Accountability and fairness

between the IP and the directors need to be given information on such matters as: the assets and valuations; projections of income on future contracts; cost savings and ongoing expenses; whether suppliers and customers will remain loyal; potential repossessions/forced sales; whether third-party funds are available; the commitment of the directors; and potential claims against the company.131 The IP is obliged to take reasonable steps to be satisfied that assets and liabilities are not materially different from the position outlined in the proposal; that the proposal will be implemented as represented and that there is no ‘already manifest yet unavoidable unfairness’ in admitting, rejecting or valuing voting claims.132 Here much depends on the skill of the IP and his/her commitment to giving a full picture to the company and creditors. Guidelines on best practice are made available to IPs by the Association of Business Recovery Professionals (R3). There are, moreover, incentives to inform: as has been pointed out, the IP’s role in a CVA demands that central importance be given to the creation of trust among affected parties.133 As for judicial scrutiny, there are indications that the courts will be inclined to defer to the professional judgements of IPs. In SISU Capital Fund Ltd v. Tucker Warren J dismissed a challenge from bondholders, stating that there was no unfair prejudice arising from the terms of the CVA that affected their position as creditors. Furthermore, the court was not in a position to judge whether proposals put forward as part of the CVA could be improved upon – this was a matter for the professional judgement of the IPs.134

The process of holding the IP to account demands not merely that information be made available but that this can be used. For a creditor this will mean that the creditors’ meeting has to be attended or a proxy be used. (Under the Insolvency Rules 1986 (Rule 1.17(1)) every creditor ‘who was given notice of the creditors’ meeting’ is entitled to vote at the meeting.) There is no procedure, though, for advertising for creditors of whom the company may not be aware at the time of summoning the

131See R. Gregory, Review of Company Rescue and Business Reconstruction Mechanisms: Rescue Culture or Avoidance Culture? (CCH, Bicester, December 1999) p. 15.

132Ibid., pp. 15–16; Greystoke v. Hamilton-Smith [1997] BPIR 24, 28. It is a criminal offence for a past or present officer of a company to make ‘any false representation’ or commit any other fraud to obtain creditors’ or members’ approval: Insolvency Rules 1986 (SI 1986/1925) r. 1.30. An ‘officer’ here includes a shadow director (r. 130(2)). See also Insolvency Act 1986 Sch. A1, paras. 41 and 42; IA 1986 ss. 6A and 7A.

133See Flood et al., Professional Restructuring, pp. 5, 20–2.

134SISU Capital Fund Ltd v. Tucker [2006] BCC 463. Warren J did, however, give guidance on how to structure proposals to avoid complaints of unfair prejudice under IA 1986 s. 6.

meeting. (The DTI had advocated a requirement to advertise the moratorium in the Gazette and a newspaper in its 1995 paper.)135 Under the Insolvency Act 2000 amendments, however, advertising is called for when the moratorium comes into force.136 A CVA approved by a creditors’ meeting, nevertheless, binds all parties who are entitled to vote at the meeting (whether or not they were present or represented) or who would have been so entitled had they been given notice.

As for the interests of unknown creditors in a CVA, these are dealt with in Schedule A1, paragraph 38 of the Insolvency Act 1986, which gives parties who have not been given notice of the creditors’ meeting a power to apply to the court to challenge a decision of the meeting on the grounds of unfair prejudice or material irregularity. They are given twenty-eight days from the date of their awareness that the meeting has taken place to make such an application to challenge. The court, if satisfied of the basis of such a challenge, can revoke or suspend the decision but can also direct the summoning of further meetings to consider revised CVA proposals. This provision substitutes for the DTI’s 1995 proposal that a further meeting of creditors should be convened where the effect of unknown claims would be to reduce the payment to creditors by 10 per cent or more. It is arguable that an advertising requirement would be fair to ‘unknown’ creditors likely to be bound by the CVA and it would enhance overall transparency and conduce to effective creditor communications.

Holding the directors to account may be as important in a CVA as the appropriate accountability of IPs. During a moratorium the directors will continue to manage the affairs of the company and secured creditors may fear that secured assets may be dissipated, with the possible result that if the CVA is not approved there will be little left over to satisfy the security.137 Some respondents to the DTI’s 1993 proposals (notably IPs and lenders) expressed concern at the low level of monitoring involved in the CVA moratorium, but the 1995 revised proposals suggested that levels of supervision by the IP nominee would ‘very much depend on the company’s circumstances’.138 The level of supervision should be settled before the nominee agrees to act, said the DTI, and it might include the nominee having full access to the company’s records and premises. Variations in supervision levels were called for because the level of supervision appropriate for a company with a large number of

135 DTI 1995, p. 22. 136 Insolvency Act 1986 Sch. A1, para. 10. 137 Brown, Corporate Rescue, p. 666. 138 DTI 1995, p. 16.

