Distressed Investing in Australia

2010 Market Update

 Distressed Debt Supplement
Market Developments
The secondary debt market in Australia has So far as investors are concerned, they tend to
grown substantially over the last 12 months. This be either institutions looking to trade the debt
growth is a result of a number of factors, including to third parties or hedge funds with longer term
falling asset prices, constrained liquidity, pressure horizons.
on bank balance sheets and the emergence of
As financial markets and the Australian economy
demand from well capitalised buyers. Australian
have stabilised over the last six months and
financial institutions are becoming increasingly
the “green shoots” have begun to emerge, well
aware that trading of distressed loans in the
capitalised financial institutions and distressed
market can be a real and rewarding alternative to
investment funds have been analysing an
a more traditional workout strategy. Regulatory
array of investment opportunities presenting
requirements are also encouraging institutions
as a result of depleted asset values, refinance
to carefully compare the cost of holding debt
risk and high gearing ratios. The Government
against trading debt.
and the Reserve Bank are sanguine about
The Australian secondary debt market has not the outlook for 2010. Nevertheless, some
been active in the past due to low levels of commentators remain unconvinced that the
corporate distress and the workout culture that Global Financial Crisis is truly behind us.
historically prevailed in the banks which was
driven by return perceptions and reputational
considerations. The one exception to this rule Legal Developments
tended to be distressed listed corporates with
US private placement issues (rather than bank A Safe Harbour for Directors?
debt), for example, Sons of Gwalia. The Government has recently released a
discussion paper, titled Insolvent Trading: A Safe
However, Australian lenders have started to
Harbour for Reorganisation Attempts Outside
manage their credit risk by at least considering
of External Administration (Discussion Paper).
the option of trading their distressed loans. In
The purpose of the Discussion Paper is to
doing so, a burgeoning secondary debt trading
propose reforms to the insolvent trading laws
market has developed over the last 12 to 18
targeted at increasing the ability of companies
months. This availability of distressed loans
to effect an informal workout.
in the Australian market has given distressed
investment funds opportunities in this market The Discussion Paper proposes three
for the first time. Some of the better known alternatives. Firstly, maintaining the status quo;
examples of Australian credits which have been secondly, modifying the business judgement
traded include Babcock & Brown International rule in the Corporations Act 2001 (Cth) (Act) to
Pty Ltd and PBL Media. provide directors with effective immunity from
insolvent trading liability if certain criteria are met;
In addition to the trading of single credits, a
and thirdly providing directors with a moratorium
number of banks with Australian portfolios have
from insolvent trading liability (subject to a veto
actively considered portfolio trades, including in
right of creditors to end the moratorium), while a
a couple of cases where the banks ran full sale
genuine attempt is made at a corporate rescue.
processes with shortlisted bidders. To date, no
corporate loan portfolio sales have transacted in The Discussion Paper surfaces in the midst
the Australian market as pricing continues to be of concerns that the current insolvent trading
a challenge to closing deals. regime in Australia is stifling genuine workout
attempts by compelling directors to appoint
For the purposes of considering the banking
voluntary administrators. While it remains a
market, it is important to categorise the banks
matter of speculation as to whether either of the
as follows:
reform proposals will in fact be implemented,
• major banks; the Discussion Paper underlines the
Government’s recognition and support for
• regional banks; and
an informal workout culture to preserve value
• international banks. in a company for the benefit of all stakeholders.
Banks in the last two categories are more likely
to actively participate in the secondary debt
market given that they are typically under more
funding pressure than the majors.


The end of Sons of Gwalia
In Sons of Gwalia Ltd v Margaretic (2007)
231 CLR 160 (Sons of Gwalia), the
High Court found that a shareholder’s
claim against a company for a breach
of the continuous disclosure laws or
for misleading and deceptive conduct,
could rank alongside the claims of
unsecured creditors in the event of
the company’s insolvency.
The Government recently announced
its intention to amend the Act to reverse
the effect of the Sons of Gwalia decision.
This is despite the recommendation of
the Corporations and Markets Advisory
Committee last year that the decision in
Sons of Gwalia be allowed to continue
to apply.
In our view, reversing the effect of the
Sons of Gwalia decision is likely to
increase the availability and lower the
cost of unsecured debt finance for
Australian companies. It will also support
the growth of the secondary debt market
in Australia by removing a layer of risk
and uncertainty in the trading of Australian
corporate debt. Finally, the decision
encourages informal workouts and
distressed investment by providing
greater certainty around balance sheets
and lowering transaction costs associated
with managing contingent liabilities.
Third Party Releases –
Lehman Brothers, Opes
Prime and Lift Capital
For many commentators, the collapse of
Lehman Brothers marked the onset of the
Global Financial Crisis. In the aftermath
of the collapse, Lehman Brothers is now
making headlines for different reasons.
In the decision of City of Swan v Lehman
Bros Australia Ltd [2009] FCAFC 130,
the Full Federal Court held that a Deed
of Company Arrangement (DOCA) under
Part 5.3A of the Act which attempted to
alter the rights between creditors and third
parties was invalid. At the time of writing,
the appeal to the High Court is awaiting
judgement and the issue of whether Part
5.3A of the Act is broad enough to apply
to third party releases in the context of
DOCAs will resurface.
In contrast, the Full Federal Court in Fowler
v Lindholm [2009] FCAFC 125 approved a
scheme of arrangement under Part 5.1 of
the Act which provided a release of certain
third parties by the creditors of Opes Prime
Stockbroking. Further, the scheme of
arrangement regarding Lift Capital Partners
and Lift Capital Nominees, which includes
a similar provision, has recently been
approved by the Federal Court (see Lift
Capital Partners Pty Ltd (in liq) (ACN 111
015 500), Re Lift Capital Partners Pty Ltd
(in liq) (No 2) [2010] FCA 84).
These decisions highlight the fact that
schemes of arrangement can provide
greater flexibility than deeds of company
arrangement in certain cases.
“Big Boy” letters
In the context of single credit or portfolio
trading, there has been an emergence
of the use of “Big Boy” letters, which are
essentially, no representation letters to
address information asymmetry between
trading counterparties. The rationale for
Big Boy letters is that, as sophisticated
investors, both the purchaser and
vendor can elect to waive their rights
for equal information in a possible
insider trading context.
From an Australian law perspective,
Big Boy letters do not provide a complete
defence to the liability of insider trading or
misleading and deceptive conduct since
these are statutory obligations that a party
cannot contract out of. However, such
letters can be used as a useful evidentiary
tool, for example to negate any inference
that the purchaser has relied on a vendor’s
representation or that the vendor owes
some duty of care to the purchaser in this
context of the trade.

