A company voluntary arrangement (CVA) is a tool which has been widely utilised by companies seeking to restructure and compromise liabilities.
In recent years CVAs have been in the limelight because of attacks by landlords who feel that they have been unfairly prejudiced by the CVA terms. Largely, challenges such as those to the Regis and New Look CVAs have been unsuccessful, but arguments about unfair prejudice based on “vote swamping” were left open for future debate.
Although not based on a challenge by landlords, the recent case of Re Mizen Build/Design Ltd[1] considered whether a CVA that was approved because of the votes of unimpaired creditors (i.e. those that would be paid in full) was unfairly prejudicial to those creditors whose claims were compromised in the CVA and who voted against it.
The case also considered a point we have not seen before the courts for a while: guarantee stripping and in this blog we explore the issues around that.
Guarantee Stripping
In Mizen, there were a number of different creditor groups; the ones of interest for the purposes of this blog are the guarantee creditors (the “Guarantee Creditors”) who benefitted from a guarantee provided by the company’s parent Mizen Properties Limited (the “Shareholder”).
Mizen Build/Design Ltd (the “Company”) sought to compromise the Guarantee Creditor claims against the Shareholder. The logic for this was to prevent so called “ricochet claims” being made against the Company by the Shareholder (which would have then caused the Company to fail).
One of the Guarantee Creditors, Peabody Construction Limited (“Peabody”) sought to challenge the approval of the CVA on grounds of both unfair prejudice and material irregularity.
In principle at least, a CVA can release a third party guarantor from its obligations for the insolvent company’s debt (often referred to as “guarantee stripping”) but it potentially gives grounds to challenge on the basis of unfair prejudice if the guarantee creditor is not adequately compensated for the loss of their rights under the guarantee.
The need for adequate compensation was recognised in the case of Powerhouse[2], although in the subsequent case of Mourant[3] the court expressed doubt as to whether a lump sum payment could ever adequately compensate a creditor for loss of a guarantee claim, thereby leaving open the question of what compensation could be adequately provided.
How did the Mizen CVA deal with the guarantee claims?
In Mizen, the Guarantee Creditor claims against the Shareholder were compromised in return for an additional distribution payment to compensate them for the loss of the Shareholder guarantee, assessed on the basis of what the Guarantee Creditor might otherwise receive in the Shareholder’s hypothetical insolvency. That was premised on the basis that if the Company became insolvent, so too would its Shareholder as a consequence of calls on the guarantees.
If the Shareholder failed, it was estimated that the Guarantee Creditors would recover 5.3% of their guarantee claim (based on an Estimated Outcome Statement (“EOS”) prepared for the purposes of the CVA). Under the terms of the CVA however, they stood to receive 7.5% of their claim.
Although on the face of it, it might seem like the Guarantee Creditors were better off under the CVA and therefore the loss of their claim was adequately compensated, it was argued that the financial position of the Shareholder had not been adequately disclosed to enable the Guarantee Creditors to assess the value of their guarantee claim. Therefore, they were unable to decide whether to vote in favour of the proposal, or not.
Peabody claimed that the lack of disclosure amounted to a material irregularity.
Extent of disclosure?
Although the judge said that there was no direct obligation of disclosure on a shareholder, he criticised the level of disclosure given in the CVA about the Shareholder’s position, given that the Shareholder’s liabilities were being compromised not by its own CVA but by the Company’s. That criticism included the fact that details about potential antecedent transactions had not been disclosed in the EOS.
The judge did not go so far as to say that a CVA that compromises the claims of a parent company requires the shareholder’s position to be disclosed to the same extent as the company’s but noted, in this particular case, that there was no good reason why such level of disclosure shouldn’t be made given the release of the Guaranteed Creditors. Even if that test were too stringent, he went on to note that a guarantee creditor would seek more information than was provided in the EOS.
Practically speaking, in cases where parent company guarantees are being compromised under a CVA, if the shareholder is required to make discloses “equivalent [to] a CVA or a scheme had the Shareholder proposed one” then an extensive disclosure exercise would need to be undertaken because, irrespective of the compromises being made, the Company’s obligation is still to provide full and frank disclosure of all matters appropriate to enable all creditors to reach an informed decision.
What the case does do is remind those proposing a CVA that disclosure is important, and that it has to be adequate, fair and full.
Where creditors are being asked to give up other rights or claims (such as guarantee claims) it is important to give very careful consideration as to how those rights should be valued, and to make full disclosure. Taking, as the Company did in this case a snapshot of the position may not be, as it was not here, sufficient to enable a creditor to make an informed decision.
In light of his conclusions that the level of disclosure was lacking, the judge therefore upheld Peabody’s challenge to the CVA and found that there had been a material irregularity.
UPDATE
Since this blog was posted, the Mizen decision has been appealed. To read our blog on the appeal judgment see here.
[1] Re Mizen Build Design/Build Ltd (in company voluntary arrangement) Newlon Housing Trust and another v Mizen Design/Build Ltd and others [2023] EWHC 127 (Ch)
[2] Prudential Assurance Co Ltd & others v PRG Powerhouse Limited & others [2007] EWHC 1002 Ch
[3] Mourant & Co Trustees Ltd and another v Sixty UK Ltd and others [2010] EWHC 1890 (Ch)
