Commonwealth Bank commenced a banking relationship with CEC Group, a stock exchange-listed company, in 2004. From that period to June 2007, CEC recorded strong financial performance with earnings before interest, tax, depreciation and amortisation (EBITDA) rising from $7m in FY05 to reach $23.5m in FY07.
Like many businesses, CEC began experiencing a marked slowdown in its trading performance in the latter half of calendar 2007 as the effects of the global financial crisis were felt across the Australian economy. Data from the Australian Bureau of Statistics shows that for the period between June 2007 and June 2009 more than 638,000 Australian businesses closed with the impact most severe in the boom states of Western Australia and Queensland. In that period 27% of businesses in Queensland failed.
CEC was always in charge of its own destiny and its accelerated growth profile, with land acquisitions forming an integral part, was a strategy driven by the company.
As part of its growth strategy between February 2007 and December 2007 CEC made 12 separate applications to CBA for additional funding for various purposes but with a large portion targeted for property acquisitions. This meant CEC’s total debt rose from $66m in February 2007 to $169m in December 2007. During that period, CEC produced proposals for a capital raising through a rights issue to bolster its equity base and proposals for the syndication of its borrowings were pursued.
In addition, CEC adopted a number of measures to reduce debt, including the sale of a number of non-core properties and a strategic change in approach to property development and sales. This was announced to the market in the Directors Report accompanying CEC’s Half Year Accounts to 31 December 2007 lodged with the ASX on 29 February 2008. That debt reduction strategy, implemented through asset sales during 2008, was controlled and managed entirely by CEC.
As is clearly evidenced by CEC’s Half Year Accounts to 31 December 2007, CEC’s trading performance had turned dramatically in those six months. The immediate consequence of that announcement was a fall of 38% in CEC’s share price to $1.05 at close of trading that day and a further drop to 60.5 cents at close of the following day’s trading. A further consequence was, with cash flow becoming an increasing problem, that CEC had breached a key financial covenant with CBA that required it to have enough funds to cover a certain level of interest repayments.
Although CBA was entitled to act on the breach of covenant CBA did not do so. Instead, CBA extended those facilities conditional on the implementation of the debt reduction strategy which CEC had already initiated and the appointment of an investigative accountant (McGrath Nicol) to work with CEC senior management in order to prepare an independent business review of the CEC Group and to assess CEC Group’s ability to meet its commitments to CBA. The McGrath Nicol reports were made available to CEC.
CBA provided multiple extensions of credit facilities between mid-2008 up until the board appointed a voluntary administrator in May 2011 following judgment obtained by the Queensland Office of State Revenue in February 2011 for unpaid payroll tax and land tax and the issue of director penalty notices in March 2011 by the Australian Taxation Office for unpaid tax in addition to other creditor demands. The extensions were granted by CBA to CEC notwithstanding CEC had committed a number of breaches, including monetary defaults.
The actions of CBA and CEC in that period are best understood through the lens of the three comprehensive reports produced by McGrath Nicol, with input from CEC. Those reports are thorough, incisive and fully transparent. The Phase Two Report of May 2008 notes the view of CEC management and Greg Kern (who was responsible for the accounting functions) that sustainable debt may be between $70m and $75m (compared to the $120m debt level it was carrying at that time and the debt of $169m in December 2007). CEC’s implementation of its debt reduction strategy during 2008 did not materially affect CEC’s ability to generate income since the assets sold did not generate any significant income.
CEC’s failure was in no one’s interests. Amongst the unpaid creditors, CBA incurred losses of $57m. Throughout its relationship with CEC, CBA worked with senior management to assist the CEC Group to continue operating as a viable business. Correspondence from the managing director of CEC (Roy Lavis) to CBA and announcements by CEC to the ASX record CEC’s appreciation of CBA’s co-operation and assistance during its difficulties.
CEC’s trading performance is a matter of public record through its own disclosures to the ASX. The conditions of trading in Australia during the GFC are well known and the three reports from the investigative accountant were provided to the Small Business Ombudsman. Yet the report produced by the office of the Small Business Ombudsman appears to have given no weight to McGrath Nicol’s findings nor to the ASX disclosures.