Acquisition finance in Australia: overview
A Q&A guide to acquisition finance in Australia.
This Q&A is part of the global guide to acquisition finance. Areas covered include market overview and methods of acquisition, structure and procedure, acquisition vehicles, equity finance, debt finance, restrictions, lender liability, debt buy-backs, post-acquisition restructurings and proposals for reform.
Market overview and methods of acquisition
Acquisition finance market
The acquisition finance market is driven principally by general corporate acquisitions and private equity investment and exits. Most businesses are privately-owned and many of these are family-owned businesses with no clear succession plan or founded by entrepreneurial individuals with a strategy to exit. This phenomenon, combined with a well-regulated banking sector, high levels of bank debt liquidity and a large number of foreign and local private equity funds, make for a robust and sophisticated acquisition finance market.
The large international private equity funds are all active in this market, including:
Kohlberg Kravis Roberts (KKR).
TPG Capital, Bain Capital.
Affinity Equity Partners.
There are also a number of funds including:
Pacific Equity Partners.
Some of these, such as Pacific Equity Partners, compete with the international firms in the top end of the market, but most are more active in the mid and small cap markets.
Lending is dominated by the "big four" banks:
Australia and New Zealand Banking Group Limited.
Commonwealth Bank of Australia.
National Australia Bank Limited.
Westpac Banking Corporation.
They compete with foreign and local investment banks such as:
Goldman Sachs JB Were.
They also compete with foreign banks such as Citibank and Bank of America Merill Lynch, particularly on A$1 billion plus transactions requiring an underwritten syndicated facility or a bridge facility prior to an equity or high yield take out. Japanese and Chinese banks such as Mitsui, Sumitomo, Mizuho, China Development Bank, Bank of China and ICBC are also active in taking senior debt positions as part of a syndicate or, particularly in the case of the Chinese banks, funding Chinese investment into Australia.
Debt funds have traditionally been limited to structured, distressed and mezzanine debt funding, however ICG has raised a senior debt fund and it is likely that others will follow.
The secondary debt trading market was traditionally dominated by banking institutions. However, hedge and other specialist funds have become increasingly active in taking participations in senior and subordinated facilities, particularly with a loan to own strategy.
Methods of acquisition
Asset acquisitions are usually limited to acquisitions where there is a structural or economic reason to structure it as an asset acquisition rather than as a share acquisition. These can include the following:
The target is unincorporated.
The acquisition is limited to one or just a few key assets.
The acquirer is concerned about undisclosed liabilities of the target company and is unwilling to rely on representations and warranties or warranty insurance is not available.
The acquirer is interested in acquiring only part of a company's operations.
It is more effective for tax reasons to acquire the assets of a target rather than the equity.
Except where the acquisition is limited to one or just a few assets, asset acquisitions are generally more complicated to complete than share acquisitions where the only asset being transferred is the equity in the target. Greater third-party consents (whether governmental or counterparty) are usually required for the transfer of business assets than a transfer of shares and prescribed form instruments of transfer are often required for specific assets in addition to the operative transfer clause of the acquisition agreement.
Except where the target is considered "land rich" or is registered in a State or Territory other than Victoria (which is unusual), the stamp duty payable on the acquisition will generally be higher. This is because transfer duty is not payable on the acquisition of shareholder debt or shares in a company that is registered in Victoria and is not "land rich". In comparison, the sale of business assets is generally liable to transfer duty.
There can also be tax considerations that drive the decision to structure the acquisition as an asset acquisition rather than a share acquisition.
Most corporate acquisitions are structured as share acquisitions. Share acquisitions are generally less complicated to complete than asset acquisitions. Generally speaking, less third party consents are required (although it is not unusual for contracts to include some form of change of control clause that require certain counterparty consents to the acquisition), and transfer duty is less likely to be payable, in a share acquisition.
The law does not recognise mergers where two companies are by operation of law combined to form one company. Although acquisitions can be completed through shareholder or creditor-approved schemes of arrangements there is no concept under the law of two companies merging to form one legal entity. There will always be an acquisition of a target company's assets or shares by the acquirer.
Structure and procedure
There are no hard and fast rules as to whether the lender's counsel or the borrower's counsel drafts the debt documentation.
