The company revealed at its annual general meeting in Perth on Tuesday it considered mothballing its mines in Western Australia after defaulting customers put pressure on its finances.
However, the iron ore miner decided instead to sell the bulk commodity at cost for the six months to June next year, and proposes raising $162.5 million, so it can continue operating as a going concern.
The defaulting steel mills, which have not been identified by Mount Gibson, first deferred then cancelled some shipments last month because the supply/demand balance suddenly changed.
After years of undersupply, iron ore stockpiles at Chinese ports have recently ballooned while steel prices have halved since July.
About half of Mount Gibson's planned full year production had been contracted to defaulting customers.
Chairman Neil Hamilton said Mount Gibson had achieved net profit of about $60 million for the September quarter.
But managing director Luke Tonkin said its cash burn rate was about $40 million a month and it also had heavy currency hedging obligations.
Mount Gibson has hedged at 88 cents, which DJ Carmichael resources analyst James Wilson said was a "smart move mid-July when the Australian dollar was high, but it has come off 40 per cent in three months, which is almost unheard of for currencies".
At 1700 AEDT, the Australian dollar was trading at 64.5 US cents.
"They couldn't have seen this coming," Wilson said.
Under a rescue plan proposed on November 3, Mount Gibson aims to settle a bargain sales agreement with two Chinese customers that will mop up spare iron ore not taken by the contract defaulters.
As part of the deal, steel mill Shougang Corporation and investment house APAC Resources will buy the spare ore at $US56 per tonne between January and June 2009.
The benchmark iron ore price is currently $US90-100 per tonne.
Hamilton said the bargain sales arrangements were "the best that could be negotiated to secure the offtake, meet operating costs and feed the hedge book".
Tonkin said the company would hold discussions with its financiers regarding rolling forward its hedging commitments "so we don't have to cover the differential with revenue".
"If we have to cash out the differential in our hedge book, these (rescue plan) funds allow us to do that," Hamilton said.
The company said its hedging strategy would not have posed a problem if three customers had complied with legally binding offtake contracts.
Tonkin said there was a possibility more customers could default on their contracts.
"If that were to continue, there will be a significant number of customers in default ... and the company would have some serious, serious issues."
Hamilton said the company would pursue its legal position regarding losses resulting from the defaults.
Shareholders will vote on the rescue plan at an extraordinary general meeting next month.
The plan includes a placement of 110 million shares to APAC and Shougang to raise $66 million, which will lift APAC and Shougang's stake in Mount Gibson to a combined 40 per cent.
This could reduce to 10.2 per cent and 18.3 per cent, respectively, if other shareholders take up a separate renounceable rights issue of 161 million shares to raise $96.5 million.
