In the Matter of OrotonGroup Limited (Subject to Deed of Company Arrangement) ACN 000 038 675; Application of Strawbridge and Kanevsky

HIS HONOUR: The plaintiffs, Messrs Strawbridge and Kanevsky, are deed administrators of OrotonGroup Limited (subject to Deed of Company Arrangement) ("ORL") and two of its subsidiaries, namely OrotonGroup (Australia) Pty Limited (subject to Deed of Company Arrangement) ("OGA") and OrotonGroup (Licence Company) Pty Limited (subject to deed of company arrangement) ("OGLC"). They seek an order for leave pursuant to s 444GA(1)(b) of the Corporations Act 2001 (Cth) ("the Act") to transfer all of the existing shares of ORL to Manderrah Pty Ltd ("Manderrah") in accordance with the terms of a deed of company arrangement executed 13 April 2018 ("the DOCA") between the plaintiffs, ORL, OGA, OGLC, and Manderrah. Manderrah was the deed proponent. In these reasons from time to time I will refer to ORL and OGA and OGLC as "the Oroton companies".

Section 444GA of the Act provides:

On 2 July 2018, Black J made orders including that the plaintiffs provide notice to shareholders of ORL of the directions date, hearing date, the availability of an explanatory statement and the independent expert's report which has been relied upon on this application, and that that be done by 5pm on 9 July 2018. The notice was to be provided in the following ways:

The plaintiffs were also to make available an independent expert’s report to shareholders of ORL and the market by no later than 5pm on 9 July 2018 by uploading the report and explanatory statement to the ASX web site, the plaintiff's web site, that is the Deloitte web site, and the web site of the OrotonGroup.

Black J also ordered that any interested person wishing to appear at the hearing of the application was to file and serve on the plaintiffs and on the Australian Securities and Investments Commission a notice of appearance in the prescribed form indicating the grounds of opposition. That was to be done by 4pm on 13 July 2018. No such notice was filed. No shareholder has sought to appear on the hearing in this application, and there is thus no opposition by any affected shareholder to the relief sought.

Messrs Strawbridge and Kanevsky were appointed as joint and several voluntary administrators of the Oroton companies on 30 November 2017 by resolution of the directors of those companies pursuant to s 436A of the Act. They were appointed on the basis that in the opinion of the directors those companies were insolvent or were likely to become insolvent.

OGA, OGLC and other subsidiaries of ORL, including overseas subsidiaries, carried on business that involved the design, distribution and sale of fashion products, including clothing, accessories and bags. "Oroton" branded goods are well-known fashion accessories. They are sold through retail shops, concession stands, department stores, online and through factory outlet channels. At the date of the appointment of the plaintiffs as administrators, there were 60 Oroton group stores across Australia, not including three online store platforms. The Oroton brand is owned by OGA. It licenses the Oroton brand for the design, production and distribution of sunglasses and other eyewear.

ORL has subsidiaries in Hong Kong, China, Singapore and Malaysia, though trading operations Hong Kong, China and Singapore are now dormant. At the time of the appointment of administrators, subsidiaries of ORL also operated a fashion apparel business in Australia and New Zealand called GAP. GAP is a global brand of clothing, accessories and personal care products. At the time of the appointment of administrators there were six GAP stores and one GAP online store platform in Australia. ORL through its subsidiaries operated the GAP fashion apparel business pursuant to a franchise agreement. On 4 August 2017 it announced that it had reached an agreement with the franchisor to discontinue the GAP franchise business in Australia. That business was closed down by 11 January 2018.

The OrotonGroup has sustained losses over the two-year period leading up to appointment of the administrators. ORL had banking facilities with Westpac. These included a cash advance facility, a bank guarantee and letter of credit issuance facility, a set-off facility, and a revolving trade facility. On 19 May 2017 ORL notified Westpac of a potential default of gearing and fixed charge covenants in June and July 2017. It sought to draw down $3 million under its cash advance facility at the end of May 2017. Westpac required, as a condition of its waiver of the potential event of default, a guarantee from a major ORL shareholder along with an agreement that by 31 July 2017 the Oroton companies would reduce the amount outstanding in respect of the cash advance facility from $16 million to $7 million.

