Roger Elford writes for EG on the UK restructuring regime
Roger Elford, Partner, writes for EG on whether the UK restructuring regime is fit for purpose. In the article, he compares the available UK processes to their US counterpart.
See full article below:
Is the UK restructuring regime fit for purpose?
It has been said that cinema is a reflection of its own society. While that has traditionally been a reference to what was being shown on screen, the phrase has a degree of prescience in the current environment within which cinema operators and other businesses in the leisure and tourism sectors operate.
When Cineworld – the world’s second largest cinema chain, headquartered in the UK and listed on the London Stock Exchange – filed for Chapter 11 bankruptcy in the US last month in order to restructure its $9bn debt burden and leasehold obligations, commentators naturally queried why the group was seeking to restructure its affairs in the US, rather than in the UK.
While more than 500 of Cineworld’s cinemas are in the US and the US Chapter 11 process is often regarded as the gold standard for debtor-friendly restructuring regimes, the UK’s restructuring framework can provide highly effective solutions in many cases.
The Chapter 11 process
Chapter 11 of the US Code provides debtors seeking to restructure their affairs a comprehensive toolkit with which to do so. On filing for Chapter 11, the company (or group of companies) enjoys what is referred to as an “automatic worldwide stay” on proceedings being brought against it by aggrieved creditors. While the extra-territorial effect of the stay is open to debate and interpretation, any creditors with any dealings in the US will be slow to test its teeth, for fear of incurring the US courts’ displeasure and censure.
Chapter 11 also provides the debtor with the ability to borrow money in order to facilitate its restructuring. This so-called debtor in possession (DIP) finance can take priority over existing creditors’ claims, including (in most cases) those with security over the debtor’s assets. This is naturally appealing to would-be lenders to the debtor who wish to ensure that their rescue finance can be recouped in the event that the restructuring is unsuccessful.
The US system contains machinery to prevent suppliers to the debtor using contractual terms (known as ipso facto clauses) turning off the tap by reason of the debtor’s insolvency/distress, thus (when coupled with the automatic stay) giving debtors the breathing space they require to formulate their Chapter 11 plan of restructuring.
Traditionally, the UK has been widely regarded as a more creditor-friendly jurisdiction within which to restructure. That is not to say that the English courts have not been the venue of choice for many groups of large companies (based both home and away) to restructure through Companies Act schemes of arrangement over the years, but the scheme machinery under English law has not traditionally provided debtors with any form of automatic stay or moratorium on legal proceedings, and further has enabled certain creditors to “hold out” their approval of the scheme, in order to either thwart the scheme or to improve their own position. Schemes have therefore been largely used where a broadly consensual solution can be achieved with the debtors’ major financial creditors.
Company voluntary arrangements
In the UK, company voluntary arrangements have become a tried and tested tool for retailers and leisure operators to restructure (predominantly) their leasehold store portfolios. At its core, a CVA is a binding contract between a company and its creditors. Unlike a scheme of arrangement, rather than splitting creditors into constituent classes and requiring each class to approve the scheme, all unsecured creditors vote on the company’s proposals as a single class, thus often enabling the votes of the company’s non-landlord creditors (whose claims may be left unimpaired by the CVA) to provide the (more than) 75% vote in favour of the CVA against the wishes of, and often to the detriment of, the company’s dissenting landlords (whose claims as calculated under the CVA are insufficient to block its approval).
Over the past 20 years, the CVA landscape has shifted significantly, with CVA proposals becoming increasingly sophisticated. While all creditors are grouped together for voting purposes (albeit with a secondary mechanism in place to prevent connected creditors from forcing CVA proposals through), multi-site retail CVAs will now typically divide landlords/properties into multiple categories, all receiving differing outcomes in the CVA (depending on how critical/viable a particular site is to the retailer).
Consequently, and in a drive to survive, commercial (particularly institutional) landlords were quick to commit significant resources to bringing court challenges to CVAs, which they say unfairly prejudice their interests, or which (they argue) go beyond the scope of what a CVA can do. Recent decisions in relation to the Debenhams, Regis and New Look CVAs (Discovery (Northampton) Ltd and others v Debenhams Retail Ltd and others [2019] EWHC 2441 (Ch); [2019] EGLR 47, Carraway Guildford (Nominee A) Ltd v Regis UK Ltd [2021] EWHC 1294 (Ch) and Lazari Properties 2 Ltd v New Look Retailers [2021] EWHC 1209 (Ch); [2021] PLSCS 96) have largely confirmed the ability of companies to use CVAs in the way they have been, and have come down heavily in favour of retail tenants (with some limited exceptions).
