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Episode 47
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Professional Skills Substantive Law
Show me the Money! Navigating Debt and Credit
Law as stated: 13 December 2021
What is this?
This episode was published and is accurate as at this date.
In this episode, Geoff Sutherland draws on his vast experience as an international trade and finance lawyer advising large corporate borrowers both nationally and internationally to provide insights into the world of banking and finance law. He gives tips on what lawyers can do to better aid in the free and productive flow of debt and credit to achieve the best outcome for their clients.
Professional Skills
Substantive Law| What area(s) of law does this episode consider? | Corporate, finance and banking law |
| Why is this topic relevant? | If your client’s company wants to make a large acquisition, embark on an ambitious new project, or grow aggressively, chances are it won’t be able to do it with the cash it has in the bank account and will need an injection of capital. While Australian companies have had higher debt-to-equity ratios than their US counterparts for some time since the Global Financial Crisis, the COVID-19 pandemic has led to interest rates plummeting to historical lows, while real property values remain high meaning debt financing is more accessible than ever for Australian companies. |
| What legislation is considered in this episode? | Corporations Act 2001 (Cth) Electronic Transactions Act 1999 (Cth) The Treasury Laws Amendments (2021 Measures No. 1) Act 2021 (Cth) |
| What are the main points? |
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| What are the practical takeaways? |
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| David Turner:
1:00 | Hello and welcome to Hearsay, a podcast about Australian laws and lawyers for the Australian legal profession, my name is David Turner. As always, this podcast is proudly supported by Assured Legal Solutions, a boutique commercial law firm making complex simple. If your client’s company wants to make a big acquisition, embark on an ambitious new project or grow aggressively, chances are it can’t do it with the cash it has in the bank account – it needs an injection of capital. Now while Australian companies have higher debt to equity ratios than their US counterparts and have done for some time since the global financial crisis, with interest rates at historical lows and asset values remaining record high, debt financing is cheaper for Australian companies than ever. Here to discuss the legal aspects of debt finance for corporate borrowers from drawdown to default is Geoff Sutherland. Geoff, thanks so much for joining us today on Hearsay. |
| Geoff Sutherland: | Pleasure to be here. |
| DT: | Now Geoff, tell us a bit about your career as an international trade and finance lawyer. You’ve practiced in large international law firms here in Australia, you’ve done some freelance work for the big four banks, you’ve practiced overseas, including in Vietnam. Tell us a bit about that. |
| GS:
2:00
3:00
4:00
5:00
6:00 | Well, it all started out by accident. I never set out to be a finance lawyer. It just sort of landed in front of me and I started doing it and kept doing it as it were. And I started off in quite a small firm, when I started off firms were much smaller than they are now. I think there were five partners when I started off in the firm. And there were three major changes I think along the way that really changed how banking and banking law was done. The first one in my time was the deregulation of the banking industry in 1983. The admission of foreign banks. I think the time keeping let in about something like 20 foreign banks. This brought in foreign capital, foreign experience, terminologies, suddenly we’re all talking about receivables rather than debts and inventory rather than stock and trade and all that sort of stuff, collateral rather than security. TIP: Now although Geoff is talking about a time that’s more than 40 years ago, it’ll help us get a clearer picture of Australia’s banking and finance landscape today if we understand what the industry looked like pre-deregulation and what the government sought to achieve through deregulation. In the words of former Deputy Governor of the Reserve Bank of Australia, Ric Batellino, the aims of the Government’s wide-ranging controls on the banking and finance sector in the early 80s were as follows:
Now to achieve these goals, the government used tools like strict controls on the interest rates banks that could charge, directives on the quantity of loans that a bank could make, close monitoring of foreign exchange transactions and the specialisation of institutions (for example, trading banks were meant to lend to businesses almost exclusively while savings banks were meant to lend to households).
Deregulation began as early as the 70s, starting slowly and tentatively with things like the removal of interest rate controls on banks until it culminated with the permitting of foreign banks to enter the country, as well as making it easier to establish new domestic banks. As Geoff’s going to explain, this new age of deregulation introduced Australia to a fiercely complex and competitive world of banking and finance and had a flow-on effect of accelerating the growth of banking and finance law here in Australia.
