Restructuring Plans V. HMRC Revisited: Death and Taxes

In Nasmyth: 

HMRC was owed £209,703 in relation to preferential debts (in relation to PAYE, VAT, and NIC) on top of unsecured tax liabilities of £236,154. HMRC's return under the Nasmyth RP was to be 4.8% of its claim, whereas in the relevant alternative insolvency (changed at the last moment on the night before the sanction hearing by the directors resolving to file for administration from a pre-pack, to an insolvent administration) - it would have zero recovery. All classes voted in favour, save for HMRC as the preferential creditor class – cross-class cram down (CCCD) of HMRC was thus required. Leech J concluded that the preferential class was "no worse off" (equal / better treatment than in an insolvent administration) on the valuation evidence accepted. Crucially, HMRC failed to produce contrary expert valuation evidence of its own. 

In GAS:

The projected distribution to HMRC was no more than a marginal improvement on the return in an insolvent administration (being the applicable "relevant alternative" to the plan in question). HMRC attacked the evidence produced by GAS, albeit again without producing expert valuation evidence of its own in comparison. In Smile Telecoms[2], it was established that if a creditor wishes to challenge an RP, it must actively attend the hearing and submit evidence.

Johnson J. agreed however that it would be simply too restrictive to say that, in the absence of opposing expert evidence, the Court must simply accept the plan company’s valuation analysis: "If, on the face of the materials put forward by the proposer, there are manifest errors, inconsistencies or matters which are not properly explained, it must be open to the Court, having regard to such matters, to conclude that the proposer has not discharged the evidential burden which rests on its shoulders." GAS’ largest asset was the “commission debtor book” (being claims by the RP company for commission due under brokerage contracts). The Court concluded that the company's valuation report was not sufficiently "robust" given "figures put forward appear in most cases to be the Company’s figures, unfiltered by any independent scrutiny or analysis", benefitting at points from very little explanation. 

In that event, the Court could not get comfortable that HMRC would be "no worse off" under the RP.

The "absolute priority rule" does not exist in relation to RPs, and was consciously omitted; meaning that the statutory insolvency payment waterfall does not generally have to be followed and can be deviated from under an RP. In Nasmyth and GAS, lower ranking creditors (who would otherwise rank below HMRC in the 'relevant alternative' insolvent payment waterfall and only be paid once HMRC's preferential claims were met in full) will receive a distribution under both RPs without HMRC having been paid in full.  

HMRC argued this represented an unequal distribution of the restructuring surplus (i.e. the potential positive value difference for the RP company generated by the RP, and the use of the business and assets of the RP company it envisages, when compared against the relevant insolvent alternative). 

The Virgin Active RP[3] ruling noted that the business and assets of the RP company belong (in economic reality) to the in-the-money creditors (i.e. who would receive a distribution in the formal insolvency) and established that it is for those creditors to determine how to divide up any restructuring surplus. The question is then whether the dissenting class (HMRC in-the-money preferential claims in Nasmyth and GAS) received a share of each enterprise’s value that was in some manner proportionate to the compromise that it was being asked to make. After GAS the Court should assess:

a) the pre-RP rights of the creditors and how the creditor would fare in the relevant alternative, 

b) what further contributions they are making to the restructuring surplus – most notably whether they are adopting new risk by making new investment / funding available; and 

c) if they are compromised under the RP (e.g. shift in waterfall ranking), then whether that difference in treatment is commercially justified relative to their contribution to the restructuring surplus.

In Nasmyth, HRMC had secondary preferential status (£209,703), and the RP was predicated on (1) a secured creditor advancing the balance of a secured loan facility; and (2) HMRC entering into new 'time to pay' (TTP) arrangements with the plan company's corporate group (£2,561,499.38 HMRC debts, and some dating back to 31 January 2020). HMRC had a "genuine economic interest" in the relevant alternative (in spite of the zero return for HMRC in that event), because it would remain one of the largest creditors of the group and the success of the plan depended upon HMRC agreeing TTP arrangements with the group. HMRC were thus contributing significantly to the restructuring surplus in a manner the RP distributions did not recognise:  HMRC's critical contribution being the proposed TTP arrangements. 