Immediately following the 2008 global financial crisis lenders became much more sensitive to risk and were able to dictate terms. Therefore, lenders generally insisted that their own legal counsel would be responsible for drafting all debt documentation. However, with increased liquidity and lower leverage levels in more recent times, legal counsel for the sponsors and borrowers, particularly private equity sponsors, have again become more likely to control the drafting of at least the principal facility agreement(s). It is not unusual for borrower's counsel to draft the principal facility agreements and for lender's counsel, who generally remain responsible for issuing the legal opinion on the documentation to the lenders, to draft the security documents. However, a particularly strong sponsor can require that its legal counsel will be responsible for drafting all documentation.
Historically, law firms would only issue a legal opinion to its own client so legal counsel for a borrower would not issue a legal opinion addressed to the lenders. In recent times, and with increased cross border acquisition activity, borrowers' legal counsel have become more willing to issue legal opinions addressed to the lenders, particularly if they are the draftsmen of the suite of documentation or the acquisition debt is being raised in the US to fund an Australian acquisition. However, the general rule is that lender's legal counsel issues the legal opinions even if the borrower's counsel is responsible for drafting the facility documentation.
It is standard practice for debt funding for any auction, bid or listed takeover to be on certain funds terms and those terms have become standardised so that there is usually very little negotiation of the certain funds language. Those terms are very similar to certain funds terms in the UK market. This practice was driven principally by European private equity funds entering the market and insisting on certainty of funding rather than any particular legal requirement. There is no obligation under the law for financial advisers to ensure that there are reasonable grounds to believe that there will be sufficient funding for a takeover under the law. The Takeovers Panel has stated that a takeover offer may be ruled unacceptable if the acquirer does not have reasonable grounds to believe that it will have sufficient funding to complete the takeover. However, this has not been interpreted to necessarily require that all takeover debt funding must be on certain funds terms.
Funding is almost always provided on the basis of full facility documentation. It is not uncommon for a bid or takeover offer to be made on the basis of a commitment letter only, with full documentation to be completed as soon as possible thereafter. However, the terms of the commitment letter are usually sufficiently extensive to ensure that all material terms are agreed so that agreeing full documentation is more of a process than a negotiation.
There was a time when vendors would look to provide a debt staple so that they could offer to a purchaser a debt funding package that the vendor had pre-agreed with lenders willing to fund the acquisition. However, this is a declining practice, as most acquirers generally choose to not take up the debt staple and to negotiate their own debt funding terms.
Debt documentation is almost exclusively in English and is governed by the law of a State or Territory. There are no material differences between the laws of each State or Territory from a governing law perspective and all companies are regulated by the same Commonwealth law irrespective of the governing law of the documentation. Accordingly, the laws of the State or Territory where the vendor or the purchaser normally operate, or in which the lawyers responsible for drafting the documentation practice, are usually adopted as the governing law.
Occasionally, debt can be arranged in an offshore jurisdiction such as China where the facility documentation can be in the national language of that jurisdiction with an English translation or governed by the law of the jurisdiction where the debt is arranged. However, any security documents affecting Australian assets are always expressed in English and governed by the law of a State or Territory. Only one jurisdiction is chosen for the governing law even though the assets subject to the security can be located in a number of different Australian jurisdictions.
Lenders usually require that any security granted over assets located outside Australia is governed by the law of the jurisdiction where the assets are located. That security is usually in addition to the law security granted by any Australian entity. Where a foreign company is giving security over Australian assets, lenders usually require that separate security documents are executed over those assets with one security document governed by the law where the foreign company is incorporated and the other security document is governed by the jurisdiction where the secured assets are located.
It is more usual for an acquirer to enter into a binding commitment to purchase where the acquirer has the benefit of at least signed commitment letters attaching fairly extensive term sheets. Occasionally, a purchaser commits to purchase on the basis of a term sheet only but this will usually only be done if either:
The purchaser is in a very strong position to borrow in the market.
The purchase is expressed to be subject to funding (although it is unusual for an acquisition to be subject to funding).
Occasionally, full documentation is signed prior to any commitment to purchase being made, but this is not usually considered necessary, provided the commitment letters are sufficiently extensive. For obvious reasons, purchasers usually ensure that any conditions precedent to funding are equivalently reflected as conditions to the obligation to complete the acquisition or otherwise within the control of the purchaser.
