Babcock's lost chances

Investigations into the collapse of Babcock & Brown by administrator David Lombe from Deloitte reveal an organisation that failed to repair long standing weaknesses in its corporate governance and had difficulty managing conflicts of interest.

Lombe's 121-page report is being made available to creditors this week ahead of a meeting later this month to vote on a proposal to liquidate the company.

A vote in favour of liquidation would give Lombe the power to pursue former directors for a range of possible breaches of the Corporations Act including unfair payment of dividends to two Babcock executives.

Those dividend payments, totalling $170,0345, caught Lombe's eye, because it is his understanding that one of the recipients had direct knowledge of Babcock & Brown's insolvency.

The report's early findings do not reflect well on the directors of the company. The report makes clear that the group's banking syndicate were the only winners from the actions taken by the directors in the dying months of the company.

Lombe's conclusion, that Babcock & Brown was probably insolvent three months before it was put into administration, deserves further investigation.

However, that will require either the provision of additional money from creditors of about $400 each to raise $600,000 or the agreement from a litigation funder to pay for further investigations and possible legal action.

Lombe wants further investigation into potential conflicts of interest between the boards of Babcock & Brown (B&B) and the operating company that holds all the assets Babcock & Brown International Pty Ltd (BBIPL)

Lombe concluded that the two companies had divergent interests with B&B's subordination to the interests of BBIPL creating conflicts of interests for the directors who sat on both boards while at the same time negotiating a debt restructure.

"Our investigations suggest that there is a question as to whether the BBL Board acted in the best interests of BBL at all times (as opposed to acting instead in the interests of BBIPL or the rest of the group),” Lombe said.

He cited at least six occasions when directors of B&B may have failed to act in the best interests of B&B, including:

– Permitting B&B to raise funds pursuant to possibly misleading public offer documents;

– Entering into the Parent Subordination Deed, which had the effect of severely restricting the rights of B&B against BBIPL;

– Permitting BBIPL to increase its secured borrowings from the BBIPL Banking Syndicate during the period April 2005 to December 2008 from $550 million to $3.2 billion with the effect of further subordinating the repayment of the $600 million in B&B subordinated notes known as BBSN and BBSN2;

– Permitting the entry by BBIPL into the restructured loan arrangements for the BBIPL Corporate Facility in or around February 2009, which provided for the payment to the banks of a 20 per cent per annum return accrual fee, with the effect of further subordinating the repayment of the BBSN and BBSN2;

– Permitting the decision by BBIPL to defer interest on the Subordinated Loan due to be paid by BBIPL to B&B on or around 15 March 2009, which led to the inability of B&B to make a scheduled interest payment on certain notes, and ultimately the appointment of administrators to B&B;

– Not adequately representing the interests of note holders in relation to the apparent decision by BBIPL to reduce the amount offered to note holders from $7 million to $600,000 which is understood to have been due to concerns that a higher offer could give rise to "greenmail” by note holders.

Other matters for investigation include the possibility of inadequate disclosure regarding public offer documents and the timing of the impairments of assets.

Lombe says there were several instances where he believed the directors failed to disclose price sensitive information through 2008 and 2009.

Also, he has uncovered the fact that B&B directors were warned about the group's corporate governance weaknesses in 2005, again in 2006 and again in 2008.

"The Administrators' preliminary investigations suggest that the B&B board may have failed to give adequate consideration to the concerns expressed by the external consultants and internal audit and risk functions and may have failed to implement their recommendations,” Lombe said.

"These circumstances may give rise to a claim against B&B directors for breaches of provisions of the Act or directors duties, including but not limited to the duty to act with due care and diligence.”

Lombe says there is no chance of shareholders getting anything back. Employees will only be paid their $6 million in entitlements if Lombe is successful in pursuing the recovery of $24 million in an employee incentive trust in California.

Unfortunately, BBIPL won't give the administrator any information about that trust and refuses to release its assets.

If the money is recovered from the trust, the note-holders might get 1.5 cents in the dollar.

The Australian Securities and Investments Commission is said to be investigating the collapse of B&B, but don't hold your breath. It looks as though any sanctions against directors will be dependent on a suitably market-based solution – litigation funding.