Petrofac in the Court of Appeal: ‘No worse off’ test clarified, but fairness of benefit allocation brings down restructuring plan

In a significant follow-on judgment the Court of Appeal has both clarified and moved beyond the High Court’s approach to the ‘no worse off’ test, but ultimately set aside the sanction of Petrofac’s proposed restructuring plans on fairness grounds. The appellate decision provides crucial guidance for future Part 26A plans, particularly on the allocation of restructuring ‘surplus’ and scrutiny of new money returns. We summarise the key takeaways below.

Background – From High Court to Appeal

In our earlier blog, we covered Marcus Smith J’s High Court decision to sanction twin restructuring plans for Petrofac Limited and Petrofac International (UAE) LLC under Part 26A of the Companies Act 2006, despite objections from dissenting creditors (notably Saipem and Samsung). The High Court had ruled that anticipated indirect economic gains (namely the removal of competitor firms) were “too remote” to be relevant under the “no worse off” jurisdictional gateway.

The dissenting creditors were granted permission to appeal on two fronts:

1. Whether the ‘no worse off’ test in s.901G(3) required the court to consider the loss of such indirect economic benefits (i.e. collateral gains from a competitor’s insolvency).
2. Whether the allocation of value generated by the restructuring was unfair—specifically, whether new money providers were being over-rewarded at the expense of other compromised creditors.

The Court of Appeal on the ‘No Worse Off’ Test: Rights, Not Interests

The Court of Appeal has affirmed the High Court’s conclusion—dismissing the Saipem and Samsung appeal on this ground—but with a slightly different rationale. The Court of Appeal held that Condition A requires the court to determine the financial value which a creditor’s existing rights would likely have in the relevant alternative, and to compare it with the financial value of the new or modified rights which the plan offers in return for the compromise of those existing rights. 

The scope of that enquiry is primarily concerned with the financial value of rights of the creditor against the plan company, but where a plan compromises or releases other rights of the creditor, it extends to those other rights. In the instant case, the loss of a competitive advantage upon sanction of the Plans is clearly beyond the scope of that test

Crucially, collateral commercial interests—such as the market advantage a competitor might gain from liquidation—do not fall within the “no worse off” test unless those benefits derive from a right to be released under the plan. The Court explained: “…the loss of a competitive advantage upon sanction of the Plans is clearly beyond the scope of that test.” ([para 79])

While wider commercial consequences remain relevant to the court’s discretion when sanctioning a plan, they are not generally relevant to the section 901G(3) jurisdictional threshold.

Scrutiny of Value Allocation and Returns on New Money – Appeal Allowed

Where the real drama arrived was on the second ground of appeal. The Court of Appeal held that the High Court had erred in finding the allocation of equity to new money providers—who stood to obtain over two-thirds of the post-restructuring equity for their investment—was justified. The Court underscored several key principles:

• Fair Distribution of ‘Restructuring Surplus’: The court must scrutinise how the value preserved or generated by a restructuring is allocated across stakeholder groups, especially when using the cross-class cram-down power. It is not sufficient to simply meet the ‘no worse off’ threshold.
• Out-of-the-Money Creditors May Deserve More than De Minimis Consideration: The court squarely rejected the premise that a creditor who would be out-of-the-money in the relevant alternative is not an economic owner of the business and for that reason not entitled to share in any benefits created by the plan.  Rigidly confining value allocation only to those creditors who would be in-the-money in the relevant alternative cannot be justified as a matter of principle.
• Returns on New Money:  those providing new money to facilitate a restructuring can properly expect to be repaid that money in priority to the existing indebtedness of the company. That also clearly applies to the return on the new money, insofar as that return reflects the price for new money that would be obtainable in a competitive market. But where the price for new money is beyond market rates for such funding this is to be classified as a benefit of the restructuring and its fair allocation must be justified by the company.

Here, there was no evidence that the new money was on market rates and no justification offered if it was not. Indeed: “[The equity valuation] begged an obvious question, one which required cogent evidence – either by way of expert evidence or by evidence of the market having been tested – to explain why allocating the lion’s share …to the providers of New Money was a fair reflection of the cost at which funding could be obtained in the market.” ([para 180])

Consequence: Plan Sanction Set Aside

The absence of evidence to support the allocation of such a large share of value to the new money providers—negotiated before the true post-restructuring equity value was known—meant the plan could not stand. In the absence of evidence as to market pricing, the Court would not re-exercise its discretion to sanction the plan.

Key Takeaways

1. No “collateral benefit” exception for ‘no worse off’: Creditors cannot invoke loss of competitive advantage (or similar indirect benefits) for the s.901G(3) jurisdiction test unless these are anchored in rights released under the plan.
2. Careful market-based justification needed for new money returns:The threshold for fairness is not set merely by hard-fought negotiation in a non-competitive process; the court expects evidence that terms of any new money provided post restructuring are at least market-standard (with the restructured entity value as the benchmark, not the distressed pre-restructuring valuation). Where the terms are above market, the  allocation of restructuring benefits would need to be explained.

The Petrofac decision underscores that while English restructuring law remains flexible and pragmatic, the courts demand a robust and evidence-based answer to the question: “who gets what value, and why?” All eyes will be on how distressed corporates calibrate value allocation and evidence justifying new money terms on future Part 26A plans.