No conspiracy in UK GRG case

The conduct of RBS’ loan workout unit GRG in the aftermath of the GFC was highly controversial, attracting media and Parliamentary attention, and resulting in a series of inquiries and reports (discussed here and here), as well as litigation by unhappy borrowers.

Some of the judgements have provided insight into the inner workings of bank restructuring teams, such as the claims pursued by PAG (discussed here), and most recently, a case in which the borrower claimed conspiracy on the part of the Lender arising from the involvement of a borrower-side adviser (the Adviser) engaged and paid by the borrower but nominated by the lender.

Background

The claims were brought by a chiropractor and his wife, and various associated entities which operated sixteen chiropractic clinics and owned property (the Claimants).

Banked by RBS since 1999, control of the account was transferred into GRG in 2009, and shortly thereafter GRG proposed a strategy which included the engagement of the Adviser.

A range of measures were tried, including a restructure in 2011, but none were successful. In February 2013 RBS appointed administrators following an attempt by the chiropractor to liquidate the companies, and in due course the Claimants commenced action for damages in respect of three claims alleging:

Mis-selling of an interest rate swap in 2007 which locked in a base rate of 5%, resulting in an interest cost £100,000 per year higher it would have been with a variable rate.
Mis-selling said to arise from the 2009 restructuring of the 2007 swap.
Conspiracy to exploit a claimed “breach by [the Adviser] of her duties of loyalty.”

A contrast in witness credibility

The Court found that the chiropractor “had become obsessed with blaming the Bank for the collapse of his business…[which] meant that it was difficult for him to give evidence comprising his best recollection…[some parts were] at best wishful thinking, mis-recollection and bluster, and at worst (as the Bank submitted) an obvious lie.”

By contrast the Court found that the Adviser was “an impressive witness” whose evidence was comprised of “honest and (usually) brief and clear answers to questions,” and that it was “easy to see why…[she] had been held in high regard by RBS.”

Findings

In CJ & LK Perks Partnership & Ors v NatWest Markets Plc [2022] EWHC 726 the Court found, in relation to the mis-selling claims:

There was no complaint by the chiropractor at the time when advised that loan approval was subject to interest rate hedging.
There was no evidence to support the conclusion that a claimed misrepresentation – that interest rates were going to rise – was made at all; and there was no evidence that the chiropractor relied upon it, because the chiropractor “wanted to expand the business and wanted the loan which RBS was proposing” and he was “happy to enter a swap if that is what the Bank wanted.”
There was no misstatement in the information provided by RBS, who in fact had warned him of significant risks which were associated with the swap.
There was no evidence to support the existence of other purported unadvised risks, and no evidence that those purported risks had actually impacted the Claimants – but even if there had been, the chiropractor would still have entered the swap, because he wanted the loan.
A claim for improper advice also failed. Not only had the RBS banker recommended that the chiropractor seek independent advice, but there was no causation grounds because the chiropractor “would still have entered into the swap, because [he] wanted the loan.”
The more limited claim in respect of the 2009 swap was also unsuccessful because there was “no substance to the case that the [relevant] risks…were not sufficiently explained.”

In relation to the conspiracy claim, the Court held:

There was no evidence whatsoever to support the allegation that the transfer to GRG “was driven by an ulterior motive on the part of RBS.”
A payment default was “obviously a serious matter” and together with clear evidence that the business would not be able to meet future obligations, justified transfer to GRG.
It was true that the Adviser had put moderate positions to RBS, but that was because she recognised that a favourable outcome for the businesses required the agreement of RBS, and that “it was unproductive to take positions which were likely to be rejected.”
Not only was there “no substance in the case of conspiracy” it was appropriate to “exonerate” the Adviser and the RBS staff, who had “acted with integrity.”

The Claimants were unsuccessful.

Small Business Restructuring: off to a good start

On 1 January 2021 a new restructuring process becomes available for some types of small business. It is a useful low cost option for those businesses that it does suit – but the Treasurer’s claim that it is part of “the most significant reforms to Australia’s insolvency framework in 30 years” is hard to support. However, it is not the nature of the changes, but rather the way that the changes were made that should concern turnaround and restructuring professionals.

First, it appears that there was no meaningful consultation with those professionals, or the organisations that represent them – which suggests that the legislators see us as part of the problem, not the solution.

Secondly – if the government really does believe what appears in its press releases – there is the prospect that after tinkering in the middle of the fringe of reform the government may move on, rather than deliver meaningful reform.

