Total Control? The Bell Group decision and its impact for lenders and their advisers

[I should highlight that this article was co-authored with Jason Harris, Senior Lecturer, UTS Faculty of Law ( a leading academic specialising in Insolvency/Reconstruction and Corporate Governance.  It first appeared in the September 2015 issue of the Australian Insolvency Journal, and is reproduced here with permission]

The issue of directors’ duties during times of financial distress and insolvency has been hotly debated for decades. It took centre stage in the long-running Bell Group litigation. Given the large sums involved and the importance of the issues, it was no surprise that the High Court granted special leave to appeal in 2013.

However, those who hoped for clarification of this difficult area of law by the High Court were disappointed when the matter settled prior to being determined by the Court. This leaves the controversial split decision of the Western Australia Court of Appeal (Westpac Banking Corp Bell Group Ltd (in liquidation)[i]) as the last word on duties to consider creditor interests.

With the case now settled, our purpose is to outline some of the practical impacts for lenders in a workout situation, and their advisers. However, before discussing the practical implications it is useful to outline in brief the facts involved in the Bell Group restructuring.

Background to Bell Group

There were two bank syndicates which provided finance to the Bond group: one to an Australian borrowing entity, one to a European based borrowing entity. Originally the two syndicates were wholly unsecured, with any comfort provided by a negative pledge – an undertaking not to grant security to other creditors.

Various companies in the Bell Group had also issued bonds to both domestic and foreign investors and there was uncertainty as to whether these were subordinated to the bank debt or not. Heading into 1989, the group had been involved in a lengthy asset sale program to pay down debt, which had left few substantial assets in the group, namely publishing and brewing assets. These were not sufficient to repay all of the debts, so a debt restructure in some form was necessary.

Bank negotiations

In July 1989, the Group advised the banks that it was unable to meet the debt pay-down obligation by the end of September, which prompted what the Court described as ‘a hostile reaction’ with two lenders serving formal notices of demand. The failure to meet debt reduction targets appeared to create tension between the group and its lenders and this would colour future negotiations.

Following a period of presumably tense negotiations, the two bank syndicates and the respective borrowers agreed a restructure and extension of the finance facilities which was executed on and shortly after Australia Day in 1990. The key terms of the agreement were:

  • The facilities were extended until 30 May 1991
  • The banks were provided with a comprehensive security package
  • All asset sale proceeds were to be used to pay down debt, except that the Group could retain the proceeds of asset sales to a maximum $5million in each six month period
  • Almost all intra-group indebtedness was subordinated to the bank.

Importantly, there was no new money being provided by the banks as part of the restructuring. For the Bell Group the sole benefit of the restructuring agreement was the additional time provided to formulate a longer-term work out proposal to address its financial situation, although in the end the banks did not accept any of the proposals made by the Bell Group.

Through 1990 the lenders allowed the Group to access asset sale proceeds on five occasions, and the directors began work on various further restructure proposals. However those restructure negotiations were not fruitful: in March 1991 the lenders declined a final restructure proposal, and in April 1991 issued notices of demand.

Insolvency appointments

In response, after obtaining legal advice concerning potential insolvent trading liability, the directors turned to formal insolvency appointments obtaining an order on 18 April 1991 for the appointment of provisional liquidators, who later became liquidators.

In 1995 the liquidators filed claims initially against both the directors of the company and the lenders in relation to claimed breaches of director’s duties, although the claim against the directors was later discontinued. The liquidators claimed that the security upgrade took place at a time when the group was insolvent, and critically, that the directors knew that to be the case.

The liquidators claimed that the directors had breached their fiduciary duties by causing disadvantage to other unsecured creditors, and claimed that the banks knew not only that the group was insolvent but also that the directors were breaching their duties by granting the security because they knew that without access to asset sale proceeds the Bell group would inevitably collapse. In addition the liquidators argued that the banks’ conduct contravened fraudulent transfer laws. The liquidators claimed that the banks should refund the proceeds of the security realisation together with interest, or pay compensation for the losses that their actions had caused.

