The English High Court has sanctioned the restructuring plans proposed by the Virgin Active group following a hearing contested by a group of the gym chain's landlords. The decision represents the first use of the restructuring plan procedure, introduced during the summer of 2020, to restructure a lease portfolio, demonstrating the utility of the tool for debtors when implementing a significant restructuring across the capital structure, and as an alternative to the much-used company voluntary arrangement.
In the third of a growing number of cases to utilise the English Court's new power to sanction a plan notwithstanding its rejection by a dissenting class of creditors, Snowden J sanctioned the inter-conditional plans of three Virgin Active group companies, despite the objections of five classes of creditors (out of seven in total for each company). Snowden J's judgment provides important guidance on the Court's exercise of its discretion to cram down dissenting classes of creditors and provides valuable insight into the Court's approach to the valuation disputes that will likely be the key battleground in future restructuring plans.
Background information and the plans
Virgin Active operates a chain of health clubs, which, like many businesses in the leisure, retail and hospitality sectors, were forced to close for extended periods of time during 2020 and 2021 as a consequence of the COVID-19 pandemic restrictions. This inevitably caused severe financial difficulties and cash flow constraints for the business. In late 2020 it became apparent that a financial restructuring would be required, and the group began to plan for the restructuring plans that would be launched in March 2021.
Three of the group's lease-holding companies, Virgin Active Holdings Limited, Virgin Active Limited and Virgin Active Health Clubs Limited launched interconnected restructuring plans under Part 26A of the Companies Act 2006 on 10 March 2021, which sought to facilitate the injection of new money into the group, extend the maturities of its senior secured debt, and effect a restructuring of its lease portfolio to reduce its accrued rental liabilities and its rental liabilities in the future.
Virgin Active grouped its creditors into seven separate classes for each of the companies proposing a plan, each of which would be treated differently under the proposals. The classes consisted of the senior secured creditors of the group, five classes of landlords (A to E), and unsecured general property creditors (creditors who were not present landlords of the group, but whose claims derived from the group's present or past occupation of certain properties).
The plans provided for the secured debt to remain in place with certain amendments to the facilities agreement including an extension of the maturity by 3 years, deferment of interest payments, significant relaxation of the financial covenants and events of default, and a basket for the plan companies to borrow additional sums of up to £50m ranked pari passu with the existing secured debt, without any requirement for further consents or waivers.
Under the plans, class A landlords would receive 100% of their future rent and accrued arrears, while landlords in classes B to E would all see their arrears of unpaid rent released in return for a payment of 120% of the estimated return in a hypothetical administration of that company (and accounting for the benefit of any guarantees provided by other group companies). Class B landlords would receive full contractual rent for a period of up to three years following the sanction of the plan (paid monthly in advance), class C would receive 50%, and classes D and E would receive no rent. Classes C, D and E would all benefit from break rights, allowing them to terminate their leases. The guarantees of these leases given by group companies were also varied in line with these compromises.
The plans were approved by the senior secured creditors and the class A landlords across the three plan companies but the plans failed to achieve the statutory majority of 75% in value of creditors voting in favour in the landlord classes B-E and by the classes of general property creditors. In other words, six classes of creditors across the three plan companies approved the plans by the requisite majority, while 15 creditor classes voted to reject the plans.
Part 26A of the Companies Act 2006 allows the Court to sanction a restructuring plan notwithstanding the rejection of the plan by one or more classes of the plan company's creditors (the so-called "cross-class cram down mechanism"). They may only do so if the following conditions are met:
- Condition A: none of the members of the dissenting class would be any worse off than they would be in the event of the relevant alternative (being, whatever the court considers would be most likely to occur in relation to the company if the plans were not sanctioned).
- Condition B: the plans have been agreed by a number representing 75% in value of a class of creditors who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative.
In this instance, and based on the valuation evidence adduced by the plan companies, there was no dispute that Condition B was satisfied by the senior secured creditors' and class A landlords' approval of the plans.
Therefore, the issues to be considered by Snowden J following a five day hearing were:
- If the plans are sanctioned, would any members of the dissenting class be any worse off than they would be in the event of the relevant alternative (the "no worse-off" test)?
- Should the Court exercise its discretion to sanction the plans?
"No worse off" test
In considering whether creditors would be worse off than in the relevant alternative, Snowden J accepted the plan companies' evidence, based on a report in evidence, that the most likely relevant alternative to the plans was a trading administration and an accelerated sale of the regional businesses of the plan companies. The evidence showed that, in that scenario, there would be no return for unsecured creditors other the prescribed part (which would be measured in fractions of one p/£).
In doing so, Snowden J highlighted that the Court is only required to select the scenario that is more likely to occur than the other scenarios identified and is not required to consider whether or not a particular alternative would definitely, or be more likely than not, occur.
Counsel for the ad-hoc group of landlords argued that the plan companies should have pursued alternatives to the plans that may have resulted in a better return for unsecured creditors, but this was rejected by Snowden J, who found that the relevant question was what the relevant alternative was now (when the Court is considering whether to sanction the plan), if the plans are not sanctioned. He said that the Court is not required at this stage to consider what might have occurred if the plan companies had acted differently nor whether the plans were negotiated in a way which was prejudicial to other creditors.