The new Small Business Restructuring Process (SBR)

The Treasurer describes the SBR as drawing on “key features from Chapter 11 of the Bankruptcy Code in the United States.” As White & Case explain, it draws on the Subchapter V process that is available to small business, rather than the Chapter 11 that we read about in the business press – but the key point is that it leaves the existing management team in situ and does not replace them with an outsider.

In summary:

The SBR is available to companies with liabilities of less than $1 million.
Just as for Voluntary Administration (VA), the process is initiated administratively by the directors, who select a registered company liquidator to act as the SBR Practitioner (SBRP).
The directors continue to manage the company, although transactions which are outside “the ordinary course of business” must be approved by the SBRP, or the court.
Unlike VA, only the company directors may propose a Restructuring Plan, and it must be proposed within twenty business days of starting the restructuring process.
The SBRP is to help the directors prepare the Restructuring Plan, and he or she then “provides a declaration to certify the restructuring plan” – arguably reporting on their own work.
Similarly to the Part IX process for personal bankruptcy, the creditors “vote” on the proposal without a physical meeting, and it is approved by a majority in value of “replies” received within 15 business days of the Restructuring Plan “being given” to creditors.
The Restructuring Plan must be executed within twenty business days of starting the restructuring process, or up to thirty business days if the SBRP grants an extension.

The “you snooze you lose” mechanism is worth noting – only votes received within the fifteen business day period are taken into account. That mechanism means that active and alert creditors will have the biggest say, and it will be common to see plans being accepted even though only a minority of creditors actually voted.

Limited accessibility to the new regime

The obvious restrictions are that the mechanism is only available to companies – not individuals, and that it only applies where liabilities are less than $1m.

There are other restrictions which will arise due to the way the SBR process operates:

Availability of credit – Creditors will know by the fact of an appointment that the company must be insolvent, and they will also know that the SBRP will not be liable to pay for any goods and services provided after his or her appointment. Directors will need to be quite sure that they will have practical access to credit, or capacity to operate on a cash on delivery basis, before they invoke the SBR.
Fixed fees for the SBRP – The Insolvency Practice Rules specify that that the fees for the SBRP must be fixed in dollar amount up to the execution of the plan, and then calculated as a percentage of the actual distributions to be made under the plan. In practice this will limit the types of Restructuring Plans that are put to creditors: prospective SBRPs will have a strong preference for simple, quick Restructuring Plans which will implicitly limit the time and work required.
Employee entitlements and tax reporting – A restructuring plan will not be valid unless the company has paid all payable employee entitlements and lodged all taxation reports and lodgements before it was circulated.

The most significant reforms to Australia’s insolvency framework in 30 years?

The SBR is clearly not the most significant reform to Australia’s insolvency framework in 30 years. That claim can be made by Australia’s VA regime: a world leading insolvency process when introduced on 23 June 1993.

Although used by companies as large as Arrium Limited, VA is less suited to businesses with multiple classes of creditors, but there no restrictions on its availability or use. It is true that VA places an insolvency practitioner as the central decision maker during the period of administration, but that is a temporary position, and the mechanism can certainly accommodate a debtor-in-possession model through an appropriately drafted Deed of Company Arrangement. Critics may say that it is relatively expensive for smaller businesses, but that is true to some extent for any insolvency process, and no doubt the new SBR will also prove to be “too expensive” for the smallest businesses.

Unfortunately, there has been no development or refinement of voluntary administration in the almost twenty-seven years since it was introduced.

It’s true that in 2016 the Government passed the laughably misnamed Insolvency Law Reform Act, which added red-tape and expense to existing insolvency processes. The Treasurer could very fairly describe the SBR as the most significant reforms to Australia’s insolvency framework in the last twenty-six years – but sadly, to say so only highlights the complete absence of any insolvency reform during that period.

Who’s asking? Who’s listening?

It seems that there was no pre-release consultation with the various organisations which (sometimes in overlap) represent turnaround and insolvency professionals: ARITA, the TMA, the AIIP, or the Insolvency & Reconstruction Committee of the Law Council or Australia; and if any individuals were consulted they have kept remarkably quiet about it.

As described in Missing Pieces, the draft Bill was released with perhaps the shortest consultation period on record: 4 business days. Those various organisations and many of their members worked very hard to meet the deadline – with almost all of the 53 submissions completely ignored.

