18 October 2012
On 17 October 2012, Nine Entertainment announced that it had reached an agreement with representatives of its senior and junior lenders with respect to a restructuring of its financing arrangements. Prior to the announcement, recent business press had been dominated by reports of Nine Entertainment's potential insolvency.
From the information at hand it appears that, but for the agreement of the three major stakeholders (senior lenders, junior lenders and the company itself), an insolvency appointment would have been the likely outcome. Given the protracted negotiations, it is timely to consider what influenced the parties' decision-making, as well as what might have occurred if the parties failed to reach an agreement.
Over the past few years, Nine Entertainment's original financiers sold their debt to hedge funds. Oaktree Capital and Apollo Global Management (both international hedge funds) are now calling the shots on behalf of the senior lenders.
The junior (or mezzanine) lenders are led by Goldman Sachs.
It was reported that recent negotiations reached a stalemate as the senior lenders refused to agree to a restructure that would allow the junior lenders to share in the equity of the company as part of a proposed debt for equity swap. The senior lenders argued that as the junior debt was out of the money (on the seniors' valuations) they had no right to share in the equity. The junior lenders disagreed and were willing to accept a proposal brokered with the company's owners (CVC Asia Pacific) allowing them to take a $150 million equity stake as part of the debt for equity swap (the face value of the junior debt is $1 billion).
Ultimately, a concession by the senior lenders offering the junior lenders a reported $100 million equity stake was enough to get a deal done. It now seems that the restructure will be effected through a Scheme of Arrangement.
Given their debt ranks first, there was little doubt that the senior lenders were in a superior bargaining position. Despite this, according to the reports, the junior lenders did have some leverage based on an assumption that, as part of any Scheme required to effect the restructure, junior lender consent would be required. It would seem likely that the junior lenders' position was backed by valuations of the company obtained by them, providing that the value of the company breaks in the mezzanine debt (ie. their debt is in the money).
Implementation of a scheme of arrangement
A Scheme is a procedure under the Corporations Act 2001 (Cth) allowing a company to come to a binding arrangement with its creditors, members or both in order to implement a restructure of the company. It is a court-driven process requiring court approval at two stages.
The most recent high-profile creditors' Scheme was the restructure of the Centro Group.
Under a creditors' Scheme, the company's obligations to creditors are deferred, rearranged or extinguished pursuant to the terms of the Scheme. A feature is that, if approved, the Scheme is binding on all relevant creditors even if individual creditors vote against the proposal.
There are various steps required in order to implement a Scheme as set out in section 411 of the Act. These can be summarised as follows:
1. A proposal must be developed and an explanatory statement prepared. At this point the applicant must assign creditors into particular classes.
2. An application is made to court for an order convening the meetings of creditors to consider the Scheme.
3. Once the necessary majority of creditors have approved the Scheme (in each relevant class) an application is made to court to approve the Scheme (section 411(6) of the Act).
4. The Scheme becomes binding on all parties to it when the court orders the Scheme be approved (section 411(4) of the Act).
Implicit in the approval process of a Scheme, is the requirement that a special resolution in favour of the Scheme is passed by each "class" of creditors of the company (see sections 411(1) and 411(4) of the Act). The term "class" is not defined in the Act, however it has been the subject of significant judicial interpretation. It has been held that "we must give such a meaning to the term “class” as will prevent the section being so worked as to result in confiscation and injustice, and that it must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest" (Sovereign Life Assurance Co v Dodd  2 QB 573, 583). Further, in Re Bond Corporation Holdings Ltd (1991) 5 ACSR 304, Justice Owen noted that (at 316):
"[i]n determining classes of creditors, the court must balance the danger of a compromise being forced on dissenting creditors by a majority, against the danger of a minority of creditors having the power to veto the scheme. The court must be satisfied that the result of a meeting is likely to reflect properly the views of the creditors concerned. In approaching its task, the court must identify the legal character of the rights and obligations of the creditors against the company and must assess the way in which those rights and obligations will be affected in the implementation of the scheme. Creditors whose legal rights and obligations (so understood) are so dissimilar to those of other creditors that it would be impossible for them to consult together with a view to their common interest must be treated as a separate class."
More recently Justice Finkelstein in Re Opes Prime Stockbroking Ltd (2009) 258 ALR 362, considered the relevant authorities (including Sovereign) and held (at 380 ) that "there is a distinction between a creditor’s interest and his rights. It is the difference in rights, not interests, that are relevant to determining whether or not separate classes exist, and it is the extent of the difference that will determine whether separate classes are required."
Thus, on the face of the above authorities, senior and junior lenders of Nine Entertainment would be considered to be separate classes of creditors for the purpose of voting on a Scheme.
Based on this assumption, it is likely that a Scheme will require the approval of the junior lenders by special resolution: that is, a majority of the junior lenders who hold at least 75% of the junior debt must vote in favour of it. Without the junior lenders' support for the debt for equity swap the senior lenders would have been required to prove to a court that the junior lenders have no economic interest in the company in order to ensure the Scheme was approved (see below).
What would have happened if the parties could not agree?
If the parties did not reach an agreement regarding the debt for equity swap it would appear that the directors of Nine Entertainment would have had no choice but to appoint an administrator to the company pursuant to section 436A of the Act given the looming debt maturity. An appointment would have been made by the directors of the company in order to potentially shield them from trading the company while insolvent and therefore minimise the risk of personal liability under section 588G of the Act. If the directors had gone down that path it would likely have prompted the senior lenders to appoint a receiver.
Alternatively, the secured lenders could have stuck to their guns, rolled the dice and attempted to get a Scheme up in spite of the junior lenders' protestations.
There would have been scope for the senior lenders to try and effect a restructure through a deed of company arrangement (DOCA). The junior creditors (as secured creditors) would, however, only be bound by a DOCA if they voted in favour of it. If the DOCA offered no upside for the junior lenders, it can be assumed that they would not have voted in favour of it, meaning their debt in the company would not have been extinguished and would remain attached to the company even after it came out of the DOCA.
That said, there is often scope in well drafted intercreditor agreements for a majority of creditors to approve the release of security as part of an enforcement. In circumstances where it is reported that Oaktree Capital and Apollo Global Management and Goldman Sachs control 75% and 80% of the senior and junior debt respectively, they could have conceivably approved a release of security so as to allow a DOCA to be utilised to compromise the senior and junior's rights.
Could the senior lenders get a Scheme approved without junior lender consent?
Much has been said regarding the destruction of value that may have stemmed from the insolvency and/or forced sale of Nine Entertainment. Further, questions have been asked regarding the ability of Nine Entertainment to maintain certain contracts (including lucrative sporting broadcast rights) which could be susceptible to termination upon insolvency. Accordingly, a Scheme appears to be a viable option (assuming it will not trigger termination rights).
While it is apparent that that the junior lenders will support a Scheme, it is arguable that a Scheme could get up without junior lender approval, if the senior lenders are able to convince a court that the junior lenders' debt is out of the money.
In re Tea Corporation Ltd  1 Ch 12 held that the dissent of ordinary shareholders would not stop a Scheme being sanctioned because although those shareholders had a technical interest as shareholders, they had no "economic interest" in the company, because the assets were insufficient to generate a return to them in the liquidation of the company.
This reasoning has been followed in subsequent UK and Australian cases.
Obiter comments by the UK High Court in In re MyTravel Group Plc  EWHC 2741 (Ch) made reference to a "notional" winding up as the basis for assessing the economic interest and therefore the right of certain creditors to be consulted in relation to a Scheme. In MyTravel this involved one group of creditors (bondholders) being excluded from the voting process of a Scheme altogether as they stood to receive nothing if the alternative to the scheme occurred: a winding up.
In the matter of Bluebrook Ltd and others  EWJC 2114 (Ch) (IMO Car Wash) considered the rights of senior and mezzanine lenders with respect to Schemes involving the IMO Group. The Schemes involved transferring the assets of the group to a new company with some of the senior debt novated across. The mezzanine debt was to remain with the old group on the justification that it was out of the money. Accordingly, the mezzanine lenders were not required to be party to the Schemes as their legal rights were not impacted by the Schemes.
The mezzanine lenders challenged the Schemes on the basis of unfairness; that is, on their valuations, value broke within the mezzanine debt so that they did have an economic interest.
After an assessment of the valuations put forward by the senior and mezzanine lenders, the court accepted the senior lenders' valuation (which valued the company according to its present value on a going concern basis) and found that, given the mezzanine lenders had no economic interest in the group, the overall restructuring (via the Schemes) was not unfair. While IMO Car Wash did not consider a situation where a class of creditors voted against a Scheme, the principles enunciated by it, particularly as regards a party's economic interest, are compelling.
In the Australian context, Justice Finkelstein in Opes cited Tea Corporation in consideration of a restructure involving a Scheme. The restructure involved the transfer of assets and liabilities of several companies to another. It was held that if the restructure affected members of the transferring company by diminishing the value of their interest in the company, their consent to the Scheme would be required. However, because the members had no economic interest in the restructure (given the company was insolvent) such consent was not required.
Following the reasoning of the above cases, junior lenders that wish to challenge any Scheme on the ground of fairness must show that they have an economic interest in the company in order to be successful. Whether that economic interest is to be assessed using a notional winding up as the basis for assessment (as in MyTravel) or through some other valuation method remains to be seen.
Whether or not the above principles would be applied in the context of Nine Entertainment should the junior creditors not consent to a Scheme is yet to be determined. However, if the senior lenders to Nine Entertainment are able to prove that, on their valuations, the junior lenders are out of the money and such valuations are accepted by the court, it is conceivable that a court may approve the Scheme in the absence of junior lender approval on the basis that the junior lenders have no economic interest in the company.
What the protracted negotiations surrounding Nine Entertainment have demonstrated is the importance of an interested party being able to assert they have an economic interest in the company. It is clear that the junior and senior lenders both considered they had an economic interest presumably based on valuations obtained by them. What is not clear, however, is what valuation methodology a court will accept in any future dispute of this kind and whether or not, consistent with the above line of authority, a court will approve a Scheme without the approval of junior lenders who are demonstrably out of the money.
On the second point, what remains to be seen is whether the principles relating to out of the money creditors will be extended from the position in IMO Car Wash. In IMO Car Wash, a challenge to Schemes by out of the money creditors whose legal rights were not affected by the Schemes (and therefore were not required to vote in respect of the Schemes) was disallowed. What has been left open is whether a court will sanction a Scheme where out of the money creditors vote against it based on the principles concerning a party's economic interest in the company.
In any event, the IMO Car Wash judgment is helpful in that Justice Mann took the time to consider the various valuation techniques put forward by the parties to support their positions and took a view as to the appropriate valuation methodology in the circumstances. While the case has been cited in Australia (see Re Centro Properties Ltd  NSWSC 1171 for example) a meaningful consideration of the valuation issues canvassed in the case is yet to occur.
Until there is more clarity around the valuation issues, interested parties will have more scope to delay negotiations and deals, and assert leverage off the back of their own valuations.
While valuations are often subjective, greater certainty around the valuation techniques accepted by courts will enable interested parties to better position themselves in negotiations and potentially minimise the discrepancy between opposing positions. This should assist parties to reach agreements and, hopefully, reduce deals being concluded at the eleventh hour as we saw with Nine Entertainment.
As it currently stands, the face-off between junior and senior lenders was not surprising.
The announced agreement between the relevant parties is a win for Nine Entertainment. However, uncertainty around the appropriate valuation methodology to be adopted remains, potentially hampering future negotiations of this type.