Case Comment: Petrofac Restructuring Plans

Introduction 

• The Petrofac group, a leading international service provider to the energy and infrastructure industries, has successfully obtained an order sanctioning two inter-conditional restructuring plans (Plans).
• We explore here the key takeaways from both convening and sanction, which include further judicial guidance on several central pillars of the UK restructuring plan framework: special fees and their impact on class composition; the no-worse-off test for cross-class cram-down; establishing (and challenging) the relevant alternative; and appropriate allocation of the restructuring surplus.

• Certain issues in the case are subject to an ongoing review by the Court of Appeal.

The Plans

• At a high (and simplified) level, two Petrofac entities each proposed an inter-conditional restructuring plan (the two plans together, the Plan) which provided for:
• The compromise of certain unsecured claims from shareholders, directors and directors & officers (D&O) insurers associated with a historic Serious Fraud Office investigation (SFO Claims) (the SFO investigation itself the source of much of the group’s financial woes).
• The compromise of certain claims associated with a contract with Thai Oil (Thai Oil Contract), including (substantial) contingent liabilities owed to Samsung and Saipem in their capacity as joint venture (JV) partners in connection with the Thai Oil Contract (as a result of the Plans, Samsung and Saipem would bear full liability to Thai Oil, with no further recourse to Petrofac, which would otherwise have shared joint and several liability with them).

• A debt for equity (/plus-debt) exchange for existing senior secured debt claims (the relevant holders of such debt, Senior Secured Creditors), with a variable ratio of equity/reinstated debt depending on participation (or not) in New Money (Senior Secured Creditors who provided the New Money would receive a greater percentage of the go-forward equity and have a portion of their existing senior secured debt reinstated, rather than receiving only equity).

• $350 million of new money financing (New Money), in the form of New Money senior secured debt (New Debt) and New Money equity (New Shares), which was available for participation by all Senior Secured Creditors, existing shareholders and new financial investors (New Investors) and backstopped by an ad hoc group of Senior Secured Creditors (AHG).

• The payment of certain fees (Special Fees) to certain of the creditor constituencies for the provision of services in connection with the restructuring, including:

• A work fee, payable to the AHG (if the Plans were sanctioned) in New Shares estimated to have a value of between $23 million and $29 million (Work Fee).

• A backstop fee, payable to the AHG (and three additional Senior Secured Creditors, together with the AHG, the Initial Backstop Parties), as consideration for agreeing to backstop the entire New Money prior to launch of the Plans, in (i) 3.75% of the backstopped New Debt (structured as an OID on the New Debt participations) and (ii) 3.75% of the new backstopped equity (in additional New Shares) (Backstop Fees).

• A backstop premium, payable to the Initial Backstop Parties and any other Senior Secured Creditor who agreed to backstop after launch of the Plans in (i) 3.75% of the backstopped New Debt (structured as OID on the New Debt participations) and (ii) 3.75% of the new backstopped equity (in additional New Shares) (Backstop Premium).

• Separately, a consent fee was payable under the terms of a lock-up agreement to each Senior Secured Creditor who committed to support the restructuring by a designated date, payable in cash at closing in an amount equal to 0.25% of their locked-up debt holdings.

At Convening

• Leaving aside a false-start due to inadequate notice initially being given to certain of the SFO Claims creditors, the primary point of contention at convening was the appropriate approach to class composition.
• Samsung and Saipem challenged the proposed classes of the meetings to be held to vote on the Plan—which provided for all Senior Secured Creditors to vote in a single class (under each plan)—on the basis that the AHG ought to vote in separate classes due to the differential interests they had as beneficiaries of the Special Fees. The court ultimately disagreed and concluded that there was more to unite the AHG with their fellow Senior Secured Creditors than to divide them.
• The starting point for the court was to note that a number of the benefits under the Plan that were available to the AHG were also available to the other Senior Secured Creditors at their option.
• While there was significant advantage to be had in participating in the New Money, provided participation rights are held equally by all members of the same class (in this case, the Senior Secured Creditors) and regardless of whether they avail themselves of those rights, those advantages will not fracture a class (albeit they may be grounds for considering overall questions of fairness and discretion at sanction, as below).

• The more important question therefore is to assess the benefits which are uniquely available only to the AHG (in this case, the Work Fee and the Backstop Fees Fee) and then to consider the cumulative effect of those benefits by reference to the overall benefits of the restructuring, and whether the difference is material enough to put AHG members in a position that is not sufficiently similar, with regards to the overall proposition posed by the Plan, to the position of the other Senior Secured Creditors.

• In particular, the court should consider the delta in the recoveries of each group on the basis that the Plan is approved versus if it is not. Given the cumulative “AHG-only” fees amounted to only 6.9% of their total expected recoveries, 93.1% of the benefits they would receive under the Plan were available to the other Senior Secured Creditors. In the context of expected Plan recoveries in the range (assuming full New Money participation) of 157.1%-198.3%, against a backdrop of a relevant alternative recovery range of 24.6%-31.1% the court concluded that there was more to unite than to divide the members of the Senior Secured Creditor class.  

• As an aside, the court recognised that the Work Fee was being paid in relation to a great deal of work undertaken by the AHG in order to progress the Plan, and that was a reason the difference in treatment in respect of the Work Fee was immaterial, particularly as the Work Fee was paid in equity rather than cash, and therefore there was a “riskiness” to this benefit. The court also indicated it should generally be cautious when evaluating whether the quantum of work fees is so high as to require a fracturing of a class.

