In life (and restructuring plans) everything is timing

It would now appear that the same is true for restructuring plans. The Court of Appeal has just handed down a much anticipated judgment in the long-running Petrofac saga. That Petrofac was contemplating a restructuring plan became apparent at the end of 2024. The development and proposal of that plan has been hotly contested since that time. The Court of Appeal ruling on 1 July is the third occasion, following Adler and Thames Water, in which the principles behind restructuring plans have been subject to appellate consideration. 

Perhaps most notably, one of the issues the judgment grapples with is whether or not any weight should be given to the treatment of "out of the money" creditors. In that respect, Petrofac builds upon the Court of Appeal judgment in Thames Water. More significant, as they go to the heart of the ruling, were the Court's comments upon the time at which the position of a company being restructured should be evaluated.

Petrofac's restructuring plan

Two Petrofac companies proposed restructuring plans – Petrofac Limited ("PL") and Petrofac International (UAE) LLC ("PIUL"); together ("Plan Companies"). The plans followed a period of serious financial difficulties starting in 2017. Those had stemmed from Serious Fraud Office investigations. A refinancing in late 2021 failed to stem the group's financial problems which, over time, became more acute. 

Attempts to sell some of the Group commenced in mid-2023. These, and a negotiated restructuring, each proved to be unsuccessful. Plan negotiations then started and the restructuring plans for each of the Plan Companies were formally announced in late December 2024. 

There were five classes of creditor:

• Senior Secured Funded Debt
• Shareholder Claims
• Directors' Claims
• PL Insurance Restitutionary Claims
• Claims connected to a "clean fuels project". The failure of this project led ultimately to the challenges to the Petrofac restructuring plans, both at first instance and before the Court of Appeal. The difficulties with this project arose on account of substantial claims by Thai Oil

The plan provided that:

• Senior Secured Funded Creditors would receive equity in the restructured group amounting to approximately 17.5% of the post-restructuring equity
• Shareholder Claims. In return for their releasing possible claims under the Financial Services and Markets Act 2000, shareholders would receive the right to participate pro rata in a settlement fund of £1m. A similar £1m fund would be available to meet directors' claims

In addition to this, all three of these groups of claimants stood to receive warrants equating to 1.5% of the post-restructuring equity of PL in the event that its market capitalisation exceeded US$1.35billion and an additional 2% of the post-restructuring equity if PL's market capitalisation exceeded US$1.5 billion.

Samsung and Saipem would receive, in return for releasing their unsecured claims, different combinations of cash, ordinary shares in PL, warrants and the right to provide up to US$ 25 million of new equity in PIUL. Their returns, while very substantially less than the payments to new money creditors, were in each case to be materially above the amounts Samsung and Saipem would have received in the "relevant alternative" to the restructuring plans; see further below.

It was accepted that the "relevant alternative" to the restructuring plans was insolvent liquidation. Teneo's valuation implied that the post-restructuring equity value of PL would be between US$1.35 billion and US$1.85 billion. The effect of these valuations was that the Senior Secured Funded Creditors would stand to receive a return of approximately 28.8%. By contrast, all other unsecured claimants including Thai Oil, Samsung and Saipem stood to receive either or both of warrants and cash equating to a return of 1.4%. 

The plans also provided for provision of new financing of US$350 million, part of which was to be provided by way of a loan in exchange for "new money notes". The balance was to be funded through the provision of US$218.75 million of "new money equity". All the existing Senior Secured Funded creditors were entitled to participate in making this new money available pro rata to the amount of their existing claims.

In addition, Senior Secured Funded Creditors stood to receive in return for providing new money a combination of back stop and work fees.

Thai Oil, Director Claimants, Samsung and Saipem voted against the plans. Saipem and Samsung (the "Appellants") appealed against Marcus Smith, J's (the "Judge") ruling sanctioning the plans.

