Cram down in Australia – does it work?
March 2014 | SPECIAL REPORT: GLOBAL RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
The emergence in recent times of a flourishing secondary debt market in Australia has brought with it sophisticated offshore distressed investors with experience in the more established markets of Europe and North America. In both the UK and US there are mechanisms available for debtors to effect a ‘cram down’ on classes of creditors and equity in certain circumstances. Those investors are usually very interested in understanding whether non-consensual restructurings are available under Australian law. In other words, they want to know whether they can achieve results under Australian restructuring law similar to what they are able to achieve elsewhere.
Recent Australian experience demonstrates that whilst the means by which a cram down can be implemented are not always the same as those available in other jurisdictions, there nonetheless remains an ability to achieve similar outcomes to those obtained elsewhere. This article explores those mechanisms.
The United States Bankruptcy Code allows for a cram down as part of a Chapter 11 restructuring plan where the cram down is ‘fair and equitable’ to each dissenting impaired class of creditors and at least one class of creditors confirms it. For a restructuring plan to be ‘fair and ‘equitable’ it will need to comply with section 1129(b)(2) of the US Bankruptcy Code and a judge must approve the plan.
The United Kingdom’s cram down framework is more limited and focuses on restructurings by way of debtor in possession driven schemes of arrangement. By using a scheme of arrangement, a formal insolvency appointment is avoided and the company is able to continue trading without the stigma or possible goodwill impact that is often attached to a formal insolvency appointment. Part 26 of theCompanies Act 2006 (UK) provides the legislative framework for how a scheme is to be effected. Case law in the UK, such as Re Tea Corporation Ltd  1 Ch 12 and Re MyTravel Group Plc  All ER 385, supports the use of schemes to cram down creditors, both secured and unsecured in appropriate cases. The decision in IMO Car Wash (Re Bluebrook Ltd EWHC 2114 (Ch)) has affirmed that where a creditor has no ‘economic interest’ interest in the company there is no need to consult with or obtain their approval for the reorganisation plan. This is of particular benefit to senior creditors as it makes the approval process easier and more streamlined. Determining whether a class of creditors has an ‘economic interest’ in the business may be difficult and usually will require specialist advice. For instance, in the IMO Car Wash case, PwC was engaged to conduct an extensive review of the business’ creditors prior to the restructure to confirm those who retained an ‘economic interest’ in the business. There is a risk that this analysis could be challenged by affected stakeholders (as occurred in IMO Car Wash, albeit unsuccessfully), which in turn can delay any impending restructure.
Under Australian law, recent case law has confirmed that cram downs are able to be effected in the following ways: (i) through a debtor in possession scheme of arrangement mechanism similar to that in use in the UK; and (ii) through different formal insolvency appointment procedures.
The use of schemes of arrangement in Australia as a restructuring tool has increased considerably over the last five years to the point where the restructure of all major listed and a number of the unlisted distressed entities has been achieved through the use of this process which has a great deal of flexibility. The recent Channel Nine and Centro Group schemes are illustrative examples of complex cram downs undertaken via interdependent creditors’ and members’ schemes of arrangement.
A scheme of arrangement is an arrangement between a company and its members or creditors or a class of them whereby a compromise is reached in respect of existing debt or equity obligations. Schemes have been used to implement debt to equity conversions amongst lenders. Doubts about the ability of an Australian scheme of arrangement to cram down secured creditors to accept equity have recently been resolved by the decision of Re Channel Nine Entertainment Group Ltd (No 1)  FCA 1464 and Nine Entertainment Group Limited, in the matter of Nine Entertainment Group Limited (No 2) FCA 40). This case represents the first time under Australian law that a creditors’ scheme was approved to convert the claims and rights of secured creditors into equity against the objections of the minority class members. Schemes are also the only mechanism available under Australian law to impose non-consensual releases of the claims of creditors against third parties; see Re Fowler v Lindholm; In the matter of Opes Prime Stockbroking Limited (2009) 259 ALR 298.
