Planning a way out of lockdown – the UK’s new restructuring procedure and its applicability to the mid-market

Looking back through the haze of Zoom meetings, online exercise classes, Amazon deliveries and failed pledges at self-improvement (“I will definitely learn the guitar/French/how to cook this time”), it’s easy to forget the anxiety which was triggered by the UK Government’s first lockdown announcement in March 2020.

Three weeks spent entirely at home seemed daunting at the time (little did we know...) and the prospect of wholesale business closures soon gave rise to serious concerns about the potential impact which those closures would have on the wider economy.

Whilst some high-profile insolvencies have occurred during the period of the pandemic, the anticipated wave of failures has yet to materialise. The real economy has, in fact, proved remarkably resilient, with many companies buoyed by financial and operational support from the investment community, which has risen to meet the challenges caused by the pandemic. In addition, Government support schemes have insulated companies from the loss (and in some cases, almost total absence) of revenue, allowing companies to remain as going concerns and hopefully get back on track once trading restrictions are lifted in their entirety.

To recap on the key aspects of those schemes, the issues which they are intended to address and when they are to end:

Although critical to the survival of many businesses, the schemes have led to an increase to the amount of debt on the balance sheets of a number of companies. Estimates suggest that the amount of rent which has been deferred between March 2020 and June 2021 could total £7bn, with around £30bn of VAT payments being deferred and over £75bn being borrowed via the various Government loan schemes. Whilst the number of companies entering into formal insolvency remains low, the effects of the increased debt burden are starting to be felt - a recent report suggests that up to 723,000 business may be in "significant financial distress" as a result.¹

To restructure or not to restructure?

As a result, companies which have accessed and benefitted from the schemes are likely to face difficult choices regarding their options when the schemes are due to come to an end.

Some companies may simply take the decision to live with an increased amount of debt on their balance sheet, which they will repay over time. Other companies which may have been unviable prior to the pandemic and have been propped up by the Government support will, in many cases, have no option but to enter a formal insolvency process once the support is withdrawn. There is however a third category of companies which are viable, and have solid foundations, but on which the increased debt will act as a drag, risking a surge of so-called "zombie" companies sustained by Government support but unable to grow.

For these companies dealing with the liabilities accrued during the pandemic at an early stage will be critical, and could potentially be the difference between those companies flourishing or ending up insolvent within the next few years. Fortunately, the range of tools available to restructure the liabilities and affairs of such companies has never been greater. In particular, the introduction of a new restructuring plan procedure into English law provides companies with a mechanism by which they are able to push through restructurings without the need for the approval of all (or, in fact, many) of their creditors.

Restructuring plans - how?

Schemes of arrangement (schemes) have been a common feature of the UK restructuring market for a number of years, particularly in the aftermath of the financial crisis. Schemes have predominantly been used as an efficient mechanism to restructure companies with complicated capital structures and a diverse base of financial creditors. Company voluntary arrangements (CVAs) have also been around since the coming into force of the Insolvency Act 1986 and have allowed companies to make a proposal for a compromise or arrangement with their creditors in order to achieve a reduction or rescheduling of their liabilities. In recent years, CVAs have risen to prominence as a mechanism by which companies with overrented premises are able to restructure and reduce their liabilities to landlords.

Restructuring plans are, in many ways, a younger cousin of schemes (which has led to restructuring plans being labelled "super schemes"). Both procedures involve a proposal made to a company's creditors regarding a compromise or arrangement of their claims, with creditors then being divided into classes based upon their rights against the company in order to vote on the proposal. Each process also involves two Court hearings; the first to approve the constitution of the classes to vote on the proposal and the second for the Court to "sanction" (i.e. approve) the restructuring plan or scheme if it is satisfied that it is fair to the company's creditors. It is also possible for an overseas company to use a restructuring plan (subject to certain jurisdictional thresholds), in the same way as a scheme.

By contrast, CVAs do not, unless challenged by an affected creditor, require any Court hearing. A company's unsecured creditors vote on a CVA as a single body rather than in classes (secured creditors cannot be bound by a CVA without their express approval, whereas in a scheme and restructuring plan secured creditors are placed into classes to vote on the restructuring plan/scheme in the same way as any other affected creditor). A CVA also cannot compromise sums due to a company's preferential creditors without their express consent - preferential creditors include, as from December 2020, HMRC in respect of certain types of tax liability, including VAT, PAYE and employee's NICs. Consequently, any CVA which sought to compromise sums owed to HMRC in respect of such amounts would require HMRC's express consent.

