Introduction
"From time to time during the last five years I felt as if I
were confined to an oubliette. There were occasions on which I
thought the task of completing this case might be sempiternal.
Fortunately, I have not yet been called upon to confront the
infinite and, better still, a nepenthe beckons. Part of the
nepenthe (which may even bear that name) is likely to involve a
yeast-based substance. It will certainly involve a complete
avoidance of making decisions and writing judgments.
For the moment, in the words of Ovid (with an embellishment
from the old Latin Mass): Iamque opus exegi, Deo gratias."
[2]
With those words, Justice Owen of the Supreme Court of Western
Australia concluded his sesquipedalian [3] magnum opus
("These reasons can only be described as a megillah" [4])
on the collapse of the Bell group and its aftermath.
His Honour's judgment is a statistician's delight [5] and
an English teacher's treat (the above quoted paragraphs are but a
minute example) but most importantly a salutary lesson for bankers,
directors and their legal advisers of the legal pitfalls involved
in refinancing and work-outs of corporate groups on the brink of
financial collapse.
Although this judgement relates to events that occurred in the
late 80's, early 90's, it is more than an historic footnote given
it 'arrived' in the midst of a current global financial
crash, the dimensions of which, arguably, have not been seen since
the Great Depression.
The facts
The Bell Group Limited (TBGL) was the holding
company of a large corporate group. The corporate dramatis personae
were: Bell Group Finance Pty Ltd (BGF), the
group's treasury entity; Bell Group NV (BGNV),
which issued bonds in several fundraising exercises in the Eurobond
market, the Bell Group (UK) Holdings Ltd (BGUK),
the English subsidiary, Bell Resources Ltd (BRL) a
39% owned subsidiary and an important cash box for the group and
Bell Publishing Group Pty Ltd (BPG) which held the
group's publishing assets.
In the mid 1980's, TBGL or BGF had banking facilities with
various Banks situated in Australia. The facilities were unsecured
but supported by negative pledge arrangements. In1986, BGUK took
out a loan facility with the 'Lloyds syndicate', a syndicate of 14
Banks situated in Europe, Canada and the Middle East. This facility
was also unsecured but supported by negative pledge arrangements.
Between December 1985 and July 1987, BGNV, TBGL and BGF between
them issued five separate bond issues, described as 'convertible
subordinated bonds' that raised about $585 million. The funds
raised via the BGNV issues were on lent by BGNV to TBGL or BGF. The
funds raised by TBGL and BGF went directly to each of them. The
on-loans were not formally documented.
In October 1987, the stock market crashed. The financial
pressure placed on the Bell group as a result eventually led to a
takeover of the Bell group by Bond Corporation Holdings Ltd
(BCHL). The takeover was completed around the end
of 1988.
Despite continuing efforts to sell assets and reduce debt, a
process started before the stock market crash, it became clear by
the middle of 1989 that TBGL and BGF could not repay its
facilities.
This sparked a series of negotiations between the Bell group and
its various Bankers, which led to the restructure of the group's
finance facilities. Completion of the documentation took until July
1990 although most were in place by mid February 1990.
In effect, the restructure involved the replacement of the
existing negative pledge facilities, an extension of time to repay
all Bank debt by May 1991, the repayment of Bank debt on a pro-rata
basis from group asset sales, the subordination to Bank debt of all
intra-group indebtedness and the giving of new guarantees and
security over assets.
During the course of the restructure, a number of important
events occurred:
- the Banks continued to receive grim cash flow projections;
- BCHL lost control of the Board of BRL;
- a Receiver was appointed to an important Bond group subsidiary,
which was overturned on appeal in late February 1990; and
- TBGL raised the possibility the bondholders might not be
subordinated and might rank equally with the Banks.
In April 1991, TBGL applied for the appointment of a provisional
liquidator. Subsequently all group companies were placed into
insolvency administrations. The Banks realised their securities and
recovered about $283 million from the sale of the group's
publishing assets, the sale of BRL shares and the collection of
debts. The Banks' debt at 26 January 1990 was approximately $262
million.
The litigation - background
The proceedings commenced in December 1995. The Plaintiffs
comprised TBGL, many of its subsidiaries, the Liquidators and the
Trustee for the bondholders in the five convertible subordinated
bond issues. The main Defendants were the 'Australian Banks' and
the 'Lloyd's Syndicate Banks'. Although directors of TBGL, BGF,
BGUK and other companies were initially named as defendants, they
were not proceeded against.
