On 13 November 2008, ASIC announced that it would lift the ban on short selling of non-financial securities but would continue the ban on covered short sales in financial securities effective as of 19 November 2008.
The ban on short selling of financial securities will remain in place until 27 January 2009. Financial securities are those comprising the S&P /ASX 200 Financials and five additional securities (Wesfarmers Limited, The Rock Building Society Limited, Wide Bay Australia Ltd, Futuris Corporation Limited and Calliden Group Limited).
Existing exemptions for covered short selling in relation to financial securities and the facilitation of the sale of securities being recalled from a stock-lending program (whether or not they are financials) will continue.
ASIC also provided some additional information in relation to disclosure requirements that will apply from 19 November 2008. This includes a disclosure and reporting framework for short sales implemented by ASIC on 12 November 2008 including the requirement for a broker to ask a client whether a sale is a long sale or short sale.
On 13 November 2008, the government announced the final bill, the Corporations Amendment (Shortselling) Bill 2008 (Bill) which was introduced to the Parliament later that day to regulate the use of short selling. The Bill has passed through the House of Representatives and is expected to be passed by the Senate in the current session.
The Bill includes:
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a ban on naked short selling;
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a comprehensive disclosure regime for permitted covered short selling;
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an expansion of ASIC’s powers to enable it to impose regulations on transactions that are substantially similar in effect to short selling; and
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a legislative confirmation of ASIC’s previous declarations temporarily banning covered short selling and requiring the disclosure of permitted covered short sales.
The details of the timing of the disclosure of the short selling data will be resolved by the Regulations.
Michael Hodgson, Partner, Sydney & Naoko Aoo, Lawyer, Sydney
Personal Property Securities (PPS) Bill
A revised draft of the Personal Property Securities (PPS) Bill has been released for comment. A copy of the revised draft bill is available at:
www.ag.gov.au/pps
The revised draft bill takes into account issues raised in the submissions received on the PPS consultation draft bill released in May.
The revised draft bill has been referred to the Senate Standing Committee on Legal and Constitutional Affairs for inquiry and report by 24 February 2009.
The Committee has invited written submissions on the revised draft bill by 10 December 2008.
Information on how to make a submission is available at:
www.aph.gov.au/Senate/committee/wit_sub/bro_one.htm
PPS reform will harmonise over 70 pieces of legislation into one Commonwealth Act and provide a single national online register of personal property security interests.
The Commonwealth has begun the IT work required to establish the PPS Register, including a method to transfer current registered interests (e.g. charges registered with ASIC) onto the new register.
David Carter, Partner, Sydney & Adam Mazzaferro, Lawyer, Sydney
Consumer Credit Law Reform
Further to our recent articles regarding the move towards a national consumer credit law there has been further information released by Federal Treasury.
Treasury has advised that:
he Federal Government has put aside $71 million to set up and implement the new national credit framework;
Treasury has established an Industry and Consumer Consultative Group to address practical implications that are faced in drafting the new legislation. Organisations who wish to make comment on the draft legislation can do so through their industry body.
Members of the Consultative Group are:
| Finance Industry |
Australian Finance Conference |
| Banking sector |
Australian Bankers’ Association |
|
Mutuals |
ABACUS |
|
Micro-lenders |
National Financial Services Federation |
| Mortgage Brokers |
Mortgage and Finance Association of Australia |
| Finance Brokers |
Finance Brokers Association of Australia |
| Advisers and Insurers |
Investment and Financial Services Association |
| Financial Planners |
Financial Planning Association |
| Dispute resolution |
Financial Ombudsman Service |
| Dispute resolution |
Credit Ombudsman Service Ltd |
| General |
Law Council of Australia |
| Consumer Advocate |
CHOICE |
| Consumer Advocate |
Consumer Action Law Centre |
| Consumer Advocate |
Consumer Credit Legal Centre (NSW) |
We will provide further information regarding the national consumer credit laws as it is released by Treasury.