On 5 June 2017, Manderrah and CJH Holdings Pty Ltd, both being companies controlled by a Mr J W Vicars, agreed to provide up to $3 million dollars in credit support for the cash advance facility. That credit support was not used. On 20 June 2017, ORL made an announcement to the ASX in which it stated that it would require working capital advances in August and November 2017 in order to purchase inventory for the Christmas and post-Christmas sale periods and that the Oroton companies would require ongoing support from Westpac to incur that debt and for the continued use of all the facilities beyond 31 July 2017.

In July 2017 Westpac indicated it would not allow further drawdowns to fund ORL's liquidity requirements in August, in the absence of additional financial support being provided by an ORL shareholder. ORL approached its substantial shareholders requesting financial assistance. On 31 July 2017 Manderrah and CJH Holdings entered into an agreement with Westpac which enabled Westpac to transfer the face value of the cash advance facility to Manderrah on or before 16 April 2018 and enabled Manderrah to call for Westpac to assign to it that facility at face value. The credit support provided by Manderrah and CJH Holdings allowed the Oroton companies time to explore a sale, refinancing of debt facilities or recapitalisation.

In May 2017, the directors of ORL engaged Moelis Australia Advisory Pty Ltd ("Moelis") to address a strategic review of the Oroton companies' business. The termination of the GAP franchise agreement referred to earlier in these reasons was a result of that strategic review. By about June 2017, ORL’s board began investigating the possible sale of the Oroton companies' business as a going concern. In July 2017, Moelis was engaged also to pursue that process. From mid-July 2017, Moelis contacted 27 parties whom it considered had a potential interest in acquiring the business. It also approached thirteen potential alternative funders with view to securing financing that would enable Oroton companies to refinance the Westpac facilities and provide working capital. Fifteen parties interested in the potential purchase of the business signed non-disclosure agreements to gain access to data and carry out due diligence. No formal indicative bid for purchase, or indeed recapitalisation, of the Oroton companies was received.

The board also engaged Moelis to investigate the possibility of an equity-raising. There was insufficient appetite from major shareholders to pursue an equity-raising. Three indicative proposals were raised from potential lenders, but none was capable of being implemented in time to satisfy ORL's short-term liquidity requirements. With those endeavours not having borne fruit, as I have said, on 30 November 2017 the plaintiffs were appointed as administrators. On the same day, Manderrah exercised its call option, resulting in Westpac's assigning to it all amounts owing under the cash advance facility (other than amounts relating to costs and expenses). Westpac also assigned the security given to it in respect of that facility.

After the appointment of the plaintiffs as administrators, they sought expressions of interest for the sale, recapitalisation or restructure of the Oroton companies. Moelis was engaged to assist with that exercise. The process was succinctly summarised in an independent expert's report prepared by Mr Ian Jedlin and Ms Joanne Lupton of KPMG Corporate Finance, a division of KPMG Financial Advisory Services (Australia) Pty Ltd. They noted that "interested parties in the sales process included":

The seven non-binding indicative offers were reviewed by the administrators with the assistance of the directors of Moelis. A proposal of Manderrah was considered to be the optimal proposal, being the proposal that could deliver substantial returns to creditors and which had greater certainty compared with others. This resulted in the administrators recommending to creditors a proposed deed of company arrangement. The details of the proposed deed of company arrangement were summarised by Mr Strawbridge as follows:

On 29 March 2018, at the second creditors’ meeting the creditors resolved that the Oroton Companies execute the proposed deed of company arrangement. In recommending that course of action, the administrators advised creditors that, in their estimation, on a liquidation, the percentage return to unsecured creditors would be between nought per cent and four per cent compared with an estimate percentage return to unsecured creditors, if the proposed DOCA were implemented, in a range of between 36 per cent and 58 per cent.

The report to creditors included the following:

According to the report to creditors, the last audited financial statements of ORL subsidiaries for the year ended 29 July 2017 reported that the group had net assets of $18,684,000, unaudited management accounts to 25 November 2017 showed net assets of $18,514,000.

