Sanctioned: Virgin Active's Restructuring Plans

Overview

On 12 May 2021, the High Court sanctioned three inter-conditional restructuring plans, under the Part 26A of the Companies Act 2006, for certain English subsidiaries of the Virgin Active group, despite major opposition of certain landlords.[1] In the landmark decision, the High Court exercised its discretion to cram-down multiple classes of dissenting landlords in each plan, compromising their claims.

This client alert is relevant to disrupted, stressed, and distressed companies, as well as their directors and creditors, including landlords.

Key takeaways

1. Valuation: the restructuring plan procedure will not be undermined by lengthy valuation disputes. A desktop valuation may be used to value a plan company — there is no absolute obligation for market testing to be carried out. Where the valuation of a company is disputed, competing valuation evidence of the alternative counterfactual should be provided to the court, as only evidence placed before the court will be assessed when considering the relevant restructuring plan.

2. The court’s discretion:when exercising its discretion to use the cross-class cram-down mechanism, the court will attach little or no weight to lower-ranking classes of creditors who would be out of the money. Creditors who are in the money should decide the division of value or future benefits that the business may generate post-restructuring.

The restructuring plans

The proposed restructuring plans related to (i) Virgin Active Holdings Limited (VAHL), (ii) Virgin Active Limited (VAL), and (iii) Virgin Active Health Clubs Limited (VAHCL) (collectively, the “Plan Companies”). The Plan Companies are key English subsidiaries of the Virgin Active group’s European and Asia Pacific sub-group (the “Group”). The stakeholders of the restructuring plans were as follows:

• Secured Creditors – creditors to whom the Group owed over £200 million under a senior facilities agreement. By the terms of the plans, there would be no haircut, the maturity of the loans would be extended by three years and various amendments would be made to the senior facilities agreement. All of the Secured Creditors voted in favour of each plan (i.e., 100%).
• Landlords – 46 landlords with a total of 67 leases, separated into five classes, based on the profitability of their respective leases to the tenants. The treatment of each Landlord class under each plan, and their voting, was as follows:

The Landlords all retained their rights to determine their leases, by forfeiture or otherwise following established principles in case law in respect of company voluntary arrangements and schemes of arrangement.[2]

• General Property Creditors: unsecured creditors, who are not landlords, but whose claims relate to properties used by the Group. Under the plans, these claims were compromised in exchange for payment of the restructuring plan return. With respect to the VAHL and VAHCL plans, 0% of the General Property Creditors voted in favour, and with respect to the VAL plan, only 6.89% voted in favour.
• Shareholders: not compromised by the plans or included as a voting class. The Shareholders will retain their equity interests and provide financial support, including by way of loans (£45 million, pre- and post-implementation), equity (up to £6 million), and waiving an applicable licence fee.

Use of the cross-class cram-down

With the Secured Creditors and Class A Landlords voting almost unanimously in favour of the plans, the Plan Companies asked the court to exercise its discretion to use the cross-class cram‑down mechanism to sanction the plans. The questions for the court to consider were:

1. Condition A – the “no worse off” test: if the restructuring plans were sanctioned, would any members of the dissenting class be any worse off than they would be in the event of the relevant alternative?

2. Condition B: had each restructuring plan been approved by 75% of those voting in any class that would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative?

3. The court’s general discretion: in all the circumstances, should the court exercise its discretion to sanction the restructuring plans?

The court held that there was no dispute that Condition B was satisfied, as the Secured Creditors and Class A Landlords approved the plans.

Condition A – the “no worse off” test

The court must be satisfied that the dissenting creditors would be “no worse off” in the relevant alternative. The “no worse off” test may be approached by identifying the alternative scenario that is “most likely” to occur and determining the associated outcome for the creditors in that scenario. The court stated that such exercise is “inherently uncertain because it involves the court in considering a hypothetical counterfactual which may be subject to contingencies and which will, inevitably, be based upon assumptions which are themselves uncertain”.[3]

In this case, the relevant alternative was accepted to be a trading administration that involved the accelerated sale of the regional businesses of the Plan Companies. Valuations are key in determining whether a creditor will be worse off in the relevant alternative. The valuations used in this case were desktop valuations that primarily used discounted cashflow methodology. The opposing landlords argued that the estimated outcome for the creditors under the relative alternative was unreliable as there was no market testing process. The court held:

