Mid-market restructuring plans and cramming down HMRC – fact or fantasy?

HMRC seems to be on a hot streak with its recent successful challenges to small to medium enterprises (SME) restructuring plans with the recent decisions in Re Nasmyth Group Ltd [2023] EWHC 988 (Ch) ("Nasmyth") and Re Great Annual Savings Company Ltd [2023] EWHC 1141 (Ch) (GAS). In this article, we consider the questions: are restructuring plans for SMEs possible, and can HMRC ever be crammed down?

To answer that, we will be looking at the basic requirements for putting a restructuring plan in place, why Nasmyth and GAS' plans were not sanctioned, and how future SMEs might work around the reasons those plans failed.

The restructuring plan process:

For a company to be able to use the process, it must have encountered or be likely to encounter financial difficulties that affect its ability to continue trading. There is no fixed insolvency test like with other processes, but existing or forecast financial difficulties can be used as a barometer.

Once that has been established:

1. A proposal must be prepared and sent to creditors and members and be filed at Court with an application for a convening hearing.
2. At the convening hearing, the Court will consider the company's eligibility, the proposed creditor classes and whether any creditors should be excluded from voting before setting a date for a vote on the proposal by the creditors.
3. With a date established, notices of the meeting will be sent to creditors and members which outline the proposed plan along with an explanation of why the plan is needed and its potential benefits / detriments to creditors and members.
4. The meeting then takes place, and assuming no challenges to the plan are put forward, the vote can move forward, the relevant threshold for approval is 75% in value of the creditors in each class.
5. The Court convenes a sanction hearing at which they consider whether to sanction the plan (assuming that the voting threshold has been reached). If the Court approves the plan, it will bind all affected creditors and members.

Criteria for a successful restructuring plan at the SME level:

At a high level, two conditions must be met for a successful restructuring plan (s901A of the Companies Act 2006):

• The company has encountered, or is likely to encounter, financial difficulties that are affecting or will or may affect, its ability to carry on business as a going concern, and
• There must be a compromise or arrangement proposed between the company and (i) its creditors, or any class of them, or (ii) its members, or any class of them, the purpose of which is to eliminate, reduce or prevent or mitigate the effect of any of the financial difficulties in question.

To approve a restructuring plan, if 75% or more in value of creditors (or class of creditors) or members (or class of members) present and voting, vote in favour of the plan, then an application can be made to Court for sanction. Restructuring plans can use cross-class cram down to force through the plan provided that conditions A and B are met (s.901G of the Companies Act 2006):

• Condition A: that the court is satisfied that if the plan were to be sanctioned that none of the members of the dissenting class would be worse off than they would be in the relative alternative
• Condition B: that the plan had been agreed by a number representing 75% in value of a class of creditors or members who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative.

Re Houst Ltd [2022] EWHC 1941 (Ch) showed that restructuring plans could be used for SMEs – the High Court approved a plan for a business with a turnover of below £10 million, and it was the first application of cross-class cram-down against HMRC. This case highlighted a few key features:

1. The sophistication of any valuation evidence provided must be comparable to the company's size - i.e. a court is willing to be pragmatic and accept evidence where the level of analysis correlates to the resources available to the evidencing company, but cutting corners here is unlikely to earn the Court's favour.
2. The plan must provide for a fair distribution of the additional funds generated by the plan.
3. The determination of critical creditors, and their full repayment must be justified - e. payments to creditors which enable a company to generate revenue, which is in turn used to pay other creditors, is likely to be looked upon kindly by the court.
4. Where possible, a cash injection (or another similar financial investment) from the company's shareholders will garner favour with the court.

It is important to note that in this example, whilst HMRC voted against the plan at the plan meetings, HMRC did not attend the sanction hearing to oppose the plan and it did not present any arguments against the plan. This is at odds with its position in Nasmyth and GAS.

Why did Nasmyth and GAS fail – are restructuring plans for SMEs still possible?

