On 22 July 2022, judgment was handed down in relation to the sanction of the first Part 26A restructuring plan to be proposed by a small–medium enterprise (SME) in Re Houst Limited  EWHC 1941 (Ch). The restructuring plan (RP) procedure set out in Part 26A of the Companies Act 2006 (CA 2006) has been widely considered to be out of the reach of SMEs due to excessive cost. The decision is also an interesting one for other reasons, notably the cram-down of HMRC as a dissenting creditor.
As HMRC’s status as a secondary preferential creditor (since the reintroduction of Crown preference in December 2020) renders it able to effectively veto any CVA which seeks to compromise its rights in relation to its preferential claims, the decision in Houst Limited may well open the door to increased use of Part 26A restructuring plans for this purpose.
Background to the proposals
Houst Limited (the company) is a property management company offering services for short term/holiday lets. After two years of severe disruption due to Covid the company was both cash flow and balance sheet insolvent. The most likely alternative if the proposed RP did not succeed was a pre-pack administration sale (the relevant alternative).
In the relevant alternative, the only creditors who would receive any recovery were Clydesdale Bank (the bank), which held fixed and floating security over the company’s assets, and HMRC as secondary preferential creditor. The bank would be likely to receive a dividend of seven pence in the pound, while HMRC would recover around 15 pence in the pound.
The plan and the class meetings
The proposed plan (the plan) would see the company issuing new preference shares, thus diluting the existing shareholding, in return for a capital injection from certain shareholders. This capital injection would enable repayment of part of the restructured debt due to the bank, as well as providing the liquidity necessary for the company to keep trading and generate funds to pay enhanced dividends to HMRC and unsecured creditors. Liabilities to customers, critical suppliers and employees would be excluded from the plan and paid in full.
Six class meetings were convened to vote on the plan as follows:
- the secured creditor (the bank), which would see its debt reduced under the plan, resulting in a dividend of approximately 27 pence in the pound
- the secondary preferential creditor (HMRC), who would receive a dividend of 20 pence in the pound under the plan
- trade creditors, who would receive a dividend of five pence in the pound
- holders of convertible loan notes, who were given the option to either convert their debt into pre-dilution equity, or participate in the unsecured creditor dividend of 5%
- a single connected party creditor, who would receive no payment under the plan
- the company’s shareholders
At the creditors’ meetings, the plan was approved by the requisite majority (75% by value) of all classes except for the secondary preferential creditor class, in which HMRC, the sole member of the class, voted against.
The sanction decision
Section 901G of CA 2006 gives the court power to “cram-down” a dissenting class, and sanction an RP, in certain circumstances. To exercise this power the court must be satisfied, firstly, that the members of the dissenting class would be no worse off under the plan than in the event of the relevant alternative (condition A) and secondly, that the plan has been approved by the requisite number of creditors voting in any class that would receive a payment, or have a genuine economic interest in the company, in the relevant alternative (condition B).
Where these conditions are satisfied, the court must also be satisfied that in all the circumstances it should exercise its discretion to sanction the plan.
In this case, the evidence showed that HMRC would be likely to receive a greater dividend in the plan – a fixed sum of 20 pence in the pound – than in the relevant alternative. Condition A was therefore satisfied. Condition B was satisfied as the bank, the sole creditor which would receive a payment or have an economic interest in the relevant alternative, had voted in favour.
As the section 901G conditions were satisfied, Mr Justice Zacaroli turned to a consideration of whether the plan was one which the court should sanction. In particular, the judge noted that an “important factor”, particularly when exercising the cross-class cram-down power, was to consider whether the plan offered “a fair distribution of the benefits of the restructuring” – sometimes referred to as the “restructuring surplus”. Key factors taken into account by the court included the following:
- The order of priority applicable in the relevant alternative was not reflected in the plan. However, the judge noted that there is no absolute priority rule in Part 26A which would prevent any junior creditor from recovering until a senior class has recovered in full.
- The payment in full of critical creditors was justified on the basis that without paying those creditors, the company would be unable to trade and therefore unable to generate revenue to pay the increased dividend. It was also important to offer unsecured creditors a better outcome than in the relevant alternative to support ongoing relations with them.
- The new value generated in the plan came principally from the capital injection by the members, rather than existing assets. This was not “a case where assets that would have been available in the administration of the company are being applied in a manner inconsistent with the order of priorities applicable in that administration.”
- The only creditor disadvantaged by the plan was HMRC, a sophisticated creditor who did not attend the hearing or mount any active opposition. Their vote against the plan appeared to be motivated by general policy rather than the specific circumstances of the plan and indeed they had apparently conceded that they would be better off under the plan.
The evidence presented to the court showed that all creditors, including HMRC, would be better off under the plan, and the judge was therefore prepared to exercise his discretion to sanction the plan.
The decision in this case was particularly interesting for the discussion of the distribution of the “restructuring surplus”, and for the confirmation that departure from the priorities in the relevant alternative will not necessarily be fatal to the sanction of an RP, where such departure can be justified.
The case is also illuminating as regards the position which HMRC will adopt in relation to any restructuring which seeks to affect its position as secondary preferential creditor. Despite acknowledging that it would be better off under the plan, HMRC stated in an email that it will not in any circumstances compromise its position as secondary preferential creditor in order to provide a dividend to unsecured creditors. It will be interesting to see if HMRC re-visits how it responds to restructuring proposals in light of the Houst case. What seems clear is that if a creditor wishes to challenge a plan, it needs to attend the hearing and submit evidence supporting its position. Time will tell if we start to see HMRC engaging more actively with restructuring proposals in much the same way as we are now seeing with the Financial Conduct Authority in relation to consumer credit schemes.
The success of this plan will hopefully embolden advisors to SMEs to view the RP as a genuine alternative to the CVA. The Interim Report on the Corporate Insolvency and Governance Act 2020 (published in March 2022) focused on the perceived excessive costs of the RP limiting its accessibility to SMEs. The fear to date has been that it is uneconomic for SMEs to launch RPs, due to the high costs involved in producing the RP documentation itself, the two court hearings required, the need to produce detailed valuation evidence and the associated costs of engaging senior counsel.
But there are moves afoot to make the process more accessible. For example, R3 (the Association of Business Recovery Professionals) are reported to be in the course of preparing an RP precedent for SMEs. The Houst case illustrates that the court is open to being pragmatic as to the level of valuation evidence required from SMEs. As to those who fear a lack of time to launch an RP, it is possible to combine it with the moratorium procedure introduced by the Corporate Insolvency and Governance Act 2020, with a view to buying more time. So, post-Houst, we have good reason to be much more optimistic about the ability of SMEs to launch RPs. Given the benefits offered by the RP procedure – notably the ability to cram-down dissenting creditors – it is to be hoped that it will become a more common part of the restructuring toolkit, at both ends of the market.