The proposed effect of the Nasmyth RP was that the secured lender (and new money provider) would be paid in full and the existing equity would obtain ownership of the group – i.e. they would share the entire restructuring surplus between them, save for £20,000 shared between the preferential and unsecured creditors. HMRC’s share of the restructuring surplus was to be "both tiny by comparison with [the secured creditor] and in absolute terms". The Court's view was that the "secured creditors appear to have seen the Plan as 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". The difference in treatment of HMRC was commercially unjustified relative to their contribution to the restructuring surplus, resulting in an unfair distribution, and refusal of sanction. 

In the Nasmyth RP, Leech J. adopted a public policy stance in respect of HMRC debts, requiring "caution" in relation to the CCCD of HMRC debts: the Court should scrutinise [an RP] with care and should not cram down the HMRC unless there are good reasons to do so"[4]. Leech J. highlighted:

a) the "involuntary" nature of HMRC debts (HMRC had not chosen to trade with the plan company); 

b) the fact that the Nasmyth plan entity had not complied with their statutory obligation to deduct and pay PAYE and NICs to HMRC on behalf of their employees and to forward VAT receipts; 

c) that the Court should not be seen to approve the non-payment of tax and that if the Court, given the collection of tax can be open to "abuse"; 

d) sanctioning the Nasmyth RP would be a green light to use RPs to cram down unpaid tax bills; 

e) the "striking" idea that the directors of Nasmyth did not consider HMRC a critical creditor to be kept whole in the face of the RP being predicated on its forbearance; 

f) the scale of the Nasmyth group debt (£2,961,674.42 – some debts unpaid since January 2020); and 

g) the refusal to treat HRMC as a critical creditor: "secured creditor appears to have seen the Plan as 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".

A “blot” is a technical or legal defect in an RP that means its terms are made inoperative or unworkable. The Court will not approve an RP containing a "blot" and, as per Snowden J in Re Van Gansewinkel Group[5], is also unlikely to approve a scheme of arrangement or RP which does not have the effected intended by the relevant company or its creditors. The survival of the Nasmyth group as a going concern was explicitly subject to the plan company’s subsidiaries agreeing TTP arrangements with HMRC. The Court viewed the risk the directors took by failing to agree new TTP arrangements in advance as a blot which prevented the plan from coming into effect: “in the absence of a clear commitment from HMRC to give the group time to pay its debts, I do not see how the Plan can take effect”. For the Court to have sanctioned the RP unconditionally would have imposed new obligations on HMRC to agree to a TTP arrangement, to which the plan company had no "right" in law. 

Ultimately, as Leech J noted, in the Nasmyth RP, the failure to lock-up HRMC's agreement to the TTP arrangements pre-RP was fatal: "what tips the balance against sanctioning the plan in the present case is the Company’s failure to agree TTP arrangements with HMRC before putting the Plan forward and asking the Court to sanction it".

Applying the Virgin Active RP ruling, the categorisation of essential creditors is primarily for assessment by management. It is appropriate to treat creditors as exceptional who provide goods or services essential for the continuation of the plan company’s business or to the implementation of the plan or the recapitalisation of the plan company. This question also goes to the "fairness" of the RP at sanction. 

Creditors will be considered essential if the directors had “respectable commercial reasons” for so classifying them. The Court won’t generally deviate from the directors' assessment unless it is “plain and obvious” that the creditors are not essential to the future operation of the plan company, or the company’s reasons do not make sense, or where there is evidence to the contrary. Payment of severance to a former director was plainly not essential in Nasmyth. The Court in Nasmyth further found it difficult to see how the directors did not consider HMRC to be an essential creditor going forward, to keep whole, especially when the group’s future existence depended on the proposed TTP.