Most acquisition structures are determined by the desired tax and accounting outcomes of the acquirer. However, it is usual practice for the acquirer to use a holding company (holdco) and bidding company (bidco) structure. Both companies are:
Limited liability special purpose vehicles.
Usually incorporated in Australia.
Registered in Victoria, in order to minimise mortgage duty.
The sponsors contribute their equity (usually in the form of a combination of shares and subordinated shareholder loans) to holdco. The allocation of equity between shares and shareholder debt is usually weighted in favour of shareholder debt so that the amount of share capital is nominal, subject to thin capitalisation rules (see Question 9). Holdco in turn provides the proceeds of the sponsors' contribution to bidco, which will be the principal borrower of any external debt funding.
Consistent with overseas trends, another special purpose company (topco) is sometimes interposed between the sponsors and holdco. The purpose of topco is usually to facilitate the raising of payment-in-kind (PIK) debt, which is structurally subordinated to the senior and subordinated or mezzanine debt incurred by bidco, although there can be other structural drivers of the topco structure.
Bidco acquires the shares in the target company or enters into an agreement to acquire the assets of the target. Shares in a listed company can be acquired:
Under a takeover offer made by bidco.
By way of a shareholder approved and court sanctioned scheme of arrangement conducted by agreement between the purchaser and the target company.
By private sale, in the case of shares in an unlisted company.
There is nothing unique about the financing structures in acquisition facilities. Senior and mezzanine or shareholder facilities are provided to bidco. If PIKs are to be issued, they are usually issued by topco but sometimes they are issued by holdco on an unsecured contractually subordinated basis or by a special purpose sister company owned by the sponsors.
It is usual to allow a period of up to 90 days, but more usually 30 to 45 days, for any target companies to accede to the facility documentation as borrowers, security providers or guarantors.
Equity financing is usually provided through a combination of equity and subordinated loans. Occasionally, vendor financing can be provided, usually by way of secured subordinated notes issued by the holding company (holdco) to the bidding company (bidco) and then endorsed (transferred) by bidco to the vendor in part satisfaction of the purchase consideration.
Structures and documentation
Debt financing structures
Debt financing can take many different forms including:
Senior secured debt.
Junior secured debt (usually referred to as mezzanine or subordinated debt).
Unsecured structurally or contractually subordinated debt.
Paid-in-kind (PIK) debt.
Equity kickers, structured as warrants or options granted in favour of the lenders, are rare and usually limited to acquisitions that are financed by non-bank lenders where bank debt is not available, or as part consideration for lender agreement to a debt restructuring. Bridging debt facilities are also used where it intended that the acquisition debt is refinanced shortly after completion of the acquisition by a capital raising or high yield debt or private paper raised in the US market. The term of bridging debt facilities is usually 365 days or less.
The Loan Market Association (LMA) equivalent is the Asia Pacific Loan Market Association (APLMA). APLMA has produced an equivalent to the LMA standard syndicated facility documentation, which is derived from and closely aligned with the LMA documentation. This version departs from the LMA pro-forma to a limited extent to reflect Australia's:
Interest withholding tax regime.
Loan market practice.
Although the APLMA's syndicated facility documentation has been in circulation for over a decade, the APLMA has not currently produced an equivalent to the LMA's leveraged acquisition documentation. Instead, leveraged acquisition documentation is drafted by the lender's or borrower's counsel based on a combination of their firm's precedents and the APLMA standard documentation. However, with the increasing presence of US and European private equity funds, documentation is becoming increasingly consistent with the LMA's leveraged acquisition documentation.
Inter-creditor agreements are typical in the market and regulate the inter-creditor arrangements between all forms of debt raised to fund the acquisition.
Inter-creditor agreements usually include contractual subordination provisions and contractual subordination is recognised under common law and company legislation. They can also provide certain senior debt with super priority.
Structural subordination is not unusual and it is usually used by payment in kind (PIK) debt or vendor financing raised at the holding company (holdco) or special purpose company (topco) level. It is usually used where senior and junior lenders are not prepared to lend sufficient debt to fund the purchase consideration at the leverage levels required by the sponsors.
