Last year we explored the driving factors and possible agendas behind the negotiations surrounding the restructuring of Nine Entertainment's financing arrangements, focusing on the importance of valuation methodologies in the context of asserting an economic interest in a company.
At the time, it was foreshadowed that, as a result of a concession by the senior lenders, a deal would be done for a debt for equity swap that was to be effected through a Scheme of Arrangement. The approval of the Scheme was, it was thought, a forgone conclusion. While the Scheme was ultimately approved in late January, not every creditor was satisfied and the Court applications required to approve the Scheme provided the dissatisfied creditors with a chance to be heard.
First Court hearing
On 17 December 2012, Justice Jacobson of the Federal Court of Australia (in NSW), first heard the application by Nine Entertainment Group Limited to approve the Scheme pursuant to s 411 of the Corporation Act 2001 (Cth). As we suggested in October, the Company sought orders convening meetings of two classes of secured creditors: the senior beneficiaries (Senior Creditors) and the mezzanine or subordinated beneficiaries (Junior Creditors).
Apollo Management LP and Oaktree Capital Management LP formed the bulk of the Senior Creditors (together they held approximately 45 percent of the senior debt through a number of investment funds). In total, however, the Senior Lenders comprised approximately 35 financial institutions; this included 13 financial institutions with whom the Company had entered into interest rate swaps in order to hedge its interest rate exposure (Hedge Counterparties). The Hedge Counterparties ranked equally with other Senior Lenders.
The Junior Creditors comprised six institutions associated with Goldman Sachs who held their interests through 10 separate funds.
The Court indicated that amounts owing to the Senior Creditors and Junior Creditors were approximately $2.5 billion and $1.14 billion respectively. The senior debt was due on 7 February 2013; hence the urgency of the negotiations and Court application. Failure to pay the senior debt by 7 February 2013 would have led to an inevitable insolvency appointment.
Issues with the Scheme proposal
The orders that were sought convening the meetings of creditors were opposed by two groups of Senior Lenders: the "par lenders" (the original senior facility lenders) and the Hedge Counterparties (together the Opponents).
The objection to the Scheme was raised on two grounds:
1. the Scheme was contrary to section 231 of the Act; and
2. the Senior Lenders do not constitute a single class.
Issue 1 – section 231 of the Act
It was submitted that section 411 of the Act did not authorise the approval of a Scheme that contains a provision which is inconsistent with another provision of the Act. Based on Australian Securities Commission v Marlborough Gold Mines Limited  HCA 15; (1993) 177 CLR 485 at 502, this submission was accepted by the Court.
However, the other element of the Opponents' argument on this issue was not as straightforward – the proposition that section 231 of the Act requires the agreement of a person to become a member and section 231 is not subject to an exception found in the express terms of section 411.
It was argued by the Opponents that Re Hunter Resources Limited  FCA 133; (1992) 34 FCR 418 was authority for the proposition that the predecessor to section 231 of the Act required the agreement or assent of a person to become a member of a company.
In this respect, Justice Lockhart in Hunter held that a reduction of capital which had the practical effect of compelling shareholders in the company to become shareholders in a different company, was contrary to the equivalent of section 231. However, Justice Lockhart went on to say that if the company wished to achieve that objective, it should invoke the provisions of the law (as it then stood) concerning Schemes which have special provisions designed to protect the interests of minority shareholders.
Thus, Justice Jacobson interpreted Justice Lockhart's reasoning in Hunter to be that section 411 of the Act can be invoked notwithstanding section 231 requires agreement of a person to become a member. It was, in his eyes, an assumption that was borne out by a long line of authority dating back over 120 years.
Justice Jacobson made reference to authorities suggesting that it would be open to a creditor to renounce the creditors' entitlement to shares and, in particular, the remarks of Justice North in Re Empire Mining Company (1890) 44 Ch D 402 at 410 that the relevant debenture holders "need not take up the shares". However, little turned on this suggestion.
