- The GFC has seen the emergence of “loan to own” acquisition strategies in Australia.
- Creditors’ schemes of arrangement are generally preferred over deeds of company arrangement by those deploying such strategies.
- The Nine Entertainment scheme is an example of a recent successfully executed “loan to own” acquisition strategy.
The global financial crisis (GFC) has seen the development of more active and liquid secondary debt markets in Australia and, as a related matter, the emergence of “loan to own” acquisition strategies.
Such strategies involve opportunistic and sophisticated financial investors (such as special situation funds, activist hedge funds, distressed debt investors and private equity investors) acquiring debt in financially distressed companies, generally at a fraction of its face value.
The investor’s ultimate intention is to use their acquired debt position to facilitate a deleveraging process involving a debt-for-equity exchange, thus resulting in the investor acquiring an equity stake in a deleveraged company in exchange for their debt position.
The disadvantages of the deed of company arrangement (DOCA) procedure means that, in the absence of a fully consensual deal, creditors’ schemes of arrangement have been and are likely to remain the structure of choice for those deploying “loan to own” acquisition strategies.
This article discusses the issue of when certain types of creditors and/or members need to be parties to a creditors’ scheme, why creditor schemes are often preferred over deeds of company arrangement, voting agreements in creditor schemes, and contains a summary of the recent high-profile creditors’ scheme involving Nine Entertainment.
When certain types of creditors and/or members need to be parties to a creditors’ scheme
A creditors’ scheme of arrangement need not involve all of the creditors of the company – it can be limited to certain categories of creditors, such as only the external financiers.
However, if the proposed scheme may adversely affect the rights of creditors who are not proposed to be made parties to the scheme (such creditors being Outsider Creditors), or the rights of members, the court will need to consider whether:
- the Outsider Creditors should be made parties to the creditors’ scheme (albeit as a separate class), and
- there should be a separate members’ scheme at which members will have a say on whether the proposed creditors’ scheme will proceed.
Specifically, the court will consider whether the Outsider Creditors and/or members are sufficiently “concerned in” the transaction or have any real “economic interest” in the assets of the scheme company. If, for example:
- the Outsider Creditors are not having their debts or claims compromised and the scheme does not result in the transfer of assets to a company in a new corporate group; or
- the equity has no value as the company’s assets are insufficient to even repay the senior lenders,
then the creditors’ scheme should, absent other relevant factors, be able to proceed without the involvement of the Outsider Creditors and/or members (as the case may be).
If a significant number of shares are proposed to be issued, existing equity holders may effectively be “wiped out” through the dilutive effect of the creditors’ scheme. If the scheme company is subject to Chapter 6 of the Corporations Act 2001 (Cth) (Corporations Act), and the creditors’ scheme would otherwise result in a creditor acquiring voting power in excess of 20%, the approval of the members will not be required given the exemption in Chapter 6 for acquisitions that result from a scheme of arrangement.
It is possible, depending on the circumstances, that the proposed scheme will either require:
- a waiver from the ASX from, or member approval under, ASX Listing Rule 7.1 (issuances in excess of the 15% or 25% cap (as applicable) in the past 12 months), ASX Listing Rule 10.1 (related party transactions), ASX Listing Rule 11.1 (significant change of the nature or scale of activities), ASX Listing Rule 11.2 (disposal of main undertaking) or one of the other ASX Listing Rules; or
- an exemption from ASIC (if possible) from, or member approval under, a requirement in the Corporations Act such as section 136(2) (modification of, or adoption of a new, constitution), section 208 (related party transactions), section 246B (varying and cancelling class rights), section 254H (share consolidation), section 256C (capital reduction) or section 257B (buy back).
Voting agreements in creditors’ schemes
It is not uncommon in creditors’ schemes of arrangement for certain creditors to enter into an agreement with the scheme company under which the relevant creditors agree to vote in favour of the scheme of arrangement.
Unlike in the case of a members’ scheme of arrangement where the number of target shares that can be the subject of a voting agreement is limited by the operation of the 20% rule in the Corporations Act, no such limitation applies in the case of creditors’ schemes.
The case law indicates that agreements under which a creditor merely agrees to vote in favour of the scheme will not result in that creditor being placed in a separate class for voting purposes. However, such an agreement may, depending on its terms, still be relevant–from an “interests” (or vote discounting or disregarding) perspective–to the court when exercising its fairness discretion in deciding whether to approve the scheme.