Payment of principal
Repayment of principal to subordinated lenders is usually deeply subordinated under the terms of inter-creditor agreements so that no principal repayments are permitted so long as any senior debt is outstanding.
Payment of principal to subordinated lenders is usually restricted under the terms of inter-creditor agreements so that it can only be paid if certain conditions are satisfied. Those conditions usually include a leverage or debt service coverage ratio (DSCR) covenant test set at a tighter threshold than the senior debt financial covenants and no payments can be made while an event of default, potential event of default or review event is occurring.
Payment of upfront fees is usually permitted but payment of recurring fees is usually restricted in the same way as interest.
Senior and junior debt usually share the same security package granted in favour of a security trustee on behalf of all senior and junior lenders. Claw-back arrangements are common.
Subordination of equity/quasi-equity
Equity or quasi-equity financing is always subject to contractual subordination unless it is structurally subordinated. The common position is that equity or quasi-equity financing is deeply subordinated to all other acquisition debt so that no payments of any kind can be made except to the extent they are made from amounts that would otherwise be permitted to be paid as distributions to equity.
Extent of security
The usual position requires all assets security or guarantees to be granted by the holding company (holdco) and bidding company (bidco). Also, within 90 days from the financial close and subject to completion of all financial assistance approval requirements (see Question 10), the target and sufficient subsidiaries of the target must accede to the facility documentation as security providers or guarantors to ensure that together entities that own 85% to 95% of the target group's assets and contribute at least 85% to 95% of total group earnings before interest, taxes, depreciation and amortisation (EBITDA) have given all assets security or guarantees in favour of the lenders. Occasionally, that test will be lifted to 100%.
It is normal to exclude from the security any leasehold interests or contractual rights where it is necessary to obtain the consent of the landlord or counterparty under the relevant contract to the grant of any such security. Traditionally, this was combined with an obligation on the borrower to use best or, more frequently, reasonable endeavours to obtain these consents within a certain period after financial close. However, increasingly this type of obligation is absent or is limited to leases or contractual rights that are necessary to ensure the normal ongoing operations of the target group.
Because New South Wales (NSW) charges mortgage duty on security documents that create security interest over assets located in NSW at a rate of approximately 0.4% of the total amount secured, it can be considered appropriate to exclude NSW assets from the security package if those assets are not considered sufficiently material in the context of the entire security package to justify payment of the duty. If this duty is not paid, the relevant security interests over NSW located assets are not enforceable in court.
Types of security
A general security agreement can be used to secure all types of property (including movable property), but with the exception of real estate, which uses a mortgage. Specific security can be granted over a particular asset or assets under a specific security deed. Any security over interests in real property must be in the form prescribed by the jurisdiction where the relevant land is located.
Security is usually granted under any such deed by an equitable charge or mortgage or, in rare cases, a legal mortgage where (except in the case of interests in real property) title to the secured asset is transferred to the secured lender subject to the security provider's equity of redemption. Any mortgage over real property in the prescribed form will, on registration, constitute a legal mortgage but without any transfer of title. An unregistered mortgage over an interest in real property but in the prescribed form will constitute an equitable mortgage at law.
The giving of a guarantee or security is voidable against the party receiving the benefit of it if that party knows, or by reason of its connection or relationship with the company should have known, that the directors of the grantor have not acted in the best interests of the company in procuring it to give the guarantee or security. Where the guarantee or security is given by the company for the benefit of a related company, such as an upstream security or guarantee, it is not sufficient to look for a benefit to the group (of which the company is a member) as a whole, as the focus is on what is in the best interests of the company alone.
However, this common law rule is modified under section 187 of the Corporations Act 2001 (Cth) (Corporations Act) if the constitution of the company includes a provision to the effect that if the directors of a company are acting in the best interests of the company's holding company, directors of a solvent wholly-owned subsidiary can act in the best interests of that holding company, and be deemed in doing so to have acted in the best interests of the subsidiary company.