It’s hard to believe that the absence of meaningful consultation was inadvertent, leading to the very disappointing alternative: that the legislators made a deliberate decision not to consult. If that is true then that is a very great concern, because it means that legislators may see restructuring and turnaround professionals as part of the problem, not part of any solution.

What should be on the Insolvency Reform agenda?

By a long margin, the very first thing that our legislators should do is to clearly establish an overall objective which applies to all insolvency processes.

SBR appears to be predicated on the basis that the most important objective is that owners stay in control of their business. VA has an explicitly stated goal: to maximise “the chances of the company, or as much as possible of its business, continuing in existence.” By contrast, liquidations seem geared to taking control of a business away from those previously responsible for managing it. Three different processes, three different objectives!

If a single overriding objective can be established then it should be far simpler to decide whether a stringent insolvent trading regime helps, or hinders, the achievement of that objective, in which case it might be possible to avoid continuing the hitherto regular policy flip-flops.

Other things that should be on the agenda:

SME insolvency – For most small business operators, personal guarantees to trade suppliers and banks mean that their personal financial position is inextricably linked to the financial position of their company. If their business fails, they will most likely become bankrupt. If that does happen, two separate insolvency appointees will run two separate insolvency processes under two separate pieces of legislation (and supervised by two separate regulators). Rationalisation so that there is a single process seems well overdue.
Employee Entitlements – Employees have a theoretical priority for repayment of their entitlements but the use of “payroll companies” by corporate groups means that in practice the cupboard can be bare. There should be a regime to ensure employees are consistently protected, regardless of variations in corporate structure and reducing reliance on the GEERS safety net.
Multi-class restructuring for VA – VA is a useful and powerful restructuring tool but there is a significant gap – the absence of a capacity to bind secured creditors or owners of property (such as intellectual property licensors, or landlords) unless they agree to be bound. The requirement for unanimous agreement means that any single lender or property owner has the ability to veto a restructure. It would be relatively simple to create a low cost statutory multi-class restructuring option by amending VA so that creditors in a class are bound by a 75% by value majority of class creditors, with a cram down of any out-of-the-money classes.
Fix scheme classes – Schemes of Arrangement are currently the only option to deal with multi-class restructuring, but the composition of those classes is problematic. In Australia, classes are constituted by grouping creditors based on how the scheme deals with their claim, rather than by grouping creditors with common rights. Changes so that classes are constituted by creditor rights would stop scheme promoters contriving outcomes by bundling together creditors with different rights.
Debt for Equity – Debt for equity can be a very effective restructuring tool, but there are constraints which make it difficult for banks to enter into such arrangements. The restrictions that quite properly limit the ability of Authorised Deposit-taking Institutions to invest in non-banking ventures apply equally to debt for equity restructures. This means that ADIs must consult with APRA before committing to any proposal to hold more than 20 per cent of equity interest in an entity. If ADIs had the capacity to more easily take equity, and hold it off balance sheet, then a rarely used restructuring tool might be more widely deployed.
Rescue Finance – In Australia rescue finance is typically provided by existing lenders either through informal workouts, or by providing finance to the receivers they appoint. Administrators are free to incur credit but they cannot grant a priority security over circulating assets (such as book debts and inventory) without the consent of existing security holders. If there is a change to allow multi-class restructuring on a majority, then there should be a similar change to the rules allowing an administrator to pledge security to obtain rescue finance with the consent of a majority of existing security holders.

Conclusion

It is hard to argue against a low-cost restructuring tool: what has been delivered is welcome – but it won’t suit all small businesses, and it leaves small unincorporated businesses behind altogether. There is a great deal more that could and should be done, but it is difficult to be confident that the Government even understands the opportunities before it, and quite worrying that they may regard restructuring and turnaround practitioners as part of the problem, rather than as professionals who can help them achieve meaningful reform.

Missing Pieces

On 24 September 2020 the Treasurer announced that Australia’s response to COVID-19 would include a new restructuring process, intended to make restructuring cheaper and more accessible for the smallest businesses.

Only two weeks later the draft Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (Cth) was released, with perhaps the shortest consultation period on record – 4 business days!

The draft legislation is a jigsaw puzzle with many missing pieces. There are several important and significant parts that have been left blank, to be completed by later regulation. Yes, it is possible to make educated guesses based on the Explanatory Memorandum and the Treasury fact sheet – but that is hardly a satisfactory way to review legislation.

