A series of recent decisions have considered the court's power to cram down HMRC as a dissenting creditor under s 901G Companies Act 2006 where a Part 26A CA 2006 restructuring plan effectively seeks to benefit creditors and shareholders of the company at HMRC's expense.
The first cram down of HMRC was in Re Houst Ltd  EWHC 1941 (Ch) (see FC Case Feature 16 August 2022). HMRC did not attend the sanction hearing to oppose the plan in that case but in some more recent cases, HMRC has put forward strong and extensively argued opposition at the sanction hearing. In Re Nasmyth Group Ltd  EWHC 988 (Ch), the court declined to exercise its discretion to sanction a Part 26A restructuring plan opposed by HMRC on the basis that it was unfair. In Re Great Annual Savings Co Ltd  EWHC 1141 (Ch), arguments put forward by HMRC helped to establish that the jurisdictional requirements for cram down of HMRC debts were not met. The court, in any event, would have declined to sanction the plan because its proposed treatment of HMRC was unfair.
However, most recently, in Re Prezzo Investco Ltd  EWHC 1679 (Ch), the court was prepared to cram down HMRC as a dissenting creditor where, among other things, almost all of the restructuring surplus to be generated by the plan (being the value or potential future benefits which the use of the company's business and assets might generate following the restructuring) was allocated to HMRC following engagement by the company to address HMRC's concerns.
Q&A references are to FromCounsel's Schemes of arrangement content, unless otherwise indicated.
Cross-class cram down
The court may sanction a restructuring plan if 75% by value of individual classes of the company's creditors vote in favour of the plan (s 901F CA 2006). Where one or more classes dissent, the court is not prevented from sanctioning the plan and 'cramming down' the dissenting creditors, provided that the following conditions in s 901G CA 2006 are met (see Q&A here):
- Condition A – the court must be satisfied that none of the members of the dissenting class would be any worse off under the plan than they would be in the event of the relevant alternative (the 'no worse off' test); and
- Condition B – the compromise or agreement must have been agreed by at least one class meeting, the members of which would receive a payment or have a genuine economic interest in the company, in the event of the relevant alternative.
The 'relevant alternative' is 'whatever the court considers would be most likely to occur in relation to the company' if the restructuring plan were not sanctioned under s 901F (s 901G(4)).
If these conditions are met, the court still has a discretion as to whether to sanction the plan (see Q&A here).
Nasmyth Group Ltd (Nasmyth) is the holding company of a group of companies (Group) operating in the aerospace industry. The Group experienced financial difficulties due to the COVID-19 pandemic and its impact on the civil aviation industry. After Nasmyth became cashflow insolvent, it proposed a restructuring plan, one of the objectives of which was to allow the Group to continue to benefit from a loan facility extended by one of its secured lenders.
One of Nasmyth's main creditors was HMRC, to which Nasmyth owed preferential and unsecured debts totalling £472,308.44. Under the restructuring plan, both HMRC's preferential and unsecured claims would be compromised in full for a payment of £10,000 each. The restructuring surplus would be divided between two secured lenders (Senior and Junior Secured Creditors), such that the quantum and security of their claims would not be compromised. Nasmyth contended that the relevant alternative to the plan was administration, in which the Senior and Junior Secured Creditors would receive either full or partial repayment and all other creditors, including HMRC, would receive nothing.
Following the convening hearing (Re Nasmyth Group Ltd  EWHC 696 (Ch)), the plan was approved by the requisite majority in all creditor classes apart from the preferential creditor class, of which HMRC was the sole member.
At the sanction hearing, HMRC and two unsecured creditors opposed the plan on the basis that it was unfair. HMRC also alleged that there was a 'blot' preventing the plan from taking effect, as the plan was dependent on HMRC entering into 'time to pay' (TTP) arrangements with a number of Nasmyth's subsidiaries, proposals for which HMRC had rejected.