If the test of commercial benefit is not satisfied (whether generally or by reason of a section 187 Corporations Act provision in the company's constitution), a general meeting of the company must be held for its shareholders to unanimously approve the transaction (after full disclosure, including specific acknowledgement that the directors would otherwise be in breach). This solution is available because the requirement that the transaction is for the benefit of the company is imposed on the directors, and it appears from case law that a general meeting can prospectively authorise directors to enter into a transaction that can possibly involve a breach by the directors of their fiduciary duty to the company. However, breach of duty by directors of a company cannot be absolved by shareholders if the company is or would be insolvent. Therefore, the approach is that if in doubt to seek shareholders' consent and obtain a certificate of solvency from the directors of the relevant company. Alternatively, sufficient consideration for the giving of the guarantee or security must be constructed.
Shares. An all-assets general security deed can be used to take security over shares, or where the shares are the only assets to be secured, a specific security deed expressed to operate as a charge or a mortgage, usually on limited recourse terms, can be used (in either case together with delivery of all share certificates). If the shares are listed, it is necessary to enter into a control agreement with the broker or company that controls the trading in those shares through the Clearing House Electonic Subregister System (CHESS) share system maintained by the stock exchange, under which the broker or controller of the shares agrees with the security holder not to deal in the shares without the consent of the security holder.
Inventory. An all-assets general security deed can be used to take security over inventory, or where the inventory is the only asset to be secured, a specific security deed can be used, in either case expressed to operate as a charge over the inventory.
Bank accounts. An all-assets general security deed can be used to take security over bank accounts, or where the bank account is the only asset to be secured, a specific security deed can be used, in either case expressed to operate as a charge over the bank account. If the bank account is of material credit importance or value, such as an escrow account, a tripartite control agreement can be required to be entered into between the:
Holder of the account.
Lender or security trustee.
Bank with which the account is maintained.
A control agreement is not necessary in cases where the bank account is maintained with the secured lender.
Receivables. An all-assets general security deed can be used to take security over receivables, or where the receivables are the only assets to be secured, a specific security deed can be used, in either case expressed to operate as a charge over the receivables.
Intellectual property rights. An all-assets general security deed can be used to take security over intellectual property rights, or where the intellectual property rights are the only assets to be secured, a specific security deed can be used, in either case expressed to operate as a charge over the intellectual property rights.
Real property. This requires a real property mortgage in the form prescribed by the jurisdiction where the land is located together with delivery of all certificates of title.
Movable assets. An all-assets general security deed can be used to take security over movable assets, or where the movable assets are the only assets to be secured, a specific security deed can be used, in either case expressed to operate as a charge over the movable assets.
Guarantees must usually, but not always, be given by any third party provider of security. They are also commonly required under any unsecured financing. Restrictions on the giving of upstream guarantees due to lack of corporate benefit apply in the same way as they do to the giving of security as outlined above.
Security is almost always given in favour of a security trustee where security is to be granted in favour of more than one lender.
Where a company is thinly capped, Division 820 of the Income Tax Assessment Act 1997 (1997 Act) applies, which prohibits debt deductions (including interest) to the extent that certain debt-to-equity ratios are exceeded.
A range of ratios apply and depend on which category stipulated in Division 820 of the 1997 Act the entity falls under. Safe harbour debt amounts apply in relation to all categories.
For non-financial institutions, the permissible safe harbour debt ratio, on a debt-to-equity basis, is 1.5:1 (or debt cannot exceed 60% of the entity's average value of assets. Excess debt capacity of certain associated entities can be taken into account for these purposes. Within a tax consolidated group, the debt capacity of all entities in the group is taken into account).
For financial institutions, the permissible safe harbour debt ratio in most cases is the lesser of 15:1 (after excluding assets which can be fully funded) or 1.5:1 (after excluding debt which is on-lent to third parties).
To determine an entity's asset value for the purposes of applying the safe harbour debt amount, assets and non-debt liabilities that are wholly or principally for private purposes are excluded.
The thin capitalisation rules do not apply where:
Debt deductions (including those of the entity's associates) are less than A$2 million.
The entity's operations are confined wholly outside Australia or, if the entity is not subject to foreign control, confined wholly within Australia, or the entity is an exempt bona-fide securitisation vehicle.
The thin capitalisation rules provide a cap on the extent where debt deductions are allowable deductions of an Australian entity in specified circumstances.
