Since the partial reintroduction of the Crown preference in December 2020, HMRC has played an increasingly important role in company restructurings, and none more so than the Part 26A restructuring plan (RP). Following the decision in Re Houst Ltd (2022) last year, HMRC has been forced to adapt its response to proposed RPs, departing from its default position of simply objecting to any restructuring that will compromise its secondary preferential creditor status and instead actively engaging with the approval process. This strategy has proven effective in two recent cases.
Re Houst Ltd [2022] EWHC 1941 (Ch)
We first wrote about the Houst case in detail previously last year.
Houst was the first RP proposed by a SME which attempted to cram-down HMRC as dissenting creditor. The “relevant alternative” (being the yardstick by which the proposed RP is judged) to the RP was, in this case, a pre-pack administration sale. In that scenario, the only creditors who would make any recoveries were the secured lender and HMRC. The RP was projected to improve the return for both the secured creditor and HMRC, and would also permit a recovery for other unsecured creditors.
The RP was approved by all classes of creditors save for HMRC, which opposed the RP on a policy basis: namely, that it was not prepared to compromise its secondary preferential creditor status to permit a distribution to unsecured creditors. However, HMRC did not make any submissions or submit any evidence to the court in opposition to the RP.
Given that all creditors were better off under the RP than the relevant alternative (the “no worse off test”), and that the secured lender (the only other creditor “in the money” in the relevant alternative) also voted in favour, the court sanctioned the plan. The court appeared to take a dim view of the fact that HMRC, as a sophisticated creditor, did not attend the hearing, submit any valuation evidence or mount any active opposition based on the specific details of the RP.
Following the Houst case, lessons seem to have been learned by HMRC, who have since successfully opposed two recent RPs that have come before the courts.
Re Nasmyth Group Ltd [2023] EWHC 988 (Ch)
The Nasmyth Group Ltd (Nasmyth) encountered financial difficulties initially resulting from the Covid-19 pandemic and its financial position deteriorated further in 2022 following supply chain disruptions and inflationary pressures. Nasmyth proposed a RP to compromise certain liabilities and facilitate continued lending with the view to returning to solvency. However, notably, the survival of Nasmyth was contingent upon HMRC agreeing a time to pay (TTP) arrangement with a number of its subsidiaries post-restructuring, so HMRC’s stance on the RP was key.
The RP proposal divided the creditors into six groups and set out the impact that the restructuring plan would have on their rights and obligations. Critically, HMRC’s secondary preferential claim (exceeding £200,000) would be compromised in full for a share of a £10,000 fund. Unsecured creditor claims (including the unsecured element of HMRC’s claim, approximately £230,000) would also be compromised in full for a share of a £10,000 fund.
Two expert reports were prepared by Begbies Traynor Group Plc to satisfy the “no worse off” test. These demonstrated that in the relevant alternative (i.e. administration) the junior secured lender would receive significantly less, while all other creditors (including HMRC) would receive nothing.
All classes of creditors voted in favour of the RP, save for HMRC, so the court was asked to exercise its cross-class cram down powers to grant sanction.
HMRC’s stance
HMRC opposed the RP, arguing that there would be an unequal distribution of the benefit of the RP across creditors which was not commercially justified in this case. Interestingly, HMRC did not file expert evidence to challenge the expert reports filed. However, it argued that the RP was unfair as the directors had prioritised payment of certain “critical supply creditors” ahead of HMRC, despite heavy reliance on HMRC’s goodwill to subsequently agree TTP arrangements, without which Nasmyth could not survive. HMRC argued that this was a roadblock which prevented the RP from taking effect as intended. It was argued that the RP was a means to put pressure on HMRC to enter into TTP arrangements where one could not previously be agreed.
The decision
The court concluded that it would be unfair if the RP were sanctioned and for HMRC to be crammed down. The court gave weight to the directors’ failure to agree a TTP arrangement with HMRC before proposing the restructuring plan and authorisation of payments to other “critical” creditors ahead of HMRC which had significant (and historic) debts. While noting that there was no matter of principle preventing HMRC from being crammed down, the court confirmed that it should exercise caution and not cram down HMRC unless there are good reasons to do so. The court was not prepared to put pressure on HMRC by sanctioning a RP which was reliant on HMRC’s agreement to a TTP, even if it had been prepared to sanction the plan, it would have been conditional on the TTP arrangements being agreed.