There are however also a number of differences between a restructuring plan and a scheme. The most significant of these differences are:

• restructuring plans are only available to companies that have encountered, or are likely to encounter, financial difficulties likely to affect their ability to carry on business as a going concern. There is no such gateway requirement for schemes (although, in practice, schemes are often used by companies which are experiencing at least some degree of distress);
• a class of creditors without a genuine economic interest in the company may be bound by the restructuring plan without being invited to vote upon it, meaning that any class which is "out of the money" is not required to vote on the plan. This contrasts with a scheme, where out of the money creditors can be excluded from voting, but not bound if so excluded;
• in order for a scheme to become binding, 75% by value of claims, and a majority in number, of the creditors in each class voting on the scheme must vote in favour of its approval. Restructuring plans contain the same value requirement in respect of voting, but no numerosity requirement; and
• perhaps most significantly, each class of creditors voting on a scheme must approve the scheme in order for it to become binding. A restructuring plan can however become binding if only one class of creditors votes in favour, provided that:
  • none of the creditors in the dissenting class would be worse off than under a relevant alternative; and
  • the creditors in the approving class would receive a payment or have a genuine economic interest if the relevant alternative were pursued (i.e. those creditors would be "in the money" if the relevant alternative applied).

The "relevant alternative" for these purposes is whatever the Court considers to be most likely to happen if the restructuring plan is not approved by creditors. It is not what would "definitely" occur if the plan was not approved, but what the Court believes to be the most likely outcome if that was to happen. In most cases, the relevant alternative will be administration or liquidation, although in some cases it could in theory be a sale of the company's business and assets via an accelerated M&A process, a refinancing of certain of its liabilities or some other outcome.

It is therefore now possible for a company to propose a restructuring plan which will be approved, and bind all of the company's creditors, if only one class of its "in-the-money" creditors approves the plan, provided that no class of creditors is worse off than they would be in the relevant alternative. The ability for a single class of creditors to cram down all other classes (termed "cross class cram down") represents an advantage over a scheme, where all classes must vote in favour for the scheme to become binding. It is also possible for a more junior class of creditors to "cram up" (i.e. to impose a restructuring upon) more senior classes by voting in favour of a plan provided that the senior class is not put in a worse position than it would have been in the relevant alternative. The introduction of cross-class cram down/cram up in this way represents a fairly seismic change to the restructuring landscape and the types of restructuring which a company may pursue, even in the face of resistance from a cohort of its creditors.

Restructuring plans - who?

Whilst schemes have proved to be an effective restructuring tool, their application has in most cases been limited to companies with numerous tiers of financial creditors, often with international operations and complicated financial arrangements. The use of schemes by companies within the "mid-market" has been limited - the cost of a scheme, given the heavy involvement of the Court, is often thought to be prohibitive when compared to the relatively lower costs of a CVA or pre-pack administration.

While it was initially feared that the cost of two Court hearings would make the use of restructuring plans prohibitive for many smaller companies, as discussed below, this may not prove to be the case. The timing of the introduction of restructuring plans into English law may indeed provide an indication regarding how the Government may wish for their use to become more widespread. Restructuring plans formed part of a package of reforms made pursuant to the Corporate Insolvency and Governance Act 2020 (CIGA) which were, in large part, designed to provide companies which were struggling as a result of the pandemic with the tools to restructure their liabilities and continue trading. Whilst restructuring plans (or a similar process) had been discussed within the insolvency community for a number of years, that they were included in CIGA is perhaps indicative of the intention that they be used to restructure the affairs of as many companies which have been impacted by the pandemic as possible, and not only companies with significant balance sheets.

At the time of writing, there have been six restructuring plans which have been sanctioned by the Courts, each with different objectives and aims. To summarise:

Even when considering the small sample size, it's clear that the types of restructuring which a plan can be used to implement are varied, and can involve all or any combination of financial creditors, trade creditors, landlords and shareholders. Restructuring plans can be used to effect debt-for-equity swaps, and may even allow for pre-emption rights to be disapplied in order to effect such swaps. It is also possible to treat creditors who ostensibly fall within the same class differently provided that the differential treatment is commercially justified (the most obvious example being the different compromises of landlord creditors effected by the Virgin Active plan).

However, so far, restructuring plans have been primarily used by companies with relatively large and complicated balance sheets - each company which has used a restructuring plan had annual revenue in excess of £150m when it proposed the plan (with a few having annual revenue much higher than that figure). The extent to which plans may become more widespread, and used by medium sized companies, therefore remains up for debate.

Can restructuring plans be used for medium sized companies?

