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12 Aug 2021

Hurricane Energy restructuring refusal: an ill wind blowing for bondholders?

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The High Court has, for the first time since the introduction of the legislation in June 2020, refused to sanction a cross-class cram-down restructuring plan under Part 26A of the Companies Act. In the matter of Hurricane Energy Plc [2021] EWHC 1759 (Ch), the court rejected a plan supported by bondholders because it had not been shown that the opposing shareholders had no better alternative prospects (i.e., the ‘no worse off condition’ had not been met). This judgment provides important guidance on the approach the court will take where a dissenting class (in this case the company’s shareholders) can show a ‘realistic prospect’ of obtaining a better outcome without the plan.

Key takeaways

  • The burden of proof for establishing the 'no worse off' condition lies with the party proposing the plan.
  • The 'no worse off' condition will not be met if it can be proved that there is a 'realistic prospect' of a dissenting class being better off under a relevant alternative. It is not necessary to prove that is the 'most likely outcome from the relevant alternative'.
  • Where a plan permanently deprives a dissenting class of any meaningful return on their investment and there is no imminent liquidity crisis, 'particular care' must be taken on a cross-class cram-down application.
  • Where shareholders have no genuine economic interest in the company (i.e., they are 'out of the money'), the views of creditors who 'are in the money' (such as bondholders) will be given more weight.
  • Identifying whether or not shareholders are out of the money is a critical element in: (1) determining whether the 'no worse off' condition has been met; and (2) in the exercise of the court's discretion.
  • The court's power to 'impose' a restructuring plan on a dissenting class under s901G of the Companies Act is entirely discretionary and, in exercising its discretion, the court will consider a range of factors, including whether the proposed plan fairly allocates value between the different stakeholders.

Background

Hurricane Energy Plc, an AIM-listed oil and gas company, proposed a restructuring plan after its board concluded it was unlikely to be able to repay bond debts of $230 million by their due date in July 2022. The plan provided for control of the company to be handed to bondholders in a debt-for-equity swap, in return for a minimal reduction to the debt and an extension to the maturity date of the bonds. The plan would have diluted the current shareholders' interest in the company to 5% and it was accepted this would not provide any 'meaningful return' to shareholders.

Although 100% of those bondholders who attended the plan meetings unanimously voted for the plan, it was fiercely opposed by the shareholders and over 90% of those voting at the meeting voted against it. The court was asked to sanction the plan, which application was formally opposed by a key institutional investor, Crystal Amber Fund Limited.

Restructuring Plans under Part 26A of the Companies Act

Schemes of arrangement under Part 26 of the Companies Act are a well-established tool for companies seeking to restructure arrangements with creditors or members. The key change introduced by Part 26A is that if a relevant class (or classes) opposes the restructuring plan, s901G provides a mechanism for the court to 'cram down' via court sanction the relevant class or classes. By contrast, under a Part 26 scheme, each relevant class has an effective veto. For more information on the reform see our here.

Given the impact of the court's 'cram-down' powers, two threshold conditions need to be met before the court will consider whether or not to exercise its discretion:

  • Condition A

    The court must be satisfied that, if the restructuring plan were sanctioned, none of the members of the dissenting class would be any worse off than they would be in the event of 'the relevant alternative' (the 'no worse off condition'). For these purposes, the 'relevant alternative' is whatever the court considers would be most likely to occur in relation to the company if the restructuring plan were not sanctioned under section 901F.

  • Condition B
    The restructuring plan must have been approved by 75% in value of at least one class of creditors or members who would receive payment or have a genuine economic interest in the company in the event of the 'relevant alternative'.

Analysis of the 'relevant alternative' in the Hurricane Plan

Condition B had clearly been satisfied; the bondholder class had approved the plan and would receive a payment in the relevant alternative.

To assess whether Condition A had been satisfied, the court considered 3 steps1: i) identifying what would be most likely to happen to the company if the plan were not sanctioned; ii) determining what the consequences would be for shareholders; and iii) comparing that outcome with the likely outcome and consequences for shareholders were the plan sanctioned.

In relation to step 1, it was accepted by all parties that there was no threat of an imminent liquidity crisis. The most likely outcome in the short to medium term was that the company would continue trading profitably for at least a year and that such trading was in the best interests of all stakeholders.

