UK: A Car Wash For Mezzanine Lenders?

Last Updated: 13 August 2009
Article by Martin Brown and Patrick Donegan

The High Court yesterday gave its much-awaited judgment in the IMO Car Wash case. This case concerned a group of mezzanine lenders' challenge to a scheme of arrangement (the "Scheme"). If approved, the Scheme would enable the company and its senior lenders to complete a restructuring that would achieve a debt for equity swap in relation to certain of the senior debt and leave behind the mezzanine lenders with a claim against an empty shell of a company.

The High Court found against the mezzanine lenders and sanctioned the Scheme on its proposed terms. It remains to be seen whether an appeal will be lodged.

The judgment will be of interest to all those involved in restructuring groups of companies labouring under too much debt, notably because of the judge's willingness to carry out a detailed analysis of the different valuation bases and comment on the same. Where the value "breaks" is of course a key driver of the terms of any restructuring, whether achieved consensually or through the use of an insolvency procedure or, as here, a scheme of arrangement combined with a pre-packaged administration sale.

Since the mezzanine lenders' rights were not being compromised by the Scheme (they were just being left behind), their only basis for objecting to the Scheme was that it treated them unfairly in ways other than altering their strict rights. Their main complaint, although not their only one, was that they did not accept the senior lenders' valuations. The judge found that the case of unfairness was not made out, principally because the judge found on the basis of the evidence that the mezzanine lenders did not have 'a relevant economic interest'. In doing so, the judge seemed to be particularly influenced by one of the valuations obtained by the senior lenders that factored in a discount to reflect current market conditions but also showed that, even without that discount, the value broke within the senior debt by some margin.

This case should give some comfort to senior lenders that where the valuation evidence is clear that the value breaks in the senior debt, including after taking into account the prevailing current market conditions, they are entitled to take action to restructure a borrower without reference to subordinated lenders who have no real economic interest.

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The High Court yesterday gave its much-awaited judgment in the IMO Car Wash case. This case concerned a group of mezzanine lenders' challenge to a scheme of arrangement (the "Scheme"). If approved, the Scheme would enable the company and its senior lenders to complete a restructuring that would achieve a debt for equity swap in relation to certain of the senior debt and leave behind the mezzanine lenders with a claim against an empty shell of a company.

The High Court found against the mezzanine lenders and sanctioned the Scheme on its proposed terms. It remains to be seen whether an appeal will be lodged.

The judgment will be of interest to all those involved in restructuring groups of companies labouring under too much debt, notably because of the judge's willingness to carry out a detailed analysis of the different valuation bases and comment on the same. Where the value "breaks" is of course a key driver of the terms of any restructuring, whether achieved consensually or through the use of an insolvency procedure or, as here, a scheme of arrangement combined with a pre-packaged administration sale.

Since the mezzanine lenders' rights were not being compromised by the Scheme (they were just being left behind), their only basis for objecting to the Scheme was that it treated them unfairly in ways other than altering their strict rights. Their main complaint, although not their only one, was that they did not accept the senior lenders' valuations. The judge found that the case of unfairness was not made out, principally because the judge found on the basis of the evidence that the mezzanine lenders did not have 'a relevant economic interest'. In doing so, the judge seemed to be particularly influenced by one of the valuations obtained by the senior lenders that factored in a discount to reflect current market conditions but also showed that, even without that discount, the value broke within the senior debt by some margin.

This case should give some comfort to senior lenders that where the valuation evidence is clear that the value breaks in the senior debt, including after taking into account the prevailing current market conditions, they are entitled to take action to restructure a borrower without reference to subordinated lenders who have no real economic interest.

The Scheme only related to the senior lenders and involved a debt for equity swap under which the senior lenders agreed to take equity in a new holding company of the IMO Group in exchange for forgiving some of their senior debt. The main part of the rest of the senior debt was to be assumed by the new group, however, a small part of the senior debt (£12 million) was to be left behind in the scheme companies, in order to be able to mop up any remaining claims that could arise. The mezzanine lenders challenged this aspect of the Scheme as well on the basis that it was simply there as a further hurdle to any claims by the mezzanine lenders and did not have a legitimate purpose. The judge rejected this.

The three companies which were subject to the Scheme were indebted to a consortium of lenders. The senior lenders had received valuations which showed that the value of the IMO Group was well below the level of the senior debt.

The intercreditor arrangements between the senior lenders and the mezzanine lenders were in the usual form: the mezzanine lenders' debt (and their associated rights) were subordinated to those of the senior lenders. Accordingly, any proceeds of realisations of the assets had to be applied first to repay the senior lenders.

The trading companies in the IMO Group would be transferred to the new holding company under a pre-packaged sale by an administrator. Importantly, the pre-packaged sale did not form part of the Scheme as the Scheme dealt only with the mechanism of the release of the senior debt in anticipation of the exchange for shares and newco debt. The overall restructuring still involved the use of the enforcement process of the intercreditor agreement, including the compulsory release of security and guarantees held by the mezzanine lenders. The judge noted that had the unanimous consent of the senior lenders been obtained to the proposed transfer, the Scheme would not have been necessary.

A group of mezzanine lenders challenged the Scheme on the basis that it unfairly prejudiced the mezzanine lenders and that the fair and reasonable thing to do would be to allow the mezzanine lenders to participate in the new IMO Group.

One of the main arguments put to the Court on behalf of the mezzanine lenders was that on a proper view of the value of the IMO Group, there was a realistic possibility that the value exceeded the value of the senior debt, i.e. the "value broke in the mezzanine".

The judge, Mr Justice Mann, rejected this. The judge considered the valuation evidence put to him in detail. The valuation evidence presented by the scheme companies and the senior lenders was on a "present value" basis and applied a discount to take account of current market conditions (although even when this discount was added back the value was still lower than the senior debt). The valuation evidence presented by the mezzanine lenders was on an "intrinsic value" basis and included a so-called "Monte Carlo simulation". The judge found that the valuation evidence presented by the mezzanine lenders did not "demonstrate with sufficient clarity that market conditions [were] giving the Senior Lenders an unfairly good deal".

The judge found that, on the valuation evidence, he could not conclude that the mezzanine lenders were getting a "raw deal" nor that there was a good or even reasonable case of them being deprived of value. The judge said that the proper approach to valuation in a case such as this requires "real world judgments as to what is likely to happen...rather than [a range] which is applied in a series of random calculations to come up with some mechanistic probability calculation".

The judge acknowledged that the senior lenders had decided to run a risk in undertaking a restructuring to keep the business alive, which he said is a 'real risk' because they may end up being worse off than they are now if it does not succeed. He noted that that is a risk that the mezzanine lenders were not prepared to run themselves - he concluded this on the basis that the mezzanine lenders were not prepared to exercise their right to buy out the senior debt (as they were entitled to do under the intercreditor arrangements) and pursue the restructuring on their own account.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 12/08/2009.

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