European Union: European Perspective: The West Lothian Question In Voluntary Arrangements

Last Updated: May 1 2012
Article by Michael Rutstein and Luke D. Johnson

A version of this article was published in the Winter 2011 issue of Recovery. It has been reprinted here with permission.

THE ROLE OF DISINTERESTED CREDITORS IN THE APPROVAL PROCESS

As the question of Scottish independence resurfaces, the West Lothian question remains embedded, thorn-like, in the side of British politics and democracy 35 years after it was first posed: How is it that Scottish members of Parliament with no apparent interest in a matter applying only to England and Wales are entitled to vote on it?

An identical question arises with voluntary arrangements: Why should a creditor who is to be paid in full have the right to vote on a proposal that compromises the claims and rights of others? The increasing popularity of company voluntary arrangements ("CVAs") gives some urgency to the resolution of this question. In this article, we will look at whether CVAs can be used to differentiate between creditors and the legal issues that arise if they are used to do so. The issues discussed here apply equally to individual voluntary arrangements, but for the sake of convenience, we restrict our discussion to CVAs.

Unlike schemes of arrangement, where creditors must be divided into distinct classes to ensure sufficient protection of their divergent interests, CVAs require the support of only 75 percent in value of the total mass of creditors (and only 50 percent in value of the total mass of creditors unconnected with the debtor) to be passed (Rule 1.19 of the Insolvency Rules). Where a CVA proposes to treat a class of creditors differently from other classes, there is a clear danger that if the differentiated class holds under 25 percent of the voting rights, it will be powerless to prevent other creditors from approving the debtor's proposal.

The small number of provisions of the Insolvency Act 1986 and the associated Rules speak of creditors as a collective. Thus, the debtor's proposal and the notice of the creditors' meeting must be sent out to all creditors, and all of them must be invited to attend the meeting and vote on the proposal. There is no basis for excluding a category of creditors on the grounds that it has no interest in the proposal or that it has no economic interest in the debtor (as is the case with a "scheme of arrangement", a procedure under the Companies Act 1985 enabling a compromise or arrangement between a company and its creditors, its members or any class of them, subject to ratification by the court).

One may perhaps then have inferred that a CVA proposal must provide for all creditors to take the pain (or, if you prefer, the haircut), such that their treatment and recovery rate contemplated by the debtor's proposal must be the same. However, voluntary-arrangement practice soon established that a debtor's proposal could offer creditors a derisory return, or no return at all, and if the creditors voted for it, it was binding. It was a matter for creditor democracy to establish whether the creditors were prepared to accept a debtor's offer of compromise, however commercially repugnant its terms might be. It was then not too big a step for debtors to start differentiating between categories (or classes) of creditors in terms of treatment and recovery under a CVA.

The landmark case of Re Cancol [1996] 1 BCLC 100 established that a debtor could legitimately offer a different deal under a CVA to those landlords of premises it wished to continue to occupy for its future business and those whose premises it wished to vacate. This line of reasoning has been refined and, in more recent times, has been adopted with considerable success by retail chains overburdened by long-term, onerous, solvency-busting leases. These debtors have used CVAs as a way of retaining leases at profitable sites (perhaps on varied terms) and escaping from unprofitable sites by leaving landlords to claim a dividend calculated in accordance with a specified formula from a pot of money reserved for them. JJB Sports is one of the most high-profile companies to have used a CVA to this effect—and not once, but twice. There has, however, been no challenge made to any of these CVAs. If there had been a landlord disgruntled with differential treatment compared to non-landlord creditors, what could the poor fellow have done about it?

There are only two grounds of challenge: material irregularity and unfair prejudice. Although the terms of a CVA are ostensibly protected by section 6(a) of the Insolvency Act 1986, challenging them as unfairly prejudicial has proved difficult for creditors. As held in Re a debtor (No 101 of 1999), the mere existence of differential treatment is not enough to support a finding that a dissentient creditor has been unfairly prejudiced. Further, even if a class of creditors would have been able to vote down a scheme of arrangement, that does not necessarily mean that a CVA proposal can, on the same facts, be successfully challenged as unfairly prejudicial.

In considering whether a CVA is unfairly prejudicial, the court will examine the dissenting creditor's position as against the other creditors (the "horizontal position"). However, it will also place substantial weight upon the return that the creditor might expect in a winding-up of the debtor (the "vertical position"). While the Powerhouse ruling (Prudential Assurance v PRG Powerhouse, 2007 EWHC 2170) confirms that a CVA will be unfair if the creditor would be in a worse position than in a winding-up, where this is not the case, the courts have been inclined to overlook an imbalance in the recoveries of creditors, swayed by the desire to let stand a CVA proposal approved by creditors.

