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Focus: Variation of registered charges and the Octaviar decision

13 March 2009

In brief: A recent decision of the Queensland Supreme Court may have serious consequences for many existing secured financing arrangements. Partner Andrew Boxall (view CV) and Senior Associate Nicholas Adkins report that it might also force a change in market practice for notification to ASIC of variations in liabilities secured by registered charges.

How does it affect you?

  • The decision in Re Octaviar Ltd; Re Octaviar Administration P/L1 may affect a large number of secured financings where there has been an increase in the liabilities secured by a charge (such as an increase in the facility limit, or the introduction of secured mezzanine debt).
  • The consequences of failing to notify the Australian Securities and Investments Commission (ASIC) of an increase in the liabilities secured by a charge are serious; the charge may be void in the event of a winding up, administration or a deed of company arrangement to the extent of any relevant increase in liabilities.
  • In light of the decision, it would be prudent to review any existing financing arrangements and notify ASIC of any variation to the terms of any document that may result in an increase of the liabilities secured by a registered charge.
  • The decision raises other questions concerning the registration procedure for charges.

Introduction

The case concerned an application by the Public Trustee of Queensland to seek the termination of two deeds of company arrangement (DOCA) in respect of Octaviar Ltd (Octaviar) and Octaviar Administration Pty Ltd (each members of the finance group formerly known as MFS).

At issue was the effect of a charge purportedly held over the assets of Octaviar by Fortress Credit Corporation (Australia) II Pty Ltd (Fortress). The public trustee contended that each DOCA was premised on the validity of that charge and that the charge was, in fact, invalid.

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Background

Fortress agreed to lend money to Young Village Estates Pty Ltd (YVE) under a loan agreement dated 31 May 2007 (the YVE loan agreement). The loan was guaranteed by Octaviar by way of an instrument of guarantee (the YVE guarantee) but no other security was provided at that time.

Fortress separately agreed to lend up to $250 million to its wholly owned subsidiary, Octaviar Castle Pty Ltd (Castle), under a loan agreement dated 1 June 2007 (the Castle loan agreement). In addition to a guarantee from Octaviar, this loan was secured by way of a fixed and floating charge from Octaviar (the Octaviar charge).

On or about 29 February 2008, Castle's debt to Fortress under the Castle loan agreement was repaid in full. However, Fortress and the administrators contended that the Octaviar charge remained on foot because, by that time, it also secured the YVE guarantee, which had been brought within the moneys secured by the Octaviar charge through the following (commonly used) designation mechanism.

Under the original Octaviar charge, Octaviar charged to Fortress all of its present and future property 'as security for the due and punctual payment and satisfaction of the Secured Money'. The term, 'Secured Money', was in turn defined by reference to amounts owing or payable by Octaviar to Fortress under or in relation to a 'Transaction Document'.

Accordingly, an obligation was secured by the Octaviar charge only if it was under or in relation to a 'Transaction Document'. The definition of 'Transaction Document' included a provision enabling new documents to be designated as 'Transaction Documents' if agreed by the parties.

Fortress claimed that the YVE guarantee was designated as a 'Transaction Document' (and therefore brought within the moneys secured by the charge) by way of a letter agreement dated 22 January 2008 between Fortress, Octaviar and Castle (the letter agreement ). The letter agreement was signed one day after Octaviar's CEO had resigned, a merger proposal had been withdrawn and Octaviar shares had gone into a trading halt.

On this basis, Fortress maintained that while the Octaviar charge had previously only secured the Castle loan agreement, it now also secured a further facility, being the YVE loan agreement (which had previously only been guaranteed on an unsecured basis by Octaviar).

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Arguments and decision

The public trustee challenged the validity of the Octaviar charge on the basis that:

  • the letter agreement amounted to a variation of the terms of the charge resulting in an increase of the liabilities secured by it (namely those liabilities under the YVE guarantee);
  • section 268(2) of the Corporations Act 2001(Cth) requires that, within 45 days after any such variation, a notice must be lodged with ASIC setting out particulars of the variation and a copy of the relevant instrument (if any) effecting the variation; and
  • as no notice of the variation was lodged with ASIC, the charge was void as a security to the extent that it secured the YVE guarantee under s266(3) of the Act.

Fortress argued that there was no variation to the terms of the Octaviar charge, because there was no change to the terms of the deed of charge under which it was created or the associated facility agreement. It contended that the letter agreement was merely a collateral agreement that resulted in no variation, and all that occurred was a 'nomination' under the facility agreement.

Fortress made a further submission that there was no variation in the secured liabilities for the purposes of s268 of the Act unless there was also an increase in the specified maximum amount of the prospective liability, which is required to be notified to ASIC under s282 of the Act.

Justice McMurdo ultimately found in favour of the public trustee and made a declaration that the Octaviar charge was void as a security on the property of Octaviar to the extent that it would secure the liability of the chargor under the YVE guarantee.