The second one, which was more gradual, was globalisation, which affected many parts of commerce, but particularly finance. Finance became global. And law firms everywhere, but particularly in Australia, had to learn more about the finance techniques internationally. How finance work was done and in order to be able to do these much more complex transactions needed specialisation, they had to learn from overseas. And this led to the growth of the size of law firms in Australia. And the third major one which had a big impact, huge impact, on the practice of finance law was emails. I remember sitting in my office about 2002 and thinking, “ah, I’m not quite enjoying this as much as I used to.” I was trying to work out what the problem was, and what had happened in the year or two before then was two major problems had been overcome: one was being able to transmit emails with confidentiality, which is obviously fundamentally important for lawyers. And there were problems with that beforehand. And the other was being able to attach and send large sized documents because there just wasn’t the capacity before. So suddenly you’re getting 150-page finance agreements landing in your inbox, whereas previously you’d have had meetings and phone calls, you’d have talked to people all the way through and suddenly you were talking to your computer instead. And those things really just changed the whole world with finance. And part of the globalisation, I got involved in a couple of ways. I was a partner in an American firm called Coudert Brothers. And then I was moved across to Deacons which became Norton Rose. But I was involved in Asia in the early 90s, I was involved in Indonesia where there were a lot of banks, like 200 banks, and at the time it was pretty clear that they were virtually all insolvent. |
| DT: | Wow. |
| GS:
7:00
| But they were still trading on. I remember one instance, they were quite small, a lot of them were family owned and they did transactions with the family and with the family’s businesses, and there was no way of telling who was worth what. But being taken into one of the banks I was talking to up there, being taken into their main branch in Jakarta and there in the middle of the floor was an ATM machine. And they were very proud of this ATM machine, but it was just sitting in the middle of the floor. It had never been installed. So that was part of the learning curve, but later on I went to Vietnam in 2009 to run the Norton Rose office there for three years, and that was a completely new experience. The Companies Act there was probably no more than 20 pages long. The Tax Act was about 10 pages long. The loan agreements, facility agreements, drafted by Vietnamese law firms at the time were usually only one or two pages long. It was just a different way of doing business. |
| DT: | I imagine there’s a few of our listeners listening now, that are probably thinking that all sounds pretty good actually. A 20-page long Corporations Act and a two-page long loan agreement, it sounds like a much easier way to practice. |
| GS: 8:00 | Yeah, in many ways it was. It was just that the legislation was very vague. Which left it wide open to discretion. And the offices in the state authorities had a lot of discretion, and that could vary between province to province, so you never actually quite knew what the law was. It was very interesting when you drafted an opinion because you just had to qualify everything, including that not all the law is publicly available and things like that. |
| DT: | An opinion, in the truest sense, really, ultimately. |
| GS:
9:00
10:00 | Yeah, that’s right. Yeah, CBA and ANZ were there at the time. And they both got licences there, banking licences there, but dealing with the State Bank of Vietnam, it took a great deal of patience. One example working there, I was engaged to, there was a Malaysian bank which was getting a license in Vietnam and they wanted their templates, their Malaysian templates which were based on Old English templates from probably the 1940s or something, and they wanted them adapted for Vietnam, but there was no point in using those documents as they were because, you know, 50 pages long or something like that. And if we’re going to enforce anything, a mortgage for example, you’d have to go before the courts in Vietnam. And there was no way the courts would have understood anything about them. So I was in this dichotomy between those instructing me being very proud of their present documents and having to say to them “look these just won’t work here.” All sorts of different issues there. There were issues with the securities registries not being reliable. The enforcement of securities was dubious. There were many foreign investors and banks, there were no-go areas of property development, for example. So it was certainly a learning curve that was really interesting. Anybody who went there learned a lot that you wouldn’t come across sitting at a desk in Melbourne or Sydney. |
| DT: | Certainly. |
| GS: | Yeah, so that was some of my involvement in international financing. |
| DT:
11:00 | And I suppose having that experience both with the international influence on the way finance law is practiced in Australia as well as the globalisation of the finance industry and finance community, and seeing the way those international and cultural contexts influence the way finance is practiced, that really gives you an interesting perspective I think on our topic today which is a legal strategy for corporate borrowers. How the legal context, how the cultural context, how all of these externalities affect that legal strategy. Turning to legal strategy for corporate borrowers, our topic for today, I want to start with the earliest stages of that strategy: negotiating debt finance terms. Now in your experience, both here and internationally, does the kind of lender on the other side of the transaction, whether we’re talking about one big four bank or a syndicate or a nonbank lender or a specialist financier, does that influence your advice on legal strategy for a borrower? |
| GS:
12:00 | You have to take it into account. I think it’s a bit like a football coach who says “look, we work out how we’re going to play the game rather than adjust it to what the opposition is doing.” And I think that that applies. You’ve got to work out for the borrower, “what do you want?”, “what’s really important for you?”, “how are we going to do that?”. And then you might take that and say, well, we’re dealing with this type of bank or that type of bank, or some other type of lender, we might approach them differently. Sometimes with a small bank it can be difficult to get them to agree to amendments to their template, for example. So you might adjust your focus a bit on that. |
| DT: | That’s surprising, I would have thought that the larger the institution, the more negotiating power and perceived bargaining power they have would result that they’re less likely to amend their documents, but you’re saying it’s sometimes the opposite? |
| GS:
13:00
