Acquisition Finance 2019

Last Updated November 07, 2019

Australia

Law and Practice

Authors



Gilbert + Tobin advises leading financial institutions, investment banks, corporations and private equity funds, and the lawyers in the Banking + Infrastructure team have strong experience in both domestic financing and cross-border transactions. The team is one of the largest dedicated banking and finance legal teams in the country, comprising ten partners, five special counsel, and approximately 40 associates. Gilbert + Tobin has offices in Sydney, Melbourne and Perth, and consistently provides an outstanding, comprehensive offering on the region’s most complex, market-leading deals. Gilbert + Tobin also has well-established relationships with some of the largest firms across the globe.

There is a long history of merger and acquisition activity in Australia and, accordingly, leveraged finance is a well-understood and active area for financiers and sponsors alike. The financing of acquisitions in Australia remains the domain of banks, both domestic and international, together with institutional debt funds.

Banks

Australia’s major domestic banks (Australia and New Zealand Banking Group Limited, Commonwealth Bank of Australia, National Australia Bank Limited and Westpac Banking Corporation) have traditionally been extremely active in the acquisition market. These banks often take lead roles in relation to arranging and underwriting acquisition facilities, and will often provide a significant portion of the commitments.

The major domestic banks compete with a range of foreign and local investment banks, such as Credit Suisse, UBS, Deutsche Bank, Macquarie Bank, JP Morgan, Bank of America Merrill Lynch, Royal Bank of Canada and Goldman Sachs, particularly on large-ticket (eg, AUD1 billion plus) transactions, which require an underwritten facility.

In addition, Japanese and Chinese banks such as Mitsui, Sumitomo, Mizuho, Bank of China and ICBC are also increasingly active in taking senior debt positions as part of a syndicate, with Chinese banks regularly funding Chinese investment into Australia.

Institutional Lenders and Alternative Capital Providers

Traditionally, debt funds and institutional lenders were limited to structured, distressed or mezzanine financing, and were not as popular in Australia as they were in other jurisdictions. While Australia remains a bank-led market (particularly in comparison to the USA and Europe), alternative credit providers such as institutional non-bank lenders and, more recently, Australian pension/superannuation funds are rapidly gaining market share.

This trend appears likely to continue and, as both political and regulatory pressure increases on the major domestic banks, alternative credit providers are becoming increasingly attractive to sponsors, particularly given their willingness to offer a range of products not offered by the major domestic banks, such as unitranche facilities. This is consistent with the process of disintermediation witnessed in the USA and Europe. The increased presence of the alternative credit providers has resulted in the importation of terms from the US and European markets, including “covenant-lite” structures and other more borrower-friendly terms.

Private equity firms are increasingly gravitating towards these alternative credit providers and products in order to benefit from higher leverage multiples, longer tenors, less amortisation and fewer lender protections. This is particularly the case with the large international private equity funds, such as those identified below, which are very familiar with these structures and are able to leverage their experience to introduce and adapt these products to the domestic market.

From a sponsor perspective, acquisition finance activity in Australia is primarily driven by private equity firms. In this respect, a number of the large international PE firms have a presence in Australia (including Carlyle, KKR and TPG). In addition to the international players, there are a number of domestic PE firms (including BGH Capital, CPE Capital and Quadrant) that are also active in the acquisition finance space.

From a market perspective, this year has been a relatively subdued one by local standards. In this respect, Australian syndicated lending has, on the whole, had a difficult first half to 2019 (year on year), with syndicated lending having decreased by 31% over this period compared to the same period in 2018 (USD36.56 billion from 84 deals in the first half of 2019 down from USD53.31 billion from 116 deals in the first half of 2018).

For domestic transactions, debt documentation (including commitment letters, term sheets and full-form facility and intercreditor agreements) are governed by the law of an Australian State or Territory – generally New South Wales or Victoria. There are no material differences between the laws of each State or Territory from a governing law perspective, with all Australian companies being regulated by the same Commonwealth law irrespective of the governing law of the documentation. If the acquisition debt is being arranged offshore, the governing law of that offshore jurisdiction may be used (typically this is English law or the laws of a state of the US).

Security documents affecting Australian assets are similarly governed by the law of a State or Territory, and only one jurisdiction is chosen for the governing law even if the assets are located in multiple States. Again, the choice of law is usually determined by where the grantor operates, where its assets are located and/or where the law firm drafting the documents practises. If assets are located outside of Australia, financiers will usually require that the relevant obligor provides security governed by the law of the jurisdiction where the assets are located. Where a foreign company is granting security over assets located in Australia, financiers will require separate security documents to be executed over those assets, with one security document being governed by the law where the foreign company is incorporated and one being governed by the jurisdiction where the assets are located.

The Loan Market Association (LMA) equivalent in Australia is the Asia Pacific Loan Market Association (APLMA), which has produced a suite of documents including bilateral facility documentation, commitment letter, confidentiality letter, mandate letter and both investment grade and standard secured syndicated facility agreements but is yet to produce an equivalent to the LMA’s leveraged acquisition documentation (although, unlike the LMA suite, these documents are not specifically tailored to acquisition finance transactions). The APLMA standard secured syndicated facility largely mirrors the structure of the LMA version, with notable differences for Australia’s interest withholding tax regime and local laws (for example, financial assistance legislation) and market practice.

Each firm tends to have its own precedent acquisition facility documentation which is, to a greater or lesser extent, based on the APLMA standard facility documentation. As US and European private equity funds have become more active in the Australian market, facility documentation has become more aligned to the LMA acquisition documentation. Similarly, as the market dynamic has changed, there has also been a number of acquisitions of Australian companies documented via an offshore law-governed facility document, whether a US-style Term Loan B or an English law-governed ‘unitranche’-style facility.

Each firm has its own precedent security documentation, though all asset security will be taken under a “general security” agreement/deed (equivalent to a UK debenture), and security over a specific asset or class of asset (typically shares or other equity interests) will be taken under a “specific security” agreement/deed.

From a domestic perspective, debt documentation (including the finance documents and security documents governed by Australian law) is almost exclusively drafted in English. Occasionally, debt might be arranged in an offshore jurisdiction such as China, where the facility documentation will be in the national language of that offshore jurisdiction, with an English translation being required by the financiers. In that case, any security documents affecting Australian assets will be drafted in English (and governed by Australian law), with security over offshore obligors being governed by the local customs applicable to the relevant jurisdiction.

As is typical, lenders will ordinarily require the provision of a legal opinion as a condition precedent to the initial drawdown of the facilities (and any subsequent accessions). Legal opinions typically cover the capacity, authority and corporate power of the obligors incorporated in Australia to enter into the finance documents, and the enforceability of the Australian law-governed finance documents against the obligors. In a secured transaction, the relevant legal opinion will also cover the creation of valid security interests.

These opinions are often expanded to cover additional matters such as the payment of stamp duty, immunity from suit and whether the transaction requires the financiers to be licensed or registered in Australia (which is often requested by international banks).

The general rule remains that counsel to the financiers will issue the legal opinion, even where the borrower’s counsel has drafted the finance documents (noting there is no hard and fast rule in Australia as to whether the borrower’s or financier's legal counsel drafts the documents, though increasingly sponsors are pushing to hold the pen on all key documents). However, due to increased cross-border acquisition activity, borrower’s counsel have become more willing to issue opinions addressed to the financiers, particularly if they are drafting the documents or if the acquisition debt is being raised in the US to fund an Australian acquisition. In a syndicated financing, it is typical for reliance on the legal opinion to be offered to financiers joining primary syndication within the first three or six months.

The one exception to the above rule is in the context of an offshore capital transaction (eg, a high yield bond), where the borrower’s lawyers will typically opine on ‘fair disclosure’ in the context of the Australian-related disclosure and risk factors in the offering memorandum.

Typically, a senior Australian acquisition finance package will feature an amortising term loan A, together with a bullet term loan B, which will collectively be used to fund the acquisition of the target group. The financing package will usually include a revolving credit facility to be used for the group’s working capital and general corporate purposes (including any contingent instrument requirements), and may include capex or acquisition facilities, as required, which tend to be on a committed basis. These facilities will typically rank pari passu in both payment and security. 

However, in recent times, the market has seen a shift away from the traditional senior bank loan capital structure highlighted above to an increased prevalence in standalone term loan B facilities and unitranche loans offered by institutional lenders (which generally contemplate limited amortisation). This competition has led the major domestic banks to offer more flexible terms in their traditional leveraged products, including reducing or eliminating amortisation and offering more flexible terms in relation to financial covenants.

The unitranche facilities are generally accompanied by a “super senior” revolving credit facility for working capital and contingent instrument purposes. Facilities of this nature are typically provided by a local bank and rank in priority to the term facilities on enforcement.

In addition to the above, loan documentation is increasingly updated to include the flexibility to incur accordion or incremental facilities, which facilitate increased leverage within the confines of the existing facility documentation.

‘Opco’ mezzanine financing was previously a common feature of the Australian acquisition finance market, but is something of an anachronism in the current market.

If additional leverage is required to fund larger acquisitions, sponsors typically achieve this via a ‘holdco’ instrument. In these circumstances, mezzanine financing is provided at a holdco level above the senior debt obligor group. This structure enables sponsors and senior lenders to avoid the complexity that comes from having the subordinated debt provided at the level of the senior debt, as the debt will be structurally subordinated to the senior debt. This also avoids the often-protracted negotiations between senior and mezzanine lenders on the intercreditor arrangements in order to achieve a contractual subordination of these facilities.

On occasions, a further special purpose company (topco) will be interposed between the sponsors and holdco, the purpose of which is to facilitate the raising of PIK (payment-in-kind) debt, which is again structurally subordinated to both the mezzanine and senior debt.

Bridging debt facilities may be used where it is intended that the acquisition debt will be refinanced shortly after completion of the acquisition by either a capital raising or a high-yield debt or private placement raised in the US market. Typically, bridging facilities have a tenor of 365 days or less. Such facilities are less common in the Australian leveraged finance market than the facilities mentioned above.