The Plaintiffs threw everything bar the kitchen sink at the
Defendants. The Plaintiffs sought an array of orders and other
relief including the setting aside of the refinancing transactions,
confirmation the on-loans were unsubordinated, the return of the
monies taken by the Banks upon realisation of their securities, the
refund of legal and bank fees, damages, interest and monetary
compensation of around $1.5 billion.
The Banks resisted the orders sought by the Plaintiffs and by
cross-claim sought orders, declarations and injunctions to preserve
the refinancing transactions, to confirm the on-loans were
subordinated, to require the Plaintiffs to pay to the Banks any
funds received in the liquidation of other Bell companies and other
relief.
The litigation - central issues
Insolvency
Cash Flow test v Balance Sheet
test
"The central feature of the insolvency concept is clear: a
person is insolvent if he or she is unable to pay debts as they
become due. But thereafter, the fog descends. An examination of
previous cases reveals the nuances surrounding the concept of
insolvency. The application of the concept in individual cases can
be both vexed and difficult."
There are two solvency tests: the cash flow test and
the balance sheet test. His Honour confirmed that in
Australia the cash flow test was generally viewed as the more
appropriate mechanism for assessing solvency and more in keeping
with the definitions of solvency in the Bankruptcy Act and
the Corporations Act. However, his Honour indicated the
balance sheet test nonetheless remained relevant and could also be
used in the right circumstances.
His Honour also confirmed that "Insolvency is to be judged
by a proper consideration of the company's financial position, in
its entirety, based on commercial reality" and that a
temporary lack of liquidity was insufficient. Directors could
legitimately take into account, besides cash reserves, funds
realisable by assets sales, by borrowings and by other reasonable
means provided they were not acting on faint hope or an unreal
view.
His Honour was satisfied a court could take into account facts
available in hindsight (post insolvency) if those facts shed light
on the state of affairs at the time and on what was, or ought to
have been, known about the state of affairs. [6]
In determining the period to be examined to assess the group's
solvency, Justice Owen rejected the contentions of both sides and
decided a 12 month period, with the major focus being on the period
26 January 1990 until the end of May 1990, was
appropriate.
The Evidence
The Plaintiffs contended the evidence showed that by 26 January
1990, the Bell group companies were beset by 'insurmountable
endemic illiquidity' that would inevitably lead to their
insolvency. Justice Owen, after analysing competing experts' cash
flow prognostications, actual and potential sales of assets,
collection of debts and the group's ability to raise new funds,
accepted the Plaintiffs' contention.
His Honour also found the situation did not improve between May
and December 1990 and that the refinancing in January 1990 did
nothing to enable the Bell group to pay its debts as and when they
fell due.
His Honour, in making his findings, pointed to evidence of:
The Directors
Breach of Duties and Corporate
Benefit
The Plaintiffs alleged the directors failed to act in the
interests of the companies, exercised their powers for an improper
purpose and failed to avoid a conflict of interest.
They argued, among other things, that the directors:
- failed to have regard to the effect of the refinancing
transactions on each company as a whole including its creditors,
future creditors and shareholders;
- caused each company to enter the refinancing transactions
thereby exposing each company to be liable for the debts of BGF
and/or BGUK (both of which were then in an insolvency context) to
the Banks in circumstances where that had not previously been the
case; and
- acted to protect their position of control of TBGL and their
financial interests in BCHL and other Bond companies and that this
was in conflict with their duties to Bell group companies
.
The Banks argued, in effect, that the interests of creditors
were essentially irrelevant considerations for directors. Justice
Owen rejected this argument. While in an insolvency context (actual
insolvency was not required) there was no principle to the effect
that directors must take into account the interests of creditors or
that their interests were paramount in deciding what was in the
best interests of the company, directors must nonetheless
consider the interests of creditors.
As for the conflict of interest argument, the pleadings were
unclear as to the case being made. The Banks argued the Plaintiffs
were alleging a breach based on the directors preferring the
interests of a third party instead of a conflict between fiduciary
and principal. Justice Owen accepted that a transaction
that benefits a third party is not prohibited by the conflicts rule
unless, coincidentally, the fiduciary's interest lies in benefiting
the third party. He was therefore not prepared to entertain a plea
to the effect that where there was a conflict between the interest
of others and those of the company, the director could not exercise
his powers in the interest of others. On the evidence, this
allegation failed.