• In the context of the unique status afforded to HMRC under the Nasmyth RP: on the one hand, the Judge specifically highlights that HMRC can be crammed down in principle, that there is no absolute priority rule (requiring insolvency waterfall to be respected in full), that HMRC does not have the statutory power (as it does in CVAs ) to veto any compromise of its preferred claims[6], and is not granted any statutory priority in the context of RPs; but, on the other hand, seems to nevertheless elevate HMRC to a more favoured position than that of a commercial creditor in spite of there being no legislative basis in Part 26A of the Companies Act or otherwise for the Court to do so. The authors query whether this policy stance is justified in the absence of statutory direction and in the face of the conscious decision by parliament to not block CCCD in relation to preferential tax claims in an RP in the same manner as a CVA. The more principled approach may be to focus on the fact that any 'in the money' involuntary creditor may be liable to be treated cautiously by the Court (especially in situations where this a particularly unequal allocation of the "restructuring surplus").   
• The Court will be alive to attempts to "engineer" the destination of any restructuring surplus. In Nasmyth, it was submitted that the secured lender had engineered the Company’s financial difficulties by withdrawing funding in order to obtain the “restructuring surplus” for itself and the equity. 
• In considering the "no worse off" test, HMRC (in both RPs) asserted possible antecedent claim recoveries might later raise value for distribution to it in the insolvent alternatives (e.g., preference claims, transfer at an undervalue, wrongful trading, misfeasance claims). The Court could not attribute clear current value to the alleged claims, where they were too inchoate to have any clear value placed on them, were unproven, and where HMRC had provided no evidence as to their valuation.
• The mid-market RP has rightly benefitted from a lighter touch approach by the Court to the weight of evidence that must be presented to the creditor body in advance of voting. The GAS and Nasmyth RPs demonstrate the limit of that approach: one must still meet the substantive duty to detail a rational commercial justification for altering the insolvent order of priority of payments; and the estimated outcome statement/ valuation evidence provided (whilst this can be proportionate in detail to the exposures involved) must still be professional and robust, containing sufficient explanation and analysis. Both GAS and Nasmyth also highlight how vulnerable mid-market RPs are to a robust challenge in Court (particularly if, as appears probable, HMRC are likely to contest any attempts to apply CCCD in future RPs). In this respect, it is illustrative to compare the outcome in the Houst RP (where HMRC voted against the plan but did not actively contest it, with the plan being sanctioned by the Court) with the result in GAS and Nasmyth (where HMRC both voted against the relevant plan and actively opposed it).
• The Court in Nasmyth accepted that whilst two out of the money creditors' votes had no value as such, they nonetheless maintained a legitimate interest in opposing the plan, meaning the Court was entitled to take their views into account in exercising its discretion. The GAS ruling adopted a more traditional approach – giving little if any value to such creditors. This divergence could potentially lead to disruptive submissions by out of the money creditor constituencies. 
• We can expect HMRC to press its advantage and  submit valuation evidence in future challenges if costs / information access permits, and we can further expect HMRC will lobby within Government to extend their power to veto compromises of its secondary preferential claims beyond CVAs, to RPs and schemes. Locking-in HMRC in advance to the RP proposal may prove key. 
• Following the refusal to sanction the Nasmyth and GAS RPs, the restructuring industry could see a pause in the use of the tool in the lower mid-market (where regular drivers of current distress are pandemic era / historic HMRC claims) - we may see a return to the use of pre-packaged administration processes (in tax driven cases) to break the existing corporate and capital structure, transferring the business and assets to a lender / management capitalised 'NewCo', stranding unsecured tax claims in the 'OldCo' group. 

[1] https://www.addleshawgoddard.com/en/insights/insights-briefings/2022/restructuring/the-mid-market-restructuring-plan-v-hmrc/. 

[2] Smile Telecoms Holdings Ltd, Re (Part 26a of the Companies Act 2006) [2022] EWHC 740 (Ch)

[3] Re Virgin Active Holdings Ltd, Virgin Active Ltd and Virgin Active Health Clubs Ltd [2021] EWHC 1246 (Ch)

[4] The GAS RP ruling also spoke to HMRC's unique position and the close attention the Court will pay to their views when in the money: "Given its status as a major in the money creditor, and the strong terms in which it has voiced its objection, not only in light of the facts of this particular case but also given its critical public function as the collector of taxes, I think HMRC’s views deserve considerable weight.”

[5] [2016] 2 BCLC 138

[6] Section 4 of the Insolvency Act, 1986.