The lenders said that they had no knowledge of any insolvency or breach of directors’ duties. They said that in any event the extension of the facility was of real and substantial benefit to the companies because it gave them time to restructure so that the group could continue in business as a going concern and avoid liquidation.

Finally, they said that the bondholders (who comprised the majority of the unsecured creditors) could not have been prejudiced because there was a subordination arrangement – albeit clearly not documented as comprehensively as it could be – by which intra-group loans were to be ranked behind the bank’s debt. If that sub-ordination was not effective, the banks argued, it did not matter because their borrower had represented to them that the subordination was effective, and they were entitled to rely on that representation.

The original hearing and later appeal covered an enormous range of issues and factual matters: closing submissions were 36,932 pages long and the appeal raised 1,179 points.

Summary of findings

By way of summary:

  • The majority found that subordination was not effective.
  • Insolvency was not even disputed at trial, and all judges found that the banks had knowledge of the insolvency.
  • A majority held that the directors had breached their duties, and that the banks would have been aware of that breach. The breach involved failing to properly consider the creditors by agreeing to give security to cover the restructuring agreement at a time when the principal debtor under the agreement was insolvent. Little or no consideration was given by the board as to how the transaction would affect the non-bank creditors.
  • All judges held that the duty to act in good faith in the interests of the company was to be subjectively assessed, but a majority decided that the directors’ evidence of acting in good faith had to be tested against the circumstances and whether a reasonable person would have believed them. All judges agreed that the duty to act for a proper purpose was to be objectively assessed.
  • All judges agreed that the duties were fiduciary in nature. This was crucial to the liquidator’s claim for liability of the banks under the rule in Barnes v Addy for knowing receipt of assets by reason of breach of fiduciary duty.[ii]
  • One of the appeal judges (Lee AJA) held that the banks had engaged in equitable fraud in obtaining security during the insolvency of the Bell Group. The majority on appeal also held that the banks’ conduct breached fraudulent transfer laws.
  • The duty owed by directors of insolvent companies to creditors – disputed by the banks, who described it as a purported duty – was ‘well established.’ One of the appeal judges (Drummond AJA) characterised this duty as a duty to act in the best interests of all creditors during insolvency, not merely as a duty to consider creditor interests and balance them with the interests of other stakeholders such as shareholders.

With that brief overview, what are some of the practical takeaways for lenders?


The Court held that by requiring virtually all asset sales proceeds to be paid to the lenders, the restructure transactions denied the group access to funds it would need to meet its obligations. Rather than restore solvency, the transactions locked in a state of insolvency.

The majority held that the extension was ‘an illusory benefit’ that was ‘immediately destroyed’ by the sequestration of asset sale proceeds, and that the Group was in default of the new facility immediately following the transactions. The banks had been provided with cash flow statements up to September 1989 and then financial statements up to November 1989, which provided grounds for the banks to be aware of the group’s insolvent state.

It was this knowledge that both the directors and the banks shared that put the banks in the position of being in ‘knowing receipt’ of the assets under the security agreement which was obtained by the directors breaching their fiduciary duties by giving security in the first place.

This is not to suggest that the banks could have avoided this situation by merely refusing to see the relevant financial information, as wilful blindness is sufficient knowledge under both limbs of Barnes v Addy.

As much as lenders may like to maintain a tight scrutiny over proposed transactions and the disposition of significant cash flows, ‘total control’ would appear to be a double-edged sword if it means that restrictions are so tight that a borrower will be unable to pay its obligations as they fall due without the exercise of a discretion by lenders.

In such a case it may be preferable to ensure that a minimum level of funding is provided during the restructuring period even if it is provided subject to conditions such as monitoring and regular reviews. Such an arrangement needs to be fully discussed up front so that the borrower’s directors can be satisfied as to how the arrangement will assist the borrower meet the obligations of all of its creditors.

The Restructuring Plan was inadequate

 The Court held that the transactions demonstrated that the directors knew that a restructure was necessary for the survival of the Group. However, it held that the transaction that was actually implemented restricted the directors’ ability to affect a restructure because it gave control over all the group’s assets to the banks, leaving the Group without any leverage to negotiate.