One of the very pleasing aspects is that those responsible for the drafting have drawn heavily on the existing voluntary administration framework and definitions. For that reason, many of the concepts and definitions are well developed and understood, and so we hopefully avoid the “what-does-that-mean” post-implementation chaos of the PPSR.

The process has been described as incorporating elements of the US Chapter 11 approach. However, it’s not the big end of town Chapter 11, where every decision is made slowly and expensively in a Courtroom. As White & Case explain, it draws on the “Subchapter V process,” and the key point is that the directors stay in charge of the business for all activities within the ordinary course of business.

Once appointed, a Small Business Restructuring Practitioner helps the directors prepare a restructuring plan. It seems – but it’s not clear – that the SBRP will provide creditors with a recommendation to accept or reject the plan, which they will do electronically, with no physical meeting. Between appointment and meeting day there will be a stay on creditor action which follows the voluntary administration moratorium.

Mark McKillop summarises the detail we don’t have, noting that the regulations will specify:

Surprisingly, nearly all of the functions, duties and powers of the restructuring practitioner. There is a generic provision for basic functions like providing advice to the company on restructuring matters, assisting and preparing a restructuring plan, making a declaration to creditors “in accordance with the regulations” in relation to the plan and any other functions given to the practitioner under the Act. Apart from that, the regulations are to provide…;

The form, content, making, implementation, varying, lapsing, voiding, contravention and termination of restructuring plans. Regulations are also to provide for the role of the restructuring practitioner in relation to the plan….

At first glance, the proposed process is a cut-down version of voluntary administration. It should be quicker and cheaper than VA, and there are eligibility restrictions which mean that a director can only invoke it on one occasion across all corporate involvements – so what’s not to like?

The biggest issue is that it is not clear whether small businesses will be able to access the process in practical terms:

The process is only open to companies up to date with “tax lodgements.” In the absence of the regulations it is not clear what that means – but potentially it may exclude companies with overdue income tax returns.
Companies are also required to have paid all “employee entitlements.” Again, it is unclear what that includes, but if it means that employee leave entitlements and so on must be paid out, that will impose a cash impost that will be too heavy for many businesses.
The SBRP has no liability for debts incurred after his or her appointment. That’s great for the SBRP – but many creditors will decide that it shifts the credit risk to them, and they may insist on CoD terms. Businesses that can’t trade on CoD will be squeezed.
The remuneration for the SBRP is another aspect to be settled later by the Regulations – but it seems that the expectation is that there will be a fixed fee for the work up to the vote, and then a percentage commission on distributions to creditors for work done after the vote. If the Regulations do cap the fee and commission as some anticipate, then we might see SBRPs refusing an appointment because the work required to do the job properly is out of line with the fees available.

Within all the uncertainty there is the framework of a useful process. Time will tell if the fleeting consultation process provides sufficient time to identify and iron out the wrinkles. If it does, we will have a useful low-cost option added to the toolkit.

The Banking Royal Commission Implementation Roadmap & Agri Lending

The Treasurer today announced the Banking Royal Commission “Roadmap.”

The roadmap document, available here, provides a response to each of the recommendations made by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

The recommendations relevant to Agricultural Lending, and the response today, are set out below:

Recommendation 1.11 – Farm debt mediation – A national scheme of farm debt mediation should be enacted.

Roadmap:

The Government is working with states and territories through the Agriculture Ministers’ Forum (AGMIN) to progress work on the establishment of a national farm debt mediation scheme

A National Farm Debt Mediation scheme is a universally supported measure, which has been recommended by numerous inquiries over several years. Implementing such a popular and well-supported measure should be relatively straightforward.

Recommendation 1.12 – Valuations of land – APRA should amend Prudential Standard APS 220 to:

require that internal appraisals of the value of land taken or to be taken as security should be independent of loan origination, loan processing and loan decision processes; and
provide for valuation of agricultural land in a manner that will recognise, to the extent possible:
- the likelihood of external events affecting its realisable value; and
- the time that may be taken to realise the land at a reasonable price affecting its realisable value.

Roadmap:

On 25 March 2019, APRA released for public consultation proposed revisions of Prudential Standard APS 220 Credit Quality. Consultation closed on 28 June 2019. APRA intends to finalise the standard in the second half of 2019 with a view to it becoming effective from 1 July 2020.

An independent internal valuation will add some cost and delays for some remote customers, but otherwise should not be controversial, or difficult to implement.

As discussed here in greater detail, it is harder to understand how valuers will change their practices to implement the second recommendation around “external events.”