Grounds of Appeal

There were two grounds of appeal:

1. The Judge had wrongly held that Samsung and Saipem would not be "worse off" in the way required for a restructuring plan
2. The Judge had been incorrect to sanction the plans, as the benefits of the restructuring were not being fairly shared between the respective Plan Creditors

The Appellants' appeal on ground one failed, albeit the Court of Appeal made some useful comments on the meaning of the "no worse off" test. However, the appeal in relation to the fairness of the distribution of the restructuring surplus between creditors was successful. Hence the Court of Appeal set aside the order of the Judge sanctioning the restructuring plans. The next two sections of this article address each of these points in turn.

What does "no worse off" mean in a restructuring plan?

One of the conditions for imposing a restructuring plan on a dissenting class of creditors is that none of the members of that class – here Samsung and Saipem – would be any worse off than they would be in the "relevant alternative" – i.e. the financial outcome if the restructuring plan failed to proceed. As stated above, the "relevant alternative" in this case was insolvent liquidation.

The Appellants said that in determining whether or not creditors would be better off under the plans, it was necessary to consider both direct monetary returns and any indirect economic benefits that would accrue on liquidation. In particular, the Appellants contended that the plans took no account of the competitive advantage that each Appellant would achieve were the Petrofac Group to go into insolvent liquidation. That would be a direct consequence of Petrofac's removal from the market. It was accepted that any assessments of the impact of a restructuring plan on a creditor or group of creditors needed to look at the position of a creditor in its capacity as creditor. 

The Court of Appeal accepted that the starting point for assessing whether a creditor was any worse off was a comparison between the value of its existing rights and the value of any new or modified rights afforded to that creditor under a restructuring plan. The Court of Appeal also accepted that it was necessary to consider the effect that a restructuring plan might have on rights that creditors would otherwise have enjoyed against third parties. 

The Court went on to hold that focusing upon the "rights" of creditors under a restructuring plan was more appropriate to determining whether or not particular outcomes were too remote from the position of creditors as creditors. Applying the "rights" test, Samsung and Saipem had no right, prior to the restructuring plans, to compel Petrofac to cease trading in competition with them. To that extent, the restructuring plans were neutral in their effect. In addition, the financial returns to Samsung and Saipem were better under the restructuring plan than would have been the case in a liquidation of Petrofac.

For these reasons, the "no worse off" ground of appeal was unsuccessful. 

The allocation of the restructuring benefits between different classes of Plan Creditor

The Court of Appeal agreed with the Judge that any prejudice that a creditor might suffer and which was not capable of being defined as a "right" went to the question of whether or not the Court should exercise its discretion in favour of sanctioning a restructuring plan. That observation – at paragraph 98 of its Judgment – was the backcloth to the Court's consideration of the Appellants' contention that the plans unfairly divided the benefits of the restructuring between the various creditor groups. The Appellants took particular exception to the generous treatment of the new money providers. The Appellants rejected the company's arguments that new money was a high risk investment. Instead, the Appellants said that the effect of the restructuring plans, should they be allowed to take effect, would be to have made the Petrofac Group profitable through the relief of the debt burden to which it had been subject before the restructuring plans' implementation. 

The Court of Appeal observed that Petrofac was the first case in which it had had to consider a full blown restructuring. In Adler, a restructuring plan was proposed to complete an orderly wind down of the company's business. In Thames Water, the restructuring plan was a "bridge" transaction. Its purpose was to extend the maturity of various credit facilities and to provide for the injection of a further £3 billion of liquidity. Those funds were in turn necessary to enable the Thames Water group to put forward and implement a second restructuring plan to give effect to a complete balance sheet restructuring.

The Appellants' principal complaint was that the new money providers were being given a disproportionate amount of the restructuring value. The Court of Appeal prefaced its discussion of this issue by pointing out that where new money was provided during a competitive process, returns on such new money had to be treated as a cost of the restructuring. The Court said the position would be identical where existing funders – here the Senior Secured Debt Funders – were invited to participate in providing new money. 

