Challenging a 444GA transfer – what are the issues?
As the world continues to grapple with political and economic volatility while adjusting to a high cash rate environment, the market sentiment in corporate Australia is becoming less optimistic. Despite seeing a resiliency to formal insolvency appointments in the recent 12 to 18 months, the current market instability might lead to an increase in the number of voluntary administrations. While there will be a number of important considerations in this uncertain financial landscape, control of the process and ultimate outcome will be more critical than ever for investors.
A tool frequently utilised by investors seeking to gain control is section 444GA of the Corporations Act 2001 (Cth), which allows a deed administrator under a deed of company arrangement (DOCA) to seek leave of the court to compulsorily transfer the shares in a distressed company. Whether the use of section 444GA is to avoid the difficulties of an asset sale, or to facilitate a “debt for equity” restructure, recent examples demonstrate its effectiveness in delivering a successful control transaction. However, with the preference to rely on section 444GA growing, it is important to remember that certain parties can challenge this process in an attempt to block the share transfer.
We expect an increase in the use of section 444GA to facilitate control transactions. It is therefore timely to consider the key threshold issues relevant to a challenge. A recent decision in the Supreme Court of Western Australia demonstrates how susceptible this process is to challenge.
An objecting party must convince the Court that the transfer would “unfairly prejudice” the interests of the shareholders.
Section 444GA challenges
To successfully challenge an application for leave under section 444GA, the objecting party must convince the Court that the transfer would “unfairly prejudice” the interests of the shareholders – the absence of compensation alone is not enough to meet this hurdle. Where this is not established, there will be no basis for the Court to withhold its approval of the share transfer and the challenge will fail.
Given that the Courts have made it clear that unfair prejudice can only be suffered if the shares hold some “residual value”, objecting parties typically attempt to introduce competing valuation evidence (to that relied on by the administrators) to support an argument that there is residual value in the equity. The Courts have consistently assessed value on a liquidation counterfactual basis such that if liquidation is the only alternative to the transfer, and the equity would receive no return in this scenario, the shares will have no residual value. That said, a business can be valued using a number of different methods which could each lead to different conclusions as to where the value breaks in the business and, as inferred by the Court in Re Nexus Energy Ltd (Subject to Deed of Company Arrangement) (2014) 105 ACSR 246 (Nexus), a non-distressed, arm's-length, going concern valuation might be appropriate in the right circumstances. While a liquidation valuation was ultimately favoured by the Court in Nexus given that the going concern valuation did not take into account the DOCA company’s lack of funding and ability to meet its capital requirements, each application is likely to have its own particular circumstances and an assessment will need to be made on a case-by-case basis as to which valuation method is the most appropriate. This is consistent with ASIC’s Chapter 6 regulatory guidance, which provides that skill and judgment is needed when selecting the most appropriate valuation method in a section 444GA context and the valuer should have a reasonable basis for choosing the selected method.
Outside of competing valuation evidence, we have also seen examples of objecting parties in Nexus and the section 444GA application in the Network Ten restructure attempt to establish unfair prejudice by complaining about the sale process that was undertaken and the conduct of the parties involved in the restructure (including the administrators’ conduct both before and during the voluntary administration). While these arguments ultimately failed as no misconduct or impropriety in relation to the sale process could be proven, the Court in Nexus interestingly noted that, in certain circumstances, the influence of a secured creditor over the sales process (including the time made available for the process) could lead a court to conclude that the sale process was not reliable and it should use its discretion to deny the share transfer. There have also been challenges on the grounds that the existence of the recapitalisation proposal itself infers that the shares held some residual value – in other words, a party seeking to acquire the shares should indicate value in those shares. Unsurprisingly, the Court rejected this argument.
Who can challenge as an "interested person"?
Under section 444GA(2), only shareholders, creditors, ASIC or any other “interested person” have standing to oppose a section 444GA application. Importantly, those seeking to challenge an application as an “interested person” will need to satisfy the threshold question of whether their interest in the share transfer is sufficient to qualify for the requisite standing. This issue was recently considered by the Western Australian Supreme Court for the first time. In doing so, the Court made it clear that not everyone with a supposed interest in the application will have standing under section 444GA(2) to challenge it (Richard Scott Tucker as joint and several administrator of Allegiance Mining Pty Ltd (Receivers and Managers Appointed) (Subject to Deed of Company Arrangement) (ACN 059 676 783) v Su [2022] WASC 178 (Allegiance Case)).
The objecting applicant in the Allegiance Case claimed to have standing as an “interested person” to challenge the compulsory transfer of shares in the DOCA company, Allegiance Mining Pty Ltd (AMPL) on the basis that they were a shareholder and creditor of Dundas Mining Pty Ltd (in Liquidation) (Dundas), the sole shareholder and parent company of AMPL.
The Court ruled that an “interested person” should only include applicants whose material rights or economic interests are directly and substantially (ie., materially, or significantly) affected by the share transfer in the relevant company – for example, the employees of the DOCA company that were a part of a share incentive scheme. Accordingly, the Court held that the applicant did not meet this standard given that their interest was not direct, and as a result any effect on it could not be considered substantial.
While the applicant did of course have an indirect interest in the share transfer as a shareholder of AMPL’s parent company, the Court was not willing to broaden the class of “interested person” to an unnecessary and unwarranted extent to accommodate it. Instead, the Court noted the proper party to represent the applicant’s reflective interest and oppose the application was Dundas in its capacity as shareholder of AMPL.
Conclusion
As the active use of section 444GA continues for control transactions, we are likely to see more disgruntled stakeholders attempting to challenge and/or dispute the merits of the application. While recent challenges have been unsuccessful, the Allegiance Case is a timely reminder for parties on either side of the application of the importance of engaging advisers early and working through the (likely) unique circumstances of an application, particularly in the context of a challenge.