AusGroup, a Western Australian resources contractor, was forced to retain KPMG as an advisor to help steer the company out of significant financial difficulty. The company breached a key financial covenant under a trust deed after its total equity fell below $160 million, requiring it to seek a waiver from holders of its unsecured notes. The company made this announcement just days after it disclosed net losses of $94 million over the nine months to March 2016. Its March quarter report also highlighted that current liabilities exceeded current assets by over $66 million.
The company has been hit hard by the decline in capital expenditure in the oil and gas sector and has been affected by delays in the environmental and regulatory approval of a fuel facility in the Northern Territory. While the facility was completed in July 2015, operations have not yet started.
Source: Adapted from M Beyer, ‘AusGroup breaches debt covenant’, Business News Western Australia; P Willams, ‘Battling AusGroup “facing crisis”, The West Australian.145

QUESTIONS

Debt covenants or restrictions are commonly used in Australian lending agreements. Discuss how they are used to reduce agency problems that exist in the relationship between entities and lenders.
Why would a company choose to enter into a lending agreement that contains a covenant that puts a restriction on the maximum debt to assets (leverage) that a company can take on?
Evaluate the costs to AusGroup from breaching the conditions of its debt contract. How can the company reduce these costs?