An extract from The Restructuring Review, 13th Edition
Overview of restructuring and insolvency activity
The past year has been an extremely volatile one for the Australian economy. Starting in late 2019 and extending through to early 2020, bushfires ravaged much of Australia (particularly the East Coast) causing significant property and environmental damage and resulting in the loss of lives, livelihood, wildlife and property. This had immediate negative consequences for the Australian economy, particularly at the local level, including small businesses directly affected as well as other varied sectors where the knock-on effects were felt. Almost concurrently, the volatile economy was hit harder by the covid-19 pandemic, which permeated Australia's borders. Unsurprisingly, this had an almost immediate and significant economic impact. In its world update in April 2020, the International Monetary Fund forecast a downturn in the global economy of 3 per cent in 2020 as a result of the impact of the pandemic – significantly greater than the global financial crisis, where the global economy declined by 0.1 per cent at its peak.
The Australian government, however, was quick to react to the pandemic, with measures (both fiscal and statutory) aimed at stabilising and preserving the economy, together with Australian businesses and jobs. In this respect, on 23 March 2020, the Australian Government announced drastic and immediate, albeit temporary, reforms to Australia's corporate insolvency laws, culminating in the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (Economic Response Bill). The overarching objective of the Economic Response Bill was to implement measures (and temporary amendments to existing legal frameworks) to minimise the economic impact of the covid-19 pandemic and promote business continuity in uncertain times.
The Reserve Bank of Australia (RBA) also estimated that the unemployment rate is forecast to rise to around 10 per cent in the June quarter, with a notable decline in headline inflation. Australia also recorded negative economic growth for the March quarter. With the June quarter almost certainly to follow suit, Australia will likely experience its first technical recession in almost 30 years. The RBA is now forecasting a fall in economic growth of 10 per cent in in the first half of 2020 and a fall of 6 per cent over the year.
Non-traditional lenders continue to make inroads into the corporate and institutional lending spaces, especially in the property and construction sectors. Tightened capital adequacy restrictions as a result of, among other things, the Basel Accords, more restrictive prudential standards and internal risk directives have resulted in the partial retreat of banks from these industries. This has encouraged more investment activity from hedge funds, investment banks and alternative capital providers and increased the number of alternative financing arrangements in the leveraged transaction space. For example, financiers in the Australian market are now utilising unitranche facilities that have traditionally been more popular overseas. The adoption of such structures over the past few years has been an interesting development and may pose novel challenges to the Australian debt market in the coming years, should these deals become distressed.
Non-traditional lenders have also benefited from the effects of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Royal Commission). With the handing down of the final report of the Royal Commission in February 2019, the Australian corporate and banking market has changed, perhaps indefinitely. Increased media attention (especially via social media platforms) has driven a transformation in Australian banks' behaviour. Reputational risk is heightened and has come to be a primary concern for management and general counsel. A key outcome of the Royal Commission was a renewed focus on regulation, with the final report recommending greater collaboration between the Australian Securities Investment Commission (ASIC) and the Australian Prudential Regulatory Authority.
Because of this increased degree of public and regulatory scrutiny, banks are generally less inclined to enforce security or make formal appointments. This has provided distressed borrowers with more leniency, giving them the opportunity to consult financiers and negotiate alternative measures to deleverage their positions through informal means. With formal insolvency appointments being an unattractive, last resort option, the number of secured creditor-led enforcement outcomes (i.e., receiverships) has declined. Banks are attempting to mitigate the effects of this shift by working with their customers rather than using enforcement, behaviour that does not seem likely to change in the near future.
Despite current trends, breaches of financial covenants, failures to meet amortisation payments or a party's inability to refinance continue to drive a significant proportion of external administration appointments. Where no informal arrangement can be reached between equity, management and lenders, directors will invariably opt to appoint a voluntary administrator over risking liability under Australia's strict insolvent trading laws (notwithstanding recent legislative amendments aimed at alleviating such fears, i.e., the Safe Harbour). This will often result in concurrent appointments where a secured creditor appoints a receiver 'over the top' of a voluntary administrator. Despite the shift in approach from Australian banks, such concurrent appointments still continue to feature in Australia's restructuring landscape.
The changing risk appetite of the banks and the general lending climate have limited opportunities in Australia's relatively new secondary debt market. While there are proactive buyers present in the Australian secondary debt market, there are generally fewer opportunities to purchase debt. Despite this, in recent years large and complex restructurings (i.e., Slater and Gordon and BIS Industries) saw lenders trading their debt to facilitate the transaction; the driver to sell the debt, in those cases, was the banks' general unwillingness to hold equity in the distressed entities. Considering the relative stability of the Australia banking sector and the robust regulatory framework governing it, it is likely that secondary debt traders will become more active as economic conditions continue to decline.
Schemes of arrangement continue to be a popular mechanism for effecting larger and more complex restructurings, such as those of Slater and Gordon, BIS Industries, Quintis Group, Wiggins Island Coal Export Terminal (WICET) and Wollongong Coal/Jindal Steel. While formal appointments (i.e., of liquidators and administrators) may be less common, they are often used as leverage against debtors in restructuring negotiations. Voluntary administration and deeds of company arrangement continue to be frequently used in debt-for-equity swaps, particularly at the small to mid-market level. The main driver for restructurings of this type is the power given to deed administrators to compulsorily transfer shares with court approval pursuant to Section 444GA of the Corporations Act 2001 (Cth) (the Act) (if the shares have no economic value).
Recently, the mining and mining services, retail and construction sectors have experienced heightened levels of distress. It is expected that each of these sectors (particularly mid-market mining projects and mining services companies in Western Australia, and retailers following the covid-19 pandemic) will experience increased levels of restructuring activity.