A summary of the Group's balance sheet provided in the administrator's report to creditors included the following:

In their estimate of likely return to creditors in the event of a liquidation, the administrators estimated that the Group's total liabilities before the cost of the Court administration to be $44,539,000, consisting of priority creditors of $5,071,000, secured creditors debt of $17.5 million, and unsecured creditors of $21,968,000. The most significant of the estimated debts for unsecured creditors was for debts to "landlords". This was explained in a notice as follows:

Estimated costs of the administration, including the costs of the voluntary administrators, was estimated to be $5,502,000, giving a total liabilities of $50,041,000.

The estimated asset realisations before costs was estimated to be between $21,235,000 and $28,972,000. This was made up of a net sum of between $5,862,000 and $7,362,000, reflecting sales and other income, less costs of trading up to 24 February 2018, plus the estimated net realisation of the remaining inventory, less the costs of orders placed by the administrators to allow the business to continue to trade, and less overhead and freight costs of between $7,338,000 $7,278,000.

In addition, the administrators then estimated receiving between $3 million and $5 million on the liquidation as an indicative value of what might be received for the brand on a liquidation. They also estimated that investment by the OrotonGroup in a company called TDE would realise $3.6 million; in fact, it realised $2.2 million. Realisations of property, plant and equipment, which were included in the audited balance sheet at cost of $5,291,000, was estimated to be between $383,000 and $680,000.

There is a number of reasons the administrators do not expect, in the event of a liquidation, to be able to realise the assets of the company for amounts which were reflected in the Group's balance sheet, as at 29 July 2017, or in the later management accounts. By way of example, one of the assets recorded in the Group's balance sheet was an asset for "deferred tax" which will not be realisable on liquidation. Another is that property, plant and equipment was included in the balance sheet at cost. The property, plant and equipment related mainly to store fit out, and there could be no expectation of receiving anything like the cost of that equipment on a liquidation, when the fit out was removed from the stores.

Likewise, the anticipated outcome on a liquidation has to take account of the claims that would be expected to be received from the owners of the stores for which the Oroton Companies have leases. Although the liquidators could be expected to disclaim the leases, the landlords would be entitled to prove in the liquidation for their costs and losses. There is no reason to doubt the reasonableness of the administrator's assessment of the extent of that liability.

Mr Jedlin and Ms Lupton of KPMG Corporate Finance, in their independent expert's report, sought to value the business or assets of the ORL Group and the value, if any, of the "OrotonGroup's equity", meaning the value of the shares in ORL, on three bases; namely, a going concern basis, a distressed basis, and the liquidation basis.

In considering the liquidation basis, they made some adjustments to the assessments made by the administrators in their reports to creditors, including adjusting the value of sale of GAP. I accept that the administrator's assessment of the likely realisation in the event of a liquidation is reasonable and should be adopted, subject to the qualifications, immaterial though they be, of KPMG. As I have said, the creditors voted to approve the proposed DOCA.

The revaluation of the Oroton companies on a going concern basis is required by ASIC Regulatory Guide 111 and may be relevant to ASIC's decision whether to grant relief under s 655A(1)(a) from the takeover provisions in Chapter 6. As Black J has observed, for example, in Re Paladin Energy Ltd (subject to Deed of Company Arrangement) [2018] NSWSC 11 at [7], the utility of a valuation that adopts the going concern methodology is of little utility in a case such as the present for determining whether the interests of members would be unfairly prejudiced if leave sought under s 444GA were given. KPMG noted that the assumption in the valuation on a going concern basis was that "OrotonGroup will continue its operations for the foreseeable future and will be able to realise its assets and discharge its post-administration liabilities in the normal course of business." That assumption cannot be made. In any event, KPMG concluded that, if the business is valued on a going concern basis, there is a net deficiency of assets to liabilities of $2.2 million and $9.1 million.

Counsel for the plaintiffs carefully took me through the assumptions and methodology used by KPMG in coming to that conclusion. It is unnecessary to set this out in these reasons. Suffice it to say that I am satisfied that the views expressed by KPMG were reasonably based.

The valuation on the distressed sale basis reflected the situation where the OrotonGroup did not have sufficient funding to pursue its operations for the foreseeable future. KPMG said of this basis of valuation (p 76):

On this basis they estimated that the deficiency of assets to liabilities was between $9.2 million and $17.1 million.

On a liquidation basis, KPMG generally endorsed the administrators' opinion in their report to creditors. They estimated that on liquidation the deficiency of assets to liabilities would be between $21.6 million and $30.4 million.

