Due to ongoing liquidity constraints and an explosion of activity in the secondary debt market, financial investors are considering a number of consensual – and where necessary, non-consensual – restructuring options to manage their distressed and non-performing credits.
One such structure is the “loan to own”. Loan to own strategies are used by financial investors seeking to take control of a target by converting debt obligations into an equity stake in the post-restructured entity. The intention is ordinarily to de-lever the company in question, returning it to a position of financial health, then realising value in a subsequent sale of its equity.
If all relevant parties consent, the loan to own strategy may be implemented through a series of contracts between the company, its secured lenders and its key stakeholders. However, in a non-consensual context, secured lenders will generally appoint an insolvency practitioner to control the transaction, or instigate a scheme of arrangement to force dissenting lenders into the proposed transaction.
Implementing loan to own
In order to manage a consensual loan to own process, there are a number of steps that financial investors and insolvency practitioners need to be mindful of. One key element is the introduction of a standstill agreement, usually providing the company with a moratorium against lender actions.
While financial investors in a consensual loan to own transaction should be mindful of the directors’ obligations to prevent insolvent trading, it is the non-consensual approach where the statutory minefield becomes apparent. In this context, secured lenders may choose to appoint an insolvency practitioner – normally a receiver – who is subject to several general law and statutory duties, to effect the restructuring. Such duties include: the receiver’s primary duty to their appointer; agency obligations to the company; duty to act in good faith; and statutory obligations under the Corporations Act 2001.
As agent of the company, the receiver’s principal duty is to gather in and realise the company’s assets, and apply the proceeds to reduce the debt owed to the appointing institution. This duty must be balanced against the statutory duties prescribed in the act, which oblige receivers to exercise their powers and discharge their duties with a degree of care and diligence that a reasonable person would exercise if they were a director or officer of the company; in good faith in the best interests of the company; and for a proper purpose.
A receiver is also prohibited from using their position as officer of the company – or the information obtained in that position – to gain an advantage for themselves or someone else, or to cause detriment to the company. In addition, a receiver must not engage in conduct that is misleading or deceptive, or likely to mislead or deceive.
In a traditional receivership, these duties need to be managed carefully. However, because the objectives of the secured lenders and the company are usually aligned – that is, both aim to seek the most value from realising the company’s assets, the subject of the secured lenders’ security – this balancing act is achievable.
This is in contrast to a loan to own transaction, where the secured lenders who have appointed the receiver may end up being the receiver’s counterparty. In this instance, their objectives may be conflicting. To implement the loan to own transaction, secured lenders will typically seek to effect a transfer of the company and/or its assets to a special purpose vehicle sponsored by the secured lenders. In this situation, receivers must have paramount regard to section 420A of the Corporations Act in order to avoid potential liability and criticism.
Section 420A of the act imposes a duty on receivers when exercising a power of sale. It requires a receiver to take all reasonable care to sell the property in relation to which the receiver is appointed, if it has a market value, at not less than its market value, or otherwise for the best price that is reasonably obtainable, having regard to the circumstances existing when the property is sold.
It is settled law that the focus of section 420A is not on the price ultimately obtained, but on the process the receiver followed to effect the sale. The courts will have regard to the individual circumstances of the case when determining compliance with this duty. To date, the courts have been reluctant to impose a prescribed set of principles to which a receiver must adhere, but it is clear from the case law that in a loan to own context and otherwise, a prudent receiver should:
- have a clear understanding of the market value of the property to be sold, which will include being familiar with the market and, if unfamiliar, taking (and following) professional advice from local and experienced agents; obtaining an up to date valuation of the property; investigating potential or actual litigation that could affect the market value of the property;
- investigate all potential and recent bids for the property;
- ensure the receiver is fully informed of any pre-appointment sales processes; and exercise caution if expected or requested to sell the property to a related party.
There is little doubt that the marketplace is changing in relation to financial investors’ options for the management of their non-performing credits. The emergence of an active secondary debt market has meant that the realisation and restructuring strategies of the “original” lenders are being exchanged for the opportunistic and alternative methods of the secondary market players. However, as this market develops, “original” lenders are also steadily embracing this new landscape.
For insolvency practitioners and their respective advisers, the pressure is on to be innovative within the framework of their existing statutory duties. This can only translate to a more sophisticated approach to restructuring, where the ultimate winners will hopefully be the companies themselves, reshaped for a healthy future.
Michael Sheng is a partner at Ashurst in Shanghai, and Timothy Sackar is a partner at Ashurst in Sydney. Ashleigh Kable, a lawyer at Ashurst in Sydney, co-authored this article
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