- A creditors’ scheme of arrangement can be used to affect the rights that creditors of the scheme company may have against third parties and/or the scheme company itself.
- The courts are prepared to approve creditors’ schemes of arrangement under which creditors grant a release in favour of a third party and/or the scheme company itself.
- In light of the increasing use of class action litigation in Australia, it is possible that we could see, in members’ schemes of arrangement, certain bidders requiring target shareholders to release any claims they may have against the scheme company (eg claims relating to breaches of the ASX’s continuous disclosure regime).
The period following the GFC has seen the re-emergence in Australia of the use of creditors’ schemes of arrangement to effect large scale corporate rehabilitations, particularly by those sophisticated investors deploying ‘loan-to-own’ acquisition strategies.
A scheme of arrangement cannot by itself bind a third party. Accordingly, it is necessary for any third party who is integrally involved in a scheme of arrangement to sign a deed poll agreeing to be bound by the terms of the scheme (this is what a bidder does in a members’ scheme of arrangement that effects a change of control transaction).
However, a scheme of arrangement can be used to affect the rights of a creditor of the scheme company against a third party – such as by having creditors grant a release in favour of that third party.
A current example of this is the creditors’ scheme of arrangement involving Lehman Brothers Australia Limited (in liquidation) (LBA).
The Lehman Brothers Australia scheme
As has been well documented in the press, LBA was being sued by a number of former clients (which included a number of Municipal Councils) on the grounds that, in selling and advising on the sales of certain investment products, it engaged in misleading or deceptive conduct, was negligent and was in breach of its fiduciary duties as a financial adviser.
LBA had insurance which potentially covered the claims against it. The insurers initially strenuously resisted claims on the policies. However, following negotiations and a mediation process, it was eventually agreed that the insurers would pay an aggregate of $48 million on the condition that each insurer be provided with releases from the ultimate claimants (being certain creditors of LBA).
To implement this settlement, the liquidators of LBA proposed a creditors’ scheme of arrangement under which, among other things, the ‘client creditors’ of LBA (broadly speaking, defined as any person who has a claim against LBA arising from the provision by LBA of investment advice or investment management services or the sale by LBA of investment products) would receive 40.7 to 49.9 cents in the dollar in respect of their claim. A similar structure was used in the schemes involving Opes Prime and Lift Capital.
Release of third parties in creditors’ schemes
The mere fact that a person happens to be a creditor of a company is not, of itself, enough to enable a scheme of arrangement to be used to affect the rights that such creditor may have against a third party or the scheme company. The scheme of arrangement must be proposed with creditors in their capacity as creditors and it must at least concern their position as creditors.
The Courts have made it clear that they are prepared to approve a scheme of arrangement under which creditors of the scheme company release a third party so long as:
- there is some element of ‘give and take’ – that is, that the creditors receive something in return for the benefit conferred on the third party by the release, and
- there is an adequate nexus between, on the one hand, the release given to the third party, and the relationship between the creditor and the scheme company, as creditor and debtor, on the other.
It is also common in creditors’ schemes for the scheme creditors to grant a broad release to the scheme company itself and also to its directors and employees.
The use of releases in members’ schemes
The acceptance by the Courts of releases in favour of third parties under creditors’ schemes gives rise to an interesting question as to the possible use of releases in favour of third parties and/or the target company in connection with a members’ scheme of arrangement which is being used to effect a change of control transaction.
Two possible uses for a release in connection with a members’ scheme come to mind:
- where the bidder is concerned that certain members may have claims against the target company resulting from representations made by the target in previous capital raisings – for example, claims resulting from the target failing to meet financial forecasts contained in the fund raising disclosure materials, or
- where the bidder is concerned that certain members may have claims against the target company in respect of the failure by the target to comply with the continuous disclosure regime in the ASX Listing Rules.
In each of these cases, the bidder may be concerned that, after it acquires the target company as a result of the scheme of arrangement, the target could be the subject of a claim from some of its former members (such as a class action claim).
By way of example, the recent members’ scheme of arrangement under which Bupa Australia acquired all the shares in Dental Corporation included a novel release granted by members in favour of Dental Corporation and its directors and employees. Such persons were released from any claim any scheme shareholder may have had, in their capacity as a member, or, if applicable, in their capacity as a person who had subscribed for shares in Dental Corporation.*
The granting of a release by creditors or members can make the difference between creditors or members (as the case may be) getting the opportunity to consider a scheme of arrangement which directors consider to be in their best interests. Third parties who have an integral role in a scheme of arrangement may, quite reasonably, not be prepared to participate in, or facilitate, a scheme of arrangement without the benefit of such a release.
With the ever increasing presence of class action litigation in Australia, it is quite possible that we could start to see an increasing appearance of releases in members’ schemes as certain bidders may not wish to go to the great expense of acquiring a target company only to find that, after the acquisition, its newly acquired subsidiary is being sued by former members.