1. Whilst a company is free to determine its own critical creditors, a clear sense of priorities is required to win over the court, and any failure in the logic deciding who is critical and who is not, will likely amount to the plan's failure.
   • In Nasmyth, after comparing the power that HMRC wielded over the Company's future against that of the Company's proposed critical creditors, the court decided that the directors had unreasonably taken the view that HMRC was not a critical creditor. The plan was ultimately defeated because the Company's choice to prioritise other creditors ahead of HMRC was held to be unwise given that the "group's future existence depends on its [HMRC's] good will".
   • In GAS, the Court undertook similar scrutiny of the critical creditors. Again, the breadth of the creditor classes that benefited from the re-ordering of priorities, and the scale of the benefits that were conferred on them unsettled the Court. It was found that the plan's reasoning for such scale and priorities was unconvincing. For example, no new money was being provided, and the plan prioritised payments to unsecured creditors at HMRCs expense.
2. Failing to award HMRC a 'fair' share of the restructuring surplus is likely to see a plan fail.
   • In Nasmyth the court found that HMRC's share would be "both tiny by comparison with JCP and in absolute terms." Essentially, the reduction in value for HMRC was not proportionate to the reduction in value to other creditors in similar positions and this was part of the failure in Nasmyth's plan.
   • GAS adds a helpful rule of thumb to determine quickly whether a plan may or may not be sanctioned by the Court: "if there is not a fair distribution, that is likely to indicate that the dissenting class has voted rationally, and that would support the Court refusing sanction."
   • GAS' plan failed in the end because the mechanism for achieving the plan's objective (creating future growth) involved the eradication of HMRC's existing debt while prioritising payments to unsecured creditors at HMRC's expense. This in of itself was not fatal, however what was fatal was the decision that any benefits from such growth were to be disproportionately allocated to the secured creditor and the shareholders, marking them as the principal beneficiaries under the plan and leaving HMRC out in the cold.
3. An improper interrogation and analysis of any proposed numbers and a lack of rigour in the figures generally will be unpersuasive to a Court.
   • In GAS the Court held that the generalised analysis carried out by the Company deeply affected the robustness of the plan, stating:

"There is very little allowance for the possibility that the "high level assumptions" might be wrong, even in part. The modelling on its face makes insufficient allowance for what appear to be obvious sensitivities."

The Court was not satisfied that HMRC would be no worse off under the plan than in the relevant alternative (being administration). As such, it did not meet Condition A (the no worse off test).

4. The Court is not prepared to sanction a plan without time to pay (TTP) arrangements having already been agreed with HMRC.
   • In Nasmyth, HMRC became critical to the success of the restructuring plan because they were not prepared to offer TTP arrangements unless they included the Company's debts.
   • Prior to attending the hearing, the Company's directors failed to agree those terms with HMRC. Perhaps more importantly, they also failed to justify why the Company would not agree new TTP terms that included the Company's debts when they had done so the year prior. This prompted the Court to conclude that the plan was a:

"Convenient opportunity to eliminate the debts which the company owed to HMRC for a nominal figure and to use the plan to put pressure on HMRC to agree new TTP terms… this is not a purpose for which Part 26A should be used".

So to answer the question above, can SMEs successfully get a restructuring plan approved by the court? Yes, provided that the plan realistically provides for the above. Not an easy feat, but it has fallen to the likes of Nasmyth and GAS' plans to fail so that others having learned from the detailed judgments, might succeed.

Can HMRC ever be crammed down?

The short answer is yes, it is not a matter of principle that HMRC cannot be crammed down. However, as recent cases have shown us, the Court will exercise caution, give thorough consideration to HMRC's preferential status and require genuinely good reasons to justify the cramming down.

Most of those reasons (that we know of), are the satisfaction of the key features evidenced by Houst above, whilst also avoiding the mistakes that Nasmyth and GAS made.

The difficulty in avoiding those pitfalls is getting HMRC to actually come to the table and discuss, amongst other things, TTP arrangements. It is hard to do (given HMRC's policy) and costly, which may further exclude SMEs from the process.

It is also worth noting that HMRC have run the argument that tax collected by a company is held on 'quasi-trust' for them. In Nasmyth the Court rejected that argument but did note that where a company has continued trading to the detriment of HMRC, Part 26A was open to being abused.

Given the successes of their opposition to the Nasmyth and GAS plans, HMRC are likely to oppose any restructuring plans that they do not consider treat them 'fairly'. It is also important to remember that the Court has discretion as to whether to approve a restructuring plan.