Key Points:
- The “insolvency tsunami” hasn’t yet hit Australia. However, rising input costs and uncertain economic conditions have led to high profile corporate collapses in certain sectors, including significant infrastructure.
- Appetite for Australian infrastructure assets remains strong with investors broadening their definitions of “infrastructure”. This has created opportunity for strategic buyers and private capital investors to use creative ways to get their hands on high quality infrastructure assets in Australia.
- The recent acquisition of Basslink by APA Group demonstrated the strategic use of a secured debt acquisition and credit bid to acquire a nationally significant infrastructure asset.
What is credit bidding?
Credit bidding is a process whereby a lender, with a secured interest over a borrower or one or more of its assets, bids on that borrower or those assets (as applicable) using the very debt that is owed by the borrower to the lender. It effectively allows the creditor to offset its secured debt as part or total payment for the corporate vehicle or asset. This can place the secured lender at an advantage in an open market process with flexibility to vary payment and other acquisition terms to ensure their bid is superior to any other bids.
There is no enshrined credit bid process under Australian law. The strategy relies on a lender on other creditor exercising right of set-off as part or full payment of the purchase price of an asset. Where the lender is a secured creditor with a first ranking security over the borrower/assets, the lender can also initiate a public sale process by appointing a receiver to the asset owing entity or key infrastructure assets.
Road Map
It is key for the investor to pre-plan a credit bid transaction, usually in advance of acquiring the secured loan. A typical road map for this approach is as follows:
Step 1: Diligence on secured loan
Investor acquires the secured debt from the existing lender, potentially at a discount to face value. This provides an early and certain return for the existing lender(s). If the loan is already in default, security may already be enforceable, effectively giving the investor a seat at the table in any proposed sale of the borrower/asset. Debt transfer restrictions require careful review, but generally will not apply if the loan is in default.
Step 2: Investor acquires secured debt
Once the acquisition price has been agreed between existing lender and investor, the debt acquisition is generally straightforward using standard Loan Market Association (LMA) terms. The loan sale can take place regardless of whether the loan is already in default.
Step 3: Security enforcement and sale process
If the loan is in default, the investor can enforce security over the asset-owning entities or assets by appointing receivers. If the asset-owning entities are insolvent, administrators will generally be appointed around the same time as the receivers. The receiver has sole and exclusive control of the asset-owning entities and the underlying assets, and the exclusive power to conduct a sale process. This would usually commence shortly after the receiver’s appointment.
In conducting the sale process, the receiver must comply with their officer duties (section 180 and following) and also the duty to take reasonable steps to achieve market value of the assets under section 420A of the Corporations Act. The receiver needs to be independently advised by separate lawyers to the investor, and will often also appoint a sale agent with expertise in sales of the relevant type of asset and in insolvency procedures.
Step 4: Security enforcement and sale process
The investor participates in the sale process as a bidder. Careful management of disclosure in the sale process is important to demonstrate the independence of the receivers from the investor, who is also the appointor of the receiver.
Step 5: Completion
The sale process will result in either:
• the investor being the successful bidder, in which case the money flow at completion of the acquisition can be structured to use the secured debt to effectively set-off against some or all of the actual consideration without requiring an actual cash payment for that portion of the sale price
• the investor not being the successful bidder, in which case:
• the investor will be asked to consent to release its security to enable the sale to complete (if the sale price is less than the total secured debt); and
alternatively, if the sale price exceeds the total secured debt, this will be paid to the investor at completion.
of the secured debt, after deducting expenses of the receiver and manager and any other amounts which must be paid out in priority. If the investor is confident that the value of the assets exceeds the amount it pays to acquire the secured debt, the investor will recover most, if not all, of what it paid.
Pre-planning
Key to the capacity to execute a successful credit bid, is an up-front assessment by the investor of:
- whether the security is over the whole or substantially the whole of the assets, is valid and enforceable;
- the transferability of the secured loan and any embedded conditions;
- the expected competitive tension in a public sale process, the type of offer that will be required to secure the asset, and whether this is likely to exceed the value of the secured debt; and
- pre-planning to achieve a “clean exit” from receivership, including:
- exiting any other insolvency procedures involved if the asset-owning entity or entities are also insolvent (generally through administration and a deed of company arrangement);
- considering tax considerations to optimise returns from the transaction;
- considering Foreign Investment Review Board (FIRB) approval requirements for Australian assets;
- managing any risks of deterioration of the value of the asset during receivership and administration, including key employee retention and counterparty termination risks on key contracts; and
- being comfortable with an acquisition without the benefit of warranties and indemnities. The sale documentation for a receivership sale contain very few, if any, warranties and no indemnities given in favour of the buyer. It also remains rare to include a deferred or contingent consideration component in the purchase price structure. Accordingly, matters typically addressed through warranties, indemnities and deferred/contingent will need to be diligenced to ensure that the risks are adequately identified, and to the extent possible, mitigated.
Properly diligence and pre-planned, the acquisition of a secured loan followed by a carefully pre-planned credit bid strategy can:
- provide a ‘floor’ for bids by purchasers for the target assets (or asset-owning entities) in an open market sale process run by a receiver;
- guarantee a minimum return for an investor that acquires secured debt, equivalent to the par value of the secured debt, plus all interest and costs (which would generally need to be paid out in full if the asset is sold to any party other than the investor); and
- enable the investor a degree of input into the timing of the sale process, although if the investor is intending to bid they need to implement careful information flow and management controls which maintain the integrity of the sale process.
How did APA Group do it?
Basslink owns and operates the 370km high voltage direct current (HVDC) electricity interconnector between Victoria and Tasmania. As the only interconnector between the two States, it is an important piece of infrastructure which enhances the security of supply in Tasmania and Victoria by protecting Tasmania against the risk of drought-constrained energy shortages and providing Victoria with secure renewable energy during times of peak demand. The 290 km undersea cable component of Basslink is one of the longest of its type in the world (we’re working on our next article about Sun Cable’s proposed 4,200 km one).
Basslink appointed administrators in November 2021. It had a secured debt facility with a syndicate of Australian and foreign lenders with multiple hundreds of millions of dollars outstanding. The secured loan was in default, with maturity dates having lapsed.
Following the appointment of administrators, the secured lenders appointed partners of KPMG as receivers and managers. The receivership was complicated by ongoing disputes between Basslink, the Tasmanian Government and Hydro Tasmania relating to a failure of the interconnector in 2015-16.
APA Group, which is pursuing electricity transmission opportunities arising with the decarbonisation of Australia's economy, acquired 100% of the secured debt and substituted KPMG as receivers with Vaughan Strawbridge, Paul Harlond and Chris Hill of FTI Consulting Australia.
The receivers and managers conducted a comprehensive sale process including appointing Houlihan Lokey as sale adviser. APA was ultimately selected as the preferred bidder in September 2022 and the acquisition completed in October 2022 with a resolution of all ongoing litigation. The asset operated sustainably and profitably during the sale process.
* KWM acted for KPMG and subsequently FTI in their capacity as receivers of Basslink.