In order to consider whether restructuring plans can be used more widely, it's helpful to conceptualise what the capital structure of a "typical" medium sized company could look like later in the year. The company may have:

• increased the borrowings under its senior facilities, fully drawn any revolving facilities and deferred or capitalised interest which accrued during the pandemic;
• borrowed additional funds under the Coronavirus Large Business Interruption Loan Scheme (CLBILS) ranking pari-passu with, or senior to, its existing facilities;
• deferred the payment of rent and other sums due to landlords in respect of any leasehold properties;
• deferred the payment of VAT and other taxes; and
• unpaid amounts owed to its suppliers and other trade creditors.

The company faces the prospect of enforcement action by its creditors to recover the sums which it has deferred/failed to pay during the pandemic when the current restrictions on winding up petitions end on 30 June 2021. It may therefore wish to take a proactive approach and seek to restructure its liabilities to avoid any such enforcement action.

In order to do so, the company may consider the use of a CVA. However, a CVA would not allow the company to restructure its liabilities to its financial creditors (i.e. its senior facilities and CLBILS loan). Further, the express consent of HMRC would be required in respect of any compromise of the company's liability in respect of deferred VAT (on the basis that HMRC is a preferential creditor for such amount, which effectively gives it a veto over the CVA).

The company may then consider a scheme. However, the fact that each class of the company's creditors is required to vote in its favour may jeopardise the prospects of the scheme being approved. It may, for example, be unlikely that landlords who are significantly compromised by the scheme (who will form their own class for voting purposes) will vote in its favour.

Instead, the company may consider a restructuring plan. Given the flexibility of the outcomes which a restructuring plan can produce, and that classes of dissenting creditors can still be bound by the plan through the use of cross-class cram down, the plan should enable the company to restructure all or some of the liabilities described above. The restructuring could include:

• an extension to the maturity dates of its senior facilities, in the event that a sufficient number of the lenders of those facilities are unwilling/unable to consent to an extension on a consensual basis;
• other amendments to the terms of its debt facilities, such as the amendment or suspension of financial covenants;
• amortising or reducing the amounts payable to HMRC and its trade creditors; and/or
• writing off the rent arrears owed to landlords and reducing the amount of rent payable under its leases (which may be done by changing the basis of that rent from a fixed rent to a turnover-based rent). In this regard, the company's leases can be split into different categories depending on their importance to the company's business and compromised in different ways, in the same way as a CVA.

A few key points arise in relation to a restructuring plan proposed along these lines.

• In order to propose the plan, the company must have encountered or be likely to encounter financial difficulties likely to affect its ability to carry on business as a going concern. Whilst the company may not be in immediate danger of cash-flow insolvency, it may still satisfy this condition if the debt which it has accrued during the pandemic has caused its long-term solvency to become unlikely.
• It is the company's unsecured creditors (specifically HMRC, landlords and trade creditors) which bear the brunt of the compromises effected by the plan. Those creditors (or at least a significant proportion of them) may therefore vote against the plan. However, provided that an "in the money" class (most likely the company's senior lenders) vote in favour of the plan, and that each unsecured creditor receives more than they would in the "relevant alternative", then the plan is still able to be sanctioned by the Court.
• The rights of creditors against the company and how those rights are proposed to be affected by the plan determine how classes of creditors are formed to vote on the plan. Unlike a scheme (where the company will usually wish for there to be as few classes as possible in order to reduce the risk that a class votes against the scheme) the company has an interest in there being as many classes as possible to increase the likelihood of one or more in-the-money classes voting in favour, and therefore being able to cram up/cram down a dissenting class. Landlords and trade creditors may sit in a number of different classes if the plan affects their rights against the company differently (for example, by reducing the rent payable under the company's leases or amounts due to different types of trade creditor to different degrees). The company will, along with its advisors, need to consider carefully how creditors may vote, particularly if the same creditor sits in multiple classes - for example, a landlord may be landlord of both a lease which is left relatively untouched by the plan but also a lease which would, if the plan is approved, be subject to a significant write off/reduction in rent against the landlord's wishes. The landlord may therefore sit in two different classes, and cast a vote against the plan in both classes in an attempt to frustrate the plan, notwithstanding that only one of its leases will be affected (although this shouldn't matter if an in-the-money class of creditors votes in favour of the plan anyway).
• The further away the company is from immediate cash-flow insolvency the more thought will need to be given to whether an administration or liquidation is the relevant alternative to the plan or whether a different alternative would be more likely. A lack of certainty around the relevant alternative provides creditors who wish to challenge the plan with a potential angle of attack, as they may claim that a different alternative, which could produce a better outcome to creditors to the alternative proposed by the company, would apply. The company will need to instruct a restructuring/insolvency firm to opine on the most likely relevant alternative, and the projected outcome for creditors, if that alternative were to apply. Creditors face a high bar when challenging a relevant alternative proposed by the company with the benefit of such expert advice (as confirmed in the Virgin Active decision), making it critical to the likelihood of the plan succeeding.

