In a substantial recent decision arising from the Arrium liquidation, the Supreme Court of New South Wales considered the materiality of significant future liabilities in assessing the company’s solvency.
The Court’s decision represents an expanded conception of “the commercial realities” available to Arrium as a publicly listed company in managing a significant non-current liability. In particular, the following key takeaway points emerge:
- Assessing whether a company can pay a debt in the future involves a prediction requiring a “high degree of certainty” based upon what was “known or knowable” at the relevant time;
- Courts should avoid looking too far into the future when determining insolvency because there are many unknowns and contingencies when predicting the future;
- It will often be more difficult to assess a company’s solvency if it is necessary to have regard to a future period of years rather than a few months;
- A court is less likely to readily infer that a large and sophisticated corporate group whose working capital is at least partially dependent on non-current borrowings lacks the capacity to rollover, refinance or compromise those liabilities.
To this extent, the judgment appears to further complicate a liquidator’s task (at least with respect to large public companies) in proving insolvency for the purpose of insolvent trading claims or voidable transaction claims where proof of insolvency is a necessary element. Correspondingly, the decision may encourage further entrepreneurial risk-taking by directors and restructuring advisers, including as part of a “safe harbour” corporate restructure.
The Court heard two proceedings brought by two different groups of plaintiffs (the Anchorage Plaintiffs and the BOC Plaintiffs) which had either lent money to the Arrium Group or taken an assignment of a debt from a lender. The judgment is lengthy and considers a range of claims brought by the plaintiffs against Arrium’s officers, including misrepresentation and negligence. One aspect of the proceeding (which is the focus of this article) required the Court to assess Arrium’s solvency at a time approximately 16 months prior to the debt falling due.
The BOC Plaintiffs claimed that by signing a Drawdown Notice or Rollover Notice in respect of a particular facility, various officers of Arrium had represented that Arrium was solvent at the time of the relevant Notice.
The representation concerning solvency was to the effect that Arrium and each of its subsidiaries was solvent at the date of the facility agreement and that at each Drawdown Date it would continue to be able to pay all its debts as and when they became due and payable. The representation was repeated on each Drawdown Date by the terms of the facility agreement.
The Court was required to consider whether Arrium was insolvent between 7 January 2016 (when the first impugned Drawdown Notice was issued) and 16 February 2016 (when the last drawdown was advanced).
Assessing solvency with respect to future liabilities
The Court concluded that an assessment of whether, as at 7 January 2016, Arrium was unable to pay a debt falling due in July 2017 required:
- a prediction based on what was known and knowable as at 7 January 2016;
- a high degree of certainty that insolvency would occur on the basis of the facts known or knowable at the earlier date.
Assessing the question of solvency as at 7 January 2016, Justice Ball noted that:
- Arrium had at least 16 months to deal with the facilities falling due in July 2017;
- according to the half year accounts, Arrium had net assets of $2,328.4 million;
- there was no suggestion that the accounts were defective, nor was there any suggestion that the net assets decreased substantially in January or February 2016; and
- given the time available, it was to be expected that in the normal course of events Arrium would either be able to sell assets (e.g. Mining Consumables) or raise finance on security of those assets in order to repay the facilities falling due in July 2017.
The BOC Plaintiffs’ argument that Arrium would run out of cash in the next few months relied principally on what actually happened (in particular, the fact that Arrium went into voluntary administration on 7 April 2016). However, Justice Ball concluded that all the appointment of administrators proved was the directors’ opinion (as at the date of the appointment resolution) that Arrium was or was likely to become insolvent. That opinion did not establish the position objectively and hindsight could not be used to establish a fact at some earlier point in time.
Likelihood of selling assets
The BOC Plaintiffs also argued that it was unlikely that Arrium would be able to sell Mining Consumables for an acceptable sum before July 2017 and adduced evidence that a deferral of that sale would give rise to certain difficulties, including concerns among Arrium’s suppliers, lenders and customers.
However, the Court concluded that the facts merely illustrated that there was considerable uncertainty concerning Arrium’s future; it did not demonstrate that there was no realistic prospect that Arrium would be able to sell Mining Consumables for an acceptable sum before July 2017.
Possibility of reaching agreement with creditors
As at 16 February 2016, it was apparent that Arrium was not going to achieve an acceptable price for Mining Consumables, leaving three options available to Arrium at that time (including refinancing its debt or pursuing a sale later in 2016 when market conditions were expected to improve). All three options required co-operation from the lenders and the Court determined that at and prior to 16 February 2016, it was reasonable to expect that cooperation would continue.
In this context, the BOC Plaintiffs argued that such a conclusion was inconsistent with authorities confirming that the defendants bore the onus of establishing that a creditor was unwilling to compromise or extend the time for payment of its debt. In rejecting this argument, the Court distinguished those cases as relating to trade creditors who had not agreed to an extension of time but had not in the past taken active steps to insist on payment. In contrast, the relevant debts in this case were not due for approximately 18 months or longer and it remained possible in January and February 2016 (given Arrium’s position as a publicly listed company reliant on borrowings for part of its working capital) that those debts would be rolled over, refinanced or compromised.  Accordingly, the BOC Plaintiffs failed to establish that Arrium was insolvent either in January or February 2016.
Relevantly, the prospects of Arrium’s recapitalisation only became terminal after 16 February 2016, when Arrium’s lenders expressed no confidence in Arrium’s board after Arrium (having already made substantial drawings in January and February 2016) insisted upon a proposal that would see the lenders recover only 60% of the face value of their loans (including the money they had just lent).
The Arrium decision represents a significant enlargement of the scope for company directors and other defendants to insolvency-related litigation to argue either that the company was not insolvent or that it was reasonable for them to expect that the company was solvent. This is particularly so where the company is a large, complex and highly leveraged business with a known ongoing refinancing history.
In an era replete with “gun shy” banks who prefer refinancing to receivership, the Arrium decision is likely to compound the difficulties for liquidators in considering the viability of insolvent trading claims involving complex and sophisticated corporate groups. Conversely, the decision is likely to further encourage restructuring activity featuring a significant incidence of highly leveraged transactions and capital structures.
The plaintiffs have until 14 September 2021 to file an appeal.