Departing from creditor priority in English cram downs – no US style “absolute priority”
Under the English regime, where one or more meetings of creditors or members has not approved a plan of arrangement by the requisite majority, the court is empowered nevertheless to sanction the plan, by using the cross-class cram-down power. English cases are of interest since they are persuasive in the offshore jurisdictions. Harneys believes that cram downs, if implemented by future legislative change, would make a positive contribution to offshore restructuring.
In Houst Limited [2022] EWHC 1941 (Ch) Mr Justice Zacaroli approved a plan of arrangement under Part 26A of the English Companies Act 2006 cramming down the HM Revenue and Customs (HMRC) who objected to the plan.
In deciding whether a plan is a fair distribution of the benefits generated of the restructuring between those classes who have agreed and those that have not, a relevant reference point is the treatment of the creditors in the relevant alternative. The court will look to see whether the priority, as among different creditor groups, applicable in the relevant alternative is reflected in the distributions under the plan. A departure from that priority is not in itself, unlike the position in the closest equivalent procedure in United States federal bankruptcy law, the Chapter 11 plan, fatal to the success of the plan. The US Chapter 11 procedure contains an “absolute priority rule” so that, in essence, no junior class should recover until a senior class has recovered in full, and no senior class should recover more than it is owed. Given that consideration was given by the UK government to including a modified form of the absolute priority rule in Part 26A, its exclusion must be taken to have been deliberate.
In considering the fairness of the scheme more generally, particularly in the context of the exercise of the cross-class cram-down power, the present case involved a clear departure from the order of priority between creditors that would exist in the relevant alternative. In the relevant alternative, there would only be two creditors in the money: HMRC and the Bank.
In contrast, under the plan, the HMRC could expect to receive a higher dividend than in the relevant alternative and the Bank was to receive a significantly higher increase on its dividend (an additional 20p/£). However, in addition, ordinary unsecured creditors would receive a dividend of 5p/£, the shareholders have the prospect of, over time, owning an interest (albeit a very heavily diluted interest) in a solvent company, and the class of critical creditors will receive payment in full. The Court was satisfied that the better treatment afforded to critical creditors is justified on the basis that the Company’s ability to generate additional funds to pay an enhanced dividend to HMRC, and to other unsecured creditors, depends on its continued trading and that without paying critical creditors, the Company would be unable to trade. This is not, therefore, a case where assets that would have been available in the administration of the Company are being applied in a manner inconsistent with the order of priorities applicable in that administration. The plan was approved.
