The High Court's decision in the recent challenge by mezzanine lenders to the IMO Car Wash group’s (the group) scheme of arrangement is not groundbreaking, as some commentators have indicated, as it does not create new law; however, it is very helpful in reinforcing the view of the English courts that a company's value is its "current" value rather than some "future" value based on an improvement in market conditions, asset prices or financial performance (In the matter of Bluebrook Ltd and others  EWJC 2114 (Ch)). It is also a victory for common sense.
As Giles Boothman, a restructuring partner at Ashurst LLP points out: "The result of the case is not surprising given the valuations that were provided, but the case is interesting and it provides judicial scrutiny of many of the arguments and issues that those working in the restructuring field are encountering on a regular basis."
The group had two layers of secured debt: a senior loan of £313 million and a mezzanine loan of £119 million. An intercreditor agreement clearly subordinated the mezzanine debt to the senior debt and provided a contractual mechanism by which mezzanine security and guarantees could be released following an enforcement of senior security.
The group breached its financial covenants and defaulted on its interest payments, so was technically insolvent. The senior lenders proposed schemes of arrangement (the schemes) to release some of the senior debt in the group in return for shares in a new holding company (newco). Newco would acquire the group’s operating companies in return for the assumption by the newco group of some of the senior debt obligations from the old group.
The mezzanine lenders were not included in the schemes and their claims against the operating companies to be transferred to the newco group were released under the intercreditor agreement. On the senior lenders’ calculations, the value of the group's assets was less than the value of the senior debt, so there was no hope of a return for the mezzanine lenders.
The mezzanine lenders challenged this valuation and claimed that the schemes unfairly prejudiced them. They produced a valuation report to show the probability of value breaking in the mezzanine debt using a technique referred to as the "Monte Carlo simulation". The report concluded that it was "highly likely" that the value of the group was in excess of the amount of the senior loan: this was intended to demonstrate that the mezzanine lenders did have an economic interest in the group and should therefore have been involved in the schemes as a class of creditors entitled to vote on the schemes.
The court rejected the mezzanine valuation and was somewhat dismissive of the use of the Monte Carlo simulation, which produces a range of values using random sampling of input and assumptions, and is more commonly used in the US and in certain specialist industries such as oil exploration and pharmaceuticals research. It said that the technique seemed "to produce not so much a range of values, professionally assessed, but a range of possibilities" and was too mechanistic. To get a real view of the value, the court felt that professional, and subjective, judgment was required.
The court pointed to the PricewaterhouseCoopers valuation report prepared for the group and the senior lenders as an example of how to deal with the impact of market conditions: this valuation had a built-in discount to reflect the lower price a buyer might pay in the current market. Importantly, even if this factor were removed, the valuation would still be lower than the value of the senior lenders' debt.
Given the court's emphasis that the aim of the exercise was to answer the question of how much a buyer would pay for the group now, on a going concern basis, it is interesting that the court did not focus more on the third party sales process which the group instructed Rothschild to carry out. This produced only one indicative offer, valuing the group between £150 million and £188 million so, again, well below the level of senior debt and below even the most conservative value in any of the valuation reports. Indeed, it might have been assumed that this would have rendered the valuation reports superfluous.
In its focus on the valuation exercise, Bluebrook is a natural successor to Re MyTravel Group plc which also considered a challenge to a scheme by bondholders on the grounds that, among other things, they had a sufficient economic interest to require their being given an opportunity to vote on the scheme ( EWCA Civ 1734; www.practicallaw.com/7-200-2414).
However, in the event, this question was struck out by the Court of Appeal so practitioners have since been waiting for a more detailed decision on this point.
Bluebrook also emphasises that a court will be reluctant to reject a scheme that has been approved by the majority of those participating in it, unless it is unfair or there is a technical defect in it (as recently highlighted in In the matter of Countrywide PLC and others ( EWHC 1347)).
On a practical level, it is clear that the terms of intercreditor agreements need to be effective from the senior lenders’ perspective to enable any mezzanine guarantees and security to be released as part of the overall restructuring. In these circumstances, junior lenders will find it hard to challenge a restructuring if the basis of the valuation is found to be reasonable and, as a result, leaves them out of the equation. As the court pointed out in Bluebrook, the mezzanine lenders did retain the right to buy out the senior debt if they were unhappy with the proposed enforcement action.
In addition, says Boothman: "A key point to understand is that the schemes were for a small (but important) element of the restructuring: to force non-consenting senior lenders to "roll over" into the newco. If 100% of the senior lenders had consented, the schemes would not have been required at all and the restructuring would almost certainly have proceeded as a pre-pack administration with the junior lenders being left with the difficult task of pursuing the administrator for not having obtained the best price reasonably obtainable."
Joanna Morris, PLC.
Latham & Watkins (London) LLP advised the group, Lovells LLP advised the senior lenders, and Gide Loyrette Nouel LLP advised the mezzanine lenders.