IMO Car Wash — Valuation in the Context of a UK Scheme of Arrangement

In the case In Re Bluebrook Limited and other companies (IMO) [2009] EWHC 2114, the UK High Court considered the basis on which to value the business of a company in the context of a scheme of arrangement under the UK Companies Act 2006. The court�s approach was to focus on the price that a purchaser would pay for the business at the current time. The court did not, however, reject the use of any particular valuation methodology or �basis� to demonstrate that price. The basis on which to value a business appears to still be open for parties with interests in future schemes of arrangement, so long as the chosen methodology shows what price a purchaser is likely to pay for the business at the current time.By Adam Plainer and Mustafa van Hien
Jones DayThe issue of valuation is an important one for parties involved in a scheme of arrangement, as it informs the assessment of which stakeholders have an economic interest in the company and therefore which ones have the right to be consulted as to the terms of that scheme. Stakeholders that cannot establish an economic interest in a company proposing a scheme of arrangement are at risk of being excluded from the restructuring and sustaining a complete loss on their investment.

The ruling is useful in providing guidance to stakeholders on the court�s approach to valuing businesses in the context of schemes of arrangement, but also demonstrates the court�s reluctance to enfranchise out-of-the-money stakeholders.

Background
The IMO Car Wash group (the group) is the world�s largest car wash business. It owed more than £300 million to certain senior lenders, approximately £100 million to various mezzanine lenders, and a further amount to other junior lenders. The companies in the group that were obligors on the debt (the scheme companies) had breached certain performance covenants in their facility agreements and were in significant arrears in relation to interest payments. Although the group was still capable of conducting business profitably at the date of the hearing, the directors of the scheme companies had concerns regarding their ability to pay their debts as they became due and the possibility that they were balance sheet-insolvent.

The initial proposals for a consensual restructuring involving the senior and mezzanine lenders were rejected by the mezzanine lenders. The scheme companies then proposed to enter into schemes of arrangement under §899 of the Companies Act 2006 (the schemes) with the senior lenders. They did not include the mezzanine lenders, on the basis that they had no economic interest in the scheme companies. The schemes involved the release of the majority of the senior debt by the senior lenders in exchange for substantially all of the equity in newly incorporated companies to which the group�s business would be transferred (a minority stake in the new companies would be granted to management).

The debt owed to the mezzanine lenders would remain in the existing group companies, and the debtholders would not participate at all in the new companies. These creditors would be left with nothing more than claims against corporate shells. The mezzanine lenders challenged the schemes in court, contending that they had an economic interest in the company that entitled them to be consulted on the terms of the schemes. They also argued that the schemes were unfair to them.

The court acknowledged the principle that there is no need for companies entering into schemes of arrangement to consult with any creditors or shareholders that are not affected by the scheme, either because their rights are not being amended or because they have no economic interest in the company. The scheme companies argued that the mezzanine lenders� challenge should be dismissed on the basis that their rights would not be altered and that there was no duty to consult them because the value of the group�s business was less than the amount owed to the senior lenders (i.e., the mezzanine lenders were �out of the money�). The mezzanine lenders argued that they were in fact �in the money� and that they therefore had an economic interest entitling them to be consulted.

The acknowledgment of the court and, indeed, of all the parties in the case, of the principle that stakeholders without an economic interest in companies proposing schemes of arrangement need not be consulted demonstrates the court�s reluctance to enfranchise out-of-the money stakeholders.

Valuing the Group
The primary issue before the court was the basis on which to value the group�s business.

The Valuations

To show that the mezzanine lenders were out of the money, the scheme companies relied on a valuation prepared by PricewaterhouseCoopers (PwC), the scheme companies� accountants, and evidence from Rothschild � the scheme companies� financial advisors � on the bids received for the group�s business in a third-party sale process they conducted. The PwC valuation was prepared as a valuation of the business on a going-concern basis, with the aim of assessing, in PwC�s words, �the amount that the business is expected to realize in a sale at the current time.� PwC did so by following various methodologies involving an assessment of the group�s projected future cash flow, transactions involving the sale and purchase of similar businesses in the group�s industry, and the likely investments that private equity investors would make in such a business in the current market.

The PwC valuation showed the business to be valued at £220 million to £265 million. The evidence from Rothschild showed that there was only one indicative offer made for the business in the third-party sale process, which valued the business at £150 million to £180 million on a cash-free, debt-free basis. The group�s evidence therefore placed the value of the business well below the £313 million owed to the senior creditors.

The mezzanine lenders relied on a valuation produced by LEK Consulting, which valued the business primarily on its projected future cash flow. The valuation criticized the use of a market price valuation (which the PwC valuation effectively was) because of the lack of transactions occurring in the current economic climate from which to draw comparisons. According to the mezzanine lenders, it was more appropriate for the court to consider the long-term or �intrinsic� value of the business because the current market conditions distorted the actual value of the business. The mezzanine lenders contended that the group�s business was sound and could be profitable in the long term and that these circumstances should be taken into account when considering the likely value of the business.

The mezzanine lenders� valuation was prepared by assessing the projected future cash flows of the business in a number of different factual scenarios in which various assumptions on the group�s performance were placed into a computer model. The end product was a graph showing the range of possible values of the business and the likelihood of each possible value being the actual value of the business. The lowest possible value was stated to be in excess of £300 million. The median and mean values given were £385 million and £398 million, respectively. The mezzanine lenders argued that this showed there was a real possibility that they were in the money.