14:00 | Yeah, sometimes it’s the opposite, and of course it depends upon, as in any negotiation, that the size of the combatants is relevant to what happens. But I think whatever you do, it’s important: read the draft documents. Because a lot of people don’t. They get documents from the bank, I’m not saying the lawyers but a lot of the customers, get the documents from a bank and just really don’t read them and are relying on the lawyers to ask some questions about it. It’s really important, I think, for any corporate borrower to have somebody in the organisation who actually knows what their banking documentation says in detail and who’s involved in the negotiations. You need to, as a lawyer, I think you need to work out with your client what are their must haves. And this will be different for different types of clients and different types of transactions. you know it might be an acquisition, finance or property finance, asset financing thing or working capital or whatever. What’s the timing? The earlier you start on this, the more time you give your people to negotiate and your lawyers to draft and that sort of thing, the better. Is it a new financing? Is it a renewal of financing? This can all affect your approach to things. It’s really important to get the major issues up front. And if there are going to be issues that are going to be important for the bank, bring the banks in on that as early as possible because the way banks operate these days the relationship banker will be the person that the company deals with has very limited scope to make decisions in many respects, anything outside the guidelines for the particular product, sort of bank speak now, they don’t lend money, they sell products. |
| DT: | Yeah. |
| GS:
15:00 | But outside the product guidelines has to be approved by whatever the bank calls it, risk or product or credit or whatever it’s called, you don’t get to meet or see these people. And this all takes time and you need to sell it. You need to give your relationship manager the information that the relationship manager can sell to the people in the state office or head office who’ll be making those decisions. So it’s really important to work out what concerns us? What don’t we like in here? What might be a real deal breaker? But if we’ll call something a deal breaker, what? What are the one or two things that we really want to change? |
| DT:
16:00 | And I like your point about someone in the business understanding that the documents even just reading them I think there’s often a misconception not just in finance, but in many fields in which transactional lawyers practice that the legal documents are really only capable of being understood by lawyers and there’s no point reading them because that’s what the lawyers are for. And I think that sometimes produces a second set of documents: the non-binding heads of agreement, the non-binding term sheet that describes the commercial terms and then the operative terms are sort of left exclusively to the province of the lawyers in a very long document. But you’re right these documents are designed to be used by the parties once they’ve been signed. They’re designed to govern the behavior and the interests of the parties. Do you think the extent to which clients are prepared to read, understand and be involved in the documentation, especially in finance transactions, do you think that has something to do with the way lawyers choose to draft them? And that can a little bit of the blame for clients not wanting to read these documents be laid at our feet for not making them a more accessible, more readable, more usable product? |
| GS: 17:00
18:00
19:00 | Yes and no. I was involved in a major project with Westpac a couple of years ago with their business banking documents which is the small medium business (SMEs) it was a major project, I wasn’t involved in all of it, but they essentially threw out all their templates and started again with blank sheet of paper and wrote these in a completely different way. It was an expensive exercise. I thought it was. I thought it was a good exercise. I was pretty impressed with the external lawyers, had the pen on it and being an internal lawyer at Westpac at the time I was in the go between the external lawyers and the business. And that was fundamentally different, it was quite different from anything I’ve seen. All the banks try, and try hard now, to make their documents as comprehensible as possible. They’ve all put a lot of time and effort into that. At the retail end it’s a bit crazy, one of our kids was just buying a place and the pile of documentation that came through for very standard housing. There were several trees that had to get cut down just to get this simple housing loan done. But I think also, it’s incumbent on lawyers too, to go through the document with their client. There’s a sort of unfortunate expression that’s used particularly in finance, documentation of boilerplate clauses, which are all the clauses in the second half of the document. And it’s as if, ‘well, they don’t matter.’ Which is not right. TIP: Now most of us will be familiar with this term, and this mindset. ‘Boilerplate clauses’ are the standardized clauses that typically appear at the end of a document. Geoff’s right – they’re often overlooked. After a long day of drafting that bespoke operating clauses in a document, terms like ‘governing law’ or ‘confidentiality’ get skimmed over in the rush to get the finished product out to the client or the other side. However, as Geoff is going to later explain in detail, it’s important not to overlook these details – they can be more important than we realise. There are a lot of very important clauses in there which may affect your client – the borrower. So things like set off for example, confidentiality, governing law, these can be really important and their matters that the client, the borrower, need to have brought to their attention. And needs to sit down and talk to their lawyer about and explain to their lawyer why it’s important for them and what outcome they want. |
| DT:
20:00 | I’m glad you mentioned the so-called boilerplate clauses. I think that is absolutely a common misconception, especially around governing law, which I do want to come back to. You mentioned earlier that advising a corporate borrower on their legal strategy for a lend is a bit like playing football. You want to play your own game rather than play their game. I suppose the opposite metaphor to playing the other person’s hand in poker. With that in mind, when you’re acting for a borrower in a finance transaction, if there’s only three things you could achieve in the negotiation of the loan documents while keeping the terms of the document on market terms. I always find it interesting this idea of market terms. I wonder whether the market standard terms are kept a bit like the kilo weight in Paris. |
| GS: | I’d love it on the other side where I’m acting for a bank or in-house for the bank. When you’re told that the borrower says, oh look, they’ve done this. You know, with several other banks exactly the same thing. I mean yeah, sure, yeah, show me the instructions. Show me the document, show me everything and then I’ll think about it. But it never happens. |
