Court refuses to sanction Part 26A restructuring plan

The ruling focused on whether dissenting shareholders were “out of the money”, as claimed by the creditors in favour of the plan. If they were not, then they had a genuine economic interest in the company and the impact of the most likely alternative course of action did not need to be immediately quantifiable to determine whether or not the dissenting creditors would be any worse off.

• Cross-class cram-down process requires satisfaction of both threshold conditions
• Application of ‘no worse off’ test requires consideration of whether dissenting creditors are out of the money
• ‘Relevant alternative’ is crucial to determining whether creditors have a genuine economic interest

Oil-extractor Hurricane Energy had issued unsecured, unguaranteed bonds in 2017 for $320 million. They were due to mature in July 2022. The bondholders constituted the majority of Hurricane’s creditors, with the shareholders forming another group. Hurricane’s business operations did not prove as successful as hoped and Hurricane anticipated that it would not be able to repay the bondholders in full upon maturity of the bonds.

A restructuring plan under Part 26A of the UK’s Companies Act was proposed, under which the maturity date of the bonds would be extended, the capital amount due under the bonds would be reduced but the coupon would be increased. Hurricane would continue to trade until 2024, which would allow it to repay the restructured bonds in full and might also entitle the shareholders to some value in the equity, before being gradually decommissioned. Crucially, shares in Hurricane would be issued to the bondholders so that the current shareholders would only retain 5% of equity in Hurricane.

84.89% of the bondholders voted in favour of the plan, while the shareholders were overwhelmingly against it and demanded a general meeting to replace the directors of Hurricane with ones who would withdraw the restructuring plan and keep Hurricane trading.

The bondholders said that they would only agree to restructure the bonds if they were granted control of Hurricane and that if the newly appointed board took steps inconsistent with the controlled wind-down envisaged under the plan, they would consider immediately appointing a liquidator in order to protect their interests. In light of the situation, the bondholders applied to request the Court to exercise its discretion to sanction the plan by way of cross-class cram-down, which would bind the dissenting shareholders even though they did not agree to the terms of the plan.

Before the Court could decide whether to exercise its discretion, two threshold conditions had to be met. Here, it was clear that the required number of creditors had approved the plan, so the point to be ruled upon was whether Condition A was met. It says that “the court is satisfied that, if the compromise or arrangement were to be sanctioned under section 901F, none of the members of the dissenting class would be any worse off than they would be in the event of the relevant alternative”. As part of this decision, it was necessary to identify what would be most likely to occur if the plan was not sanctioned, determine the consequences for the shareholders and compare that outcome with the outcome and consequences for the shareholders if the plan was sanctioned.

The bondholders argued that the shareholders’ position should not be given any weight as they were ‘out of the money’ and therefore could not have a genuine economic interest in Hurricane, a position which had been accepted in cases involving Virgin Active and Deep Ocean. This is because the bondholders claimed that the relevant alternative to the restructuring plan was immediate liquidation, in which case, since Hurricane did not currently have sufficient cash to repay the bonds in full, it followed that there would be no cash left for a distribution to the shareholders at all and the fact that the shareholders would retain 5% of the equity under the plan would mean that they could not be worse off than under that relevant alternative. However, the judge ruled that there was also a distinct possibility that, whether or not the plan was sanctioned, Hurricane would be able to keep trading until at least July 2024 – and this was the most likely relevant alternative.

Consequently, shareholders were not necessarily out of the money and the judge ruled that there was “a realistic possibility that the financial outcome for the shareholders in a year’s time will be better than that offered by the plan”, although it was not necessary or possible to quantify this with any certainty at this stage. The judge was satisfied that as there was a real prospect that Hurricane could repay the bondholders if it could keep trading, using bridging finance to cover a shortfall if necessary. This would mean that the shareholders would be better off keeping 100% of equity in a trading company than only retaining 5% with “a prospect of less than meaningful return” under the restructuring plan. As a result, the judge ruled that the Court could not exercise its discretion to implement the cross-class cram-down on the dissenting shareholders, because Condition A had not been satisfied.

In addition, the Court also stated that, even if Condition A had been met and it had been able to exercise its discretion, it still would have declined to do so. Because evidence pointed to the company remaining economically viable and continuing to trade for at least a couple of years, the dissenting shareholders would be worse off if the plan was sanctioned as they would lose nearly all their equity in a trading company. There was a real possibility of the company performing better than anticipated and, if that did not happen and the bonds could not be repaid in full on maturity, a restructuring could easily provide the balance of necessary funds. Overall, “the interests of the company, the shareholders and the bondholders are likely to be aligned in ensuring the company continues to [trade] until the point it ceases to be economically viable” and the Court would, therefore, still have declined to sanction the restructuring plan.

This decision illustrates that the Court will not accept at face value what is presented as the relevant alternative to a restructuring plan, but that it will consider the facts of each case before coming to a conclusion as to which alternative is most likely. In addition, it shows that the Court takes its consideration of whether dissenting creditors would be “any worse off” seriously and, even if it may not be possible to put an exact value on this, the realistic prospect of a distribution may be enough to determine that creditors have a genuine economic interest in a company and would be better off if the plan was not sanctioned.

Co-written by Sara Segura, a restructuring expert at Pinsent Masons, the law firm behind Out-Law