PLC Global Finance update for April 2010: Australia

Practical Law UK Articles 8-502-0701 (Approx. 12 pages)

PLC Global Finance update for April 2010: Australia

by Minter Ellison

Secured lending

Personal Property Securities Act: attachment and perfection

Eamon Nolan and Keith Rovers

In the March update, we took an introductory look at the major issues flowing from Australia's adoption of the Personal Property Securities Act 2009 (Act) (which is due to commence in May 2011).

The Act establishes a national law governing security interests in personal property including (among other things) providing for a single register to replace the many existing registers that apply to various asset classes and security interests (including the register of company charges held by ASIC). The Act also introduces a comprehensive national law relating to creation, perfection, registration, priority, extinguishment and enforcement of personal property securities.

This month, we focus on two of those key concepts: attachment and perfection.

Attachment

'Attachment' and 'perfection' are concepts not previously given a distinctive legal meaning in the context of the law of securities in Australia. Under the provisions of the Act, a security interest is not effective in relation to personal property until it has attached to that property. Under section 19 of the Act, attachment is deemed to occur when both:

The grantor has rights in the collateral, or the power to transfer rights in the collateral to the secured party.
Either value is given for the security interest, or the grantor does an act by which the security interest arises.

A security interest which has attached to personal property is enforceable between the grantor and a secured party but not, merely by having attached, against third parties.

It is important to note that section 19 distinguishes between a grantor with ownership of collateral, and a grantor that simply has rights in it, and permits attachment to occur in either case.

The nature of the rights which a grantor must have in the collateral is not at this stage clear, but Dr James O'Donovan in his commentary 'Personal Property Securities Law in Australia' cites the judgment of Hansen J in the case of Graham & Gibson v Portacom New Zealand [2004] 2 NZLR 528, where he suggested at [28] (in the context of the equivalent New Zealand securities legislation) that "rights in the collateral…must be understood as requiring a bare right to possession or a power to convey a greater interest than has the debtor".

Perfection

The Act also permits the parties to vary the time of the attachment of the security interest to the collateral to (should they elect to do so) a later time of their mutual choosing. That is, a security agreement can allow for attachment to occur at some date in the future as agreed by the grantor and the secured party. However, a security interest which is merely 'attached' is not enforceable against third parties claiming a competing interest in the property unless one of the following has also occurred:

The secured party possesses the collateral.
The secured party has perfected the security interest by way of control.
A security agreement that provides for the security interest:
- is signed by the grantor or is adopted or accepted by the grantor by an act specified in writing which was done with an intention of so adopting or accepting, and the evidence in writing describes the collateral (whether specifically or by statement that all the present and after-acquired property is taken); and
- contains a description of the collateral (whether by way of specific reference to the collateral or by way of statement that all present and after-acquired property are the subject of the security interest).

Enforceability against third parties, however, does not necessarily give a secured party priority ahead of purchasers and other secured parties. It is the achievement of perfection that provides the additional rights (over and above enforcement against third parties) that enables a party to ensure it achieves a priority secured position. That is, perfection's importance arises because its occurrence determines priority between competing interests in the collateral (whether of purchasers or competing secured parties).

A security interest may be perfected in four ways:

By registering the collateral in accordance with the Act.
By the secured party or a person on its behalf taking possession of the collateral.
If the collateral is of a certain type known as controllable property, by the secured party or a person on its behalf taking control of the collateral (controllable property includes some intangible collateral such as certain types of bank accounts, investment entitlements and instruments, negotiable instruments and letters of credit, as well as tangible collateral such as satellites and other space objects which are rendered rather difficult to possess once they enter orbit).
By obtaining temporary perfection in accordance with the Act. There are provisions conferring temporary perfection throughout the Act. Some examples of situations where a security interest may be temporarily perfected are:
- where the collateral is moved to Australia from another jurisdiction (section 40);
- if a security interest is not perfected in respect of the proceeds of collateral (the security is temporarily perfected under section 33 for five business days); and
- if collateral which is subject to a perfected security interest is transferred (the security is temporarily perfected under section 34 for up to two years).

The Act does contain additional specific rules which apply to the determination of what constitutes possession and control, both in a broad sense and in relation to specific assets.

