Analysis of solvency does not have the benefit of hindsight: the Arrium collapse

Anchorage Capital Master Offshore Ltd v Sparkes (No 3); Bank of Communications Co Ltd v Sparkes (No 2) [2021] NSWSC 1025

1. Background

Justice Ball has handed down his decision in two proceedings which arose from the collapse of Arrium Limited, an Australian listed company, and its broader corporate group (Arrium): Anchorage Capital Master Offshore Ltd v Sparkes (No 3); Bank of Communications Co Ltd v Sparkes (No 2) [2021] NSWSC 1025. Arrium was a mining and steel company, with around 8,000 employees. The plaintiffs were banks which had either lent money to Arrium or taken assignments of debts from banks which had lent money to Arrium.

The background facts to this litigation are complex. In short, from around June 2015, Arrium conducted a strategic review to consider how the business would manage approximately $1.125 billion of debt which was due to mature in July 2017. There were a number of options on the table, including asset sales, refinancing, recapitalisation and or/debt restructuring. Arrium took advice from several financial and legal advisors. In January and February 2016, while the strategic review was ongoing, Arrium issued a series of drawdown and rollover notices under various facility agreements it held with its lenders. Under the terms of the loan agreements, Arrium was required to repeat various representations on the date of each drawdown and rollover notice. For the purposes of insolvency practitioners, the key representation regarded solvency: that Arrium was solvent at each drawdown date. Arrium went into voluntary administration on 7 April 2016.

Among the Plaintiffs’ claims, the Plaintiffs alleged that Arrium breached its representations as to solvency.  This was because, at the date that it made the drawdown and rollover requests (variously in early 2016), it had no means of repaying debt which would mature in July 2017.

These claims in effect turned on the question of whether Arrium was insolvent at the time that drawdown and rollover notices were issued. This required an analysis of how the Court should deal with future events in assessing the question of solvency.

2. Principles

In his judgment, Ball J set out four principles on which the Plaintiffs relied:

1. The fact of insolvency must be proved on an ordinary civil standard – that is, on the balance of probabilities.
2. A debt is taken to be owing at the time stipulated for payment in the contract unless there is evidence that this is not the time for repayment.
3. The test of insolvency is future looking – that is, the question of solvency requires consideration of an ability to pay debts falling due in the future.
4. The question of solvency is to be determined by reference to the circumstances as they were known or ought to have been known at the date at which the question of solvency is assessed and not in hindsight. That said, the Court can have regard to what happened to the extent that what actually happened sheds light on what was likely at the time when the question of solvency is to be assessed.

From those principles, the Plaintiffs submitted, followed two further propositions which the Court considered:

1. First, a company will be insolvent if it can be said, on the balance of probabilities, that the company is not able to repay a debt falling due on some future date. Ball J rejected this proposition. His Honour considered that this conflated two issues. First, the Court needed to be satisfied, on the balance of probabilities, that Arrium was unable to pay its debts as they became due. Secondly, the Court was required to predict whether it could be said that as from January 2016, Arrium was unable to pay a debt falling due in July 2017. This required a prediction based on what was known and knowable as at January 2016. The first question required an assessment of solvency judged on the balance of probabilities. The second question required an assessment of the likelihood of a future event. The second component of this proposition also required a high degree of certainty about what would come about. His Honour stated that “[t]he difficulty involved in predicting the future with sufficient certainty so as to be able to say that what is predicted is true at the time of prediction explains the general reluctance of courts[ …] to determine the question of solvency by reference to debts that are not payable immediately or in the new future.”
2. Secondly, a mere theoretical possibility that a creditor may, at some time prior to the debt falling due, agree to alter the amount of the debt or payment date is insufficient to preclude a finding of insolvency. Whilst this proposition is well established, it did not avail the plaintiffs in this case. This is because Arrium was a publicly listed company, not a trade creditor, which would in the normal course of events rollover or replace borrowings. As the banks bore the onus of proving that Arrium was insolvent, it followed that the banks would need to prove that financiers would be unprepared to extend loans to Arrium. The submission as put by the Plaintiffs attempted to flip the burden back onto Arrium to prove that a compromise of their debts was unavailable. Justice Ball’s finding on this principle ultimately went to the question of burden of proof
3. Decision

His Honour held that the Plaintiffs’ reliance on Arrium’s entry into voluntary administration on 7 April 2016 to evidence insolvency in early 2016 was misplaced. This was an impermissible use of hindsight.

He held that, between January and April 2016, Arrium’s circumstances changed. At some point, it became clear that a proposed asset sale was off the table. However, it still had realistic strategies, including refinancing its debt, reaching an agreement with its current lenders or weathering the storm until market conditions improved.

The relevant debts were due 18 months in the future as at early 2016. In the normal course of events, it would have been expected that those debts would be refinanced or compromised.

The claims of the banks were dismissed.