Out of the money, but not down and out: UK Court of Appeal overturns Petrofac restructuring plans

Background

The Petrofac Group is an international service provider in the energy sector employing over 8,000 people.

Petrofac has experienced serious financial difficulties for several years, which can be traced back to an investigation by the Serious Fraud Office launched in 2017 relating to bribery, corruption and money laundering and were exacerbated by the COVID pandemic, global sanctions and other challenges in the energy sector.  The proverbial camel’s back was ultimately broken by the “disastrous” (as described by the Court of Appeal) Clean Fuels Project in Thailand – this was the project for which Petrofac had partnered with Samsung and Saipem.

Petrofac launched its twin plans in December 2024.  Broadly, the plans provided for the injection of significant new money, the compromise of the plan companies’ senior debt, certain performance bond liabilities and contractual liabilities relating to the Thai Clean Fuels Project in exchange for equity and the compromise of shareholder and director claims relating to the SFO investigation.  Each plan was sanctioned at first instance by the High Court in May 2025.

Samsung and Saipem appealed the sanction on two grounds, which led to the Court of Appeal having to consider two issues:

1. whether indirect benefits which would accrue to Samsung and Saipem if Petrofac were to fail and exit the energy sector could be considered under the “no worse off test”; and
2. whether providers of new money had been allocated an unfair portion of the benefits arising from Petrofac’s plans.

Indirect benefits and the no worse off test

The High Court found (and Samsung and Saipem did not dispute on appeal) that the relevant alternative to the plans would be an insolvency of the Petrofac Group.

The relevant alternative evidence relied on by Petrofac showed – and Samsung and Saipem accepted – that Samsung and Saipem would likely be better off under the plans than in the relevant alternative if regard were had solely to the amounts which Samsung and Saipem could expect to recover in respect of their debts owed by Petrofac in each scenario.

Samsung and Saipem argued however that in assessing whether they would be “no worse off” under the plans, the court should not only consider direct financial returns.  Rather, consideration should also be given to the indirect economic benefits which would accrue to them if Petrofac were to go into liquidation, as Samsung and Saipem would seek to capture Petrofac’s lost business and make substantial profits.

Based on the specific circumstances of this case, Samsung and Saipem were able to convince the High Court that they would enjoy those benefits in their capacities as creditors (rather than as competitors) of Petrofac.  The High Court nevertheless found that the benefits were too remote to be considered as part of the “no worse off test”.

The Court of Appeal also found against Samsung and Saipem on this issue – but rejected the High Court’s adoption of remoteness as part of the “no worse off test”.  Instead, the Court of Appeal preferred to focus on their rights as opposed to their interests. The scope of the court’s enquiry under the “no worse off test” is concerned with the rights of creditors and the financial value of existing rights when compared with the financial value of the new or modified rights which the plan provides in return for a compromise of those rights.  Whilst indirect rights (for example where a creditor’s rights against third parties are released as part of the plan) may be considered as part of the “no worse off test”, the loss of a competitive advantage which Samsung and Saipem may have enjoyed from a Petrofac insolvency was “clearly beyond the scope of” the “no worse off test”.  Any potential competitive advantage was not a “right” which Samsung and Saipem were losing through sanction of the plan – counsel could not “point to any rights that Saipem or Samsung had under the joint venture (or otherwise) to compel the Plan Companies to cease trading in competition with them in any particular situation”.  However, the Court of Appeal did agree that any prejudice suffered by a creditor should a plan be sanctioned and which went beyond the financial value of its rights went to the issue of the court’s discretion rather than forming part of the “no worse off” test.

Distribution of restructuring benefits and new money returns

The terms of the plans provided for the injection of US$350m new money into the Petrofac Group.  A significant portion of the new money would be provided by existing senior lenders to Petrofac who were also plan creditors (albeit the majority had bought into the structure at below par). On Teneo’s post-restructuring equity valuation of the Petrofac Group (which was US$1.5 billion in the low case), existing senior lenders who participated in the new money would enjoy returns of at least 266.8%.  More than two-thirds of the value preserved or generated by the restructuring (worth approximately US$1.25 billion) was to be allocated to returns on the new money.

The High Court had accepted Petrofac’s evidence that the pricing of the new money was reflective of the significant risk attached to Petrofac’s restructuring and the market price of the capital which could be obtained by a company in Petrofac’s dire financial circumstances.  It therefore did not consider that the substantial new money returns gave rise to an issue of fairness.

The Court of Appeal disagreed, and it was on this ground that the appeal was allowed.