Under Australian law, for a scheme to be implemented, 75 percent of each class of creditors in terms of value and an overall majority of creditors must approve the arrangement. The Act requires the approval of each class of creditors and then provides a final discretion to the Court to approve the scheme having regard to whether it is fair and reasonable. Whilst schemes have proven popular recently, they do suffer from the correct perception that they are expensive, time consuming and require special majorities across all affected classes. Accordingly, alternative means of achieving the same outcome are usually explored by restructuring advisers in Australia. Typically this involves an assessment of the formal insolvency options.
Under Australian law, secured creditors retain a virtually unfettered right to appoint a receiver to undertake a sale of the secured assets. A receivership initiated by a secured creditor, pursuant to which a receiver implements a ‘pre-pack’ sale of the business or its significant assets to a vehicle funded by the secured creditors (i.e., a credit bid) may provide a vehicle by which a cram down can be effected by the relevant secured creditor more cheaply and easily than through a scheme of arrangement.
Typically in Australia, a receiver sale effects an automatic release of mezzanine debt through the operation of the intercreditor arrangements. Accordingly, the consent of mezzanine creditors does not need to be sought to the sale.
A receiver appointed by the secured creditor enjoys broad powers to facilitate the realisation of the assets of the company in payment of the secured debt. In realising the assets the subject of the security, a receiver is subject to the duties laid out in section 420A of the Corporations Act 2001 (Aus) (Act). In substance, section 420A of the Act requires a receiver to realise the assets of the company at ‘market value’ or, if there is no market value for the relevant assets, at a value ‘reasonably obtainable, having regard to the circumstances existing when the property is sold’. Case law considering this obligation has held that some form of ‘testing’ of the market by the receiver is generally required, usually by way of public auction. To the extent that the sale does not meet the requirements of section 420A of the Act, a disaffected creditor may approach the court to obtain an injunction to prevent the pre-pack being effected, or may subsequently bring a claim against the receiver for any loss. Accordingly, when contemplating a restructure through a receivership sale and credit bid process, care must be taken to ensure that a market price is obtained. The receiver must therefore either undertake a fresh sale process or rely upon a recent sale process undertaken by the company (‘go to market’ clauses are common in Australia and can establish a valuation which can then inform the restructuring).
Whilst the process can only effect a cram down of unsecured debts and claims, the voluntary administration procedure under Part 5.3A of the Act is widely used in Australia to effect compromises of such claims. Voluntary administration can be commenced by a resolution of the board of directors or by a secured creditor with a security interest over the whole, or substantially the whole, of the assets of the company. The company may seek to effect a cram down of unsecured debts by proposing a Deed of Company Arrangement (DOCA) which offers a compromise to ordinary unsecured creditors. If the DOCA is accepted by creditors, the claims of the ordinary unsecured creditors against the company will be extinguished, often in exchange for a right to claim against a fund established by the DOCA. A DOCA will be approved if at the second meeting of creditors, a majority of creditors in value and number vote in favour of the DOCA. All unsecured creditors and secured creditors can vote their claims and there is no requirement to create different classes of creditors. If the vote is split between value and number, the voluntary administrator can exercise a casting vote to resolve the split. Further, there remains an ability for disaffected creditors to challenge a DOCA on certain limited grounds including that they would have received a greater return on a liquidation of the company.
Both the scheme of arrangement and voluntary administration procedures provide a great deal of flexibility for cramming down the rights of equity. In the case of schemes of arrangement, in most cases, a simple majority resolution of shareholders will be required to support a debt for equity restructure by creditors. However, in the case of voluntary administrations, the administrator has both the power to ‘flood’ the existing equity, or confiscate their shares in support of a restructure by way of DOCA provided that the Court approves such an outcome having regard to whether it is unfairly prejudicial to the interests of members.
As can be seen from the analysis above, Australian law does present a variety of means to achieve a cram down of secured and unsecured debt and also equity. There is every confidence to expect that whilst the tools may be different, the restructuring outcomes achievable in Australia will be similar to those achievable in the UK and US. Sophisticated offshore distressed investors will accordingly see Australia as a place where they can do business.
James Marshall is a partner, and Tom McDonald and Jakeob Brown are laywers, at Ashurst. Mr Marshall can be contacted on +61 2 9258 6508 or by email: firstname.lastname@example.org.
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James Marshall, Tom McDonald and Jakeob Brown