Leech J was comfortable that Conditions A and B in s 901G were satisfied without issue. With regard to Condition A, neither HMRC nor the unsecured creditors would be worse off under the plan than they would be if the company went into insolvent administration, which was the relevant alternative. Notably, during the sanction hearing, Nasmyth's board resolved to file a notice of intention to appoint administrators if the plan was not sanctioned. HMRC and the unsecured creditors argued that this move was intended to "hold a gun to the head" of the court. Although Leech J agreed that the company's board of directors appeared to be "jumping the gun" by filing a notice of intention to appoint administrators before the court had decided whether to sanction the plan, he was satisfied that the board's decision represented the genuinely held views of the directors. Condition B was also satisfied because at least one class of creditors that would receive a payment or have a genuine economic interest in the event of Nasmyth's administration had voted in favour of the plan.
The main issue before the court was therefore whether it should exercise its discretion to sanction the plan. Leech J began by considering the principle established in Re Virgin Active Holdings Ltd  EWHC 1246 (Ch) (see FC Case Feature 3 June 2021) that it is for the 'in the money' creditors to determine how any potential restructuring surplus should be divided up. In his view, this was not a rigid rule and there could be circumstances in which 'out of the money' creditors had a legitimate interest in opposing the plan. In any event, following the approach taken by Trower J in Re DeepOcean 1 UK Ltd  EWHC 138 (Ch) (see FC Case Feature 8 February 2021), the court had to take into account all the legal consequences of the plan for the relevant class of creditors in deciding whether they would be worse off under the plan, including the group-wide consequences. In this case, although it would be out of the money if Nasmyth went into administration, HMRC would remain one of the largest creditors of the Group and it would be open to HMRC to negotiate more satisfactory TTP arrangements with the Group's administrators than it would be required to agree if the plan was sanctioned. Accordingly, Leech J found that HMRC had a genuine economic interest in Nasmyth and weight could properly be attributed both to HMRC's vote against the plan and to its interests.
As to the proposed distribution of the restructuring surplus, Leech J concluded that it would be unfair to sanction the proposed arrangement enabling Nasmyth to cram down the debts owed to HMRC. In his view, there was potential for Part 26A to become an "instrument of abuse" where a company had been trading at the expense of HMRC and the court should generally exercise caution in relation to HMRC debts. In this case, sanction of the proposed plan could give a "green light" to companies to use restructuring plans to cram down their unpaid tax bill. In reaching this decision, Leech J took the following factors into account:
- the size of the debts owed to HMRC (£472,308.44);
- that part of the debt ranked as a secondary preferential debt;
- that the Group owed approximately £3 million to HMRC;
- that some of the debts went back as far as January 2020; and
- that HMRC was only given a "tiny" share of the restructuring surplus under the plan.
The balance was tipped against sanction of the plan by Nasmyth's failure to agree TTP arrangements with HMRC before putting the plan forward. Leech J noted that Nasmyth appeared to have seen the plan as "a convenient opportunity to eliminate the debts it owed to HMRC for a nominal figure and to use the plan to put pressure on HMRC to agree new TTP terms" which was not the purpose for which Part 26A should be used. The judge also found that the failure to reach the required agreement as to new TTP terms with the Group constituted a 'roadblock' (or blot) that would prevent the plan from taking effect in the manner in which the company and its creditors intended.
The Great Annual Savings Company Ltd (GAS) was a broker of energy supply contracts between energy suppliers and business users. Due to the impact of the COVID-19 pandemic on its business and volatility in the energy pricing market, GAS found itself in serious financial difficulties and a winding-up petition was brought against it by HMRC in November 2022. A restructuring plan was proposed which aimed to reduce GAS's debt exposure and, in appropriate cases, defer payment terms to improve the pressure on cashflow, enabling GAS to continue trading and return to profitability over time. The broad terms of the plan were as set out below.
- Secured Creditor – GAS's lender would receive a partial debt for equity swap and there would be a reduction of GAS's secured liabilities from £28 million to £4.5 million.
- Secondary Preferential Creditor – HMRC, the sole member of this class, would receive a dividend of 9.1p in the £ payable over two years, leading to a reduction of GAS's tax liabilities of some £6.6 million to £600,000.
- Other creditors and shareholders – other classes of creditor, and the shareholders of GAS, would receive varying deals according to their class.