His Honour, in considering whether there had been a breach of
directors' duties, had to decide whether the test to be applied was
objective or subjective. The end result was an 'each way bet';
while the court accepted directors and not courts made the
commercial decisions and that their subjective intentions
or belief were relevant, when considering an impugned transaction,
the courts were entitled to look objectively at the
surrounding circumstances to test the directors' subjective
intentions or belief and to intervene where the decision made was
one that no reasonable board could think was in the interests of
the company.
Justice Owen found there had been a breach of directors' duties
by the Australian and UK directors.
His Honour was satisfied the Australian directors knew the
companies were of doubtful solvency or nearly insolvent but not
that they were insolvent. They therefore had a duty to consider the
interests of creditors but instead considered the interest of only
one creditor, the Banks.
Further, these directors:
- focussed their concern on the group and not on the interests of
individual companies ('we all survive or we all go down');
- the refinancing transactions were 'step one' in a plan to save
the group, yet the plan beyond 'step one' had not been developed or
thought out in sufficient detail; and
- two of the three directors were more concerned about the
interests of the BCHL group than the Bell group companies of which
they were directors.
His Honour also found the directors exercised their powers for
an improper purpose by causing companies with no
pre-existing indebtedness to the Banks to place their assets in
jeopardy in the interests of borrowers and guarantors that were
insolvent, nearly insolvent or of doubtful solvency. In this sense,
the directors failed to ensure there was a corporate
benefit to the individual companies in entering the
refinancing transactions. The "plan" was simply a means to stave
off financial collapse and this too was insufficient to ground an
argument that the refinancing transactions provided a corporate
benefit to individual companies.
His Honour was far less critical of the UK directors. He
accepted they had approached their consideration of the refinancing
transactions appropriately but "stumbled at the last obstacle" by
failing to get reliable financial statements and information to
verify the Bell group companies were solvent and that letters of
comfort given by TBGL on which they were relying (Justice Owen
described this as the critical factor in determining
whether the refinancing transactions were in the best interests of
the individual companies of which they were directors) would be
honoured if called on. Instead, they relied on assurances from
officers of the Australian Bell group companies and Alan Bond (who
was not a director of any company relevant to these issues) to that
effect. Those assurances turned out to be wrong.
The Banks
Their Knowledge and Conduct
The evidence showed that as at 26 January 1990, the Banks held a
strong suspicion the Bell group companies were insolvent or nearly
so and did or must have had serious concerns about the Bell group's
ability to continue as a going concern.
As the refinancing negotiations progressed, the Banks, contrary
to normal banking practice, sought less and less information about
the ongoing financial circumstances of the group such as cash flow
information, audited company accounts and company creditors.
Tellingly, the Banks waived the requirement that solvency
certificates be provided when having pushed for them earlier in the
refinancing negotiations.
The Banks after much deliberation about the structure to be
adopted for the refinancing transactions settled on the borrowers
structure as that would avoid the threat of 'double jeopardy' (the
securities being set aside and the Banks having to compete with
other creditors in a liquidation) and would leave them no worse off
if the refinancing transactions were set aside.
In all of these circumstances, the usual proposition that it was
for the directors to determine corporate benefit and that the Banks
could rely on their determination did not apply. The banks had too
much knowledge of the true situation to argue there was corporate
benefit in the refinancing transactions for many of the group
companies.
Barnes v Addy [7]
The Plaintiffs alleged the Banks knowingly received
trust property within the meaning of the first limb of the rule in
Barnes v Addy. The second limb of knowing
assistance or knowing participation in a breach of
fiduciary duty was inapplicable.
For the allegation to be made out the recipient must have had
actual knowledge of the trust and the misapplication of the trust
property; turned a blind eye to the facts, refrained from making
enquiries an honest and reasonable person would make or knew of
facts that to an honest and reasonable person would indicate the
existence of the trust and the misapplication.
Justice Owen held the relevant 'property' was created and
disposed of when the directors, as part of the refinancing
transactions, created security interests over company assets that
were previously free of any relevant third party interests.
