Treading a fine line in restructuring work

Facilitating restructuring and turnaround of companies in financial difficulty is one of the goals of Australia’s modern corporate insolvency laws. A recent case (Walton Constructions) has highlighted some of the difficult legal liability issues that may arise when restructuring a company.

Recent amendments that introduce a safe harbour for company directors against insolvent trading, and to offer protection for company’s seeking to restructure under voluntary administration, receivership or a creditors’ scheme of arrangement, are aimed at encouraging restructuring efforts to try to save companies, and to preserve jobs and maximise enterprise value. However, not all restructures succeed and some restructures can look like shuffling the deckchairs on the Titanic. There have been public concerns expressed about the need to distinguish legitimate restructuring activity and illegitimate phoenix activity or manipulating restructuring to benefit particular stakeholders over unsecured creditors.

Australia’s corporate insolvency laws offer a variety of clawback powers to address uncommercial transactions entered into in the shadow of formal insolvency proceedings. These serve to both discourage such conduct as well as allowing liquidators to recover some value for creditors: see Corporations Act 2001 (Cth) ss588FB, 588FDA.

The recent decision in Re McCann; Walton Construction (Qld) Pty Ltd (In Liq) v QHT Investments Pty Ltd [2018] FCA 1986 offers a detailed examination into the role of restructuring advisors, through the lens of assessing the application of s 588FB to asset transfers within groups of companies during a restructuring. The case highlights key risks for restructuring advisors when advising companies to sell assets as part of a broad restructuring effort, particularly in situations where the restructuring appears to primarily benefit a secured creditor and the company’s advisors and associates, rather than benefiting the company itself. The case also makes it clear that the desired benefit to the company should be explicitly set out in the engagement letter between the advisor and the company.

The facts

The Walton Construction Group was involved in construction projects around the country. The relevant companies in the group for the purposes of this case were Walton Construction Australia Pty Ltd and its subsidiaries Walton Construction (Qld) Pty Ltd and Walton Construction Pty Ltd (which handled projects in NSW and Victoria). The group was controlled by Mr Walton, who had given personal guarantees to secure liabilities that the group owed to NAB, which provided financing and bank guarantees for the group’s construction projects. The bank’s financing was only partly secured, and there were concerns about the potential application of s588FJ (which renders a security interest void if enforced 6 months prior to the relation-back day) if the bank took enforcement.

Companies in the group experienced significant losses in 2012 and the bank appointed Deloitte as investigating accountants. Deloitte reported in March 2013 that the group’s financial position was such that the bank would be likely to suffer a significant loss if it enforced its security. The group’s major liquid asset was a deposit account where customer payments were made, but there was insufficient funds in that account to satisfy the full liability owed to the bank. The restructuring of the group resulted in increased funds into this account resulting in the bank’s liability becoming fully secured.

The bank advised Walton that it would withdraw financial support in early April 2013, which meant no more bank guarantees, although the guarantees in fact remained in place for some time after that. At the same time (April 2013), a NAB employee referred the Mawson Group (an advisory group that specialised in turnaround and restructuring work) to Walton to advise on its financial position. The liquidators subsequently found that the group was insolvent from this time. The court acknowledged that once the company was insolvent, the interests of the company included unsecured creditors (at [40]). The company met with Mawson and agreed to engage its restructuring services.

The contracts between the company and its restructuring advisors

The engagement letter set out the objects of the appointment as to preserve the Queensland business; to gain further time from the bank and to avoid enforcement; and to create an outcome that “looks after the 1/2 dozen individuals referred to by [Craig Walton, the controller of Walton]” (at [41]) . The letter also listed a key deliverable as “providing alternative options to the shareholders and directors of the Walton Group to maximise and preserve stakeholder value.” The court held (at [39]) that:

the … conduct of Mawson reveals, its activities were mostly directed to protecting and improving the position of the NAB and Mr Walton rather than advancing the interests of Walton Construction.

The court went on to state (at [40]):

it is clear from the conduct of Mawson, the NAB and Mr Craig Walton that none of them sought to advance the interests of the companies and their unsecured creditors and if the companies received any advantage from their actions it was purely coincidental.

It should be noted at this point that a secured creditor is not required to manage their security for the benefit of the debtor and may act in their own interests (subject to duties on exercising a power of sale). There is nothing improper about a bank seeking to obtain the best commercial outcome for itself in restructuring negotiations, or imposing strict conditions on continued financial support for a debtor. The duty to act in the best interests of the company rests on the directors of the company and not on secured creditors.