It was not disputed that the relevant alternative to the plan was administration and GAS put forward projections indicating the amounts which several creditors, including HMRC, would recover in the best and worst-case scenarios. In the 'high case', HMRC would receive 5.2p in the £ while, in the 'low case', it would receive nothing. All other creditor classes would receive nothing in the case of administration.
Following the convening hearing (Re The Great Annual Savings Company Ltd  EWHC 1026 (Ch)), the plan was approved by 100% of claim value in 12 of the classes of creditors but not by the requisite majority in the other 3 classes. The Secondary Preferential Creditor class (of which HMRC was the sole member) voted against the plan.
At the sanction hearing, HMRC and four creditors opposed the plan. While it was common ground that Condition B in s 901G was satisfied, the dissenting creditors contended that the court should not exercise its cram down power on the basis that:
- the 'no worse off' test in Condition A was not satisfied; and
- even if the jurisdictional requirements were satisfied, the court should not exercise its discretion in favour of sanction because the plan operated unfairly.
1. Was the 'no worse off' test in Condition A satisfied?
Adam Johnson J concluded that GAS had not discharged the burden of showing that HMRC would be 'no worse off' under the plan. As GAS's projections showed a return to HMRC that was only marginally better than that expected in administration, any viable challenge to the assumptions underlying those projections would be likely to give rise to a finding that HMRC would be better off in the relevant alternative. In this case, viable challenges included that the assumptions took too pessimistic a view of likely recoveries and ignored the possibility of future claims that might be made by insolvency officeholders against third parties.
Adam Johnson J rejected GAS's argument that, as HMRC had not filed expert evidence of its own, the court should accept the calculations put forward by the company. In his view, Re Smile Telecoms Holdings Ltd  EWHC 740 (Ch) (see FC Case Feature 4 April 2022) should not be read as laying down a rule that, in the absence of evidence from an opposing party, the court is bound to accept the valuation analysis put forward by the company. Scrutinising the company's proposals was an important part of the court's function in considering a plan under Part 26A and, in this case, Adam Johnson J was not convinced by the robustness of the conclusions reached in GAS's valuation analysis, not least because the figures put forward appeared to be the company's figures "unfiltered by any independent scrutiny or analysis".
The judge also rejected the argument that potential future tax payments from GAS constituted a benefit to HMRC that should be taken into account for the purposes of the 'no worse off' test. Not only did this incorrectly assume that any future tax benefits would be lost to HMRC in the relevant alternative, the benefits flowing from such future payments were also "too remote from the plan" to be relevant in applying the test.
2. Should the power to sanction be exercised in any event?
Even if the conditions in s 901G had been satisfied, Adam Johnson J indicated that he would have declined to sanction the plan anyway on the basis that it was unfair.
The pertinent question for this purpose was whether the plan provided a fair distribution of the benefits generated by the restructuring between those classes who had agreed to it and those who had not, notwithstanding that their interests were different. If the distribution was not fair, this would indicate that the dissenting class had voted rationally and would support the court refusing sanction. In this case at least, Adam Johnson J considered that it was useful to have in mind: (i) the existing rights of the creditors and how they would fall to be treated in the relevant alternative; (ii) what contributions they would be expected to make to the success of the plan; and (iii) whether they would be disadvantaged under the plan as compared to the relevant alternative and whether such difference in treatment was justified.
As a major creditor, HMRC had the most significant economic interest in GAS along with the Secured Creditor and it was, in the court's view, principally for these two 'in the money' parties to determine how to allocate any value or potential future benefits generated following implementation of the plan. The plan was intended to stabilise GAS and return it to profitability, not by the introduction of any new money, but by writing down or deferring debt payments and directing the cash made available towards creditors who were considered able to assist with generating revenue. The mechanism for achieving this objective involved both the eradication of HMRC's existing debt and prioritising payments to various unsecured creditors who would have been treated less favourably than HMRC in the relative alternative.