Debt deductions arise from debt interests. A debt interest must satisfy the tests in Division 974 of the 1997 Act (Debt Equity Rules). The Debt Equity Rules classify interests as either debt or equity for, among other things, the purposes of the thin capitalisation rules.
In summary, a "debt interest" is one where an entity receives a financial benefit (that is the advance of loan money) and has an "effectively non-contingent obligation" to provide a financial benefit (that is principal repayment and interest payments) after the receipt of the initial financial benefit of at least equal value to that of the benefit received. Different valuation rates apply depending on the term of the instrument.
In contrast, an equity interest is, among other things, an interest that carries a right of return that is contingent on the economic performance of the company (for example, where the company has profits) or is contingent on the company exercising its discretion to pay a return. The loans made by foreign lenders generally need to satisfy the debt test for interest payments to be an allowable income tax deduction to the borrower subject to the cap on deductions imposed by the thin capitalisation rules.
If any acquisition (including by subscription) of shares or options or interests in shares is involved in a financing transaction, then section 260A of the Corporations Act 2001 (Cth) (Corporations Act) must be considered.
A company can financially assist a person to acquire shares (or options over or interest in shares) in the company or a holding company of the company only if either (section 260A, Corporations Act):
Giving the assistance does not materially prejudice the:
interests of the company or its shareholders; or
company's ability to pay its creditors.
the assistance is approved by shareholders in accordance with section 260B of the Corporations Act.
Financial assistance can be given before or after the acquisition of shares and can take the form of a dividend.
Although a transaction that breaches section 260A of the Corporations Act is not invalid (section 260D, Corporations Act), any person involved in the contravention of the provision is guilty of a civil offence.
If there is any concern that the proposed transaction may breach this section, then the safest approach is to obtain shareholders' approval of the transaction, in accordance with the provisions of the Corporations Act.
Shareholder approval of financial assistance by a company must be given by (section 260B( 1), Corporations Act):
A special resolution passed at a general meeting of the company, with no votes being cast in favour of the resolution by the person acquiring the shares (or options over or interests in the shares) or by their associates.
A resolution agreed to, at a general meeting, by all ordinary shareholders.
The financial assistance must also be approved by a special resolution of shareholders of the holding company of the target if, because of the acquisition, the target company:
Becomes a subsidiary of a listed domestic corporation immediately after an acquisition of shares (section 260B( 2), Corporations Act).
Will have a holding company that is an unlisted domestic corporation but that is not itself a subsidiary of a domestic corporation (section 260B( 3) , Corporations Act).
Section 260B of the Corporations Act also requires notification to the Australia Securities and Investment Commission (ASIC).
Regulated and listed targets
Change in ownership or control of companies that, because of the nature of their business, are regulated by various governmental bodies at a Federal or State level usually require governmental approval. Examples of these bodies include:
The "big four" banks (see Question 1).
Owners of key infrastructure, such as airports and power and utility providers.
Although foreign investment is welcomed, the acquisition by foreign persons of a legal or equitable interest in Australian companies, land or businesses is generally (subject to varying minimum thresholds) regulated under the Foreign Acquisitions and Takeovers Act 1975 (Cth) and associated regulations (FATA). Where FATA applies to a proposed acquisition, the proposed acquisition must be notified to the Foreign Investment Review Board (FIRB). The Treasurer then has a discretion to prohibit the acquisition on the grounds that it is contrary to the national interest, which can be exercised within 30 days (subject to extension for up to an additional 90 days) of notification.
There is an exception to the requirement to notify FIRB for a security interest granted in favour of either:
A foreign person engaged in the ordinary course of money lending.
Security trustees that hold the benefit of a security interest on behalf of these people.
However, that exception does not apply to a lender or security trustee where a foreign government controls at least a 20% interest, unless it is authorised under the Banking Act 1959 (Cth) to take deposits.
Effect on transaction
Regulatory consents can be required in order to complete an acquisition of an entity operating in a regulated industry or to take security over the assets of the entity. However, this usually does not affect the financial covenants required under the terms of the financing.
Specific regulatory rules
The acquisition of a relevant interest in a listed entity is regulated by the takeover provisions of the Corporations Act 2001 (Cth) (Corporations Act).
Methods of acquisition
In the context of leveraged acquisitions, a listed target is acquired in one of two ways.
