When are dissenting creditors 'no worse off' under an English restructuring plan?

The power of the court to sanction a restructuring plan where one or more classes of creditors or members has not voted in favour of the plan by the requisite majority (being 75% in value of those present and voting) is referred to as the "cross-class cram down".

We have previously analysed how the court determines what would happen if a plan is not sanctioned, called the "relevant alternative". Once the relevant alternative has been determined, the court will then consider if the dissenting creditor(s) will in fact be any worse off under the plan – referred to as the "no worse off" test. But how is this test approached by the courts?

When may the cross-class cram down be exercised?

Where there is at least one dissenting class, section 901G of the Companies Act 2006 provides that this opposition does not prevent the court from sanctioning the plan under section 901F, providing that the following conditions are met (emphasis added):

• Condition A: the court is satisfied that, if the restructuring plan were to be sanctioned, none of the members of the dissenting class would be any worse off than they would be in the relevant alternative. This is often referred to as the "no worse off" test.
• Condition B: the restructuring plan has been agreed by a number representing 75% in value of those present and voting in another class who would receive a payment, or which has a genuine economic interest in the company, in the relevant alternative.

Section 901G provides that if Conditions A and B are met, the fact that the dissenting class(es) oppose the restructuring does not prevent sanctioning of the plan, however, such sanction remains subject to the discretion of the court. The court's general discretion will be considered further, later in this series.

The 'no worse off' test

Once the relevant alternative has been determined, the court may only sanction a restructuring plan which has been opposed by one or more classes of creditors if, in accordance with Condition A above, it is satisfied that the members of each dissenting class would be no worse off in the relevant alternative.

There is an increasing volume of case law regarding the application of the "no worse off" test. In one of the most prominent decisions, Virgin Active [2021] EWHC 1246, Justice Snowden (as he then was) summarised how the test can be approached:

• First, identify what would be most likely to occur in relation to the company if the plan is not sanctioned – this is the relevant alternative.
• Second, determine what would be the outcome or consequence of that for the members of the dissenting classes (primarily, but not exclusively, in terms of their anticipated return).
• Third, comparing that outcome and those consequences with those which would most likely apply if the plan is sanctioned.

This exercise can be "inherently uncertain" due to the fact that it involves consideration of a hypothetical counterfactual, which will commonly be subject to certain assumptions and contingencies which may not be borne out in reality. Notwithstanding that restructuring plans were brought in relatively recently (in 2020), the court is able to draw on case law relating to both:

• Schemes of arrangement under Part 26 of CA 2006. This includes the appropriate comparator used for determining the composition of the classes.
• Unfair prejudice challenges relating to company voluntary arrangements. This includes the "vertical comparator" test, which compares the projected outcome of the arrangement against the realistically available alternative and sets a "lower bound" for the purpose of the arrangement and whether certain creditors would be unfairly prejudiced by the proposal.

Quite often, the relevant factors will be determined on the facts of each case.

What outcomes or consequences are relevant?

The case law to date often cites the opinion of Mr Justice Trower in DeepOcean [2021] EWHC 138 when considering the outcomes or consequences which may be relevant when determining whether any of the dissenting classes are any worse off than under the relevant alternative (emphasis added):

"Doubtless, the starting point will normally be a comparison of the value of the likely dividend, or the amount of any discount to the par value of each creditor's debt. However, the phrase used is "any worse off", which is a broad concept and appears to contemplate the need to take into account the impact of the restructuring plan on all incidents of the liability to the creditor concerned, including matters such as timing and the security of any covenant to pay".

The starting point on comparison of value means that the evidence filed in support of a restructuring plan will set out the level of the anticipated distribution to the relevant class of creditors both in both (i) the relevant alternative, and (ii) following implementation of the restructuring plan. This is usually expressed as [x] pence in the pound of the total liabilities for each class of creditors.

However, Mr Justice Trower's judgment in DeepOcean makes clear that other factors, including the timing of distribution, also play into whether a class of creditors is, or is not, worse off under the plan.

