Increasingly, formal restructures, whether solvent or insolvent in nature, are closely aligned to court-supervised processes, adding certainty and transparency to the restructuring process.
In October 2018, Quintis Limited, with some 13,000 hectares (32,110 acres) of sandalwood to grow and harvest in Australia, completed a recapitalisation of its business and restructuring of the group balance sheet and debt instruments. The restructure design utilised Australian voluntary administration and scheme of arrangement processes in conjunction with a U.S. Chapter 15 filing recognition proceeding.
Quintis is the latest formal Australian turnaround to use rescue features recognisable to a North American readership. Others include Ten Network, Paladin Limited, Atlas Limited, Arrium Limited, Nexus Energy, Mirabela Nickel, Emeco, Boart Longyear, and Bis Industries, to name a few. Each involved restructures across groups of associated entities.
These corporate groups cover agribusiness, broadcast media, African uranium mines, iron ore producers, steel fabricators, Brazilian nickel producers, equipment hire, mining services contractors, and logistics and long-haul transport businesses. Some of these businesses are asset rich while others are contract- or logistics-driven. In common, the net present value of the businesses as going concerns significantly exceeded breakup values of underlying assets in liquidation.
Although each of these rescues was innovative in different ways, they all successfully worked within the creditor-driven Australian system to keep businesses operating, saving jobs, preserving tax revenues, and protecting communities. This article traces some of the ways in which administrators are using court and out-of-court processes in Australia to continue and save distressed businesses.
A common language and emerging comity
Larger Australian corporate situations often have some form of U.S. paper within the capital structure—Term Loan B, sub-investment grade notes and bonds, value investing instruments across the capital structure, special situations capital, and the like. It is unsurprising that as a result, many expressions heard in U.S. restructures also feature in Australian restructures—debt priming, drag along rights forcing minority holders to join a sale or restructure, stalking horse, and break-up fees being common language in both places.
Australia still differs in its sense of what falls within and outside “priming baskets” and “permitted liens,” and does not follow the American model in terms of its treatment of restricted material on expiry of nondisclosure agreements (NDAs).
Australians are also still new to ideas of debtor-in-possession (DIP) funding and equity cushions, though even these are seen across the restructuring landscape, mostly as Australian trading banks learn to work with, and occasionally cede priority to, global market funds providing rescue financing options.
Australian restructures also commonly include debt compositions throughout the group structure using cramdowns; priming new capital in priority to old capital (with the consent of original instrument holders); a court-supervised process, albeit one run concurrently with a creditor-driven process; DIP funding on a super-primed basis and the encouragement of roll-ups; and a loan-to-own thesis.
The Australian framework
Corporate rescues in Australia are usually effected via voluntary administration, receivership, scheme of arrangement, or nonformal workout negotiations. Only schemes of arrangement require a court process. Only schemes of arrangement and voluntary administration can be used to cram down debt compositions on creditors. Only voluntary administrations provide an automatic stay or moratorium on claims, though in contracts written after July 1, 2018, certain ipso facto rights can also be the subject of a stay in schemes of arrangement and other processes.
Workouts and safe harbour reform
Since the introduction of safe harbour protections in 2017, directors executing on turnaround plans “reasonably likely to lead to a better outcome for companies” than insolvency and meeting certain preconditions are not liable for trading debts incurred as part of the plan if the entities later fail. Under previous law, directors could technically become personally liable for debts of trading on the business after entering the twilight zone of insolvency, even if the trading continued as part of an unsuccessful plan to rescue the company.
According to a recent survey undertaken by the TMA Australia Chapter, safe harbour reforms encourage boards of companies to investigate workout solutions outside of formal processes. Once companies realise they are operating in distressed conditions, advisors should be brought in to assist the board and management in developing turnaround plans. In practice, those plans usually involve an optimisation of business strategy, divestment of non-core businesses, renegotiation of costly counterparty arrangements, reductions in headcount and head office expenses, and raising of some form of transition capital, often from special situation funders. A successful turnaround can lead to significant cost savings within the business, enhancing profitability as against peers.
The engagement of a safe harbour or execution of a turnaround plan is not necessarily a market disclosable event under Australian trading platform rules. Accordingly, most workouts are undertaken as part of a confidential process. However, the plan could become disclosable if, for example, it results in changed profit guidance previously divulged to the market because of media or other speculation of insolvency or liquidity in the company. Disclosure may also be needed if there is some doubt that “turnaround options” are achievable; hence, whether a “better outcome” than insolvency is achievable.
