Challenging CVAs

Michael Ellis, of Healys' insolvency law team in London, looks at a High Court judgement regarding Company Voluntary Agreements and the successful challenge of a CVA put forward by directors of an East Sussex-based airline.(London December 2010) Company Voluntary Arrangements (CVAs) have been in the spotlight recently particularly with the recent decision in the case of Miss Sixty UK (Mourant & Co Trustees Limited v Sixty UK limited (in administration) 2010).In the case the High Court held that the purpose of the CVA was to compel the landlord to give up its rights under a third party guarantee for a fraction of its fair value. The CVA was set aside and criticised as being "fatally flawed". Furthermore, the administrators who proposed the CVA were criticised heavily for not maintaining an independent stance or acting in good faith.Healys' CVA challengeHealys recently successfully challenged a CVA put forward by the directors of MK Airlines Ltd, a cargo freight airline, which operated from its East Sussex Headquarters in Landhurst on grounds of material irregularity and unfair prejudice.The Facts of the CaseMK Airlines put forward a proposal to creditors offering to pay them merely two pence in the pound in satisfaction of its total indebtedness. The basis of the dividend to creditors was that a third party connected to the airline would pay a lump sum into the CVA to enable such a dividend to be paid.This was the second CVA put forward by MK Airlines in the space of 12 months. The airline clearly had a rocky past because the previous CVA had only ended in January 2010 and the company was in administration prior to that in 2009. It had only therefore been trading out of its prior insolvency for as little as 6 months and during that short period of time, it had incurred a substantial amount of new debts to unsecured creditors in circa of �104 million.The airline had also voluntarily suspended its Air Operator's Licence ("AOL" - the licence required to enable it to continue to fly and thus trade) and although it was briefly mentioned in the proposals that the Company intended to re-instate its AOL and trade again, there were no details provided in the proposals to re-assure creditors as to the steps it would be taking to do so.On top of this, just one day prior to the creditors' meeting, the previous administrators of MK Airlines had applied to the Court and obtained an Order to be appointed provisional liquidators over the airline on grounds that they were concerned over the security of the assets. Unusually, they were appointed provisional liquidators despite also being secured creditors (pursuant to a statutory charge under Paragraph 99 of Schedule B1 of the Insolvency Act 1986) for unpaid fees and expenses which had been incurred in the previous administration.The CVA was nevertheless approved by the Chairman. Its approval particularly rested upon the valuation of one creditor's claim, an aircraft lessor, which was accepted in full by the Chairman despite its claim including sums for future rents and termination payments.The ChallengeWe challenged the CVA on grounds of material irregularity and unfair prejudice in light of the following two main points:

1. The wrongful decision to allow an aircraft lessor's vote to be counted for the high sum in which it was; and
2. The wrongful decision to allow the proposal to be voted upon in light of the unclear picture of the Company which the creditors had been given.

(1) The Aircraft Lessor's VoteThere was no dispute that the lessor had the benefit of accrued debts in the form of arrears. However, the Chairman accepted that it had a good claim for future rent (including termination payments) in excess of $20 million US Dollars despite recent precedents such as Doorbar v Alltime (No.2) [1995] BCC 726 and Re Sweatfield Ltd [1997] BCC 744 where it was held that a claim for future rent is both unliquidated and unascertained.These matters were extremely important because the approval of the CVA was reliant on the lessor's debt for future rent being allowed for at least �3 million. Without this, the CVA would have unquestionably failed.It was our case that the future rent should have been allowed for only �1 in accordance with Rule 1.17(3) of the Insolvency Rules 1986 and the termination payments would be void as being penalties under English law.Rule 1.17(3) provides that where the debt is unliquidated and unascertained (as with future rent), the proper course is for the Chairman to allow the vote for �1 unless he agrees to put a higher value on it.However, the Chairman took a different approach and allowed the vote in full marking it as objected to under Rule 1.17A(4) of the Insolvency Rules 1986.The Chairman's position was that it had sought independent legal advice as to the implications of future rents in aircraft leases. As this lease was subject to New York Law, the advice sought was that the future rents would be liquidated unlike in English Law. Further, they claimed that as Nominees they were not legal advisors and it was correct therefore to mark the claim objected under Rule 1.17A(4) leaving any creditors open to challenge their decision in the courts if they wished to do so.(2) Unclear Picture of the CompanyThe creditors were given an unclear picture of the company to allow them to make a proper assessment of the Proposals and whether this was the right course of action for them. In particular, the Proposal failed to deal adequately with the Company's assets. In main, it did not disclose certain assets which would benefit the company worth millions of pounds which would have been available to creditors in a liquidation but were not included in this CVA.The RulingLord Justice Lewison ruled in favour of the Applicants and held that the CVA be revoked on grounds of material irregularity and unfair prejudice.He accepted the submissions of the termination payments on the part of the Applicant were correct and should be followed (i.e. the payment was viewed as a penalty and thus unenforceable). Hence it would not be recoverable as a liquidated sum.He also held that the Chairman should have valued the claim for future rent at one pound only in accordance within Rule 1.17(3) and should not have applied Rule 1.17A(4) (i.e. allowing full value and marking it objected to).He stated in his ruling that the process of placing a higher value would require a 'conscious' decision on part of the Chairman to arrive at such a value but in this case there was no evidence that the Chairman went through this process. It was noted that the Chairman did take legal advice, but there was no evidence that the lessor's claim was "valued" as part of a process envisioned in the Insolvency Rules. On this footing the creditor should have been allowed to vote for arrears plus one pound only.Justice Lewison stated that the CVA was procured by the vote of someone not entitled to vote, or entitled to vote but not to the extent of which he did. He held that this gave rise to an unfair prejudice (because it deprived the other creditors of an alternative outcome) and thus triggering Rule 1.17A(5). He therefore ordered that the approval of the CVA be revoked.Healys also successfully challenged the application by the Provisional Liquidators to be appointed as Liquidators in the winding up on the basis of a conflict of interest (as they were also secured creditors under their Paragraph 99 statutory charge referred to above) and independent insolvency practitioners were appointed in accordance with the wishes of the majority creditors.ConclusionAlthough a different set of circumstances applied to the Miss Sixty UK case, there is a clear underlying message to take from this recent influx of CVA challenges for all parties involved whether approving, proposing or advising on them. The Courts are showing a clear willingness to step in to revoke the CVA where it can satisfy itself of those grounds as to material irregularity or unfair prejudice and will even go as far as reporting insolvency practitioners to their representative body as was done in the Miss Sixty case.Healys can offer a full range of advice and assistance on challenges to CVAs and the implications for all parties involved. Should you have any queries regarding the contents of this item or any insolvency law issues, please do not hesitate to contact us at enquiries@healys.com on 020 7822 4000 �who will be happy to assist with your enquiries.