| DT: 21:00 | Yeah no, it’s funny that that evidence doesn’t quite come up, but if there were those three things that you’d want to achieve on behalf of a borrower negotiating the loan documentation, what would those three things be? |
| GS: | Well, I think the first thing, and it’s really important, is events of default and review events. You don’t go into financing, usually, you don’t go into financing for any reason other than you’re expecting the result that financing on your business to be successful and the business will be better and you’ll make more money and all that sort of thing. But, things can go wrong. And the time to address that is when times are good, not when you’re facing a crisis. |
| DT: | Absolutely. |
| GS:
22:00
23:00 24:00 25:00 26:00 | And things can go wrong that are nothing to do with the business, there can be a global financial crisis, there can be a virus, there can be all sorts of things and you’ve got to be prepared. And there are, in my experience, you can make a lot of progress on things to look out for are if there’s a problem, either if there’s a review taking place, get as much time built into it as possible. If the bank says “oh we’re going to do this in 30 days,” say “no, no, we can’t do that, we need 90 days.” If there’s an event of default, for example, that allows for remedy, gives you 5 days to remedy, go back, say “you know we can’t remedy this in five days, we’re going to need 30 days to remedy it.” It’s not a life-threatening thing. Say we’re not dealing with a payment default, we’re dealing with something more minor, get materiality built into it and reasonableness so that something has to be not reasonable in the opinion of the bank, but has to be objectively reasonable. If there’s a default, it has to be a material default. TIP: What do materiality and reasonableness mean in this context? Both conditions mitigate or affect the threshold for an obligation, but in slightly different ways. Let’s look at materiality first in the context of a ‘material breach’ or a ‘material adverse change’ – these are events that go to the root of the contract, and substantially deprive a party of the benefit of that contract. Insisting on certain rights being exercisable in the event of a material breach – such as a right to accelerate the loan and require it to be repaid in full ahead of its due date – means that the right couldn’t be exercised in the event of a mere technical breach. Now reasonableness, on the other hand, is about the exercise of a right in circumstances where the event that enlivens it is a matter of opinion or subjectivity. Say the bank has a right to accelerate the loan if, in the opinion of the bank, a material adverse change occurs. Now requiring the occurrence of that event to be in the ‘reasonable’ opinion of the bank theoretically means that the bank can’t exercise that right capriciously if they just decide a material adverse change has occurred, even if the circumstances objectively don’t show it. Now I say theoretically because, there has been a line of authority, since the NSW Court of Appeal’s decision in Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187, that all commercial contracts will be construed by the courts consistent with principles of good faith and fair dealing, leading to the arguable conclusion that all contracts contain an implied term of that rights and powers will be exercised in good faith and reasonably. Now, is this a reason not to specify that the exercise of contractual discretions are subject to reasonableness? No! Of course not! It’s far better to rely on an express clause and hopefully avoid having to litigate on the contract altogether, than rely on a clause arguably implied at law. You don’t want to get tripped up, for example, when a standard undertaking is that the borrower will comply with all its legal obligations. Well you don’t want to get tripped up by some minor glitch in the law. And make sure that where possible that you’re given the opportunity to remedy any defaults. Even if it’s a payment default, you can say “well, look, you exclude defaults caused by technology.” And banks, in my experience, will go along with that. They often won’t put it in their template, but they’ll go along with that because they understand it. They have enough technological problems themselves. And so you give yourself a lot of space, as it were, some protection against a pre-emptive strike by a bank if things go wrong or it’s not happy. |
| DT: | I have seen that term around payment defaults and late payments as a consequence of the unavailability of payment systems increasingly in documents as well myself. So it does seem to be one that institutions and syndicates are prepared to accept. On that topic of materiality, tell us a little bit about the level of discretion or not vagueness, but I suppose intangibility in the definition of a material breach, or commonly I suppose a material adverse change to the business as an event of default. Do you find that reasonable minds differ greatly in terms of what a material breach or what a material adverse changes, or is the law quite settled in that area? |
| GS: 27:00
28:00 | Well, I think that materiality is inevitably going to be a matter of opinion, and you’re certainly better having materiality in the events of default than not having it in there. It gives you something to argue with, at the very least. And is likely to cause the bank to think twice before taking action. Some banks still include in their corporate borrowing facilities what we call material adverse change clauses. In all my time, I’ve never known a bank to call a default on the basis of that clause. And I think it’s perfectly reasonable to argue that it should not be in there. It’s just sort of a catch all, if we can’t default you for something for any of the other 30 events of default, we’ll hit you with this one. You need to know what will be a default. That’s really important, and from a borrower’s point of view material, adverse effect ’cause it’s just, it’s too vague. |
| DT: | I’ve heard the argument before that the material adverse change clause is there, for example, to catch events which are objectively material adverse changes to the business, but which are not permitted to terminate for. For example, the ipso facto provisions prevent you from terminating a contract on the basis of a voluntary administration. But you just say that the voluntary administration is a material adverse change. Of course, that doesn’t work, because the ipso facto provisions still prevent you from terminating on the basis of the voluntary administration whether it’s a default under the insolvency event clause or whatever else you call it. It’s specious reasoning, but I’ve nevertheless heard it. |
| GS:
29:00