It was true that the banks allowed the Group to retain of the asset sale proceeds on five occasions. But the Court held that they only did so to prevent liquidation action by the bondholders during the six months hardening period.

Borrowers need to have a reasonable prospect of restoring solvency prior to expiry of the loan term or possible default, with either cash reserves or access to funds sufficient to meet creditor payments and cover any trading losses until solvency is restored whether by a combination of improved profitability, asset sales or equity raise.

File Notes

There were various internal bank documents created to recommend the release of asset sale proceeds so that the Group could make bond interest payments, which evidenced a very clear focus on the six month hardening period.

For example, one memo identified the importance of avoiding liquidation ‘before the six months period has finished as the security documentation may not stand up in a court of law,’ and another celebrated the passing of the six month period: ‘Our arrival at 1 August marks a valuable step forward in the hardening of our security, as six months have elapsed since execution of the Australian Security.’

Those and similar documents were taken as evidence that the banks only approved the release of asset sale proceeds to avoid a liquidation that would render their security void. This is certainly a difficult balance for lenders: the credit approval process requires written explanation of transactions and detailed justification for decisions made, but care should be taken with the words and phrases used in those documents.

In addition, the directors had been provided with pro forma corporate benefit resolutions and pre-prepared minutes by the company’s external lawyers with input from the banks and their lawyers. These were drafted so as to include wording that would purportedly satisfy the legal requirements. They were insufficient to satisfy the court that the directors actually considered the benefit to each individual company and to the effect of the transaction on the creditors of each company.

The failure to consider the position of each company was one of the key elements in finding a breach of directors’ duties. It is therefore important for lenders to recognise that while a group may operate as a single business it is treated in law as separate entities and the directors must ensure that they act in the best interests of the company on whose board they sit, not merely for the interests of the broader group.

It should be noted that s 187 of the Corporations Act which allows wholly-owned subsidiaries to include constitutional provisions allowing their directors to act in the best interests of the parent company, did not exist at the time of the Bell Group facts.

 Abandoning the requirement for a Solvency Certificate

The early drafts of the terms sheet included a fairly standard requirement for certificates of solvency. However, this requirement was dropped in December 1989 and did not appear in later versions.

The Court held that the banks had been unable to provide ‘any plausible explanation’ for its removal and concluded that it was dropped because the Banks had formed the opinion that the directors would be unable to certify that the companies were solvent. In other words the dropping of the requirement was taken as a ‘smoking gun’ – clear evidence that the banks knew the companies to be insolvent.

If a certificate of solvency is a standard requirement then lenders need a strong justification to drop it. This is true at the start of negotiations, but even more important as negotiations progress.

 A requirement for additional due diligence?

The Court said that lenders are generally entitled to rely on an assurance from the directors that they have given due consideration to their duties. However such an entitlement may be displaced.

In this case the presumption had been displaced because the banks were ‘aware of facts that raised doubts about the presence of a real and substantial benefit for the Bell companies’ and had no other evidence that the directors had properly considered the relevant issues.

It would appear that in some circumstances it may be appropriate for lenders to commission due diligence to confirm that directors are acting reasonably in forming their assessment of benefit and the viability of the restructuring plan. In this situation the banks needed a clearer demonstration that the directors had thoughtfully considered the separate position of their companies and determined that the transaction would benefit each company.

Merely relying upon pro forma resolutions, prepared in part by the bank’s lawyers, was not sufficient where the circumstances demonstrated insolvency and the restructuring plan did nothing to address those circumstances other than given more time.

 Lessons Learnt

The duty of company directors to consider creditor interests is a minefield for both directors and their advisers. The Bell Group litigation demonstrates that lenders are not immune from these risks. Common actions that lenders take to strengthen their position in the face of borrower distress may fall within the scope of liability determined by the Bell appeal, a situation that is commercially unfortunate as it may make lenders less likely to support restructuring efforts.

As all parties acknowledged in Bell, the only alternative to the restructuring on the table was liquidation and destruction of value. Lenders will be best placed if there is a restructuring plan that establishes an endpoint of solvency and business viability, and a clear, funded pathway to get to that point. It may be appropriate for lenders to confirm the existence of appropriately detailed plans and board papers, and to commission specific due diligence if not satisfied by those documents.