In future articles, we will be taking a look at the other key concepts of the Act, namely:

Extinguishment of security interests.
The various priority rules as amongst competing security interests.
Enforcement of security interests.
Maintenance of the register and achieving registration.
The transitional arrangements that will apply once the Act is introduced.

Corporate governance

Lenders and other third parties as shadow directors or officers – law clarified and explained

Michael Hughes

Lenders and other third parties dealing with companies in distress are often concerned that by exercising legitimate legal rights they can become shadow directors, especially when the directors allege they have no choice but to do what the lender wants, because receivership is the only alternative.

In dismissing a claim brought against Apple and one its employees by the liquidator of the failed Buzzle Group, White J in the Supreme Court of New South Wales has now given important guidance as to where the limits really lie (reported as Buzzle Operations Pty Ltd (In Liquidation) v Apple Computer Australia Pty Ltd [2010] NSWSC 233).

The Court confirmed that:

It is not enough that a third party imposes conditions on their ongoing support, and it is left to the directors to discharge their own duties to the company to decide whether or not to comply, even if they may feel they have "no choice".
There must be a causal connection between the third parties' intentions and wishes, and the directors' conduct. It is not enough that the directors were going to act as they did for their own reasons.
There must be a habitual compliance with the third parties' intentions and wishes over a period of time.

Background

In 2000, the owners of the top seven Apple resellers hatched a plan to merge their businesses and float the rolled up enterprise on the Stock Exchange. This needed Apple's support. Each of them had acquired stock from Apple on credit, which held a fixed and floating change over the assets of each business, and directors' guarantees. This stock had to be acquired by the new entity, which was incorporated for this purpose in July 2000, under the name Buzzle Operations Pty Ltd (Buzzle). Buzzle would need its own reseller agreement and, for the float to succeed, Apple would need to give up the right to terminate that agreement on the previously prevailing 30 days' notice. Apple consented to the merger, and granted a reseller agreement to Buzzle. The merger took effect on 13 and 14 September 2000. Buzzle granted a fixed and floating charge to Apple.

There is no doubt that Apple's employee – who was sued as well – was closely involved. At one point the employee had his own office at Buzzle's premises (paragraph [305]) and required one reseller take over the business of another before Apple would support the plan; but he was not involved in the plan's formulation which was only presented after agreement between the resellers and it was found that at all times, he was acting to protect Apple's interests.

Unfortunately the merged venture did not perform well. The new single management information system did not materialise, and the float did not proceed. In February 2001 Apple appointed investigating accountants. On 31 March 2001, they were appointed as receivers and managers. In another action, Apple successfully sued the directors under the personal guarantees it was given along with the charge.

The liquidators' case

The liquidator launched the action alleging that because of Apple's involvement, Apple was an "officer" of Buzzle, or "a person associated, in relation to the creation of the charge" with such a person, and so the charge could not have been enforced for a period of six months (section 267(1), Corporations Act 2001 (Cth)).

It was alleged that the charge was enforced when the investigating accountants were appointed. Claims were brought against the receivers for trespass and conversion. Secondly, the liquidator claimed that as Buzzle was insolvent from January 2001, Apple and its employee had become "shadow directors" of Buzzle, and so should be held liable for the debts incurred from that time – including those to Apple (section 588G). There were separate claims that some transactions and payments made to Apple should be set aside as uncommercial transactions and unfair preferences.

All the liquidators' claims failed.

Officers and directors – statutory definitions

A primary focus of the case was the meaning of "officer" and "director" as set out in section 9. The "officer" definition has two limbs; it is either a person who:

"(i) makes or participates in making decisions that affect the whole or a substantial part, of the business of the corporation, or (ii) ... has the capacity to affect significantly the corporation's financial standing".

A "director" is defined to include a person in accordance with whose "instructions or wishes", the directors "are accustomed to act". While not defined as such, such a person has come to be known as a "shadow director". This is separate to another limb which has a person as "director" simply because they "act in the position" even though they have not been validly appointed. Such a person is a "de facto director". (Paragraph [227]).

In relation to the argument about Apple's charge, it was said that it was associated with the directors' as "a person in concert with whom the primary person is acting, or proposes to act" (Section 15).

These concepts are important not just to questions of the validity of charges or insolvent trading. As an "officer" or "director" of a company the third party would be subject to all of the duties imposed on people who occupy such a position, including those set out in sections 180 and 181, which would in effect force them to subjugate their own interests to those of the corporation. All these consequences were referred to by White J as a reason why limits should be placed on the definitions, notwithstanding their apparently wide terms (paragraphs [126] and [247]).

