Review of 2010 / What to expect in 2011

Practical Law UK Legal Update 5-504-5430 (Approx. 8 pages)

Review of 2010 / What to expect in 2011

by Nigel Clark and Ralph AylingMinter Ellison

Published on 31 Jan 2011 • Australia

This article is part of the PLC Global Finance January 2011 e-mail update for Australia.

The Australian economy was one of the strongest performing of the developed economies in 2010. This was primarily as a result of a mining export boom driven by demand in China and to a lesser extent India. Consensus forecasts expect the economy to grow by an above trend 3.4% in 2011.

As a small, open economy the Australian outlook is dependent on the world economy. What happens in Europe and the United States is important but Australia's economic performance in 2011 depends substantially on China and the other economies of developing Asia.

The position at the height of the credit crisis, where borrowers locked in whatever liquidity was available at whatever cost, has been replaced with a more balanced environment – at least for those borrowers who have been able to repair balance sheets and lower gearing, and they are now well placed to raise funding on more advantageous terms. The flight to quality has seen competition intensify for those lenders wanting to fund the best corporate borrowers and project sponsors.

Corporate credit growth declined in 2010 with companies reducing debt levels through equity raisings and retained earnings. An estimated AUD60 billion to AUD80 billion of debt is expected to be refinanced in 2011. Not all of that will be refinanced in the loan markets. It is also expected that there will be a greater level of M&A activity in 2011 leading to an increased volume of acquisition lending.

We are now seeing signs that the markets are returning to equilibrium and stronger borrowers are continuing to push back on the recent years' tightening of lending covenants and increased margins. This has been assisted by the fact that there is now strong competition between lenders looking to grow their loan books again after shrinking them over the past two years. Also, the loan market has been supported by deposit rich Asian banks keen for exposure to top quality Australian companies.

Borrowing margins have contracted since the height of the credit crisis, for instance standard pricing for a BBB rated company has narrowed from between 275 and 300 basis points to about 200 basis points above the bank bill rate. It is anticipated that margins may tighten by about a further 20 basis points during 2011.

Reflecting greater confidence and liquidity, we have also seen the lengthening of tenors from three years, with some five year and in some cases, seven year money emerging in the corporate finance markets. The re-entry of rated entities into the bond markets, particularly into the US market, has allowed borrowers to extend and manage their debt mix and maturity profiles. A simplified disclosure process has recently been established to assist development of a deeper Australian corporate retail bond market, although only a small number of issues have taken place.

As in other countries, banks are seeking further clarification on the key elements of implementation in Australia of the Basel III reforms. Australian banks have obtained a concession on the liquidity rules because of the low levels of Australian government debt. Banks will be able to make up the shortfall in government debt securities by drawing from the Reserve Bank of Australia under a new liquidity facility.

In the securitisation market, CMBS programs continue to be refinanced with bank debt and very few new issuances have occurred, whilst the RMBS market continues to function on the back of federal government support - as part of measures unveiled in December 2010 to improve competition in the banking sector, the federal government pledged to spend another AUD4 billion on RMBS, taking to AUD20 billion its investment in non-bank lenders since the onset of the credit crisis – the federal government has invested in 80 per cent of the RMBS market issuance in 2008 and early 2009, with the private sector investing in the remainder, but that situation has since reversed. Issuance by non-bank lenders in 2011 is not expected to be substantial.

The federal government has also announced that it will permit banks to issue covered bonds. This will require an amendment to the Banking Act and it would appear to be of most benefit to the major Australian banks.

On the project front, as was the experience in numerous foreign markets, Australian public private partnership (PPP) sponsors found it difficult to secure committed debt finance greater than AUD250m per project during the credit crisis. Available funding came with higher costs, shorter maturities and tighter covenant packages. As a result, the number of PPP projects to reach financial close during the credit crisis was significantly down on previous years.

During the credit crisis, Australian governments became more accepting of structural adjustments and adopting certain risks that had previously been allocated to the private sector. For example, during the credit crisis, the Australian private sector no longer had any appetite to accept patronage risk. The Peninsula Link road project, which was the only closed PPP road project in Australia since the commencement of the credit crisis, used an availability payment model. Additionally, the public sector showed a willingness to provide more debt support by sharing in refinancing losses, market disruption risks and swap break costs.

