The Court of Appeal has handed down judgment in the Petrofac restructuring plan, overturning the sanctioning of the plans by the High Court. This is only the third time a restructuring plan has been considered by the Court of Appeal, in this blog we focus in on some of the key points of interest for future plans:
- No worse off test: the court reaffirmed the approach taken to-date that the relevant rights to consider when looking at whether a creditor would be better or worse off in the relevant alternative are that creditor’s rights as a creditor rather than their wider interests.
The court’s primary consideration should be the value that a creditor is receiving under a plan, compared with the financial value that they would receive in the relevant alternative. Where the plan interferes with the rights of creditors against third parties (for example, where guarantee claims are compromised), the scope of the ‘no worse off’ test will extend to consider these types of compromise. However, indirect benefits that a creditor may receive (in this case, a competitive advantage that the creditors would benefit from if Petrofac entered insolvent liquidation) are not relevant when considering the ‘no worse off’ test, but these types of creditor ‘interests’ may influence whether the court will exercise its discretion to cram down dissenting creditors.
- Allocation of the benefits generated by the plan: the court considered that determining a fair allocation of any benefits generated by the plan is likely to be straightforward where all creditors rank equally (as happened in Adler), however it is likely to be more difficult where creditors have different priority rankings, or where the plan envisages a complex restructuring. The court considered two issues relating to this allocation: how should “out of the money” creditors be dealt with; and to what extent “new money creditors” should be rewarded. The court came to the following conclusions:
- Out of the money creditors: the approach taken in Virgin Active was rejected with the court affirming that there is no blanket rule that out of the money classes can be excluded from the benefits of the restructuring in all cases. Instead, the case of out of the money creditors must be considered on a case-by-case basis. It was noted that, even if creditors would receive nothing in the relevant alternative, they were still contributing to the restructuring by giving up their claims against the plan company, and they should receive some value in return.
- New money creditors: those providing new money can reasonably be expected to be repaid in priority to existing creditors, and to make a return that reflects the risk associated with the loan. The burden is on the plan company to demonstrate that (and it should provide evidence to satisfy the court that) the returns being provided to the new money creditors are either: i) equivalent to funding at market rates, referred to in the judgment as ‘the cost of the restructuring’; or ii) where the returns are in excess of market rates, that the return is justified. The court’s approach was that any returns made by the new money creditors in excess of the costs of the restructuring were properly interpreted as a ‘benefit of the restructuring’ and should, therefore be allocated fairly between competing classes of creditors. The relevant date, when considering the market price for funding, is the first day after the restructuring of the company once its current debts have been restructured or released, not the price for funding an insolvent company. In Petrofac, the new money creditors stood to receive just over two thirds of the post-restructuring equity of the group, worth around US$1bn, which represented a return on the new money of 211%. The Court of Appeal was unable to agree with the High Court that the new money carried sufficient risk to justify this level of return and was of the view that the plan company had not demonstrated that providing this benefit to the new money creditors was a ‘fair allocation’ of the plan benefits. On this ground, the appeal was allowed. It should be noted that the court did not find that the allocation was unfair, only that the plan company had not produced evidence of its fairness. This failure to discharge the evidentiary burden was sufficient to overturn the High Court’s sanction.
The impact of these takeaways on future plans will remain to be seen, however, this decision stands as a warning to plan companies that they will need to discharge a significant evidential burden to demonstrate that the plan is fair to all plan creditors in order for the court to exercise its discretion to cram down any dissenting classes.
The court’s approach to the allocation of the benefits generated by the plan in respect of new money creditors in particular, is interesting and diverges from the approach taken in the Thames Water restructuring plan. It remains to be seen how easily evidence as to the ‘market price’ of debt or equity can be produced in respect of the hypothetical ‘day one post-restructuring’ situation, and we anticipate that this could be a highly contested area in future restructuring plans.
