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“Eradicate” Tax Debts at Your Peril

The High Court has ruled that a restructuring plan, which expressly targeted the “eradication of legacy debt built up with HMRC” in the sum of £7m, would not be approved.

In Re The Great Annual Savings Company Ltd [2023] EWHC 1141 (Ch) Johnson J declined to sanction the proposed plan for two reasons. Firstly, he was not satisfied that Condition A was met as the company had not persuaded him that HMRC would be no worse off under the plan. Secondly, in the event he was wrong about that, he declined to exercise his discretion as the plan was unfair.

The company is an energy broker. It was paid commission for brokering energy supply contracts between energy suppliers and commercial users. The commission was linked to the energy used under those supply contracts based on the company’s predictions of its customers’ usage. In the event the customer used less energy, overpaid commissions could be clawed back by the energy companies. The company faced growing debts to the energy suppliers due to over-prediction and/or under-usage of energy. The Company also owed its secured creditor some £28m in addition to the debts owed to HMRC.

The Company was insolvent and HMRC, supported by other creditors, presented a winding up petition.

In response to that the Company proposed a restructuring plan under Part 26A of the Companies Act 2006. Under the Plan it would write down HMRC’s and many of the energy supplier’s debts in order to continue trading. It planned to convert much of the secured creditor’s debt into equity in the parent company, pay HMRC some £600,000, which was 9p/£ and its landlord would receive 20.9p/£. Many of the other creditors would receive a maximum of 2p/£.

HMRC and various of the energy suppliers voted against the Plan. The Company applied to Court to sanction the Plan notwithstanding the fact 3 classes had not voted in favour of the Plan. The Plan was opposed on the basis that the creditors would be worse off if the Plan were approved than in the relevant alternative and in any event that the Court should not exercise its discretion in favour of the Company.

Condition A
HMRC’s argued it would worse off under the Plan compared to the likely alternative of administration. Firstly, HMRC argued that the Company’s figures on which they sought to base the analysis were inaccurate. HMRC criticised the Company suggesting that in an administration it would receive a maximum of 4.7p/£. Their case was that the returns in a formal insolvency would be greater than the Company predicted, and the Company’s expert evidence could not be relied on. Secondly, HMRC asserted that in a formal insolvency, claims could be made against the directors and other third parties personally to increase the sums available to HMRC.

The Company’s case was that HMRC had put forward no expert evidence of its own such that the Company’s evidence, with the lower estimated returns, should be relied upon. The Company argued the third-party claims were too uncertain to be relied upon at this stage. The Company also put forward a novel argument that ran as follows. By continuing to trade, the Company would incur and pay on time and in full further tax liabilities (such as VAT, PAYE, NIC etc.) and that those further tax payments should be included in the analysis to say that HMRC would be better off under the Plan than in the alternative.

The Court was critical of the Company’s evidence and did not find it persuasive, particularly on the calculation of the book debt. That debt was valued at roughly £18m. Under the Plan, the Company estimated I would recover £9m of that but in the relevant alternative it was only estimated to recover some £500,000 at the highest. The reasoning for that reduction “rather thin and unconvincing” [69]. Condition A not satisfied as the Company could not persuade the Court that HMRC would be no worse off under the plan.

The Company succeeded on the third-party claims as the Court agreed they were too uncertain such that there was difficulty in attributing value to those claims.

The Company’s final point on Condition A was also rejected. The payment of future tax revenues could not be counted as a benefit which existed only under the Plan and that in the relevant alternative those payments would not accrue to MRC. However, the Company’s evidence was that its staff would work for rival companies and the energy contracts would still be brokered such that those companies would incur the tax liabilities of VAT, PAYE and NIC. Johnson J also went on to conclude that Condition A is limited in its scope as one can only consider a creditor who is “any worse off as regards the existing rights which the plan seeks to compromise” and in doing so relied on the reasoning of Trower J in Re DeepOcean 1 UK Limited [2021] EWHC 138 (Ch) at [34-35].

