A victory for seniority

It was a decision awaited with bated breath – but which, in the end, confirmed what most observers had already assumed to be the case. Namely: UK bankruptcy processes tend to favour senior lenders.

In 2006, the Carlyle Group led the £450 million (€522 million; $746 million) buyout of UK car wash group IMO Car Wash, a deal which included a £355 million debt package led by HBOS. In February this year, IMO breached banking covenants and its equity and debt holders began restructuring talks.

These talks ended up in the UK's High Court, with the subordinated debt lenders – understood to be mainly hedge funds – arguing that IMO should be valued using the kind of “intrinsic value” technique common in US Chapter 11 procedures. This seeks to establish what the value of the business would be post any restructuring. In the UK, the value of a business in a distressed scenario is normally determined by the “current market value”, i.e., what a third party would be prepared to pay for the business today.

The significance in this case was that the normal UK valuation technique would result in a valuation so low that the senior lenders would be entitled to 100 percent of the equity and the junior lenders wiped out. Under their proposed valuation technique, there was a much higher chance of entitlement to some of the equity. Mr Justice Mann, in a verdict delivered on August 11, came down in favour of the senior lenders.

Observers close to the case say junior lenders to leveraged buyouts during the boom years (many of them US-based) probably underestimated the differences between the US and UK bankruptcy procedures. Only now have they been forced to wake up to them. “The UK is seen as creditor-friendly,” says Bruce Bell, a partner at law firm Linklaters. “What they didn't realise is that it's senior creditor-friendly, whereas the US has a more expansive view of the creditor class.” In his view, the court case represented a “rearguard action”.

The outcome only further underlines the plight of mezzanine investors, which have extensive exposure to leveraged deals like IMO.