Innovations lie in the bespoke suite of terms included in restructuring instruments. The more common of these are structured around obligation resets; cash maintenance, utilisation, and sweeps; permitted lien baskets; assessing spend against probability patterns in funding support payments from associates; control lock-ups; and waterfall restrictions. Obligation resets usually involve some form of maturity extension, repayment deferral or suspension, composition for PIK, interest holiday, amended covenants, and/or reporting relief. The basic concept is to match financial counterparty rewards to sponsor improvements in free cash flow and/or equity value.
Safe harbour protections also enable boards to preplan rescues that need to be implemented through formal structures. The latter may be required to cram down debt compositions through classes or to transfer liabilities or property to new cleanskin entities or to take advantage of statutory moratoriums and restrictions on the exercise of creditor rights. Some examples of preplanned administrations discussed later in this article include Paladin Energy, Wiggins Island Coal Export Terminal (WICET), and Quintis.
Voluntary administration was introduced in Australia in 1993 to offer a quick and cheap restructuring mechanism for small and medium-size companies. Administrations are usually initiated by the passing of a simple resolution of directors. On passing that resolution, voluntary administrators assume power to administer the entity’s business and to investigate whether a deed of company arrangement (DOCA), or a form of restructuring plan, can be developed to settle a fund on creditors and/or for working the company back to solvency via a trade on plan. Directors’ powers are suspended during the administration period, and shareholders are restricted in the sale of securities.
Administrators are appointed without the need for any court filing. They have no obligation to pay ad hoc committees, trustees, or third-party advisors. Creditors are expected to fund their own advisors. An automatic stay of proceedings operates against all non-owners and security holders, and the rights of both owners and security holders are restricted in various ways under Personal Properties and Securities and Corporations Act legislation. Ipso facto rights on instruments written after July 1, 2018, are also restricted.
Creditors may approve a restructuring plan via a DOCA, which then allows composition of debts and distributions according to statutory or DOCA waterfalls.
The statutory period to complete a corporate rescue inside the voluntary administration process is ordinarily 28 business days unless that period is extended by the court or creditors. As a plenary, the latter may extend this period by up to 45 business days, though, as recognised by the High Court of Australia late in 2018, “holding” or “restructuring” DOCAs can also be approved by creditors to allow administrators more time to find a rescue option.
Although administrations may be undertaken and the restructuring plan (the DOCA) may be executed without any specific court overview, approval, or supervision, the process has four built-in mechanisms to prevent abuse of creditors:
- First, only third parties registered with the Australian Securities and Investments Commission (ASIC) and with no existing commercial arrangement with the distressed entity may act as voluntary administrators. As a result, the business ends up being run by unbiased practitioners who are experienced in insolvency and unlikely to risk their reputations by acting improperly. If they do, the court or ASIC may investigate their actions during the administration or after it concludes.
- Second, voluntary administrators are personally liable for all new and, in most cases, continuing debts of the entity following their appointment. As a result, administrators are not incentivised to incur new debt and will instead be looking for solutions to either quickly restore the business to an operating condition or to deliver a result to creditors that is better than liquidation.
- Third, the Corporations Act sets out a series of rights, objectives, obligations, timetables, and approved dealings with certain asset classes. These provide broad pro forma rules and direction or a framework for undertaking and completing administrations.
- Fourth, all parties—administrators, creditors, other affected parties, and ASIC—may apply to the court to change the framework, disallow oppressive or disadvantageous dealings, or otherwise supervise the administration process.
Originally devised for small and medium companies, the voluntary administration process has also become the restructuring mechanism of choice in most large Australian corporate group restructures. Arrium Group and Channel Ten provide recent examples. This is partly driven by the ease of an appointment (a board vote or secured creditor appointment when the company is or may become insolvent) and partly by the good restructuring outcomes achieved for large corporate groups over the past two decades.
It would be more appropriate to say that with few exceptions, all major distressed entities have restructured either via the consensual and informal workout process (i.e., consensual renegotiations with counterparties) or via the voluntary administration process.
