Houst Limited Restructuring Plan: High Court Sanctions SME Restructuring Plan to Cram Down HMRC

 
August 22, 2022

On 22 July 2022, the English High Court sanctioned Houst Limited’s (“Houst” or the “Company”) restructuring plan (the “Restructuring Plan”), which significantly, is the first time a Restructuring Plan has been used to cram down HM Revenue & Customs (“HMRC”) as preferential creditor.1

Background

Houst provides property management services in respect of short-term holiday lets. The Company assists homeowners who are looking to rent their properties on a short-term basis by listing the property on different platforms and managing bookings and logistics. In exchange, the Company takes a share of the amounts paid by customers for booking the properties.

Since March 2020, the Company’s business has been severely impacted by the coronavirus pandemic and the ongoing effect that the pandemic has had on the travel industry.

Since January 2020, the Company had been unable to service its loan obligations to its secured creditor, Clydesdale Bank Plc (the “Bank”).  Further, three of the Company’s creditors had either threatened winding-up petitions against the Company and/or served statutory demands on the Company. These creditors were, (i) HMRC (as preferential creditor) in respect of sums owed to it, (ii) Almaviva Services SRL (“Almaviva”), a call center provider, which was owed approximately £385,000, and (iii) Citiclient (CPF) Nominees No 2 Limited (“CPF”), the Company’s former landlords, who were owed approximately £112,000. The Company did not have sufficient cash to meet these demands and was both cash flow and balance sheet insolvent.

The Restructuring Plan

The Company proposed the Restructuring Plan so as to enable it to return to solvency and to ensure a better return for the Company’s stakeholders. The Company submitted that if the Restructuring Plan were not sanctioned, it would most likely enter into administration (the “Relevant Alternative”), under which, only the Bank and HMRC would receive any dividend.

For the purposes of proposing the Restructuring Plan, the Company proposed six class meetings comprising (i) the Bank as secured creditor, (ii) HMRC as preferential creditor, (iii) certain trade creditors, (iv) convertible loan note holders, (v) a connected party creditor, and (vi) equity.

Pursuant to the terms of the Restructuring Plan, the Company proposed to make certain payments to the Bank, HMRC and certain of its other creditors, as set out in further detail below. The Company also intended to (i) issue new preference shares in return for a new capital injection by electing shareholders, and (ii) convert the Company’s existing preference shares into ordinary shares.  

Creditor

Anticipated return in the Relevant Alternative

Treatment under the Restructuring Plan

Liabilities owing to the Bank consisting of: (i) a £400,000 overdraft facility; and (ii) a £2,365,000 term loan2

8p/£

The Bank will receive £750,000, of which £500,000 will be provided by shareholders within 10 days of the Restructuring Plan becoming effective, followed by a further £250,000 to be paid over three years, altogether equalling a return of 27p/£

HMRC (preferential creditor) liabilities in the sum of £1,775,238

15p/£

HMRC will receive £12,000 per month for the first 12 months from the Restructuring Plan taking effect, then £20,000 per month for the following 12 months, altogether equalling a return of 20p/£

Trade creditor liabilities in the sum of £1,643,000, which includes sums owed to Almaviva and CPF

Nil

To receive a dividend out of the unsecured creditor payment fund, with an expected return of 5p/£

Convertible loan holders and loan note holders, who were owed £3,298,000

Nil

Given the opportunity to either (i) participate in the capital injection under the Restructuring Plan in exchange for new preference shares and to convert their existing debt into ordinary shares, or (ii) remain unsecured creditors and be paid out of the unsecured creditor payment fund.

 

Homesorted Limited, a connected party creditor, who was owed £494,000

Nil

Nil, but would benefit from the survival of the Company

Critical suppliers, who were owed £326,000

Nil

Excluded3

Customer liabilities in the sum of £658,000

Nil

Excluded3

Employees

Certain preferential payments

Excluded3

Members

Nil

Diluted – new shares issued in exchange for capital injections and certain preference shares to be converted into ordinary shares

Each class of creditor voted in favour of the Restructuring Plan save for HMRC who opposed the plan on the basis that the effect of the plan would be for HMRC to relinquish its preferential creditor status by allowing dividends to be paid to unsecured creditors in priority to it.

As such, the sanctioning of the Restructuring Plan turned on the court’s power to exercise its discretion to impose a cross class cram down on a dissenting class of creditors (or members), for which it must be satisfied that: (Condition A) no member of the dissenting class would be any worse off than in the relevant alternative; and (Condition B) one class, that is “in the money”, votes in favour of the plan.

Outcome

After careful consideration, the court was satisfied that the Restructuring Plan should be sanctioned for the following reasons.

Cross class cram down

  • Condition A: Under the Relevant Alternative, there would only be two creditors “in the money”, HMRC and the Bank. HMRC adduced no evidence disputing the Company’s valuation evidence, and in fact acknowledged that it was expected to receive a greater dividend under the Restructuring Plan than under the Relevant Alternative. As such the court was satisfied that HMRC would be no worse off as a result of the Restructuring Plan being sanctioned.
  • Condition B: The only creditor that would have a genuine economic interest in the Relevant Alternative is the Bank, who voted in favour of the Restructuring Plan, satisfying this condition.

General Discretion

  • The court has a general discretion to sanction a restructuring plan. Little guidance is provided under the relevant legislation, however, our legal updates on the Hurricane Energy restructuring plan here and the Amicus Finance restructuring plan here include summaries of the legal framework for the sanctioning of a Part 26A restructuring plan, including the legal principles applicable to the use of the court’s cross class cram down power.
  • As to the key factors for the court to consider, the court was satisfied that the relevant legislation had been compiled with, the relevant statutory majorities had been obtained in all but one class (HMRC), the explanation of the plan to creditors was fair and accurate, creditors were fairly represented, and the plan was otherwise considered fair.
  • In coming to its decision, the court considered whether the plan provided for a “fair distribution of the benefits generated of the restructuring” between the classes who had voted in favour of the plan and those who had not.
    • The court considered whether it was fair for the plan to override the absolute priority rule. The absolute priority rule (a feature of U.S. Chapter 11 proceedings) provides that no junior class of creditor should receive any payment until a more senior dissenting class of creditor is paid in full. Pursuant to the terms of the Restructuring Plan, it was proposed that the Company’s ordinary unsecured creditors would receive a payment in circumstances where HMRC (being a more senior ranking preferential creditor) would be left impaired.
    • The court acknowledged that the treatment of creditors in the Relevant Alternative is a “relevant reference point” in determining the fair distribution of the benefits generated of the restructuring. However, the court ultimately determined that it was “not fatal to the success of the plan” to depart from the statutory order of priority which would apply in the Relevant Alternative. In particular, Justice Zacaroli noted that the exclusion of the absolute priority rule from the restructuring plan’s enacting legislation, the Corporate Insolvency and Governance Act 2020 (“CIGA”), should be taken to be deliberate. During the consultation phases for CIGA, the application of the absolute priority rule was specifically considered by the Government, with the view being taken that the application of the absolute priority rule could act as an impediment to the rescue of certain companies on a going concern basis, as certain creditors could use the rule to hold out for better terms in any proposed restructuring.
    • In considering whether there had been a fair distribution of benefits of the restructuring, the court turned its attention to the source of such benefits, which, in this case, were injected by participating shareholders. The court noted that these funds were being made available to provide essential liquidity for the Company necessary for it to achieve a successful rescue. Absent the Restructuring Plan, such monies would not have been made available to HMRC for payment in the Relevant Alternative. Whilst a successful restructuring would result in unsecured creditors receiving a payment in circumstances where HMRC remained impaired, HMRC was not being deprived of a benefit which would otherwise have been available to it in the Relevant Alternative.
  • Requiring the Company to restart negotiations with HMRC in order to achieve a different restructuring outcome would place a disproportionate burden on the Company, particularly given its size. Further, it was unclear whether a different proposal would result from renegotiations given that HMRC’s position was not well known.
  • The court noted that HMRC was a “sophisticated creditor able to look after its own interests”. It neither sought to engage with the Company or negotiate an alternative deal, nor did it choose to oppose the Restructuring Plan at the sanction hearing or present any arguments against it.
  • The court placed little weight on the votes of the other consenting classes, given that they would all be “out of the money” in the Relevant Alternative.
  • The evidence unequivocally showed that all creditors (including HMRC), would be worse off if the court refused to sanction the Restructuring Plan.

Significance

In the circumstances, the Company was permitted to request that the court impose a cross class cram down on HMRC with the support of the Bank (despite the Bank being in a class of its own). The court was satisfied, in this case, that it was not abusive for a cross class cram down to be utilised with the support of one creditor. However, the court held that attempts to artificially create an in-the-money class of creditor for the purposes of providing an anchor creditor so as to propose a cross class cram down should be resisted, and will be subject to close scrutiny by the court.

Following the reintroduction of Crown Preference (which provides HMRC with a preferential right of payment in any formal insolvency proceeding), going forward there are likely to be a significant number of companies with arrears outstanding to HMRC. Amounts outstanding to HMRC cannot be compromised pursuant to a company voluntary arrangement without its consent. Accordingly, following Houst, it is likely that an increasing number of companies will seek to utilise restructuring plans in order to cram down HMRC if they are unable to agree appropriate arrangements on a consensual basis.

The case highlights how the rights of shareholders can be varied using new tools available pursuant to the restructuring plan to amend the rights of equity – in this case the Company’s preference shares were converted into ordinary shares and diluted.

Amicus Finance and Houst illustrate how the restructuring plan can be used by small to medium-sized enterprises (“SMEs”) to restructure their liabilities and be rescued on a going concern basis. Whilst it was always the stated intention of the Government for restructuring plans to be utilised by companies of all sizes (including SMEs), in practice, the cost of using a restructuring plan is not insignificant and was considered by many to be prohibitive in the SME market. The English court has recognised the need for proportionality with regard to the disclosure requirements and other evidential hurdles for companies when proposing a restructuring plan. It is therefore hoped that, whilst seeking to maintain the integrity and credibility of restructuring plans, over time as more companies seek to utilise the restructuring plan, the barriers to entry will reduce and permit greater access to this comprehensive restructuring tool.

Footnotes

  1. In the matter of Houst Limited [2022] EWHC 1941 (Ch).
  2. Secured by a Debenture dated 28 January 2020 granted by the Company.
  3. Notwithstanding that these creditors were excluded from the Restructuring Plan, they were to be paid in full given the impact non-payment would have on the Company’s ability to continue trading.

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