Much of the directors' evidence about the extent of Apple's involvement and that of its employee was contested and resolved in Apple's favour. But in White J's carefully considered reasons for judgment, a number of legal principles emerge which provide clear guidance to the third parties.

Apple not an officer

As noted already, the "officer" definition has two limbs. On the first, the liquidator argued that Apple had participated in 12 separate decisions that affected the whole or a substantial part of Buzzle's business. White J analysed the evidence about each of these decisions, and concluded that Apple had not participated to the extent required. For example, it was not enough that after a decision was made by the resellers it was communicated to Apple. Nor was it enough for Apple to propose something which the directors felt they had "no choice" but to agree with. In a recurring theme in the judgment, White J considered a decision that Buzzle enter into a "payments deed" under which limits were placed on its ability to incur debts other than in the normal course of business:

"Mr Hartono deposed that he felt he had absolutely "no choice but to agree to the terms contained in the Payments Deed". This does not mean that Apple participated in Buzzle's decision-making. To the contrary, Mr Hartono said he had no choice but to agree to what Apple proposed. For a director of a company to acquiesce in a third party's demands does not mean that the third party participates in the company's decision-making. Given that officers of a company have a statutory duty to act in the best interests of the company, it would be an impossible position if a third party making demands on a company in its own interests become an officer of the company because its demands were acceded to." (Paragraph [118] (emphasis added).)

As to the second limb, the liquidator argued the definition should be applied literally, that Apple was an officer because (plainly) it "[had] the capacity to affect significantly the corporation's financial standing". After reviewing the definition's legislative history and placing the definition in the context of the duties imposed, White J concluded that the person must be an insider involved in the management of the company's affairs:

"[it] should be taken as referring to a person who, in his or her management of the affairs of the corporation, has the capacity to affect significantly the corporation's financial standing. It does not refer to a person who has that capacity as a third party but is not involved in the management of the corporation's affairs". (Paragraph [126].)

White J makes the point that if the liquidator was correct, there would and could be no real limit on the definition, with the "absurd" result that every government, bank, wealthy company or individual would be an "officer" because they have the capacity to affect the financial standing of every company (paragraph [124]).

In this case, Apple had no involvement at all in Buzzle's management prior to the charge being granted.

Apple not an associate

The liquidator's argument that Apple and the directors were "acting in concert", and so must be "associates", was also rejected. On this score, the liquidator could not point to any conduct falling within this description, it being well established that there must be something beyond the output of the parties' conduct which is attacked – in this case the entry into the charge. The liquidator argued that Apple had its "own reasons" for permitting the merger to proceed, including improving the prospects of recovering the debts that were due to it by the resellers before the merger proceeded.

"However, none of the purposes attributed to Apple in the taking of the charge was common to Buzzle. It was no part of Buzzle's purpose that Apple obtain better security for the repayment of the vendors' debts. The fact that both Apple and Buzzle saw the merger as potentially beneficial to each of them does not mean that they had a common purpose in relation to the merger, let alone that they had a common purpose in relation to the creation of the charge." (Paragraph [132].)

Apple's charge enforceable

Accordingly the liquidator's attack on the charge failed. Given this, White J deliberately left open the question of whether the investigating accountants' appointment was of itself a step in the enforcement of the charge. He does however refer favourably to an earlier decision of Palmer J, in which it was found that the appointment of a voluntary administrator by the secured creditor would not be sufficient (Australian Innovation Ltd v Dean-Willcox & Ors (2001) 40 ACSR 521), and on this basis expressed the view that Apple did not seek to enforce its security by appointing investigating accountants (paragraph [140]).

Apple not a shadow director

Apple argued that because it was a corporation, which by its nature cannot be appointed as a director of a company (section 201B), it could not therefore be a "person" within the shadow director definition. White J rejected this argument, noting that it had been "held more than once and assumed on many occasions that a company can be a shadow director" (paragraph [231]).

The second and perhaps most important point to emerge from the decision is that in White J's opinion, the formally appointed directors must be accustomed to act as directors of the company, in accordance with the shadow directors' instructions or wishes as to how they should act. Any control that Apple may be said to have exerted over the directors when they were conducting their business as resellers prior to the merger, and which meant they felt constrained to meet sales targets to obtain rebates needed to achieve realistic margins, was not enough because it was quite separate to their functions as directors of Buzzle.

