A bit of a mezz in the Carwash

August 20, 2009

It’s not all bad news for mezzanine investors after the recent UK court verdict on the debt restructuring of IMO Carwash, the Carlyle-backed management buyout which defaulted earlier this year. Senior lenders devised a plan transfer its assets to a new company, leaving junior-ranking mezzanine investors with nothing.  The mezzanine debtholders contested the plan, but a UK judge disagreed and approved it.

That is a blow for mezzanine investors everywhere, because it tips the balance in favour of senior lenders for future restructurings under so-called schemes of arrangement. But they shouldn’t feel too hard done by, and the judge’s arguments may even help them in future.

Schemes of arrangement are designed to keep businesses alive. Provided they are approved by the court, they can be implemented with only 75 percent of creditors in each class of debt agreeing. Junior creditors can be excluded, and may be wiped out.

The mezzanine investors challenged the Carwash scheme, arguing that senior lenders were getting the company on the cheap simply because valuations are currently so depressed.

To convince the court, the senior lenders backed their proposal with discounted cash flow valuations, as well as evidence of a recent attempt to sell the company. The judge rejected the mezzanine investors’ (higher) valuation, which used a computer simulation.

However, the ruling lifts the bar for squeezing out junior creditors in future schemes; it sets a precedent for companies to be valued as going concerns rather than on a liquidation or break-up basis. Other schemes have used liquidation valuations, something which promises to be difficult after the Carwash ruling. Senior lenders won this time, but in future the valuation debate will be more closely fought.

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