This case represents a successful change of tack from HMRC in opposing RPs and is a model which was replicated in the RP proposed by The Great Annual Savings Company Ltd.
Re Great Annual Savings Company Ltd [2023] EWHC 1141 (Ch)
Hot on the heels of the Nasmyth case was the RP proposed by the Great Annual Savings Company Ltd (GAS). This RP was “self-funded” – i.e. it did not require any injection of funds but simply sought to reduce GAS’s debt exposure and defer payment obligations where appropriate to enable it to trade its way out of financial difficulty. HMRC would be repaid in two tranches over a two-year period from a segregated fund into which GAS would pay monthly, resulting in an estimated return of 9.1p/£. The “relevant alternative” was a non-going concern sale of the business out of administration, with HMRC anticipated to receive between 0p and 4.7p/£ return. These findings were supported by two reports by experts in the field of insolvency recoveries of similar energy brokers.
The RP received 100% support at 12 out of 15 creditors’ meetings. HMRC was among the dissenting classes of creditors.
HMRC’s stance
Despite the improved return under the RP, HMRC argued that GAS had failed to discharge the evidential burden that it would be “no worse off” under the RP than in the relevant alternative. Again, HMRC did not adduce its own expert evidence, but disputed the assumptions in the valuation reports which formed the basis of the estimated outcome statements. In particular, HMRC argued the reports:
- Were too pessimistic about the recovery of book debts (which had a headline value of £18.2m, with a projected maximum 2.8% recovery).
- Disregarded the prospect of any claims the insolvency officeholders might have against third parties in the relevant alternative (e.g. wrongful trading for continuing to trade without discharging HMRC debts).
Adjustment of the assumptions underlying the projections could give rise to a different outcome in which HMRC could achieve a better result in the relevant alternative than under the RP.
HMRC also argued that the RP did not provide for a fair distribution of the benefits of the plan across creditor classes. Notably, only four of the 15 classes of creditors were "in the money", of which HMRC and the secured creditor were the major creditors.
The decision
The High Court refused to sanction the RP and cram down HMRC on the basis that GAS had failed to show that HMRC would be “no worse off” under the RP. The court had serious reservations about the assumptions underlying the valuation reports, particularly the prospect of likely recovery of the book debts. The court was not inclined, however, to attribute any value to prospective claims against third parties given the inherent risks of litigation and many variables involved.
The court’s approach to the valuation evidence and willingness to interrogate the company’s expert evidence is a welcome development for creditors seeking to challenge RPs and a departure from previous caselaw on this point. In Re Smile Telecoms Holdings Ltd [2022] EWHC 740 (Ch) the court held that a creditor opposing a plan based on a company’s valuation evidence should file valuation evidence of its own. It seems the court may be willing to adopt a pragmatic approach where a major “in the money” creditor (being those who have an economic interest in the “relevant alternative”, such as HMRC) may potentially be prejudiced by a RP.
When considering the issue of fairness of the RP, the court considered that it is principally for the company to determine how to distribute the “restructuring surplus” (being the additional monies available above those available in the relevant alternative) following the implementation of the RP. However, the interests of the creditors who are “in the money” will need to be given proper consideration, and engagement with those creditors by the company will be key to the success of the RP.
So how has HMRC adapted in its challenges of RPs?
The recent spate of successful challenges to RPs by HMRC demonstrates a determination by HMRC to avoid being forced into a restructuring which it considers prejudicial, especially given its secondary preferential status. In contrast to its opposition in Houst, in the two more recent cases HMRC has made the following changes:
- Taken an active approach to its opposition.
- Responded to the particular circumstances of the RP.
- Engaged with the company in financial difficulty.
The court has been clear in both Nasmyth and GAS that where it is asked to cram down HMRC it will act cautiously and will not exercise its cross-class cram down powers without good reason. By properly engaging with the court process, HMRC has convinced the court to adopt a sympathetic approach and prevented a cram down of significant debts. HMRC’s response to these two RPs will likely form a blueprint for its engagement with any RPs seeking to compromise tax debts in the future. And SMEs with large debts owed to HMRC will need to consider their plans even more carefully to ensure they have maximised the chance of obtaining the court’s approval.
David Steinberg
Lucy Trott