• The court had to consider a somewhat novel aspect of the class composition challenge: neither Samsung nor Saipem were in the class they were seeking to fracture. While Petrofac appears to have taken a fairly robust position that the composition of classes that do not include Samsung or Saipem was none of their business, the court acknowledged the right of any stakeholder to interrogate the terms of the Plans, including class composition. However, the absence of any objection from members of the relevant classes was (unsurprisingly) a significant factor in the court’s determination of the class composition challenge (i.e. if members of a class have no concerns about voting together, that likely goes a long way toward establishing that they can indeed vote together, noting that in this case 65% of the Senior Secured Creditors in the class were not members of the AHG).

At Sanction

• At the class meetings for the Plan, the Plan was approved by all classes except for two classes of creditor, including notably Samsung and Saipem. To that end, the court was required to consider whether to cram down the dissenting classes.

• A number of interesting issues were raised at sanction and addressed by the court. In particular:

• Relevant alternative:

• Samsung and Saipem argued that the relevant alternative would not be an insolvent liquidation but would instead be a modified version of the Plan as proposed by them in an open offer (i.e. a Plan B), arguing that Petrofac and the AHG/Senior Secured Creditors would, in practice, always support a Plan B over a value-destructive insolvent liquidation. The court was not convinced by this and was more persuaded by Petrofac’s arguments.

• An asymmetric change to the Plan as proposed by Samsung and Saipem in their “plan B” would face fairness challenges and would require a broader set of changes to those proposed by them in order to properly address the issue of fairness. While Petrofac conceded in evidence it would support a Plan B, the Plan represented the outcome of complex negotiations over the course of more than a year and Samsung and Saipem were wrong to assume that the providers of the New Money who are not creditors of Petrofac (and so have no other skin in the game), and the AHG/Senior Secured Creditors, would agree to those changes and pivot to a Plan B. Shifting from the Plan to a Plan B would be the start of further negotiations, for which there was no time left.

• Drawing on prior authority, the court reiterated that the relevant alternative must always be a specific, ascertainable scenario which would be most likely to come to pass but for the Plan. It cannot simply be an allusion to there being “some other plan” that would be agreed to in practice on the basis that an insolvent liquidation would be avoided at all costs.

• No-worse-off:

• Samsung and Saipem also ran a rather novel argument that notwithstanding the financial evidence showed that they would receive greater (albeit marginally so) recoveries under the Plan than in the relevant alternative (on which basis Petrofac asserted that they were “no-worse-off” under the Plan and therefore the jurisdictional hurdle for implementing cross-class cram-down was met), that failed to take into account that they would actually be better off in the relevant alternative (insolvent liquidation) because a key competitor would have exited their market.

• The court accepted the potential for there to be certain “indirect” benefits associated with a relevant alternative but concluded that the scope of the words “no-worse-off” for these purposes should be considered by reference to the concept of “remoteness”. The indirect benefit to Samsung and Saipem, in their capacity as competitors of Petrofac, of an insolvent liquidation was, in the court’s view, too hard to quantify and somewhat speculative (it appears the only reason the point had traction with the court at all was because of the marginal difference for Samsung and Saipem in their direct financial position under the Plan and in the relevant alternative of insolvent liquidation).

• Since the no-worse-off test goes to the jurisdiction of the court to approve a plan, the matter needs to be as clear-cut and as binary as possible and it is beyond the realms of the court to enter into a wide-ranging investigation of the position. Rather, in applying the no-worse-off test, the court should be focused on whether a creditor is any worse off in the relevant alternative as regards the claims that the plan seeks to compromise, with “indirect” interests that they may have in the relevant alterative being considered “too remote” to be factored in.

• However, the court did (although without providing much specificity) acknowledge that indirect benefits could, in certain circumstances, be relevant in the exercise of the court’s assessment of overall fairness/discretion to sanction. But not, it appears, in this case.

Fair allocation of restructuring surplus:  

• Samsung and Saipem argued that Petrofac, when devising the restructuring, had failed to ensure a fair allocation of the restructuring surplus.

• The court’s starting approach was to identify the preserved value (representing the shortfall between the relevant alternative and the recoveries under the Plan) and whether there was a justification for that to be allocated on a basis other than pari passu. The court then considered the different classes of creditor and their relative positions, before ultimately concluding there is a clear justification for treating secured creditors differently from and better than unsecured creditors (noting that applying a pari passu approach as between those two types of creditor would in itself be inappropriate and unfair). The court then went on to assess whether the degree of departure from a pari passu distribution was disproportionate and unfair, finding that it was not when the positions of those creditors was considered relative to their respective recoveries in the relevant alternative.

Appeal

• Samsung and Saipem had sought permission to appeal the convening judgment. Specifically, the decision of the court on the class composition challenge. While the convening court refused permission to appeal, the Court of Appeal granted permission and therefore at the time of the sanction hearing a live but unheard/unresolved appeal of the convening order was still pending.

• Interestingly, at the appeal hearing (2-4 June) the convening issues were not progressed and rather the focus was primarily on sanction, with the key issues for determination being whether the judge at sanction was correct in his assessment of the no-worse-off test and the degree to which “indirect” benefits in the relevant alternative should be taken into account in assessing the no-worse-off test and the overall fairness of the Plan.