Lenders not misled in $2.5bn Arrium collapse

Following a lengthy trial of 38 days in the NSW Supreme Court in March and April 2021, Justice Michael Ball (no relation) has handed down the decision in the two proceedings, Anchorage Capital Masters Offshore Ltd v Sparkes (No 3); Bank of Communications Co Ltd v Sparkes (No 2) [2021] NSWSC 1025.

In dismissing these proceedings, Justice Ball has given some comfort to restructuring in Australia,

The Arrium attempted restructure and collapse

The proceedings were brought by two groups of lenders or parties who had taken assignments of debts either directly or indirectly from banks who had lent money to the Arrium Entities, against the Arrium Group's former CFO, Group Treasurer and three other former employees who were signatories to the debt drawdowns, alleging misleading and deceptive conduct and negligence in relation to loans advanced to or rolled over by the Arrium Group before it collapsed in April 2016.

Arrium was an ASX listed public company which operated three businesses in mining, mining consumables and steel. A sharp downturn in commodity prices forced management to commence a strategic review to address the approximately $2.8 billion of debt set to mature between July 2017 and June 2023. This strategic review resulted in a recapitalisation proposal which Arrium put forward in February 2016, and involved lenders approving significant write-offs of debts and a proposed sale of the mining consumables. The lenders rejected the proposal on 1 April 2016, and informed Arrium that its management no longer had their confidence. This led Arrium's directors to resolve to place the company into voluntary administration on 7 April 2016, and eventually resulted in the liquidation of the company on 20 June 2019. 

Prior to the administration, Arrium had entered into a number of bilateral and syndicated facility agreements with lenders. Between December 2015 and February 2016, it issued drawdown and rollover notices to the lenders in connection with these agreements, which resulted in the lenders advancing additional funds to Arrium and rolling over funds previously advanced. Each drawdown or rollover notice was signed by two employees and contained a number of representations in accordance with each respective facility agreement, including:

• that there had been no change to Arrium's financial position constituting a "Material Adverse Effect" (MAE representation); and
• Arrium was solvent at the time of the Notice (solvency representation).

The first group of lenders, the Anchorage Plaintiffs, brought proceedings in 2018 against the signatories to the notices (three employees of Arrium), Arrium's former CFO, Robert Bakewell and Group Treasurer, Delia Sparkes. At the claim's core was an allegation that the "Material Adverse Effect" representation in the notices was false, and that a duty of care which was owed to them by the signatories and Arrium in relation to this and other representations in the notices, was breached. They further alleged that Mr Bakewell and Ms Sparkes should be held personally liable for their conduct in relation to the breach, as well as for engaging in misleading and deceptive conduct in contravention of the Australian Consumer Law, the Australian Securities and Investment Commission Act 2001 (Cth) and the Corporations Act 2001 (Cth).

The second group of lenders, the BOC Plaintiffs, commenced proceedings in 2019 against Mr Bakewell and Ms Sparkes, alleging that they had engaged in misleading and deceptive conduct which contravened the Australian Consumer Law in issuing drawdown notices that contained both the MAE representation and solvency representation.

Mr Bakewell also filed a cross-claim in each of the proceedings against Herbert Smith Freehills (HSF), claiming that if he was found to be liable in either of the proceedings, then HSF should be liable for legal advice they gave as to solvency upon which he relied as the basis for his conduct. Mr Bakewell also named HSF as a concurrent wrongdoer in his proportionate liability defence.

The BOC plaintiffs alleged that the Arrium Group was insolvent by no later than 7 February 2016 because by that date it had no means of repaying the debt totalling approximately $871 million which would mature on or about 10 July 2017, because of the group’s deteriorating financial position. They chose not to file any expert evidence and relied upon the liquidator's solvency report.

In dismissing both proceedings and the cross claim against HSF, Justice Ball made a number of findings

Who has to prove what in a corporate insolvency?

Importantly, Justice Ball noted the BOC Plaintiffs sought to bring their insolvency case on a narrow and atypical way namely, that Arrium was insolvent from 7 January 2016 because from at least that date, it could not pay its long term debt owed under the banking facilities which were to mature in July 2017. In other words, it was not the BOC Plaintiffs' pleaded case that Arrium was insolvent because it could not pay other debts that became due before July 2017, although the BOC Plaintiffs did allege that Arrium’s diminishing liquidity position affected its ability to deal with the facilities falling due at that time.

