The European Lawyer

Australia Banking/Finance

10 Mar 2010

International Acquisition Finance - Australia

Editors: Allens Arthur Robinson - Simon Lynch

1. MARKET
The large international private equity funds, including Kohlberg Kravis Roberts (KKR), TPG Capital, Affinity Equity Partners, CCMP Capital Asia, Carlyle and CVC Asia Pacific, were active in the Australian market before the advent of the global credit crisis. There are a number of Australian funds as well including Pacific Equity Partners, Ironbridge, Archer Capital, Allco and CHAMP.

The investment banks participating in this market both as underwriters and advisors include Credit Suisse, UBS and Goldman Sachs JB Were. A number of foreign and domestic banks compete with the investment banks in debt underwritings and LBO facilities.

Unlike the situation in Europe, the secondary market with respect to debt facilities has been dominated by banking institutions. It was only just before the credit crunch that hedge and other specialist funds started to take up participations in Australian senior and subordinated facilities, but this has stopped as a result of current market turbulence.

Australia’s first billion dollar plus private equity deal occurred in 2006 when TPG acquired the Myer retail business from Coles. This was followed by KKR’s first acquisition in Australia of the Brambles Cleanaway and Industrial Services business for A$1.8 billion. A KKR-led consortium also unsuccessfully bid A$17.5 billion to acquire the Coles retail empire. Another spectacular, but equally unsuccessful, attempted acquisition of an Australian asset was led by a consortium of international private equity players wanting to takeover Qantas, Australia’s national airline, for over A$11 billion.

Industries which have been the target of private equity plays include retail chains (Coles, Myer, Colorado, JB Hi Fi, Rebel Sport, Flight Centre), media, entertainment and publishing (APN News & Media, Hoyts, PBL, Seven Network), industrials (Pilkington Australia, Brambles), care and health services (DCA, Symbion). It is likely that Australia’s booming resources sector will also attract the attention of various funds and other players. However, leveraged acquisition activity has been depressed for all of 2008 and is likely to remain subdued for some time.

2. DOCUMENTATION
Loan and security documentation is typically expressed to be subject to the laws of one of the Australian States. Australia, like the United States, is a federal political system; so just as US documentation is expressed to be governed by say the New York law, Australian documentation is often expressed to be governed by the law of Australia’s principal State, New South Wales. On occasion, the law of the State of Victoria is chosen as the governing law.

There are no relevant material differences in law between the various Australian jurisdictions and all of them are subject to the same legislation regulating companies.

The LMA’s equivalent in Australia is the Asia Pacific Loan Market Association (or APLMA). The APLMA has produced an Australian equivalent to the LMA standard syndicated facility documentation. That documentation is derived from and closely aligned with the LMA documentation. The Australian version departs from the LMA pro-forma to a limited extent to reflect Australia’s interest withholding tax regime, loan market practice and local laws.

Although the APLMA’s syndicated facility documentation has been in circulation for about five years, the APLMA has not produced an equivalent to the LMA’s leveraged acquisition documentation. Instead, leveraged acquisition documentation is drafted by the underwriters or borrower’s counsel based on their firm’s precedents.

Most acquisition structures are determined by the desired tax and accounting outcomes of the sponsors. However, the sponsors commonly employ a holding company (holdco) and bidding company (bidco) structure. Both companies will be special purpose vehicles, usually incorporated in Australia for the proposed acquisition.

The sponsors will contribute their equity (whether in the form of shares or subordinated shareholder loans) to holdco. Holdco in turn will provide the proceeds of the sponsors’ contribution to bidco to help fund the acquisition.

Consistently with overseas trends, another Australian special purpose company (topco) is sometimes interposed between the sponsors and holdco. The purpose of topco is to facilitate the raising of debt through the issue of payment in kind (PIK) notes which are structurally subordinated to the senior and subordinated or mezzanine debt incurred by bidco.

Bidco will acquire the shares in the target company or enter into an agreement to acquire the assets of the target. Shares in a listed company may be acquired under a takeover offer made by bidco by way of a shareholder approved and court sanctioned scheme of arrangement or, in the case of shares in an unlisted company, private sale.

There is nothing unique about the financing structures in Australian LBO facilities. Senior and mezzanine/shareholder facilities will be provided to bidco. If PIKs are to be issued, they are provided to topco but sometimes have been provided to holdco.

Most facilities are documented during the pre-bid stage by way of mandate or commitment letters with very detailed term sheets appended to them. Occasionally, interim facility agreements have been used and drawn upon to fund the acquisition.

3. REGULATED TARGETS
Change in ownership or control of companies which, because of the nature of their business, are regulated by various governmental bodies at a Federal or State level usually requires governmental approval. Examples of such bodies include casinos, broadcasters and owners of key infrastructure such as airports.

Australia also regulates foreign investment in businesses generally (subject to varying minimum thresholds). The relevant legislation is the Foreign Acquisitions and Takeovers Act (Commonwealth of Australia) (FATA). Where FATA applies to a proposed acquisition, approval must be obtained from the Foreign Investment Review Board (FIRB). Obtaining this approval is generally not difficult. 
There is an exception to the requirement to obtain approval in section 11(5)(a) of FATA for a security interest in favour of lending institutions.

4. LISTED TARGETS
In the context of leveraged acquisitions, a listed target is acquired in one of two ways.
The first way is for bidco to make a takeover offer under Chapter 6 of the Corporations Act 2001 (Commonwealth of Australia) (Corporations Act). In general terms, a person must not acquire voting shares in a listed company without making a takeover offer for all or a specified proportion of the shares in a listed company if the person (together with its associates) as a result of that acquisition would hold more than 20 per cent of the voting shares.

The takeover offer or bid may be either supported by the target’s board or hostile. In the case of the latter, bidco will not be allowed by the target’s board to conduct due diligence on the target.
The consideration for the shares the subject of the takeover bid may be cash, scrip or a combination of cash and scrip.

The takeover offer will remain open for acceptance for a period specified in the offer document (the period must comply with the Corporations Act and may be extended in certain circumstances). The takeover offer may also be subject to specified conditions which are not prohibited under the Corporations Act. Those conditions may include an insolvency event or a material adverse change in the business condition of the target not having occurred. They will also typically include a minimum acceptance condition (ie, a condition requiring the bidder to have received a minimum number of acceptances with respect to the shares in the target). The minimum level is usually initially set at 90 per cent which is the minimum number of acceptances required for the bidder to use the compulsory acquisition procedures under the Corporations Act to mop up minority shareholders who have not accepted the offer. Frequently, however, this minimum acceptance condition is reduced to just over 50 per cent during the course of the takeover.

In Australia, there is no legal requirement for a bidder to have debt facilities available to it on a certain funds basis (unlike the situation in the UK). However, the Corporations Act prohibits persons from making takeover offers if they know they are unable, or have been reckless as to whether they will be able, to complete the offer. The Takeovers Panel has issued a guidance note explaining the effect of this provision in the context of financing a bid. Essentially, the Takeovers Panel expects that a bidder will have, at the time of announcing its takeover offer, binding commitments from its debt underwriters. Nor should a bidder declare its bid unconditional unless it is highly confident that it will be able to draw down under the debt facility (ie, all conditions precedent which are not within its control should have been satisfied).

The Takeovers Panel has stated in its guidance note that if the debt facility contains material conditions precedent (eg, a material adverse change clause), these should be set out in the takeover offer documentation so that the market is aware of them. In other words, such conditions are permissible but should be disclosed so that shareholders in the target can make an informed decision whether to accept the offer for the shares.

Although, as a matter of law, there is no requirement for the debt facilities to be subject to certain funds provisions, variations of such clauses have been used in takeover financings. The typical provision will provide that the material adverse change condition precedent will be suspended for a period commencing at such time as the bidder declares the bid to be unconditional.

