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Background

Houst Ltd (“the Company”) is a property management company which specialises in short-term holiday rentals through an online platform. It is an SME (small or medium-sized enterprise) with total liabilities of approximately £10 million at stake. The Company became both cashflow and balance sheet insolvent having experienced financial difficulty during the Covid pandemic and this resulted in creditors having threatened winding-up petitions.

The purpose of the restructuring plan was to return the Company to solvency and for all stakeholders to receive more than they would do under the relevant alternative. Analysis prepared by Begbies Traynor in April 2022 concluded that if the Company did not enter into a restructuring plan then the relevant alternative would be a pre-pack administration.

The Debt Position

Clydesdale Bank was the secured creditor and was owed approximately £2.8 million (estimated to realise around £300,000 from the fixed charge assets). No recovery was anticipated from the floating charge assets as its claim would rank behind HMRC's £1.8 million claim as preferential creditor.

A summary of the overall debt position is as follows:

Creditor

Approximate value of debt

Clydesdale Bank

£2.8 million

HMRC

£1.8 million (preferential status)

Trade Creditors

£1.6 million

Convertible loan note holders

£3.3 million

Connected party creditor

£500,000

 

The Restructuring Plan

In return for the Company issuing new preference shares the Company's shareholders had agreed to a minimum capital injection of £500,000. The Bank's debt was dealt with by reducing it to £750,000 to be paid over the course of three years. The Company agreed that it would pay into two separate funds:

  1. A secondary preferential creditor payment fund to be used to fund a dividend payment to HMRC of 20p in the £.
  2. An unsecured creditor payment fund to fund a payment of 5p in the £ to all unsecured creditors entitled to receive a payment.

Any liabilities which were owed to customers, critical suppliers and employees were excluded from the restructuring plan and were to be paid in full. The Company believed that these payments were critical to enabling the Company to continue to trade and contribute to the two creditor funds. Convertible loanholders were provided with the option to convert their debt into equity (pre-dilution) or to participate in the dividend available to unsecured creditors.

The element of the restructuring plan that caused HRMC to vote against it was that it departed from the usual order of priority. If the Company were to have entered into the relevant alternative of administration, HMRC would have ranked behind the Bank and received an estimated £15p in the £ with the Bank receiving 7p in the £. HMRC actually received a higher payment under the restructuring plan of 20p in the £ but the Bank's position was also significantly improved as it received a greater share of the restructuring surplus therefore increasing its dividend to 27p in the £. The unsecured creditors, who would have received nothing in an administration, also received a dividend under the plan.

Voting

All parties except for HMRC voted in favour of the plan. HMRC refused to vote in favour of the plan as it would not "relinquish this status [its preferential status] in order to provide a dividend to unsecured creditors…with the reinstatement of HRMC as a secondary preferential creditor as the end of 2020, this is a position we are not willing to compromise on". It was in a dissenting class on its own due to its preferential status and the fact it held no security.

Conditions for cross-class cram down

A dissenting class does not necessarily prevent the Court from sanctioning a plan as long as two relevant conditions are met:

  1. Condition A being that the Court is satisfied that were the plan to be sanctioned none of the members of the dissenting class (e.g. HRMC) would be worse off than under the relevant alternative. It was clear in this case that all parties would be better off under the plan than the relevant alternative.1
  2. Condition B was that the compromise or arrangement had been agreed by a number representing 75% in value of a class of creditors or members, present and voting either in person or by proxy, who would receive a payment or which had a genuine economic interest in the Company in the relevant alternative. The only other creditor to receive a payment or that had a genuine economic interest in the relevant alternative would have been the Bank which had voted in favour.

The Court will also take into account in all the circumstances whether it should exercise its discretion to sanction the plan. As such, the Court was satisfied that both Condition A and B had been met.

Had the restructuring surplus been fairly distributed?

The Court considered whether the restructuring plan provided for a fair distribution of the restructuring surplus i.e. the additional benefits which had been generated by the plan. It was held that although the order of priority is a useful point of reference when determining the appropriate share of the restructuring surplus it would not be fatal to a restructuring plan if this was departed from (unlike with a Chapter 11 process).

The Court was satisfied that the full repayment of the critical creditors was justified as this enabled the Company to generate funds to pay HMRC and the unsecured creditors through the two creditors funds and allowed it to continue to trade. The Court was also satisfied with the treatment of the new shareholders due to their capital injection without which the Company was unlikely to survive.

The Court held that the Company's justification for (i) the payment of the unsecured creditors on the basis that they were creditors with whom the Company would need to trade or would look to for potential future trading and (ii) the enhanced dividend paid to the Bank on the basis that it was the least the Bank would accept in exchange for supporting the plan were weak arguments, but it exercised its discretion to sanction the plan despite this.

It was noted that as an alternative the Company could have gained HMRC's support instead and bound the Bank as the dissenting class. However, the Court concluded that "while it would in theory be possible to require the Company to start again and seek to negotiate with HMRC, that is highly undesirable where the costs and delay in requiring it to do so would impose a disproportionate burden on the Company, a small to medium enterprise".

Also relevant in the Court’s judgment was that the new value resulting from the plan was largely due to the shareholder capital injection and therefore it was not the case that assets which would have been available in the relevant alternative of administration had been applied inconsistently with the order of priority.2

It is a positive development to see that the restructuring plan tool is able to be used for SMEs.



1 Note that the court required additional evidence to be provided before it was satisfied on this point as it concerned HRMC.

2 Note that although HMRC voted against the plan, it did not actively oppose it before the Court.