Australia: Deleveraging to control

Last Updated: 20 December 2017
Article by Timothy Sackar and Ashleigh Kable

As deleveraging to control transactions continue to be part of the legal landscape in Australia, we anticipate seeing further examples, particularly where the distressed company is a listed entity.

As the restructuring landscape in Australia continues to develop we are seeing new and innovative structures being utilised to delever distressed Australian companies. In particular, a deleveraging of debt coupled with an issue or transfer of equity continues to be a favoured and useful path for investors seeking to gain control. Whether you refer to it as "loan to own", a "debt for equity swap" or something else, there are a number of structures being used to implement these transactions.

These conversion structures are being promoted in a variety of restructuring scenarios in both a consensual and a non-consensual context. In particular, we are noticing a pronounced increase in the application of these structures to borrowers listed on the Australian Securities Exchange (ASX), with the necessary adaptations to accommodate the ASX Listing Rules and various restrictions under the Corporations Act 2001 (Cth). These examples demonstrate a willingness on the part of investors to push the boundaries of the Australian statutory framework in an effort to obtain control of a corporation with the intention of generating a viable return from a newly restructured company or group.

As the innovation continues, there are a number of issues arising that investors need to keep in mind when implementing a transaction of this type. This article seeks to draw together a number of the examples encountered in the Australian market to date to highlight some key considerations relevant to an investor with a focus on value and control — that is, what should the restructured equity look like in a transaction of this nature?

Where does the value break?

The first consideration that is key to the pursuit of these transactions is a clear understanding of where the "value breaks". Put another way, investors will want to satisfy themselves that they understand (as best they can) the true value of the relevant company and its assets, such that if the restructuring fails and the assets are liquidated, their initial investment can be recouped.

In a consensual context, understanding value is important in managing stakeholder interests as not all stakeholders will be able to recover their investment. If it is clear on the valuation evidence that a group of creditors would receive nil on an insolvency, offering a small return to these creditors can sometimes be sufficient incentive to secure their agreement to the restructuring. On the other hand, in a non-consensual context, valuation evidence has become an integral part of any necessary court application to demonstrate that the creditors as a whole would receive a better return if the transaction is implemented than they would on a liquidation (which is invariably the only alternative). We explore below how the Australian courts have relied on valuation evidence when determining whether to approve a non-consensual control transaction.

Valuation evidence in section 444GA applications

Investors are more frequently seeking to utilise section 444GA of the Corporations Act, pursuant to which a deed administrator under a deed of company arrangement (DOCA) can seek leave of the court to compulsorily transfer the shares in a distressed borrower. The court will grant leave if the deed administrators can demonstrate that the transfer would not "unfairly prejudice" the interests of the shareholders. In considering whether unfair prejudice would result from the transfer, the court has made it clear that prejudice can only be sustained if the shares hold some "residual value".1

Some shareholders have argued that the simple fact that the deed proponent is seeking to acquire the shares indicates that there must be some residual value in them — why else would the proponent seek to acquire them?2 This was the case in Weaver in their capacity as Joint and Several Deed Administrators of Midwest Vanadium Pty Ltd v Nobel Resources Ltd3 (Weaver) where the objecting shareholder argued that the mere existence of the recapitalisation proposal in that case inferred that the shares held some value. However, in determining whether there is residual value in the equity, the courts4 have consistently held that if liquidation is the only alternative to the proposal and on a liquidation the company's assets would be insufficient to discharge the whole of its debts (meaning that equity will receive no return), the shares will have no residual value. Accordingly, the courts have to date solely had regard to liquidation scenario valuations. However, there are clearly a number of ways in which a business can be valued which can influence the conclusion as to where the value breaks.

For example, in Re Nexus Energy Ltd (Subject to Deed of Company Arrangement)5 (Nexus), both the deed administrators and the opposing shareholders brought substantial valuation evidence to support their arguments on value — the deed administrators arguing that a liquidation valuation was necessary and the shareholders arguing that a non-distressed, arm's-length, going concern valuation was more appropriate. Unsurprisingly, the deed administrators' valuation indicated that the company's assets were insufficient to satisfy its liabilities and the shareholders' valuation showed that there were sufficient assets to discharge the debt and make a distribution to equity. The court ultimately found in favour of the deed administrators on the basis that a going concern valuation did not take into account the specific circumstances Nexus was in, including that it had no funding in place, was in administration and was unable to meet its capital commitments at that time. Despite this, the court inferred that a going concern valuation (assuming a non-distressed, arm's-length, going concern sale) could be appropriate in other circumstances.6 We are yet to see this valuation methodology being adopted by the courts in respect of section 444GA applications.