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31:00 | The same sort of approach applies also to undertakings and reps and warranties. Build in materiality and build in reasonableness, those sort of expressions into as many of the reps, majorities and undertakings as you can. And that’s perfectly reasonable because they’re not in there. The purpose of having reps and warranties and undertakings is not to create a default. It’s to give the bank notice of there being a potentially major problem. And you don’t want to spend your whole time trying to administer the facility by contacting the bank about trivial matters and the bank doesn’t want to be contacted about trivial matters. And another important, always an important thing, is to look at the provisions for –– and they all sort of go together –– termination, the agreement, cancellation of facilities and the requirements for repayment, what has to happen with repayment if, for example, the bank cancels the facility. You don’t want to get in that position if at all possible, even if the company is having problems, you don’t want to get into a position where the bank calls a default because it makes it really, really hard to get refinancing. You need the bank to give you, say 90 days to refinance. You’re going to need that amount of time to refinance and if things are going on and you get to 90 days and the bank can see that the refinances are coming through they’ll know to extend it for you, but you’ll need at least that amount of time to do the refinancing. And it’s always worth remembering, banks don’t want to appoint, they don’t want administrators and receivers in there because it takes them a lot of time and money, a lot of time, they’re doing endless internal reports when it comes to that and it can be very bad PR for the bank. They don’t want to know about that. So you’ve got to set it up as best you can so that you can talk to the bank. The documents give you the opportunity to talk to the bank, because if you do get into trouble, you won’t be dealing with your relationship manager, you’ll be dealing with somebody who deals with distressed companies and who may have a totally different approach to things to the people that you’ve known and dealt with before. |
| DT: | I think there’s this exercise in stakeholder management at the point of default, but as you say, if you’re carried along into this irreversible default situation because of the terms of the documents, then you’re not going to have the opportunity to do that stakeholder management exercise. |
| GS:
32:00 | I did a lot of work for a borrower who was a major property developer, this was, between about 2000-2010. And prior to time I got involved with it, it had in the early 90s after the Wall Street crash, the late 80s, where a lot of property developers went broke, its bank was one of the Big 4 and it essentially just cut off the funds one day. And after that, the CFO said “we’re never going to allow this to happen again.” And “we’re going to make sure that we do not get into facility agreements where that can happen. We’ve got to have all these opportunities.” They may not like us, they may want to get rid of us, but they can’t just turn off the tap and leave us hanging out there. |
| DT:
33:00 | One of those other terms or sets of terms in the finance documents that came to mind as you were describing that was the financial covenants and it ties back to something you said before about making sure that someone in the business has actually read and understands the documentation. Because on the one hand, I imagine a materiality provision to breaches of financial covenants is very important, but also the reasonableness of the levels of financial covenants is really entirely within the knowledge of the business itself, isn’t it? It’s really entirely within the knowledge of the business whether or not the financial covenants in terms of revenue and net profit and debt servicing ratios is, you know, within normal limits for the company or not. |
| GS:
34:00 | And for many people, many business people, financial covenants are easy to deal with because their numbers and equations and that sort of thing and they can see it, and they can readily understand why it’s important to the bank. But by the same token often the bank uses the financial covenants as a flag. Now, say, look you’ve reached this financial covenant, the banks take that very seriously when you breach a financial covenant, but they’ll usually, they will talk to the customer and work it through. Now that may immediately cause a review event and that may lead to an increase in pricing or something like that. And it might involve the bank getting somebody on to that they know to go in and have a look at the accounts of the customer that sort of stuff. But they won’t, unless it’s really drastic and they feel that they’re not getting information they won’t be looking to appoint, but there are other provisions there in the events that have filed which are just as important as the financial covenants, but don’t often get as much attention as the financial covenants do. |
| DT: | So they kind of occupy a lot of time in the negotiation and the attention of the business because they’re more accessible, whereas some of the equally important events of default are kind of a bit impenetrable, and so they’re left to the lawyers, and therefore a bit ignored or underappreciated? |
| GS: 35:00 | I mean many times these documents are being reviewed by the finance team who may not have any legal experience, but they know about financial covenants. |
| DT: | I suppose that old adage “when all you’ve got is a hammer everything looks like a nail”, I suppose, to lay into that analogy a little bit, if all you’ve got is a hammer, nails might be all you look for and so you might find the solutions that you can fix with your existing skill set. But unless you’re looping some other skill sets in you’re not going to identify the other issues. |
| GS: | That’s right. |
| DT: | Those three things that you described in terms of the key things to achieve negotiating the loan documents for a borrower, making sure there’s time to remedy defaults, or discuss defaults and refinance. Making sure that there’s materiality provisions in the documents and making sure that those events of default are reasonable. Can you tell us about a time when you’ve seen a corporate borrower get one of those things really wrong? Where the negotiation of the time limits in a document or the negotiation around materiality and reasonableness went really wrong for the borrower? |
| GS: 36:00 | Well, I suppose the example that comes to mind is the one I just gave about the property developer who hadn’t built in breathing space. And when the whole global economy got into a time of financial crisis, they were caught and my understanding is that there was a sort of nervous gun happy banker who had the file and just wanted to sort of take it off his desk, as it were, by appointing somebody in and which they didn’t do, but if they had done, it would have destroyed the business. |
