The main advantage of a formal arrangement using statutory procedures is that if the requisite majorities of creditors vote in favour of it, it is legally binding on all creditors, even if they voted against it or did not vote on it at all.
Three possible types of formal arrangement can be made:
- a Scheme of Arrangement under ss.895 – 901 CA 2006;
- a Company Voluntary Arrangement under ss.1-7 IA 1986; or
- a Restructuring Plan under CIGA 2020 the provisions of which are contained in part 26A CA 2006.
Scheme of Arrangement under ss.895 – 901 CA 2006
A scheme of arrangement is a complex formal arrangement or compromise made between the company and its creditors (or one or more classes of creditors). The compromise must be agreed by three-quarters in value and a majority in number of each relevant class of creditors at a meeting and then sanctioned (i.e. approved) by the court. Once the scheme has court sanction, it will bind all creditors including any dissenting or unknown creditors. However, because of the cost and the requirement of the court’s involvement, schemes of arrangement have tended to be used to restructure debt obligations of companies with significant secured liabilities or complex funding arrangements with tiers of secured and unsecured debt and, more recently, by foreign companies which have borrowed money from banks or other creditors under English law loan agreements.
There has been a recent trend where companies (UK and foreign) have been using schemes to extend maturity dates for the repayment of loans where the majority of lenders needed to agree this under the terms of the loan agreement cannot be obtained. It should be noted that if a company wishes to compromise secured liabilities and it does not have 100% agreement among the secured creditors as to how to achieve this, the only way a company can seek to compromise those liabilities is by way of a scheme or, as discussed below, by a restructuring plan. A CVA cannot be used.
A company may need to obtain a pre-insolvency moratorium or go into administration before proposing a scheme of arrangement in order to receive the benefit of a moratorium to prevent creditors from taking hostile action against the company or its assets during the period it takes to implement the scheme procedure.
Note: schemes of arrangement may also be used by a solvent company or a group of companies to effect a reorganisation or restructuring.
Company Voluntary Arrangement – ss.1-7 IA 1986
A CVA is usually less costly than a scheme of arrangement mainly because it does not require court sanction. Often, the purpose of a CVA is to seek to put in place a timetable for the repayment (usually only in part) of liabilities owed to (usually) unsecured creditors which will enable the company to survive; alternatively, where rescue is not feasible, CVAs can be used to achieve a better asset realisation and distribution to creditors than would be the case in a winding up. The CVA is implemented and supervised by a “supervisor” (who until approval of the CVA by creditors is known as the “nominee”). The nominee/supervisor must be a licensed insolvency practitioner (‘IP’).
Setting up a CVA
In order to implement a CVA, the directors of the company, usually advised by an IP, formulate a written proposal for the repayment or restructuring of the company’s debts. The proposal will include the nomination of the IP (called a nominee) to act as the supervisor of the arrangement. Once the proposal has been finalised (perhaps after having consulted with major creditors in advance and making sure they are on board with the proposal), the nominee will seek creditors’ approval for the CVA using one of a number of permitted decisionmaking procedures provided for under the IR 2016 (likely to be a virtual, or possibly a physical, meeting). Once the creditors’ decision has been made, the nominee must call a separate meeting of the company’s shareholders (to be held within 5 days of the creditors’ decision).
Two creditor majorities are required if the CVA proposal is to be approved. The first is that at least three-quarters in value of those creditors who respond to the nominee’s chosen decision procedure vote in favour of it. There is no requirement for a majority in number of creditors to vote in favour (in contrast to a scheme). The second majority which is needed is that the proposal must be approved by a simple majority in value of unconnected creditors (e.g. the claims of related companies must be ignored for this purpose). The members approve the CVA by passing an ordinary resolution (their voting rights to be determined by the company’s articles of association).
If the CVA proposal is approved by the majorities of creditors and members (or if the members vote against, by the creditors alone) referred to above, the CVA proposal binds (subject to what we say below about secured creditors and CVA challenges) all creditors i.e. those who voted for it, those who voted against it, those who did not vote at all and those creditors who did not receive notice of the decision-making procedure adopted to approve the CVA. All those creditors’ claims are then dealt with in accordance with the terms of the CVA.
A CVA cannot compromise the rights of secured creditors (including the right to enforce security) or the rights of preferential creditors without their unanimous consent. In practice, secured creditors rarely agree to be bound by a CVA and a company would have to seek a consensual agreement with them (which may be conditional on unsecured creditors voting in favour of a CVA on certain terms) or may have to propose a scheme of arrangement in order to compromise secured liabilities.
CVA challenges
A creditor can challenge a CVA within a 28 day period (commencing with the date of filing of the nominee’s report on the approval of the CVA on grounds of “unfair prejudice” (i.e. one creditor has been treated under the CVA unfairly compared to another creditor) or because of a “material irregularity” relating to the procedure which the company has followed in seeking the approval of the CVA (such as the way that creditors’ votes were calculated). Subject to that, a CVA becomes binding on all creditors at the end of the 28 day challenge period.