Additionally:

"a person or company is not within the definition ... merely because that party imposes conditions on his or her commercial dealings with the company with which the directors feel obliged to comply. A lender who is entitled to demand repayment of a loan and appoint a receiver can say, for example, that it will stay its hand only if the borrowing company sells certain assets. A supplier or buyer might impose conditions and because of its superior bargaining power, the directors of the company with whom it deals might feel they have no choice but to comply with the conditions imposed. It has been uniformly held that this is not sufficient to make the third party who exercises such powers in his dealings with the company a shadow director, even though the directors of the company are accustomed to comply with its demands

....

In my view the reason that third parties having commercial dealings with a company who are able to insist on certain terms if their support for the company is to continue, and are successful in procuring the company's compliance with those terms over an extended period, are not thereby to be treated as shadow directors within the definition, is because to insist on such terms as a commercial dealing between a third party and the company is not ipso facto to give an instruction or express a wish as to how the directors are to exercise their powers. Unless something more intrudes, the directors are free and would be expected to exercise their own judgment as to whether it is in the interests of the company to comply with the terms upon which the third party insists, or to reject those terms. If, in the exercise of their own judgment, they habitually comply with the third party's terms, it does not follow that the third party has given instructions or expressed a wish as to how they should exercise their functions as directors." (Paragraphs [242] and [243] (emphasis added).)

The third point is that there needs to be a causal connection between the shadow director's "instructions or wishes", and what the directors actually do. In this case, the liquidator sought to rely on steps that were taken by the directors which they would have taken anyway. For example, it was alleged that Apple had instructed Buzzle employees to prepare financial reports, prepare a plan for debtor collections and devote resources to that activity. White J decided that no reliance could be placed on these matters because these were basic steps for the operation of the business and things that the directors were in any event attempting to do (Paragraph [244]).

"For the reasons I have already given, I do not accept that to establish that person is a shadow director, it must be shown that the directors of the company do not exercise any discretion of their own. Nonetheless, the authorities provide powerful support for the defendants' submission that there must be a causal connection between the instruction or wish of the shadow director and the act taken by the directors. There is good reason for this. If a person is a shadow director, he, she or it owes statutory duties to act in good faith in the best interests of the company, and with the reasonable care and diligence of a director of the company. A shadow director is also liable to statutory liabilities, such as the liability of a director for insolvent trading. When the definition is construed in the light of the purpose of subjecting a person who is not appointed, and does not (or might not) act as a director, to the statutory duties and liabilities of a director, it makes good sense that there must be a causal connection between the acts of the directors and the instructions of the putative shadow director for the definition to be satisfied. I accept the defendant's submissions that such a causal connection is necessary." (Paragraph [247].)

Finally, care must be taken to analyse precisely who is acting in accordance with the third party's instructions or wishes, and the capacity in which that person receives the relevant communication. First, the directors collectively must be accustomed to act on that person's instructions or wishes, in which regard it will be enough that the governing majority is so accustomed. However it is not sufficient that executives who are not directors may be accustomed to act on the person's instructions or wishes; there is still scope for the person to be a de facto director, but they are not a shadow director.

Next White J accepted the position adopted in the earlier decision in Harris v S ((1976) 2 ACLR 51 at 72) that instructions given or wishes expressed to a director in his or her capacity as a working executive, as distinct from an instruction or wish relating to the director's performance of his or her function as a director, is not relevant: there must be a "board of directors claiming and purporting to act as such" (paragraph [250]).

This became important to the case, because the communications from Apple on which reliance was placed were made to three board members, and Buzzle's CEO. Apple had little involvement with the other directors (paragraph [255]). It would have been sufficient if the instructions or wishes were passed on and acted on with sufficient frequency, but neither all nor a majority of the directors of Buzzle acted in accordance with the alleged instructions (paragraph [307]).

White J then analysed each of 17 instances of instructions said to have been given by Apple, going back to before Buzzle was incorporated to determine whether by 31 December 2000, Buzzle's directors were accustomed to act on the instructions or wishes of Apple or its employee. The following can be distilled from his treatment of this aspect:

Negotiations or a requirement expressed as a part of a commercial negotiation do not amount to instructions, where it remains open to the directors to accept or reject the proposed terms (paragraphs [280], [281] and [292]).
Trivial matters – in this case the drafting of the announcement of the proposed merger – can be disregarded (paragraph [291]).
A creditor cannot be a shadow director because it demands payment of debts due to it, and those debts are paid in whole or part (paragraph [297]).
Steps taken or which would have been taken irrespective of the third party's instructions or wishes are to be disregarded (paragraphs [296] and [301])

Significantly, in respect of the period after 1 January 2001, by which time Buzzle had become insolvent, it was contended that Apple should in some way be held liable for effectively allowing Buzzle to continue to trade by not appointing receivers before it did. There was evidence that from the start of 2001, Apple had taken a "proactive role" in exploring the possibility of attracting third party investors, and pursuing a proposal for a demerger, albeit no instructions or wishes were given which the directors acted on (paragraph [325]).

On 22 January 2001, Apple sent a carefully crafted letter to the CEO in which it disavowed any involvement in any corporate decision making, either at managerial or directorship level and said that if it is invited to attend any meetings at which corporate decisions are made, it will only do so as an observer or adviser (paragraph [326]). White J rejected the directors' evidence that Apple's employee said that unless he signed his acceptance of this letter, Apple would "pull the plug". He also said that the letter would not have helped Apple, if it had in fact crossed the line, but did make the point that this was a very clear statement that Apple was not purporting to give any directions to the directors with which they were expected to comply (paragraph [329]).

These comments are important in the context of a work out, as they suggest that a clear statement of the lenders' position, which is not contradicted by the lenders' conduct will go some distance to minimising risk. Finally in this context, Apple did not become a shadow director, simply because for its own reasons it did not act earlier:

"The [Liquidator] stressed that Apple perceived it to be in its interests for Buzzle to continue to trade whilst Apple worked out what it wanted to do with Buzzle. It did not want winding-up proceedings to be commenced against Buzzle. The reason for this was that Buzzle was by far the largest Reseller and accounted for perhaps 30 per cent of its revenues. Apple faced substantial losses if Buzzle went into administration or receivership from the loss of sales and damage to Apple's brand. But motive for Apple to give directions to Buzzle's board, does not establish that Buzzle's directors were accustomed to act in accordance with Apple's wishes." (Paragraph [331].)

It is unclear whether there will be an appeal from the Court's decision, but pending this we think this decision will provide important guidance for lenders and other third parties whose contribution to a company has become essential.

Dispute resolution

St George Bank Limited v Perpetual Nominees Limited and another

Nigel Clark and Wayne Fellows

A recent Queensland Supreme Court case clarifies that a financier who is a first registered mortgagee and chargee is able to exercise its power of sale to sell assets to a buyer free of subsequent security interests.

In St George Bank Limited (St George) v Perpetual Nominees Limited (Perpetual) & Another [2010] QSC 57, it was confirmed that a first registered chargee is able to pass clear title in property to a buyer without requiring the consent of subsequent chargees. This principle is known as 'passing through subsequent charges' or 'selling through subsequent security interests'. This issue has not been tested in a court in Australia before.

In this case, St George held a first registered fixed and floating charge over the assets of SP Hotel Investments Pty Ltd (SP Hotel), as well as first registered mortgages, granted by SP Hotel, over the properties on which the hotel business was run. Perpetual and LJK Nominees Pty Ltd (LJK) held subsequent charges and mortgages in relation to the same assets. After SP Hotel defaulted by failing to pay required interest repayments, St George sought to exercise its power of sale.

The question for the court was whether on exercise of the power of sale the buyer took the property and the business and assets of SP Hotel free of any security interest of Perpetual and LJK.

The court confirmed that the receivers and managers were able to deliver good title to the land and the business and assets to the buyer and sell through subsequent security interests without obtaining releases from Perpetual and LJK.

The decision provides financiers with further certainty regarding the ability to pass through subsequent security interests and provide clear title to prospective buyers.

Re Octaviar – registration of security

Stewart Robertson and Gretchen Shipman

Uncertainty about bank practice with regard to the validity of charges will continue in Australia after the High Court granted an application for special leave to appeal to the High Court from the Queensland Court of Appeal's decision in Re Octaviar Ltd (No 7) [2009] QCA 282 (Octaviar).