The Australian debt capital markets are traditionally not as diverse (or deep) as those in Europe or the USA. As such, there is no domestic high-yield market to speak of.

There have been limited examples of acquisitions being accompanied by subordinated retail notes issuances (which sit alongside a more traditional senior loan structure), although these are relatively rare. Such issuances are made to retail as opposed to institutional investors, so are distinguishable from high-yield products.

Whilst the domestic Australian market does not cater for the high-yield needs of sponsors, it is not uncommon for Australian companies to seek to raise funding through offshore capital markets. Accordingly, there are a number of examples of companies that have sourced funding through the US high-yield and private placement markets (see below). 

Consistent with the position expressed above, domestic private placement transactions are not a feature of Australian acquisition financings.

However, the ‘tapping’ of the US private placement market is a common feature for sponsors and companies that seek longer term debt. This style of financing is particularly common in the infrastructure space, where the longer-term nature of the debt (together with the flexible terms) is attractive to investors. Often, a private placement will be sought to refinance a portion of the original acquisition debt (rather than being a form of debt that is sought to fund the acquisition itself).

Accordingly, sponsors who are raising debt in the Australian market will often have their intercreditor and security sharing arrangements reviewed by US counsel to ensure that they are able to be marketed to investors in the private placement markets.

Intercreditor agreements are customary in the Australian market and, as is typical, regulate the rights and obligations of the providers of the various classes of debt that is raised to fund the acquisition (including shareholder debt and hedging liabilities).

Unlike the position in Europe, where the LMA suite of documents contains various market standard intercreditor agreements, there is no market standard document in Australia. A set of intercreditor principles (primarily applicable to leveraged transactions) has been circulated within the market but has not been universally adopted. Several provisions, such as drag-rights, standstill periods, mezzanine information rights and release provisions, remain negotiated points.

Australia recognises the concept of contractual subordination and, as such, intercreditor agreements contractually regulate the order of priority for the repayment of each class of debt. The senior debt will rank ahead of the junior debt, and any “super senior” facilities will rank ahead of the senior debt on enforcement. Repayment of the junior debt is typically deeply subordinated so that no principal repayments are permitted until the senior debt has been repaid in full. The payment of interest to the junior creditors is permitted, subject to certain conditions being satisfied (which may include a leverage or debt service coverage ratio set at a tighter threshold than the financial covenants contained in the senior debt documents, and that no event of default is occurring).

Equity or quasi-equity financing provided by non-sponsor entities will always be subject to contractual subordination, unless it is structurally subordinated (sponsor debt is typically subject to both). The common position is that equity or quasi-equity financing is deeply subordinated to all other layers of the acquisition debt and no payments can be made, except to the extent they are made from amounts that would otherwise be permitted to be distributed to equity holders.

Structural subordination is not unusual and, as discussed in 3.2 Mezzanine/PIK Loans, it is mainly used for mezzanine or payment-in-kind debt or other vendor financing raised at the holdco or topco levels.

Intercreditor agreements usually contain a provision whereby any amounts paid by a debtor to a subordinated creditor are agreed to be paid by the subordinated creditor to the senior creditor (this is referred to as “turnover subordination”) or held on trust by that subordinated creditor for the benefit of the senior creditor until such time as the senior creditor has been repaid (this is referred to as “trust subordination”).

In addition to regulating the right of repayment of competing creditors, intercreditor agreements will also regulate how the proceeds of the enforcement of security are to be applied (commonly known as the enforcement waterfall), and will set out which creditors can instruct the security agent in relation to the enforcement and release of the security (which is typically shared by the senior and junior debt).

The default position will be that the senior creditors rank ahead of the subordinated creditors in the waterfall and, as such, the senior creditors will form the “instructing group”, unless and until the subordinated creditors obtain rights to enforce. The rights of subordinated creditors to enforce their security will be limited, and will often arise only after a standstill period has expired (in some transactions, the subordinated creditors will not benefit from any such right prior to the senior debt being discharged).   

As noted above, there is no domestic high-yield market to speak of. Accordingly, the bank and bond transactions seen in the market are governed by laws other than those of Australia (and therefore the intercreditor position and approach reflect the norms in those markets).

There will often be hedging liabilities owed to hedge counterparties relating to the hedging of interest and/or exchange rate risks under the senior (and potentially the mezzanine) debt documentation.

Under the terms of the intercreditor agreement, hedge counterparties will typically benefit from security and will rank pari passu in right of payment and right of enforcement proceeds with the senior lenders.

However, the intercreditor will typically contain restrictions on hedge counterparties’ right to terminate the hedging arrangements prior to enforcement, to make amendments to the terms of the hedging documents, to take enforcement action or to benefit from additional guarantees and/or security. These restrictions are often coupled with provisions that enable the hedges to be novated to a new hedge provider in certain circumstances.

Acquisition financings in the domestic market are typically always secured.

To this end, a general security agreement (akin to a debenture) is used to secure all types of property other than real estate, which requires a mortgage to be entered into, and typically all obligors would enter into a general security agreement to grant all asset security. Specific security can be granted over a particular asset under a specific security deed (these are commonly used for standalone security over shares or bank accounts).