In relation to step 3, it was also accepted by all parties that the consequences for shareholders if the plan were sanctioned were that there would be 'no meaningful return'.

The argument centred around step 2. What would be the consequences for shareholders if the plan were not sanctioned?

The court concluded that in identifying a 'controlled wind-down' with an ultimate recovery of 76.4% of the bond debt (and no recovery whatsoever for shareholders), the company had not put forward the appropriate 'relevant alternative'. Where the relevant alternative is that the company trades profitably for another year (as opposed to entering an immediate insolvency), shareholders are not required (as suggested by the company) to identify the one strategy over the course of that year that the company would be most likely to adopt. Nor is it necessary (as further asserted by the company) for them to identify a definitive value for any future income stream. It is sufficient to identify 'possible courses of action' with a 'realistic possibility' of a better financial outcome for shareholders than the outcome under the plan. The burden in a cross-class cram-down application lies on those proposing the plan, not those opposing.

In this instance, the shareholders were able to identify a number of possible alternative investment strategies over the year's potential trading. Given the lack of any 'meaningful return' under the plan, it is perhaps unsurprising that the court determined that there was a realistic prospect of one of the alternative strategies affording a better outcome for shareholders and that Condition A had not been met.

What does this mean for cross-class cram-downs?

One of the key differences between this scenario and that of Re Virgin Active Holdings (see our earlier article here) in which the plan was sanctioned, was that in this case there was no imminent threat of insolvency. This may mean the evidential bar is higher for creditors trying to obtain court sanction for a restructuring plan which effectively compromises the rights of the dissenting class permanently, when there is a significant period of potential profitable trading ahead. Zacaroli J emphasized that 'particular care is needed in the application of the cross-class cram-down provision where, as here, the Plan would deprive the members of the dissenting class of all but a fraction of their interest in the Company'.

While the court concluded the criteria for a cross-class cram-down had not been met, it also found it would not have exercised its discretion to sanction the plan in any event. The reasons for the court's decision can be neatly summarised by the final factor: 'There is no other sufficient ground of urgency which means that it is imperative that the Bonds be restructured now. In particular, the [ad hoc committee of bondholders'] desire to obtain control of the Company is not a good reason to deprive the shareholders, now, of all but a fraction of their equity in the Company rather than waiting to see if actual performance over the coming months improves the outlook for the shareholders.'

Urgency and the threat of the replacement of the board

The court also appeared to be unimpressed by the reasons underlying the urgency of the application. Although it held the hearing and handed down judgment on an expedited basis, it found that the grounds relied on for expedition had not in fact been met.

The company had indicated that one of the reasons the plan needed to be sanctioned before the next AGM was because it was anticipated that the company's board would be replaced as a result of changes proposed by Crystal Amber. It was accepted that in the event of the board members being replaced, it was highly likely that the company would withdraw the restructuring plan.

The ad hoc committee of bondholders opposed the changes to the board proposed by Crystal Amber. It had informed the company that if the new board were voted in and took steps inconsistent with the controlled wind-down envisaged by the restructuring plan, it would need to consider whether the immediate appointment of an independent liquidator would be required to protect creditors' interests.

However, Zacaroli J did not consider that the desire of the ad hoc committee to avoid replacement of the board was a legitimate ground for urgency.  In the absence of a formal insolvency process, the court confirmed that shareholders, not unsecured bondholders, retained a collective right to replace the board as they saw fit. A desire to avoid replacement of the board was not, therefore, a legitimate ground for urgency.  

Furthermore, as part of his analysis of what was most likely to happen if the plan was not sanctioned, Zacaroli J was not swayed by the sabre rattling of the ad hoc committee. He observed that, despite their stated current position, the bondholders might be persuaded to delay enforcement action if the shortfall was relatively small and the company could continue to trade profitably, adding " If …. as next July approaches it remains in the Bondholders' interests to permit the Company to continue trading so as to be able to generate further revenue which would be used to repay the Bonds, I should not assume they would act against their interests".



1 As identified by Snowden J at [106] in Re Virgin Active Holdings Ltd [2021] EWHC 1246 (Ch) 

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