Workin' out the carwash! (Europe)

Originally published August 14, 2009

♫Workin' out the carwash!♫ (Europe) On Tuesday, 11 August, the English High Court of Justice, Chancery Division handed down its decision in the widely watched case Re IMO (UK) Limited1 . The Court effectively granted control over what is left of IMO Car Wash ("IMO"), the world's largest dedicated carwash company, to IMO's senior lenders and, in the process, foreclosed any possible recovery by IMO's mezzanine lenders and other junior creditors. The central question in the case, namely how and when IMO should be valued, vividly illustrates the tension that exists between senior and junior creditors in deeply distressed situations. Did the mezzanine lenders in IMO suffer an unfortunate loss? Undoubtedly. Does this case highlight inherent weaknesses in existing documentation for European intercreditor arrangements or in the UK insolvency regime? As discussed more fully below, we don't think so. Background The IMO group was purchased by The Carlyle Group in 2006 for £450m. The acquisition was financed through a mixture of senior debt provided by a group of banks led by HBOS and mezzanine debt provided largely by funds. As is typical in European acquisition financings, the intercreditor agreement grants the senior lenders priority for all purposes over the mezzanine. The security agent appointed under the intercreditor agreement is required to act in accordance with the instructions of the majority senior lenders until the senior debt is discharged in full. Hence, in an enforcement scenario, the majority senior lenders are entitled to instruct the security agent to liquidate IMO's assets. The proceeds of any such liquidation are to be applied to repay the senior debt and, only if proceeds remain after the senior debt is fully satisfied, the mezzanine debt. Unfortunately, IMO underperformed badly following its acquisition and both the senior debt and mezzanine debt fell into default. The outstanding debt, including capitalised and default interest is approximately £313m of senior debt and £90m of mezzanine debt. To address its financial woes, IMO and two related group companies (the "Debtor Companies") each proposed a scheme of arrangement (the "Schemes") to compromise the claims of the senior lenders. The Restructuring Pursuant to the Schemes: i. the business of the IMO group as currently structured ("Existing IMO") will be transferred to newly formed entities within a restructured group ("Newco") which will be owned by the senior lenders in proportion to their holding of the existing senior debt; ii. approximately £252m of the senior debt will be novated to Newco and approximately £67m of that will be capitalised and issued as equity to the senior lenders, leaving Newco with a reduced senior debt of approximately £185m; iii. approximately £12m of the senior debt will remain at Existing IMO, with the balance being released; and iv. the claims of the mezzanine lenders against any assets (including subsidiaries) transferred to Newco will be released in accordance with the intercreditor agreement. The Debtor Companies each convened a meeting of their senior lenders to approve the Schemes. Importantly, the Debtor Companies did not convene meetings of the mezzanine lenders or otherwise seek to bind the mezzanine lenders under the Schemes. The meetings of the senior lenders were duly held in late July 2009, and the Schemes were approved by the requisite majority in number representing more than 75% in value of the senior lenders. Thereafter, 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. In essence, the mezzanine lenders argued that: i. although the valuation methodology utilised by the Debtor Companies and senior lenders showed that the current value of the IMO group was less than...