Material adverse change clauses and absolute discretion

A recent Australian case, Brighten Pty v Bank of Western Australia, involved a material adverse change (MAC) clause specifying an event of default if: "In the Lender's opinion there is a material adverse change in the obligor's financial condition".  When a default notice was issued the borrower sought an injunction to prevent the appointment of a receiver.  The court dismissed the application, and commented on MAC clauses that confer an absolute discretion on the lender to assess whether it has been triggered.  By analogy with trustees, the court took the view that the bank's assessment would be valid so long as the decision is not made in bad faith, arbitrarily or capriciously.

Even though such a test is helpful for lenders, caution will still be required when taking enforcement steps based on a MAC event of default.  A lender should turn its mind to the matter and actually form the necessary opinion that an event of default has occurred (rather than a mere possibility), taking into account the specific words of the clause.  This view should be based on information of which the bank has actual knowledge and can rely on as evidence if the decision is later challenged.

See court decision here.

Unsecured creditors: cramming down

A common occurrence in the past 2 years for lenders that have a second or lower ranking security has been the discovery that the security may be worthless and the prior ranking security holder and debtor are either planning to restructure or to sell, leaving lower ranking secured creditors with nothing.  The ability of senior creditors to "cram down" junior parties is often an important component of a successful restructuring.

The English High Court last year considered this issue in the context of a scheme of arrangement that excluded junior lenders.  In Re Bluebrook (also known as the IMO Carwash case) the court confirmed that:

• The scheme arrangement process can be used to cram down junior creditors without their consent, if they have no economic interest in the outcome;
• Current market valuations are appropriate for the assessment of economic interest, even in a depressed market; and
• The onus is on the junior creditors to show that they do have an economic interest, if they wish to avoid being crammed down.

IMO Carwash has not been applied in New Zealand yet, but the broader principle on which the decision was founded is already recognised here and is therefore certain to be applied, in restructurings other than just by schemes of arrangements.

See court decision here.

Application for approval of Part 5 proposal refused

A recent case, Marsh v Commonwealth Bank of Australia, explored the Court's discretion to refuse an application for approval of a proposal to creditors under Part 5 of the Insolvency Act 2006.  The case related to the applications by Messrs Marsh and Perriam, for approval of their respective proposals to creditors for the satisfaction of their debts (which exceeded NZ$150m) by payment of a dividend of less than one cent in the dollar.  The applications were opposed by CBA.  In spite of the fact that both the proposals to creditors had been approved by the requisite majority of creditors (by number and by value), the court refused to approve the proposals.

The court concluded that although the economic result to creditors, if the proposals were approved, might be better than bankruptcy, it would be inexpedient to approve the proposals in this case on the basis that the debtors had demonstrated manifest financial irresponsibility and represented an ongoing risk to the commercial community.  If approved, the proposals might result in the insolvents escaping the normal consequences of their spectacular business failures and this would not be acceptable in terms of the public interest in the integrity of the insolvency regime.  As such, the public interest would be best served by an investigation of the debtors' financial affairs conducted by the Official Assignee.

Postscript:  Messrs Marsh and Perriam filed appeals against the judgment.  They then filed for their own bankruptcies last week.  This will likely bring to an end their appeals against the rejection by the High Court of their proposals.

See court decision here.

Statutory management - associated persons

The recent decision to place into statutory management Allan Hubbard and various unincorporated charitable trusts highlights the limited number of statutory remedies available to take control of "at risk" assets of non-corporates.

Statutory management is the only statutory procedure for seizing and controlling unsecured assets of an individual, other than the receivership process provided for in section 50 of the Insolvency Act 2006.

A recommendation by the Securities Commission that a corporation be placed in statutory management may be made only if the Securities Commission is satisfied on reasonable grounds that (a) the corporation is, or may be, operating fraudulently or recklessly or (b) it is desirable for the Corporations (Investigation and Management) Act 1989 to apply.  The power to declare an "associated person" of a corporation also to be subject to statutory management arises under the Act if the person's affairs are sufficiently closely connected to the corporation.

As a result, statutory management can only be used in very limited circumstances.  However, when it can be used, it is a useful tool for controlling the assets of individuals and unincorporated trusts, as well as companies.

Law firms not immune from recession

Manchester-based law firm Halliwells has recently applied to appoint an administrator.  Halliwells had suffered a difficult 2 years in which profits had fallen significantly, dozens of partners had departed and its levels of debt had increased.  Royal Bank of Scotland recently took security over all of the firm's assets.

The appointment of an administrator would trigger a moratorium on Halliwells' liabilities, creating a chance for the firm to negotiate its future.  Two other firms are said to be interested in acquiring parts of its practice.  Once any sale is completed, the administrator is expected to be appointed.

This is believed to be one of the first occasions on which insolvency administrators have been appointed to a law firm.