Any security interests in real estate must be in the form prescribed by the jurisdiction where the relevant land is located. The granting of security over “personal property” by Australian companies is governed by the Personal Property Securities Act (2009) (PPSA).

Security will be provided by each borrower, by the relevant holding companies and by sufficient operating companies to ensure compliance with the guarantor coverage test.

The latter category of obligors will generally accede and grant security within a prescribed timeframe post-funding (which can range from 30 to 120 days, depending on the sponsor’s bargaining power).

Consistent with offshore jurisdictions, the guarantor coverage test typically requires entities that own between 80% and 95% of the target group’s assets and contribute between 80% and 95% of the target group’s EBITDA to grant guarantees and security in favour of the financiers. Security will nearly always be granted in favour of a security trustee, who will hold the security for the benefit of the secured parties (including lenders, hedge providers and the facility agent).

Each of the main asset classes are considered below:

  • Shares: an all asset general security agreement can be used to take security over shares, or a specific security agreement can be used where shares are the only asset to be secured (for example, where an offshore entity is granting security over the shares in an Australian entity). Shares are considered “personal property” under the PPSA, and security interests may be perfected by either control or registration. While financiers will always perfect security interests by registration of a financing statement on the Personal Property Securities Register (PPSR), the security document will also require delivery of all share certificates and stock transfer forms executed in blank to be delivered to the security trustee in order to allow perfection by control. If the shares being secured are shares in a listed company, a secured party will be able to perfect its security interest over such shares by control, by entering into a Clearing House Electronic Subregister System (CHESS) security deed with the CHESS participant, under which the CHESS participant agrees to hold the shares subject to the secured party’s order. 
  • Inventory: an all asset general security agreement can be used to take security over inventory, or a specific security agreement can be used where the inventory is the sole asset to be secured. Security over tangible movable assets which is stock-in-trade (“inventory” under the PPSA) is usually a circulating security interest over fluctuating assets, and is called a “circulating asset”. Circulating assets are assets over which the secured party has given the grantor permission to transfer the asset in the ordinary course of the grantor’s business, free of the security interest. A security interest over tangible movable property is perfected by way of the registration of a financing statement on the PPSR.
  • Bank accounts: an all asset general security agreement can be used to take security over bank accounts, though security over bank accounts is also commonly taken by way of a specific security agreement in respect of the relevant accounts. It is customary for bank accounts that are subject to security to be held with an authorised deposit-taking institution (ADI). If the bank account is of material importance or value, an account control agreement will often be entered into between the account holder, the security trustee and the ADI where the account is maintained. The reason for the use of the control agreement where the secured party is not also the ADI is because the ADI itself may have a security interest in the account, and this will have priority over the secured party’s security interest (even if that is perfected by registration on the PPSR) because the ADI perfects its security interest by control over the account (which it does solely by reason of being the ADI). A control agreement is not necessary where the bank account is maintained with the secured party.
  • Receivables: an all asset general security agreement can be used to take security over claims and receivables (such as debts, trade receivables or contractual rights), or a specific security deed can be used where security over specific claims or receivables will be taken. In certain circumstances, an assignment of receivables will also constitute a deemed security interest (and will be capable of a separate registration without the need for a standalone security document).
  • Intellectual property rights: an all asset general security agreement can be used to take security over intellectual property rights, such as trade marks, patents, registered designed and copyright, or a specific security agreement can be used if intellectual property is the sole asset class to be secured. A security interest over intellectual property must be registered on the PPSR in order to preserve its priority. Specific registers exist for patents, registered trade marks and registered design rights, and security interests can be recorded in those registers that are maintained by the Intellectual Property Office of Australia. 
  • Real property: most Australian land is registered under a system known as the Torrens system. Each State and Territory operates its own Torrens system for land located in its jurisdiction, and records details of the land and any registered interests in that land, such as mortgages, via a centralised registry. The most common form of security granted over real estate is a registered real property mortgage, which is a separate document to the all asset general security agreement. While the general security agreement will secure all assets of the grantor including land, the PPSA excludes interests in land and this means a registration on the PPSR in relation to the secured property which is the subject of the general security agreement will not perfect the security interest over land. Financiers therefore require a mortgage over land to be registered on the Torrens system, which is done so by recording the particulars in the relevant land titles register. Mortgages must follow the form prescribed by the relevant land registry, though many States have now implemented a “National Mortgage Form”. While this is a national form, each participating State does impose its own requirements on how the form is completed and executed. It should be noted that it is not uncommon for the agreed security principles to specifically exclude any real property mortgages being granted, though this will of course depend on the nature of the transaction, the value of the real estate in the context of the deal, and the bargaining position of the parties.
  • Movable assets: security over tangible movable property is generally created under a general security agreement over the assets of the grantor or a specific security agreement over specified goods. As mentioned above, security over tangible movable property which is stock-in-trade (‘inventory’ under the PPSA) will usually be a circulating security interest over fluctuating assets. These fluctuating assets are referred to as ‘circulating’ assets under the PPSA, and are assets the grantor has authority to transfer in the ordinary course of its business, free of the security interest. A security interest over collateral that secured the obligations of a grantor to pay the purchase price of that particular collateral is a ‘purchase money security interest’ under the PPSA, which may, if certain conditions are satisfied, afford the secured party a form of ‘super priority’ over the relevant collateral in priority to even a prior-perfected security interest.

