July 06, 2021
Some further important guidance by Zacaroli J in the recent judgment on Hurricane Energy. In that case, the company (with the support of the company's ad hoc committee of bond holders who were going to take 95% of the equity under the plan in return for certain adjustments to the bonds) sought to cram down the class of dissenting shareholders through a restructuring plan ("plan"). In considering whether to sanction a cram-down under a plan, the court must be satisfied that dissenting creditors or shareholders are no worse off under the plan than they would be in the relevant alternative and that a consenting class would receive a payment or have a genuine economic interest in the company in the relevant alternative (the so called "cram-down conditions"). Once those conditions have been satisfied, the court can then exercise its discretion to sanction the plan.
The relevant alternative is "whatever the court considers would be most likely to occur in relation to the company if the compromise or arrangement were not sanctioned". Hurricane follows the three-limb test set out in the Virgin Active plan:
Hurricane - Step One
The court did not need to find that an alternative would definitely occur, just that it is most likely to occur. Here, the court considered that where there is no burning platform and there is time to maturity, a profitable company has many options available to it. The relevant alternative in such cases is not necessarily a liquidation or administration.
In this case, the company's liquidity, on-going profitability, valuation, commodity prices, oil production, refinancing options, shareholder investment and bond buy-back options were all considered by the court to be factors which cast doubt on the company's assertion that an insolvent wind-down was the only alternative. The court found on the evidence that it was likely the company would continue to trade.
Hurricane - Step Two
The outcome and consequences for the dissenting class are to be assessed primarily in terms of anticipated returns on the affected claims. However, financial returns are not the exclusive consideration. In particular, the court held that it was not necessary for the outcome to be the most likely – in other words it was not necessary to show that absent the plan, once the most likely alternative was established, the outcome in that alternative was also the most likely given the range of options that might be available in that alternative (here, continued trading).
Zacaroli J held that "Pursuant to 901G, the relevant alternative is to be identified by reference to that which is most likely to happen if the Plan is not sanctioned. But once that has been identified, the question is whether I can be satisfied that none of the shareholders would in that event be any better off. If the relevant alternative was, for example, an immediate liquidation then the question would be whether the shareholders could expect some meaningful return in that liquidation, i.e. whether that was the most likely outcome from the liquidation. Where, as here, however, the relevant alternative is that the Company carries on trading for at least a further year, I do not think the analysis is the same. The Company may or may not go into an insolvency process in a year's time, and whether it does, and the resulting outcome for shareholders, will depend in part upon what happens in the intervening period. It cannot be right that, in addressing that question at this stage, the shareholders must identify the one strategy (or combinations of strategies) that the Company is most likely to adopt. Nor is it necessary, in my judgment, unless there is some other legitimate ground of urgency, to arrive at a definitive present value for the future income stream. Rather, the possible courses of action open to the Company over the next year, and beyond, are factors to be considered in determining whether there is a realistic possibility that the financial outcome for the shareholders in a year's time will be better than that offered by the Plan. If there is a realistic possibility of this, I consider that the shareholders would be better off in the relevant alternative than the less-than-meaningful return anticipated under the Plan."
In Deep Ocean the "any worse off" test was found to require a consideration of the impact of the proposed plan on all incidents of the liability to the relevant class, including the impact on timing and security, not just recoveries. Hurricane follows this broad approach and takes into account the nature of all the shareholders' rights – the fundamental right which the court focused upon was that of upside value, being the shareholders' only means of return for their investment. A different measure of value to the equity value of the shares at the date of the sanction.
Hurricane – Step Three
In the comparison of the proposed plan and the most likely alternative the court found that depriving the shareholders of so much of their hope value, diluting them to 5% owners, made them significantly worse off under the plan than the most likely relevant alternative of continued trading – and whatever position that might bring.
In conclusion, the court held that "the fact that there is a realistic prospect that the company will be able to discharge its obligations to bond holders, leaving assets with at least the potential for exploitation, is enough to refute the contention that the shareholders will be no better off under the relevant alternative than under the plan" (emphasis added).
Hurricane – Factual Matrix
There are a number of factual elements of this case which may be distinguished in due course, and therefore allow the court to reach a different view in relation to the exercise of its discretion to sanction a shareholder cram down plan:
Burning platform – there was no burning platform. There was no immediate liquidity shortfall and there was a consensus that the company could continue to trade until the maturity of the bonds and beyond – the company was profitable on an on-going basis. This fact pattern goes to the formulation of Step 1 in determining what the likely relevant alternative is.
The court did not consider that the likely risk that the shareholders would replace the board at a forthcoming shareholder convened general meeting amounted to a burning platform.
Fiduciary Duties – in the face of concerns raised by the bond holders that future appointed directors might engage in steps to "risk" cash on speculative activities, in the absence of clear evidence, the court was entitled to presume that any appointed board of directors would abide by their fiduciary duties. This finding is important as it means that creditors' recourse in such circumstances is to the law of fiduciary duties (where creditors' interests become paramount in the twilight of insolvency) and wrongful trading and not through a pre-emptive use of a plan (at least absent very clear evidence as to the relevant alternative).
Valuation evidence and alternatives – given that the company could continue to trade for a year prior to the bond's maturity, and that oil prices and extraction volumes in that time were uncertain it was not definitively proved that the bonds could not be paid at maturity. Further, the valuation evidence presented did not consider the possibility of the company trading past the maturity of the bonds, which, as a matter of fact, it could do operationally and doing so would constitute profitable trading.
Shareholders – the economic relationship between a shareholder and a company is fundamentally different from the relationship between a lender/noteholder and a company. One aspect of a shareholder's interest in a company is the possibility of upside in the future and it may be proper that such future rights are considered affected rights in a plan scenario.
Disenfranchisement – there was currently no present or near future trigger for the bonds to be able to take control of the group via an enforcement. Therefore the status quo in this case is such that the shareholders continue to possess upside potential absent the plan.
Dissent – over 90% of the shareholders voting (representing a turnout of circa 33%) voted against the plan. Previous plan case law has made clear that the court will look at the level of support among the dissenting class in considering the exercise of its discretion to sanction.
Discretion to sanction – the cram-down conditions must be satisfied before the court has jurisdiction to exercise its discretion to sanction. The court made it clear that even if the conditions to cram down had been satisfied (i.e. even if it were found that the shareholders were no worse off under the plan than the relevant alternative) the court would have still refused to exercise its discretion to sanction. That is important as it makes clear that satisfaction of the cram-down conditions are not determinative of whether the court will ultimately sanction.