• the use of restructuring plans should not be undermined by lengthy valuation disputes. The preservation of the protection of dissenting creditors (provided by the “no worse off test”) and the court’s general discretion is important.
• there is no absolute obligation to conduct a market testing process. The question is whether it was necessary or practicable in the circumstances to have done so. Any market testing in this case would need to have been treated with “extreme caution”, as the market could not have been less favourable. It would have involved the offering of the business at a time that the sector was closed for an indeterminate period due to the pandemic. 
• the valuation and calculations were reasonable and capable of being relied upon to determine whether to sanction the plans.
• only evidence before the court can be assessed and any creditor wishing to challenge the valuation, demonstrating a better deal could be obtained in the relevant alternative, should adduce evidence to that effect. This was not done in this case.
• no member of any dissenting class would be worse off under the plans than in the relevant alternative of an administration. Under the terms of the restructuring plans, they would receive the restructuring plan return, which was up to 20% more than they would have received in an administration. Further, the restructuring plan return would likely be paid sooner than any administration dividend.

The court’s general discretion

The legislation provides little guidance on the factors the court should consider when exercising its discretion to sanction a restructuring plan using the cross-class cram-down. It was argued by the opposing landlords that the Shareholders, in retaining their shares to the exclusion of the landlords, would obtain value from the restructuring in the form of a restructuring surplus (i.e., the enhancement in value of the shares in the Plan Companies). In the relevant alternative of an administration, the Shareholders would rank behind the Landlords (unsecured creditors) and their shares would be worthless. Any treatment that enables the Shareholders to obtain value to the exclusion of the unsecured creditors that rank ahead of them in the insolvency waterfall is contrary to the principles of insolvency law.

The court held that:

• a restructuring plan may provide that different treatment and substantial value be given to some, but not all, creditors who are out of the money, as referenced in DeepOcean.
• creditors who are out of the money in the relevant alternative can be bound by a plan that compromises their claims without being given the opportunity to vote (as provided by section 901C(4) of the Companies Act 2006). In circumstances where out of the money creditors are invited to vote, their vote should not weigh heavily or at all in the decision of the court as to whether to sanction the plan and cram them down. In this case, the opposing landlords would be out of the money in the relevant alternative and as such their votes carry little or no weight.
• creditors who are in the money should decide how the value and potential future value that the business and assets may generate post-restructuring should be divided. There may, however, be limits to this principle. In this case, there were justifiable commercial reasons for allowing the Shareholders to retain their equity, as the Shareholders were providing new money on better terms than would otherwise have been available in the market (and this was distinguishable from the waiver of existing liabilities).
• a restructuring plan can be used as opposed to a company voluntary arrangement, where it is more likely to achieve the rescue of a company in the interests of the company’s stakeholders generally.

Commentary

The reasoned judgment given by Snowden J. provides useful guidance on the practical aspects of the restructuring plan and was the first true test of the cross-class cram-down mechanism. The court made clear that it is for creditors who are in the money to determine the division of value that a business may generate post-restructuring and, accordingly, their vote is afforded more weight. Out of the money creditors are not required by legislation to vote, and, if they are invited to do so little or no value should be attached to their vote — unless evidence that they are not out of the money in the relevant alternative is adduced to the court. Further, this decision does not impute the absolute priority rule, which provides that junior creditors cannot be paid before all senior creditors are paid in full, into English law. Though the court acknowledged that there may be limits to the value out of the money creditors or shareholders may receive.

This was first time the restructuring plan has been used to compromise lease obligations. Companies may begin to favour this tool to combat their unviable real estate portfolios over company voluntary arrangements. The court made clear that that there is nothing inappropriate about companies making use of the restructuring plan over company voluntary arrangements if it is more likely to achieve the rescue of the company in the interests of its stakeholders generally.

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

[2] Discovery(Northampton) v Debenhams Retail Ltd [2020] BCC 9 in relation to company voluntary arrangements and Re Instant Cash Loans Ltd [2019] EWHC 2795 (Ch) with respect to schemes of arrangement

[3] Re Virgin Active Holdings Ltd, Virgin Active Ltd and Virgin Active Health Clubs Ltd [2021] EWHC 1246 (Ch) at [108]