Though utilitarianism may motivate the court to overlook an unevenness of treatment under a CVA, it is not hard to understand the court's reluctance when a CVA is approved by the weight of votes of those creditors who have nothing to lose by the CVA and who are in the happy position of saying: "It's not my money at risk, so why not vote yes?"

The court considered this very situation in HMRC v Portsmouth City Football Club (in administration) [2010] EWHC 2013, where Her Majesty's Revenue and Customs ("HMRC") objected to the participation in the vote of "football creditors" who, pursuant to Premier League and Football League rules, have to be paid in full under a CVA if the Premier League or Football League is to renew the membership of a football club that is subject to an insolvency procedure. Football creditors are creditors related to the football industry (e.g., other clubs, if there are transfer fees outstanding; player salaries; and various football authorities and organisations). Whether you love or hate HMRC, it deserves a medal for its determination to overturn CVAs that it sees as disadvantageous to its interests, even though its history of success has—how shall we put it?—not been crowned with glory. Not one to give up without a jolly good fight, HMRC challenged the football club's CVA on both material irregularity and unfair-prejudice grounds.

By making an analogy between a CVA and a scheme of arrangement, HMRC initially invoked "material irregularity" as a means of challenging the football creditors' exercise of voting rights. However, Mr Justice Mann rejected this argument, ruling that, as the provisions for voting in CVAs do not require, or indeed allow for, separate classes of creditors, there could not be any irregularity. This decision makes clear that "irregularity" refers only to a digression from the statutory provisions and not a complaint of inherent unfairness.

Minority creditors are therefore left to interpose an unfair-prejudice argument if they wish to challenge the participation of West Lothian creditors in the yes vote. This line of argument was similarly rejected in Portsmouth, albeit on a factual basis. The judge held that the football creditors did in fact have an interest in the CVA's being approved. If the CVA were not approved and a liquidation followed, the court concluded, their contracts of employment would come to an end. In contrast, were the football clubs to continue operating after approval of the CVA, then the balance of the football creditors' existing contracts would be honoured.

COMPANY VOLUNTARY ARRANGEMENTS

If a UK company and its creditors can reach agreement on a plan to deal with the company's debts, an appropriate means of implementing such agreement may be a company voluntary arrangement ("CVA" ) , largely under the UK Insolvency Act 1986. Under this process, the debtor makes a proposal to its creditors to repay a certain percentage of their claims over a specified period of time. If more than 75 percent in value of the debtor's creditors taking part in the creditors' meeting to consider the proposal vote in favour of the proposal, then, subject to certain safeguards, the proposal becomes binding on all creditors, including those who voted against it (although secured creditors need to consent specifically to a CVA in order for it to be binding on them).

Notwithstanding his factual ruling vis-à-vis the football-creditor athletes, the judge did note that:

[I]f it were the case that these creditors had no real interest in the CVA at all then there might be something in it. Why should those with no interest in the CVA at all, and who were being paid outside it, be entitled to force unwilling creditors into a CVA which is not approved by a requisite majority of that smaller class?

Interestingly, the judge did not apply this line of analysis to the non-employee football creditors, such as rival clubs owed transfer fees by the insolvent club.

Although the battle is lost, the war might yet be won by the launch of a separate campaign. HMRC has brought proceedings against the Premier League to challenge the validity of the football-creditor rule.

Although the West Lothian question has thus far arisen only in the idiosyncratic world of football insolvency, it is not inconceivable that West Lothian creditors may appear in a more typical commercial context—for example, where a creditor is able to recover in full outside a CVA (such as by way of a third-party guarantee that will not be discharged by the CVA). It is apparent that there is friction between the freedom which the Insolvency Act gives to a debtor to craft its proposal in whatever way it wishes (subject to certain safeguards) and what we might grandiosely call "the laws of natural justice". The authors' view is that the courts have correctly interpreted the statutory regime for voluntary arrangements. In applying English insolvency law, the courts appear to have resolved the West Lothian question in favour of the Scottish MPs. Whether that result was intended by the UK Parliament is another matter. In any case, we can see that the result, however commercially convenient, does lead to unfairness and an abuse of creditor democracy. The football-creditor rule also rankles. It is not hard to see the force of the argument that it breaches the golden rule of English insolvency law that all unsecured creditors must be treated equally. We await the outcome of HMRC's proceedings with great interest, in the hope that it will rule on the validity of the football-creditor rule once and for all and throw light on how to resolve the West Lothian question with respect to voluntary arrangements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Michael Rutstein
 
In association with
Related Video
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Law Practice Management
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.