♫Workin’ out the carwash!♫

8월 12, 2009


Yesterday, the English High Court of Justice, Chancery Division handed down its decision in Re IMO (UK) Limited (“IMO”). The Court effectively granted control over what is left of IMO, the world’s largest dedicated carwash company, to the holders of senior debt (“Senior Lenders”) and, in the process, shut out the holders of mezzanine debt (“Mezzanine Lenders”).  At its heart, the case was about how and when IMO should be valued. The case vividly illustrates the tension which exists between senior and junior creditors.  Such tension was present in the recent Asia Aluminum saga and is likely to continue to arise in other cases.


The IMO group was purchased by The Carlyle Group in 2006 for £450m.  The acquisition was financed through a mixture of senior debt (“Senior Debt”) and mezzanine debt (“Mezzanine Debt”).  The Senior Debt was largely provided by a group of banks led by HBOS, whilst the Mezzanine Debt was largely provided by funds.  The Mezzanine Debt carried a higher coupon, but would only be repaid after the Senior Lenders were repaid.  By virtue of the intercreditor arrangements which were agreed, the Senior Lenders have priority for all purposes over the Mezzanine Lenders.  The security agent appointed under the intercreditor arrangements is required to act in accordance with the instructions of the majority of the Senior Lenders until after the date on which the Senior Debt is discharged.  Prior to that date any enforcement by other creditors is prohibited without the consent of the facility agent acting on the instructions of the majority of the Senior Lenders.  Currently, there is approximately £313m of Senior Debt and approximately £90m Mezzanine Debt outstanding. 

Unfortunately, IMO has underperformed badly and both the Senior Debt and Mezzanine Debt are now in default.  To address its financial woes, IMO and two related group companies (the “Debtor Companies”) each proposed a scheme of arrangement (the “Schemes”) with their respective Senior Lenders.


Pursuant to the Schemes:

  1. the business of the Debtor Companies as currently structured (the “Business”) will be transferred to newly formed entities within a restructured group (“Newco”) owned by the Senior Lenders in proportion to their holding of the existing Senior Debt;
  2. approximately £252m of the Senior Debt will be novated to Newco and approximately £67m of that will be capitalised and issued to the Senior Lenders, leaving Newco owing the Senior Lenders a reduced amount of Senior Debt of approximately £185m;
  3. the remaining Senior Debt will be released as against the Debtor Companies and their affiliates who have guaranteed the Senior Debt; and
  4. the claims of the Mezzanine Lenders against any subsidiary of the Scheme Companies which form part of Newco will be released in accordance with the intercreditor arrangements.

The Debtor Companies each convened a meeting of their Senior Lenders for the purpose of considering and, if thought fit, approving the Schemes.  The meetings were duly held in late July 2009 and the Schemes were agreed to by a majority in number representing more than 75% in value of the class of creditors.  Recently the Debtor Companies applied to the English High Court of Justice, Chancery Division for sanction of the Schemes.

Court Sanction

The Mezzanine Lenders opposed the sanction of the Schemes on the ground that they were allegedly unfair because, amongst other reasons:

  1. The Schemes relied on a break-up/liquidation valuation of the Debtor Companies or a market pricing process to exclude the Mezzanine Lenders, but proceeded on the basis of the transfer of the Business as a going concern.
  2. The value of the Debtor Companies, if valued using what the Mezzanine Lenders describe as “an appropriate going concern methodology” (being a theoretical discounted cashflow methodology (“DCF”)), broke in the Mezzanine Debt.  The range produced by this methodology was in excess of £300m on average at the lower end, with a median valuation of approximately £385m.
  3. The Schemes did not take proper account of the improved (and improving) performance of the Business.
  4. The directors of the Debtor Companies failed to comply with their obligation to extract a proper benefit for the creditors (other than the Senior Lenders), in particular for the Mezzanine Lenders.

In response to these complaints, the Senior Lenders said that the Mezzanine Lenders were without standing to oppose the sanction of the Schemes because the Schemes were not put to them and the Mezzanine Lenders rights as regulated by the intercreditor arrangements were unaffected by the Schemes.  Furthermore, in any event, the Senior Lenders said that the Mezzanine Lenders were without standing because they had no realistic economic interest in the Debtor Companies because:

  1. The Debtor Companies are insolvent.
  2. The Debtor Companies are in default of their interest repayment covenants under both the Senior Debt and Mezzanine Debt facilities and these breaches cannot be cured.
  3. The Business continues as a going concern only because of the forbearance of the Senior Lenders.
  4. Without the sanction of the Schemes, the operations and/or assets of the Business are highly likely to be sold via an administration process either as a result of enforcement by the Senior Lenders or appointment of an insolvency practitioner by the board of directors.
  5. The board of directors must take seriously its duty to creditors and cannot allow the Business to trade in circumstances in which its financial position is not viable.
  6. The realistic comparison for valuing the Business and for sanctioning the Schemes is therefore a sale in the market now, which produces a value in the range of approximately £150m to £265m and which clearly breaks within the Senior Debt, and not a theoretical DCF valuation.
  7. The Schemes are therefore fair because they are not in any way misleading and they correctly identify the classes of creditor with an economic interest in the Debtor Companies and disregard those who have none.

The Issues

The principal issues for the Court are therefore:

  • Whether the Mezzanine Lenders had standing to oppose the Schemes in circumstances in which the Schemes were not put to them and their rights as regulated by the intercreditor arrangements were seemingly not affected.
  • Whether a DCF valuation as relied upon by the Mezzanine Lenders was appropriate in the circumstances.