Recommendation 1.13 – Charging default interest – The ABA should amend the Banking Code to provide that, while a declaration remains in force, banks will not charge default interest on loans secured by agricultural land in an area declared to be affected by drought or other natural disaster.

Roadmap:

The ABA has announced the amended Banking Code, incorporating recommendations 1.8 and 1.13, will be implemented by March 2020.

Recommendation 1.14 – Distressed agricultural loans – When dealing with distressed agricultural loans, banks should:

ensure that those loans are managed by experienced agricultural bankers;
offer farm debt mediation as soon as a loan is classified as distressed;
manage every distressed loan on the footing that working out will be the best outcome for bank and borrower, and enforcement the worst;
recognise that appointment of receivers or any other form of external administrator is a remedy of last resort; and
cease charging default interest when there is no realistic prospect of recovering the amount charged.

Roadmap:

The Government expects that banks will implement recommendation 1.14 as soon as possible.

Banks will believe that they already manage every distressed loan on the footing that working out will be the best outcome for bank and borrower, and enforcement the worst and recognise that appointment of receivers or any other form of external administrator is a remedy of last resort. In my opinion they will be untroubled by those recommendations, and comfortable with immediate implementation.

A requirement to offer farm debt mediation as soon as a loan is distressed may be problematic – depending on what is meant by distressed, which is not otherwise defined. For example, in Victoria a lender can only initiate FDM by serving a notice that they “intend to take enforcement action.” If the recommendation is intended to make FDM available in situations where enforcement is not planned, then the respective FDM legislation will require amendment.

A mandatory requirement to ensure Agri loans are managed by experienced agricultural bankers will have banks working to understand what “managed” means. Often the banker in contact with the customer is not the banker making the final credit decision. Does the recommendation require the customer contact to be an experienced agri banker, or the credit approver, or both?

New rules from APRA? A draft APS220 update

In March 2019 APRA released a draft Prudential Standard APS 220 Credit Risk Management. The new standard is intended to replace the current APS 220 Credit Quality.

The revised standard, available together with a discussion paper here, represents the first significant update since 2006. It provides APRA with the opportunity to respond to both the Banking Royal Commission, and also to recent guidance issued by the Basel Committee.

The change in the name of the standard is intended to emphasise the importance of a ‘whole of loan life’ approach, rather than just focus on origination. Some noteworthy points include:

The cost of bank recognition of borrower hardship

The definition of restructured loans will expand. Currently, restructured loans are those where loan terms have been modified “for reasons related to the financial difficulties of an entity.” Under the draft standard this would expand to loans for which “a borrower is experiencing temporary financial difficulty or hardship in meeting its financial commitments.”

Further, the rehabilitation period – the length of time for which loans must meet those modified terms to be considered as performing – will increase from 6 months to 12 months, likewise increasing the time period in which a higher risk weighting penalty is applied.

These two measures have the potential to make it more expensive for banks that grant hardship relief. Applying a cost overlay if hardship relief is granted is probably technically sound, and conservative, but might surprise those who believe that banks should be encouraged to provide hardship relief, not penalised.

Use of covenants

The draft standard makes it mandatory for banks to consider the use of “covenants designed to limit the ADI’s exposure to changes in the future risk profile of the borrower.”

The most common covenants are based around financial ratios such as interest cover ratios and loan to valuation ratios. The use of such covenants was heavily criticised by another arm of government – the office of the Small Business Ombudsman – with the result that the 2019 Banking Code of Practice no longer allow banks to use them (except in relation to specialised lending) as an event of default.

It seems that lenders to small business might need to choose between complying with the draft APS220, and complying with their own Banking Code of Practice – because they may be unable to comply with both.

Valuation methodology

The discussion paper notes that the draft standard implements one of the recommendations of the Royal Commission, requiring valuations of agricultural land taken as security to:

take into account the likelihood of external events, such as drought and flood, which may impact the valuation of the land

Prior to the Royal Commission, valuations were widely understood to be point-in-time assessments of current value under current conditions, and were not thought to be estimates of future value. In most cases, reliance beyond a three month period from the date of valuation is specifically excluded by a written disclaimer.

It will be interesting to see how valuers respond to the change if it proceeds as proposed. Some may expand their reports to include commentary on the likelihood of external events for the three month period in which the valuations are “live.” Others may add (more!) boiler-plate text to make it even clearer than they do not provide a view as to future value.

Next steps?

The period for feedback closed on 28 June 2019. Market feedback suggests that further, less formal, consultation processes may already be underway.