The Supervisor’s role
Where the directors propose a CVA, the directors remain in place during the CVA and will be able to exercise their usual powers except as the CVA proposal provides otherwise. The supervisor’s role will be to agree creditors’ claims, collect in the funds which the company is to use to pay dividends to the creditors on their agreed claims and generally ensure that the company complies with its obligations under the CVA. When a CVA has been completed, the supervisor will send a final report on the implementation of the proposal to all members and creditors who are bound by the CVA, then step down from his position and the company will carry on under the management of its directors in the normal way.
CVAs used in conjunction with other pre-insolvency and insolvency procedures
An administrator and liquidator can also propose a CVA. A company may need to obtain a pre-insolvency moratorium or go into administration before proposing a CVA in order to receive the benefit of a moratorium to prevent creditors from taking hostile action against the company or its assets during the period between the sending out of notice to the creditors of the CVA decision procedure and the holding of the procedure itself (e.g. a virtual meeting) which will be at least 14 days. The same IP will usually act as monitor under a pre-insolvency moratorium or as administrator, liquidator or supervisor of a CVA.
Small companies’ CVA and moratorium procedure
Directors of certain “small” companies have the option of applying to the court for a short moratorium (initially 28 days) in order to propose a CVA; see amended s.1A and Schedule A1. This moratorium provides the company with protection from hostile creditor action in the period up to the time when the creditors decide whether to approve the CVA proposal. ”Small companies” are defined in s. 382(3) CA 2006. Where the application is made, the company will have the benefit of an administration style moratorium. In practice, very few companies have used the “small companies” CVA and moratorium procedure.
Restructuring plan under CIGA 2020
CIGA 2020 has introduced a new restructuring plan that may well displace in many cases the use of CVAs and schemes of arrangement. The purpose of a plan is to compromise a company’s creditors and shareholders and restructure its liabilities in such a way that the company is made solvent and can continue as a going concern.
Restructuring plans can only be used by companies which have or are likely to encounter financial difficulty. Restructuring plans must comprise of a compromise or arrangement used to eliminate, prevent or mitigate the impact of financial difficulties that a company is facing.
The restructuring plan is a hybrid of schemes and CVAs. The procedure for implementing a restructuring plan is similar to a scheme. It is therefore a court driven process and the plan becomes binding on all creditors following the court sanctioning the plan. Like schemes, creditors and members must be divided into classes and each class which votes on the plan must be asked to approve it.
The votes needed by the class meetings for approval are more similar to those under a CVA i.e. the plan must be approved by at least 75% of each class voting; there is no majority in number requirement as there is for schemes.
The restructuring plan procedure has some novel features. Two are worthy of mention:
- The court can exclude creditors and shareholders from voting even if they are affected by the plan if they have no genuine economic interest in the company (e.g. they would not receive any payment from the company in any other realistic outcome for the company).
- The court can sanction a plan which brings about “cross-class cram down”.
The second point is best explained by way of an illustration. Suppose the company has senior and junior creditors. The senior creditors have the right to receive payment before the junior ones. The court can sanction a plan approved by the senior creditors even if rejected by the junior creditors provided the court is satisfied that (i) the junior creditors are no worse off under the plan they would be in the relevant alternative outcome for the company (this might be a liquidation, administration or following a sale of the company’s business as a going concern) and (ii) the plan has been approved by a class of creditor or shareholder which would receive a payment or have a genuine economic interest in the company in the relevant alternative outcome.
Consider another example of a cross-class cram down. The court could sanction a plan approved by the junior creditors but rejected by the senior creditors if (i) the junior creditors would receive a payment or have a genuine economic interest in the company in the relevant alternative outcome for the company, (ii) the senior creditors receive under the plan at least what they would have received in the relevant alternative outcome and (iii) the court considers the plan to be fair.
A restructuring plan can be thought of as better than a CVA because it can compromise the rights and claims of secured creditors and shareholders. A CVA cannot do this. The restructuring plan can also be thought of as better than a scheme because in general, a scheme is only binding on those classes of creditors or shareholders who vote in favour of it. This is not the case for restructuring plans because of its ‘cross class cram down’ feature. It can also force through changes in shareholdings which a scheme cannot do. Finally, schemes of arrangement can be used by solvent companies. Restructuring plans can only be used by companies facing actual or prospective financial difficulty.
A company may need to obtain a pre-insolvency moratorium or go into administration before proposing a restructuring plan in order to receive the benefit of a moratorium to prevent creditors from taking hostile action against the company or its assets during the period it takes to implement the scheme procedure. An administrator and liquidator have power to propose a restructuring plan but in most cases, it will be the directors who will do so (very possibly having first obtained a pre-insolvency moratorium).