initiation of a CIGA2020 moratorium: the much more involved Court application process would have been required in order to stay the winding-up petitions and bridge towards the RP. Expect pre-emptive launches of the moratorium going forward in the mid-market RP space to try to stabilise the (perhaps less sophisticated) trade creditor body, and to help manage HMRC towards engagement with the RP.
Managing Associate, Restructuring