Tax office response to Myer IPO
In late 2009, the Australian Taxation Office (ATO) took
steps against two TPG Newbridge entities (TPG) to
recover taxes allegedly owing as a result of the sale
of shares in Myer Holdings Limited (Myer) in the initial
public offering (IPO) of Myer in October 2009. TPG
had originally purchased shares in Myer through a
holding structure that included entities located in
the Cayman Islands, Luxembourg and ultimately the
Netherlands. The ATO issued assessments against
the TPG Newbridge entities located in the Cayman
Islands and the Netherlands.
Two subsequently released draft taxation
determinations reflect the ATO’s views on the tax
treatment of the gains arising from the sale of shares
in an Australian company by a private equity investor:
• gains on the sale of shares in an Australian
company by a private equity investor may be
ordinary income and not capital gains (capital gains
of non-residents are generally subject to Australian
tax in only limited circumstances, which would not
have included the Myer IPO) (TD 2009/D18); and
• the insertion of a tax treaty resident entity (eg, the
Netherlands in the TPG/Myer case) may attract the
anti-avoidance provisions in Part IVA of the Tax
Act where obtaining a tax benefit is the dominant
purpose (TD 2009/D17).
The ATO’s views as expressed in the draft taxation
determinations have significant ramifications for
private equity investors with a strategy of investing
into distressed Australian companies with a view to
working out the company and selling it into a trade
sale or IPO. The industry is working with the ATO
and Government to resolve the differences of view
between them.
Contact information
Blake Dawson
James Marshall
Partner, Sydney
Restructuring & Insolvency
T 61 2 9258 6508
james.marshall@blakedawson.com
Goodridge case
In February 2010, Rares J of the Federal Court
handed down a decision in Goodridge v Macquarie
Bank Limited [2010] FCA 67, which related to the
purported transfer of rights and obligations in respect
of a margin loan arrangement. The margin lender
had sold the margin loan book relying on the general
terms of transfer (including rights and obligations)
within the margin loan documents. As unit prices fell,
the transferee of the margin loan made several margin
calls on Mr. Goodridge (Goodridge) (a margin loan
borrower). Goodridge defended his failure to comply
with the margin calls on the basis that the calls were
not properly made in accordance with the terms of the
margin loan documents and that he had not consented
to the transfer of his margin loan to the transferee.
The Court agreed with Goodridge and found, amongst
other things, that:
• no valid novation of rights and obligations took
place as Goodridge’s consent had neither been
sought nor obtained to the purported novation – as
is required to effect a valid novation under law; and
• no valid assignment of rights took place as the
original lender’s obligations under the margin loan
agreement were “so interconnected with its rights”
that they were incapable of separation.
In doing so, it was held that the deemed consent
provision in the margin loan document merely
constituted an agreement to agree with no contractual
effect. The case reaffirmed the long standing principle
that obligations are not capable of assignment.
The decision has implications for the margin lending
industry as well as, potentially, some equitable title
securitisation transactions for lenders who wish to
sell-down rights under loan arrangements where
there are continuing obligations to provide funding
to debtors. However, the case can be distinguished,
for example, to syndicated loan arrangements where
the documents generally contemplate multiple
financiers with an agent appointed to deal with
effecting transfers/novations between existing lenders
and third parties. These types of loan documents
normally provide for a novation by way of transfer or
substitution certificate.
PricewaterhouseCoopers
Michael McCreadie
Partner, Melbourne
Distressed Debt Group
T 61 3 8603 3083
michael.mccreadie@au.pwc.com