David Carter, Partner, Sydney & Adam Mazzaferro, Lawyer, Sydney
Regulation of Unfair Contract Terms
In addition to the consumer credit law reform, there will also be the introduction of general consumer law reform through the implementation of a single unified Australian consumer law based on the provisions of the Trade Practices Act 1974 (Cth) and a national unfair contract terms regime.
One important aspect of the reforms is the recommendation that the proposed national regime provide for the introduction of a national unfair contracts scheme which would govern all standard form (i.e. non- negotiated) contracts, including consumer credit contracts.
In the Review of Australian Consumer Policy Framework (“Report”) the Productivity Commission voices concerns about the absence of provisions in the current Trade Practices and Fair Trading Acts of the various states and territories which deal with one-sided or unfair contract terms. For example, standard form consumer credit contracts are viewed with unease, as they are rarely read and are offered on a “take it or leave it” basis which, in the view of the Commission, exposes consumers to potential exploitation.
What is an Unfair Contract Term?
The proposed provisions would deem void any term that causes detriment, or there is a substantial likelihood of detriment being caused, to the consumer (individually or as a class). Detriment is not limited to financial detriment. More specifically, the Report proposes that a contractual term would be considered “unfair” if it causes a significant imbalance in the parties’ rights and obligations arising under the contract which is not reasonably necessary to protect the legitimate interests of the supplier/credit provider. The application of the test would require the consideration of all circumstances of the contract including the broader interests of consumers, as well as the particular consumer(s) affected.
The Commission favours an ex post enforcement model, which would restrict action taken by the regulator to situations where detriment had actually been suffered (or is likely to be suffered) by a consumer or class of consumer, rather than allowing unfair contract terms to be declared void by the regulator without any action taken by consumers.
Impact for Credit Providers
Under the proposed new provisions, credit providers will have to carefully consider all terms to be included in standard form contracts. Examples of standard terms which may be
challenged on the grounds that they are unfair might include:
- Unilateral change
- Material adverse change
- All monies
- Payable on demand
The new laws are likely to introduce uncertainty for credit providers as they will involve a judgment i.e. what is or isn’t “fair” is obviously a subjective test. Also, although a term may, on its face, appear unfair, it may not be unfair when all circumstances are taken into account. For example, a unilateral change to a term may appear unfair, however it may not be if the contract also includes terms which require adequate notice of any change to be given, as well as a term which allows the consumer to exit the contract, without penalty.
The unfair contract term legislation is due to commence in 2011. It will not be retrospective and a transition period will apply.
Marcus Suliman, Lawyer, Sydney & Ross Rydge, Senior Associate, Sydney
Bell Group Limited Decision
In Bell Group Limited (in Liquidation) v Westpac Banking Corporation & ors [2008] WASC 239, Owen J in a landmark decision has considered the obligations of Directors and Financiers when a company is either insolvent or likely to be insolvent and the steps the Directors and Financiers should take to allow the group of Companies to continue trading. In particular, he examines the specific fiduciary duties imposed on Directors in these circumstances and the potential consequences which flow to a financier.
Factual Matrix
The germane facts were that Bell Group Limited (In Liquidation) was the holding company. The Bell Group Limited Group (“Group”) consisted of a large number of companies, which had banking facilities with 14 overseas banks and six Australian banks, (collectively “Banks”). Each of these facilities were independently advanced and, whilst unsecured, were supported by negative pledge arrangements.
Following the stock market crash of October 1987 it became apparent to the Banks in the second half of 1989 that debts owed to the Banks were unlikely to be repaid, and negotiations began to restructure the facilities. The Banks were particularly concerned in relation to the current state of their documents. Subsequently new refinancing documents were executed. In essence these included the following:
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an extension of the Banks’ facilities;
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a provision the effect of which was that during the currency of the facilities, if the Group realised assets, the proceeds of the sale were to be applied to the Banks pro-rata; and
- the majority of the intra-Group indebtedness was subordinated behind the Banks’ claims.