| DT: | We’ve spoken a little bit about what to do when a loan falls into default, that stakeholder engagement exercise, as in, exchanging information with the bank, making sure that you’ve got enough time to either negotiate that exit or negotiate that refinance, is it realistic to expect that you might be able to negotiate a refinance and come back from the default? Or is it at that point in time to get out and find a new financier? |
| GS: 37:00
38:00
39:00 | If there’s an event of default, it’s going to be difficult getting a new financier whilst that event in default remains. And that sort of leads onto my other point that to get in the events of default that is that if the event of default is remedied you need to have the bank require to send you a letter or something saying that there is no longer any default. But if there is an event of default, the important thing to do is to have a plan. So you have a reasoned, achievable, sensible plan. You need to convince the bank that you’re in control, that appointing an external, insolvency practitioner to come in is going to do damage to the business and reduce the worth of the bank security over the business. And that, you’re going to be open with the bank and be happy to provide all the reporting under the sun to them. If the bank loses trust in management then nothing will save the day. But as long as the bank says “right, you’re being up front, you’re being honest with us. Let’s see what we can do here.” Give them too much information rather than too little. It helps, I think, it can help if you have an experienced turn around accountant who is well known to the bank to be at your meetings and if it’s appropriate for that person to be leading the discussion with the bank because they’ll know the bank and the bank officers and will know what they want to hear. So it’s not a matter of, “oh there’s a default, we’ll just trash the place.” You want an immediate commitment from the bank, the bank says there’s fault default. You need to get them not to make demands for repayment, because if they do that and you can’t repay, you’ll be insolvent, and you’ll have no choice but to appoint administrators. So you need to take immediate steps and work hard to deal with the immediate threat and then to constructively deal with the longer term position. |
| DT:
40:00
41:00 | A lot of the steps you just described involving specialist advisors like turn around accountants and lawyers, enhanced reporting, having a really clear plan to turn the business around, a lot of that sounds very much like the safe harbour defence to insolvent trading that came in in 2017. And I imagine that turn around proposal to the bank shares a lot of the features of the kind of turnaround plan or safe harbor plan that you might be privately putting in place if you are facing the prospect of insolvency or some financial distress. Do you think there’s a thematic connection there? Do you think that where a business is facing financial distress and therefore facing some prospective financial or non-financial default under their debt facilities that they should be sharing their safe harbor plan with the bank?
TIP: Now for those who may be unfamiliar, the safe harbour defence to insolvent trading allows directors to avoid liability for insolvent trading under the Corporations Act 2001 (Cth) while ever they are developing or implementing a course of action which is reasonably likely to lead to a better outcome for the company than its immediate liquidation. To avail themselves of the safe harbour defence, directors usually need to make sure that the company is paying its taxes and employee entitlements on time, taking advice from specialist lawyers and accountants, collecting information and reporting more regularly to check if the turnaround plan is succeeding, and otherwise ensuring that the company performs its obligations. We’ve talked about safe harbor a couple of times in previous episodes of Hearsay and I’ll give you some recommendations for those at the end. |
| GS: | Well, I think the safe harbor plan is probably a good place for them to start if they’ve got one. Means they don’t have to go back to the blank sheet of paper to start from. But it’s important to have something that’s realistic, that’s the important point. That and you’ve got to sell it to the bank, and get the bank to get on side with it. And if the bank agrees to give you some leeway, on certain conditions, you must fulfill those conditions. You sort of have got to rebuild the financial trust, as it were with the band. |
| DT:
42:00 | You mentioned before that one of those levers that you can pull when negotiating with the bank is really explaining that narrative about erosion of value in the bank security suite. In terms of negotiating the assets that will form part of the security suite at the outset of the transaction when you’re negotiating the facility in the first place, are there levers that the corporate borrower can pull when negotiating that security suite, or is it the case that they almost always will be giving all assets security? |
| GS:
43:00
44:00 | It depends on how big the companies and what the nature of the business is, for example, if you’re a smaller company, usually the security arrangements are pretty standard that yes it’ll be in all assets security, there’ll probably be guarantees from directors and depending upon the position they may require mortgages over the real estate from the to support the guarantees as well. As things get bigger, you can often drop off the personal guarantees, and that’s important to keep in mind, I think a lot of people just sort of leave those sitting there without talking to the bank. So you can drop off the personal guarantees. It’s hard to get rid of all asset security unless you’re a much bigger corporation and you get up to the stage where you’ve got a credit rating and then you can go without security. But for most corporations, there’s going to be an all asset security. It’s also useful, if you can do it, to establish relations with more than one bank. Now you might have one bank that’s your main banker that has all the asset security. But you might be able to establish relations with another bank to provide asset financing, for example over for vehicles or things like that. There may be another bank that you want to provide, trade facilities, provide your letters of credit, that sort of thing. And so by doing that you can build up relations with other banks and then along the way that can open the door for you to go and talk to them and say look, “this is the package that we’ve got at the moment, can you guys do any better than that?” |
| DT: | I suppose that’s the discussion you want to have in that 90-day period before you’ve fallen into a proper default is to start leveraging those other relationships. |
| GS: | Well, that’s right, but you might want to do it at the best of times. If you’re coming up for a review with your bank you might think, well, I might just go and talk to somebody else and see what rates they’ll give us, or whether they’ll drop off some of the security, something like that. |
| DT:
