15 May, 2016
What you need to know
- Given adverse movements in the iron ore markets in recent times, Atlas Iron Limited (Atlas) experienced difficult trading conditions and incurred considerable losses over a sustained period. Atlas also faced the prospect of a likely breach of its debt facilities and the impending maturity date of its principal funding source, a USD term loan B facility, which was unlikely to be re-financed by the market.
- A creditors' scheme of arrangement proposed by Atlas has been approved by the Federal Court of Australia which will have the effect of substantially de-leveraging Atlas's balance sheet by converting approximately US$125 million of debt into equity and extending the term of its remaining debt.
- Under the scheme, Atlas' term loan B lenders will convert around half their debt in exchange for shares and options such that the lenders will hold 70% of the issued equity and options in Atlas.
- For the first time, the Court has approved a scheme of arrangement which utilises section 411(5A) of the Corporations Act 2001 (Cth) (Corporations Act) to release Sons of Gwalia style subordinate claims without requiring a meeting of those creditors to consider or agree to the scheme.
- This outcome provides a useful case study, particularly for listed entities that have experienced a period of distress and adverse share price movements, which shows how a section 411(5A) scheme can be used to provide secured creditors comfort that they will not be exposed to the risk that shareholder litigants establish claims that may impact the value of equity following a debt for equity swap.
- The Court has also confirmed that, where a creditors' scheme effects a debt-for-equity swap, there is no requirement for a concurrent members' scheme.
Atlas Iron Limited – creditors' scheme of arrangement
Overview
On 28 April 2016, the Federal Court approved a creditors' scheme of arrangement between Atlas, its term loan B lenders and the holders of certain subordinate claims against Atlas.
Under the scheme, Atlas’ term loan B lenders will convert around half their debt in return for equity in Atlas and the appointment of new directors to the Atlas board.
In addition, subordinate claims within the meaning of 563A(2) of the Corporations Act (i.e. Sons of Gwalia style
shareholder claims) will be released, notwithstanding those subordinate claim holders did not have the opportunity to vote on the scheme. This is the first occasion on which the Courts have approved a scheme which releases subordinate claims pursuant to section 411(5A) of the Corporations Act.
A significant majority of Atlas' lenders agreed to the scheme, however the Australian Securities and Investments Commission (ASIC) raised a number of objections prior to the first court hearing and suggested that a concurrent members' scheme was necessary.
These objections were mostly rejected by the Federal Court at the first hearing which moved to convene the scheme meeting; see Atlas Iron Limited, In the matter of Atlas Iron [2016] FCA 366 and were not raised by ASIC further at the second hearing.
Atlas' shareholders also voted overwhelmingly in favour of the issue of shares and options required to effect the scheme.
Background
Atlas is an iron ore miner and exporter, operating in the Pilbara region in Western Australia.
In December 2010, Atlas borrowed US$275 million from a syndicate of lenders under a term loan B facility (TLB Lenders). The facility agreement contains a number of covenants including an asset coverage ratio, tested bi- annually.
With the dramatic fall in iron ore prices during 2015 – 2016 and the decrease in value of the Australian dollar over the same period, Atlas risked breaching the asset coverage ratio which would have caused a default under the TLB facility agreement.
Atlas was unable to consensually restructure its debt obligations with the TLB Lenders, which required unanimous consent under the TLB facility agreement. As a result, with the support of a majority of the TLB Lenders, Atlas proposed a creditors' scheme of arrangement as a means to effect the capital restructure.
Scheme details
Under the scheme:
an amount of approximately USD$125 million owed by Atlas to the TLB Lenders under the facility agreement is to be released by the TLB Lenders;
in exchange for the debt release, TLB Lenders will collectively receive 70% of all shares and options on issue in Atlas;
Atlas' TLB facility agreement will be amended to alter or remove certain financial covenants and substantially extend the term of the TLB loan;
three new directors will be appointed to Atlas' board by the TLB Lenders; and
certain subordinate claims will be released. Release of subordinate claims
Once the scheme is implemented, Atlas' TLB Lenders will hold a substantial portion of the equity in Atlas. TLB Lenders' claims as shareholders would therefore come last in any liquidation waterfall after payment of all creditors.