In early 1991 Provisional Liquidators were appointed to many of the Group companies and the Banks realised on their securities recovering approximately $283 million. Subsequently, in 1995 the Liquidators commenced proceedings against the Banks and Directors challenging the validity of the securities and sought recovery of the $283 million.
Owen J’s Principal Findings
The Directors concentrated on the Group and failed to consider the interests of the individual companies, separately.
The Directors caused the companies to undertake obligations when they had not previously had such obligations and with knowledge that there was an insolvency context.
The Directors contravened their duty to act in the best interests of the companies and the duty to exercise their powers only for proper purposes. By their actions the Directors exposed the companies and their creditors and shareholders to the possible prospect of loss and no probable prospect of gain.
The critical feature of the transactions was to transfer to the Banks a level of control over all worthwhile assets of the companies including over the proceeds from the sale of those assets. This meant that the destiny of the companies and the shape and timing of any such plan for restructure was under the control of the Banks.
As part of the principal findings Justice Owen held that the Banks were liable for received trust property whilst the Group was either insolvent or close to insolvency knowing that it arose from a breach of the Directors’ duties. In this regard, he found that the Banks knew of the existence of the Directors’ fiduciary duties, they knew their duties encapsulated the assets over which they were to obtain security, and they knew that by taking the securities they were receiving property that arose from a breach of that fiduciary duty. However, His Honour upheld the Banks’ counter claim that the bondholders were subordinated to the claims of other unsubordinated creditors thus allowing the Banks’ to rank ahead of the claims of all other creditors of the Group.
Important guidelines in determining whether a Company is insolvent
In Bell, Owen J had to consider and make a number of determinative findings relating to the solvency or otherwise of the Group. Many of these will now be the guiding lights in determining the solvency or otherwise of a company or group of companies and will be of particular interest to insolvency accountants and financiers:
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Q. Over what period of time should solvency of a company be assessed?
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A. In assessing solvency there is no finite period of time over which the assessment extends. The relevant period for assessment must be determined according to the peculiarcircumstances of the case at hand. The period of time over which the assessment of solvency extends may differ depending on whether the court is retrospectively assessing solvency as at a particular date or whether it is assessing prospective insolvency.
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Q. What cash flows may be considered in determining solvency?
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A. solvency has to be judged by a proper consideration of a company’s financial position, in its entirety, based on commercial reality. It is not to be found or inferred simply from evidence of a temporary lack of liquidity.
- “Insurmountable endemic liquidity” is a convenient description of a financial state that amounts to insolvency as defined in the authorities and statutes.
In restructuring a company’s cash flow in order to assess its solvency at a particular time, the Court has to be satisfied, on the balance of probabilities, that the company was able to pay its debts as they became due. However, in respect of individual items of cash flow, the Court does not have to be satisfied on the balance of probabilities that the relevant cash flow would have occurred before that cash flow can be considered. It is appropriate to take a cash flow item into account if it is likely to materialise. This test does not require every cash flow item to be established on the balance of probabilities. However, the level of satisfaction must rise above a mere hope or vague expectation.
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Q. How much hindsight may be used to retrospectively assess solvency as at a particular date.
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A. The issue of solvency is a question of fact to be determined in light of all the circumstances as they were known or ought to have been known at the relevant time. The Court first determines the prevailing circumstances of the relevant time having regard to any relevant event or fact (both before or after the relevant date), if it helps to determine the actual state of affairs. Having determined the prevailing circumstances, the Court then considers whether or not at the relevant date and under the circumstances found, the company had the alibility to pay its debts. This involves balancing existing debts with available assets and resources over a period of time. Facts that were not in existence or not properly knowable at the relevant date are not relevant to a retrospective assessment of a company’s solvency. However, a Court can take into account facts available in hindsight (that is, after the determinative date of solvency), if the facts help determine which version of conflicting accounts concerning the state of affairs is more likely. The fact that an event actually took place may weigh in favour of the alleged expectation being a commercial reality. However, that fact alone is not determinative. It is one only of a host of matters that may intrude into the decision making process.
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Q. What is the appropriate test of insolvency? The cash flow test or the balance sheet test?