No escaping a guarantee

Matrix Custodian v Cotton and Ors involved a claim by a lender against guarantors of a failed development company.  The summary judgment application was only opposed by one of the 3 defendants, (D).  The grounds of opposition put forward by D included non est factum (it is not my deed) and undue influence, both of which were rejected on the facts in relatively short order.  The majority of the judgment was dedicated to considering a defence related to the release of co-guarantors.

The other 2 defendants, as insolvents, had lodged proposals to creditors under the Insolvency Act 2006.  The proposals were accepted by a sufficient majority of creditors.  D argued that the proposal was binding on the plaintiff and the result was that the co-guarantors were effectively released from their guarantees.  D relied on the equitable principle that release of one or more joint and several guarantors is a release of them all.

The court had little difficulty in rejecting D's defence.  The guarantee in question expressly provided that the release of one guarantor would not release others.  The court reaffirmed the effectiveness of such express exclusionary terms.  The court also affirmed the effectiveness of a principle debtor clause, by which D was deemed to be liable as a principal debtor and not merely a surety.  All comprehensively drafted guarantees will exclude the application of equitable defences and provide for the guarantor to be deemed to be a principal debtor, making it exceptionally difficult for guarantors to avoid liability.

See court decision here.

Administrator's use of casting vote to approve DOCA a nullity

In Commissioner of Inland Revenue v Damien Grant and Steven Khov a Deed of Company Arrangement (DOCA) was entered into in respect of the administration of Jones Publishing at a watershed meeting of creditors of the company.  The Commissioner of Inland Revenue filed an application to declare the DOCA void on grounds that the voting to approve the DOCA was in contravention of section 239AK(3) of the Companies Act 1993 and that the DOCA was oppressive, prejudicial and unfairly discriminatory against the Commissioner.

This case clarifies when a casting vote may be used by an administrator pursuant to the Act's provisions.  It also gives some guidance to the circumstances in which the court may find a DOCA to be oppressive, prejudicial or unfairly discriminatory.

Grant and Khov were appointed administrators of the company.  At a watershed meeting of the company's creditors, the administrators put a resolution to the creditors that the creditors confirm the proposed DOCA.  10 out of 11 voting creditors voted for the DOCA.  Nonetheless, their debts did not total 75% in value.  Grant purported to use a casting vote conferred on chairs of creditors' meetings, voting in favour of the resolution and declaring it passed.

The IRD had voted against the DOCA, as it would have obtained a better outcome in the liquidation of the company.  The Commissioner filed an application to terminate the DOCA or declare it void.

The court resolved that in order for a casting vote to be valid, it must be made when votes in number are equal on the first round of voting, so that the subject casting vote is effectively the deciding vote.  In this instance, 10 out of 11 creditors voted in favour of the resolution so the votes were not equally divided.

The court also relied on section 239AK (Conduct of creditors' meetings) of the Act, which sets out the requirement that a resolution is adopted if a majority in number representing 75% in value of the creditors' debts (voting by proxy or otherwise) vote in favour of the resolution.  The Commissioner's vote represented approximately 30% of the value of the company's debt, so the required 75% threshold was not met.

The administrators asserted the DOCA was validly approved with the use of the casting vote, relying on case law and the more prescriptive Australian legislation.  The court ruled that a casting vote may only be used to resolve a deadlock in the number of votes cast, and not to achieve the 75% threshold.  In this case, there was no deadlock in the number of votes cast, and the DOCA had not been validly approved.

The court also concluded that the DOCA was oppressive and unfairly prejudicial, because the DOCA made no allowance for the fact that the Commissioner's debt was preferential.

The court held that "those proposing DOCAs where debts preferential in liquidation are amongst the company's total indebtedness, should propound schemes which recognise that factor to a degree at least, or explain why no such recognition is proposed."

The court held that section 239AK(3) was inoperative and Grant's exercise of a casting vote was a nullity.  The administrator could not exercise the casting vote to make up a majority in number (due to the vote already being that of a majority), and he could not exercise the vote to make up the required 75% in value as he had no voting debt that he could personally exercise.  The court also held that even if the administrator's casting vote was deemed to be valid, the DOCA would have been terminated on the grounds that it was oppressive and unfairly prejudicial to the Commissioner.

See court decision here.

Financiers as shadow directors revisited

In our banking newsletter in February 2008 we commented on banks as shadow directors (see here).  The issue was also considered in Australia recently in Buzzle Operations Pty (in liquidation) v Apple Computer Australia Pty.  A key question in this case was whether there was any basis on which it could be said that the directors of the insolvent company were accustomed to act in accordance with the directions of its financer.

Delay in enforcement

One of the liquidator's complaints was that Apple should be held liable for allowing Buzzle to continue to trade i.e. that Apple did not appoint receivers as early as it could have and should therefore pay for the additional trading losses.  Inferentially, the claim was based on the notion that an earlier receivership appointment would have resulted in fewer losses to unsecured creditors.