There may be some bright news on the horizon. Recent parliamentary and government inquiries have recommended that more policy work needs to be done to encourage restructuring and corporate rescue. One of the proposed measures is the introduction of a safe harbour defence.

While the debate has centred on insolvent trading liability, it is certainly possible to extend such a safe harbour to include liability for breaches of fiduciary duties and thereby limit financier’s exposure under Barnes v Addy. Commercial parties need confidence that good faith participation in restructuring efforts will not lead to liability. No one wants to be sucked into a destructive vortex of complex litigation because they sought to restructure a struggling business.

[i] [2012] WASCA 157

[ii] It should be noted that the Appeal Court’s consideration of the second limb of Barnes v Addy (knowing assistance) has been rejected by the subsequent NSW Court of Appeal in Hasler Singtel Optus Pty Ltd

Auditors, Bankers, and Company Directors

[Originally published in the December 2014 issue of Governance Directions, and reproduced here with permission]

In September 2014 CPA Australia released ‘Audit Reports In Australia 2005–2013’ which identified that almost one-third of all ASX-listed companies, and more than half of the bottom 500, received ‘going concern warnings’ from their auditors.


Such public disclosures about the possibility of financial difficulties tend to be self-fulfilling. Credit insurers adjust their cover, suppliers rein in credit terms, and customers switch to suppliers seen as more financially stable. As a result going concern warnings can have an immediate negative impact on liquidity as well as a loss of future income and profit, and so it is no wonder that company directors work hard to avoid them. The purpose of this article is to explain when and how those disclosure requirements can lead to renegotiation with bankers, and what that renegotiation may entail.

As set out in the joint 2009 AICD/AASB publication ‘Going Concern issues in financial reporting: a guide for companies and directors,’[i] there are a number of accounting and regulatory requirements for disclosure of banking arrangements[ii] — however the most significant disclosures are around the availability of the ‘going concern assumption,’ and the classification of liabilities into ‘current’ and ‘non-current.’

Disclosure requirement —going concern

Companies have two separate reasons to assess going concern status.

First, the Corporations Act 2001 requires directors of a listed entity to provide users with sufficient information to allow an informed assessment of the financial position of the entity. According to ASIC Regulatory Guide 247 this should include ‘any doubt about the solvency of the entity, or any issues or uncertainties about the entity as a ‘going concern’.[iii]’ Secondly, accounting standard AASB101 requires an assessment of an entity’s ability to continue as a going concern when preparing financial statements.

Curiously, there is no definition of going concern contained in any of the Corporations Act, RG 247, the Australian Accounting Standards, or the International IFRS framework. The sole source of guidance in Australia is Auditing Standard ASA 570 Going Concern, which sets out an auditor’s responsibilities around the use of the going concern assumption in the preparation of the financial report.

Auditing Standard ASA570 Going Concern

ASA570 gets no closer to a definition of going concern than paragraph 2 ‘under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future’ which in effect is the period from the date of the current audit report until the expected date of the next audit report.

More helpfully, ASA570 provides an extensive list of issues that ‘may cast significant doubt about the going concern assumption.’ Those relevant to lending arrangements include:

  • fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment or excessive reliance on short-term borrowings to finance long-term assets
  • indications of withdrawal of financial support by creditors
  • inability to comply with the terms of loan agreements.

If the auditor’s initial work gives rise to concerns about going concern status, then further work is necessary, which includes:

  • reading the terms of loan agreements and determining whether any have been breached
  • confirming the existence, legality and enforceability of arrangements to provide or maintain financial support, and assessing the financial ability of such parties to provide additional funds
  • confirming the existence, terms and adequacy of borrowing facilities.

Disclosure requirement — current/ non-current classification

AASB 101 sets out rules for classification of liabilities into current and non-current. Ordinarily, liabilities that provide financing on a long-term basis are to be treated as non-current.

