Just how was a private equity buyer to comply with a “best endeavours” obligation to secure a loan approval when just five days after inking a contract for the $42 million acquisition of 56 apartments, the outbreak of Covid 19 suddenly led to lockdowns, travel bans and economic uncertainty?
Such a scenario faced some of Australia’s biggest property players at the start of 2020 as the worst fears of the potential impacts of the pandemic began to dawn.
Fund manager Altis Property Partners – who had a mandate from US private equity firm Kohlberg Kravis Roberts (KKR) to invest funds in the Australian residential property market – signed up for a deal with funding from Westpac to buy all of the unsold apartments at a significant discount in a development at Majors Bay in the western reaches of Sydney Harbour from developer MDB.
Its investment plan was to rent the apartments short term and long term to pay some or all of the interest costs and to sell them over a period of time at a profit.
The parties executed a Heads of Agreement which provided for an exclusive due diligence period of 35 days from the date of the agreement to ascertain the cost of remediation combustible aluminium cladding on the buildings.
After substantial negotiations Westpac provided KKR with an indicative terms sheet in January 2020 “subject to formal credit, other internal approvals and satisfactory documentation …”).
Westpac’s Denis Dundovic notified Altis the bank was prepared to lend notwithstanding the potentially non-compliant aluminium cladding if a suitable arrangement in relation to same was reached between the buyer and seller.
Seller MDB – anxious to get the fund manager on paper after several months of negotiations – was content to include a finance clause to the effect that the buyer would use its “best endeavours” to finalise the approval of the loan for which it had already sought from Westpac, by 11 June.
Conditional contracts were exchanged on 27 February 2020 when Altis paid a deposit of $2.099 mil as the grave implications of the pandemic had just begun to emerge.
Internal KKR memos from prior to inking the contract revealed that it was keen to secure the property but to leave “enough scope in the conditions precedent on exchange that we have the ability to walk away”.
On 11 March 2020, the World Health Organisation declared the spread of COVID-19 to be a global pandemic.
On 17 March 2020, Dundovic sent KKR’s Peter White a further terms sheet for an approved loan conditional on the bank’s credit committee’s approval of the rectification plan for the non-compliant cladding and conditional on its pricing committee’s approval.
That committee approved the deal a few days later but on the basis of a price increased to a 45 basis point margin and with an obligation to maintain a minimum interest coverage ratio (ICR), ie an obligation for rental income to cover interest payments.
On the same date the bank notified its concern at the borrower’s ability to meet the ICR covenant – given lockdowns and travel restrictions that had just been announced – as had been anticipated for holiday periods.
Altis responded to Westpac affirming its interest in the loan but with a request for a moratorium on the ICR covenant.
Westpac then decided to withdraw its offer stating “a lower ICR covenant is not acceptable based on the asset class, market conditions (which have changed substantially) and heightened risk factors associated with rental rates, vacancy allowances and sales activity.”
Altis then had it solicitors then notify MDB the loan had not been approved despite its best endeavours to obtain same and that the position would not change before the finance date.
“The Bank is and remains inward-focused on its existing exposures making any new loans extremely hard to obtain,” the solicitors explained. “The Bank has concerns about underwriting assumptions around rents and letting up times and the reliability of any new valuations”.
Had the buyer used its best endeavours to obtain approval of the loan envisaged by the contract special condition?
Or had there been a conspiracy on and around 17 March to procure a refusal of finance to allow the buyer’s termination of the contract?
MBD viewed it as a conspiracy. The refusal of finance was contrived between the bank and its customer, it claimed. It refused the return of the deposit.
The dispute came for determination before Justice Michael Ball in the NSW Supreme Court who identified that the contract special condition concerning “best endeavours” raised two issues of construction.
The first was whether the reference to “loan” was a reference to the terms of the Westpac loan that had already been applied for by the buyer or whether it refers more generally to the terms of any loan that might be obtained the bank.
The second was whether the right to rescind given by the clause was dependent on compliance with the obligations to use “best endeavours”.
He decided both questions in favour of the buyer, namely the buyer was under an obligation to use its best endeavours to have “the loan” it had already applied for approved; and any failure to use its endeavours did not prevent it terminating the contract if the loan was not approved.
Such failure – if it had an adverse effect on the bank approving the loan – could after all, form the basis of an MBD lawsuit for damages for breach of contract.
MBD nevertheless contended Westpac had “in effect conspired” with the buyer or KKR “to bring about a situation in which Westpac withdrew its offer to provide financing in order to permit KKR to get out of the transaction”.
It pointed to some tampering with the email giving notice of Westpac’s rejection decision and KKR’s tepid effort to re-jig the application so as to meet the financier’s requirements.
Further, the bank’s adjustment upwards of the margin of the loan by 45 basis points had in fact resulted in a lower lending rate due to a drop at the same time in the bank bill rate.
Justice Ball rejected the allegation that Altis’ Marco Cunningham and KKRs Peter White deliberately sought to engineer a situation where Westpac would refuse to lend.
Regardless, any failure by KKR could not involve a breach by the buyer of its best endeavours obligation: “It remained free to withdraw from the proposed acquisition at any time”.
The fact that KKR took comfort from whatever conditions were included in the contract – believing that they could get out of it if it proved to be unattractive – was ultimately irrelevant to the buyer’s willingness to comply with its best endeavours obligations.
In any event there was no reason to believe that Westpac’s statements did not reflect genuine concerns it held at the time or that it was designed to create some separate evidence trail in anticipation of litigation.
And in the absence of evidence that Peter White and Marco Cunningham had decided between themselves that they did not want to proceed with the acquisition of the units, the conspiracy allegation had to fail.
“The most that could be said was that the rapidly evolving situation in relation to COVID-19 was causing them and Westpac concerns,” His Honour observed. “That seems entirely plausible”.
Regardless of Altis “going through the motions to preserve its right of rescission,” the ‘best endeavours’ obligation did not require it to seek quite different (and less favourable) terms from Westpac.
The court concluded that the contract had been validly rescinded and ordered the return of the deposit to the buyer. The seller was also ordered to pay the buyer interest of $236k on the deposit for the period of its delay in consenting to its return to the buyer.
Altis PropCo2 Pty Ltd v Majors Bay Development Pty Ltd  NSWSC 403 Ball J, 8 April 2022 Read case