The Takeovers Panel has the power under the Corporations Act to review the conditions of a takeover offer and to determine whether the financing arrangements comply with its guidance note. If the Panel determines that they do not, the Panel may effectively stop the takeover offer from continuing.
Generally, once a bidder holds more than 90 per cent of the voting shares in the target and at least 75 per cent of the shares the subject of the takeover offer, the bidder can proceed to compulsorily acquire the remaining shares under the Corporations Act. Once it has acquired all the shares in the target, the target and its wholly owned subsidiaries will be able to pass financial assistance whitewash resolutions (see below) and, shortly after they have done so, guarantee the acquisition facility and give encumbrances over their assets securing that facility. However, as alluded to previously, it is common for bidders to reduce the minimum acceptance condition from 90 per cent to just over 50 per cent in order to encourage shareholders to accept the offer. But the risk with this strategy is that the hoped for rush of acceptances does not materialise or a third party acquires a blocking stake of more than 10 per cent so that the bidder is left holding less than 90 per cent of the target shares. In those circumstances, the target and its subsidiaries will be unable to implement the financial assistance whitewash procedure, with the consequence that the lenders under the acquisition facility will be left holding only the security over the shares held by bidco in the target.

Another means by which listed targets are acquired is the scheme of arrangement. Chapter 5 of the Corporations Act permits a court sanctioned and shareholder approved transfer of shares in a company (listed or unlisted) to a bidder. The procedure involves the production of a scheme booklet explaining the arrangement, its effect on the shareholders and any other information that is material to the decision of the shareholders whether to approve the scheme. Having regard to the booklet and whether the corporate regulator, the Australian Securities Investment Commission (or ASIC), has any objection to the scheme, the court will decide whether to allow the booklet to be issued to shareholders in the target and for a meeting of shareholders in the target to be convened for the purpose of voting on the scheme. The scheme requires the approval of at least 75 per cent of the votes cast at the shareholders’ meeting and of a majority in number of shareholders present and voting at the meeting. If the shareholder approval is so obtained, the matter returns to court for final orders approving the scheme. This second order is more a rubber stamping procedure than a substantive hearing. The order is then lodged with ASIC and the transfer of shares will occur usually several days later.
The scheme route will only be available if the target’s directors are in favour of it. If they are, bidco and its advisers will usually be able to conduct due diligence on the target.

There is no statutory requirement for certainty of funding with respect to a scheme. However, there is an expectation that the court may require that there be no remaining conditions precedent to be satisfied by the time of the second court hearing. In any event, as a practical matter, sponsors require their debt underwriters to execute mandate letters containing certain funds provisions in order to help win the target board’s approval to the scheme. These letters are typically issued shortly before the target’s board of directors decide whether to support the scheme proposal. Months often follow the board meeting before the second court hearing with the result that the certain funds period may be lengthy.

5. MEZZANINE DEBT AND INTERCREDITOR ARRANGEMENTS
In the early days of LBO financings in Australia, subordinated facilities were subjected to very onerous intercreditor terms favouring senior debt. However, in recent times the market has witnessed a relaxation of these as Australian intercreditor arrangements increasingly resemble European style intercreditor arrangements.

The introduction of PIK facilities in Australia has been relatively recent (and, in the current market, short lived). Again, the terms applicable to PIKs follow the European market.

6. EQUITY KICKERS
Equity kickers have rarely, if ever, featured in Australian LBOs.

7. SECURITY
The most common form of security in Australia is the fixed and floating charge. This form of security operates essentially in the same way as its English equivalent. Accordingly, charges can be taken over all the assets of the chargor with no particular difficulties.

Charges created by companies must be registered with ASIC under the Corporations Act. Failure to register may result in the charge being void as against a liquidator or administrator appointed to the company. Registration is also important in order to ensure the priority of the charge over subsequently created or earlier created, unregistered registrable charges. It is possible and necessary for lenders to search ASIC’s register in order to determine whether there are any prior registered charges recorded against the bidder or target.

Although an all assets charge is sufficient to create an effective security interest over such assets, separate mortgages over shares, contractual rights and bank accounts are often taken.
Land (both freehold and leasehold) in Australia is generally subject to the Torrens system of title and registration. Each State and Territory has its own legislation dealing with the transfer and mortgaging of land and the registration of such dealings. However, there are no fundamental differences between them.

Although land is capable of being encumbered under the charge discussed above, the only way to ensure priority over other dealings (including security interests) in land is to take a separate mortgage specifically over the land and to register that mortgage with the applicable State or Territory land registry.

As is the case with the charges register maintained by ASIC, searches of the relevant land registries should be undertaken by the lenders to ascertain whether there are any registered prior ranking dealings affecting the land.

It should be noted that the Australian government is likely to introduce a new securities regime similar to that in the United States, Canada and New Zealand.

Upstream and downstream guarantees are commonly taken in Australia. With the exception of the financial assistance prohibition (discussed below), the main legal issue with guarantees and other third party securities is whether, in deciding to approve the giving of such security, the directors of the company giving the security have performed their duty to act in the company’s best interests (discussed further below).

In the case of downstream guarantees, if the guarantor is solvent, it is not difficult for directors of a company to conclude that a guarantee of the debts of the company’s subsidiaries is in the company’s best interests. It becomes more difficult for the directors of the subsidiaries to reach that conclusion with respect to guarantees from the subsidiaries of their parent’s or each other’s debts. However, it is generally accepted in the case of a solvent group comprising a parent and its wholly owned subsidiaries, that upstream and sidestream guarantees will benefit each subsidiary company.

Another issue with respect to charges and mortgages in several Australian jurisdictions is stamp duty. Up until recently, each Australian State imposed ad valorem mortgage duty on charges and mortgages directly or indirectly securing borrowings. Mortgage duty has been abolished in several States and is being phased out in the other States which still have it. At the time of writing, the States of New South Wales and South Australia still impose mortgage duty, but at differing rates. The highest rate is 0.4 per cent which is charged in New South Wales. For example, if a charge is taken over assets in New South Wales securing advances totalling A$100 million, the duty payable would be about A$400,000.
Although stamp duty is always for the borrower’s account, lenders are nonetheless concerned to ensure that it is paid because, if it is not paid, the charge or mortgage will be unenforceable.

8. CORPORATE THIN CAPITALISATION RULES
Where a company is thinly capped, Division 820 of the Income Tax Assessment Act 1997 (the 1997 Act) will apply to deny debt deductions (which includes interest) to the extent that certain debt to equity ratios are exceeded.

A range of ratios apply and depend on which category stipulated in Division 820 that the entity falls in. Safe harbour debt amounts apply in relation to all categories.

For non-financial institutions, the permissible safe harbour debt ratio is 3:4 (or debt cannot exceed 75 per cent of the entity’s average value of assets. Excess debt capacity of certain associated entities can be taken into account for these purposes. Within a tax consolidated group, the debt capacity of all entities in the group is taken into account).

For financial institutions, the permissible safe harbour debt ratio in most cases is the lesser of 20:1 (after excluding assets which can be fully funded) or 3:1 (after excluding debt which is on-lent to third parties).

In determining an entity’s asset value for the purpose of applying the safe harbour debt amount, assets and non-debt liabilities which are wholly or principally for private purposes are excluded.

The thin capitalisation rules do not apply where debt deductions are less than $250,000, the entity’s operations are confined wholly outside Australia or, if the entity is not subject to foreign control, confined wholly within Australia, or the entity is an exempt bona-fide securitisation vehicle.

The thin capitalisation rules provide a cap on the extent to which debt deductions are allowable deductions of an Australian entity in specified circumstances.

Debt deductions arise from debt interests. A debt interest must satisfy the tests in Division 974 of the 1997 .00 (the Debt Equity Rules). The Debt Equity Rules classify interests as either debt or equity for, among other things, the purposes of the thin capitalisation rules.

In summary, a ‘debt interest’ is one where an entity receives a financial benefit (ie the advance of loan moneys) and has an ‘effectively non-contingent obligation’ to provide a financial benefit (ie principal repayment and interest payments) after the receipt of the initial financial benefit of at least equal value to that of the benefit received. Different valuation rates apply depending on the term of the instrument.
In contrast, an equity interest is, among other things, an interest which carries a right of return which is contingent on the economic performance of the company (eg where the company has profits) or is contingent on the company exercising its discretion to pay a return.