The issue in terms of the basic fairness of the plan was that it was not HMRC who was intended to benefit from the intended future growth and value creation, brought about (in material part) by the eradication of HMRC's debt. Instead, the primary beneficiaries were intended to be the Secured Creditor and the existing shareholders/connected party creditors. Referring to Re Virgin Active, Adam Johnson J noted that the treatment of existing shareholders under a restructuring plan can raise particular difficulties. In that case, the retention of equity by the existing shareholders was justified both on the basis that that was the wish of the senior secured creditors, and on the basis that the existing shareholders were injecting new money. In this case, there was no new money and while the proposed treatment of the existing shareholders was supported by the Secured Creditor, HMRC had made it clear that it had no faith in the existing management team and had expressed a strong preference for an insolvency process so that their conduct could be investigated.
Taking into account HMRC's views, and while there was nothing inherently objectionable in a plan proposing a different order of priorities than would apply in the relevant alternative (per Zacaroli J in Re Houst), the judge considered that GAS had not given a sufficiently good reason for the re-ordering of priorities under the plan. Given the extent of GAS's debt to HMRC, there was a requirement for "real discernment" in the selection of 'out of the money' creditors who would benefit under the plan "effectively at HMRC's expense". In this case, the justification for the less favourable treatment of HMRC under the plan appeared to be only that HMRC did not intend to assist the company with generating any restructuring surplus.
Prezzo Investco Ltd (Prezzo) is the parent company of a subsidiary which operated an Italian restaurant chain business. Prezzo had relied on funding provided under secured loan notes that had been issued by it to the majority of its shareholders (Secured Loan Noteholders). By April 2023, due to the COVID-19 pandemic and the impact of price increases, Prezzo became insolvent on both a cash flow and balance sheet basis. The company owed a debt of £24.4 million to the Secured Loan Noteholders which it could not discharge. In addition, Prezzo had incurred tax liabilities to HMRC in the sum of £11.8 milion, with £9.9 million of that debt having secondary preferential status.
The proposed restructuring of Prezzo's liabilities sought to allow the business to continue trading as a going concern, albeit from a much smaller number of outlets. It was common ground that the relevant alternative to the restructuring plan was the administration of both Prezzo and its subsidiary. Under the plan, the Secured Loan Noteholders would be paid in full, albeit with extended note maturity dates. The rationale was that they were the senior ranking secured creditors in the group and could properly be regarded as Prezzo's present economic owner. HMRC, as second preferential creditor, would receive a cash payment equal to the projected value of Prezzo's floating charge assets in the relevant alternative (approximately £1.3 million). This was on the basis that HMRC would receive a return equal to this value if Prezzo went into administration. Other creditors would receive nothing under the plan.
At the convening hearing, HMRC indicated that it would not support the plan. Prezzo subsequently engaged with HMRC and negotiated with the Secured Loan Noteholders to enable it to offer an additional £2 million to HMRC, which meant that most, if not all, the restructuring surplus generated by the Plan would be received by HMRC.
Following the convening hearing, two creditor classes voted to approve the plan and two classes, including HMRC, voted against the plan.
At the sanction hearing, HMRC opposed the plan on the basis that its treatment was unfair. Although it accepted that it would be better off under the plan than in the relevant alternative, it objected to the plan for a number of reasons, including that Prezzo had continued to trade to the detriment of HMRC while preparing the plan in the period from April to June 2023. HMRC contended that Prezzo had continued to deduct PAYE and NIC on behalf of its employees and had collected sums in respect of VAT yet had failed to make any payments to HMRC while making payments to other 'critical' creditors.
Richard Smith J first considered whether the plan constituted an 'arrangement' for the purposes of s 901A(3)(a) CA 2006 (see Q&A here) as two classes of creditors would receive a nil distribution under the proposals because they were out of the money. He concluded that an 'arrangement' under Part 26A could not be interpreted as requiring consideration to be provided to 'out of the money' creditors. Rather, as Part 26A allowed for the sanction of a plan against dissenting creditors provided that the relevant class was 'no worse off' than in the relevant alternative, the claims of such creditors could be compromised under a plan in which they would receive nothing if they would have received nothing in the relevant alternative.
