The English Court has refused to sanction two separate restructuring plans proposed by Nasmyth Group Limited (Nasmyth) and The Great Annual Savings Company Ltd (GAS). Both companies sought to use Part 26A of the Companies Act 2006 to “cram down” His Majesty’s Revenue and Customs (HMRC). Whilst neither decision is the first time that Part 26A has been used in this way1, they are the first to involve any active participation by HMRC in the sanction hearing2.
There is no doubt that the decisions are significant for companies considering a restructuring plan (Plan) which would involve a compromise of amounts owed to HMRC. However, both decisions are fact specific, as we consider in further detail below.
Our key takeaways from the decisions are:
- The English Court will not refuse to sanction a Plan as a matter of principle because it involves the cram down of HMRC.
- However, the English Court will “exercise caution in relation to HMRC debts” and will not cram down HMRC “unless there are good reasons to do so”.3
- Part 26A of the Companies Act does not preserve the order of priorities that would otherwise apply in an insolvency and so a Plan which proposes a different order of priorities which results in unsecured creditors receiving more favourable treatment than HMRC (in its capacity as preferential creditor) may be justified but only if there is good reason for it.
- A creditor wishing to challenge the company’s valuation evidence as to the position in the relevant alternative does not necessarily need to put forward expert evidence of its own. The burden of proof is on the company to show that, on the balance of probabilities, the opposing creditor would be no worse off under the Plan than in the relevant alternative, and it is open to the Court to conclude that the company has not discharged this burden without competing expert evidence. This does appear to be a slight departure from the position in previous cases and there is no clear guidance as to the circumstances in which expert evidence will be required. What is clear is that a creditor wishing to challenge a company’s valuation evidence will, at the very least, need to participate in the sanction hearing; the facts of each case will determine whether expert evidence is required.
- When considering the expert evidence relied on by the company, the Court will make an allowance for the experience and expertise of the expert but will expect the expert to have independently scrutinised and analysed the figures provided to them by the company.
- The exercise of the Court’s discretion to sanction a Plan may involve a consideration of the distribution of benefits generated by the restructuring between those creditor classes who have agreed to the Plan and those who have not, and whether the distribution is fair - if the Plan does provide a fair distribution, it will likely indicate that the negative vote of the opposing class was not rationally motivated and would support the Court sanctioning the Plan; if the Plan does not provide a fair distribution, it will likely indicate that the opposing class of creditors did vote rationally and would support the Court refusing sanction.
- A company wishing to use a Plan to compromise amounts owed to HMRC should therefore give careful consideration to the terms of the compromise.
Nasmyth – further detail
The principal features of the Plan proposed by Nasmyth were, relevantly:
- The senior secured lender would waive existing defaults and be unable to take enforcement action for three months following sanction but there would be no compromise to the amount of its debt or its security.
- The junior secured lender would make available the balance of an existing facility (which amounted to approximately GBP8 million) on new terms, together with a new committed tranche of GBP1 million. The repayment date would be extended but there would be no compromise to the amount of the junior secured lender’s debt or its security.
- The claims of preferential creditors would be compromised in full for GBP10,000 to be distributed on a pari passu basis. HMRC was the only preferential creditor.
- The claims of “critical supply creditors” identified by Nasmyth would be unaffected by the Plan and be repaid in full.
Nasmyth relied on two expert reports from BTG to demonstrate that (i) the relevant alternative to the Plan was administration, and (ii) no member of an opposing class of creditors would be worse off under the Plan than they would be in administration. BTG estimated the returns to creditors under the Plan vs in administration to be as follows:
Conditions A and B satisfied?
There was no direct challenge to the expert evidence of BTG and the Court accepted that neither HMRC nor the unsecured creditors who opposed the Plan would be worse off under the Plan than if Nasmyth had gone into administration. The Court also accepted that the Plan had been approved by at least 75% in value of a class of creditors who would receive a payment or have a genuine economic interest in the event of the relevant alternative. Condition A and Condition B were therefore satisfied.
The key question in Nasmyth was whether the Court should exercise its discretion to sanction the Plan and cram down HMRC. The Court declined to do so on the basis that it would be unfair to HMRC.
There are a number of key takeaways from the judgment regarding the exercise of the Court’s discretion in this case:
- The Court accepted that it will not usually be unfair to cram down unsecured creditors who would be out of the money if the company went into insolvent administration. However, it also considered that “there may be circumstances in which the out of the money creditors have a legitimate interest in opposing the Plan.”
- Although it was accepted that HMRC would be out of the money if Nasmyth went into administration, the Court considered that HMRC retained a genuine economic interest if Nasmyth went into administration for two reasons: (i) the Group companies owed HMRC approximately GBP3 million and Nasmyth’s subsidiaries would continue to owe HMRC approximately GBP2.6 million if Nasmyth went into administration, and (ii) the success of the Plan depended on HMRC agreeing Time to Pay (TTP) arrangements with Nasmyth’s subsidiaries if the Plan was sanctioned.
- It was accepted that the Court should not refuse to sanction a Plan as a matter of principle because HMRC will be crammed down. However, the Court was also satisfied that “the court should exercise caution in relation to HMRC debts” and “not cram down the HMRC unless there are good reasons to do so.”