| Puts a little bit of the bargaining power back in the hands of the borrower then. We mentioned before the governing law clause and the other boilerplates at the back of a document that are often maligned, overlooked, underappreciated. Yell us a bit about the governing law clause, especially given your international experience in Indonesia and Vietnam, why shouldn’t we just treat the governing law clause as one of those boilerplates that we can ignore? |
| GS: 45:00
46:00
47:00
48:00 | Well, because laws are different in each jurisdiction and I think that’s not widely understood. Or not thought about I suppose in the commercial community. An example. I think there’s probably a general thought that New Zealand laws are much the same as Australians, and in some respects they are, but in major respects they’re quite different. If you go to the US, which again we think is a very similar legal system and similar society to our own, if you go to the US, their laws are radically different to Australian laws. And the same if you go to the UK although our legal system is inherited from the UK, our laws are now radically different to those of the UK. And of course, if you go to somewhere like China or Vietnam, it’s just a totally different world. But you don’t need to go that far, laws are radically different between the states of Australia. And that can be important, and in fact I was giving some advice on a matter yesterday about signing of deeds using electronic signatures during lockdown to sign deeds. And the position between New South Wales and Victoria is fundamentally different, so in NSW you need a witness in Victoria you don’t. But when you apply electronic signatures that can make a big difference. Because doing electronic signatures, where it’s not just the signature, but you need the witness to witness the signature as well, takes it into a different world, and particularly if you’re getting into the type of signature it’s scanned signatures, for example, how does the witness, who’s remote, witness the affixing of a scanned signature and things like that. But that’s simply a difference between New South Wales and Victoria. So it’s important, and this is a matter for your lawyer to advise you on at any stage, but it’s important to understand that if you’re doing anything that’s outside the jurisdiction, NSW, for example, if you’re doing something in Victoria that the laws might be different there. But certainly, if you’re going into cross-border transactions, it becomes very important to know what the law of the jurisdiction is. And, if possible, you want to have the governing law and the jurisdiction by which I mean which courts will hear it as being your home jurisdiction because if for example, you get into a dispute with a Chinese supplier, and if the supply contract states that the governing law is UK law, and the jurisdiction is UK courts, then it suddenly becomes staggeringly expensive to try to resolve the dispute. You don’t want that. If it’s a Melbourne company, for example, you want the governing law to be Victoria and the jurisdiction to be the courts of Victoria so that it’s manageable for you. So, especially if you’re doing cross-border transactions, the governing law and jurisdiction are really important. |
| DT:
49:00 | I’m glad you mentioned though, the significance of a governing law jurisdiction, even between Australian states. I think that’s certainly one of those boilerplates, where someone will say, “oh, it doesn’t matter, whatever city the bank’s lawyers are based in is fine by me” and won’t give it much other thought. But as you say, we are a federated system and our states can have dramatically different laws, especially as you say at the moment where we’re adjusting some of our legislation around the execution of documents and deeds relating to land and things like that to adjust to COVID-19. Can you tell us a bit about one part of the governing law and jurisdiction clause which some listeners might be confused about, sometimes you see that the governing law will be stated, for example, “this agreement is governed by the laws of New South Wales” and the parties submit to the non-exclusive jurisdiction of the courts of New South Wales and the Commonwealth of Australia. Tell us a bit about that non-exclusive jurisdiction provision and what the significance of those words is? |
| GS:
50:00
51:00 | If you have a cross-border matter, the courts have to get jurisdiction to hear the matter. Now that jurisdiction may come from where the parties reside, so for example, if both parties reside in New South Wales, if the transaction is in New South Wales, then the courts of New South Wales will have jurisdiction to hear the matter. The courts of New Zealand would not have jurisdiction to hear the matter. You can get into a situation where more than one country, one jurisdiction, does have jurisdiction to hear a matter. And you don’t want to get into a situation, if you can avoid it, where the litigation gets into a jurisdictional dispute. Because that is really expensive, it takes a lot of time and you’re talking about really expensive legal fees to do that sort of thing. So there’s a difference between exclusive and non-exclusive jurisdiction which essentially is that if the parties agree that one place has exclusive jurisdiction, it’s a lot harder for one of the parties to argue against that jurisdiction hearing the case. If it’s non-exclusive, then it leaves it open to one party to say, “no look, I think it should be heard in my jurisdiction.” And that can be reasonable in the circumstances ’cause it might be that one side has 10 witnesses and the other is a documentary case for the other side, and it’s reasonable that it be heard in the jurisdiction of the party that has 10 witnesses. So that’s sort of what it gets down to. But again, if you’ve got any concerns, talk to your lawyer ’cause that’s a matter for a lawyer to advise you. |
| DT: | And have you seen a matter or a case where the decision about the governing law of the document or the jurisdiction governing the document had some really adverse consequences for one of the parties? Have you seen that in your practice maybe here or overseas? |
| GS:
52:00
53:00
54:00 | Vietnam was crazy, you never drafted a document there which was subject to Vietnamese law of the jurisdiction of Vietnamese courts. For a couple of reasons, one is that the law in Vietnam is never really certain. But the other was that the Vietnamese courts were what might be called unpredictable. The documents would commonly be subject to UK or U.S. law. If it involved Australian companies, sometimes Australian law. With the jurisdiction usually being arbitration in Singapore or Hong Kong, but sometimes it would be in the courts of the UK. And one of the reasons for that was that you wanted your arbitration because there was really no provision in Vietnam if the other party was a Vietnamese party, there was no ability in Vietnam to get foreign judgments registered in the court system there so you couldn’t enforce foreign judgments. Vietnam was a party to the New York Convention on enforcement of arbitral decisions.
