A Supreme Court decision has delivered a hefty blow to
holders of HIH Holdings (NZ) convertible notes leaving them with
little hope of recovering any of their investment.
The decision brings into sharp focus the risks of
convertible notes for both investors and issuers. In particular,
poor structuring can leave investors unable to claim against an
issuer if it becomes insolvent. This has relevance in all sectors,
particularly in the mid cap mining sector where single asset
entities struggle to raise bank debt and so have increased their
reliance on convertible notes significantly.
Convertible notes are "hybrid" securities with both
debt and equity characteristics. Like ordinary bonds, convertible
notes have an issue size, maturity date, face value and coupon.
What makes them different is that noteholders can typically choose
to redeem the notes for an agreed cash value at maturity or convert
them into shares in the issuing company.
The treatment of convertible notes as either debt or equity has
important consequences for investors and issuers, from both a tax
perspective as well as the claims that may be made against the
issuer on its insolvency.
The recent New South Wales Supreme Court decision in
Perpetual Trustee Company Ltd v HIH Holdings (NZ) Ltd (In
Liq)1 highlights why issuers need to be clear on
the nature of convertible notes at the time they are issued.
HIH NZ issued 42,620,000 unsecured convertible notes having a
face value of $A213 million. The Notes were issued on the basis
that if HIH NZ did not elect to redeem them in cash by a certain
date, they would "automatically" be converted into
ordinary shares in HIH NZ's parent company, HIH Insurance
This conversion process involved two discrete steps, which in
the courts' view could not be collapsed into a single
HIH NZ would redeem the notes for an amount equal to their face
HIH NZ was automatically directed to use the money payable to
it on redemption to subscribe to shares in HIH.
HIH NZ did not elect to redeem the Notes for cash prior to going
into liquidation in 2001and in 2007 Perpetual Trustee Company
successfully sought to terminate the subscription agreement.
In 2009, the noteholders made a creditor's claim with HIH
NZ's liquidators, alleging that the company was indebted to the
noteholders and obliged to redeem the Notes for an amount equal to
their face value.
The claim was rejected by the liquidators, who declared that all
the noteholders had was a right against HIH NZ for damages for
breach of its obligation to convert the Notes to HIH shares. It was
common ground that this right was worthless as by 2009 HIH was
In his judgment, Macfarlan JA brought into focus that a debt can
take many forms, and that the obligation to repay may not sound in
money. He likened the convertible note structure to that of a
limited recourse financing, in which the right to recover is
limited to specific assets.
While subscription agreements frequently provide for redemption
upon the issuer's insolvency, in the HIH NZ case the obligation
to redeem the Notes for their face value was not regarded as the
primary liability, but rather the direction for HIH NZ to utilise
the funds to subscribe for shares in HIH.
For noteholders, this meant the difference between being a
creditor who would receive 24 cents in the dollar, versus being an
equity holder whose claims are generally subordinated to those of
HIH shares are worthless of course, leaving noteholders with
We don't know why the HIH NZ Notes were structured in this
way, but it may have been to ensure they were treated as equity
rather than debt for tax purposes.
The resounding lesson is that prior to issuing a convertible
note, it is essential issuers consider not only their own financial
needs, but also the impact of the structure on investors. How will
the notes be treated for tax purposes and what are ramifications in
the face of any potential insolvency?
1 2013 NSWCA 47 (NSW)
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
Most awarded firm and Australian deal of
Australasian Legal Business Awards
Employer of Choice for
Equal Opportunity for Women
in the Workplace (EOWA)
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
In the years following the global financial crisis of 2008 many Australian investors lost their life savings as financial products failed and the Australian Stock Exchange shed over 3,000 points.
Some comments from our readers… “The articles are extremely timely and highly applicable” “I often find critical information not available elsewhere” “As in-house counsel, Mondaq’s service is of great value”
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).