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A. In Australia, the cash flow test of insolvency (which focuses on an entity’s income sources and expenditure obligations) is generally viewed as the more appropriate mechanism for assessing solvency than the balance sheet test (which concentrates on the value of assets and liabilities reflected in the entity’s books). However, the balance sheet test continues to have relevance in some circumstances. In this case, in assessing the Group’s solvency at the relevant date, the primary focus was on the cash flow test. However, the balance sheet test was used to determine some contentious issues.
Obligations on financiers
In respect of companies which are insolvent or are likely to be insolvent:
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Banks cannot enter into a transaction which enhances their existing security position and, in effect, provides them with priority to the claims of creditors and future creditors of the group or individual companies in the group. Such an act would be construed as prejudicial to the individual company, its creditors and shareholders and may have ramifications;
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A bank which obtains further security from a group of companies when it is aware that the company is insolvent or may be insolvent shortly after the security is obtained may be held accountable as being privy to the directors breaching their fiduciary duty to an individual company in the group, its shareholders and creditors;
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A bank should not take further security from an individual company or group when they suspect that the directors may have breached their fiduciary duty to an individual member of the group. If a bank proceeds in this manner it will be held to hold any such property subject to the further security on trust for the group as it arose from a breach of the directors’ fiduciary duty (the first limb of Barnes v Addey);
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The mere fact that a transaction document states that the directors have considered the corporate benefit and entered into a transaction does not by itself mean that directors have applied their minds to the corporate benefit for the individual company and a bank cannot rely solely on this statement;
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If further facilities are provided the banks should consider the cash flow situation of individual companies and satisfy themselves that there is a real and substantial benefit to each corporate entity;
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It is not good practice in a transaction document to waive compliance with obligations under the document in an attempt to avoid defaults that may trigger the liquidation of the company within the six months preference period. This will normally be construed as a sham;
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A bank cannot raise by way of defence that it was not aware that a director was breaching his fiduciary duty to an individual company, shareholders and creditors if there is no plan existing prior to the further security being taken to restructure the company or the group
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A bank could be held to be acting inequitably or unconsciously where a Court was to find that there was an inequitable or unconscionable bargain because the directors of an individual company or group were not as commercially astute or were not receiving competent legal advice;
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For a case of equitable fraud to be made out against a bank, the directors would have had to engage in dishonest and fraudulent conduct and the bank would have known that the directors were so acting
Director's Obligations
In respect of companies which are insolvent or are likely to be insolvent, the directors of the company owe the following duties:
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If the group is either insolvent or possibly insolvent, by providing existing lenders with further security from individual companies in the group, the directors have breached their fiduciary duties owed to the individual company, if they have not considered the benefit of any such transaction to the individual company;
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By acting in this manner, the directors would be acting for an improper purpose if they provided further security to a secured lender to prevent that lender putting the group into liquidation. Such an act will be construed as acting in the interests of the bank rather than acting in the interest of the group of companies and their creditors;
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The company cannot enter into a transaction even if the transaction is in the best interests of the group as a whole unless the transaction is also in the best interests of the company individually and the interests of its creditors and shareholders;
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For a director to procure companies individually to provide further security to a financier to remove the threat of one company in the group and the group globally going into liquidation without properly considering the interests of the company individually, including shareholders and creditors, is an improper exercise of a director’s power and the act will be construed as acting for an improper purpose.
Conclusion
The above legal findings impose heavier duties on directors and banks than had been originally envisaged. Importantly, it exposes a bank which obtains further security to the real risk that their security will be declared invalid and the proceeds of realisation of the security will be returned to the company, its shareholders and creditors. Importantly, it will make informal workouts subject to unexpected risks particularly where a financier proposes to provide further working capital or obtain further security. In this context, a financier may be better placed appointing a receiver to a company or a group of companies, to protect its position. The findings of Owen J apply both to syndicated and non-syndicated loans where there is a group of companies. Many of the complex legal issues raised by this case will probably ultimately be appealed and more than likely, be reviewed by the High Court of Australia.
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