Agreeing rescues with creditors

Seeking creditors’ approval of business rescues has recently increased – using company voluntary arrangements (“CVAs”) under Insolvency Act 1986, Part 1 and schemes of arrangement (“schemes”) under Companies Act 2006, Part 26. Both are flexible and can be combined with a moratorium (for a “small company” CVA, without needing administration) or a pre-pack business disposal from administration.

Some ground rules

A CVA is a proposal for a debt composition or other arrangement relating to the company’s affairs, to be implemented under supervision of an insolvency practitioner, initially as “nominee”. The nominee convenes meetings to approve the proposal, following, in the case of a directors’ proposal, a report to court by the nominee that the proposal has a reasonable prospect of being approved and implemented.

A CVA requires the approval of (broadly) 50% of shareholders’ votes and 75% of creditors (by value), following which a “supervisor” – normally the nominee – is appointed. Once approved, it binds all relevant shareholders and creditors, subject to challenge (within a limited time) on grounds of unfair prejudice or procedural irregularity.

It cannot affect secured creditors’ rights of enforcement, nor can it be restricted to specific classes of creditors.

Schemes are more often used for mergers and reorganisations of solvent companies than for companies with financial problems. Meetings of the relevant classes of shareholders and/or creditors are convened following a court application by the company, a creditor or shareholder, or the administrator or liquidator. Following approval by 75% (by value) of the classes concerned, the court must sanction a scheme before it becomes binding on all those in the relevant class(es).

Recent developments

CVAs have gained prominence following the approval in April of the CVA for JJB Sports. Rent on closed retail premises was discharged in exchange for a dividend from a fund established for the purpose. Rent on premises remaining open became payable monthly for 12 months. Other creditors were unaffected. A similar CVA was approved by the creditors of Focus DIY. There seems to be an emerging consensus regarding rescue terms in the current market, the keys to which appear to be transparency and the prospect of a better out-turn than administration, with or without a pre-pack business disposal.

Some have argued that JJB’s CVA could have been challenged as “unfairly prejudicial”: landlords of closed shops were treated less well than those whose shops remained open, or the other creditors. In Prudential Assurance Co v PRG Powerhouse [2007] EWHC 1002 (Ch), fairness between different classes of creditors was required, and landlords deprived of guarantees by the CVA were considered unfairly treated relative to other creditors. Powerhouse did not, however, exclude the possibility of different classes of creditors being treated differently. It is telling that with JJB the closed shops’ landlords appear largely to have voted in favour of the CVA.

CVAs may allow unsecured creditors to vote to treat some a bit better than others. Schemes permit majority secured creditors to impose a scheme and require a vote only of the classes of creditor affected.

Any value?

This latter point was emphasised in the IMO carwash schemes in August: Re Bluebrook Ltd [2009] EWHC 2114 (Ch). The schemes involved a complex debt for equity swap, business transfer (using pre-pack administration) and refinancing under which the original senior secured lenders acquired equity in the business and reduced their debt, leaving mezzanine secured debt to rank in the administration.

The mezzanine creditors objected, arguing that they were unfairly affected. It was accepted that a scheme could be proposed to whichever class or classes of creditors its proposer chose. It was also accepted that the effect of a scheme on other creditors was relevant to sanction by the court – but that in turn those “out of the money” at that time had no grounds for objecting to a scheme relating to another class of creditors.

All turned on the value of the business. In Re MyTravel Group

[2005] 2 BCLC 123 a liquidation valuation was used to assess the economic interest of bondholders excluded from the scheme. A valuation based on sale of the business as a going concern at the time was used for the IMO schemes. Values derived from an offer for the business and net present values assessed by PricewaterhouseCoopers from detailed data on the business (all less than the amount of senior debt) were preferred to a valuation using a statistical methodology which brought out a value from which some recovery might have been available to mezzanine creditors.

The IMO rescue could have proceeded through administration and pre-pack without the schemes had all the senior creditors agreed – though perhaps the valuation point would have been an issue.

What next?

CVAs have asserted themselves as an option in the rescue toolbox. The risk of unfair prejudice challenge remains where one type of creditor is seen to gain advantage over another. Schemes may offer a solution in such cases, but remain more complex and expensive than CVAs. Unless it is necessary to impose a rescue on minority secured creditors, or certain classes of creditors are “out of the money”, a CVA seems the initial option to consider.

Dr Hamish Patrick and Alistair Burrow, Partners, Tods Murray LLP