- The key factor which resulted in the Court refusing to sanction the Plan was Nasmyth’s failure to agree TTP arrangements with HMRC – HMRC debts were critical to the survival of Nasmyth and the wider Group because HMRC were not prepared to agree TTP arrangements unless they included the full amounted owed to HMRC by Nasmyth.
- Nasmyth could have taken the view that it was in its commercial interests to treat HMRC as an essential or critical creditor for this reason, but did not do so. This was said to be “striking” when compared with the debts considered to be essential or critical (which included amounts due to trade associations and a recruitment agency).
- The Court noted that Nasmyth’s directors and secured creditors “appear to have seen the Plan as a convenient opportunity to eliminate the debts which [Nasmyth] owed to HMRC for a nominal figure and to use the Plan to put pressure on HMRC to agree new TTP terms.” The Court was clear that this is not a purpose for which Part 26A should be used.
GAS – further detail
The principal features of the Plan proposed by GAS were, relevantly:
- The debt owed to the secured creditor would be converted to equity in GAS’ parent company, with the new shares to be redeemed and the debt repaid (either in part or in full) if the group returned to profitability within a certain timeframe.
- Amounts due to “connected party creditors” (being directors’ loans) would remain outstanding and be repaid in full at a future date if / when sufficient cash became available.
- HMRC would receive a return of approximately GBP600,000 – the equivalent of 9.1p/GBP.
- Certain trade creditors, who were considered by the board / management of GAS to be essential to GAS continuing to trade (and therefore designated as “Critical Creditors”), would be paid in full.
Condition A satisfied?
HMRC did not accept that it would be no worse off under the Plan than in the relevant alternative (being administration). In particular, HMRC challenged GAS’ expert evidence regarding the recovery of book debts (essentially unpaid commissions) in the event of an administration – those book debts had a book value of GBP18.2 million as at November 2022 but GAS’ valuation of the book debts in the event of administration (based on a report prepared by Cerberus Receivables Management Limited (CRM)) estimated a “high case” recovery of 2.8% and a “low case” recovery of zero. On GAS’ “high case” in administration, HMRC would recover GBP307,000 whereas under the Plan, HMRC would receive GBP600,000 in total – a difference of only GBP293,000. HMRC argued that if the valuation of the book debts was even slightly wrong, it would be enough to wipe out this difference.
GAS argued that its valuation evidence should be accepted because the estimated returns from book debts were supported by the valuation work undertaken by its experts, and HMRC had not put forward any competing evidence. GAS relied on the comments made by Lord Justice Snowden in Re Smile Telecom Holdings Ltd to the effect that a creditor wishing to oppose a plan on the basis that the company’s valuation evidence was wrong should file expert evidence of its own.
The Court did not accept that Lord Justice Snowden was laying down an invariable rule in Smile Telecoms that, in the absence of expert evidence from an opposing party, the Court is bound to accept the valuation evidence put forward by the company – whilst it was accepted that it may be necessary for an opposing party to put forward expert evidence in some cases, the Court did not consider that it would be required in every case.
The Court stated that if, on the face of the evidence put forward by the company, there are manifest errors, inconsistencies or other matters which are not properly explained, it must be open to the Court to conclude that the company has not discharged the burden of showing that the opposing class of creditors will be no worse off.
The Court also noted that the figures put forward by CRM in their valuation of the book debts appeared, for the most part, to be figures provided by GAS and did not appear to have been independently scrutinised by CRM. Therefore, whilst the Court was willing to make some allowance for CRM’s experience and expertise, it wasn’t persuaded by the valuation.
For these reasons, the Court was not satisfied that HMRC would be no worse off under the Plan than in the relevant alternative.
The Court also considered whether it would have exercised its discretion to sanction the Plan if Condition A had been satisfied. The main dispute between HMRC and GAS on this point was whether the Plan was fair and should be imposed on HMRC.
In cases where the interests of the creditors who have agreed to the Plan are very different to those of the opposing creditors, the Court considered that the question to be asked is whether the Plan provides a fair distribution of the benefits generated by the restructuring between those classes who have agreed to it and those who have not, notwithstanding that their interests are different. If it does provide a fair distribution, that is likely to indicate that the negative vote of the opposing class was not rationally motivated and would support sanctioning the Plan, despite the opposing class of creditors not having approved it. If the Plan does not provide a fair distribution, that is likely to indicate that the opposing class of creditors did vote rationally, and would support the Court refusing sanction.
In GAS, only 4 creditor classes were in the money and of those, the major creditors were the Secured Creditor and HMRC. The Court therefore expected the interests of the Secured Creditor and HMRC to be at the forefront of the Plan. However, whilst the Secured Creditor was a primary beneficiary of the Plan, HMRC was not – its debt was being substantially eradicated for the future benefit of the Secured Creditor and existing shareholders / connected party creditors, whose debts would be deferred but repaid in full at some point in the future. The Court therefore considered the distribution of benefits to be disproportionately allocated to the Secured Creditor, existing shareholders and connected party creditors, and unfair to HMRC.
Tax as a special debt?
Parliament had as recently as 1 December 2020 changed the law to recognise the importance of HMRC debts by the establishment of secondary preference for such debts (please see our previous insight piece detailing this change), so any Court endorsed departure from this priority is clearly significant. Given the importance of the integrity of the taxation system, the Court has demonstrated that it will have public policy and precedent considerations in its rear view mirror when considering the compromise of tax debts in the way sought in the GAS and Nasmyth restructuring plans.