The Court�s Findings

The court preferred the valuation evidence presented by the scheme companies and found that the mezzanine lenders were out of the money, had no economic interest in the group, and therefore had no right to be consulted as to the terms of the schemes.

The court said that the group had �produced expert evidence which is comprehensible and relates to a real point � how much would a purchaser pay for the group now?� By contrast, the court stated that the LEK report was based too much on mechanistic and theoretical calculations, rather than upon real-world judgments, and that it was difficult to understand. It was not, the court said, a convincing exercise of assessing what a purchaser would pay for the business. According to the court, the report produced merely a range of possibilities as to what the valuation might be rather than an actual valuation.

The conclusion to draw from this is that, when assessing the value of a company in future schemes of arrangement, UK courts are likely to focus on the price that a purchaser will pay for the business at the present time. The judgment suggests that the courts find market price-based valuations such as PwC�s particularly convincing in this regard. However, it does not show, as some commentators have suggested, that the courts will absolutely reject or ignore evidence relating to the intrinsic value of a business.

The court did not dismiss the concept of valuing a business on the basis of its intrinsic value. It merely said that the evidence used to demonstrate the likely size of the business�s intrinsic value in the present case was inadequate. Evidence of intrinsic value was not presented in a way that the court could understand, and there was no evidence to show that the valuation was produced using the same reasoned, real-world assumptions that the PwC report used. It may be that the mezzanine lenders would have succeeded in their argument had the evidence been presented in a different manner.

It is also significant that the court considered the LEK report in the context of the question of what a purchaser would pay for the business at the current point in time. This suggests that if a valuation based on intrinsic value is to be relied on in the future, it should be used only as a means of demonstrating that a purchaser would pay the price suggested by that valuation. More broadly, it suggests that while the focus of the courts will be on the price that a purchaser would pay, there is no restriction on the basis of the valuation used to prove that point.

Liquidation Valuation

Before the hearing began, commentators had expected the argument on valuation to center on whether the group should be valued on a liquidation basis or on a going-concern basis. However, because the scheme companies were able to show that the mezzanine lenders were out of the money even on a going-concern basis, there was no need to argue the �liquidation versus going-concern� valuation issue.

The court did observe in dictum that, in the circumstances of this case, it was appropriate to value the group as a going concern, but it did not give any reasons. In an initial ruling in the case In re MyTravel Group plc [2005] 2 BCLC 123, the same judge remarked in dictum that, in circumstances where the alternative to a scheme of arrangement is a liquidation, it would be appropriate to value the relevant companies on a liquidation basis.

In MyTravel, the alternative to the scheme of arrangement at issue was clearly a liquidation because the company faced the withdrawal of a license it required to carry on business if the scheme of arrangement was not approved. In IMO, the court did not comment on whether a liquidation was the only alternative to the schemes, although it recognized that the senior lenders had the ability to take enforcement action (including instigating a liquidation) in response to the breaches by the scheme companies of loan covenants. It may be that the reason the court concluded that a going-concern valuation was appropriate in this case was because it was not clear that liquidation was the only alternative to the schemes.

The court has therefore not ruled out the possibility that companies involved in schemes of arrangement can be valued on a liquidation basis, although this is likely to be appropriate only in circumstances where the sole alternative to a scheme of arrangement is liquidation. This will be useful for senior lenders seeking to argue that subordinated creditors are out of the money with respect to future schemes of arrangement in such circumstances.

Other Grounds for Objection

In addition to their contentions regarding the value of the group, the mezzanine lenders argued that the schemes should not be approved for several other reasons, such as alleged breaches of duty by the directors of the scheme companies to the companies and their creditors by arranging a restructuring only with the senior lenders. The court rejected this argument and all other arguments put forward by the mezzanine lenders because they did not have sufficient evidence to substantiate their contentions. However, the court did not rule out the possibility that future schemes of arrangement could be challenged on the legal grounds put forward by the mezzanine lenders.

Implications of the Case
The IMO case shows that, when assessing the value of the business of a company in the context of a scheme of arrangement, the courts are likely to focus on the price that a purchaser will pay for that business at the current time. Parties supporting or challenging such schemes should gear any valuations that they intend to rely on with that approach in mind.

The case also demonstrates courts� reluctance to enfranchise out-of-the-money creditors. Stakeholders of distressed companies should consider this when assessing their negotiating position in proposed restructurings. Such parties will benefit from obtaining valuations upon which they can confidently rely as early as possible in negotiations in order to assess their positions.

Stakeholders that consider themselves to be without a realistic prospect of being in the money will have to seek negotiating leverage elsewhere in the factual matrix before them. By contrast, senior lenders or stakeholders that consider themselves to be the only party in a restructuring to be in the money may wish to consider the use of a scheme of arrangement with the debtor company as a means of bypassing obtrusive out-of-the-money stakeholders.

In the matter of Bluebrook Ltd and others [2009] EWHC 2114 (Ch).

 
Adam Plainer, partner, and Mustafa van Hein, associate, are members of the Business Restructuring and Reorganization practice at Jones Day in the firm’s London office.

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