This gives rise to the prospect that shareholder claims could later be brought which could adversely affect the value of Atlas' equity. This risk could be sufficient to prevent secured lenders from supporting a debt for equity swap, thus creating an impediment to a sensible balance sheet restructuring. Following implementation of the Sons of Gwalia reforms in 2010, the Corporations Act now allows Courts to protect lenders considering converting into equity from such risk in appropriate circumstances.
Section 411(5A) provides:
If the compromise or arrangement:
(a) involves creditors of a Part 5.1 body with subordinate claims (within the meaning of subsection 563A(2)); and (b) is approved by the Court;
those creditors are also bound by the compromise or arrangement despite the fact that a meeting of those creditors has not been ordered by the Court.
Section 563A(2) provides:
"subordinate claim" means:
(a) a claim for a debt owed by the company to a person in the person's capacity as a member of the company (whether by way of dividends, profits or otherwise); or
(b) any other claim that arises from buying, holding, selling or otherwise dealing in shares in the company.
In this case, the Court was prepared to approve a scheme releasing subordinate claims to support the debt for equity swap on the basis that:
expert evidence was put before the Court valuing any such claims at nil in a liquidation scenario (regardless of whether the scheme was implemented);
there was no evidence that any such claims had been brought or threatened as at the date of the hearing; and
claims could still be brought by subordinate claimholders to the extent of available insurance to meet those claims (if any).
This is the first instance that section 411(5A) has been utilised to compromise subordinate claims to support a debt for equity swap. In the absence of judicial guidance on the operation of the provision, extrinsic materials provided support for the submission that the purpose of section 411(5A), together with section 600H(1)(b), is to prevent shareholder compensation claimants, who would otherwise be entitled to vote as a separate class on a scheme which releases their claims, from frustrating a restructuring in which they have no real financial interest.
The genesis of section 411(5A) appears to have been the November 2010 report of the Legal and Constitutional Affairs Legislation Committee of the Senate in relation to the Sons of Gwalia amendments to the Corporations Act. In that report, the committee suggested in response to concerns raised by the Law Council of Australia that:
"[that] part of the Corporations Act dealing with the administration of creditors' compromises could be amended to extinguish the subordinate claims where the return to those creditors will be less than complete satisfaction of their debts and claims"
Subsequently, the supplementary explanatory memorandum to the Corporations Amendment (Sons of
Gwalia) Bill 2010 (which introduced s411(5A)) provided that:
"…in relation to a meeting convened under section 411(1) in relation to a compromise or arrangement under Part 5.1 of the Corporations Act, creditors subordinated under section 563A are only entitled to vote as creditors if they obtain leave of the Court. The Bill provides that creditors who are subordinated under section 563A are bound by the compromise or arrangement under Pt 5.1 of the Corporations Act, even if they do not obtain the leave of the Court… to vote at the creditors meeting".
Following the Court's approval of the scheme, it has been confirmed that section 411(5A) can be employed in circumstances such as Atlas', where there would otherwise be a possibility that shareholder compensation claimants could frustrate the passage of a scheme in relation to a company in which they had no real economic interest at the time the scheme was proposed. This is good news for the practice of restructuring in Australia and the preservation of Australian jobs.
ASIC concerns and member approval
ASIC raised several objections to the scheme prior to the first Court hearing on 31 March 2016. Those objections centred largely on the impact of the scheme on the interests of Atlas' existing members.
One of ASIC's principal contentions to the Court was that Atlas' existing members should be afforded the opportunity to consider and, if thought fit, agree to the terms of the scheme on the basis that it would significantly dilute their holdings of Atlas' shares. This was, according to ASIC, to be effected via a concurrent members' scheme of arrangement and a supporting fair and reasonableness opinion from an independent expert.
It was in any event necessary to seek shareholder approval issue the shares and options to TLB Lenders pursuant to ASX Listing Rule 7.1. That approval was obtained with an overwhelming majority of shareholders voting in favour of the transaction.
Ultimately, the Court concluded that a concurrent members' scheme (or a separate independent expert's report addressing the interests of members) was not necessary. This conclusion is consistent with authorities in relation to creditors' schemes and reinforces the position that a members' scheme of arrangement is not required when seeking to implement a debt for equity swap with creditors.
For further information please contact:
James Marshall, Partner, Ashurst
james.marshall@ashurst.com