The Law

It is settled law that a company need not include in a scheme any class of creditors whose rights are not altered by the terms of the scheme (In re British & Commonwealth Holdings plc [1992] 1 WLR 672), nor consult any class of creditors who have no economic interest in the company (In re Tea Corp Ltd [1904] 1 Ch 12, 23-24).  In re Telewest Communications plc (No 1) [2005] 1 BCLC 752, 763 at [29], David Richard J elaborated on these principles as follows:

“[T]he relevant rights of creditors to be compared against the terms of the scheme are those which arise in an insolvent liquidation.  Strictly speaking, because the company is not in liquidation, the legal rights of the bondholders are defined by the terms of the bonds.  However, the reality is that they will not be able to enforce those rights and that in the absence of the scheme or other arrangement their rights against the company will be those arising in an insolvent liquidation.”

In terms of the issue as to whom a scheme of arrangement must be put, a company is free to select the creditors provided that the rights of the creditors and the effects of the scheme on those rights are not so dissimilar as to make it impossible for those creditors to consult together with a view to acting in their common interest (Sea Assets Limited v Persahaan Perseroan (Persero) PT Perusahaan Penerbangan Garuda Indonesia [2001] EWCA Civ 1696).

The issue of economic interests was recently discussed at length by Mann J of the Chancery Division in Re myTravel Group plc [2005] 2 BCLC 123.  In that case, Mann J ruled that in any liquidation of the company, the subordinated bondholders would likely not receive any distribution, and accordingly that their economic interest in the company was “nil”.  Mann J made such comments notwithstanding that the “economic interest issue” was not before the Court.  The question before Mann J was whether the class meetings of those creditors and shareholders with whom the company intended to make a scheme were properly constituted.  The Court of Appeal firmly set the recital of Mann J in relation to the issue of economic interests aside because it was unnecessary and might give rise to problems in the future”.

The Decision in IMO

After three days of hearings last week, Mann J decided yesterday that the Mezzanine Lenders had no economic interest in the Debtor Companies and accordingly sanctioned the Schemes.

In terms of the question as to whether the Mezzanine Lenders had standing to oppose the Schemes, Mann J stated the following:

The schemes do not involve the Mezzanine Lenders in the sense of engaging them as parties.  They will not bind them, and their legal rights are unaffected.  The Mezzanine Lenders therefore cannot, and do not, complain as persons whose legal rights are being altered by the schemes in some unfair way.  However, they are still entitled to object as creditors on grounds of unfairness if the schemes unfairly affect them in ways other than altering their strict rights.  The court is exercising a discretion, and as a matter of principle can consider unfairness in that sense, if it is made out. That is the essence of the case of the Mezzanine Lenders.

With regard to the issue of valuation, the Court and each of the parties agreed that a going concern valuation was appropriate, not a liquidation valuation in the sense of a break-up valuation.  All of the valuations before the Court sought to answer the question of what a purchaser would likely to pay for the Business.  It was clear that the Court was unimpressed with the valuation evidence filed by the Mezzanine Lenders and much preferred the valuations of the Senior Lenders, which were prepared by, amongst others, PricewaterhouseCoopers.  For example, Mann J commented that he had “misgivings as to the ultimate soundness” of the DCF valuation relied upon by the Mezzanine Lenders and that he preferred the “real world judgments” in the valuations relied upon by the Senior Lenders.

In terms of resolving disputes as to valuations, Mann J referred to his decision in myTravel Group plc and commented as follows:

"If there is a dispute about this, then the court is entitled to ascertain whether a purported class actually has an economic interest in a real, as opposed to a theoretical or merely fanciful, sense, and act accordingly - see the reasoning in In re MyTravel Group plc [2005] 2 BCLC 123 at first instance.  Where things have to be proved, the normal civil standard applies.  The same case indicates that the mere fact that the possibility of establishing a negotiating position and extracting a benefit from a deal is not the same as having a real economic interest (though obversely a real economic interest may establish, or enhance, a negotiating position).  The basis on which the assessment of that interest is to be carried out will vary from case to case."

At the end of the day, Mann J was not prepared to give the valuation of the Mezzanine Lenders “as much weight” as the other valuation exercises and he came to the conclusion that the evidence was “not good enough” to establish that the Mezzanine Lenders had an economic interest in the Scheme Companies.

The Court also concluded that it was “unrealistic” for the Mezzanine Lenders to say that the Scheme Companies (in their distressed financial state) had some bargaining power with the Senior Lenders to extract value for the Mezzanine Lenders.  The Court was unimpressed with allegations, which were raised at a very late stage, that the directors of the Scheme Companies were in breach of their duties to both the companies and the Mezzanine Lenders.  The Court was also seemingly swayed by the decision of the Mezzanine Lenders not to exercise their rights under the intercreditor arrangements to compel a sale to them of the rights and obligations of the Senior Lenders for the amount of the outstanding Senior Debt (i.e. notwithstanding the assertions of the Mezzanine Lenders that the value of the Business broke in the Mezzanine Debt).


The decision in IMO is important because it represents the first time that the Court has been asked to consider the issue of valuation of a distressed company.  This decision will clearly not be the last word on valuations, rather it is likely to be just the beginning of a new and developing area of jurisprudence.  We would be surprised if some of the sophisticated principles developed by the US courts in the area of business valuation did not eventually find their way into English Common Law.

In our view, IMO was largely decided on its facts and had the Mezzanine Lenders tendered more compelling evidence as to what they believed was the proper value of the Scheme Companies, the outcome could have been different. Accordingly, whilst the decision in IMO is likely to embolden senior lenders to take control of other companies through similar schemes of arrangement, this case should not be seen as the death knell for junior lenders.

Junior lenders wishing to avoid the same fate as the Mezzanine Lenders would be well advised to present strong and compelling valuations to the relevant company and its directors early in, and throughout, the restructuring process; and also to raise any concerns with the directors about potential breaches of their duties early in the process, not on the doorstep of the Court.