He then went on to make a number of interesting observations regarding Schemes including that the:
"essence of a scheme is that it involves a compromise or arrangement between a company and its creditors or members. A compromise entails the resolution of a dispute. Section 411 confers jurisdiction on the Court to approve it, provided the statutory majorities are achieved. Of course, the effect of the Court’s approval is to bind dissenting creditors or members."
Accordingly, Justice Jacobson held that section 231 must be read subject to section 411 and to "do otherwise would be to emasculate the broad scope of section 411".
The broader implications of the Opponents' submission on this point were not lost on the parties. It was acknowledged that, if accepted, it would exclude from the purview of section 411 not only debt for equity swaps, but also Schemes under which a shareholder exchanges equity in one company for equity in another.
Issue 2 – Classes of creditors
As we foreshadowed in October, the Court reaffirmed that the statement of Lord Justice Bowen in Sovereign Life Assurance Co v Dodd  2 QB 573 at 583, is the appropriate test in order to establish the composition of different classes of creditors. Thus, when grouping creditors into classes, the relevant consideration is 'whether their rights are so dissimilar as to make it impossible for them to consult together with a view to their common interest'.
The Scheme contemplated Apollo and Oaktree having the right to appoint directors to the Company and therefore obtain control of the board. It was argued by the Opponents that this right conferred legal rights upon them that, when compared with the rights conferred on other Senior Lenders, were dissimilar such that they, and the balance of the Senior Lenders (including the Opponents), could not consult together in a single meeting and therefore should not form the one "class" of creditor.
Justice Jacobson disagreed; he did not consider that the interests of Apollo and Oaktree were so different to the other Senior Lenders that it would be impossible for them to consult with each other. He noted that there was nothing that destroyed the Senior Lenders' ability to consult on the terms of corporate governance provided for in the draft constitution. Further, there was nothing that rendered it impossible for the Opponents to consult all of the other Senior Lenders (including Apollo and Oaktree) in one class meeting.
The Scheme meetings were held off the back of the earlier judgment and the Scheme was overwhelmingly approved at the meeting of Senior Creditors (96.61 percent of the Senior Creditors voted in favour and 96.88 percent in value of the debt held by those Senior Creditors voted in favour of the scheme). At the meeting of Junior Creditors, the Scheme was also unanimously approved both in terms of number and value of the debt held.
Second Court hearing
On 29 January 2013 at the second hearing, Justice Jacobson approved the Scheme in relation to the Company.
Interestingly, evidence was given that if Oaktree and Apollo were excluded from the meeting and voted as a separate class, the resolution of the Senior Creditors would nevertheless have been approved by 93.46 percent in value and 96.23 percent of the remaining Senior Creditors present and voting. Thus, even if his Honour had accepted the arguments of the Opponents, it would have made no practical difference to the result.
Unsurprisingly, the Opponents indicated that they no longer opposed the orders approving the Scheme and did not appear at the second hearing.
The recent judgments represent the final steps required in order to effect the debt for equity swap in respect of Nine Entertainment. In the interests of ensuring that Schemes remain an effective way to structure debt for equity swaps, it was encouraging that Justice Jacobson quickly dispensed with the Opponents' arguments relating to the debt for equity conversion. Otherwise, the efficacy of Schemes to effect these types of restructures may have been questioned.
However, it should not be taken for granted that a Scheme will be approved in every instance. Built into section 411 of the Act is the requirement that a Court oversee the Scheme process and inherent in this requirement is the right for a dissenting creditor to be heard (as we saw with the Opponents). Notwithstanding this, the very nature of a Scheme encompasses some sort of compromise and the ratification of the Nine Entertainment Scheme reflects the courts' view that this entails a binding of the minority to the decisions of the majority.
Thus, Justice Jacobson's unwillingness to depart from the interests of the majority in relation to Nine Entertainment should give parties confidence that Schemes remain an effective way to effect debt for equity swaps or transactions of a similar nature. This should encourage debt traders particularly in circumstances where they are able to acquire enough debt to maintain a blocking stake.
While the decisions will give greater confidence to investors that trade in distressed debt with the intention of implementing a loan-to-own strategy, whether the senior non-par participants in this trade stand to make a return on their investment remains to be seen.
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