By contrast, where the returns offered on new money were materially in excess of those available on the open market, the excess returns should be treated as a benefit conferred by the restructuring. 

In any case where a company sought to exercise the cram down power, that company bore the burden of justifying the fairness of its allocation between creditors of the benefits of the restructuring. The Court of Appeal further justified this conclusion by pointing out that in many cases, including Petrofac, the "relevant alternative" to a successful restructuring plan would be an insolvent liquidation (or administration). The Court went on to say – correctly – that prior to the restructuring plan, any company facing creditor pressure would need to negotiate a genuine commercial settlement between its different creditor classes. It therefore followed that the "reasonable starting point" for assessing the appropriate price of any new money was – paragraphs 152 and 153 of the judgment – the value ascribed to the company by an independent expert immediately after the approval of the restructuring plan. 

The Court of Appeal went on to support this analysis by reviewing the valuation evidence. The Court concluded that the evidence did not provide any analysis of the range of prices at which debt or equity might have been obtained by the restructured group. The Court of Appeal then inferred that the allocation of new equity to the new money providers had in fact been settled in late December 2024, the time at which the restructuring plans were first mooted. The companies' failure, in its subsequent valuation evidence, to revisit those initial allocations to new money creditors led to the excessively high returns afforded to the new money providers. For all of these reasons, the Appellants' appeal succeeded on its second ground and the order sanctioning the two restructuring plans should be set aside.

What, if any, say should "out of the money" creditors have in the division of the benefits in a restructuring plan?

As explained above, the Court of Appeal concluded, on the evidence, that the return given to new money creditors was excessive. The timing of the valuations was a material factor in that conclusion. On its own, this was sufficient for the Appellant's appeal to succeed. 

Another question that was debated extensively in the Court of Appeal was the correctness or otherwise of submissions made in Thames Water that "out of the money" creditors should never be entitled to share in the benefits of a restructuring plan. Strictly speaking, the Court of Appeal's treatment of the position of "out of the money" creditors was obiter. The Appellants were not complaining that they had been excluded from the restructuring plan as "out of the money" creditors. Their complaint was that the return afforded to new money creditors under the restructuring plans was disproportionate in the circumstances facing the Petrofac Group. 

The Court of Appeal in Petrofac endorsed and developed the approach taken by the Court of Appeal in Thames Water. It accepted that Virgin Active was not authority for the complete exclusion of "out of the money" creditors from the restructuring plan process. The difficulty with Virgin Active was its failure to take full account of a restructuring plan's effect. The effect of an, approved, cross-class cramdown would be to implement a restructuring and in doing so to restructure or remove from the balance sheet the levels of debt that had previously exposed the distressed company to the risk of an insolvent liquidation or administration.

Conclusions

The further Court of Appeal ruling in Petrofac on restructuring plans is welcome but also disappointing. The disappointment is the Court's failure to come up with a clear set of principles as to how the benefits of a restructuring should be allocated between different creditor classes. Standing back, that outcome is to a material degree unsurprising. As we said in our article on Thames Water the restructuring plan process is capable of use in a wide range of differing situations. As we also said, that fact-based approach affords substantial flexibility to distressed companies and their advisors. Such flexibility will inevitably be on occasion a mixed blessing that will sometimes invite challenge. An easy riposte would be to say that this challenge risk, coupled with the requirement for careful valuation evidence, risks making restructuring plans unworkable. 

An alternative assessment would be to say that if the threat of a challenge in any given case leads a company and its creditors to reach a consensual settlement that would not have been achievable without the threat of cross class cramdown, the restructuring plan process will still, even if indirectly, have achieved its objective of promoting the rescue culture. The writer subscribes to this view.

[DAC Beachcroft continues to advise the board of directors in the Thames Water restructuring, working with Linklaters and others advising the company]