Valuation evidence in schemes

Similarly, when proposing a creditors' scheme of arrangement, the scheme company will invariably need to satisfy the court based on expert valuation evidence that if the scheme of arrangement is not approved, the only alternative is liquidation, and that creditors will receive a superior return under the scheme than if the borrower was wound up.7 The valuation evidence needs to be, wherever possible, incontrovertible. For example, in Re Boart Longyear Ltd,8 the expert evidence concluded that, amongst other things, the amount owing under the group's finance facilities exceeded its enterprise value by more than US$500 million, that secured scheme creditors would receive a better return under the schemes than on a liquidation, and that unsecured scheme creditors and subordinated claim holders would likely receive no recovery on either a winding up or under the schemes.

Interestingly, the scheme of arrangement jurisprudence is developing such that an assessment of value can now also be a relevant factor when determining class constitution. The courts have consistently held that creditors should be in separate classes for voting purposes if their "rights" are sufficiently dissimilar as to make it impossible for them to consult together with a view to their common interests.9 In the decision of First Pacific Advisors LLC v Boart Longyear Ltd10 the Court of Appeal held that if the only alternative to the scheme proposal is a liquidation of the scheme company, when determining whether the creditors in a particular class have rights which are sufficiently dissimilar, the court should have regard to the creditors' rights afforded by the scheme as compared with their rights in a liquidation of the scheme company. This affirmed the decision of the judge at first instance and, although the applicant pursued special leave to appeal to the High Court of Australia, the application was subsequently withdrawn.

Can you take too much equity?

The courts in Australia have not yet been asked to consider in detail whether the amount of equity to be issued to a party or group under a debt to equity transaction was too much (or too little) having regard to the value of the debt being compromised. Instead, the court applications involving a transfer or issue of equity have broadly involved:

  • an acquisition of all of the shares in a private company11 — for example, Weaver, Re Kupang Resources Ltd (Recs and Mgrs Apptd) and Re Western Work Force Pty Ltd concerned applications under section 444GA of the Corporations Act pursuant to which an incoming investor sought to acquire 100% of the equity in the distressed company as part of a broader deleveraging proposal
  • an acquisition of all of the shares in a listed company that was to be delisted12 — this was the case in Nexus where the DOCA proposal involved a transfer of 100% of the shares in Nexus Energy Ltd (then ASX listed) to SGH Energy (No 2) Pty Ltd (a related entity of Nexus' sole secured creditor) and a subsequent delisting of Nexus Energy Ltd
  • an acquisition of a parcel of shares in a listed entity to ensure compliance with an ASX direction — this was the case in Shepard, Re Quest Minerals Ltd v Mutual Holdings Pty Ltd13 where, in connection with a recapitalisation proposal, the ASX indicated that it would only allow the proposal to proceed if the shares held by certain related entities were subject to restrictions on their transfer for a period of 12 months. As the related entities refused to sign the restrictive agreements, the deed administrators sought orders under section 444GA of the Corporations Act to compel the transfer of the shares to the deed administrators so that they could sign the restrictive agreements to allow the recapitalisation to proceed or
  • an issue of new shares to an investor group (resulting in a dilution of the existing shares)14 — for example, in both Re Atlas Iron Ltd15 (Atlas Iron) and Re Boart Longyear Ltd, the scheme proposals involved an issue of shares to creditors of the scheme companies in exchange for a significant reduction in their debt.

In each of the above scenarios the number of shares proposed to be transferred or issued was not in dispute (the challenge instead focused on the fact of the transfer or issue of shares). Having the value of the company or enterprise less than the outstanding debt (as was the case in each of the above examples) is not uncommon.

Having said that, the acquisition by an investor group of all of the equity in a distressed company may not always be an available (or viable) option. If the company, for example, is listed on the ASX and it is intended that the entity remain listed following completion of the transaction, compliance with the ASX Listing Rules will be key.16 In particular, ASX Listing Rule 1.1, Condition 8 requires that, for an entity to be admitted to the official list as an ASX Listing it must, amongst other things, have a minimum of 300 non-affiliated shareholders.

Accordingly, we have seen a number of transactions structured in a way that facilitates continued compliance with the ASX Listing Rules. In both Atlas Iron and Re Boart Longyear Ltd the respective schemes of arrangement provided that the existing shareholders would continue to hold their shares but be substantially diluted as a result of the issue of new shares to the investor groups. Similarly, in Re Mirabela Nickel Ltd (subject to Deed of Company Arrangement),17 the existing shareholders were ordered to transfer 98.2% of their shares under the section 444GA application, but continued to hold 1.8% of their shares following completion of the DOCA.