I accept these opinions that there will be a substantial deficiency of creditors' claims on a winding-up, and that there would also be a deficiency of assets to meet all the claims of creditors, even if the business could be sold on either a going concern basis or a distressed sale basis. The only realistic alternative to the DOCA is a liquidation of the Oroton companies. If leave is not given for the transfer of shares, the condition to the implementation of the DOCA will be unfulfilled. The deed administrators will be required to convene a meeting of creditors for them either to consider any alternative proposal, or to terminate the voluntary administration, or to wind up the companies. No alternative proposal is foreshadowed, and there is no prospect of an alternative proposal that could provide a potential return to or value for members.

The possibility of simply terminating the voluntary administration is not realistic. The companies are insolvent, and they could not lawfully be allowed to continue to trade if voluntary administration were terminated. Hence, the only realistic alternative to the implementation of the DOCA is a winding-up.

Any alternative proposal would also require the support of secured creditors and key suppliers if Manderrah's proposed DOCA does not proceed because leave to transfer the shares is refused. There would be every prospect that it would use its powers as a secured creditor to appoint a receiver.

It may be that Manderrah sees future potential value in the shares if the DOCA is implemented. It does not follow that the shares have any value if the DOCA is not implemented.

It has consistently been held that if liquidation is the only realistic alternative to a proposed transfer of the shares, and the shares would have no value in a liquidation, then there is no prejudice, or no unfair prejudice, to the interests of members if leave is given pursuant to s 444GA1(b) (Weaver (in their capacity as joint and several deed administrators of Midwest Vanadium Pty Ltd) v Noble Resources Ltd (2010) 41 WAR 301 at [79]; Re BCD (Operations) NL (subject to Deed of Company Arrangement) [2014] VSC 259; (2014) 100 ACSR 450 at [55]-[57]; Re Lewis; Diverse Barrel Solutions Pty Ltd [2014] FCA 53 at [25]; Re Mirabela Nickel Ltd (subject to Deed of Company Arrangement) [2014] NSWSC 836 at [42]; In the Matter of Kupang Resources [2016] NSWSC 1895 at [16]; Re Nexus Energy Limited (subject to Deed of Company Arrangement) [2014] NSWSC 1910 at [22]; Re TEN Network Holdings Ltd (subject to Deed of Company Arrangement (Receivers and Managers Appointed) [2017] NSWSC 1247 at [32]-[39]; Re 3GS Holdings Pty Ltd (subject to Deed of Company Arrangement) [2015] VSC 145 at [22]; Paladin Energy Ltd (subject to Deed of Company Arrangement) [2018] NSWSC 11 at [35]).

As the shares have no value, there is no prejudice to members if leave for the transfer of shares is given, except such as might be possibly discerned from the fact that their property will be expropriated. I doubt that that constitutes prejudice in the relevant sense. As Black J observed in Re Nexus Energy Limited [2014] NSWSC 1910 at [18], s 444GA is to be understood "... in the context that provisions for the compulsory transfer of shares have long existed in the companies legislation, both in respect of schemes of arrangement and takeovers, and the significance of shareholders’ proprietary rights in their shares are recognised by the wider concept of ‘unfair prejudice’ in s 444GA(3) of the Corporations Act.” The possibility of a compulsory transfer of shares where the shares do not have value under s 444GA is an incident of, or qualification to, the rights enjoyed by shareholders.

In any event, as the authorities clearly demonstrate, where the shares have no value, there is no unfair prejudice in the grant of leave.

In Re Nexus Energy Limited, Black J also observed (at [30]) that:

The exercise of the discretion under s 444GA will be made having regard to the objects of Pt 5.3A. That section provides:

The grant of leave to the transfers of shares under s 444GA would maximise the chances of as much as possible of the business of the Oroton companies continuing in existence and would result in a better return for creditors than would result from an immediate winding-up. The deed administrators’ most recent estimate of the return to unsecured creditors if the DOCA is implemented is a return of between 40 per cent and 57 per cent. There will be substantial prejudice to the unsecured creditors if leave is not given (s 435A(b) of the Act).

For these reasons I consider that orders should be made as sought in the originating process. Those orders include not only the grant of leave under s 444GA, but also ancillary orders to accommodate the mechanics of transferring the shares.

I make the following orders: