30 August, 2015
Summary
- After Nexus Energy’s shareholders voted down a 2 cents per share scheme of arrangement, a Seven Group Holdings subsidiary proposed a deed of company arrangement under which it would pay an amount to compromise Nexus Energy’s debts and acquire all Nexus Energy shares for no consideration.
- This relied on a provision of the Corporations Act – section 444GA – which was introduced after Pasminco’s failure exposed gaps in the regime for creditors to realise value from failed companies.
- The question of the value and economics of Nexus and its underlying projects was key to the granting of the ASIC relief and a court order necessary to complete the deal.
Background
Nexus Energy was an ASX-listed company which found itself with too much debt in the challenging environment which developed for oil and gas companies.
Nexus’ portfolio of assets included:
- the Crux exploration asset in the Browse Basin, a joint venture majority-owned by Shell, which required significant capital expenditure over the long term to develop it to a profitable, revenue-generating position,
- the Longtom gas fields in the Gippsland Basin off the coast of Victoria, and
- several other smaller exploration assets.
Longtom was Nexus’ only revenue-generating project. It had been beleaguered by technological failures throughout 2013 and 2014, and was failing to produce the revenue bandwidth necessary to reduce debt and fund Nexus’ capital-hungry exploration assets.
In early 2015, with debt deadlines looming and extensive asset sale efforts not having yielded acceptable offers, a Seven Group Holdings subsidiary put an offer to Nexus Energy to acquire all of its shares for two cents per share under a scheme of arrangement, and offered a lifeline of bridging finance which would tide Nexus Energy over until its shareholders could vote on the deal.
The independent expert rated Seven Group’s two cents per share offer as fair and reasonable, and Nexus Energy’s board recommended it to shareholders. However, Nexus Energy’s long-suffering shareholders voted the scheme down.
As had been foreshadowed in the scheme disclosure, when the scheme vote failed Nexus Energy’s directors appointed administrators to the company and Seven Group moved to implement the fallback path of acquiring Nexus from the Administrators (which, again, had been disclosed in the scheme booklet).
This involved Seven Group, which had already acquired Nexus’ debt and provided debt funding to get the company through to the scheme vote, providing further loan funding, this time to Nexus Energy’s administrators, which had been appointed by the Nexus Energy board. Although Nexus Energy’s assets and the company itself had been marketed extensively before the scheme of arrangement proposal, the administrators ran a further marketing process to ensure the market had been fully tested.
Despite a number of parties running the ruler over Nexus Energy and its assets during that process, only one offer was made to the Administrators – an offer from Seven Group through a proposed deed of company arrangement, which involved:
- Repayment in full of the senior debt – which was by then owed to an SGH subsidiary, including the bridge financing and the loan funding to the administrators,
- $30 million in settlement of a litigation claim by Sedco – a contractor for one of Nexus’ other projects who had initially claimed upwards of US$80 million under a contract dispute,
- 74.5 cents in the dollar for Nexus’ subordinated noteholders, and
- Payment in full of Nexus’ unsecured creditors through a creditors’ trust.
Key conditions to the deed of company arrangement proposal included:
- The court granting leave for the share transfer to the Seven Group entity, and
- ASIC relief to overcome the takeovers law restrictions.
- Legal hurdles to getting the deal through – leave of the court and ASIC relief
Following the administration of zinc mining company Pasminco and earlier court decisions which cast doubt on the power of administrators to transfer shares in an insolvent company for the benefit of creditors, section 444GA was introduced into the Corporations Act to make it clear that an administrator can sell or transfer the shares in the company for the benefit of creditors, provided a court grants leave. The court can grant leave if it is satisfied that the transfer will not unfairly prejudice the interests of members of the company.
The court approval requirement is a 'check and balance' to prevent creditors exploiting a liquidity crunch for a company which still has positive net asset value (and therefore some residual value to shareholders). It may 'unfairly prejudice' members of the company for the administrators to sell the company’s shares where the value of the company’s assets outweighs its debts.
For listed companies, like Nexus, ASIC relief from the takeovers regulations was also needed, giving ASIC an opportunity to apply its own scrutiny to the transaction and meaning that ASIC too needed to be persuaded that it was appropriate to grant relief.