Disadvantages of DOCAs
The reasons why creditors’ schemes are generally preferred over DOCAs by those seeking to implement “loan to own” acquisition strategies include:
- the company must first enter administration to do a DOCA – the appointment of an administrator may give counterparties to material contracts the right to terminate or demand accelerated payment terms, and may have adverse consequences on any regulatory licences and approvals which the scheme company relies on to do business. Furthermore, the mere stigma attached to any administration process can have a detrimental effect on the company’s goodwill and other business relationships;
- the inability of a DOCA to bind secured creditors – once a creditors’ scheme has been approved by the court, it binds all creditors who are parties to the scheme, including creditors who voted against the scheme. However, under a DOCA, a secured creditor who did not vote in favour of a DOCA will generally remain entitled to continue to realise or otherwise deal with its security;
- timing risk of court ordered termination of DOCA – an application may be made to the court, including by a creditor, to terminate a DOCA and, if successful, the company is taken to have passed a special resolution that the company be wound up voluntarily,
- inability to extinguish rights of creditors against third parties – unlike a creditors’ scheme, a DOCA cannot extinguish creditors’ claims against third parties, and
- DOCAs are not exempt from Chapter 6 – if the relevant company is subject to Chapter 6 of the Corporations Act, and the rehabilitation proposal involves a debt-for-equity swap that would, if implemented, result in a creditor acquiring voting power in more than 20% of the voting shares in that company, there is no applicable exemption from the 20% rule in Chapter 6 of the Corporations Act.
The Nine Entertainment Group creditors’ scheme*
A recent successfully executed, and high profile, “loan to own” acquisition strategy involved the Nine Entertainment Group creditors’ scheme of arrangement.
Prior to the scheme, the Nine Entertainment Group was owned by CVC and had outstanding:
- senior secured debt of approximately A$2.3 billion (including contingent liabilities under certain hedging arrangements) (Senior Debt); and
- secured subordinated notes with a face value of approximately A$1.14 billion (Subordinated Debt).
There were approximately 73 providers of Senior Debt (Senior Lenders) and 14 providers of Subordinated Debt (Subordinated Lenders).
Terms of the scheme
The creditors’ scheme was between Nine Entertainment Group Ltd, the Senior Lenders and the Subordinated Lenders. The Senior Lenders formed one class and the Subordinated Lenders formed a separate class. The scheme was conditional on the approval of each class.
In summary, it was proposed that the Senior Lenders and the Subordinated Lenders would relinquish their existing rights in the Senior Debt and the Subordinated Debt (respectively) by way of an assignment of that debt to the holding company of the Nine Entertainment Group, Nine Entertainment Co. Holdings Pty Ltd (NEH). In consideration for this:
- the Senior Lenders would receive a cash payment of A$573 million and the issue of such number of ordinary shares in NEH as would represent 95.5% of all the ordinary shares on issue, to be divided pro rata between the Senior Lenders;
- the Subordinated Lenders would receive a cash payment of A$22.5 million and the issue of such number of ordinary shares in NEH as would represent 3.75% of all the ordinary shares on issue, to be divided pro rata between the Subordinated Lenders, and
- CVC would receive a cash payment of A$4.5 million and the issue of such number of ordinary shares in NEH as would represent 0.75% of all the ordinary shares on issue.
The scheme stated that CVC would receive these additional amounts with the consent and at the direction of the Subordinated Lenders and in consideration of CVC taking various steps at the request of the Subordinated Lenders to facilitate the scheme.
The Senior Debt included amounts contingently owing under hedging arrangements (interest rate swaps) (Hedging Transactions).
Under the terms of the creditors’ scheme, it was proposed that each Hedging Transaction would, by force of the scheme, be terminated on the effective date of the creditors’ scheme. The “close-out amount” of each Hedging Transaction (Early Termination Amount) was calculated in accordance with the relevant documents evidencing the Hedge Transaction. It was proposed that the Early Termination Amount would form part of the total amount of the Senior Debt.
The Early Termination Amounts were then used to determine the amount of the cash payment and the number of ordinary shares issued to each hedge provider. In doing so, the hedge providers and the other Senior Lenders were treated proportionally equally and were, accordingly, treated as being in the same class as the other Senior Lenders for voting purposes.
Certain hedge providers argued in court that they could not be forced to become members of NEH as a result of the scheme of arrangement unless they individually agreed to become a member. The court rejected this argument and stated that a creditors’ scheme of arrangement was capable of effectively forcing creditors (such as the hedge providers) to become members of another company (such as NEH).
Outcome of the creditors’ scheme
The Nine Entertainment Group creditors’ scheme was approved by the court on 29 January 2013 and was implemented on 6 February 2013.