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Mergers-and-acquisitions

Dealing with distressed companies

Entities proposing to enter into material transactions with a contracting company need to be alert to indicia that the directors of the contracting company might be acting in breach of their duties in respect of the transaction. This issue has assumed a new prominence in today’s business environment, following the global financial crisis and its consequences for Australian corporations and financiers.

Entities can be adversely affected when contracting or dealing with distressed companies in circumstances where the entity, whether a financier, asset buyer or contractor, ought to have known or knows of the financial stress the contracting company is under, and therefore that the directors of the contracting company may be breaching their directors’ duties by entering into the transaction. Such a situation can have several consequences for the entity. This was recently highlighted in Owen J’s decision in The Bell Group Ltd (in liq) v Westpac Banking Corporation [No. 9] [2008] WASC 239 (“The Bell Group Case”).

What is a distressed company?

A distressed company is a company which is insolvent, so cannot pay its debts when they fall due, or is solvent but there is a reasonable apprehension that it may be insolvent in the foreseeable future. Companies which are not in a strong financial position and are involved in restructuring, refinancing, going through a work-out, selling assets or raising equity may be a distressed company.

What to do when entering into a transaction with a company which may be distressed

When dealing with a company which may be distressed, the following (non-exhaustive) steps can be taken:

  • make enquires that an honest and reasonable person would in a similar position. This means ensuring that the directors are not breaching their directors’ duties, the company is solvent and will remain solvent after the transaction, and obtaining documents such as cash flow statements, management accounts and other relevant financial information

  • obtain, as a condition precedent, a solvency certification signed by two of the directors of the company, and

  • obtain, as a condition precedent, a certified extract of board minutes which includes a resolution confirming that the directors of the company have resolved that:

    • the transaction will benefit the company and setting out the reasoning behind their conclusion

    • the directors are acting for a proper purpose, and

    • the company is solvent and will remain solvent if it complies with its obligations to the counterparty.

However, The Bell Group Case has demonstrated the importance of a counterparty not relying blindly or passively on solvency certifications and other similar documentation or information given by the distressed company. Despite receipt of such documentation, a counterparty which has knowledge or ought to have known that the distressed company may be facing insolvency or that the directors giving the certificates or extract of board minutes were not acting honestly, should make an independent assessment as to whether it should in fact contract with that company. A counterparty needs to be satisfied that the directors of the company have satisfied themselves as to corporate benefit and solvency, in addition to making its own independent assessment in relation to such matters.

Consequences of failing to make due enquiries

If a counterparty fails to make due enquires or knows that the directors of the company are breaching their fiduciary duties by entering into the transaction, it may face several consequences, including:

  • be personally liable as a “person involved” in the contravention of the Corporations Act and face civil penalties

  • having the transaction deemed voidable in equity, or

  • being held accountable as constructive trustee of money or property received from the distressed company.

Companies proposing to enter into transactions with an entity which may be a distressed entity must take further steps to satisfy themselves as to both corporate benefit and solvency.
Who does this affect?

Companies whose business operations are involved in the energy and resources sector.

What do you need to do?

This publication aims to provide you with an overview of recent legal developments that are relevant to your business. Should you wish to discuss any of the information attached please contact the relevant Partner. ​

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