Security over real property requires a real property mortgage form to be used and lodged at the relevant land titles office. The form must be the one prescribed by the jurisdiction where the land is located.

There are generally no prescriptive form requirements for other types of security, though it is common for all asset security to be granted by way of a general security agreement, and for security over a single class of asset to be granted by way of a specific security agreement.

There are two main restrictions on the granting of upstream security. These are the rules regarding financial assistance and corporate benefit issues, which are outlined in 5.4 Financial Assistance and 5.5 Other Restrictions.

Section 260A of the Corporations Act 2001 (Cth) (Corporations Act) prima facie restricts a company from providing financial assistance for the acquisition of its shares or its holding company's shares.

The concept of financial assistance includes the granting of security and the provision of guarantees, which means that financial assistance is always a consideration in acquisition finance when looking to take security over the target entities.

Whilst a transaction that breaches the prohibition on financial assistance is not invalid, any person involved in a contravention of the prohibition is guilty of a civil offence; this liability could therefore extend to the financiers and advisers involved in a transaction. If any involvement in the contravention of the prohibition is found to be dishonest, that person also commits a criminal offence.

The most common workaround is to rely on the ‘whitewash’ process, under which the shareholders of the company and the ultimate Australian holding company approve the granting of the financial assistance by the relevant target entities. Notice of all shareholder resolutions must be lodged with the Australian Securities and Investments Commission (ASIC) at least 14 days prior to the provision of the financial assistance itself. Any special resolution passed must also be lodged by the relevant company within 14 days of it being passed. Given the timeframes involved, security over Australian target entities is generally granted within an agreed period post-closing, but this is typically no less than 30 days and may be as generous as 90 or 120 days.

There is also the possibility for borrowers and lenders to rely on the ‘no material prejudice’ exception, which permits the granting of financial assistance where it does not materially prejudice the interests of the company or its shareholders, or its ability to pay its creditors. However, given the potential consequences of breaching the prohibition, the customary way to avoid the financial assistance restriction in the context of an acquisition financing is to undertake a whitewash.

The prohibition on financial assistance does not affect the grant of security by any Australian special purpose vehicle set up for the purposes of the acquisition (ie, holdco or bidco), or any offshore parent over its shares in an Australian-domiciled entity, each of which can provide security in a more timely fashion and – typically in the case of holdco or bidco – as a condition precedent to the initial utilisation of the facilities.

For completeness, it should be noted that there are other exceptions to the general restriction, although these are more targeted and typically not relevant to an acquisition financing.

Under Australian law, directors owe a number of duties to the companies to which they have been appointed, including a duty to act in good faith, for the benefit of the company as a whole and for a proper purpose. These duties are enshrined under sections 181 and 184 of the Corporations Act but also arise under general law (as fiduciary duties). 

The directors will need to consider these duties in a secured lending transaction to determine whether the transaction is sufficiently beneficial to the company. In making that determination, both direct benefits (such as the company’s ability to use funds drawn under the facility) and indirect benefits (for example, if the company requires the ongoing support of other companies within the group) can be considered. However, each company within the transaction must derive sufficient benefit itself when entering into the financing transaction. 

It is not sufficient that the benefit is derived by the group as a whole or by other members of the group. The duty to act for the benefit of the company as a whole and for a proper purpose will come under scrutiny where a subsidiary is requested to guarantee or secure the obligations of its parent. Where a party obtaining a benefit of a guarantee or security knows or ought to have known that the directors have not acted in the best interests of the company as a whole, the guarantee or security will be voidable against that party. 

One helpful provision of the Corporation Act is section 187, which provides that a director of a corporation that is a wholly-owned subsidiary of a body corporate is taken to act in good faith and in the best interests of that company if the director acts in good faith in the best interests of the holding company, provided that certain conditions are met. One of those conditions is that the constitution of the subsidiary company expressly authorises the directors to act in good faith in the best interests of the holding company. Financiers will usually request that any wholly-owned subsidiaries that are providing credit support have this provision in their constitution.

A secured party’s right to enforce its loan, guarantee or security will be governed by the terms of the underlying debt and security documents. A financier will typically be able to accelerate the debt upon the occurrence of an event of default or other enforcement event. Guarantees can only usually be enforced following a default by the principal obligor.

A secured creditor will have enforcement rights under the security documents and applicable legislation. The security documents will typically set out the secured party’s right to enforce its security by appointing either a receiver or a receiver and manager. A holder of a registered security over all – or substantially all – of a company’s assets can also appoint a voluntary administrator. Under the Corporations Act 2001 (Cth), once a company goes into voluntary administration, a person cannot enforce a charge on the property of the company except with the written consent of the administrator or with the leave of the court, unless the person who holds the charge does so over the whole or substantially the whole of the property of the company. During administration, a person who holds a charge of the latter type can enforce that charge within the first 13 business days following the appointment of the administrator.