Background

Until recently, market practice in Australia has been to only lodge a variation of charge notice with ASIC (the corporate regulator who administers the charge register) if the terms of the charge document have been varied.

However, the decision in Octaviar in the Supreme Court of Queensland in March 2009 called this practice into question. The judge in Octaviar held that, where a charge secures obligations under 'finance documents' (rather than being all moneys) and new documents are designated as finance documents which may increase the amount of the liabilities secured, the parties should lodge a variation notice for the charge with ASIC.

McMurdo J had held that a charge granted to Fortress Credit Corporation (Aust) II Pty Ltd (Fortress) by Octaviar Limited (in liquidation) (receivers and managers appointed) had been varied to increase the liabilities secured by it and the charge was therefore void against the administrators of Octaviar Limited (in liquidation) (receivers and managers appointed) to the extent of the variation as Fortress had not registered the variation under section 268(2) of the Corporations Act.

Similarly to the UK, in Australia charges and mortgages are often drafted in relation to a transaction so as to define the relevant 'secured money' by reference to money owing under or in connection with certain documents - usually 'transaction documents' or 'finance documents'. These are often listed in a facility agreement or common terms deed, but not always in the charge itself, and usually extend to further documents that may be designated or agreed in future to be transaction documents. The nature of the liabilities secured by a registrable charge (by reference to the transaction documents definition) are then described in an ASIC Form 309 and a copy of the charge lodged with ASIC.

Unless the instrument creating the charge is contractually varied, market practice was to not lodge a further notice with ASIC for an increase in liability secured under the charge where such increase in liability arises because the parties designate or agree to add (or vary) a transaction document.

This is because the charge instrument itself is not being varied, and the scope of such liability (being the liability under any present or future document that could be a transaction document) has been considered to be established at the outset. The finding reached by the Judge in Octaviar was inconsistent with this market practice and view.

First appeal: Queensland Court of Appeal

In September 2009, the Queensland Court of Appeal found in favour of the appellant in its appeal to reverse the decision of the Supreme Court of Queensland and held that an increase in the liabilities secured by the charge does not automatically amount to a variation of the charge and the validity of the appellant's charge was upheld. This accords with what had been typical banking practice.

Second appeal: special leave granted

In granting the Public Trustee of Queensland's application for special leave, the High Court has allowed the Public Trustee to appeal the Queensland Court of Appeal's decision in the High Court.

The appeal will be heard by a full court of the High Court later this year. Until then, lenders are advised to seek legal advice when amending or adding new financing documents to consider whether a variation of a charge should be lodged with ASIC.

Project finance

Australia: Innovative funding models – breaking the mould

Paul Paxton

The growing Australian appetite for infrastructure is driving an evolution in delivery models.

Government procurement has evolved from a merely mechanical act into an integral tool for achieving the government's strategic objectives.

Both government and the private sector proponents financing, constructing and operating the infrastructure are looking for greater efficiency, productivity and profitability and financing options that make economic sense.

As these factors coalesce, models are being sought that look after the interests of all the relevant stakeholders and still deliver the infrastructure the community needs. Against this background and the climate generated by the largest financial crisis in a generation, a first-of-a-kind funding model used in Queensland to deliver a number of public schools breaks new ground and causes controversy in both the public and private sectors.

PPP with a twist

Over the past 20 years, the public private partnership (PPP) model has successfully delivered projects throughout Australia and the world, traditionally procuring 100% debt and equity finance from the private sector.

But private debt and equity finance is not the only way to go. Many governments, both overseas and locally, have been closely scrutinising the cost of private finance for large government infrastructure projects and wondering if there is some way of utilising government funds to assist in these projects while retaining the benefits and, in particular, the rigour of a PPP procurement with the private sector.

Recently, Australia successfully closed its first PPP using Queensland's answer to the UK Credit Guarantee Finance model – the supported debt model (SDM). It was used for the South East Queensland (SEQ) Schools project and varies from the traditional PPP model because it is partly debt financed from the public sector.

The SEQ Schools project involves the construction of a number of schools in South-East Queensland – one of Australia's fastest growing regions by head of population. The construction phase of the project is being wholly debt-funded by the private sector. 70% of that debt, however, will eventually be taken out by the Queensland Treasury Corporation (QTC) at various milestone dates during the course of the project (linked to the completion of construction of the schools). The remaining debt will be taken by subordinated private sector lenders.

