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, business press had been dominated by reports of Nine Entertainment's potential insolvency. 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 and, in particular, how questions around the appropriate valuation methodology to adopt in the circumstances may have played a part in the standoff.
Nine Entertainment's finance arrangements
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) now control the majority of the senior debt. 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. Ultimately, a concession by the senior lenders offering the junior lenders a reported $100 million equity stake was enough to get a deal done; 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 (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 Corporations Act).
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).
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).
Could the senior lenders get a Scheme approved without junior lender consent?
While it would now seem 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 being novated to the new company. The mezzanine debt remained with the old group on the justification that it was out of the money. Accordingly, the mezzanine lenders were not consulted on 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 and they therefore had an economic interest.
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 creditor's economic interest, are compelling.
In the Australian context, Justice Finkelstein in Re Opes Prime Stockbroking Ltd (2009) 258 ALR 362 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 the above principles would be applied in the context of Nine Entertainment if the junior creditors do 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 not clear, however, what valuation methodology a court will accept and whether, 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.
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