In re Petrofac – Court of Appeal judgment

The Court of Appeal has handed down an important judgment concerning the fair distribution of the restructuring surplus in restructuring plans.

The restructuring plans entailed a balance sheet restructuring involving the restructure, inter alia, of certain senior secured debt and unsecured debt owed to the two appellant companies Saipem and Samsung. These companies had entered into a joint venture with the plan companies that had failed. 

The relevant alternative was a group liquidation. The plan companies had commissioned a report from Teneo on the valuation of the business in the relevant alternative and under the plans.

Under the plans, the senior secured creditors were to receive equity in the group in the form of shares equating to about 17.5% of the post-restructuring equity. Furthermore, they would be entitled to participate in the provision of the new money. 67.7% of the equity in the restructured group was be allocated to the providers of such new money.  

The plans were approved at first instance and Saipem and Samsung appealed on two grounds:

1. That the judge was wrong to hold that, even though Saipem and Samsung would be "worse off" under the plans [being the jurisdictional threshold test under condition A in section 901G of the Companies Act 2006], they would not be "worse off" in a way that was relevant for the purposes of the statutory test
2. That the judge was wrong to sanction the plans because the benefits generated by the plans were not being fairly shared between the plan creditors

Ground 1

Saipem and Samsung accepted that, if regard were had solely to the amounts they could expect to recover in respect of their debts, they were likely to be better off under the plans than in the relevant alternative. 

At first instance the judge held that the "no worse off" test was exclusively concerned with the impact of a plan on a creditor in its capacity as a creditor. Saipem and Samsung contended that the indirect economic benefits of the liquidation – namely the dissolution of the Petrofac Group – did arise in their capacity as creditors as a result of their joint venture: where joint venturers are competitors, and one of the joint venturers can't meet their obligations, at least the solvent joint venturers have the benefit of a competitor leaving the market. The plans undercut that outcome.

The judge concluded that the indirect benefits which Saipem and Samsung would lose if the plans were sanctioned would have accrued to them in their capacity as creditors, but that condition A was nonetheless satisfied because the indirect benefit that would accrue to Saipem and Samsung was too remote. 

The Court of Appeal agreed with the judge’s conclusion but differed from him in their reasoning. It held that under the condition A test the court is required to determine the financial value which a creditor's existing rights would likely have in the relevant alternative and compare it with the financial value of the modified rights under the plan. Where a plan compromised or released rights of the creditor against third parties, it extended to those other rights. (Rights for this purpose were to be contrasted with interests being as this was a test that went to jurisdiction rather than discretion.) 

The court gave the example of a plan that compromised the claim of a holder of a debt instrument: a creditor might bring a claim against a financial advisor who had advised the creditor to acquire the instrument and the financial adviser might in turn seek a contribution from the plan company. Such claims against third parties would be difficult to characterise as an incident of the debtor-creditor relationship but were a relevant consideration when applying the condition A test. For this reason the Court of Appeal preferred the test as set out above to a test based on the impact of the plan on the creditor qua creditor. 

An approach which focused on the valuation of rights affected by the plan was also preferable, in the court’s judgment, to some form of remoteness test as adopted by the first instance judge. The Court of Appeal did, however, agree with the first instance judge that any broader prejudice that a creditor contended it would suffer as a consequence of a plan would go to the issue of discretion.

Counsel for the appellants could not point to any rights that Saipem or Samsung had under the joint venture to compel the plan companies to cease trading in competition with them, and so this ground of appeal failed.

Ground 2

The Court of Appeal referred to its earlier decision in Thames Water which, it stated: (i) had squarely rejected the submission that an out of the money creditor in the relevant alternative was not entitled to share in the benefit created by a plan; and (ii) was not to be read as an indication that in most cases an out of the money class could fairly be excluded from the benefits of a plan by being given a de minimis amount.