The prospect of creditors challenging the plan, and the requirement for advice from a restructuring advisory firm, are also relevant to what is likely to be the determining factor for whether plans can be used in the mid-market - cost. Given that restructuring plans require two Court hearings, necessitating the involvement of counsel working alongside the company's solicitors and financial advisors, advisors' costs can be significant, particularly if the plan is heavily contested by creditors. However, the company does at least have some certainty of costs from the outset of the plan as, assuming the plan is sanctioned at the second hearing, it is extremely unlikely that leave to appeal the Court's decision would be granted. This is in contrast to a CVA, where the company may only find out that a creditor intends to challenge the CVA in the mandatory 28 day "challenge" period after the CVA has been approved by creditors. The costs of defending such a challenge are, when added to the costs of the CVA itself, also likely to exceed the costs of a plan. A company can, by using a restructuring plan, gain more certainty, more quickly, than a CVA and seek to move on once the plan has been approved by the Court.

Certain factors may also help to reduce the potential costs of the plan.

• Some market participants have advocated for a form of standard "protocol" which can be used for restructuring plans in order to standardise terms and reduce costs. Whilst the use of such a protocol may be challenging for all but the most simplistic plans, the fact that the drafting of a plan can be substantially based upon the terms of a CVA, scheme or the plans which have already been approved means that there is significant precedent already available to law firms tasked with drafting plan documents.
• The costs involved in the plans which have been used for larger companies may not be indicative of the costs which a company in the mid-market can expect to incur in respect of a plan. Those companies often have complicated financing structures and large bondholder groups, which are likely to be more difficult (and costly) to manage than the finance creditors described in our above example (which may only comprise a credit fund/bank lender of the company's senior facilities and bank lender of its working capital facilities and CLBILS facility). Further, a fairly lengthy process of "locking up" relatively disparate groups of bondholders is usually required to procure their agreement to vote on the plan, as well as the payment by the company of fees and costs to ensure such agreement. Those fees and costs can be avoided in less complicated financing structures.
• There are various methods by which creditors' meetings to vote on the plan can be held by non-physical means in order to reduce costs. The use of virtual meetings for schemes of arrangement was clarified and expanded up by the Court in relation to the scheme of arrangement proposed by Castle Trust (for whom Macfarlanes acted on its scheme during the first lockdown) and became commonplace in relation to the schemes, CVAs and restructuring plans which have been approved during the pandemic.
• The potential disruption caused by creditors seeking to obtain an advantage by issuing winding up petitions against the company whilst it formulates the plan can be mitigated by the company obtaining a moratorium under part A1 of the Insolvency Act 1986 (a process which was also introduced by CIGA) by a simple filing of forms at Court. Obtaining a moratorium should ensure that the costs of dealing with multiple winding up petitions (either by settling the petition debt or defending the petition at Court) can be avoided. It should also possible for the company to obtain a stay of a winding up petition if it can demonstrate to the Court that the plan has a reasonable prospect of succeeding.
• There is a substantial body of case law in relation to CVAs, schemes and (already) restructuring plans which provide clear guidance on the parameters of the compromises which can be effected through those processes. Consequently, the prospects of a challenge by creditors can be reduced by proposing a plan which does not stray too far outside these parameters (as creditors should not wish to waste costs on what is likely to be a futile exercise).
• The Court has confirmed, in its decision on the Virgin Active restructuring plan, that there is no requirement for a full marketing process to be conducted in order to establish what creditors would receive in the relevant alternative, and instead that a less expensive "desktop" valuation will suffice.

Taking each of the above factors into consideration, the up-front costs of a restructuring plan for a medium sized company may not be materially greater than the costs of a CVA, particularly a CVA which is challenged by a creditor. In any case, those costs will most likely be proportionate to the benefit of the improvements to the company's balance sheet which can be effected by the plan, and the avoidance of the costs of negotiating bilateral agreements on a consensual basis with the company's creditors instead of the use of a plan to implement those agreements. What is clear is that taking action early to draw up a plan which addresses the company's issues and restructures its liabilities in a way which allows it to remain (and grow) as a going concern will be preferable, both from a costs and execution perspective, to waiting until things have become unsustainable.

¹ Per Begbies Traynor's 'Red Flag Alert' research report for Q1 2021