The level of equity to be issued or acquired will also depend on whether any required waivers have been obtained from the Australian Securities and Investments Commission (ASIC) or the ASX where the transaction would result in a breach of the Corporations Act or ASX Listing Rules (for example, the prohibition on a single shareholder acquiring greater than 20% of the shares in a listed entity or increasing their hold from greater than 20% to greater than 90%). This was relevant to the Atlas Iron restructuring, following which it is now clear that ASIC and the ASX are prepared to grant such waivers in connection with these types of transactions.

Finally, it may be that the debt to equity transaction contemplates that certain steps are taken by the existing shareholders. In these circumstances, we have seen a nominal amount of equity being offered to the relevant shareholders to incentivise them to support the proposal (for example, in Re Nine Entertainment Group Ltd (No 1)18 where the entity that held all of the shares in the parent of the scheme company was offered a cash payment and a nominal percentage of shares in the restructured group as incentive to give up its shares).

Where to from here?

As deleveraging to control transactions continue to be part of the legal landscape in Australia, we anticipate seeing further examples, particularly where the distressed company is a listed entity (we note, the example of Ten Network Holdings Ltd, which was recently the subject of an application under section 444GA of the Corporations Act).19 We also expect that the insolvency law reforms approved by the Australian Government, especially relating to "safe harbour", will assist further in promoting these types of restructurings.20

It will, however, be interesting to see whether these reforms influence the type of structures that investors have been using to implement their control transactions. Given that the gating issue to most consensual transactions is unanimity in stakeholder consent, it may be that formal procedures will continue to be deployed to address dissenting minorities even where there is a supportive corporate board acting in "safe harbour". The toolkit then typically involves voluntary administration coupled with a DOCA and section 444GA application, receivership with a credit bid, scheme of arrangement or a combination of elements of the above. Whatever the path to the restructuring might look like, the intent will be the same for each investor group — a deleveraging of the capital structure that delivers control in a manner or form that can be monetised at a future point to provide a desired return.

This article was first published in the Insolvency Law Bulletin, Vol 18 No 10, December 2017

Footnotes

1 Weaver and Ors in their capacity as Joint and Several Deed Administrators of Midwest Vanadium Pty Ltd v Nobel Resources Ltd (2010) 41 WAR 301; 79 ACSR 237; [2010] WASC 182 (Weaver); Re Lewis; Diverse Barrel Solutions Pty Ltd (Subject to a Deed of Company Arrangement) [2014] FCA 53; Re Mirabela Nickel Ltd (subject to Deed of Company Arrangement) [2014] NSWSC 836 (Re Mirabela); Re Nexus Energy Ltd (Subject to Deed of Company Arrangement) (2014) 105 ACSR 246; [2014] NSWSC 1910 (Nexus) at [22].

2 Nexus, above n 1.

3 Weaver, above n 1, at [54].

4 Weaver, above n 1; Re 3GS Holdings Pty Ltd (subject to deed of company arrangement) & Ord v Stone & Ors [2015] VSC 145 (3GS); Re Mirabela, above n 1.

5 Nexus, above n 1, at [40].

6 Nexus, above n 1, at [96].

7 Re Nine Entertainment Group Ltd (No 1) (2012) 211 FCR 439; [2012] FCA 1464; Re Atlas Iron Ltd (2016) 112 ACSR 554; [2016] FCA 366 (Atlas Iron); Re Boart Longyear Ltd (2017) 121 ACSR 328; [2017] NSWSC 567.Back to article

8 Re Boart Longyear Ltd, above n 7, at [16], [81].

9 Sovereign Life Assurance Co v Dodd [1892] 2 QB 573 at 583.

10 First Pacific Advisors LLC v Boart Longyear Ltd (2017) 320 FLR 78; 121 ACSR 136; [2017] NSWCA 116.

11 Weaver, above n 1; 3GS, above n 4; Re Kupang Resources Ltd (subject to a deed of company arrangement) (Recs and Mgrs Apptd) [2016] NSWSC 1895; Re Western Work Force Pty Ltd [2017] FCA 342.

12 Nexus, above n 1.

13 Shepard, Re Quest Minerals Ltd v Mutual Holdings Pty Ltd (2016) 118 ACSR 166; [2016] FCA 1559.

14 Atlas Iron, above n 7; Re Boart Longyear Ltd, above n 7.

15 Atlas Iron, above n 7.Back to article

16 ASX Listing Rules (at 19 December 2016) Ch 1 r 1.1 Condition 8.

17 Re Mirabela, above n 1. 18. Re Nine Entertainment Group Ltd (No 1), above n 7.Back to article

18 Re Nine Entertainment Group Ltd (No 1), above n 7.

19 This matter was filed on 25 September 2017 but had not been listed for hearing at the time of writing.

20 See the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth).

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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.

Authors
 
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”

Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
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).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions