19 Aug 2010

Acquiring distressed companies

by David Landy

An administrator of a deed of company arrangement has been allowed to sell the company over a shareholder's objections.

The GFC has seen a significant rise in the number of corporate insolvencies.[1]

Many of those insolvencies have been the result of tighter credit, rather than a collapse of the company's business. It's no surprise, therefore, that there is a major appetite for the acquisition of distressed businesses and companies.

This market may benefit from a change made to the Corporations Act just before the GFC hit. The amendment allows an administrator to transfer ownership of a company to a buyer, without having to obtain the agreement of the shareholders.

The WA Supreme Court recently handed down the first ruling on the extent of this power.

Background

When a company collapses and appoints a voluntary administrator, the administrator may be able to recover some value for creditors by putting together a deed of company arrangement to sell off those parts of the company business which may still be viable. Sometimes, the entire business may have a willing buyer. For a variety of reasons, that buyer may prefer to acquire the company intact, rather than take a transfer of its assets.

Of course, acquiring the company means acquiring 100% ownership of its shares. Deed administrators' powers are very wide but, around the end of the 1990s, Courts ruled that they did not extend to stripping shares from existing shareholders without their consent.

One possible solution was used in the aftermath of the Pasminco collapse in 2001. The company's banks were willing to do a debt for equity swap. The administrators of Pasminco proposed to do this by a massive share issue to the banks which would dilute existing shareholders to well under 5% of the company. This proposal was greenlighted by the Takeovers Panel.[2]

A dilutionary issue was particularly suited to the circumstances of Pasminco, because there were a number of creditor banks which would assume majority ownership of the company. It would not be particularly attractive to a buyer who was unwilling to share ownership with other creditors or the existing shareholders.

As a result, section 444GA was inserted into the Corporations Act. This allows a deed administrator to transfer a shareholder's shares to another person if the shareholder consents or the court approves the transfer. In other words, the court can override dissenting shareholders' objections.

It is not known how many times deed administrators have exercised this power with the consent of shareholders (although it's not likely to have been often, if at all). The alternative route - an application to the court - received its first outing in May.

The Court's ruling shows that dissenting shareholders may face an uphill battle when opposing a section 444GA application.

Recapitalisation proposal

Midwest Vanadium became insolvent and appointed voluntary administrators. The administrators put together a holding deed of company arrangement (to keep the company in operation while the administrators worked out what to do with it).

The deed administrators found a buyer for the company who would recapitalise the company. The buyer wanted 100% control, so the deed administrators asked all the shareholders to agree to have their shares transferred to the buyer.

One shareholder would not agree to the transfer. The deed administrators then asked the court for approval under section 444GA.

Unfair prejudice

Under section 444GA, the court can only approve a compulsory transfer if it would not "unfairly prejudice the interests of members of the company".

This being the first reported application under section 444GA, the court set down the principles to be applied when determining whether the compulsory transfer of shares would "unfairly prejudice the interests of members of the company":

  • is there any residual equity in the company of which it would be prejudicial to derive existing shareholders?
  • where only one shareholder is holding out, the Court can attach significance to the fact that everyone else has agreed to the transfer;
  • the unfairness of any prejudice is to be assessed by reference to "the scheme of Pt 5.3A [of the Corporations Act], the interests of the other creditors, the company and the public generally";
  • if a company is so insolvent that the members would receive nothing on a winding up, then transfer of their shares does not prejudice them, let alone "unfairly" prejudice them.

Applying the principles

The deed administrators argued that, since the shares were worthless, their transfer could not prejudice the objecting shareholder. The shareholder's response was that the buyer's demand for 100% ownership did not tally with a view that the shares (ie, the company) were worthless.

The Court said that the buyer wanted 100% control to ensure that there were no free-riders on the benefits of recapitalisation:

"The recapitalisation, in order to be undertaken, would require the provision of a benefit to flow to the investor who takes the risk involved in injecting further capital into a project that has already revealed the risks of such a course. It would be extremely unlikely for an investor to take that risk on the basis that existing shareholders (whose risks of ownership and investment have already materialised and resulted in the loss of all value) could receive some free-carried benefit from further investment in which they take no risk."

The shareholder also raised objections based on its interests as a creditor and commercial partner of the company. The Court said that these were irrelevant: section 444GA only looks at the interests of members as members.

Comment

This decision will not result in a flood of compulsory share transfers by deed administrators: in most cases, voluntary administration is simply the scenic route to liquidation, rather than a path to corporate salvation.

Nevertheless, the Court's restricted interpretation of "unfairly prejudice the interests of members" may encourage more administrators to explore the possibility of selling the company in one line, rather than breaking it up.

One matter which the decision does not address is the possibility of the company's being subject to the takeovers provisions in Chapter 6 of the Corporations Act (ie. a listed company or an unlisted company with more than 50 members). Even if they were able to get Court approval under section 444GA, administrators would not be able to transfer ownership of such a company without an exemption from section 606 or a modification of section 611.

In the Pasminco case, none of the banks would have individually emerged with ownership of more than 20% of the company, but their participation in the rescue would have given each of them a relevant interest in the other shares, so that they would, in legal terms, each have acquired a relevant interest of more than 95% in the company. The Panel's comments when it allowed this arrangement to proceed are quite ambiguous. They do not give a clear indication of the Panel's likely attitude if, instead of a "technical" 95%, a successful buyer were to emerge with 100% ownership of all voting shares


[1] Although precise figures are not available, ASIC's monthly insolvency statistics suggest that corporate insolvencies are at least 10% higher than immediately before the GFC hit.Back to article

[2] Over the objections of existing shareholders and, extremely unusually, of one of the three Panel members who heard the matter: Pasminco Ltd [2002] ATP 06.Back to article

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.