In Australia, it is common to take ‘featherweight’ security to address the administration risk, whereby a secured creditor needs to hold security against all or substantially all of the assets in order to be able to appoint a receiver during the administration of a company. Where the security only covers a small part of the business, lenders will often seek to have a featherweight security that “springs” upon the remainder of the assets when the “featherweight event” occurs – eg, the appointment of an administrator. The amount recoverable from the featherweight is usually a nominal amount (eg, AUD10,000) to reflect that the purpose is not to asset back the security, but to address the administration risk.

The key benefit of the inclusion of a featherweight security clause in a security document is that the secured party can then argue that, in a default scenario, it has security over all or substantially all of the assets of the company – this entitles them to enforce that charge within the first 13 business days following the appointment of the administrator, and to appoint a receiver. Without the featherweight, where security has been taken (and assuming this does not comprise all or substantially all of the assets of the company), the secured party would not have a right to appoint a receiver during the voluntary administration of the company. This does not affect the quality or existence of the secured party’s security interests, but it means that they will be unable to enforce their security for the duration of the administration (without the leave of the administrator or the consent of the court).

The courts are generally not involved in the enforcement of consensual security interests against corporate borrowers, and there is generally no requirement to obtain a judgment before enforcement. A range of enforcement remedies are available under the PPSA, depending on the nature of the collateral, including seizure of the collateral, retention of the collateral (ie, foreclosure without the need for a court order, by which the collateral is forfeited to the secured party and the secured debt is extinguished in full) and disposal of the collateral either to a third party or to the secured party itself. Certain sections of the PPSA enforcement provisions may be contracted out of.

When enforcing security over real property, the secured party will be required to satisfy various notice requirements contained in state-based property legislation, and the common law remedies of sale, possession, foreclosure or the appointment of a receiver will be available depending on the nature of the security interest.

Guarantees in an acquisition finance context are typically ‘all monies’ cross-guarantees, which extend to all obligations owed by each borrower and each other guarantor. As is customary in most markets, the guarantors’ secondary obligations under the guarantee provisions are supplemented by indemnification obligations. There are no substantive differences between Australian law-governed guarantees and those used in other common law jurisdictions.

As mentioned in 5.1 Types of Security Commonly Held, the terms of most acquisitions financings require guarantees from sufficient entities to comply with the guarantor coverage test.

Such guarantees are typically contained in the facility agreement or security trust deed, although standalone guarantees may be provided in unsecured financings or by third parties that sit outside the obligor group.

A company can grant a guarantee for the debt of a borrower regardless of whether the borrower is located in Australia or elsewhere, provided that the company is not restricted from doing so in its constitution, and that it has complied with the financial assistance legislation and corporate benefit issues outlined in 5.4 Financial Assistance and 5.5 Other Restrictions above, which apply equally to the giving of a guarantee.

There is no requirement under Australian law for there to be a guarantee fee (or fees associated with the enforcement of guarantees). There is also no requirement for the guarantees to be registered, although if a guarantee document also contains a security interest (such as a turnover trust), it may be advisable to register that security interest.

Unlike the position in jurisdictions such as the USA, there is no concept of equitable subordination in Australia. Shareholder claims, in their capacity as a member of the company (for example, for dividends), generally rank behind all other claims. Typically, any debt claims that a shareholder may have against members of the acquisition group are contractually subordinated to the claims of the lenders.

The Corporations Act and PPSA both contain provisions that can potentially affect a creditor of an Australian entity in an insolvency scenario. If a transaction is voidable, the court can make a range of orders, including for the repayment of money received by the creditor under the transaction and for the discharge/release of debts and security.

A security interest will be voidable under the PPSA and the Corporations Act if the secured party has failed to perfect it. In order to be enforceable against third parties, a security interest must be perfected (by either control, registration or possession). If perfecting by registration of a financing statement on the PPSR, the financing statement must be registered within 20 business days of the relevant security agreement coming into force, or at least six months before the start of the winding up or voluntary administration for most security interests (though this is not applicable to deemed security interests, which do not secure payment or performance of an obligation, nor to security interests where no other method of perfection is used, such as control or possession).

Transactions are vulnerable to challenge once a company enters into liquidation, and a liquidator has the power under the Corporations Act to bring an application to court to declare certain transactions void. This contrasts with an administrator, which is required to identify potential voidable transactions (which would then need a liquidator to recover them) in its report to creditors but does not itself have the standing to challenge the transactions.

There are several types of transactions that can be held to be voidable:

  • unreasonable director-related transactions;
  • unfair preferences;
  • uncommercial transactions;
  • transactions entered into to defeat, delay or interfere with the rights of any or all creditors in a winding up; and
  • unfair loans.

Transactions held to be an unfair preference, uncommercial or entered into to defeat, delay or interfere with the rights of any or all creditors in a winding up will only be voidable if the transaction was also an “insolvent transaction” – that is, it occurred while the company was cash-flow insolvent, or contributed to the company becoming cash-flow insolvent.

