The Court of Appeal recently overturned the approval of two related restructuring plans under Part 26A of the Companies Act 2006.
Petrofac Limited (PL) and Petrofac International (UAE) LLC (PIUL), with their subsidiaries, are a leading international service provider to the energy industry. The group encountered serious financial difficulties starting in 2017 due to a Serious Fraud Office (SFO) investigation, which led to a £70m fine relating to failure to prevent bribery. A refinancing in 2021 did not result in the long-term stabilisation of the Group. Those financial difficulties were further exacerbated by factors like the COVID-19 pandemic and the war in Ukraine.
To address their financial issues, PL and PIUL proposed restructuring plans. These plans aimed to settle liabilities across five creditor categories, including senior secured creditors, groups with claims connected to the SFO investigation and one group linked to a problematic joint venture in Thailand (the Plan Creditors).
The terms of the restructuring plans were primarily negotiated between PL and PIUL and an ad hoc group (AHG) of five entities representing senior secured fund creditors.
The relevant alternative to the restructuring plans was accepted to be an insolvent liquidation of the group.
Two creditors with claims relating to the Thai joint venture appealed against the decision of the High Court to sanction the restructuring plans on two grounds:
- The first ground related to the meaning of the “no worse off” condition for the application of the Court’s discretion to impose a restructuring plan on a dissenting class of creditors. The appeal on this ground was not successful.
- The second ground related to the appropriate allocation of the benefits of the restructuring and the treatment of “out of the money” creditors.
Court of Appeal’s findings on restructuring surplus (Ground 2)
The core issue was whether the benefits preserved or generated by the restructuring were being fairly shared among the Plan Creditors. The Court of Appeal considered several key principles:
Fair allocation of benefits
When the Court exercises its discretion to impose a plan on a dissenting class, it must inquire how the value sought to be preserved or generated by the restructuring plan, over and above the relevant alternative (in this case, liquidation), is to be allocated between different creditor groups.
The essential question for the Court is whether any class of creditor is receiving “too good a deal (too much unfair value)”.
Treatment of “out of the money” creditors
The Court of Appeal rejected a rigid approach that “out of the money” creditors (i.e. those who would receive no recovery in the relevant alternative) are not entitled to any share of the benefits created by the plan. The assertion that “in the money” creditors are the sole “economic owners” of the business and thus entitled to all benefits of a plan was deemed a non sequitur (the conclusion did not logically follow on from the argument).
In cases where the relevant alternative is liquidation, the business as a going concern is lost. If “in the money” creditors wish to preserve the company and its going concern value, they must negotiate a genuine commercial compromise with all classes of creditors, including those who would be “out of the money” in liquidation. The cross-class cram-down power is not designed as a tool to enable assenting classes to appropriate to themselves an inequitable share of benefits of the restructuring.
Provision of new money
New money providers can properly expect full repayment of their funds in priority to pre-existing creditors and their return on such new money, if it reflects what would be obtained in a competitive market.
However, if the returns offered to new money providers are above and beyond market rates for such funding, this excess is to be analysed as a benefit conferred by the restructuring, and its allocation must be justified. The burden of proof rests with the plan company to demonstrate that the returns on new money are competitive or that their allocation is fair.
Application to the Petrofac restructuring plans
- The Plan Companies’ valuation report indicated that the restructuring preserved or generated, on the low case, approximately US$1.25bn in value, compared to liquidation.
- However, 67.7% of the new equity, valued at about US$1bn on the low case, was allocated to the providers of US$350m in “new money”. This represented an overall return of 211.7% on the sums invested, and for participating senior secured funded creditors, a return of 266.8%. It followed that the return on the equity investment portion of the new money was significantly higher.
- The Court of Appeal found that the High Court Judge made a material error by focusing on the pre-restructuring risks when assessing the return on the new money. The provision of the new money was conditional on the sanction of the plans and the completion of the restructuring. The correct question was the cost at which new money could be raised by the restructured group on day one after the restructuring and conditional upon the sanction of the plans, once it was freed of virtually all its debt.
- The Plan Companies did not provide cogent evidence, such as expert market evidence or sufficient market testing, to explain why the new money providers were allocated such a disproportionately high return (appearing to be an immediate three-fold or higher return). It was not sufficient to say that all creditors were offered the opportunity to participate in the new money.
- The terms for the new money, including Work Fees, were agreed in December 2024 based on a notional post-restructuring equity valuation of US$351m, but the valuation report later valued the restructured Group’s equity significantly higher (US$1.5bn to US$1.85bn). The equity allocations were not revisited despite this substantial increase in estimated value. The “Work Fees” were said to be compensation for the work undertaken by the AHG in relation to the restructuring, and for the fact that when the members of the AHG obtained access to confidential information relating to the Group they became “restricted” under applicable market abuse laws.
- The Court concluded that the Judge’s finding that the new money was provided on “competitive” terms that were not disproportionate terms, could not stand. This material error vitiated the Judge’s exercise of discretion to sanction the restructuring plans against the dissent of the appeal creditors.
The Court of Appeal allowed the appeal on Ground 2, setting aside the Judge’s order.
The Plan Companies now have the option to appeal to the Supreme Court, revise the restructuring terms, or provide further evidence addressing the fairness concerns.
Implications for future restructuring plans
The ruling provides useful authority on how fairness and value allocation should be assessed.
It sends a clear message that restructuring plans should be supported by robust, transparent and market-tested evidence, especially when allocating substantial value to select stakeholders.
Plan creditors would be well advised to ensure that the proposed returns to new money providers are kept under review whilst the restructuring plans are shaped and as valuation evidence is refreshed.