Despite vigorous opposition to the proposal from a shareholder group – which lobbied ASIC and fought the transfer in a 5 day court hearing, ultimately both ASIC and the Supreme Court of New South Wales granted the necessary relief and court order respectively for the transfer of the shares to Seven Group.
Valuation was key to the Court and ASIC’s decision
The key issue facing the court and ASIC was one of value – did the value of Nexus’ debts outweigh the value of its assets and was there therefore any residual economic interest that Nexus shareholders had which would be unfairly stripped away as a result of the deal.
This was ultimately a question of simple economics – and the policy of both the administration provisions of the Corporations Act and corporate law more generally in weighing up the interests of shareholders versus creditors once a company has become insolvent. It is an underlying principle of corporate law that, once a company is insolvent (particularly if on a balance sheet basis rather than just a liquidity basis), the interests of creditors prevail over those of shareholders.
However, valuing Nexus Energy’s portfolio of oil & gas assets – particularly those presently in the exploratory phase with development profiles and capital expenditure programs extending out some 10-15 years into the future – was a more complex process and one in which competing expert evidence was produced. Chief among the difficulties was that deriving a theoretical value for the most objectively valuable asset in Nexus Energy’s portfolio – its interest in the Crux exploration project – was heavily dependent on assumptions about a handful of key variables, including:
- long term movements and forecasts in the global oil price,
- the development scenario assumed (principally whether Crux would be integrated with Shell’s Prelude FLNG facility or whether a standalone FLNG facility would be constructed),
- the discount rate applied to the discounted cash-flow valuation of the project, and
- the appropriate point of reference from which a comparable transactions analysis should be performed.
There was wide divergence between the expert valuation evidence commissioned by the Deed Administrators on the one hand and the shareholder group on the other hand on each of these key elements. ASIC closely scrutinised the valuation evidence in considering its position on whether or not to grant relief.
An example of the differences in approach included what His Honour Justice Black described as “a somewhat complex analysis of a value which a third party would pay for Crux” – essentially a theory propounded by the shareholders’ valuation expert that someone might pay more for Nexus’ interest in Crux (which is subject to a pre-emptive right) in insolvency than was ever offered when the company was solvent.
Ultimately, however, what both ASIC and the Court found persuasive in evaluating the value of Nexus’ assets were the actual offers which had previously been received for them. His Honour Justice Black referred to an earlier decision of Elkington v Shell Australia Ltd 1, in which it was held that where valuation evidence involves the “evaluation of inherently uncertain matters and the making of fairly speculative assumptions in highly significant areas” – particularly relevant in Nexus’ case – “weight should be given to the ‘more mundane reality of the marketplace'".The values of Nexus’ assets put forward by the valuation experts for the shareholder group far exceeded any offers Nexus had received when Nexus was solvent and not in financial distress.
The reality for Nexus, which was also reflected in the valuation expert evidence commissioned by the Deed Administrators, was that it was in a net deficit asset position. There had not been any offers for the whole or part of Nexus in the extensive sale process conducted by the company prior to the administration, nor the sale process conducted by the administrators, which would have suggested that on a liquidation (which the court considered to be the relevant counterfactual) there would have been sufficient value in Nexus’ assets to satisfy all of Nexus’ liabilities. Indeed, the fact that other external creditors of Nexus Energy, having made their own assessment – supported the DOCA rather than a liquidation – was a powerful indication to ASIC and the Court as to where creditors’ assessment of value lay.
Nexus Energy shareholders would have received the same return – nil – whether the DOCA was implemented or whether Nexus Energy went into liquidation. It was the creditors who would have suffered if Nexus Energy went into liquidation, with the effect that all creditors would have been substantially worse off than if the DOCA was implemented. What ASIC and the Court did was prevent those shareholders from standing in the way of creditors maximising their return and Nexus Energy’s employees keeping their jobs, when shareholders would not get a return on any scenario (having voted down the solvent scheme of arrangement which would have delivered them two cents per share).
End notes
- (1992) 10 ACSR 568 at 571; and on appeal at (1993) 32 NSWLR 11 at 21.
For further information, please contact:
Rebecca Maslen-Stannage, Partner, Herbert Smith Freehills
rebecca.maslen-stannage@hsf.com