Notwithstanding retailers’ successes in defending CVAs, their use has been curtailed dramatically since December 2020, following the reintroduction of HM Revenue and Customs’ preferential creditor status in respect of PAYE, VAT, employee national insurance contributions and Construction Industry Scheme deductions. CVAs cannot compromise debts due to secured creditors without preferential creditors’ consent and, to date, HMRC has maintained that their preferential status must be respected in any CVA proposals.
The English CVA has been used to successfully restructure English retailers’ UK and US store portfolios. For example, in 2020, clothing retailer All Saints implemented a CVA to restructure its liabilities to both its US and UK landlords. The CVA was recognised and given effect in the US under Chapter 15 of the US Code.
Save in the case of small companies (as defined under the Insolvency Act 1986) companies proposing CVAs do not obtain a moratorium on creditor action prior to creditors voting on the CVA unless the company enters administration first (whereupon the CVA will be proposed by the administrator rather than the directors). The problem with that is that CVAs as a rescue tool should be light-touch in nature and by definition; administration is not.
Restructuring plans
In a drive to keep UK companies competitive and to ensure that the UK kept pace with a general trend globally to provide debtors with a robust framework within which to restructure their affairs (more in the vein of US Chapter 11), in 2020 the UK government introduced a new restructuring tool in the form of the restructuring plan under the Corporate Insolvency and Governance Act 2020. The 2020 Act introduced a new part 26A into the Companies Act 2006, which can, in appropriate circumstances, be preceded by a restructuring moratorium.
A restructuring plan under Part 26A adopts the scheme of arrangement framework laid down by the 2006 Act with a few important twists, making them more suitable to companies in acute distress. First, where a licensed insolvency practitioner (known as “the monitor”) is of the belief that the company has a realistic prospect of successfully using the restructuring plan process to restructure its affairs, the company may apply for a moratorium to prevent hostile creditor action while the company formulates its plan. Further, while (unlike with a CVA) the restructuring plan must divide creditors into representative classes of creditors, it is open to the court to approve a restructuring plan against the wishes of a dissenting class (or classes) of creditors, provided that class would be no worse off under the restructuring plan than they would be in the alternative scenario (usually administration or liquidation). That is the case even if the dissenting class is a higher-status class of creditors than other classes beneath them that voted in favour – a significant departure from the so-called “absolute priority” rule.
This will be of relevance to those companies for which a CVA may not be viable due to HMRC’s preferential creditor status referenced above. In July, in Re Houst Ltd [2022] EWHC 1941 (Ch), involving a property management company offering services for short term lettings, Mr Justice Zacaroli exercised his discretion to approve the company’s plan despite HMRC (being the second ranking class of creditor out of six) opposing the plan.
As with a traditional scheme of arrangement, two court hearings are required: namely a convening hearing, approving the calling of a creditors’ meeting(s) and a sanction hearing, at which the court will approve the scheme or restructuring plan (or not). The professional costs involved in drafting schemes and the attendant costs of the two hearings has acted as a barrier to entry for many, historically. However, the Re Houst restructuring plan is being hailed by many as the precedent for small and medium enterprises to start using the process as a genuine alternative to a CVA.
Roll credits
As the UK emerges from the pandemic, the headwinds being faced by retailers and leisure operators cannot be overstated – supply chain issues, rising energy prices, changes in consumer habits/demand, the post-Brexit landscape, inflationary and interest rate pressures and geopolitical instability all point towards uncertain times ahead. UK-based restructuring professionals will have to use all of the tools in the kit to avoid large-scale business collapse and retailers will have to adapt in order to secure their future. Inevitably, commercial landlords will bear the brunt of many of those measures.
The late, great movie director Mike Nichols said of making films that “the only safe thing is to take a chance” – very fitting in the current economic climate.
The article was first published in EG (subscription required).
