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The Bell Group Litigation – the lessons learned
Diccon Loxton, Partner, Allens Arthur Robinson

The Bell Group litigation which has recently been completed in Australia has given some timely insights into how the Australian courts will approach the legal issues involved in work-outs.

The court advised banks and company directors to take a more cautious approach in work-outs, and in the standard procedures that apply whenever members of corporate groups give guarantees. Despite this being an Australian case, based on (now outdated) Australian law, some key principles emerged from the decision.

Simplified facts

  • The Bell Group Limited (TBGL), an Australian listed holding company, and its English subsidiary, had borrowed money from banks on an unsecured basis. The loans were guaranteed by various members of its corporate group.

  • TGBL subsequently suffered financial difficulties. It entered into a refinancing transaction with the banks, pursuant to which:

    • the term was extended;
    • the banks took guarantees and security over principal assets from many members of the group; and
    • the borrower and the guarantors undertook that all asset sale proceeds would be used toward repayment of the bank debt or would be paid into escrow.

  • Most of the refinancing documents were executed in early 1990. In April 1991, TBGL appointed provisional liquidators, and the banks realised the assets subject to their security. TBGL and a number of its subsidiaries, the liquidators, and the trustee for the bondholders, sued the banks.

  • They alleged, among other things, that the companies were insolvent when they entered into the refinancing transaction and gave the securities, and that their directors were in breach of their directors' duties. They claimed the banks were aware of the breach, and consequently were liable as constructive trustees to return the proceeds of realisation of the securities, and the refinancing transaction should be set aside.

  • Further, there were various claims that the banks' conduct amounted to an equitable fraud on the companies and their creditors, including the bondholders, and claims that the security should be set aside under bankruptcy legislation as it then affected Australian corporations (the law has since changed).

The court's findings

The court found that:

  • TBGL and its subsidiaries were insolvent when they entered the refinancing transaction and gave securities;

  • the directors knew or should have known that the companies were insolvent, or nearly insolvent;

  • entering into the transaction and giving the securities involved a breach of the directors' duties (specifically, the duty to act in the company's best interests); and

  • the banks knew of that breach, and were therefore liable as constructive trustees.

Practical application of the lessons learned

The decision of the court included the following advice:

When groups of companies are in financial difficulties or seeking a work-out

Directors:

  • Obtain and critically examine forward looking cash-flows showing a prospect of paying, continuing or refinancing existing debt.
  • Examine the position of each company in determining corporate benefit.
  • For each company, don't create security in favour of one group of creditors, unless there is a plan, or a reasonable prospect of a plan, for the company to continue to pay creditors.
  • Treat with great caution any proposed guarantee from a company that has not previously given a guarantee of the debt.
  • Ensure that the minutes of any meeting are accurate and a meeting is actually held for the company.

Banks:

  • Examine the position of each company in determining corporate benefit.
  • Obtain and critically examine cash-flows showing a prospect of paying, continuing or refinancing existing debt.
  • Be aware of the restrictions on directors (see above).
  • Ask for your standard requirement in relation to information, certificates and the like, and do not give up the request without extreme caution.
  • In relation to each company, unless the corporate benefit is blindingly obvious, get defensible, reasonable statements (preferably not full minutes) setting out the reasons why the directors are entering into the transactions, and the corporate benefit for the company.
  • Be very wary of accepting evidence of directors' resolutions that are implausible (i.e. they set out formalities that may not be followed).
  • Be very cautious about becoming involved in the drafting of directors' resolutions.
  • Be cautious about accepting identical pro forma minutes or resolutions for every company.

When companies in a solvent group are giving a guarantee of a new financing

Directors:

  • Separately examine the position of each company in determining corporate benefit.

Banks:

  • Insist on your standard requirements; be careful about giving them up.
  • In relation to each company, unless the corporate benefit is clear, get defensible, reasonable statements (preferably minutes) setting out the reasons why the directors are entering into the transactions, and the corporate benefit (not simply a statement that there is a corporate benefit).
  • Be very wary of accepting evidence of directors' resolutions that are implausible.
  • Be cautious about pro forma resolutions for every single company – i.e., ensure each are appropriately adapted.
  • Be aware that there may still be a risk where every company's constitution has a provision allowing its directors to act in the best interests of its holding company.

Enquiries and information

For more information on any of the cases, articles and features in Financial Services Quarterly, please email Rachel Gowing or call on 64 9 916 8825.

Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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