As administrators of the company’s assets and business, the appointees have a statutory duty to come up with a plan to either maximise the prospect of the company, or aspects of its business, continuing in existence or, if this is not possible, to obtain a better return to creditors than would be the case in liquidation. The plan is then voted upon by creditors, who determine the fate of the plan. Disgruntled creditors can appeal a voting outcome to the court, though they have the burden of establishing special disadvantage, oppression, misleading information, or some other invalidating aspect.
In typical form, a DOCA is negotiated among the company, creditors, and third parties to settle a fund on creditors in return for the release of most or all creditor claims against the company. The fund may come from a third party (e.g., directors or holding companies), from the release of property by senior lenders looking to cleanse a company of trading and employee debts, or from profits realised in a trade-on of the business.
Administrations and large corporate rescues
Since at least 2014, administrators have been utilising the Section 444GA mechanism of the Corporations Act to cause compulsory transfers of shares to recapitalising creditors, creatively applying DOCAs to extinguish liens from corporate groups, and seeking judicial guidance to effectively manage restructures and to simplify restructuring processes within a court-supervised regime. In its most creative form, the scheme of arrangement process is engaged by administrators to close out administrations.
Administrators may ask the court to compel the transfer of all or some securities in a company (without compensation to old shareholders) to a new owner; that is, to the recapitalising party, usually in some form of debt-for-equity swap arrangement. Administrators must provide evidence to demonstrate that value breaks within the debt stack and that existing equity, which sits as a subordinated class of claim, has, but for the recapitalisation, no value in the securities.
To obtain orders, administrators are generally required by the court to comply with valuation rules set by ASIC, to satisfy or have obtained waivers around financial disclosures, to have satisfied Australian Security Exchange (ASX) and any Foreign Investment Review Board (FIRB) requirements, and to have allowed contradictors to oppose the application. There is accordingly some mirroring of responsibility on administrators between the level of information disclosure and regulatory compliance, as would be necessary in respect of a scheme of arrangement. It is accordingly costlier to run a Section 444GA process than an ordinary DOCA, though not as costly as a scheme of arrangement.
Paladin Group provides a recent example of a Section 444GA process. The restructure took place after more than 12 months’ planning by the Paladin board. Over that period, the company successfully negotiated a proposed bond restructure and new senior debt facility, with tagged equity rights and deferral of rights by existing senior holders and most offtaker parties. It was resolving a dispute with a joint venture partner and had moved to satisfy offshore shareholders that its workout plan would lead to a better outcome than would be achieved under an administration process.
In short, the board, well-advised and working with turnaround professionals, was well on the way to saving the corporate group and preserving significant value for debt and shareholders. Unfortunately for the company, the single holdout party, Electricite De France (EDF), an offtaker with security top-up rights, refused to participate in a nonformal restructure. Its call for top-ups in security already allocated to other parties as part of the turnaround plan triggered the appointment of administrators.
During a nine-month period, the administrators essentially executed on the preappointment plan, at some considerable cost to existing shareholders. The administrators initially used the court process to approve a new financing facility to undertake the restructure. EDF was stopped by the statutory moratorium from exercising claims in damages for Paladin’s refusal to provide additional security. This enabled administrators to proceed with the restructure outlined, including by bringing a Section 444GA application to cause 98 percent of securities in Paladin to be compulsorily transferred to recapitalising parties.
Existing bondholder claims were released and exchanged for a combination of new debt instruments and equity in a recapitalised Paladin. New senior facilities, supported by an equity raising, were negotiated. Existing equity was left, on a pro rata basis, with the remaining 2 percent of equity in a restructured Paladin.
Close interaction with a court-supervised process was again used in the restructure of Ten Network. In that case, administrators worked in tandem with receivers for transfer of shares in the public holding company of the network to CBS, again utilising the Section 444GA process. Senior creditors, employees, and key suppliers were paid in full. The Ten Network continues to operate a national broadcast media business.
A useful application is seen in the Arrium Group restructure. At the time administrators were appointed in April 2016, companies within the Arrium Group formed one of Australia’s two largest steelmakers, employing more than 6,000 and contracting with many thousands of suppliers across its various mining, fabrication, transport, shipping, and marketing businesses.