The loans made by foreign lenders will generally need to satisfy the debt test for interest payments to be an allowable income tax deduction to the borrower subject to the cap on deductions imposed by the thin capitalisation rules.

Another tax which offshore lenders and sponsors need to be aware of is Australian interest withholding tax. This is a tax imposed on payments of interest (which is broadly defined in the relevant tax legislation) by an Australian resident borrower or non resident operating through an Australian permanent establishment to:

• a non-resident lender not operating through a permanent establishment here; or
• an Australian resident operating through an offshore permanent establishment.

The interest withholding tax rate is 10 per cent. Although the tax is a liability imposed on the recipient of the interest payment, the borrower is obliged under the relevant tax legislation to withhold the tax from the interest payments and to remit it to the Australian Taxation Office (or ATO). The ATO is the governmental body which administers Australia’s federal tax system and collects income and other taxes.

There are two relevant exemptions from interest withholding tax. The first is contained in a limited number of double tax treaties between Australian and certain other countries. For instance, the double tax treaty with the United Kingdom exempts from Australian interest withholding tax interest payments to certain UK resident financial institutions. A similar exemption applies under the treaty with the US with respect to interest payments to US resident financial institutions. It should be noted that the UK or US branch of a non UK or US bank would not be entitled to treaty relief.

It is anticipated that the double tax treaties with France and Japan will eventually be  amended to include a similar exemption for French and Japanese resident financial institutions.

However, in the context of syndicated facilities, the most common exception relied upon is contained in section 128F of the Income Tax Assessment Act 1936 (Commonwealth of Australia). That exception is available where invitations or offers to take up loan participations satisfy the ‘public offer test’ under section 128F. Briefly, the test will be met if offers or invitations are made to at least 10 unaffiliated financial institutions (described as the ‘10 offeree method’) or to any number of investors via an electronic service (such as Reuters or Bloombergs) or other media used by the applicable financial markets. The 10 offeree method is the more commonly used of the two. The section also sets out the circumstances in which the exemption can be lost.

9. FINANCIAL ASSISTANCE
If any acquisition (including by subscription) of shares or options or interests in shares is involved in a financing transaction, then section 260A of the Corporations Act needs to be considered.
Section 260A provides that a company may financially assist a person to acquire shares (or options over or interest in shares) in the company or a holding company of the company only if:

•  giving the assistance does not materially prejudice:
   (i)  the interests of the company or its shareholders; or
   (ii) the company’s ability to pay its creditors; or
• the assistance is approved by shareholders in accordance with section 260B of the Corporations Act.

Financial assistance may be given before or after the acquisition of shares and may take the form of a dividend.
Although a transaction which breaches section 260A is not invalid (section 260D), any person involved in the contravention of the provision is guilty of a civil offence.

If there is any concern that the proposed transaction may breach this section, then the safest approach to take is to obtain shareholders’ approval of the transaction, in accordance with the provisions of the Corporations Act. This process should be run by the borrower’s Australian lawyers and a certificate provided by two directors, or a director and secretary, of the relevant entities to the foreign lender confirming the process set out in the Corporations Act has been completed.

Under section 260B(1) of the Corporations Act, shareholder approval of financial assistance by a company must be given by:

• Aa special resolution passed at a general meeting of the company, with no votes being cast in favour of the resolution by the person acquiring the shares (or options over or interests in the shares) or by their associates; or
• a resolution agreed to, at a general meeting, by all ordinary shareholders.

The financial assistance must also be approved by a special resolution of shareholders of the holding company of the target if because of the acquisition:

• the target company becomes a subsidiary of a listed domestic corporation immediately after an acquisition of shares (section 260B(2)); or
• the target company will have a holding company that is an unlisted domestic corporation but that is not itself a subsidiary of a domestic corporation (section 260B(3)). Section 260B also requires notification to ASIC.

Invariably, the financial assistance prohibition is relevant in any LBO involving the acquisition of shares in a target. The LBO financiers will want security from the target and its subsidiaries. It may also be desirable to push down the acquisition debt into the target. In all cases, the whitewash procedure outlined above should be implemented in order for the security to be given or the debt to be pushed down.