Encouragingly, post-credit crisis trends are starting to emerge in the Australian PPP market. This is in part due to the support for the PPP model shown by Australian governments during the credit crisis by adopting additional risk where necessary. As markets improve, we are seeing the beginnings of a preparedness by sponsors to take back some risks (particularly in relation to refinancing and market disruption) in order to gain a competitive edge over rival consortia. There are a number of Australian PPP projects in the pipeline, local and foreign banks are showing interest and there is confidence and optimism in the sector.

Sons of Gwalia response

In 2007, the High Court of Australia in Sons of Gwalia v Margaretic (2007) 81 ALJR 525: [2007] HCA 1 confirmed the general law principle that shareholder claims for compensation are not subordinated to the claims of ordinary unsecured creditors of the company.

This decision caused some controversy, as it was contrary to the widely accepted view that Section 563A of the Corporations Act 2001 (Cth) postponed debt claims owed by a company to a person in his or her capacity as a member of that company. In particular, there were market concerns about the impact of the decision on the corporate bond market (especially US bond issues).

After intense market pressure the Commonwealth Government announced that it would legislate to abolish the principle established in the Sons of Gwalia decision. New legislation amending the Corporations Act 2001 (Cth) has been introduced into the Commonwealth parliament and has been considered by the Senate Economics and Legislative Committee without comment. The broad thrust of the Bill is that shareholder claims should not rank equally with the claims of 3 LON1_322656_1 (W2003) unsecured and trade creditors. Although, significantly, the reform does not abolish what have come to be called Sons of Gwalia style claims that is, that a person is not prevented from obtaining damages and other compensation from a company simply because they are a shareholder. Instead these types of claims are subordinated until all other claims made against the company are satisfied. The amendments are not retrospective. They will only apply where the shareholders' claim arises after the amendments come into effect. This means they will not apply to current administrations but will apply in future administrations even where the shareholders' claim arises through actions that occurred before the amendments came into effect.

Lenders and other third parties as shadow directors or officers

Lenders and other third parties dealing with companies in distress are often concerned that by exercising legitimate legal rights they can become shadow directors, especially when the directors allege they have no choice but to do what the lender wants, because receivership is the only alternative.

In a judgement handed down by White J in the Supreme Court of New South Wales (reported as Buzzle Operations Pty Ltd (In Liquidation) v Apple Computer Australia Pty Ltd [2010] NSWSC 233), the Court has now provided some much needed guidance as to where the limits really lie. In his detailed examination of the meaning of the terms 'officer' and 'director' in Section 9 of the Corporations Act 2001 (Cth), his Honour has confirmed that:

It is not enough that a third party imposes conditions on their ongoing support. It is left up to the directors to discharge their own duties to the company and to decide whether or not to comply, even if they may feel they have 'no choice' but to comply with the conditions imposed by third parties.
There must be a causal connection between the third parties' intentions and wishes, and the directors’ conduct. It is not enough that the directors were going to act as they did for their own reasons.
There must be a habitual compliance with the third parties' intentions and wishes over a period of time.

In finding that the third party, in this case Apple and one of its employees, was not an "officer" or a "shadow director" of Buzzle Operations Pty Ltd, his Honour noted that:

Mere acquiescence by the directors of a company to a third party's demands, does not mean that the third party is participating in the company's decision-making.
It was not enough that the third party had the capacity to affect the company's financial standing but rather that the third party must be an insider involved in the management of the company's affairs.
Directors would be expected to exercise their own judgment as to whether it is in the interests of the company to comply with the third party's demands.

Securitisation and sell-downs: lessons from Goodridge

Goodridge v Macquarie Bank Limited [2010] FCA 67, related to the purported transfer of rights and obligations in respect of a margin loan that had been made available by Macquarie Bank to an investor (Goodridge) and the validity of a margin call made subsequent to the purported transfer. Despite broad assignment and novation provisions in the underlying loan documents, the lender's rights were held to be incapable of assignment where they are inherent and necessary to its obligations under the whole loan and security arrangements (as was found to be the case with a margin loan product). A novation of the lender's rights and obligations would therefore be required in order to transfer the lender's rights. This in turn led to an examination of the requirements to effect a valid novation, including whether a borrower can prospectively authorise a novation by a lender without any consent, or further involvement or knowledge on the part of that borrower.