Each type of voidable transaction has different criteria and different hardening periods (which may be longer if the transaction involves a related party). An unfair preference will occur where an unsecured creditor receives a greater amount than it would have received if the creditor had been required to prove for it in the winding up of the company. A loan, guarantee or security may be set aside as an uncommercial transaction if a reasonable person in the company’s position would not have entered into the transaction. An unfair loan to a company at any time before liquidation is liable to be set aside, irrespective of whether or not the company was insolvent at the time the loan was made. A loan is unfair if the interest or charges in relation to the loan were either extortionate at the time the loan was made or have since become extortionate (eg, following a variation). This provision has seldom been used, as Australian courts are reluctant to intervene unless the commercial terms greatly deviate from typical market terms.

There is an active secondary market where a borrower can buy-back its own debt if it has the ability to do so under the terms of its finance documents. The ability of the borrower to buy-back its own debt is usually regulated (and restricted) by the terms of the facility documentation. Those restrictions and regulations typically follow the Loan Market Association position. The language will be negotiated, with positions ranging from a total prohibition on debt buy-backs to disenfranchisement of the relevant sponsor-related lender.

An ad valorem mortgage duty was previously a feature of secured financings, but is no longer payable in any Australian jurisdiction.

Stamp duty may be payable on transactions involving either a transfer of property or the settlement (creation) of a trust. In most acquisition financings it is the creation of a trust that is relevant, as the security trustee will hold the security on trust for the benefit of the financiers. The document creating that trust (usually the security trust deed) may attract nominal stamp duty, depending on the jurisdiction involved. Instruments not duly stamped may be inadmissible in court.

Broadly, interest withholding tax (IWT) at a domestic rate of 10% applies on gross payments of interest (or payments in the nature of or in substitution for interest) made by Australian borrowers to non-resident lenders (except where the lender is lending through an Australian permanent establishment) or residents lending through a foreign permanent establishment. IWT is a final tax and can be reduced (including to zero) by domestic exemptions (such as the ‘public offer’ exemption outlined below) and/or the operation of Australia’s suite of double tax agreements (DTAs), each of which is outlined below.

IWT may be exempt under Australian domestic law if the debt satisfies the ‘public offer’ exemption in s128F or s128FA of the Income Tax Assessment Act 1936 (Cth). Satisfying this exemption will make the debt more attractive in the market, as incoming lenders generally remain entitled to the benefits of the exemption from IWT if certain criteria are met. 

In summary, the public offer exemption will apply where an Australian company or an Australian trust meeting certain requirements publicly offers the debt via one of several prescribed methods, including (most commonly):

  • offering the debt to at least ten persons, each of whom carries on a business of providing finance, or investing or dealing in securities in the course of operating in financial markets, and who is not known or suspected by the borrower to be associates of one another; or
  • offering the debt to the public in electronic form used by financial markets for dealing in debt instruments or debentures.

Two key points to note in respect of the public offer exemption are:

  • the exemption is taken to have never applied if it was known or suspected, at the time offers/invitations were made, that a non-resident associate of the borrower would become a lender (unless the associate becomes a lender in the capacity of a dealer, manager, clearing house, custodian, funds manager or responsible entity of a registered scheme); and
  • if the debt is in the form of a  syndicated facility agreement, it can only benefit from the public offer exemption if there are two or more lenders, the agreement describes itself as a “syndicated loan facility” or “syndicated facility agreement”, and the borrower(s) will have access to at least AUD100 million (or its equivalent) at the time of the first drawdown (even if that amount is not actually drawn at such time).

Australia has DTAs in place with Finland, France, Germany, Japan, New Zealand, Norway, South Africa, Switzerland, the United Kingdom and the United States of America, under which there is no IWT payable for interest derived by a qualifying financial institution unrelated to the borrower (subject to certain exceptions).

The thin capitalisation rules are a set of integrity provisions designed to ensure that excessive amounts of interest cannot be deducted against income that is subject to tax in Australia.

Very broadly, the rules apply to the Australian operations of foreign entities investing into Australia (ie, foreign controlled Australian groups) and to Australian entities or groups investing overseas, if the group’s Australian debt deductions exceed AUD2 million per income year (on an associate inclusive basis). 

When applicable, the thin capitalisation rules deny tax deductions for interest to the extent that the amount of debt used to fund the group’s Australian operations exceeds a “safe harbour amount” (broadly being 60% of the difference between the value of the group’s assets and its non-debt liabilities). There is also an arm’s length debt test, which broadly permits Australian groups to be debt-funded up to the amount a third-party lender would be willing to lend, and a worldwide gearing test, which broadly allows an entity to gear its operations in certain circumstances by reference to the level of its worldwide group.

Certain industries are regulated in Australia, including casinos, the “big four” banks, media broadcasters and owners of key infrastructure such as airports and power and utility providers. A change in the ownership or control of companies in the regulated industries (at either a Federal or State level) will usually require governmental approval. Regulatory consents may be required in order to complete the acquisition itself or to take security over the assets of the entity, but these consents do not usually affect the financial covenants or other terms of the debt documents.

