Two high profile restructuring cases came before the courts this week, but under different circumstances.
On Tuesday, ailing fashion retailer New Look defended itself against a challenge from some of its landlords over the use of a Company Voluntary Arrangement (CVA) to help stave off administration. The following day, Virgin Active was in front of Mr Justice Snowden, hoping he would approve its restructuring plan under the UK’s new corporate insolvency regime.
In both cases, the judges struck down challenges from landlords.
New Look opted for a CVA to reset its rents and write down arrears to its landlords, after the company lost earnings through the pandemic, when it was forced to close its shops. While CVAs do not have to go through court, landlords can prompt a judicial ruling by objecting to the process. In New Look’s case, British Land and Land Securities, among other landlords, opposed the company’s terms.
Virgin Active, on the other hand, used the UK’s new restructuring law, in which a restructuring scheme has to be approved by a judge. The regime emerged in June last year, and was heralded as a huge leap forward by those in the restructuring industry, as it offered companies in distress greater flexibility to manage their capital structures.
The most important new power introduced was the “cross-class cramdown”, meaning creditors in a given class can be bound by agreements made by other classes of creditors, and be forced to accept a debt writedown.
A company needs the approval of 75% of the noteholders by value to pursue the restructuring. It was colloquially called the 'super scheme', in reference to it being more powerful than the long-standing scheme of arrangement legislation.
Under the new regime, the judge must find the plan has been approved by 75% of those voting in any class by value. Then, there is a ‘no worse off’ test, where a judge must consider whether any dissenting class is worse off under the proposal than the relevant alternative.
Under Virgin Active’s proposal, its shareholders — Brait with a 72.1% stake and Richard Branson with 17.85% being the largest — have offered to put in £45m to the company. Lenders will extend some £200m of debt facilities by three years to June 2025, as well as amending interest payments and relaxing financial covenants.
The landlords, which include Aberdeen Standard Investments, British Land and Land Securities, will write off and defer some arrears as well as reduce rent as the gyms reopen.
“If we hadn’t had the restructuring plan with Virgin Active, we’d have had to do both the CVA and scheme of arrangement — and the CVA would have failed,” said Paul Kirkbright, head of EMEA financial restructuring at Alvarez & Marsal, which advised more than 80% of the senior lenders in Virgin Active. “The restructuring plan is a mechanism whereby the weight of senior lenders can force the cramdown onto the landlords. Without the restructuring plan, Virgin Active would have been in administration.”
Though some of the landlords challenged the proposal, the judge approved the plan. The landmark judgement will likely prompt more companies to opt for the new corporate restructuring regime, over the CVA process which has been used extensively in the past by high street retail chains.
Bevis Metcalfe, head of Baker McKenzie’s restructuring team in London, said the judgement means restructuring plans have been shown to be a strong tool. “As expected of a process that allows for dissenting classes to be crammed down, the burden on a dissenting creditor to challenge the sanction of a plan — particularly where that creditor is out of the money and the other statutory tests have been met — is very high indeed.”
Hannah Valintine, a partner at Allen & Overy, which advised Virgin Active, said the ruling “provides significant guidance to the restructuring market on practical aspects of the new restructuring plan legislation which will assist practitioners greatly — both those with clients looking to promote and support a plan and those looking to challenge one.”
Step aside CVAs?
The Virgin Active case shows that the new regime can at least match a CVA process and, from the company's perspective, trump it.
Before the new restructuring regime came into in effect, UK companies would often have to run a dual process to restructure their debts. While a scheme of arrangement was used for the secured creditors, a CVA would be used for the landlords and unsecured creditors.
The CVA has its advantages. It can be quick and cost-effective. In theory, it sidesteps the courts. But, if challenged by one of the stakeholders, the CVA has to go through the courts — as happened with New Look. Challenges to CVAs for Debenhams and Regis are shortly to be heard as well. Moreover, critics say that CVAs often do not help companies back to full fitness.
Many of the major UK high street chains have already conducted CVA processes, sometimes more than one, in the past few years, but the sector is still struggling. Lockdowns have added to secular shifts to online shopping, declining footfall and high business rates. New Look’s CVA, for example, is its second in three years.
A CVA allows a company to write down liabilities if more than 75% of creditors by value agree, but it cannot touch secured debt. This makes a CVA a poor tool for cutting down bank or bond debt, which is usually secured — and means landlords are often the major creditor class that loses out. They tend to be minor creditors to any given chain, so can be played off against one another.
Mark Fine, a partner at McDermott Will & Emery, said that challenging a CVA successfully is hard. “There would be certain cases where unfair prejudice could be successful,” he said, also pointing to challenges on jurisdictional grounds as possibilities. “What will be interesting over the next few months is to see what the favourable route to restructuring is. With the new corporate insolvency regime, you now have the option of cross-class cramdowns.”
Cross-class cramdowns can only happen under certain conditions and with certain protections in place — for example, the judge approving the scheme must be satisfied that the creditors in question will be better off than in an insolvency — but it adds a lot of flexibility to the process.
Creditors can be separated into classes with different recovery profiles, but treated as one class when it comes to voting on approval for a restructuring. This is a powerful borrower-friendly shift, strengthening the hand of struggling companies and their advisers in negotiations.
Cross-class cramdown was only tried for the first time earlier this year, in the restructuring of offshore underwater services firm, DeepOcean — only the third company ever to use the new UK restructuring law, after Pizza Express and Virgin Atlantic.
Virgin Active’s restructuring proposal included an unprecedented 21 creditor classes — an approach that would be impossible if each creditor class had to approve a restructuring as a class, which is required under a scheme of arrangement. Under the super scheme, however, the cross-class cramdown capability makes these differences in treatment more manageable.
Landlords damned
Some landlords appear to dislike the provisions of the super scheme even more than the CVA, since it further limits their freedom of manoeuvre — and, once it has been endorsed by the courts, cannot be challenged.
“This is possibly the most significant development we will see this year,” said Katherine Campbell, head of real estate disputes at Reed Smith. “In allowing Virgin Active to cram down landlord creditors [as part of] its contentious restructuring plan, the courts have just cut off landlords at the knees.
"This is more than a set-back, the sector will likely now see cross-class cramdowns treated as a default option whenever a restructuring plan hits choppy water.”
Others argued, however, that landlords should feel better about super schemes than CVAs, since they mean that banks and bondholders share the pain too. Writing down financial creditors as well as landlords ought to mean better recoveries, if retailers and high street businesses turn first to the super scheme rather than a CVA.