Whilst dealing specifically with an invalid transfer of a margin loan, the case raised issues applicable to loan securitisations, sell-downs and substitutions. Following the case, a lender wishing to validly transfer its rights needed to consider whether, due to the type of loan, it was necessary to also transfer loans its obligations (by novation). A lender seeking to transfer its rights and obligations needed to consider the extent to which borrower involvement was needed to effect the novation. The case had substantial implications for the margin loan industry and equitable title securitisations, but also for sell down rights under a range of other transactions.

On 18 January 2011, three judges of the Federal Court of Australia (Leveraged Equities Limited v Goodridge [2011] FCAFC 3) upheld an appeal from this case by Macquarie Bank and Leveraged Equities. As a result, the law as it stood prior to the primary decision was reinstated. The judges in the appeal decision considered the issues in two separate groups; the margin call case and the transaction case.

The margin call case turned on whether the lender (Macquarie) could shorten the period for compliance once a margin call had been made.

The transaction case reviewed the series of documents that gave rise to the assignment of the lender's rights. It was held at the primary judges ruling:

That the lender's rights were incapable of assignment where they are inherent and necessary to its obligations under the whole loan and security arrangements was not correct. The appeal court held that the lender's rights were capable of assignment.
That a borrower cannot prospectively authorise a novation by a lender without consent or further involvement or knowledge on the part of that borrower, was also found not to be correct. The appeal Court held that a contract could prospectively authorise a novation without further consent of the borrower.

Althought the law is now as it was before the primary Goodridge case, the case clearly demonstrates that careful consideration needs to be given to the drafting of notice, assignment, novation and sell down provisions in all agreements.

High Court dismisses Octaviar appeal

The Corporations Act requires that notice of a variation in the terms of a registered charge must be lodged with the Australian Securities and Investments Commission (ASIC) where the variation increases the liabilities secured by the charge. Failure to do this may render the charge void as security for the increased liabilities as against a liquidator or administrator. Before the litigation in relation to the collapse of the MFS Group (later re- badged as the Octaviar Group) commenced it was common to vary the amount secured by a registered charge by adding or amending related transaction documents, without lodgement of a notice of variation of the charge with ASIC. A decision bv a single judge in the Queensland Supreme Court (Re Octaviar Ltd; Re Octaviar Administration Pty Ltd [2009] QSC 37) (First Instance Decision) called this practice into question and suggested that lodgement with ASIC was necessary (either because the practice created a new charge or because it varied the terms of an existing charge in a manner which increased the liability secured). The First Instance Decision was potentially very significant for financiers in a volatile financial environment where insolvencies were on the rise. As a result, financiers sought to take new charges and/or to convert the existing charges to all moneys charges.

The First Instance Decision was appealed to the Queensland Court of Appeal which overturned it in a unanimous 3-0 verdict. On subsequent appeal to the High Court of Australia (Australia's highest court) the decision of the Queensland Court of Appeal was upheld in a unanimous 5-0 decision.

The High Court decision confirms that an increase in the liabilities secured by a registered charge will not usually require separate lodgement with ASIC unless the increase is effected by an amendment to the charge document. In particular, where:

A charge is expressed to secure all money owing to the chargee under or in connection with a defined class of documents (often called "Transaction Documents").
The definition of Transaction Documents contemplates that additional documents can be added by a separate agreement between the chargor and the chargee.

ASIC will not need to be notified of the addition of a new Transaction Document. This has restored market practice to the ‘pre-Octaviar’ position.

Bofinger v Kingsway Group Ltd [2009] HCA 44

The case was brought by the guarantors of defaulting debts, owed to first, second and third ranking mortgagees. A development company, B&B Holdings, borrowed money from the first-, second and third ranking mortgagees and granted mortgages over various properties in support of such loans. A director of B&B Holdings and his wife guaranteed repayment of the loans.

B&B Holdings then defaulted under the first-ranking mortgagee's loans and the guarantors sold properties they owned and applied the proceeds in reduction of the first-ranking mortgagee's debt. The first-ranking mortgagee then exercised its power of sale to recover the balance owed by B&B Holdings.