The court gave the following further explanation for why it rejected the premise that out of the money creditors in the relevant alternative were not entitled to any benefits under the plan:

• In the scenario – as in the instant case - where the relevant alternative was a liquidation, the plan company would be unable to pay its debts to its creditors and would be forced to cease to trade.
• The business of the company as a going concern would be lost, and neither it, nor its value, would be realised for any group of creditors.
• In these circumstances, absent recourse to the scheme of arrangement or restructuring plan procedure, if a class of creditors wished to obtain the additional benefit of the value of the company’s business as a going concern free of the claims of other creditors, they would have to negotiate with the company and with the out of the money creditors for the latter to give up their claims. That would inevitably require a genuine commercial compromise by all parties.
• The primary purpose of the introduction of the cross-class cram down power was to allow the court, in an appropriate case, to override the absence of assent in each class and thereby to prevent any one or more classes of creditors from exercising an unjustified [emphasis added] right of veto. 

Where the plan itself invited existing creditors to lend new money, if the returns to such creditors were equivalent to what it would cost the company to obtain the funding in the market, the provision of new money was to be regarded primarily as a cost of the restructuring. If, however, the returns were such that it cost materially in excess of that which could be obtained in the market then the excess cost was better analysed as a benefit conferred by the restructuring.

The burden of showing that the returns on new money were either equivalent to that which could be obtained in the market (and hence not a benefit of the restructuring), or of justifying the fair allocation of those benefits, rested with the plan company.

Counsel for the plan companies submitted that the fairness of a plan was to be assessed by reference to its purpose, distinguishing Thames Water from the present case on the ground that the plan in Thames Water was designed merely to provide a "bridge" rather than a comprehensive balance sheet restructuring. The court agreed that the purpose of the plan was one of the factors to be taken into account but stated that there was nothing in Thames Water which supported the proposition that the impact on the out of the money creditors should carry no or even little weight in a balance sheet restructuring case.

The court noted that, so far as the participating senior secured creditors were concerned, the evidence indicated that in return for their investment of the new money they would receive equity and debt with a value of approximately US$500.2 million, representing a return of 266.8% (on Teneo’s likely low case outcome). The court further noted that much of the evidence from the plan companies seeking to justify the cost of the new money relied on the difficulties in obtaining funding from the market in the very different context of considering alternatives to the proposed plans, ie obtaining funding for the insolvent group. This was not the relevant consideration, however: what mattered was what price could be obtained in the market for new debt and/or equity funding in the restructured group once it was freed from virtually all of its debt. 

The plan companies also relied on the fact that not all senior secured funded creditors were willing to participate in the new money. The court stated that that was a legitimate point but only went so far when set against the fact that nothing was known as to the reasons why the relevant secured creditors chose not to participate.

The court also pointed to evidence which appeared to show that the allocations of new equity to the providers of new money were set in stone by late December 2024, before Teneo's valuation report was prepared, and there was no evidence that they were revisited thereafter even though, on the basis of Teneo's subsequent report, the rights to be conferred on the providers of new money turned out to be significantly more valuable than they would have appeared to be in December 2024.

Keeping the same allocation of equity entitlements as between existing creditors, even when it later transpired that the valuation was substantially higher, might not be of such concern because it could be said that what matters is the entitlement of such creditors relative to each other. That was not so, however, where the increase in the valuation resulted in an increase in the value of the rights granted to the providers of new money in absolute terms; these fell to be benchmarked against the market and not measured against the entitlements of other stakeholders. 

Furthermore it was not an answer to these objections to say that Saipem and Samsung were (belatedly) offered an opportunity to participate in the new money on the same terms. This might have been a commercial solution to prevent objections being pursued by Saipem and Samsung, but it did not answer the underlying problems the court had identified.  

Moreover, the offer was made only in relation to one of the plans but not in respect of the much larger claims under the other plan. The court stated that it was unclear whether the unfairness inherent in the fact that providers of new money were being given an excessive return could be cured by offering the same opportunity to all creditors, but only at a further cost to them. There may be many and varied reasons why creditors were not prepared to make the further investment (irrespective of whether they were unable to do so). The court noted, however, that it had not heard full argument on this point and so did not rule on it. 

The court, therefore, allowed the appeal on ground 2.

In re Petrofac, Court of Appeal (Civil Division) [2025] EWCA Civ 821