TIP: The Convention on the Recognition and Enforcement of Foreign Arbitral Awards, more commonly known as the New York Convention, was adopted by a United Nations diplomatic conference on 10th June 1958 and entered into force on 7th June 1959. It’s widely considered the foundational instrument for international arbitration, it requires courts of contracting states to give effect to private agreements to arbitrate and to recognize and enforce arbitration awards made in other contracting states. An award made in a country which is not a signatory to the Convention can’t take advantage of the Convention to enforce that award in the 168 Contracting States, unless there is some bilateral recognition of arbitral awards between those countries. The Convention has some 168 parties, the most recent of which Vietnam, included since 12th September 1995. And so there was the possibility of getting an arbitral award enforced in Vietnam. While I was there, nobody had actually succeeded in doing so. But at least they’d opened the opportunity and it had the potential benefit of, if a Vietnamese company wanted to have an international presence, get international finance or do major transactions outside Vietnam, if it didn’t comply with an arbitral award out of Singapore, for example, it would face a lot of difficulties in getting people to do business with it. |
| DT: | It’s interesting that there was really no provision to enforce foreign judgments, but arbitral awards were significantly easier. Did you find that there were very few commercial disputes litigated in the domestic courts in Vietnam? |
| GS:
55:00 | Certainly involving foreigners they were none in my experience. The Vietnamese did, but it’s a different court system. Nothing like what we understand the court system to be. Outside of Western countries there’s a lot of arbitration, it’s common if you’re dealing with courts that don’t have a well-established and recognized court system for parties to resort to arbitration. |
| DT: | And I suppose often the finance documents will include an arbitration clause to facilitate that, or not just to facilitate it, but to require it where that clause hasn’t been included in a finance document, is arbitration still an option? |
| GS: | Well the parties can agree to arbitrate at any time, or in some jurisdictions certain disputes, certainly in New South Wales courts in some disputes have the power to direct the parties to arbitrate. |
| DT: 56:00 | And it’s a power that hasn’t been used frequently but has been used quite a bit more in the last year when it’s been difficult for parties to litigate in court given the COVID-19 restrictions that increasingly matters have been sent to arbitration. |
| GS: | In my experience in Australia, arbitration has really been principally used in building disputes, but not much otherwise and that’s because we have a very experienced court system for dealing with commercial disputes which a lot of other countries don’t. In a lot of other countries the judges have no commercial experience, and certainly no experience of international finance. |
| DT:
57:00 | Geoff, we talked about a whole range of topics today, we’ve talked about negotiating finance and security documents about how the financier on the other side of those documents changes one’s strategy about defaults, financial covenants, reps and warranties. We’ve talked about governing law, we’ve talked about that stakeholder engagement exercise when you’re nearing or in circumstances of default. If there was one thing that you wanted our listeners to remember from this episode, when they’re advising their own corporate borrower clients, what would that one thing be? |
| GS: | Read the documents. |
| DT: | That’s good advice! |
| GS:
58:00 | I was looking at a facility agreement yesterday, clause two started on page 55. When you do that, there’s a great tendency to flick over stuff. An experienced finance lawyer will recognize provisions and can quickly see whether they’re in a familiar form. But work out what are the points that are important to you: is set off important? Is withholding tax important? Whatever it is, and certainly go through all those provisions in detail and see if they’re going to cause you any difficulties, administrative, do those provisions work? Or when you go to do something, you’re going to find, “oh, that’s not what I thought was going to happen.” |
| DT: | Well Geoff, thanks so much for joining us today on Hearsay to talk about corporate debt finance strategies for borrowers! |
| GS: | It’s been a pleasure. |
| DT:
59:00 | As always, you’ve been listening to Hearsay The Legal Podcast. I’d like to thank my guest today Geoff Sutherland for coming on the show. Now, we mentioned the safe harbor regime briefly in today’s episode, so if you’d like to learn a little bit more about that listen to my interview with Professor Jason Harris, that’s Episode 9 of Hearsay, which is about voluntary administration but it touches on safe harbor as else. Or, if you’d like some other finance related content, our episode with Nicholas Mirzai about the PPSR is a great primer for learning about security interests over personal property that are often given to secure loans. If you’re an Australian legal practitioner, you can claim one continuing professional development point for listening to this episode. Whether an activity entitles you to claim a CPD unit is, as you well know, self-assessed, but we suggest this episode entitles you to claim a substantive law point. More information on claiming and tracking your points on Hearsay can be found on our website. Hearsay The Legal Podcast is proudly supported by Assured Legal Solutions a boutique commercial law firm making complex simple. You can find all of our episodes as well as summary papers, quizzes, transcripts and more on our website. And if you’re a subscriber to Hearsay we’ll let you know by email whenever we release a new episode. And by the way, our free trial episodes are now available on Apple Podcasts and on Spotify now, so if you like us give us a rating on your preferred platform and maybe tell a friend to listen to an episode too. Thanks for listening and I’ll see you next time! |
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