Threshold conditions

Part 26A of the Companies Act 2006 enables the court to exercise its discretion to sanction a restructuring plan notwithstanding that certain classes of creditors may dissent, provided Conditions A and B are met: 

(i) Condition A is met if the court is satisfied that if the restructuring plan was sanctioned, none of the members of the dissenting class would be any worse off than they would be in the relevant alternative. 

(ii) Condition B is satisfied where the restructuring plan has been approved by a class of creditors who would receive a payment or have a genuine economic interest in the plan company, in the relevant alternative.

The relevant alternative is whatever the court considers would be most likely to occur if the plan was not sanctioned.

The Company had commissioned PwC to determine the relevant alternative. PwC’s report maintained that in the relevant alternative, the Company would either experience an immediate uncontrolled liquidation or a controlled wind-down where oil would continue to be extracted from the Lancaster site, followed by a decommissioning process with all unsecured debts (other than the Bonds) being paid off in full. 

Condition B was considered to be satisfied given the Bondholders’ approval of the plan. In his analysis of Condition A, Justice Zacaroli applied the three-step approach taken by Justice Snowden in Virgin Active as set out below:

1: Identifying what would be most likely to occur in relation to the Company if the plan was not sanctioned

Of the two outcomes PwC deemed possible should the restructuring plan not be sanctioned, the Company considered the most likely scenario to involve a controlled wind-down, whereby the Company would continue to trade for another year. Accordingly, it was accepted as common ground that if the plan was not sanctioned, the Company would most likely continue to trade profitably in the short to medium term. It was estimated that in a controlled wind-down, the Bondholders would receive 76.4 per cent of their total debt and the shareholders would be “out of the money”. It was held that there was no immediate threat of the Company entering insolvency proceedings.

2: Determining the outcome or consequences of the relevant alternative for the shareholders

The burden of proof in respect of the “no worse off” test rests with the Company. The Company had to demonstrate that leaving the shareholders with less than a meaningful return would be no worse than if they retained their shares and the Company continued trading in the short to medium term. On the basis that a controlled wind-down would leave the shareholders out of the money, the Company argued that the shareholders would be better off under the plan as they would retain 5 per cent of the diluted equity.
However, the main point of contention between the representatives of the shareholders and the Company concerned: (i) the uncertainty in determining the Company’s future revenue and (ii) the feasibility of repaying or refinancing the Bonds at maturity. In considering the expert evidence put forward by the parties and taking these two points in turn:

(i) while accepting the Company’s expert submissions on the future price of oil, Justice Zacaroli did not consider it necessary to reach a definitive conclusion on the present value of a future revenue stream given that the maturity of the Bonds was more than a year away; and

(ii) Justice Zacaroli accepted the arguments put forward by shareholders that there were a number of alternative options available to the Company in order to repay the Bonds in full at maturity, which included: 

a. raising money from a third party or existing shareholders;

b. seeking a joint venture partner for the other assets owned by the Company;

c. buying back some of the Bonds; or 

d. persuading the Bondholders themselves to delay enforcement action if the shortfall is relatively small and the Company could continue to trade profitably. 

In addition, Justice Zacaroli was satisfied, on the evidence put forward by the shareholders, that if the Company was to continue trading and able to fund the shortfall in the amount due to repay the Bonds by one of the means suggested above, there was a realistic prospect that the Company would retain an income-producing asset of at least some value to its shareholders, namely the Lancaster well, which was expected to remain economically viable until 2024.

For these reasons, Justice Zacaroli concluded that there was a realistic prospect that the Company would be able to discharge its obligations to the Bondholders while leaving assets of some value for the shareholders. To retain 100 per cent of the equity in the Company, which had a realistic prospect of generating cash to repay the Bonds as they fall due, was better than to immediately give up 95 per cent of the equity with a prospect of a less than meaningful return as to the remaining 5 per cent. Accordingly, threshold Condition A was not satisfied. 

3: Comparing the outcome of the relevant alternative with the outcome and consequences for the shareholders if the plan was sanctioned

In considering the third step, Justice Zacaroli noted that it was common ground that the restructuring plan was not anticipated to provide any meaningful return to shareholders and that in any event the shareholders’ interest in any returns would be limited to 5 per cent of the Company’s equity.

Court’s discretion

Even where both threshold conditions are met, the court is able to decline sanction as a matter of discretion. As threshold Condition A was not satisfied, the court did not need to consider whether to exercise its discretion in this case. However, had it been necessary to do so, Justice Zacaroli noted that he would have declined to sanction the plan for the following reasons:

(i) the Company was profitable and expected to remain profitable for another year;

(ii) the Lancaster well was likely to remain economically viable until early 2024;

(iii) there was a reasonable possibility that the size of the shortfall to repay the Bonds on maturity could be bridged;

(iv) the plan would immediately remove all but a fraction of the current shareholders’ equity in the Company; and

(v) if the financial outlook for the Company did not improve, it was reasonable to believe that a restructuring could be undertaken at a later stage and so shareholders should not be immediately deprived of anything other than a de minimis interest in the equity.

Comment

The Company’s restructuring plan was not sanctioned. Yet the relevant alternative put forward by the Company (a controlled wind-down) does not appear to be playing out. In completing a bond buy back instead, the Company did indeed pursue one of the alternatives put forward by the shareholders, vindicating the court’s decision to refuse sanction.

The court’s judgment is helpful in showing the risks involved in seeking to effect a restructuring plan by way of a cross-class cram down in circumstances where more than one relevant alternative may be considered as realistic outcomes. It demonstrates that without an immediate threat of insolvency, it can be difficult to properly and realistically demonstrate the likelihood of the relevant alternative put forward. The decision also provides useful guidance for practitioners as it builds on the framework set out by Justice Snowden in the Virgin Active case, demonstrating how the court approaches the two threshold conditions when determining whether the conditions to exercise the cram-down mechanism have been met.