retail outlets operating on a cash basis would differ from that called for in relation to an operation relying on one director serving two or three customers. What there should be, said the Department, was a statutory level of supervision comprising scrutiny of weekly management accounts by the nominee. Further control of directorial activities during the moratorium would be provided for by a series of provisions.139 First, criminal sanctions and civil penalties would apply to directors who, for example, concealed, removed or destroyed assets and/or records; second, directors would only be able to dispose of assets (other than in the ordinary course of business) with the approval of the nominee and either the court or the creditors’ committee; and third, there would be general provisions for creditors and shareholders to apply to the court for relief. The Insolvency Act 2000 amendments duly made provision for such criminal sanctions,140 asset dispositions141 and applications for relief.142

The philosophy underlying such control provisions was that directors who were left in control of the troubled company should be strongly aware of their obligations: ‘the supervision and regulation of directors’ activities and the existence of penalties for non-compliance are thought necessary to provide a very clear signal that abuse of the moratorium period will not be tolerated. It should also allay concerns that creditors may have about management being left in charge of the company during the moratorium period.’143

The fairness of the approval process has been debated with regard to three main issues: the unfair prejudice rule; whether the approval majority for creditors’ meetings is set at the right level; and whether shareholders should, through the company meeting, have a power to approve the CVA at all.

Unfair prejudice

Under section 6 of the Insolvency Act 1986 any creditor who was entitled to vote at the creditors’ meeting may apply to court to challenge the CVA on grounds of unfair prejudice or material irregularity. In relation to the former ground, a notable difference between the CVA and the Companies Act 2006 scheme of arrangement creates considerable scope for allegations of unfairness. In the scheme of arrangement, as discussed above, account is taken of the divergences of interest between different creditor groups. Each class must approve with a majority in number representing three-quarters

139 See ibid., p. 17. 140 See now Insolvency Act 1986 Sch. A1, paras. 41–2. 141 Ibid., para. 18. 142 Ibid., para. 38. 143 DTI 1995, p. 17.

in value of the creditors for a scheme of arrangement to be approved. This is not the case in a CVA where all creditors vote together and, provided that the threshold of three-quarters in value in favour is reached, the CVA is approved. Such an arrangement can lead certain creditor groups to pursue their own interests in a contentious manner and the courts have looked at the issues in a number of cases.144 In the Wimbledon Football Club case,145 Lightman J stated that unequal or differential treatment of creditors in the same class did not constitute unfairness per se but might require an explanation; that, in looking at the unfairness issue, the surrounding circumstances should be considered, including alternatives to the arrangement at issue (taking in both liquidation and the possibility of a fairer scheme);146 and that differential treatment might be required to ensure fairness or the continuation of the business. Where, however, a group of creditors uses its votes to deprive a creditor or group of their rights against third parties while preserving its own rights, the courts are likely to find that unfair prejudice is suffered. This was so in Re a Debtor (No. 101 of 1999)147 and in the important Powerhouse decision.148

Powerhouse concerned the possibility that a troubled company might be able to ‘cram-down’ landlords by obtaining approval for a CVA in which those landlords surrender their proprietorial rights. In that case, a struggling electrical retailer (PRG Powerhouse Ltd) wanted to rid itself of thirty- five unprofitable leases (on underperforming stores) in pursuit of turnaround. The CVA demanded, inter alia, a release by the landlords but also a release by the parent company of Powerhouse from the lease guarantees that it had given. The CVA was approved in February 2006 at a meeting to which all creditors were invited –whether or not the CVA directly affected

144See Godfrey, ‘Legal Update’; Segal, ‘Schemes of Arrangement and Junior Creditors’, p. 55. See pp. 513–14 below.

145IRC v. Wimbledon Football Club Limited [2005] 1 BCLC 66; see also SISU Capital Fund Ltd v. Tucker [2006] BCC 463.

146[2005] 1 BCLC 66 at para. 18. In Re Greenhaven Motors Ltd [1999] 1 BCLC 635, however, Chadwick LJ stated that the court’s role was not to speculate on whether the proposed arrangements were the best available: the onus was on the disaffected creditors to show that some option presenting less prejudice to unsecured creditors was available to the company.

147[2001] BCLC 54 (creditors used their votes to force the Revenue to receive a reduced amount for its debt while retaining their own rights in full and this was held to be unfairly prejudicial).

148Prudential Assurance Co. Ltd v. PRG Powerhouse Ltd [2007] BCC 500. See the discussion in M. Chalkiadis, ‘Powerhouse: Has the Power Really Gone?’ (2007) 21 Company Law Newsletter 1; L. Verrill and P. Elliot, ‘Reflections on the Powerhouse Case’ (2007) Recovery (Autumn) 28.