TotalEnergies Gas and Power (TGP), one of the energy suppliers which had worked with the Company for many years and was owed c.£3m, argued that it too would have been worse off under the Plan. TGP would have been worse off if the Plan were approved as the Company would divert its renewal portfolio to TGP’s commercial rivals which had been categorised as Category 1 Energy Suppliers, which consisted of the select few ‘critical’ energy suppliers the Company had chosen to work with going forward. The Court rejected this approach for the same reason it rejected the Company’s argument.

Practitioners should note that the ambit of Condition A is not being treated as widely by the Court as its natural wording may indicate at first blush. TGP argued that its approach was with that adopted by Snowden J (as he then was) in Re Virgin Active Limited [2021] EWHC 1246 (Ch) where the commercial reality of how different landlords would act in the market depending on whether the proposed restructuring was approved or not was taken into account [199-206]. Condition A is drafted in wide terms. When contrasted with Condition B the difference is stark. Condition B is concerned only with in the money creditors whereas Condition A is not limited, and the statutory test is whether a creditor is any worse off. The limitations applied by Trower J in DeepOcean and approved by Johnson J (that the analysis relates only to the creditor’s existing rights which are to be compromised by the Plan to the exclusion of other rights which could accrue outside the plan) are not found in statute.

All that being said, whilst the precise extent of Condition A as it relates to commercial creditors remains in some doubt, the position of the payment of future tax liabilities is not in doubt. Johnson J concluded that “the Company’s obligation to pay taxes in the future is not an obligation that arises under the Plan: it arises independently, under the relevant tax legislation”.

Practitioners will also need to note the subtle evolution in how evidence, particularly expert evidence, is being treated in this developing jurisdiction. The general principles of English law apply to expert evidence in this arena (as set down authoritatively in Griffiths v TUI (UK) Ltd [2021] EWCA Civ 1442) and opposing creditors do not need to obtain their own expert evidence in order to challenge the basis of a proponent of a plan claiming the creditors will be worse off on the alternative.

HMRC argued the Plan was unfair based on how the ‘restructuring surplus’ was distributed. In short, their case was that they and the secured creditor fared similarly in the relevant alternative but they diverged significantly under the Plan. It was also unfair, so the argument went, that existing shareholders and directors would be repaid in full despite not adding in any new money. Further, The ‘Category 2 Plan Creditors’ would be paid 10p/£ (more than HMRC) but would recover nothing if the Plan were refused.

The Company’s response to that was that that difference was justified and there was nothing inherently wrong with a plan seeking to alter the priorities which would apply in the relevant alternative.

Johnson J was against the Company on the question of fairness: “while the basic idea of the Plan is to provide “a solid platform for future growth and value creation”, and while the mechanism for achieving that objective involves both the eradication of HMRC’s existing debt and prioritising payments to various unsecured creditors at HMRC’s expense, the benefits from such value growth as might be achieved are allocated disproportionately to the Secured Creditor and the existing shareholders/Connected Party Creditors. They are the principal beneficiaries under the Plan. In the circumstances, this distribution of benefits to my mind is unfair.”

Practitioners will need to have in mind that those creditors who will do best under an alternative to a restructuring plan do not need to be treated the best under a plan, but they need to be treated fairly with any departure from the ordinary rules of priority justified. One cannot hope to eradicate tax debts in order to return a company to profitability for the benefit of its shareholders and connected parties.

HMRC will no doubt be relieved that such a direct attack on its debts has not been approved. Practitioners will need to consider that in future companies proposing such plans will have to make greater allowances for HMRC’s debts to be paid. An argument that HMRC does not contribute to the economic success of the company will not gain traction as payment of tax is a necessary condition of doing business at all. The Scope of Condition A is much clearer as regards the revenue but its scope for other creditors remains uncertain.

Plans need to be fair to prevent in the money creditors challenging the allocation of the restructuring surplus but such challengers do not need to bring their own expert evidence.

Written by Matthew Gillett 

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