The landlords also argued that the valuations adduced by the plan companies, which the plan companies and their financial advisers had relied on in preparing their analysis, and the report filed on the outcomes in the relevant alternative, were inherently unreliable because (1) the valuations were produced on a desktop basis, without market testing, and (2) the reports included significant limitations and disclaimers. The landlords argued that as a consequence, the Court could not satisfactorily conclude that no member of a dissenting class would not be worse off under the relevant alternative.
Dismissing these arguments, Snowden J said that it was important that the utility of Part 26A restructuring plans was not undermined as tool for restructuring by lengthy valuation disputes, albeit that creditors must be adequately protected. He found that there was "no absolute obligation" to undertake a market-testing process prior to launching a restructuring plan, noting that in many instances the results of such a process would be unreliable and could be subject to potentially unfavourable market conditions, such as those present during the lockdowns imposed as a consequence of the COVID-19 pandemic. He also considered the various limitations and disclaimers relating to the impact of the COVID-19 pandemic in the reports prepared by the plan companies’ financial advisers and noted that such exercises would always be subject to uncertainty, and in this instance did not consider that the limitations and disclaimers meant that the reports could not be relied on.
In the absence of compelling evidence to the contrary, Snowden J considered that the valuation evidence was reasonable and there was "no basis upon which to impugn it". He was satisfied that each creditor would receive a better return under the plans than in the relevant alternative.
Further arguments were made by the ad-hoc group of landlords that they had not been furnished with sufficient information prior to the sanction hearing, but this was dismissed by Snowden J. He pointed to the "enormous volume" of documents that had been provided, noting that the landlords had failed to act with "the urgency one might expect" to obtain information from the plan companies. It was therefore significant that the landlords had failed to bring forward adequate evidence to challenge the conclusions of the plan companies and their advisers.
A matter of discretion
Once the Court has concluded that Conditions A and B have been satisfied, it must consider whether it should exercise its discretion to sanction the plan. The relevant provisions of Part 26A provide no express test to satisfy, and little guidance as to the factors that the Court should consider in making this decision. Judicial guidance also provides little assistance owing to the novel "cross-class cram down" feature of restructuring plans. Snowden J undertook a review of the legislative history and the first exercise of this power in the DeepOcean case earlier this year, concluding that there was no clear test that a plan should be sanctioned if it is "just and equitable", and that while a company may have a "fair wind behind it" if Conditions A and B are satisfied, the Court must nevertheless consider all of the facts and circumstances.
The plan companies' evidence was that, in the relevant alternative (an administration), the value would "break" in the class of secured creditors and they would be entitled to the full value of the business in that scenario to the exclusion of the dissenting creditors, who would only be entitled to the prescribed part. On this basis, a distinction can be made between those creditors who are "in the money", the secured creditors, and those creditors who are "out of the money", the unsecured creditors.
The landlords' objections focused on the structure of the plan that saw the existing shareholders retaining 100% of the equity of the restructured group, albeit as part of a package in which they would provide new money on a junior ranking basis relative to the existing secured lending and write off or capitalise substantial intercompany loans. They complained that this was contrary to basic principles of insolvency law in that the shareholders, who would be at the bottom of the waterfall in an administration or liquidation of a plan company, would stand to receive all of the benefits of the implementation of the plans (the so called "restructuring surplus"), at the expense of the unsecured creditors.
Considering these arguments, Snowden J found that it was for the "in the money" creditors (in the language of the legislation, those with a "genuine economic interest") to determine how the "restructuring surplus" was to be divided and that the allocation of that value to the existing shareholders in this instance was permissible. Accordingly, he held that the objections of landlords, all of which were "out of the money", and the substantial majorities that had rejected the plans, carried no weight. Consequently, any complaint that the landlords had as to the way negotiations were conducted prior to the launch of the plans, which landlords said they were effectively excluded from, were of little significance.
Notably, while acknowledging that plans may legitimately provide for differential treatment of creditors, and differential treatment could be justified by reference to factors such as commercial importance and profitability, Snowden J left the door ajar to a challenge of a plan where landlords were "in the money" but were nevertheless treated differently.
Future for lease portfolio restructurings?
This judgment comes hot on the heels of the judgment relating to the New Look CVA, and was followed shortly after by the judgment on the Regis CVA, all of which present a number of challenges for the landlord community, highlighting the importance of organising and seeking information at an early stage.
Although CVAs have traditionally been the process of choice for lease portfolio restructurings, the sanction of the Virgin Active plans makes it clear that a restructuring plan is a viable tool for debtors in distress with a portfolio of leases or similar long term commitments. The ability to compromise various levels of the capital structure means that this tool will be of particular interest to debtors seeking to implement a comprehensive restructuring that in the past would have required multiple processes.
If you’d like to find out more about other aspects of the restructuring plan and its use so far, please see our COVID-19 response blog and podcast and our updates on the PizzaExpress, Deep Ocean and Gategroup restructuring plans or get in touch with your regular contact at the firm.