However, there are important limitations contained in paragraph 74 — if the borrower ‘breaches a provision of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand’ then the borrower may need to classify the liability as current. There is an exception if before the end of the reporting period the lender agrees to provide at least twelve month’s grace, otherwise reclassification is mandatory.

Such a re-classification is likely to result in a very severe imbalance between current assets and current liabilities, casting significant doubt about solvency and going concern status.

Terms of loan agreements

Loan agreements for corporate borrowers include a wide range of obligations, including reporting and information requirements which are usually referred to as reporting covenants, and requirements about financial metrics which are usually referred to as financial covenants.

Financial covenants focus on financial ratios, most commonly interest cover, debt service cover, leverage and gearing ratios; and will typically be referenced against a benchmark. Bankers will often speak of ‘headroom’ as shorthand for the gap between the actual rate and the benchmark — for example, a borrower with an actual leverage ratio of 2 and a requirement to maintain a rate below 2.5 has headroom of 20 per cent.

Reporting covenants typically include the provision of financial accounts as well as certificates which report on compliance with financial covenants. Bankers may seek monthly, quarterly, six-monthly or annual reporting: as a general rule the frequency of reporting will provide guidance as to the banker’s view of risk and the need for closer monitoring.

Consequences of a breach of covenants

The consequences of a breach of covenant will be set out in the loan agreement. Usually a breach will constitute an Event of Default which allows a lender to call in the loan — but that is not always the case. Sometimes a breach may constitute an Event of Review which leads to a good faith renegotiation of terms. In other cases a borrower may have the option to provide additional equity to avoid a default — known as an ‘equity cure.’

In practical terms the financial covenants regime is linear. Borrowers prepare their financial statements after the end of the reporting period. Once the accounts are finalised then the borrower will prepare a compliance certificate to send to the lender. A borrower might withhold a certificate to avoid a breach of a financial covenant but would usually then be in breach of their reporting covenants. Depending on the terms of the loan agreement non-compliance with a financial ratio may be automatic on receipt of the certificate, or it may require the lender to take a further positive action — but absent specific drafting in the loan document it is a well-established principle of banking law and commercial practice that a breach of a financial covenant cannot occur before the receipt of the compliance certificate.

Avoiding a breach of covenants

Lenders are usually well aware of the negative impact of public disclosure of default, and will often be prepared to work with their customer to sidestep the problem — although they may seek concessions in return. If borrowers and lenders do agree to renegotiate financial covenants to avoid an event of default there are several options:

  1. waive the requirement to test altogether
  2. reset the benchmark to a lower threshold so the test becomes easier
  3. defer the test date until a time when it is likely that the borrower will be able to comply
  4. defer the date of delivery of the financial information.

‘On or before’

In the aftermath of the GFC many auditors adopted a more cautious stance. One consequence was a reinterpretation of the rules around the current/non-current distinction, such that some auditors took the view that a breach arising from the delivery of a certificate after the end of the period was in fact a breach arising ‘on or before’ the end of the period. This view if correct would mean that some breaches — most notably those arising because of an accounting treatment mandated by the auditors themselves after the end of the accounting period — were not capable of waiver under any circumstances whatsoever!

More recently it appears that most auditors now follow the plain wording of the standard, recognising that a breach of financial covenant can only occur after the end of the accounting period that it measures.

Conclusion and summary

Companies usually prepare comprehensive three-way projections — balance sheet, profit and loss and cashflow. It is essential that this be taken one step further to create a forecast of financial covenant compliance, to confirm that the company will be able to meet financial covenants, and has a reasonable amount of headroom.   If there is uncertainty over a likely future compliance then management should either develop an action plan to improve financial performance capable of satisfying the auditors, or engage with lenders as early as possible to negotiate waiver or modification of the covenant regime.

[i] Available online at

[ii] For completeness, AASB 7 Financial Instruments requires information about any defaults and whether the default was remedied or the terms of the loans payable renegotiated, and AASB 107 Cash Flow Statements requires details of undrawn borrowing facilities together with any restrictions on their use

[iii] ASIC Regulatory Guide 247 Effective disclosure in an operating and financial review, available at