After execution of a holding DOCA to preserve moratoriums and undertake a worldwide sale and restructure process, the administrators negotiated a relatively new form of facilitation and distribution arrangement whereby the creditors of 93 companies agreed to the value received from the sale of assets to be applied to a distribution company and to participate in a fund created from the sale of those assets. This enabled the sale of various parts of the Arrium business to Liberty OneSteel as a going concern, preserving jobs (direct employees, as well as the employees of contractors) and probably saving the town of Whyalla.
The administrators used an aggregation (rather than pooling) and funds application structure across a very complex group, cleansing the group structure of debt, allowing the assets to be sold free of liens. Although not a statutory requirement, the administrators ensured the restructure was undertaken under the supervision of, and with guidance from, the court. Doing so reduced the risk of challenges to the administrators’ decisions and assisted them in streamlining meeting and disclosure processes. Obtaining judicial direction at points in time in the process ensured a high level of transparency and provided an equality of participation in that process to all stakeholders.
DOCA and schemes of arrangement
Traditionally, Australian and U.K. composition and equity transfer schemes were effected by scheme of arrangement. After 1993, when the voluntary administration process began, creditor-driven schemes fell out of vogue. More recently, schemes are undergoing a resurgence in acceptance and are being used in conjunction with the DOCA process.
- Schemes of arrangement, unlike a DOCA, are court-driven processes. As a result, involuntary scrip transfer schemes have four advantages over a DOCA:
- Schemes, unlike DOCAs, can extinguish the rights of third parties. The Lift Property and Lehman Bros schemes are examples.
- The court has power to cause part or all of the property or liabilities of the moribund company, including contracts, to transfer to a properly capitalised newco.
- Entities in corporate groups can be dealt with together.
- Australian Taxation Office rollover relief rules (allowing the taxpayer to defer or disregard a capital gain or from a forcible transfer of assets or scrip) are easier to satisfy when the transfer occurs under court order.
Since at least 2016, administrators have increasingly used schemes of arrangements to close out restructures.
In 2017, Emeco, a mining assets contractor, undertook a recapitalisation and merger with two other similar and ailing businesses. The recapitalisation was executed by a creditors’ scheme of arrangement sanctioned by the court and allowing the extinguishment of existing debt instruments in consideration for the issue of newly rated and extended maturity bonds and partial debt-for-equity conversion. The company also raised funds via a new loan facility and rights issue.
Similarly, in Quintis creditors approved a DOCA to deal with legacy debts on a composition basis. Each DOCA negotiated within the various Quintis companies was structured as part of a recapitalisation of the Quintis group of companies by BlackRock, as incumbent senior creditor. The DOCAs proceeded on the basis that a recapitalised Quintis would be able to provide the pooled forestry and marketing services originally promised to growers of sandalwood plantations administered by the Quintis companies.
Subsequent to execution of the DOCAs, schemes of arrangement were undertaken by the companies in conjunction with a U.S. Chapter 15 process. In substance, a third party (Black Rock, as senior and priming creditor) provided additional funding into a top-hatted new entity, which assumed many of the operational commitments of the former head entity.
The original Quintis holding company is in the process of being liquidated.
Creditor schemes without voluntary administration
In late 2018, senior and subordinated debt holders to WICET extended timeframes under financing instruments to enable sponsor improvements in the performance at the port. Without full consent of all lenders, and with a complicated credit stack across senior and various levels of mezzanine debt as well as preference share rights (with the added complication that the owners of WICET were also users so opposed to charge rate increases), the creditor scheme process enabled senior holders to effectively force subordinated debt positions to extend time under instruments even though the multilayered financing structures had not incorporated such rights on execution.
Australian mega corporate turnarounds are increasingly planned events. The more interesting happen without any formal process and involve bespoke instruments and strategies employed to rebuild brand, encourage engagement, optimise business, and improve balance sheet and cash performance. Those that do involve a formal process generally do so to take advantage of statutory moratoriums, cramdown rights, liability transfer, or other mechanism-based charge.
Increasingly, formal restructures, whether solvent or insolvent in nature, are closely aligned to court-supervised processes, adding certainty and transparency to the restructuring process. While a court process will not always be required, the more complex the balance sheet or the tax affairs of the restructuring entities, or the greater the spread of shareholders or creditors across U.S. and Australian jurisdictions, the more compelling is the story to undertake the restructure with some degree of court supervision and to ensure a controlled outcome.
Which leaves only one final question—what to do with 13,000 hectares of sandalwood?