The court queried the level of Mawson’s fees, with the letter of engagement specifically denying that it provided legal or accounting advice, which the court interpreted as meaning that the strategies recommended by the engagement were not recommended on the basis that they were legal or financially efficacious. It should be noted that the fees were not subject to a claim that they were an uncommercial transaction. The “general terms of business” attached to the letter of engagement limited Mawson’s liability to Walton to 20% of the fee payable for the services, but also required Walton to give an indemnity against any liability owed by Mawson to a third party arising from the services. The terms also rejected any fiduciary relationship and allowed Mawson to act in its own interests. The restructuring effort did result in companies associated with Mawson making substantial profits, in addition to the fees earned by Mawson for the restructuring advice. The initial fees were $35,000.

Mawson’s initial report advised as to how the bank’s exposure could be managed through a gradual restructuring process involving a joint venture or sale campaign. While the bank rejected this recommendation, it held the guarantee facilities in place. A 2nd retainer with Mawson was entered into at the end of April 2013, which provided for $180,000 in fees plus a success fee for each of the companies if they continued to operate in whole or in part after end of June 2013 and a 5% success fee if the companies were sold. The aims of the 2nd retainer were to assist the companies with their relationship with the bank; assist in securing refinancing; advising on asset sales and attempting to procure short term contracts. A 3rd retainer agreement, which contained the same fees, was entered into 2 weeks later, although the court did not otherwise explain what the content of this was.

Mawson then undertook investigations for a sale campaign, although no sale eventuated and for several months reported to the bank on how its exposure was being reduced with a goal of full security. While the bank did not appear to formally approve of Mawson’s activities, it did not enforce its security either. Mawson also sought to replace Walton’s bank guarantees with surety bonds provided by a third party (which greatly reduced the bank’s exposure), although some existing customers would not agree to this and some major contracts were assigned to other builders. The end result of these activities was to fully secure the bank’s debt.

The restructure

Mawson’s restructure of the Walton Group involved creating a new company (Lewton) to address potential defect liabilities and maintenance obligations owed by the Group (and for which the bank’s guarantees provided coverage), which was managed by a Walton employee. Lewton also took responsibility for the liability to repay a debt of more than $18m owed by Walton Construction to Walton Construction (Qld). Lewton was funded by a company associated with Mawson (QHT), which also took security over Lewton’s assets and required certain funds paid to Lewton to be paid into an account controlled by QHT. QHT also took an assignment of the benefit of the debt (now owed by Lewton) that was owed to Walton Construction (Qld), for only $30,000. The court held that QHT did not in fact provide any new finance to Lewton and there was no commercial explanation for Lewton to take the assignment of the large debt or why QHT was assigned the benefit of that loan. The court held that the transactions involving Lewton and the assignment of assets and liabilities were designed to increase a refund of GST and also to increase the success fee payable to Mawson (at [70], [89]). QHT argued that the value of the intra-group loan was effectively nil, but this was contrary to an expert valuation report provided to QHT that valued the loan at between several hundred thousand dollars to potentially several million dollars.

The company also assigned several construction projects and plant, equipment and leased property to a company controlled by Mawson (Peleton). The purchase price was determined by the value of liabilities outstanding on the assets (construction contracts, plant and equipment and leases), which the court held bore no relationship to the actual value of the assets. Furthermore, the contract assumed that the property assigned was unprofitable and required the seller to make a payment to the purchase to cover expected losses of $1.3m. This was despite the fact that the purchase had the contractual right to exclude unprofitable contracts, and following the execution of the contract did in fact do so (at [95]). The Peloton assignment was not itself part of the uncommercial transaction case, although the court rejected including the assignment of the debt to QHT with the Peloton transaction as one whole transaction (at [66]).

Following the execution of the assignments the group was placed into administration the following day.

QHT argued that the debt assignment needed to be viewed in the context of the broader restructuring effort, which, it said, constituted the ‘transaction’ for the purposes of s588FB. This would have included the Peloton transaction and the financing facility established for Lewton. However, the court held that the assignment to QHT of the intra-group loan was directed to securing a GST refund rather than serving an essential element of a restructuring of the group. The court repeatedly stated that despite agreements called ‘restructuring agreements’, the agreements did not, in substance, restructure the company’s affairs for the purposes of saving the company. Rather, the goal was to reorganise the company’s finances for the purposes of reducing and securing the bank’s liabilities and to reduce or remove the personal liability of Walton’s directors under their guarantee for the company’s liability to the bank (at [115]).