As the requirements in Conditions A and B of s 901G were satisfied, the main question for the court was whether it was appropriate to exercise its discretion to sanction the plan, taking into account the objections of HMRC. Richard Smith J rejected the suggestion that, as a matter of principle, the court should not entertain sanction of a restructuring plan without the discharge of HMRC's preferential liabilities incurred during the process of preparing the plan. This would be an "inappropriate fetter on the power afforded by Part 26A which, on its terms, admits the possibility of the 'cram-down' of such debts". Instead, the proper approach was for the court to take into account relevant factors as set out in the authorities in the particular circumstances of the case.
In this case, the judge was satisfied that the allocation of benefits under the plan was fair. The plan reflected the priority status of the Secured Loan Noteholders' claims since, as fixed charge security holders, they would rank in priority to any other creditor in an administration. Furthermore, HMRC would receive most, if not all, of the restructuring surplus generated by the plan. He distinguished Re Nasmyth as, in that case, a much larger aggregate debt was owed by the relevant corporate group, some of which had accrued over a far longer period, and the company had also failed to conclude relevant TTP arrangements. Likewise, the facts of Re GAS were materially different, in particular due to the much lower proposed return to HMRC in that case. In the present case, Prezzo had "meaningfully and promptly communicated" with HMRC regarding its concerns about the plan and had taken "positive steps to engage with the secured loan noteholders to procure a significant improvement in HMRC's position under the plan compared to administration".
In addition, taking into account Prezzo's evidence that it had lacked sufficient funding to pay its creditors in full during the period the plan was being prepared and that other non-critical creditors as well as HMRC had gone unpaid, Richard Smith J was satisfied that it had been appropriate in the interests of creditors for Prezzo to continue to pay critical creditors during this period.
On this basis, the judge concluded that it was appropriate for the court to exercise its discretion to sanction the plan. It was not being used by Prezzo as an "instrument of abuse" and sanction would not give a green light to companies to use Part 26A to cram down their unpaid tax bills, a risk to which the court was astute.
To begin with a potential point of interest, it is notable that, following the court's decisions to decline sanction of the respective plans proposed in relation to each of them, GAS entered into administration and, although Nasmyth – whose directors had passed the resolution regarding administration during the sanction hearing – did also eventually enter administration under a new name some weeks later, the group also announced that it had managed to undertake a "holding company restructuring" which, along with increased capitalisation, it was said, would allow the business to "prosper into the future" (Nasmyth Press Release).
Turning to matters of greater substance, the most significant arising from this series of cases is that a clearer picture is emerging of the way in which the court is likely to approach a proposed cram down of debts owed to HMRC.
On the one hand, it is, of course, possible to cram down HMRC in respect of any debts owed to it, even where it not only votes against a proposed plan but actively opposes it during the court process. The court will, in what it considers to be appropriate cases (as discussed further below), approve a proposed plan. This follows naturally from the legislative architecture set out in Part 26A which imposes no specific barrier to a cram down of this kind – the legislative language is generally applicable in nature and so there is no reason to suppose that HMRC could not be crammed down at all (in notable contrast to certain other jurisdictions that do not allow tax debts to be compromised). It is also reflected in the approach taken by Zacaroli J in Re Houst in which he concluded that, given the UK government had considered including a modified form of the absolute priority rule in Part 26A, its eventual exclusion must be taken to have been deliberate (see FC Case Feature 16 August 2022).
To this it may be added that an ability to cram down HMRC, among other creditors, is arguably also consistent with the general 'rescue' purpose that animates the existence of the restructuring plan in the first place, and this is a policy consideration that could and should be influential with the court. This is especially so when one considers that attempts to compromise HMRC debt are generally observed in the SME space. All that said, this (arguable) intention to assist SMEs in general does not necessarily appear to have softened the court's approach to the treatment of tax debts so far.
On which note, and other the other hand, what is also becoming clear is that, whilst there is no blanket principle against an HMRC cram down, the court is nevertheless astute to avoiding giving a green light to companies to use Part 26A to cram down their tax bills and will exercise real caution in sanctioning a plan that would cram down HMRC debts. Undoubtedly this follows from, and is consistent with, strong policy considerations that arise in the particular case of HMRC, to which the court has referred or at the very least alluded in these cases. In short, HMRC performs a critical public function as the collector of taxes: it does not acquire its status as creditor by way of trading or commercial choice and, self-evidently, the tax debts to which it is entitled are ultimately destined to be spent on public services. It does arguably therefore follow that the debts owed to it should not necessarily be compromised lightly and that (as the courts have considered) particular weight may need to be attached to its views.
