Restructuring plans: effective but expensive

The Corporate Insolvency and Governance Act (CIGA) obtained Royal Assent in June 2020 and restructuring plans in the mid-market space are catching headlines with their increasing usage.

Whilst the restructuring plan is a powerful tool with the ability to deliver commercial compromise across a broad range of stakeholders, we have not yet seen wide adoption in the small and medium-sized enterprises (SME) market. The high cost in legal and professional advice is a substantial hurdle to their success.

What is a restructuring plan?

A restructuring plan (RP) is a compromise agreement with creditors and members.The agreement can include any commercial terms which the proposer considers suitable and fair but must be better than the relevant insolvency alternative. It is then for the stakeholders to decide whether they wish to accept the terms when they vote.

The directors can split the various stakeholders into several ‘classes,’ or groups, and offer different terms to each class within an RP.

This process is a similar approach to a Company Voluntary Arrangement (CVA). However, an RP has several additional powers including the ability to compromise secured and preferential creditors, restructure equity positions and ‘cram down’ dissenting classes of creditors.

Why use RPs?

In common with all insolvency processes, an RP seeks to achieve the best possible outcome for creditors. However, unlike most formal appointments, the directors remain in control of the business and continue trading through (and beyond) implementation of the RP.

This means that the outcome for creditors is not limited to the assets on hand at the point of restructuring or introduced by a third party. Creditors can also benefit from the future success of the company and trading cash flows it generates over several years.

Middle-market companies are increasingly using RPs. They are more familiar with the process, having seen it widely adopted by large entities, following the sanctioning of the first true mid-market RP in July 2022. This is proof that the process can be used for SMEs.

The use of CVAs has been waning following the -introduction of HMRC’s second preferential status in December 2020. This means a CVA can no longer mitigate the often-substantial HMRC debts and with secondary preferential status for all VAT and PAYE arrears. This can leave little or no funds available to critical trading partners to make a CVA or other restructuring commercially viable.

The RP enables a compromise of preferential creditors, secured lenders or even shareholders table through ‘cross class cram-down.’  Cross class cram down occurs when the court sanctions a RP, despite one or more classes of creditors not achieving the 75% support required in voting. The court must be satisfied that the dissenting class(es) are not worse off than the relevant alterative and it is deemed to be ‘fair’ – a broad term which leaves the decision very much to the judge’s discretion.

This means it is possible for a RP to break from the insolvency order of priorities in how it shares the available funds between creditors, and that it cannot be blocked by a single creditor for non-commercial reasons. What must be shown however, is that the proposal provides a better outcome for all stakeholders (including the dissenting creditor).

For example, scenarios which could be sanctioned under a RP but are beyond the remit of a CVA would include:

• proposing a return to unsecured creditors even if preferential or secured creditors are being asked to discount their debt positions
• diluting or subordinating existing shareholders to grant equity to a party who is injecting funds to support the restructuring.

What are the drawbacks?

CIGA introduced RPs in 2020. Before that, the most recent insolvency process to be introduced was Administration in 2002. Given the recent introduction of RPs, there is less precedent, guidelines and case law to rely on. There are also a couple of practical reasons why the process may not lend itself to the mid-market despite the enhanced powers and commercial outcomes which might be achieved.

Cost

• RPs are technical and involve (at least) two court hearings to be sanctioned. This requires substantial legal and professional support, both in crafting the terms of the RP itself, but also assessing creditors’ outcomes under the ‘relevant alternative’ and engaging with creditors to gain support for the proposal ahead of voting.
• While there are no publicly available figures, the cost of a recent uncontested RP is said to have been six figures. This puts an RP out of reach for distressed SMEs who cannot afford to implement the process, even if it would give the best outcome for creditors.

Dissenting creditors

• Each class of creditor in an RP has the right to vote in support or opposition of the proposed scheme.
• If there is insufficient support in any class, the court can still ratify the RP if it considers:
  • ono members of the dissenting class to be worse off under the RP
  • at least one class which is ‘in the money’ in the relevant alternative has approved the RP.
• It is then left to the court’s broad discretion whether to sanction the RP in context of all the circumstances of the case.
• However, the dissenting creditor(s) have the right to attend the second hearing and present their arguments and submit counterevidence to oppose the plan.
• This will not only result in additional cost to defend the RP in court, but it also increases the uncertainty that an RP will be ratified and achieve its aim.

As more cases are tested at court and precedents or guidelines are established for RPs, it is hoped that costs will reduce to more attainable levels for the average SME.  The powers and benefits of a RP are substantial, and the process supports a rescue culture for businesses. It is a missed opportunity if RPs cannot be used more widely than large restructurings.

There will be scenarios where a RP is the best available option for creditors, however the limiting factor will be the available funds needed to implement the process. Whilst the RP is a powerful addition to the restructuring toolkit, without further legislative changes to simplify the legal process, it is likely to remain out of reach for many corporates in the mid-market.

How can we help?

At Crowe, we have a team of experienced and licensed Insolvency Practitioners who can advise you on the best course of action, depending on your business’s circumstances. Please get in touch with either Steven Edwards or Vince Green who are licensed Insolvency Practitioners, or your usual Crowe contact.