After satisfying the balance of the indebtedness owed, the first-ranking mortgagee paid the surplus proceeds to the second-ranking mortgagee. The guarantors contended that the firstranking mortgagee should have paid the surplus proceeds to them so that they could recoup, under their right of subrogation, the amount they had paid to reduce the indebtedness of B&B Holdings.

In a unanimous decision, the High Court overturned a decision of the New South Wales Court of Appeal and found in favour of the guarantors. The court found that the guarantors, having paid down some of the first-ranking mortgagee's debt, had the right to the surplus proceeds and the first-ranking mortgagee should have accounted to them. Having paid the second-ranking mortgagee, the first-ranking mortgagee was still liable to the guarantors.

This was based on the principle of subrogation which allows a guarantor, having paid off the guaranteed debt, to stand in the shoes of the lender and have all the rights of the lender against the borrower.

Prior to this case, mortgagees would have taken comfort from section 58(3) of the Real Property Act 1900 (NSW) which requires the proceeds from the sale of land by a mortgagee to be applied first in payment of the first mortgage and second in payment of the second mortgage and so on. However, the Court found that 'upon that first mortgagee equity may place requirements as to the disposition of the surplus purchase money'. The Court found that the guarantors could have excluded their right of subrogation by agreement or conduct but the terms of the documentation in this case did not operate in that way.

The decision is contrary to common practice and statutory authority. It allows a guarantor to step in the lender's shoes and enjoy all the lender's rights against the borrower, following the repayment of guaranteed debt, resulting in a subsequent mortgagee becoming unsecured through no action or fault of its own. As a result, particular attention needs to be paid to the terms of a guarantors right to repay under a guarantee.

Personal Property Securities Reform

In 2011, Australia will implement a major overhaul of its personal property security legislation; the Personal Property Securities Act 2009 (Cth) (PPSA). The PPSA will replace over 70 Commonwealth, state and territory Acts, administered by 30 government agencies, and will be supported by a national online system for registering interests in personal property securities, the Personal Property Securities Register. Originally scheduled to commence in May 2011, on 15 December 2010, the Business Regulation and Competition Working Group of the Council of Australian Governments (COAG) has recommended to COAG that the PPSA's commencement should be delayed until October 2011. At the time of writing, COAG has not yet endorsed this recommendation, but it is expected to do so when it meets on 14 February 2011.

Broadly, the PPSA applies to all personal property other than land, although there are certain statutory exclusions. It introduces a functional approach to personal property securities where the form of the transaction (and the identity of the person with title to the secured property) is not important if the substantive effect of the transaction is to secure payment of an amount or performance of an obligation.

The PPSA will fundamentally change how security interests in personal property are taken and perfected and will extend to a range of transactions that are not currently considered security (or even quasi-security), such as certain leases, retention of title supply arrangements, flawed asset arrangements and turnover trusts. Under the PPSA, a person (a secured party) who holds a security interest (or is deemed to hold a security interest, such as in the case of certain lessors of goods) will need to take steps to perfect that security interest to protect its interest in the relevant personal property. This is the case even if the secured party has title to the relevant secured property (as is the case with a lessor, or a supplier using retention of title terms). Failure to perfect a security interest could result in a secured party losing secured property, for example, in a priority dispute, or on the insolvency of the person granting the security interest.

Following the PPSA's commencement, the current statutory regime for registering charges against Australian companies will be repealed, with the effect that security documents will no longer be lodged with ASIC, rather notice of security interests will be filed on the electronic Personal Property Securities Register.

Generally, the PPSA will apply if secured property is located in Australia or if the grantor of the security interest is an Australian entity. Further information on the PPSA is available in various PLC Global Finance multi-jurisdictional monthly e-mails.

Consumer credit legislation

In 2008, the Council of Australian Governments agreed that the Commonwealth Government should take over responsibility for the regulation of consumer credit from the states and territories. The Australian Securities and Investments Commission (ASIC) has become the national regulator for consumer credit and finance broking. The reform programme consists of two phases.