Consistent with this, some priority has been given, in legislation, to certain debts owed to HMRC. This was relevant in these cases where the sums in question derived in part from taxes paid by employees and customers and where it could have been (or ultimately was) seen as unfair for those funds to be diverted. As Leech J reasoned in Re Nasmyth (at paras 113 and 115), although the English courts do not treat HMRC debts as trust monies, companies have a statutory obligation to deduct and pay PAYE and NICs to HMRC on behalf of their employees and, similarly, VAT is throughput tax which is paid by third parties and for which a company is also obliged to account to HMRC. That said, Leech J (at para 113) did also accept that HMRC should not be treated as if it were a secured creditor and so, as observed subsequently in Re Prezzo, it remains possible that HMRC's preferential priority status may be departed from under the terms of a plan if there is adequate justification.
The question then is what can be gathered from these and other cases about what is more likely to see a proposed plan succeed even where it seeks to cram down HMRC. Although every plan will turn on its own facts, it seems possible to discern the below factors.
- Size of debt – significantly (if a little rudimentarily), it appears that size does count. The larger the debt owed to HMRC sought to be crammed down and the smaller the relative return to HMRC under the plan, the lower the chances seem to be of persuading the court that the plan is fair – see in particular Re Nasmyth and Re Prezzo.
- Age and length of accrual of debt – this may be relevant in a similar way, with older debt to HMRC and/or debt accrued over a longer period of time potentially making a court look less favourably on a proposed cram down – again see in particular Re Nasmyth and Re Prezzo.
- Proper engagement – the court generally looks favourably on a scheme or plan that demonstrates a company's efforts to engage with affected creditors and takes their views on board in designing or adjusting the operative terms. As such, and as seen in these cases, the court is likely to scrutinise the company's efforts to engage with and accommodate HMRC's concerns. By contrast to instances of extensive and/or constructive engagement, where there has been something more akin to selective engagement, this may end up being counterproductive. In Re Houst, for example, material engagement with the secured creditor led to terms acceptable to that secured creditor and potentially painted a picture of a party being deliberately selected for cross-class cram down.
- Respecting the otherwise applicable order of priority or having convincing reasons, with corresponding evidence, for any departures – where a plan prioritises the claims of creditors that would usually rank behind HMRC in the relevant alternative, the company needs to be able to demonstrate a "good reason" for this (Re Houst) or "real discernment" in the selection of such creditors (Re GAS).
- Treatment of essential or critical creditors – demonstrating a sound commercial rationale for selection of "essential or critical creditors" (Re Nasmyth and Re Gas, with the court being particularly engaged (and critical) on this subject in Re Nasmyth).
- Continued trading – having a justification for continuing to trade during the period in which the plan is being prepared (Re Prezzo).
It is worth noting that the restructuring plan that was subsequently sanctioned in Re Fitness First Clubs Ltd  EWHC 1699 (Ch) (perhaps) represents a model for good balance. There, HMRC was to be paid back in full under the plan in respect of a historic VAT liability and ultimately voted in the plan's favour. Notably, HMRC did not object to the plan notwithstanding that, in comparative terms, its treatment was apparently less generous than in Re Prezzo (where HMRC's objection was vigorous).
The decision in Re Fitness First also highlights the varying approach that HMRC appears to be taking to these cases. That is, its approach has ranged, for example, from relatively extensive opposition (including in respect of the plan in Re Prezzo, which arguably provided a very generous allocation) to no active opposition in Re Houst (which the court considered to be a borderline case) to the approach just described in Re Fitness First (the terms of which, again, were less generous than in Re Prezzo). It remains therefore unclear as to which plans HMRC will challenge and, where it decides to do so, the resources that it will devote to that challenge. In this regard, guidance from HMRC on the circumstances in which it will challenge a plan would be very welcome.
First published on the Corporate News Service on 6 October 2023.
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