Where the sponsor’s bidding company has acquired all of the shares in the target, the whitewash procedure is relatively easy. However, difficulties arise if it has acquired less than all the shares and less than those number of shares necessary for it to be in a position to compulsorily acquire all the shares (generally it will need to hold at least 90 per cent of the shares in order to do that). This is because the section 260B procedure requires the approval of the minority shareholders which have held on to their shares, and their approval is unlikely given they are probably holding out for a better price for their shares or some other favourable treatment. Financiers are therefore left holding debt owing by the bidding company with no assets of value other than the shares it holds in the target.
To alleviate the risks associated with a lack of security and uncertainty of the borrower’s cashflows, financiers may require the bidding company to procure the target to make a capital return to shareholders either by way of a reduction of share capital under Division 1 of Part 2J.1 or a share buy-back under Division 2 of Part 2J.1 of the Corporations Act. In order to fund the capital return, the LBO lenders may agree to underwrite debt facilities which will be provided to the target directly and which will invariably be guaranteed by the target’s subsidiaries and secured over their and the target’s assets. The bidder will be required to apply the proceeds it receives from its share of the capital return in permanent reduction of the acquisition facility outstandings.

Share buy-backs and capital reductions are exempted under section 260C(5) from the financial assistance prohibition in 260A. However, if the target has entered into a facility for the specific purpose of funding the capital return and it and its subsidiaries have given security in support of that facility, consideration should be given as to whether those transactions amount to giving financial assistance.
If they do constitute financial assistance, the question arises whether the borrowing and provision of security satisfy the no material prejudice test in section 260A(1)(a).

10. DIRECTORS’ LIABILITY
Directors of a company owe a number of general law and statutory duties. In particular, they have a fiduciary duty to act in good faith in the best interests of the company. The applicable test established by case law is whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transaction was for the benefit of the company. Breach of a fiduciary duty may lead to a transaction being set aside by the courts.

The classic example in which the directors are put to the test is where a subsidiary company gives a guarantee or security interest in relation to moneys borrowed by its holding company. The guarantee or security will be voidable as against the party receiving the benefit of it if that party knows, or by reason of its connection or relationship with the company ought to know, that the directors have not acted in the best interests of the company in procuring it to give the guarantee or security. Where the guarantee or security is given by the company for the benefit of a related company (as in this example), it is not sufficient to look for a benefit to the group (of which the companies are members) as a whole, as the focus is on what is in the best interests of the company alone.

However, that general law rule has been modified where, for example, a wholly owned subsidiary guarantees its holding company’s debt under section 187 of the Corporations Act: that section provides that, if expressly authorised by the subsidiary’s constitution, and if they are acting in the best interests of the holding company, directors of a solvent wholly owned subsidiary can act in the best interests of its holding company, and be deemed in doing so to have acted in the best interests of the subsidiary.

If the test of commercial benefit will not be satisfied, then a general meeting of the company should be held and for its shareholders to unanimously approve the transaction (after full disclosure including specific acknowledgement that directors would otherwise be in breach). This solution is available because the requirement that the transaction be for the benefit of the company is imposed on the directors, and it appears from case law that a general meeting may prospectively authorise directors to enter into a transaction which may possibly involve a breach by the directors of their fiduciary duty to the company. However, breach of duty by directors of a company cannot be absolved by shareholders if the company is or would be insolvent. Therefore, the approach is, if in doubt, seek shareholders’ consent and obtain a certificate of solvency from the directors of the relevant company.

11. LENDERS’ LIABILITY
In Australia, a lender does not owe a borrower any general law duties simply as a result of the borrower/lender relationship (other than to keep the borrower’s information and details about the banking relationship confidential). There is no duty on the lender to provide a wholesale borrower with advice or to ensure that the borrower has made a prudent decision in entering into the transaction.
However, a lender may incur duties or liability if it is taking on other roles in relation to the acquisition such as providing advice or participating in the acquisition with the borrower.