Phase one was completed in 2010 with the commencement on 1 July 2010 of the substantive requirements of the National Consumer Credit Protection Act 2009 (Cth) (Credit Act), including the National Credit Code (NCC) and the National Consumer Protection (Transitional and Consequential Provisions) Act 2009 (Cth) (Transitional Act) (collectively, the Credit Legislation). In addition, the Corporations Act 2001 (Cth) was extended to regulate margin lending.

The intention of the Credit Legislation is to provide a single set of rules, and a single system of regulation, for the consumer credit industry. To summarise the key provisions of the Credit Legislation:

A national licensing regime was established to require providers of consumer credit and credit-related brokering services and advice to register with and subsequently obtain a licence from ASIC.
ASIC became the national regulator of the new credit framework with enhanced enforcement powers.
A new National Credit Code was introduced which replaces the state-based UCCC and applies to credit provided for residential and residential investment property purposes.
The provision of 'credit' to individuals and strata corporations is regulated, in general, where the credit is provided or intended to be provided wholly or predominantly for personal, domestic or household purposes or to purchase, renovate or improve residential property for investment purposes.
Credit activities include providing or assisting with the provision of credit, being a lessor under a consumer lease, being a mortgagee under a regulated mortgage and being a beneficiary of a regulated guarantee.
The introduction of a number of general conduct requirements for licences.
The requirement for licensees to comply with 'responsible lending' obligations including obligations to carry out unsuitability assessments; to provide certain disclosure documents; and not to provide unsuitable credit.
Mandatory membership of an external dispute resolution body by all providers of consumer credit and credit-related brokering services and advice.

Looking at phase two of the reforms, these were announced to include a review of unsolicited credit card limit extension offers, the possible regulation of reverse mortgages and further measures, where necessary, to address unfavourable lending practices. A Green Paper on Phase Two of the COAG National Credit Reforms was released for comment in July 2010, which outlined the options for reform. While phase two reform consultations continue, the government has already committed itself to reform in two areas:

The government has committed to credit card reforms in its Fairer, Simpler Banking policy, which includes proposals that consumers are not charged over-limit fees unless they specifically agree that their account can go over the limit, credit card providers must allocate repayments to higher interest debts first and interest charges are applied consistently under an industry-agreed standard, including when interest starts to accrue and on what balances.
Legislation is proposed to be implemented by mid 2012 in relation to reverse mortgages to give statutory protection against negative equity and require greater disclosure of features and fees.

Consumer protection reforms

In addition to the consumer credit reforms, a single, national consumer law has been passed by Parliament to provide stronger protection to Australian consumers. In March 2010, the first part of the Australian Consumer Law (ACL) was passed as the Trade Practices Amendment (Australian Consumer Law) Act (No.1) 2010 (Cth). The ACL introduced new laws relating to unfair contract terms. Under the ACL, from 1 July 2010 unfair terms in standard form consumer contracts will be void. However, a contract continues to bind the parties to the contract to the extent that the contract is capable of operating without the unfair term.

From 1 January 2011, the ACL commenced as a law of the Commonwealth and of each State and Territory. At the same time, the name of the Trade Practices Act 1974 will change to the Competition and Consumer Act 2010. The ACL will be Schedule 2 to the Competition and Consumer Act 2010.

The ACL is a single, national consumer law which replaces provisions in 17 national, State and Territory consumer laws. This will be achieved by each State and Territory preparing laws to repeal any existing consumer laws and to apply the ACL as the law of each respective State or Territory.

Victoria has already passed the:

Fair Trading Amendment (Australian Consumer Law) Act 2010.
Fair Trading Amendment (Unfair Contract Terms) Act 2010.

Under the ACL (including as incorporated into the Fair Trading Act 1999 (VIC)) a term of a standard-form consumer contract will be unfair, and therefore void, if it causes a significant imbalance in the parties’ rights and obligations under the contract, is not reasonably necessary to protect the supplier’s legitimate interests and would cause detriment to the consumer if it were relied on.

The provisions of the ACL dealing with unfair terms will apply to a term of a housing loan if that housing loan is renewed or varied, or the term is renewed or varied, after 1 July 2010. A term of a housing loan which is unfair under this legislation may be declared void. Equivalent changes have been passed for financial services under the ACL by way of amendments to the Australian Securities and Investments Commission Act 2001 (ASIC Act).

Review of 2010 / What to expect in 2011 | Practical Law