Companies must approach HMRC with suitable care when proposing a restructuring plan, mindful of lessons learned from recent case law.

Ever since unpaid taxes due to HMRC were “crammed down” pursuant to a restructuring plan that it voted against but did not actively oppose in Houst,[2022] EWHC 1941 (Ch). HMRC has challenged restructuring plans and asserted its interests more aggressively, causing the failure of restructuring plans in Nasmyth[2023] EWHC 988 (Ch).and Great Annual Savings (GAS).[2023] EWHC 1141 (Ch). In the latter cases, the court was unwilling to exercise its discretion to cram down and bind HMRC as a dissenting class. As general statements of principle, the court said that HMRC is a creditor whose views “deserve considerable weight” due to its “critical public function as the collector of taxes”, requiring the court to “exercise caution” in relation to cramming down HMRC debts. Plan companies will need to ensure that they treat HMRC with appropriate caution when proposing a restructuring plan, and should be wary of using the plan as a device for eliminating tax liabilities without proper commercial justification. The re-elevation of certain tax liabilities to preferential status since November 2020 has sharpened focus on HMRC’s opposition and has influenced the court’s analysis of what, in any given case, constitutes a fair division of the benefits of the restructuring between stakeholders and the circumstances in which the court may be prepared to depart from the statutory order of priorities.

A Fair Distribution of the Benefits of the Restructuring?

HMRC has placed particular emphasis on whether a plan provides for a fair distribution of the benefits of the restructuring, sometimes called the “restructuring surplus”.As further considered in the McDermott restructuring plan: Re CB&I UK Limited [2024] EWHC 398 (Ch). This has a bearing on the court’s discretion to sanction a plan, in particular when the plan company requests that the court engage its power to cram down dissenting creditor classes. The court will closely scrutinise any differences in treatment between creditors to determine whether the differences are justified.

In Nasmyth, the court took into account the size of HMRC’s debt, as well as the length of time it had been owed. The court balanced this consideration against the plan company’s proposed share of the restructuring surplus for HMRC under the plan and found that share to be tiny, both by comparison with the junior secured creditor’s share (who was in a subordinated position to HMRC) and in absolute terms. The court noted that these were all “strong reasons” why it should be slow to sanction the plan. Although HMRC was out of the money in that case, the court considered that it had materially contributed to the restructuring surplus through its forbearance in giving the company and its group time to pay. It was therefore appropriate to attribute weight both to HMRC’s vote against the plan and to its interests in the court’s consideration of whether to exercise its discretion to cram down was appropriate.

In GAS, the court noted the plan was inherently unfair, involving a serious imbalance in allocating the anticipated benefits of the restructuring. The benefits would have been materially generated by the proposed compromise of HMRC as one of the two largest in-the-money creditors, but would also have disproportionately flowed to the secured creditor and shareholders and certain connected party creditors. Because these classes would each have contributed very little under the plan compared to HMRC, and importantly did not inject any new money, the court had little difficulty in refusing sanction.

Towards a “Relative Priority Rule”?

When considering if a plan fairly allocates value between the different creditor classes, the court will consider whether the priority as between them in the “relevant alternative” is reflected in the proposed distributions under the plan. The US Chapter 11 procedure contains an “absolute priority rule”, which provides that no junior class should recover until a senior class has recovered in full, and no senior class should recover more than it is owed; there is no such statutory absolute priority rule under Part 26A.

As the court indicated in Houst, a departure in a restructuring plan from the priority, as among different creditor groups, applicable in the relevant alternative, is not in itself fatal to the plan’s success as there is no equivalent absolute or modified absolute priority rule in Part 26A. The court may therefore sanction a restructuring plan that alters the priorities of creditors in the relevant alternative. In Houst, the preferential status of HMRC, an in-the-money creditor, was reversed to provide a greater proportionate recovery to the other in-the-money secured creditor, part of whose claim was secured by only a floating charge ranking below HMRC’s preferential claim. However, when the reason for differential treatment is the need for critical suppliers to be paid in order for an enhanced dividend to be paid to the unsecured creditors (including HMRC), that may prove a sufficient basis to depart from creditor priorities in the relevant alternative.

No sufficient justification was provided in GAS, with the court noting the overall structure in the case proposed a “rather muddled” re-ordering of priorities to try and promote overall growth, the future benefits from which HMRC was excluded.

Additionally, prioritising payments to other creditors that appear less critical in the circumstances could prove dangerous. Indeed, in Nasmyth, the court was doubtful that payment for the plan company’s membership of a trade association and of a former director’s severance pay were essential when the group’s future existence depended on the continued goodwill of HMRC, the creditor that the company intended to cram down. In GAS, given the extent of the company’s debt to HMRC, the court noted that it would have expected to see real discernment in the company’s selection of the out-of-the-money creditors that would benefit under the plan, effectively at HMRC’s expense.