The court relied on an entire agreement clause in the assignment deed as supporting a conclusion that the assignment could be assessed as a stand-alone transaction (at [118]). It was also significant that the assignment of the loan was the only transaction involving Walton and QHT (at [119]).

The court held (at [129]):

there is nothing in any of the documents which suggests that Mr Walton or Mawson had any consideration to the interests of Walton Qld or Walton Construction or their unsecured creditors, in particular.

QHT argued that ‘what was good for the secured creditors was good for the unsecured creditors as debt would be reduced’. However, the court pointed out that such an approach would allow the companies to trade whilst insolvent and this would disadvantage new unsecured creditors (at [130]). The court also rejected an argument that entering into the restructuring agreement gave the Walton companies a better chance to either avoid liquidation or to provide a better return for creditors than an immediate liquidation, given that the companies entered administration so close to the execution of the agreements and then entered liquidation shortly thereafter (at [131]).

The court held that the purpose of the assignment deed was to allow QHT to collect a GST refund and to make QHT a secured creditor (at [132]).

The court held that the restructuring agreements were not made at commercial arms’ length, but rather were devised by Mawson to achieve the aims set out in its retainer agreement (i.e. to reduce the bank’s exposure, to delay or avoid bank enforcement and to maximise value for stakeholders, namely the directors of Walton) and to provide a financial return for itself (at [134]). The court made the point that there was nothing in the documentation that established how the transactions would benefit the companies.

Overall, the court held that the assignment of the debt was an uncommercial transaction and was voidable, and ordered that QHT pay almost $700,000 to the liquidators of Walton Construction (Qld).

Navigating a safe harbour?

A safe harbour against insolvent trading was included into s588GA of the Corporations Act 2001 (Cth) in September 2017. The Walton case was not concerned with insolvent trading, and the timing was years before the commencement of the amendments so the safe harbour was not an issue in this case. However, it is interesting to ponder whether the restructuring effort in Walton Construction would be likely to satisfy the safe harbour provisions if the case had involved insolvent trading and the facts occurred in 2019 rather than 2013.

In short, the likely answer is no. The safe harbour requires that conduct undertaken must be likely to lead to a better outcome for the company (s588GA(1)(a)). The findings in Walton Construction that the restructuring agreement was undertaken for the purposes of reducing the bank’s exposure and to maximise value for the directors would be unlikely to satisfy s588GA(1). Also, the conduct of assigning property for an undervalue to companies associated with the restructuring advisor would be unlikely to satisfy s588GA(1). Furthermore, the fact that the company entered administration immediately after the execution of the agreements and that the administration led to a winding up without a concrete plan to save the company or its business, would suggest that the conduct was not likely to lead to a better outcome for the company.

It seems clear that acting to shift assets and liabilities to maximise security for the company’s bank while not improving the company’s financial position to facilitate a turnaround would be unlikely to satisfy s588GA(2)(e) (‘developing or implementing a plan for restructuring the company to improve its financial position’).

These issues draw some similarity to the ‘restructuring’ in the Bell case, where unsecured bank loans were converted into secured loans together with a cash sweep provision to ensure that the bank debt was paid before all other creditors, which gave rise to a breach of directors’ duties to consider creditor interests as part of the duty to act in good faith in the best interests of the company and to act for a proper purpose. I co-wrote an article on this with workout banker (and ARITA board member) Geoff Green in the ARITA Journal (‘Total Control? The Bell Group decision and its impact for lenders and their advisers’ (2015) 27 Australian Insolvency Journal pp. 23-26). I’ve also written about the directors’ duties issues in the Bell case with Anil Hargovan (of UNSW) in ‘For Whom the Bell Tolls: Directors’ Duties to Creditors after Bell’ (2013) 35 Sydney Law Review pp. 433-450. While the Walton case did not consider, nor establish, a breach of directors’ duties, the findings by the court that the conduct was uncommercial and offered little to no benefit to the company, while significantly benefiting the professional advisor and the secured creditor, offer a degree of similarity with the Bell case.

The Walton case gives useful guidance for restructuring advisors and their clients.

Key takeaways 

  • Ensure that the benefit to the company is made clear in the documentation (and of course, that the transaction offers the company some tangible benefit).
  • Ensure that the directors of the company independently assess the restructuring proposal and provide minuted evidence of this. In this case, the court relied on the fact that the restructuring agreement seemed to be completely devised and implemented by the Mawson Group.
  • If a restructuring advisor is to take a stake in the restructure by assigning company assets to one of its controlled entities this is going to raise greater scrutiny by the court, so there needs to be a tangible commercial reason to do this (that is, something other than merely benefiting the advisor).

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