Apple was able to avoid liability in respect of that allegation by relying on a letter that explained to Buzzle that Apple was not involved in any corporate decision-making in relation to Buzzle.  Another factor relied upon by the liquidator of Buzzle was that Apple had a motive to keep Buzzle going because, as Apple’s biggest reseller, there was a financial benefit to Apple in Buzzle continuing to trade.  The judge held that such did not demonstrate that the board of Buzzle was accustomed to acting in accordance with Apple’s directions.

The liquidator's claims were unsuccessful, reinforcing the difficulty of liquidators and others succeeding in shadow director claims.

See court decision here.

GSA prevails over liens in receivership

McKay v Toll Logistics (NZ) was an application for directions made by receivers to determine whether ASB Bank, a secured party under a GSA, or Toll Logistics claiming under common law and contractual liens, had priority over DVDs owned by the company in receivership, Scene 1, which were warehoused by Toll.  Toll asserted a common law lien over the DVDs for all money owed to it by Scene 1 prior to 5 June 2009 and a contractual lien for all money owed to it after that date.  Toll's contractual lien was a security interest that was perfected at the time it gained possession of the DVDs after the creation of the lien by contract on 5 June 2009 (Personal Properties Securities Act 1999, section 41(1)(b)(ii)). ASB had perfected its security interest under its GSA by registration of a financing statement on 4 March 2008.

Although ASB denied the existence of a common law lien, both parties agreed that if there was a common law lien it would have priority over ASB's perfected security interest pursuant to section 93 of the PPSA.  The parties disputed, however, whether Toll's contractual lien had priority over ASB's security interest.

The court held that Toll had failed to establish the existence of a common law lien.  A packer or warehouse of goods was not, in New Zealand, a member of the recognised categories of relationship, such as solicitor, stockbroker or factor, which gives rise to a common law lien as a matter of law once the relationship is established.  In order to establish a lien it was necessary, therefore, for Toll to bring evidence to establish proof of custom and usage and it had failed to do so.

The court then held that ASB's perfected security interest had priority over Toll's perfected security interest, as ASB's security interest was perfected earlier in time than Toll's security interest, by its possession of the DVDs.  The court rejected Toll's argument that section 93 of the PPSA applied to contractual liens.  The court held that section 93 only applied to liens that were excluded from the operation of the PPSA by section 23(b), being liens created by any other Act or by operation of any rule of law, such as common law liens.  A contractual lien is a security interest, as defined in section 17(1)(a) of the PPSA, and as such its priority over other security interests is to be determined by the priority rules for contests between security interests.  By contrast, Part 8 of the PPSA, which begins with section 93, is concerned with the competition between security interests and interests which are not security interests.

See court decision here.

Trustee liability for trust tax obligations

Newmarket Trustees v CIR concerned an application by Newmarket Trustees (Newmarket) to set aside a statutory demand seeking payment of NZ$293,251.23 to the Inland Revenue Department (IRD).

Newmarket was a bare corporate trustee of the clients of a firm of solicitors and had no assets of its own.  It was a corporate trustee of 118 trusts, the registered proprietor of 145 properties and held shares in both listed and unlisted companies.

One of these trusts was a family trust established for Mr Goh, who was also a trustee.  It was this trust that owed the money to the IRD.

Newmarket argued that the statutory demand should be set aside under section 290(4)(c) of the Companies Act 1993.  It argued that Mr Goh had undertaken the day-to-day management of the trust which included filing all necessary tax returns and that he had not informed Newmarket that the trust had outstanding tax obligations.  It also argued that in the event it went into liquidation there would be substantial cost and inconvenience for all the other trusts for which it was a trustee.

Furthermore the trust deed contained an indemnity provision in respect of liabilities assumed by the trustees.

The Judge refused the application.  Among other things, the Judge found that there was no information before the court to enable an assessment to be made as to what prospects the liquidator, if appointed, would have in pursuing the indemnity rights provided by the trust deed against the trust's assets.  The Judge felt this was particularly important as "it may well be the only practical way the Commissioner…can effect real recovery of the outstanding taxes."

In addition, the Judge stated "the court will not endorse any waiver by a trustee of its obligations.  The fact that [Newmarket] took no active part in the day-to-day management of the trust cannot, in my view, be advanced as an excuse justifying the exercise of the discretion under the Companies Act."  However, the Judge did allow an extended period of time for the corporate trustee to negotiate with the Commissioner.

The lesson in this case for trustees is to remember that while they can contractually limit their liability for their contractual obligations, no such limitation applies to liabilities they assume other than under contracts.  This would include liabilities for the trust's tax obligations and liabilities that arise from the nature of the assets held by the trust - such as liabilities arising under the Resource Management Act in relation to property, or for calls on unpaid shares.  Trustees have to be vigilant to monitor whether and the extent to which any such liabilities can arise.

See court decision here.

This article is provided for general information purposes only and not as legal advice.  For further information, please contact a member of our insolvency law team - David Perry, Scott Barker, Laura O'Gorman, Michael Dineen, Willie Palmer, Jan Etwell, Scott Abel, Susan Rowe, Myles O'Brien or Kelly Paterson.