The Court Will Not Sanction in Vain

In Nasmyth, the company’s failure to conclude further Time to Pay (TTP) agreements for tax arrears between a number of its subsidiaries and HMRC prior to the launch of the plan was considered to “tip the balance” against the court exercising its discretion to cram down HMRC, despite the threshold conditions for sanction being met and the fact that HMRC was out of the money. This was because the survival of the group as a going concern, and therefore the success of the plan, was dependent upon the TTP agreements being in place. The failure in Nasmyth to agree new TTP arrangements, and HMRC’s stated unwillingness to do so, constituted a roadblock to the stated outcome of the plan. The court noted that the company and its secured creditors appeared to have regarded the plan as a convenient opportunity to eliminate the debts that 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 purpose for which Part 26A was not designed.

Court Keeps HMRC’s Appetite in Check

Significantly, to date, the court has maintained that it will not refuse to sanction a restructuring plan as a matter of principle only because HMRC will be crammed down — the court did just that in Houst and subsequently in Prezzo.[2023] EWHC 1679 (Ch).

In Prezzo, HMRC’s objection to the proposed plan appeared to be conceived as a point of principle, including on the basis rehearsed in Nasmyth, that sanction risked giving a “green light” to companies to use Part 26A to cram down their unpaid tax bills. While noting that this was a risk to which it is “astute”, the court found against HMRC, being firmly of the view that it should sanction the plan. HMRC did not dispute that the relevant alternative in the Prezzo plan was a costly and value-destructive administration, nor that its anticipated return under the plan would be significantly higher than that relevant alternative. HMRC’s objection instead turned on whether it was fair for the court to cram down HMRC in the circumstances.

Importantly, the court distinguished the facts in Prezzo from those in Nasmyth and GAS, including the low level of the proposed distribution to HMRC under the plans in both of the earlier cases. Unlike in those cases, where the applicant companies had appeared to treat HMRC’s concerns as an afterthought, in Prezzo the company proposing the plan had, in the court’s view, “meaningfully and promptly” communicated with HMRC. Moreover, the company had taken positive steps to respond to HMRC’s concerns in arranging for an additional preferential creditor payment to it of £2 million, thereby increasing the total return to HMRC under the plan by 250% compared to the estimated return in the administration. This meant that most, if not all, of the restructuring surplus generated by the plan would be received by HMRC. As such, the court was satisfied that the allocation of benefits under the plan was fair and that there was no departure from the order of priority in which HMRC would be paid a distribution in the relevant alternative.

A key pillar of HMRC’s argument in Prezzo was that, when the company was preparing and proposing the plan for some six weeks, the company continued to trade and make substantial payments to creditors to the detriment of HMRC, with the ongoing business being funded by monies (including PAYE and NICs deducted on behalf of employees and monies collected from third parties in respect of VAT) that should have (but had not) been paid over to HMRC. The court accepted the company’s evidence that it lacked sufficient funding to pay all its creditors in full, and that, while the company could reasonably have formed the view that HMRC should not be treated as a “critical” creditor, those creditors the company continued to pay (and proposed to exclude from the plan) were and remained critical to the preservation of its business and ability to trade, with a number of other non-critical creditors going unpaid. The court was therefore satisfied in the circumstances that the company had not been deliberately trading “at the expense of” HMRC. The question arises as to the circumstances in which a debtor might in future find itself on the wrong side of this line, perhaps due to the length of the period during which it trades on this basis, or is less discerning in the choice of creditors that it considers it appropriate to pay.

Any regard the court may have had to matters of public policy in Prezzo proved to be to HMRC’s detriment: the court found that the cost of an administration could be avoided under the plan and the saving be made available instead to HMRC and, therefore, the taxpayer.

Based on the outcome in Prezzo, the court is seemingly less likely to be sympathetic to arguments against sanction advanced by HMRC when it can be shown that, on the facts, there is a fair distribution of the benefits of the restructuring and the relevant company has taken steps to engage constructively in addressing HMRC’s concerns insofar as its circumstances allow.

Lessons Learned by HMRC and Plan Companies

HMRC has recently published a guidance note regarding its approach to restructuring plans, reflecting the case law to date.  https://www.gov.uk/guidance/using-debt-management-schemes-to-restructure-a-companys-finances. HMRC advises that companies should be in contact as soon as they decide to restructure their finances, and that HMRC will consider plans on a case-by-case basis when deciding whether to offer support to a proposal. The guidance sets out factors relevant to HMRC’s consideration: including, HMRC is likely to look more favourably on a plan that recognises HMRC’s function as the collector of taxes to fund public services and the company’s statutory obligations to deduct and pay tax, while HMRC will be less likely to support a plan in which other creditors are being paid whilst HMRC is not (and the different treatment cannot be justified), or where HMRC considers that the applicant company has not dealt fairly with payments to creditors during the period it is preparing its plan. Whether this will develop into more assertive policy-based lobbying to prevent HMRC liabilities from being the subject of a restructuring plan, in a way that would mirror the treatment of pre-petition tax liabilities in US Chapter 11 bankruptcy as priority claims, remains to be seen.

ENDNOTES

1. ¹[2022] EWHC 1941 (Ch).
2. ²[2023] EWHC 988 (Ch).
3. ³[2023] EWHC 1141 (Ch).
4. ⁴As further considered in the McDermott restructuring plan: Re CB&I UK Limited [2024] EWHC 398 (Ch).
5. ⁵[2023] EWHC 1679 (Ch).
6. ⁶https://www.gov.uk/guidance/using-debt-management-schemes-to-restructure-a-companys-finances.