The first way is for the bidding company (bidco) to make a takeover offer under Chapter 6 of the Corporations Act. In general terms, a person must not acquire voting shares in a listed company without making a takeover offer for all or a specified proportion of the shares in a listed company if the person (together with its associates) as a result of that acquisition would hold more than 20% of the voting shares.
The takeover offer can either be:
Supported by the target's board.
Hostile. In this case, the bidco is prevented by the target's board from conducting due diligence on the target.
The consideration for the shares in the subject of the takeover bid can be:
A combination of cash and scrip.
The takeover offer remains open for acceptance for a period specified in the offer document (the period must comply with the Corporations Act and can be extended in certain circumstances). The takeover offer can also be subject to specified conditions that are not prohibited under the Corporations Act. Those conditions can include an insolvency event or a material adverse change in the business condition of the target not having occurred (provided that, in the case of the latter, the breach of the condition can be adjudged by reference to objective thresholds). They also typically include a minimum acceptance condition (that is a condition requiring the bidder to have received a minimum number of acceptances with respect to the shares in the target). The minimum level is usually initially set at 90%, which is the minimum voting power required for the bidder to use the compulsory acquisition procedures under the Corporations Act to catch minority shareholders that have not accepted the offer. However, frequently this minimum acceptance condition is reduced to just over 50% during the course of the takeover in order to generate momentum and further acceptances.
Another means by which listed targets are acquired is the scheme of arrangement. Chapter 5 of the Corporations Act permits a court-sanctioned and shareholder-approved transfer of shares in a company (listed or unlisted) to a bidder. The procedure involves the production of a scheme booklet explaining:
Its effect on the shareholders.
Any other information that is material to the decision of the shareholders whether to approve the scheme.
Having regard to the booklet and whether the corporate regulator, the Australian Securities Investment Commission (ASIC), has any objection to the scheme, the court decides whether to allow the booklet to be issued to shareholders in the target and for a meeting of shareholders in the target to be convened for the purpose of voting on the scheme. The scheme requires the approval of at least 75% of the votes cast at the shareholders' meeting and of a majority (in number) of the shareholders present and voting at the meeting. If the shareholder approval is obtained, then the matter returns to court for the final orders approving the scheme. This second order is more of a formality than a substantive hearing (provided that no objections are raised to the transaction by ASIC or by an interested party). The order is then lodged with ASIC and the transfer of shares usually occurs several days later.
The scheme route is realistically only available if the target's directors are in favour of it. If they are, bidco and its advisers are usually able to conduct due diligence on the target.
There is no legal requirement for a bidder to have debt facilities available to it on a certain funds basis (unlike in the UK). However, the Corporations Act prohibits people from making takeover offers if they know they are unable, or have been reckless as to whether they will be able, to complete the offer. The Takeovers Panel has issued a guidance note explaining the effect of this provision in the context of financing a bid. Essentially, the Takeovers Panel expects that a bidder has, at the time of announcing its takeover offer, binding commitments from its debt underwriters (or other financiers, unless the bidder will fund its obligations through existing cash). Nor should a bidder declare its bid unconditional unless it is highly confident that it will be able to draw down under the debt facility (that is, binding funding documents must be documented in final form and all conditions precedent that are not within its control must have been satisfied).
The Takeovers Panel has stated in its guidance note that if the debt facility contains material conditions precedent (for example, a material adverse change clause), these should be set out in the takeover offer documentation so that the market is aware of them. In other words, these conditions are permissible but must be disclosed so that shareholders in the target can make an informed decision whether to accept the offer for the shares and the market can assess the likelihood of the funding being available.
Although, as a matter of law, there is no requirement for the debt facilities to be subject to certain funds provisions, these clauses are typically used in takeover financing.
The Takeovers Panel has the power under the Corporations Act to review the conditions of a takeover offer and to determine whether the financing arrangements comply with its guidance note. If the Panel determines that they do not comply then the Panel can effectively stop the takeover offer from continuing.
