The increase in the availability of alternate capital in Australia over the past decade has provided a landscape for well-tested global restructuring techniques to be applied locally. This includes 'loan to own' strategies. More recently in Australia, two key factors are driving the opportunities for the implementation of 'loan to own' structures: first, the continuing flow of non-bank capital into the Australian market from abroad; and secondly, the willingness of existing holders of debt to trade, not least because Australian banks are subject to some of the toughest regulatory capital constraints globally.
This article explores the key mechanisms available in Australia to convert target debt to equity, namely:
- Mutual agreement
- Scheme of arrangement
- Deed of company arrangement
- Credit bid
If the target is not already subject to an insolvency proceeding, parties will usually attempt to reach agreement consensually so as to preserve value. The target company will be minded to avoid the more adverse consequences associated with enforcement of the debt.
In Australia, there is another key factor at play. Directors of the target company will be concerned to avoid personal liability for debts incurred whilst trading insolvent. Whilst the risk of insolvent trading can be a useful 'stick' to incentivise agreement to a transaction, investors need to be mindful that this 'stick' can play out in a number of ways. The stakeholders may seek to remove insolvency risk by agreeing a transaction, the directors may resign or the directors may protect themselves from insolvency risk by appointing a voluntary administrator. Strategies need to be put in place accordingly.
Scheme of arrangement
The claims of any class of member or creditor of a company can be restructured via a scheme of arrangement. A scheme is approved if:
- A majority in number and 75% in value, of the relevant class of creditor or member present and voting at the scheme meeting vote in favour of it
- The Court approves it
A scheme is most suited where there are hold-out parties in a class; it can effectively bind any member or creditor class, including secured creditors. A scheme can effect a debt for equity swap, as occurred in Nine Entertainment Group (2013). The Nine scheme involved a compromise under which the senior and junior lenders assigned their debt to Nine's Hold Co, in exchange for 99.25% ownership of Nine's Hold Co plus a cash payment. A scheme can also effect a release of creditor claims against third parties (eg guarantors).
A scheme is not suited however to a hostile takeover. The scheme must be proposed between the company and the relevant class of members and/or creditors, and it is the company that produces the scheme proposal documentation and makes the application to the Court for its approval.
Australia's scheme provisions operate almost identically to those governing UK schemes of arrangement.
Deed of company arrangement
A company which is subject to voluntary administration (or liquidation) may restructure its obligations via a deed of company arrangement (DOCA).
A DOCA is well suited to a hostile takeover - a key feature is the ability to recapitalise an insolvent company and take equity ownership without shareholder consent. A DOCA is also suited where the whole debt matrix, including trade creditors, needs to be compromised. However, it is important to note that a DOCA does not bind dissenting secured creditors unless ordered by the Court. Also creditor claims against third parties (e.g. guarantors) are not released. In any 'take control' strategy involving a DOCA, the secured debt should be acquired or on side.
A voluntary administrator can be appointed to a target company by its directors, a secured creditor with security over all or substantially all of the target company's property, or a liquidator of the target company.
A proposal for the company to be restructured via a DOCA must be submitted to the company's voluntary administrator for review and the anticipated outcome compared to a liquidation outcome. The voluntary administrator is obligated to report to creditors, and will ordinarily recommend a DOCA proposal to the company's creditors if it provides a better outcome than liquidation.
For a DOCA proposal to be approved:
- A majority of the company's creditors must vote in favour of it - either on a show of hands, or if a poll is requested, by a majority in number and value
- If the value votes one way and the number vote the other way, the voluntary administrator has a casting vote to determine the outcome
The 'take control' mechanism arises under section 444GA of the Corporations Act, which provides that a DOCA administrator may transfer the shares in a company to another party with the consent of the shareholder or Court approval. The Court will approve the share transfer if it does not unfairly prejudice shareholders.
This power was used to effect Seven's 'loan to own' takeover of Nexus Energy Ltd (2014). Some shareholders opposed the Court transfer on the basis they were paid nil consideration and were accordingly, unfairly prejudiced. The Court rejected that argument and confirmed the relevant test, namely, whether or not a shareholder is unfairly prejudiced depends on the value of the shares in a (hypothetical) liquidation. There is no prejudice if the shares in that scenario, have no value.
Credit bid is a control mechanism available to holders of secured debt, with rights of enforcement including the right to sell the secured property.
Implementation of a loan to own credit bid strategy involves:
- Acquiring debt secured by all or substantially all of the company’s property, where there is a current or potential event of default that cannot readily be cured or remedied
- Proposing a take-control consent transaction to the owners of the company, and advising the owners of the enforcement steps to be taken if they do not agree
- Enforcing the security if agreement cannot be reached (by which time it is necessary for there to be an event of default), either by entering into possession, appointing a receiver or appointing a voluntary administrator
- acquiring the secured property out of insolvency, or taking a transfer of the shares in the company via a DOCA
The key consideration in Australia relates to the price that needs to be paid for the secured property.
- A receiver is required to take all reasonable care to sell property at no less than market value, or if there is no market value, the best price reasonably obtainable in the circumstances, under section 420A of the Corporations Act
- At general law, where secured property is sold on behalf of a secured party, the secured party has an obligation to account to the borrower for any surplus. An aggrieved borrower may look to the secured party for damages, where they consider the sale price is too low.
As such, in exercising a power of sale upon enforcement, steps need to be taken to assess the market price for the property. Steps might include:
- Identifying and seeking expressions of interest from parties in the market who are likely to be interested in acquiring the property
- Obtaining independent valuations of the market value of the property, on a market basis and a forced-sale basis
Marketing efforts undertaken prior to any enforcement will inform a security trustee, receiver or administrator tasked to sell the property about price, and any additional steps that need to be taken to satisfy themselves that an enforcement sale complies with the law.