As mentioned previously, the security given to a lender may be set aside if the lender has participated in a breach by the directors of their duty to act in the relevant company’s best interests.
Criminal and civil liability can attach to a lender and its employees involved in the transaction if they are knowingly involved in a breach of the financial assistance prohibition discussed above (sections 79, 260D(2) and 260D(3) of the Corporations Act).

Security given for, and repayment of loans, can also be set aside under section 588FA of the Corporations Act if the provision of the security or the repayment is given to an existing creditor of an insolvent company within six months before the company’s winding up or administration.

Alternatively, any transaction between a lender and an insolvent company may be set aside if it is entered into within two years before the company’s winding up or administration and is an uncommercial transaction from the company’s perspective (section 588FB of the Corporations Act). A transaction is uncommercial if, and only if, it may be expected that a reasonable person in the company’s position would not have entered into the transaction having regard to the benefits and detriment to the company, and the benefits to the lender of entering into the transaction in question. The lender does not need to be an existing creditor of the company for this section to apply.
Certain defences against having the security, repayment or transaction set aside are available to lenders.

Section 588G of the Corporations Act also imposes liability on a director who allows a company to trade or incur debts while the company is insolvent. The risk for the lender is that it may be regarded as a director under section 9 of the Corporations Act; under that section, ‘director’ is defined as including persons or corporations whose instructions or wishes the directors of the company are accustomed to act in accordance with. Persons falling within that part of the definition of director are commonly described as being ‘shadow directors’.

If a lender is regarded as being a shadow director of an insolvent company, the risk for it is that it may incur liability under section 588G of the Corporations Act if the company continues to trade.
There have been no cases to date where a financial institution has been taken to be shadow director. However, it is common for lenders to become more actively engaged in a borrower’s affairs if the borrower is experiencing financial difficulties. If, in those circumstances, the lender is in effect making decisions for the company, it will run the risk of being treated as a shadow director.

12. LEGAL OPINIONS
Legal opinions given by Australian firms to financiers with respect to LBO facilities do not give rise to any particular issues. Opinions issued by Australian firms say much the same as the typical opinion issued by a major English or US firm.

The practice in Australia is for the lawyers acting for the financiers, and not the sponsors’ lawyers, to issue opinions on the financing documents to the financiers. However, lawyers acting for sponsors are often required to issue opinions on the acquisition documents.

13. POST-ACQUISITION RESTRUCTURING
Prior to the exit by the sponsor by way of trade sale or the acquired business being floated on the stock exchange there is no typical restructuring which occurs with respect to an acquired business. However, we have seen sponsors sell part of the business they have acquired soon after the acquisition.
In those circumstances where a sponsor holds less than all the shares in a target but 90 per cent or more, it is possible for the sponsor to squeeze out the minority shareholders under Part 6A.2 of the Corporations Act. The procedure for doing so is different from that available to a bidder which has acquired at least 90 per cent of the shares in a target under Part 6A.1 of the Corporations Act. For example, if the sponsor uses the Part 6A.2 procedure, it must obtain an independent expert’s report supporting the price it has offered (no expert’s report is required under Part 6A.1). There are other differences between the two procedures.

14. DEBT RESTRUCTURING
Most debt restructuring prior to the appointment of a liquidator or an administrator is conducted out of court. Commonly, distressed borrowers will negotiate with their lenders and major creditors a standstill agreement. The standstill agreement will give the borrower a brief period of relief from an enforcement action while it negotiates with these key creditors more permanent terms of a debt restructuring.
Debt restructuring can also occur via a creditor and court approved creditors’ scheme of arrangement under the Corporations Act.

It is possible for creditors to swap debt owing by a company into shares issued by the company. However, the creditors may be regarded as ‘insiders’ for the purposes of the insider trading prohibition in the Corporations Act.

If a company is insolvent, a court may appoint a liquidator to the company under the Corporations Act. The purpose of the liquidator is to realise the company’s assets and wind up its affairs. It will distribute the money coming into its hands for the benefit of all creditors according to any priorities afforded to them through holding security interests or by law. The liquidator, when appointed, takes control of the company’s assets (other than those over which a security interest has been enforced) and is not subject to creditor control or direction.

Alternatively, the directors of an insolvent company, a liquidator appointed to it or a holder of a security interest over all or substantially all of its assets may appoint an administrator to the company. Like a liquidator, an administrator takes control of the company’s assets (including assets over which security has been enforced unless it has been enforced over all or substantially all of the assets of the company).

Unlike a liquidator, an administrator’s function includes determining whether the company can survive. If the administrator determines that it can, it may recommend to its creditors that the company enter into a deed of company arrangement. The deed may in effect provide for a write-off of part of the debt owing to the creditors. The deed must be approved by a majority of creditors by number and by the creditors holding a majority of the company’s debt.

Australia’s insolvency regimes are uniform throughout the country. Consequently, forum stopping is not usually an issue.

15. ENFORCEMENT OF SECURITY
Unless the guarantee otherwise specifies, a lender may enforce a guarantee directly against a guarantor on default by the debtor by making a demand on the guarantor without proceeding first against the debtor. The guarantee document usually sets out where the demand is to be served, how it is to be served and the circumstances in which the demand is deemed to have been served. If the guarantee documents do not specify a time limit for satisfying a demand under the guarantee, then a demand under a guarantee must be satisfied within a reasonable period.

If such a demand is not satisfied by the guarantor, the following options are available to the lender:

• (in respect of a company guarantor) an application for winding-up under Part 5.4 of the Corporations Act. The normal procedure is for the lender to serve a statutory demand requiring payment within 21 days (section 459E).  Within that 21 day period, the guarantor may apply to the court for an order setting aside that statutory demand (section 459G).  If at the end of the period, the demand is still in effect and the company has not complied with it, the company is taken to have failed to comply with the demand (section 459F). The lender may then apply to the court for a company to be wound up in insolvency relying on the failure by the company to comply with the statutory demand (sections 459P and 459G);
•  (in respect of the individual guarantor) petition for bankruptcy. The lender may petition for the bankruptcy of an individual if he or she does not satisfy his or her guarantee to the lender, but normally the lender would obtain a judgment first.

Assuming the lender is not on notice of the insolvency of the grantor of security and the documents are enforceable, the Australian enforcement procedures in summary are as follows:

• The lender may enforce its security interest over the grantor’s assets that are the subject of the security, including by appointment of a receiver of those assets.  The receiver will be a local registered insolvency practitioner (rarely a lawyer) who can realise the assets and pay money secured by the security.
•  If the assets are the whole, or substantially the whole, of the property of the grantor of the security then the lender may enforce its security interest over the assets. However, if a voluntary administrator is appointed to the grantor of the security (eg, by its directors) the lender must enforce the security within 13 business days (the decision period) after notice of administration of the grantor is given to the lender. This will effectively cause the administration to cease for practical purposes. Voluntary administration is a means for a company in solvency difficulties to in essence achieve a freeze on creditor action in an effort to recover. If the lender does not enforce within the decision period it may be significantly delayed in enforcement of its security but ultimately not prejudiced (as determined by a court).
• If a voluntary administrator is appointed and if the assets secured are not the whole, or substantially the whole, of the property of the grantor of the security or the lender fails to enforce its security within the decision period, then the lender may not enforce its security except with the leave of the court or with the administrator’s written consent while the administration is ongoing. There are time limits for administration which are relatively short (approximately 2-3 months) but which may be extended by the court.

In Australia it is common for the enforcement and priority rights of a first ranking security holder and a second ranking security provider to be governed by a deed of priority.

A deed of priority will typically set out the priority standing of the security holders with respect to the repayment of moneys owing on enforcement of the securities and also determine the rights of the security holders to take enforcement action. It is usual for the first ranking security holder to have priority with respect to any enforcement action taken by it over the second ranking security holder. However, the second ranking security holder is often able to exercise enforcement rights should the first ranking security holder decide not to.

In the absence of a deed of priority, at law any proceeds received on enforcement of security by the second ranking security holder, to the extent that security is over the same assets secured in favour of the first ranking security holder, will be payable in the first instance to the first ranking security holder.