Legislation relating to the foreign investment or acquisition by foreign persons of a legal or equitable interest in Australian companies, land or businesses generally must be considered. The Foreign Acquisitions and Takeovers Act 1975 (Cth) and associated regulations may require a proposed acquisition to be notified to the Foreign Investment Review Board (FIRB), which has a discretion to prohibit the acquisition if it considers it to be contrary to the national interest.

There are two principal methods of acquiring control of an Australian publicly listed company or managed investment scheme. These are pursuant to either a takeover bid or a scheme of arrangement.

Takeover Bids

Takeover bids in Australia are regulated by Chapter 6 of the Corporations Act. A takeover bid can be made on an ‘on-market’ or ‘off-market’ basis, and can be made on either a ‘hostile’ or ‘friendly’ basis. For both on-market and off-market bids, a bidder must prepare and send to the target security holders a document (known as a ‘bidder’s statement’) that includes details of the offer, information about the bidder and certain other prescribed information (eg, in relation to the bidder’s intentions). The target must respond by preparing and issuing a ‘target’s statement’, including the target board’s recommendation as to whether security holders should accept the offer, as well as any other material information.

An on-market bid is made through a broker and can only be used to acquire securities in a listed entity. On-market bids are far less common than off-market bids because they require the consideration to be 100% cash and, importantly, are required to be made on an unconditional basis. Accordingly, it will often be the case that an on-market bid is not a viable option – for example, because the bidder requires regulatory approvals or other conditionality, or because the bidder’s financing arrangements require security to be taken over the target’s assets (which can only be assured in a 100% ownership scenario).

An off-market bid essentially takes the form of a written offer to security holders to purchase all or a specified proportion of their securities. The consideration can take the form of cash or securities, or a combination of the two. The offer must be open for acceptance for a period of no less than one month and no more than 12 months. All offers made under an off-market bid must be the same.

An off-market bid may be subject to any conditions the bidder chooses, other than conditions that are solely within the control of the bidder (or that turn on the bidder’s state of mind) and certain other prohibited conditions.

Typical conditions include those relating to the non-occurrence of certain statutorily prescribed events (including certain insolvency type events), the non-occurrence of a material adverse effect, the obtaining of any necessary regulatory approvals, the absence of any legal restraints or prohibitions to the acquisition completing, and the receipt of a minimum number of acceptances (usually 50% or 90%, with the latter corresponding to the threshold for the compulsory acquisition – or ‘squeeze-out’ – of minorities).

Schemes of Arrangement

A scheme of arrangement is a court-approved arrangement entered into between a body (ie, the target) and all, or a class, of its members. For a scheme to become binding on the target and its members (or the relevant class thereof), it must be approved by more than 50% of members who vote on the scheme, and those members must represent at least 75% of the votes cast on the scheme. If these thresholds are met, the scheme is binding on all members (or all members in the relevant class), including those who vote against the scheme or do not vote at all.

The typical operation of a scheme in the context of an acquisition financing is for the scheme to affect the transfer of target securities to the offeror in exchange for a specified consideration (whether cash or securities, or a combination of both).

A scheme of arrangement is a target-driven process, with the target preparing the necessary materials and seeking the necessary orders from the court. As such, a scheme requires the support of the target’s directors and therefore is only a viable option in ‘friendly’ transactions.

As with ‘off-market’ bids, schemes can be subject to conditions, and it is common to see schemes being subject to the receipt of any necessary regulatory approvals, together with the non-occurrence of any material adverse effect with regards to the target. In addition, there are standard conditions relating to the necessary shareholder and court approvals.

Certain Funds Requirements

Neither method imposes a strict legal requirement for ‘certain funds’ financing. However, from a practical perspective, financiers’ commitments to fund are often provided on a certain funds basis.

The Corporations Act prohibits persons from making a takeover offer if they are unable to complete the offer, or if they are reckless as to whether they are able to complete the offer. The Australian Takeovers Panel has indicated that, where an offer is funded by debt, the bidder would have binding commitments from its financiers when it announces its offer and would not declare an offer as unconditional unless it was highly confident it could draw down the facilities (ie, that the finance documents were in final form and that commercially significant conditions precedent to utilisation had been satisfied or there is no material risk they would not be satisfied).

As part of the court-led scheme of arrangement process, the offeror will be required to satisfy the court that it has sufficient funds to pay the scheme consideration and complete the transaction. From a practical perspective, this often results in offers seeking certain funds financing from their financiers.

Gilbert & Tobin

Level 35, Tower Two
International Towers Sydney
200 Barangaroo Avenue
Barangaroo
NSW 2000

+61 2 9263 4000

+61 2 9263 4111

info@gtlaw.com.au www.gtlaw.com.au
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Gilbert + Tobin advises leading financial institutions, investment banks, corporations and private equity funds, and the lawyers in the Banking + Infrastructure team have strong experience in both domestic financing and cross-border transactions. The team is one of the largest dedicated banking and finance legal teams in the country, comprising ten partners, five special counsel, and approximately 40 associates. Gilbert + Tobin has offices in Sydney, Melbourne and Perth, and consistently provides an outstanding, comprehensive offering on the region’s most complex, market-leading deals. Gilbert + Tobin also has well-established relationships with some of the largest firms across the globe.

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