Financial position and solvency not anchored to unaccepted sale price

In this week's TGIF, we consider the Court of Appeal's decision in Anchorage Capital Master Offshore Ltd v Sparkes [2023] NSWCA 88 and the challenges faced by lenders in accepting representations as to solvency and the financial position of borrowers.

Key takeaways

• It is increasingly difficult to satisfy courts that a company is insolvent because it is unable to pay future debts. The prediction of a company's inability to pay future debt is multifaceted and challenging given the uncertainties and contingencies naturally prevailing over time. For example, consideration must be given to the probabilities of the company realising assets, restructuring, compromising debts or raising capital to meet future liabilities.
• The failure of a company to sell an asset for a desired price does not necessarily change the company's financial position or require lender disclosure. Regard must be had to all financial information in the company's accounts when assessing financial position at the prevalent time.
• A duty of care is unlikely to be owed to a lender by persons authorised by a company to complete pro-forma drawdown and rollover notices. However, a personal liability may arise when a person with certain knowledge, expertise or seniority is specifically asked to provide material company information which is relied upon by a lender.

Background

Arrium's steel business was negatively impacted by falling iron ore prices. Concerned about Arrium's ability to meet its future debt obligations, Arrium's board decided to sell part of its business, MolyCop, review its core business and engage lenders to restructure existing debt.

During this process, Arrium issued drawdown and rollover notices to its lenders which included representations that there had been no change in Arrium's financial position constituting a Material Adverse Effect (MAE) under its financial arrangements and that Arrium was solvent.

Ultimately, Arrium's board was dissatisfied with the bids received for the sale of MolyCop and the lenders consequently rejected Arrium's restructuring proposal. Arrium's directors placed the company into voluntary administration and the company tipped into liquidation.

Alleged representations by Arrium

Arrium's lenders alleged that the drawdown and rollover notices provided by the company contained false representations because:

• the decrease in the likely sale value of MolyCop was a change in financial position that had a MAE; and
• Arrium's solvency could not be determined solely on their balance sheet, but required consideration of the MolyCop sale process and its impact on Arrium's ability to meet debts as they became due and payable.

The findings

The Court of Appeal found that the representations provided by Arrium were not false at the time they were given because:

• until the appointment of the administrators, Arrium had paid all debts when they fell due and was solvent on a balance sheet analysis;
• Arrium's financial position was not limited to information disclosed on the company's balance sheet but extended to all financial information contained in the company's accounts;
• the sale value of MolyCop was not known until the final bids were received. The failure of the sale process was not a MAE and not reflected in the company's accounts;
• Arrium continued to have options including selling assets or raising finance which may have allowed the company to meet future debt obligations; and
• the persons who signed the drawdown and rollover notices did not owe the lenders a duty of care in making the representations.

Comment

Lenders and liquidators face an uphill battle convincing a court that a company is insolvent due to an inability to pay future debts owed by the company in the coming years, as opposed to weeks or months.

For lenders, who are often perceived by the courts to be commercially astute in protecting their own interests, this decision is a timely reminder to:

• carefully assess the borrower's financial accounts when concerned as to deteriorating financial position or a change in circumstances and make specific requests for pertinent company information from persons with appropriate seniority, expertise and responsibilities to objectively assess solvency;
• properly document reliance placed on information provided by the borrowing company and its key personnel in lenders' decision making;
• encapsulate appropriate contractual remedies in financing arrangements to afford fair and sufficient protection;
• methodically construct and implement objective MAE clauses; and
• cautiously consider restructuring activities particularly in cyclical and volatile markets where refinancing and rollovers are common.