Generally, once a bidder holds more than 90% of the voting shares in the target and at least 75% of the shares the subject of the takeover offer, the bidder can proceed to compulsorily acquire the remaining shares under the Corporations Act. Once it has acquired all the shares in the target, the target and its wholly owned subsidiaries can pass financial assistance whitewash resolutions and, shortly after they have done so, guarantee the acquisition facility and give encumbrances over their assets securing that facility. However, it is common for bidders to reduce the minimum acceptance condition from 90% to just over 50% to encourage shareholders to accept the offer (see above, Methods of Acquisition). This strategy carries the risk that the desired rush of acceptances does not materialise or a third party acquires a blocking stake of more than 10% so that the bidder is left holding less than 90% of the target shares. In these circumstances, the target and its subsidiaries are unable to implement the financial assistance whitewash procedure, meaning that the lenders under the acquisition facility are left holding only the security over the shares held by bidco in the target.
Issues very rarely arise unless the target company maintains a defined benefit scheme that is underfunded. Very few organisations maintain defined benefit schemes anymore and most pension arrangements are maintained as accumulation superannuation funds. If a defined benefit scheme is operated by the target it is important for the acquirer to confirm and model the potential future funding requirements of the scheme.
A lender does not owe a borrower any general legal duties simply as a result of the borrower or lender relationship (other than to keep the borrower's information and details about the banking relationship confidential). However, a lender can incur duties or liability if it is taking on other roles in relation to the acquisition such as providing advice or participating in the acquisition with the borrower.
Criminal and civil liability can attach to a lender and its employees involved in the transaction if they are knowingly involved in a breach of the financial assistance prohibition discussed above (sections 79, 260D(2) and 260D(3), Corporations Act 2001 (Cth) (Corporations Act)).
Security given for, and repayment of loans, can also be set aside under section 588FA of the Corporations Act if the provision of the security or the repayment is given to an existing creditor of an insolvent company within six months before the company's winding up or administration.
Alternatively, any transaction between a lender and an insolvent company can be set aside if it is entered into within two years before the company's winding up or administration and is an uncommercial transaction from the company's perspective (section 588FB, Corporations Act). A transaction is uncommercial only if it is expected that a reasonable person in the company's position would not have entered into the transaction having regard to the benefits and detriment to the company, and the benefits to the lender of entering into the transaction in question. The lender does not need to be an existing creditor of the company for this section to apply.
Certain defences against having the security, repayment or transaction set aside are available to lenders.
Section 588G of the Corporations Act also imposes liability on a director that allows a company to trade or incur debts while the company is insolvent. The risk for the lender is that it can be regarded as a director under section 9 of the Corporations Act. Under that section, "director" is defined as including persons or corporations whose instructions or wishes the directors of the company are accustomed to act in accordance with. Persons falling within that part of the definition of director are commonly described as "shadow directors".
If a lender is regarded as being a shadow director of an insolvent company, the risk is is that it may incur liability under section 588G of the Corporations Act if the company continues to trade.
There have been no cases to date where a financial institution has been taken to be a shadow director. However, it is common for lenders to become more actively engaged in a borrower's affairs if the borrower is experiencing financial difficulties. If, in those circumstances, the lender is in effect making decisions for the company, it runs the risk of being treated as a shadow director.
Gilbert + Tobin
Professional qualifications. New South Wales, Australia, Solicitor
Areas of practice. Banking, finance.
Independence Group NL on its debt facilities in relation to the A$1.8 billion acquisition of Sirius Resources NL by scheme of arrangement.
Woolworth Holdings Limited (South Africa) on its A$2.8 billion debt raising and ZAR10 billion rights offer in relation to the acquisition of David Jones Limited by scheme of arrangement, and on its A$213 million acquisition of the minority shareholdings in Country Road Group Limited.
Pacific Equity Partners and the Spotless Group in relation to Spotless Group's US$845 million and A$200 million (First Lien) and US$235 million (Second Lien) term loan B debt financing, and subsequent refinancing in relation to the initial public offering of the Spotless Group.
Pacific Equity Partners and Hoyts Group in relation to Hoyts Group's US$450 million term loan B debt financing arranged by Credit Suisse and UBS.
Hoyts Group in relation to its AU$485 million refinancing of its then existing term loan B debt facilities.
Credit Suisse AG as agent and Credit Suisse Securities (USA) LLC as co-lead arranger in relation to the US$5 billion term loan B debt financing for the Fortescue Metals Group, and US$4.9 billion term loan B refinancing.