Several plan creditor classes would have been out-of-the-money in a liquidation of the Petrofac Group.  In its earlier judgment in Thames Water, the Court of Appeal had rejected the argument that there was a hard-edged rule which allowed a plan company to ignore out-of-the-money creditors when deciding how to distribute the benefits of a restructuring (beyond giving such creditors a de minimis amount).  The Court of Appeal re-affirmed that principle in this judgment: “It should also not be read as an indication that in most cases an out of the money class can fairly be excluded from the benefits of a restructuring and need only be given a de minimis amount necessary to satisfy the jurisdictional requirement that the plan should amount to a “compromise or arrangement”⁴. It is now clear that there will be cases where it is incumbent on a plan company to distribute more than a de minimis portion of the restructuring benefits to out-of-the-money creditors.  However, exactly what constitutes a fair allocation of the benefits derived from the restructuring will remain fact-specific.

The Court of Appeal accepted that new money providers should rank ahead of pre-existing plan creditors.  The question is, how much of a return can new money providers receive?  Naturally, new money will come at a price.  Where that price is proportionate to the price at which equivalent finance could have been obtained in the market, it will be treated as a cost of the restructuring.  Where the price is disproportionate to the market price however, the difference between the market and actual price will be treated as a benefit of the restructuring flowing to the new money providers and will impact the assessment of whether there has been a fair allocation of the benefits of the restructuring.

The Court of Appeal found that the High Court had asked the wrong question in determining whether the cost of the new money being provided to Petrofac had been competitively priced.  Petrofac’s evidence and the High Court’s reasoning had focussed on Petrofac’s attempts to obtain financing by reference to its pre-restructuring circumstances (i.e. as a financially distressed asset).  The new money, however, was conditional on the plans being sanctioned and so was being provided to Petrofac post-restructuring where it had been relieved of most of its financial debt and certain very material contractual liabilities.  Petrofac’s own evidence showed that it would have a post-restructuring equity value of $1.5 billion.  Crucially, Petrofac had failed to provide evidence of market testing to demonstrate that the new money was competitively priced for a company in Petrofac’s post-restructuring circumstances.

Further, US$218.75m of the new money was being provided in return for equity in the post-restructuring Petrofac Group.  The number of shares to be issued to new money providers had initially been calculated by reference to a notional equity valuation of US$351 million, before Petrofac had prepared its valuation evidence showing it would have a post-restructuring equity value of at least US$1.5 billion.  Notwithstanding that material increase, no change was made to the portion of the Petrofac post-restructuring equity which was to be allocated to the new money providers.  The calculation of the work fee to be paid to the ad hoc group of supporting creditors was subject to the same issue.  The allocated equity was also listed and therefore immediately monetizable post-restructuring.

The burden of establishing that a plan is fair, in order to justify the exercise of the court’s discretion to sanction a plan, rests on the plan company.  The Court of Appeal found that, by failing to provide evidence as to the price at which new money could have been obtained in the market, Petrofac had failed to discharge its burden of explaining why the allocation of the lion’s share of the value preserved or created by the restructuring to the new money providers was fair and so the plans therefore failed on the grounds of fairness.

Conclusions

With the benefit of a more limited set of issues to consider and more time to do so than the High Court, the Court of Appeal rulings in Adler, Thames Water and Petrofac have certainly provided more considered guidance on some key issues that practitioners have been debating.  However, it remains to be seen whether the High Court’s imminent revised practice statement for restructuring plans (and schemes of arrangement) will alleviate some of the burden imposed on the High Court through short timetables, compressed hearings and a need for urgent written judgments.

The Court of Appeal’s judgment in Petrofac is a further development of recent cases which have focussed on the position of out-of-the-money creditors and new money returns.  Crucially, it affirms that rights rather than interests are to be considered under the “no worse off test” and that “remoteness” forms no part of the “no worse off” test.

The most significant aspect of the case, which will impact how companies need to build plans going forward, is that out-of-the-money creditors cannot necessarily be ignored or issued with purely de minimis amounts when distributing restructuring benefits.  Plan companies also need to be prepared for more scrutiny on returns to new money providers, particularly if those returns are off-market by reference to financing costs for the post-restructured business. Where plans involve the provision of new money, we anticipate a need for better evidence of market-benchmarking on overall return.  However, there will be an inevitable difference of view between distressed investors seeking opportunities to deploy capital and what an out-of-the-money compromised creditor thinks can be obtained in the market for a restructured business.  This is going to be the hot topic for the next plan which comes to market with a new money feature and no doubt a significant area for debate on future plans.

We wait with interest to see what Petrofac does next.

Authored by Patrick Dunn, James Maltby, Margaret Kemp, and Mo Davis.