Restructuring plans were introduced into law at the height of the coronavirus crisis in 2020 to provide businesses with a new tool with which to overcome financial difficulty.
The hearing to approve the restructuring plans proposed by Virgin Active is scheduled to commence on Thursday 29 April. If approved, the restructuring would bind opposing landlords into writing off overdue rent and to accepting reduced future rental income. This is likely to have wide implications for landlords in other cases.
The Virgin Active group, a health club business, says it has been severely impacted by the Covid-19 pandemic. It is seeking to urgently implement a restructuring of its financial debt and lease liabilities to avoid collapse when cash runs out in mid-May 2021.
The group has proposed three restructuring plans. These are the first restructuring plans targeted at lease liabilities since restructuring plans were provided for in law in June 2020. The Virgin Active restructuring plans propose new funding from shareholders whilst writing-off rent arrears and reducing rent on less profitable sites going forward.
If the proposed restructuring plans are approved by the court, the restructuring plans will be only the sixth of their kind to be approved following the introduction of the new restructuring tool. The decision, however, has the potential to set a much more significant precedent for the use of restructuring plans in the future if the court is willing to bind landlords that vote against the restructuring plan proposed by Virgin Active.
The proposed restructuring plan
The Virgin Active restructuring plan involves three groups of creditors: secured lenders, creditors of unsecured property liabilities and landlords of 67 leasehold properties.
At the first of two hearings in the case, known as the convening hearing, the judge, Mr Justice Snowden, decided that meetings of seven different groups of creditors should go ahead as proposed by Virgin Active, despite challenges raised by certain landlords. The seven groups are made up of secured lenders, creditors of the unsecured property liabilities and then landlords, who are split into five groups, classed A to E, based on the profitability of the sites. This was the first time a ranking system based on profitability of sites had been approved by the court in respect of a proposed restructuring plan.
At the convening hearing, a group of landlords opposed the convening of meetings of the company’s creditors without further information being disclosed by the company and said the restructuring plan proposed was disproportionately unfair to landlords compared to other creditor groups. They also argued that two weeks’ notice of the convening hearing was unreasonable and that more time was required to consider the proposals.
The judge did not discount the objections raised. In a ruling which demonstrates the court’s willingness to carefully balance a corporate entity’s urgent need to restructure against a creditor’s right to vote on an informed basis, the judge ruled that the meetings of creditors should go ahead as planned.
Mr Justice Snowdon did say that the creditors are entitled to raise any issues at the sanction hearing, the second and final hearing, which takes place on 29 April 2021. In the meantime, it was suggested by the judge that Virgin Active should disclose its five-year business plan, cash flow forecasts and historical financial information pre-dating the pandemic to the landlords’ professional advisers, provided that confidentiality undertakings were provided in return. If the information was not provided voluntarily, the landlords were entitled to apply for an order for specific disclosure. In future, it is possible that corporate tenants seeking to compromise their rental liabilities may need to provide enhanced disclosure on a confidential basis to landlords and other objecting creditors.
Requirements for approval
For the restructuring plan to be approved at the next hearing, each of the seven groups of creditors must have voted on the plan and, within each group, 75% in value of creditors who voted must have approved the plan. If the requisite 75% has not been reached in one or more classes, the court can still decide to approve the restructuring plan; the dissenting groups of creditors effectively being “crammed down” by the consenting classes. The ‘cross class cram down’ mechanism is a feature unique to restructuring plans. To date, the court has only exercised its discretion and crammed down a group of creditors in limited circumstances, which did not involve landlords’ debts being compromised.
Institutional landlords will be acutely aware that to exercise the “cross class cram down” mechanism, the court must be satisfied that that dissenting group would be no worse off than in the “relevant alternative” and there must be no unfairness in the treatment. The relevant alternative in this context is what the court considers is most likely to occur if the restructuring plan is not approved. This test means that valuation issues will be at the heart of the judge’s scrutiny.
If the court is satisfied that landlords would not be better off in the alternative scenario and that there is no unfairness in the application of the test, it can force the dissenting landlords to be bound by the restructuring plan, requiring them to write off rent arrears and accept reduced rents going forwards.
The Virgin Active restructuring plan is likely to be fiercely contested at the sanction hearing. The court may well consider similar fairness issues to those in the New Look and Regis cases, where company voluntary arrangements (CVAs) have been proposed and challenged. Judgment is awaited in both those cases. Regardless of those decisions, if the Virgin Active restructuring plan is approved by the court exercising the cross class cram down, the restructuring plan could theoretically offer a potential solution to corporate tenant’s ever-increasing Covid-related rent arrears – now estimated to total around £5 billion in the UK.
Mr Justice Snowden will also be required to decide whether two of the opposing landlords can recover their no doubt significant costs of attending the convening hearing from Virgin Active, which the legislation does not currently provide for.
The combined benefits of a court supervised process and the cross class cram down mechanism means that the restructuring plan is already emerging as the restructuring tool of choice for many corporate entities facing significant financial hardship due to the pandemic, and given the increasing uncertainties around the use of a CVA. If the court decides to sanction the Virgin Active restructuring plans, it is this decision that could potentially be the case that opens the floodgates to corporate tenants seeking to compromise pandemic-related lease liabilities.
Co-written by Sarah Jennings and Lucy Cinnamond of Pinsent Masons.