David Nelson looks at the impact on landlords of a controversial High Court decision to allow a restructuring plan for a chain of health clubs.
The High Court has sanctioned a controversial restructuring plan for the Virgin Active Health Clubs, despite widespread opposition from a large group of its commercial landlords in Virgin Active Holdings Limited & Ors  EWHC 1246 (ch).
With the ramifications of the COVID-19 pandemic dealing a heavy economic blow to many companies, more and more businesses are seeking ways to restructure their debts. CVAs have become increasingly popular over the course of the past few years and a new kid on the block, Part 26A Restructuring, has now stepped into the insolvency arena.
The Corporate Insolvency and Governance Act 2020 (‘CIGA’) introduced the new restructuring scheme into the existing Companies Act 2006 under Part 26A (herein referred to as ‘Part 26A Restructuring’). This new scheme enables companies in financial distress to arrange a compromise plan (similar in approach to that of a CVA) with their creditors or members to eliminate or alleviate existing debts, be it rent or otherwise. Such a plan requires 75% approval from each class of voting creditors and must be sanctioned by the court in order to become legally binding.
Part 26A Restructuring is similar to the pre-existing ‘scheme of arrangement’ procedure as per Part 26 of the Companies Act 2006. The core difference in the case of Part 26A Restructuring is the introduction of a ‘cram down’ mechanism, which enables the distressed company to ask the court to ‘cram down’ (essentially an overriding tool) on a dissenting class or classes of voters – even if they have voted 75%+ in opposition to the proposed plan.
In determining whether to ‘cram down’, a court must ensure that two conditions are satisfied. These are:
- Will any of the dissenting parties be worse off under the Part 26A Restructuring than they would under a ‘relevant alternative’ scenario (being the likely alternative if the plan was not approved – usually administration or liquidation); and
- Has the approved Part 26A Restructuring Plan been approved by at least one class of creditors or members who would have a genuine economic interest in the relevant alternative.
Notwithstanding the court discretion in their ability to ‘cram down’, even if the procedural steps are met, courts can refuse to sanction a Part 26A plan if it is considered that the plan is neither just nor equitable in the circumstances.
The impact of the COVID-19 pandemic on the leisure sector has been well documented, especially in relation to the state-enforced closure of health clubs and gyms. The financial position of three companies within the Virgin Active group (herein referred to as ‘Virgin Active’) has been severely affected by the COVID-19 pandemic, with the EBITDA of the group dropping from £56.8 million in 2019 to -£42.1 million in 2020 (a drop of 173.7%).
Virgin Active took their proposed Part 26A Restructuring plan to the High Court with a view to restructuring liabilities to seven classes of creditor:
- Secured creditors
- Landlords (divided into five classes ‘A’ – ‘E’)
- General property creditors
Insofar as the landlords were concerned, the provisions of the proposed restructuring plan differed depending on the class of landlord. For example, Class ‘A’ landlords were treated considerably better (than the other four classes) under the proposed terms of the plan – which provided for all rent arrears paid and a guaranteed fixed rent payable. Conversely, Class ‘E’ landlords were set to receive zero past, present or future rent in exchange for a ‘restructuring plan return’ (or, a cut of Virgin Active profit).
With the exception of Class ‘A’ landlords, who voted overwhelmingly in favour of the proposal, all other classes of landlord did not vote in favour. As a Result, Virgin Active did not receive the required majority to enable the court to sanction the plans.
Knowing this, Virgin Active asked the court to ‘cram down’ on the dissenting classes in order to push through and sanction the plans. In doing so, the court had to consider the two-stage test as mentioned above.
On the first limb, Virgin Active adduced evidence to the court to set out that the ‘relevant alternative’ would be company administration. As such, all classes were set to receive more under the Part 26A Restructuring than they would if Virgin Active went into administration. The court agreed. The second limb was not disputed – the fact that one class of creditor (with a genuine economic interest) had approved the plan was enough to satisfy the court.
Counsel representing an ad hoc group of the landlords made representations to the court to opine that the cram down would not be just or equitable, however this was not accepted and the court sanctioned the Part 26A Restructuring.
Considerations for landlords
A victory for Virgin Active, but a precedent of particular concern for commercial landlords.
The Virgin Active case has shown that commercial tenants have a useful tool to utilise when in a position of financial difficulty. The effectiveness of the ‘cram down’ mechanism was demonstrated very clearly in the decision of the court. In essence, so long as companies are able to point towards a graver alternative (in this instance, administration), it will allow companies to restructure their existing, present and future debts – often to the detriment of their landlords.
Landlords should consider the following:
- Assess – once a Part 26A plan has been proposed, consider the terms carefully and weigh up the pros and cons of what is being put forward. A commercial landlord will want to check the class of creditor that they have been categorised into, as this may determine the amount of rent that they are set to get under the plans (note: category ‘A’ landlords in the Virgin Active case voted overwhelmingly in favour of the plan as their rent was mostly unaffected).
- Property Rights – a landlord’s proprietary rights may be limited (for example, the right to receive a set rent can be compromised) but cannot be removed by a Part 26A plan or a similar ‘scheme of arrangement’ – e.g. a landlord cannot be compelled to accept a surrender of their lease (Re Instant Cash Loans Ltd  EWHC 2795 (Ch)). Commercial landlords may therefore wish to consider whether, based on what they are set to receive under the proposed plan, forfeiture may be a better option.
- Rent Deposits – if a company has notified its landlord as to the proposed plan, a commercial landlord may wish to consider drawing against a rent deposit. Depending on the terms of the proposed plan (and unlike CVAs) secured creditors can be captured by a Part 26A plan.
- Challenge – although challenge is not prescribed under the Insolvency Act (unlike CVAs), affected creditors may make representations to the court when it is in the process of determining whether to sanction a Part 26A plan. Nevertheless, much like with CVAs, expert advice from either a litigator and/or a barrister should be sought to weigh up the merits of a challenge.
- Exit – Part 26A proposals can include ‘break rights’ to enable landlords to take back and re-let their properties. Much like with CVA break rights, this is likely to come at a cost to commercial landlords and should be considered against market conditions and the viability of prospective new tenants.
David Nelson is a solicitor at Sharpe Pritchard LLP
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