July 13, 2009 2:27 pm

IMO Car Wash court ruling could shift the European debt restructuring landscape

This article is provided to FT.com readers by Debtwire—the most informed news service available for financial professionals in fixed income markets across the world. www.debtwire.com

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It will be standing room only at the sanction hearing for IMO Car Wash (IMO) on 3 August, as hoards of restructuring lawyers and distressed investors pack the public gallery, Debtwire reports. The recent decision by Mr Justice Arnold to review arguments from mezzanine lenders opened the door to a full trial, and a potential landmark shift in the European restructuring arena.

IMO is a critical case and the argument is very clear, said a source close to the situation. “Is it legitimate for a business to be looked at purely on break-up value alone?” From a market perspective, mezzanine holders have no reason to exist in the event they lose this case.

Disenfranchisement under UK schemes?

The IMO trial could force through a debt restructuring via a UK court-based scheme without junior creditor consent, according to restructuring lawyers and distressed debt market participants. While evading the cram-down mechanisms of Chapter 11, the outcome of a UK Scheme of Arrangement could be much the same.

Under a UK scheme of arrangement, a company is placed into interim administration upon receipt of approval from 75% of creditors (in classes deemed to have a vote). Assets are subsequently purchased and transferred into a vehicle owned by the eventual owner – in this case - senior creditors. Junior debt holders are left with claims against an empty shell. The final act is the release of guarantees and security following the sanction of a scheme.

Cleansing via a transfer of assets using the inter-creditor deed is straightforward, given the inherent weaknesses of documentation on vintage 2005-2007 LBOs. The scheme is an efficient process when the value clearly breaks above junior classes attempting to block a restructuring, according to legal sources.

In 2009, schemes for UK homebuilders McCarthy & Stone and Crest Nicholson and UK foam manufacturer British Vita, the process was clear-cut on the grounds it was obvious where the economic value lied, said the source close and one of the legal sources.

The general rule is establishing claims under insolvency, the legal source continued. A company has considerable clout in determining the economic interest of creditor classes. “To a large extent, IMO has been driven by what the senior steering committee is saying – management is being offered 10% of the equity by the seniors,” added the source close.

A request was made for the court to bless a pre-pack administration which rolls 100% of the senior, explained a second source close. “The court is not being asked to rule on valuation as under Chapter 11, this will be a matter for the administrator PwC to decide.”

Standing apart from the crowd

IMO’s mezzanine holders argue the UK-based car wash concession differs from former companies under UK schemes. The group faces no liquidity issues, and financial performance is improving. Sufficient doubt also surrounds the argument that value breaks in the senior debt. IMO’s mezzanine lenders commissioned a discounted cash flow valuation showing an enterprise value north of the GBP 305m senior tranche, as reported.

The seniors argue the business is over-indebted, with earnings at the mercy of the weather. Under a plan devised by senior steering committee members Angelo Gordon, Axial, Henderson, Varde and HBOS, IMO’s GBP 400m debtload would be reduced to GBP 185m.

Under the terms of IMO’s loan documentation, mezzanine holders have the right to buy out the seniors if they believe the value breaks in the junior tranches. The subordinated creditors can pitch to take over the company themselves, commented the second source close. “It is up to the judge to decide whether to use liquidation value, or be convinced that this business can be funded and survive,” said a second legal source.

Take it from here

On 3 July, Justice Arnold heard submissions from both sides. Creditor class votes will be held on 29 July ahead of the sanction hearing. “Friday was in a way a triumph for the mezzanine. The judge said there is clearly an issue here,” said the first legal source.

The judge requested mezzanine investors submit evidence by 10 July. One week later, the company and the seniors will be required to respond and put their case forward. Mezzanine investors will have one further week (24 July) to respond to the senior case. Skeleton arguments for all parties are required by 30 July.

Senior trump card

In the event the court rules in favour of the mezzanine and stymies the scheme, senior lenders have the right to enforce on non-payment of interest in January, the sources said. Lenders waived their right to interest under an agreed standstill, despite GBP 27m of cash on IMO’s balance sheet, said the first source close. IMO is cash flow positive and requires virtually no capex.

Mezzanine holders are contractually bound under the inter-creditor agreement. Holders cannot be repaid until seniors are paid out in full, said the second source. Senior debt holders could enforce with a sub-set of lenders clubbing together to purchase the assets.

Mezzanine lenders could challenge enforcement and the role of PricewaterhouseCoopers (PwC) in negotiations, speculated the first legal adviser. PwC originally provided a company valuation, before subsequently switching to advise the seniors. The accountancy firm is also lined up as provisional insolvency administrator. “There is a potential conflict. They [PwC] are working for a party who may be buying assets at below fair value based on their own valuation,” the same adviser noted.

PwC did not respond to requests for comment.

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