The BOC Plaintiffs argued that the requirement that they prove that Arrium was insolvent on the balance of probabilities meant that “a company will also be insolvent if it can be said, on the balance of probabilities, that the company is not able to repay a debt falling due on some future date."

Noting that the test of insolvency for the purposes of the relevant facility agreements is that test adopted by the Corporations Act, in section 95A, the first, threshold issue in considering the representation made in the draw down notice concerning solvency was the standard of proof to be applied to the question. Justice Ball held that whether Arrium was unable to pay its debts as they became due from a particular date (that is, from 7 January 2016) is a question of fact, not likelihood.

Following from this, the Court must decide whether from 7 January 2016, Arrium was unable to pay a debt falling due in July 2017. This is not a question of fact; instead it involves a prediction based on what was known as at 7 January 2016. Justice Ball found that there needs to be a high degree of certainty and at most, all that could be said is that it was unlikely that Arrium would be able to pay debts falling due in July 2017.

The onus of proving that Arrium was insolvent fell on the BOC Plaintiffs (which was common ground). Further, the question of solvency should be determined at a group level (because of cross-guarantees between companies in the Arrium group and inter-company loans between companies in the group). The BOC Plaintiffs had to prove that as from 7 January 2016, it was unlikely that the relevant banks would be prepared to extend their loans on some basis. To hold otherwise would wrongly shift the burden of proof on the question of solvency to the defendants.

Was Arrium actually insolvent?

Arrium had at least 16 months to deal with the facilities falling due in July 2017 and total assets of $6,196.9 million and net assets of $2,328.4 million. Given the time available, said Justice Ball, it is to be expected that in the normal course of events Arrium would, if necessary, either be able to sell assets (eg. the mining consumables) or raise finance on security of those assets in order to repay the facilities falling due in July 2017.

The fact that Arrium went into voluntary administration on 7 April 2016 is not an answer to the company's insolvency. The question of solvency as at a particular date is to be examined by identifying all the liabilities of a company that existed at that date and asking whether each of those liabilities could be paid when it fell due. On the available evidence, Arrium would not run out of cash at any time before July 2017.

Once the lenders said that they had lost confidence in the Arrium board, however, it became clear that an agreement with them and co-operation from them were no longer possible. That was a dramatic change in circumstances which ruled out any possibility of acceptance of a recapitalisation proposal, or an amend and extend proposal or any accommodation or agreement with the lenders if Arrium was to continue under the control of the board. That explains why the board appointed administrators.

Against this background, the BOC Plaintiffs failed to prove not only that Arrium had insufficient liquidity to continue to trade for the foreseeable future but also that the solvency representation was false. At the time each of the representations were made in the respective notices "there were still a sufficient number of possibilities open to Arrium to deal with its bank debt that it could not be said that it was insolvent in January or February 2016".

No duty of care and no misleading and deceptive representations

Justice Ball then turned his attention to the duty of care and the representations. The signatories to the drawdown and rollover notices did not owe a duty of care in relation to representations made, as the representations and warranties were "made and given by the borrowing entity" (Arrium) not the signatories themselves, and the signatories would not expect the lenders to be relying on "their personal knowledge or expertise in making the representations".

Additionally, the lenders did not rely on the representations because they "must have appreciated" that there was a risk that they would not be repaid in full and that the lenders were, "making their own assessment of Arrium’s financial position and what was in their best interests in the circumstances". Arrium was placed on a watchlist or equivalent and its file transferred to the asset management or similar group within the Lenders to monitor Arrium’s financial position and closely manage the loans owed by it which supported the Court finding that

the Lenders were making their own assessment of Arrium’s financial position and what was in their best interests in the circumstances.

The claims against the signatories, Mr Bakewell and Ms Sparkes, for misleading and deceptive conduct failed, as they "merely acted as a corporate organ, and their own conduct could not be said to have a tendency to lead the Lenders into error". The accessorial liability claims against them likewise failed; they did not know the MAE Representation was false, Ms Sparkes was not shown to have appreciated that Arrium's change of financial position could have a "Material Adverse Effect", and the Anchorage Plaintiffs could not show Mr Bakewell should be held liable for "harm arising from the fact that the Lenders advanced the funds that they did" in accordance with the facility agreements.