For example, in Fitness First [2023] EWHC 1699, HMRC was estimated to receive full repayment under both the relevant alternative (insolvent administration) and the restructuring plan. However it was considered that HMRC would be better off under the plan on the basis that it would receive payment in a much shorter timescale, being six months, instead of 12 to 18 months.

Market testing

Even once the relevant alternative has been determined on a base level, does a relevant alternative which involves a sale of the business and/or certain assets of the plan company require a market testing exercise to be conducted? The value ascribed to the sale has an impact on where the value breaks and the likely outcome (at least in monetary terms) for each class of creditor.

It was argued by certain dissenting creditors in Virgin Active [2021] EWHC 1246 that the value ascribed to the business on a desktop basis was unreliable, and that the plan company should have conducted market testing for the purpose of determining the realisations available for creditors in the relevant alternative. Mr Justice Snowden disagreed, considering there was "no absolute obligation to conduct market testing [and] no authority for the contrary". Instead, market testing need only be conducted where it is necessary or practicable in the circumstances.

Indeed, in Virgin Active, the judge queried whether the sale of the business in a sector which had been significantly affected by the lockdowns imposed during the coronavirus pandemic would in reality produce a more reliable estimate than the desktop valuation.  Potential buyers were suffering the same issues and may have been unwilling to commit substantial resources and time to make a reliable bid.

Professional advisers can often give a good steer on whether a market testing exercise is necessary or appropriate in the circumstances, and it may be that there is a more reliable alternative basis for valuation. For example, the valuation of the business in Re Houst [2022] EWHC 1941 was based on a comparable transaction entered into by the plan company itself only a couple of years before. It was considered that the significant level of distress made the alternative (a discounted cashflow analysis) less reliable.

Assessing possible claims against third parties

Does the plan company need to take into account claims which may be made against third parties to determine realisations in the relevant alternative? Where the relevant alternative is an insolvent administration or liquidation process, it is possible for the officeholders or the plan company (acting by the officeholders) to bring claims against third parties. This may include, among other things:

• Wrongful trading – an action against directors or shadow directors for trading beyond the point at which they concluded (or should have concluded) that there was no reasonable prospect of avoiding insolvent administration or liquidation, where these directors have not taken every step to minimise potential loss to creditors.
• Clawback actions – this may include clawback or seeking a contribution in relation to transactions or other things which may constitute, among other things, a transaction at an undervalue or preference or a transaction defrauding creditors in the lead up to the company's insolvency.
• Other breach of duty or misfeasance claims.

It has now been argued in a number of restructuring plan cases that potential recoveries under claims against third parties should be taken into account, as this may have a positive impact on the realisations available for creditors, and what each class of creditor might receive as a distribution.

In Amicus Finance [2021] EWHC 3036, Sir Alastair Norris said that while the court cannot conduct a "mini-trial" of claims at a hearing relating to a restructuring plan, evidence filed relating to such claims would be considered and would be relevant to the extent that they raised a challenge to the plan company's assertion that creditors (or certain classes of them) were no worse off under the restructuring plan.

The plan company's evidence was also scrutinised in Re Houst as it appeared that no consideration had been given as to the possibility of any such claims. This resulted in further evidence being provided at the sanction hearing, from which the judge considered there was no reason to suspect that creditors would benefit from such claims in the relevant alternative.

Osborne Clarke comment

The "no worse off" test has been a substantial battleground of restructuring plan case law to date, and a wide variety of factors can be considered by the court (including monetary considerations, the timing of distribution and other matters) in determining whether a dissenting class is any worse off.

It is likely that there will be further judicial developments, and it is clear that the court is not taking a cookie cutter approach to the "no worse off" test. Whether a dissenting class of creditors is any worse off will be highly dependent on the facts of each case, and expert valuation evidence will likely be key.

This article is part of Osborne Clarke's restructuring plan series, which explores the key developments affecting restructuring plans and the developing body of case law in this area. In the next instalment, we consider other factors of the court's general discretion to sanction a contested plan, even if Conditions A and B have been met.