The Banks knew:
- of the legal consequences if the companies went into
liquidation within six months of the creation of the securities
taken as part of the refinancing transactions (they would be set
aside);
- there was a real doubt about whether there was a corporate
benefit for all relevant companies; and
- of the parlous financial condition of the companies;
and the Banks recklessly refrained from finding out about:
- the actual financial position of the companies;
- the position of the on-loans;
- the effect of the refinancing transactions on other creditors;
and
- whether the directors might be breaching their duties in
determining whether there was a corporate benefit to each company
that entered into the refinancing transactions.
In these circumstances, Justice Owen found the 'knowing receipt'
allegations to be proved.
Form over Substance
The Banks required the refinancing documents, minutes of
directors' meeting and resolutions to address the issue of
corporate benefit and to positively assert such benefit
existed.
The Banks had received legal advice that there had to be a
corporate benefit for each company entering into the refinancing
transactions and that this would or at least may involve
considering the interest of creditors. The Banks instructed the
lawyers to draft the documents with this in mind. The minutes of
meeting were identical.
Justice Owen found the drafting of the recitals to the
refinancing documents and the minutes were a triumph of form over
substance. What was crucial was the directors' actual belief as to
the existence of corporate benefit; the evidence showed the
Australian directors did not appreciate what the corporate
benefit test involved and therefore could not have made a bona fide
decision as to its existence.
Justice Owen found, in contrast, that the UK directors were well
informed about the substance of the corporate benefit test and
applied themselves diligently to the task of complying with it.
There was no form over substance approach by them. As mentioned
earlier in this article, the UK directors nonetheless failed in
their duties but for other reasons.
The Plaintiffs' Other Claims
The Plaintiffs made a number of other allegations (the kitchen
sink referred to earlier) including:
- the Banks conduct in entering into the refinancing transactions
engaged in equitable fraud as against the non Bank creditors of the
Bell group generally and to the bondholders;
- the refinancing transactions constituted an inequitable and
unconscientious bargain (another equitable fraud) on each Bell
participant;
Justice Owen found the evidence did not support these
allegations.
- Certain of the security documents comprising the refinancing
transactions constituted dispositions by certain Bell companies
made with an intent to defeat creditors or future creditors
contrary to section 121 Bankruptcy Act and equivalent
state and territory legislation;
Justice Owen found that because the Plaintiffs had not pleaded
an essential element of the cause of action - an actual dishonest
intent on the part of the directors - this allegation failed.
- The same set of security documents as above but as entered into
by four only of the Bell companies constituted settlements made
within two or five years before the commencement of the winding up
of those companies under sections 120 (1) or 120 (2) Bankruptcy
Act;
Justice Owen found this allegation to be proved.
Justice Owen also found the bondholders interests were
subordinated to the Banks and therefore the Banks had not failed to
pay due regard to their interests.
Conclusion
Final orders have not yet been made. Justice Owen has
'suggested' to the parties that it is not too late for a negotiated
settlement. Whether they heed his Honour's words remains to be
seen.
The law has moved on since the events the subject of this case.
There have been changes to the insolvency laws, to the laws on
directors' duties and to corporations law that now allows a company
to act in the best interests of its holding company provided the
company is not insolvent. It is questionable however, whether any
of these changes would have produced a different outcome for the
Banks.
There are many lessons to be learned from this saga for
directors, bankers and their legal and accounting advisers. Bankers
again find themselves in a similar situation to that which
prevailed in this case, in managing the 'work-outs' of a number of
current major Australian corporate collapses. Whether the lessons
have been learned may well be a topic for a later article.
[1] Decision No 9, [2008] WASC 239.
[2] For those readers whose English and Latin skills are
not as good as Justice Owen's, oubliette is a form of
dungeon accessible only from a hatch in a high ceiling,
sempiternal means everlasting, nepenthe means a
drug of forgetfulness and Iamque opus exegi, Deo gratias
means And now I have finished the work, thanks be to God.
[3] Relating to a long word; characterised by using long
words.
[4] In this context, the Yiddish word Megillah
means a long boring tediously detailed account.
[5] The hearing took 404 days, there were 166 witnesses,
86,340 documents were tendered in evidence, there were 37,105 pages
of transcript and the reasons for decision comprised 2,643
pages.
[6] Lewis v Doran (2004) ALR 385 and on appeal (2005) 219
ALR 555
[7] (1874) 9 Ch App 244