The insolvency and restructuring market continues to develop and provide opportunities, particularly in these unprecedented economic times. Notwithstanding the expected decline in the Australian economy in the wake of the covid-19 pandemic, with a more diverse lending market the authors anticipate that the next decade will bring new challenges and give rise to novel trends in the Australian insolvency and restructuring market.
Recent legal developmentsi The Australian government's response to the covid-19 pandemic for distressed businesses
In the wake of the covid-19 pandemic, the Australian government responded swiftly to enact the Economic Response Bill which came into effect on 25 March 2020. The Economic Response Bill seeks to implement immediate economic and other relief measures to ensure continuity for Australian businesses and jobs during these incredibly uncertain economic times. Included in the relief measures are very specific and considered amendments to parts of the Act, which operate in parallel with the various other legislative reforms over the last four years to Australia's insolvency landscape. Arguably, these new measures demonstrate a continued development of Australia's insolvency laws to promote corporate rescue and restructuring.
With effect from 25 March 2020, the amendments seek to relieve financially distressed business for a temporary period of six-months. It is intended that the specific changes related to Australia's insolvency law will operate in parallel with recent reforms aimed at protecting directors, being the safe harbour regime.
The temporary provisions that seek to provide a safety net for businesses in financial difficulty can be summarised as follows:
- relief for directors and holding companies from any liability for new debt incurred during the period a company trades whilst insolvent provided the debt is incurred in the ordinary course of the company's business;
- an increase in the threshold at which creditors can issue a statutory demand (from A$2,000 to A$20,000) and the time companies have to respond to a statutory demand (from 21 days to six months); and
- the ability for the Treasurer to provide targeted relief for classes of persons from provisions of the Act (by legislative instrument), to enable companies to deal with unforeseen events and government actions resulting from the coronavirus.
Significant transactions, key developments and most active industriesi Ipso facto stay
In July 2018, amendments to the Act came into operation, introducing an automatic stay into the Act on the enforceability of ipso facto provisions that allow a contract to be terminated or altered owing to:
- a company entering into a scheme of arrangement;
- the appointment of a receiver or controller to all or substantially all of the company's assets;
- the appointment of an administrator to a company; or
- the appointment of a liquidator immediately following administration or a scheme.
The automatic stay does not apply retrospectively (i.e., for agreements entered into prior to the new provisions coming into force). In addition, the automatic stay does not explicitly apply to: receiver or controller appointments that are not over all or substantially all of the company's assets; entry into a deed of company arrangement; or liquidations that do not immediately follow an administration or scheme.
Under the new Sections 415E and 451F of the Act, a court may lift the automatic stay in respect of certain ipso facto clauses if it is satisfied that doing so is in the interests of justice or where a relevant scheme of arrangement is found to not be for the purpose of avoiding winding up.
The operation of the automatic stay excludes certain rights prescribed in an accompanying ministerial declaration and certain contracts, agreements or arrangements separately set out in the Corporations Regulations 2001 (Cth) (Regulations). We also note that the automatic stay does not apply to ipso facto rights attached to financial products that are necessary for their provision, in agreements made after the commencement of the formal restructure or to other types of contracts set out in regulation or declared by the minister.
By way of illustration, some of the contractual rights excluded from the operation of the automatic stay provisions include: (1) a right to terminate under a standstill or forbearance arrangement; (2) a right to change the priority in which amounts are to be paid under a contract, agreement or arrangement; and (3) a right of set-off, combination of accounts or a right to net balances or other amounts.
Similarly, among the agreement types excluded by the Regulations include: (1) contracts, agreements or arrangements that are a licence or permit issued by federal, state or local government; (2) contracts that are derivatives and contracts for the underwriting of an issue or sale of securities or financial products; and (3) contracts under which a party is or may be liable to subscribe for, or to procure subscribers for, securities or financial products.
As the automatic stay provisions have only been in operation for nearly two years, there has not been any judicial consideration as to the operation of these provisions, including the excluded rights and contract, agreements and arrangements.ii Sargon Capital
Gilbert + Tobin advised Stewart McCallum and Adam Nikitins of Ernst & Young in their capacity as voluntary administrators of certain entities within the Sargon Group (Sargon) in respect of the sale of their business and assets to the Cloverhill Group, which completed on 4 May 2020. Sargon owned and operated businesses in the financial planning, corporate trustee, responsible entity, superannuation and related financial services sectors.
The sale included shares in operating subsidiaries which continued to operate with independent boards and were not under external administration, including CCSL Limited, Diversa Trustees Limited and Tidswell Financial Services Limited. The sale was conducted on an accelerated time frame to preserve regulatory licences, minimise disruption to operations continuing on a business as usual basis and address the entities' urgent insurance and funding requirements.
The transaction required engagement and negotiations with a large number of stakeholders, including external administrators appointed to other parts of the Sargon Group, the independent boards of the operating subsidiaries, secured creditors, unsecured creditors and parties claiming ownership or security rights in respect of the assets subject to the sale. Engagement with regulators, securing regulatory approval for the sale and putting in place urgent insurance arrangements were also key facets of the process, as was ongoing management and resolution of issues deriving from Sargon's complex intra-group arrangements.
Despite extensive negotiations with various third parties whose consent or participation was required to effect a consensual sale to Cloverhill, the administrators were ultimately required to make an urgent application to the Federal Court of Australia to enable the sale to proceed within the time constraints. The application was heard before the Honourable Justice O'Bryan and on 1 May 2020 his Honour granted leave for the sale to proceed.
Among other things, the successful sale provides for continuing employment for all of the relevant entities' employees (approximately 100 in total) and stability for the $15.5 billion worth of superannuation funds under management and in excess of 230,000 superannuation fund members.