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Issues arising from the decision

Two of the primary issues arising from the decision are the construction of s268 and the ultimate purpose of the charge registration regime under Chapter 2K of the Act.

To date, it has been common practice to notify ASIC of changes in secured liabilities under s268 only where there has been a change to the terms of the registered charge that directly amend the definition of the liabilities secured. Often, as in the present case, the secured liabilities are defined broadly in a way that permits the inclusion in the secured liabilities of further obligations through a nomination mechanism, without any change to the terms of the charge. In this respect, the secured liabilities are analogous to 'all moneys' mortgages, under which all moneys owed by the chargor to the chargee for whatever reason are secured by the mortgage.

Justice McMurdo held that s268 of the Act should be interpreted as requiring notification in circumstances where there has been a change in the underlying commercial arrangements that may have the effect of increasing the secured liabilities, even where there is no change to the actual terms of the registered charge document. In coming to this decision, His Honour drew a distinction between, on the one hand, a variation of 'the terms of the charge' (as that expression is used in s268) and, on the other, an amendment of the instrument or instruments by which the charge was created.

His Honour espoused the view that it was unlikely to have been an intended consequence of the scheme of registration of charges prescribed by Chapter 2K that, where the parties to a charge agree it will secure a certain liability, together with any other liability as they might later agree will be secured by it, then any such later agreement would neither create a charge nor vary the existing charge so as to engage s268. Prior to the decision, the general view in the market has been that, if the underlying documents change but there is no variation in the charge, there is no need to register a variation with ASIC.

Justice McMurdo commented that failure to notify of the designation of a document under s268 could 'leave the public completely uninformed of a variation to a registered charge, which might have resulted in an important change to the reach of the charge by the addition of a distinct and substantial liability'. This raises the broader issue of the intended purpose of the charge registration regime, and in particular, whether it is intended simply to put third parties on notice of the existence of a charge, or to disclose a level of detail that enables third parties to assess the precise quantum of liabilities secured by the charge.

Justice McMurdo concluded that s268 required notification to ASIC following the addition of a 'distinct and substantial liability' (in this case, the addition of a new and unconnected loan facility) to a charge. The extent to which s268 requires notification of any increase in the underlying secured liabilities is something that remains to be explored. Depending on how the secured moneys are described, it might be argued by an administrator or liquidator that a new notification would be required each time the principal amount under a secured facility is increased following the initial ASIC registration, which would be a significant administrative burden (and cost) on the company. However, 'all moneys' mortgages are treated differently under s268(3) of the Act, which specifically provides that an advance under a charge securing a debt of 'an unspecified amount' is not an increase of the secured liabilities for the purposes of s268(2).

Finally, the decision left open the question as to what documents describing the secured liability should be lodged at the time of registration of a charge and in support of any subsequent variation. In the present circumstances, it was held that a copy of the letter agreement should have been lodged with the variation notice as the instrument affecting the variation. There was also a suggestion that the facility agreement should have been lodged with the original charge notice, though this was not ultimately considered due to ASIC's acceptance of the charge. If lodgment of facility documents is required, this would necessitate another significant change in market practice.

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What you should be doing in light of the decision

The drafting technique considered in this decision is very common in the Australian debt markets and therefore the decision may have an impact on a significant number of existing secured financings, particularly those where the designation mechanism has been used to identify the liabilities secured by a charge.

Subject to any successful appeal of this decision, it would be prudent for secured lenders to:

  • lodge an ASIC notification in respect of any variation to the terms of any document, or designation under a document, which may result in an increase of the liabilities secured by a registered charge, even where the terms of the charge are not specifically amended;
  • review any existing financing arrangements in order to determine whether there has been any change in the liabilities secured requiring ASIC notification (particularly where a designation mechanism has been used to bring new liabilities into existing charges: a common refinancing technique in recent years); and
  • in respect of transactions that are yet to be documented, consider whether to replace the definition of the secured liabilities with an 'all moneys' concept, rather than a designated document mechanism (to take advantage of the exception under s268(3) of the Act).

Where notification can be made within 45 days after the variation, all that will be required is the lodgment of a notice under s268(2) of the Act using the ASIC Form 311B. If more than 45 days has elapsed since the date of the relevant variation, it is still important to lodge the variation as soon as possible so as to start the six-month waiting period under s266(3)(c)(ii) of the Act. In certain circumstances, it may be necessary to seek the leave of a court to extend the period for notification, as contemplated under s266(4) of the Act.

Receivers should review the charges under which they were appointed, to consider their validity in light of this decision. If receivers are concerned that the validity of their appointment is in doubt, they should consider seeking appropriate orders under s418A of the Act.

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Footnotes
  1. Re Octaviar Ltd; Re Octaviar Administration P/L [2009] QSC 37

Published 13 March 2009

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