One of the key drivers for the project (and one of the elements of the price the equity sponsors were prepared to commit to in their financial modelling from the outset) was to provide the private sector access to technically cheaper public sector funding during the longer term operational phase of the project.

Not all plain sailing

Because it is the first of its kind, the SDM model encountered some teething problems that had to be resolved by intensive negotiations and lateral thinking.

One of the issues was to determine in what circumstances the public sector would be obliged to take-out the construction debt. Ultimately, the approach taken was designed to provide certainty of take-out from the private sector's perspective, while still affording the public sector adequate protection as the senior financier.

Through negotiation, the parties agreed a position that ensured that the overall project would not unravel at the first sign of a problem (such as a potential event of default) and which provided incentives to the construction financiers to actively work out any problems during the construction phase to preserve the value in the QTC take-out.

Another hurdle was to strike the right balance in relation to the extent of the State of Queensland's passivity in enforcement due to its dual role as concessionaire as well as senior term financier.

As concessionaire, the State has various termination rights in relation to the project as a whole under the project documentation and, in the ordinary course, the senior term financier would have standard default and step-in rights in relation to its borrower under the financing documentation – with each of the State or the senior term financier's respective rights heavily impacting on the other if they were to be exercised. The parties therefore spent considerable time working to ensure the sponsors and the private sector financiers were afforded the right level of breathing room to manage the project and deal with defaults to protect the concession.

This was particularly critical in relation to the operating term phase of the debt, where the State's dual role becomes more acute. The process required balancing the circumstances when the State, as senior debt provider, had to stand on the sidelines and when it could accelerate or take enforcement steps. To protect the concession, a position was finally agreed where, in certain circumstances, the State would cede control of the enforcement processes to the private sector financiers to avoid a conflict under the dual 'state' interests in the project.

Not your usual bank calculations

Refinancing and prepayment presented another significant commercial issue. In the prevailing market conditions, private sector debt was not available for a 20 to 30 year term on any reasonable value for money basis and, accordingly, shorter term debt (which would need to be refinanced at five to 10 year intervals) was procured.

The sponsors and QTC were however keen to ensure that the QTC debt remained for the duration of the project – they did not want to see it prepaid unless circumstances arose, such as a partial termination, which made prepayment unavoidable. Given the lower cost economics of QTC's debt, one can imagine the difficulties that the private sector equity participants would have in refinancing QTC's debt through private sector financiers at some point in the future.

Accordingly, a position was ultimately achieved that requires QTC debt to remain in the project (except in specific termination circumstances) whilst the private sector debt is permitted (and required) to be refinanced several times over the life of the project.

Break costs payable to QTC in the event of a prepayment or cancellation of its facility also became an issue that required some lateral thinking. QTC's funds are not deployed in the same manner as those of a traditional bank, so accurate break fees could not be easily calculated based on a standard bank break-costs methodology.

Additionally, QTC's base interest rate is not calculated in the normal bank manner based on a BBSY (or a similar base rate) plus a set margin. Rather, the base rate is calculated according to a fixed rate determined by setting a zero net present value when all future drawdown amounts and remaining mandatory repayments are discounted (using certain discount factors and involving the calculation of a zero coupon yield curve based on the QTC yield curve). A margin is then applied to that rate.

To address QTC's entitlement to compensation in the event of prepayment, both parties had to be comfortable that the formula agreed was a fair representation of the State's cost of funding, a position which was ultimately achieved through some rigorous negotiation.

Negotiating the world's first SDM Project was a challenging and rewarding process. The model broke new ground in the Australian PPP market for participation in a PPP by a government treasury.

In doing so, many innovative solutions were developed to complex scenarios that result when public and private funding is combined together in the financing and procurement of public infrastructure. These solutions and the effort that the public and private participants put into working through the process to achieve a successful financial close offer many valuable lessons for future projects that may again contemplate the injection of public funds into the more traditional PPP model.

They have also been instrumental in enabling the procurement of a highly successful, state of the art, package of seven new schools into the local community in South East Queensland. These schools are critical to the development of the region and would not have been possible without the dedication and commitment of the individuals from both the government and the Aspire Schools consortium involved in the project.

PLC Global Finance update for April 2010: Australia | Practical Law