Concessional RIC loans for farmers impacted by Drought or Flood

The Federal Government established the Regional Investment Corporation in March 2018 to administer concessional farm business loans. This began with Farm Drought loans, and in 2019 was expanded to also include AgRebuild loans for farmers affected by the North Queensland floods.

The AgRebuild loans are very tightly targeted, but eligibility for the Farm Drought loans is broader than many might expect.

Loans for working farmers

The loans are available owners of farms that are Australian citizens or permanent residents – although it is important to understand that the farms can be held through companies or trusts.

Not all members of a farming partnership must work on the farm, but at least one person must contribute at least 75% of their labour to the farm business under normal circumstances, and at least one partner must rely on the farm for their income – so the loans are not available for corporates.

Terms and pricing

As of 1 August, the year loans are currently at a variable interest rate of 3.11%, with no application or other fees,

Drought loans are interest only for the first five years. AgRebuild loans are interest free for the first two years, then interest only for the next three years.

Support of the current lender

Although the loans can be used to reduce bank debt, they can’t be used to completely replace it – normally a farmer must keep 50% of their debt with a “commercial lender.”

It’s worth highlighting that RIC will often agree to take second mortgage security. This means that in practical terms the commercial lender’s security cover (i.e. loan-to-value ratio) can significantly improve, and so they might be quite happy about RIC becoming involved!

One other point is that even if the current lender isn’t prepared to confirm support, it may still be possible to get a conditional offer from RIC. With a much better LVR to offer the incoming lender it may be easier for farmers to secure a refinance.

Drought loans

Drought loans are up to $2m, available to farmers across Australia, which can be used to:

Prepare for drought or recover from the effects of drought.
Pay down debt.
Invest in productivity or water efficiency measures.

Farmers will need to provide a copy of their drought management plan.

Flood loans (AgRebuild)

The AgRebuild loans have a much tighter eligibility criteria. They are for farmers affected by the flooding caused by the Monsoon Trough from 25 January to 14 February 2019 North Queensland.

The AgRebuild loans are for a maximum of $5m, but rates and other terms are the same.

There are some key differences to the drought loans:

As noted, the loans are interest free for the first two years.
RIC might waive the requirement that 50% of the debt stays with a commercial lender – but only in cases of “extreme hardship,” and will be assessed on a case by case basis.
The loans are only available until 30 June 2020.

Restrictions

There are some restrictions:

RIC is not a lender of last resort and will not lend unless it is satisfied that the farm is viable and has capacity to repay the loan.
RIC will require a drought management loan for drought loans.
As above, the ongoing involvement of a commercial lender is required, although this can be a new lender in some cases.

Summary

For eligible farmers the RIC loans can be a great option and it is well worth checking availability. There is a lot of useful information at www.ric.gov.au, or you can contact the author on 0404 885 062. You can also get structured assistance through a website that I have a link to, via my involvement with Ecosse Capital Partners: ricloan.com.au.

This article first appeared on my Harbourside Advisory website

Senate Inquiry Report: Credit and financial services targeted at Australians at risk of financial hardship

On 22 February the Senate Economics Reference Committee inquiry into Credit and financial services targeted at Australians at risk of financial hardship issued its report, available here.

Much of the report deals with the regulation of credit providers, but one aspect will be of interest to Restructuring & Turnaround professionals, recommendation 8:

The committee recommends that the government implement a regulatory
framework for all credit and debt management, repair and negotiation activities
that are not currently licensed by the Australian Financial Security Authority,
including:

compulsory membership of the Australian Financial Complaints Authority, giving clients access to an External Dispute Resolution scheme;
strict licensing or authorisation by the Australian Securities and Investments Commission or the Australian Financial Security Authority;
prohibition of upfront fees for service;
prescribed scale of costs;
an obligation to act in the best interests of their clients; and
banning unsolicited sales.

There seems to be growing recognition of the problems caused by phoenixing, and growing concern about the role played by those unscrupulous “pre-insolvency advisers” who promote and facilitate phoenixing.

A regulatory framework ‘for all credit and debt management, repair and negotiation activities’ has the potential to apply to pre-insolvency advisers – although the detail suggests that it is personal credit which is the primary focus for the Committee.

Restructuring and Turnaround professionals who believe – as I do – that there is a pressing need for regulation of pre-insolvency advisers should take any opportunity via submissions or otherwise to ensure that legislators understand the link between phoenixing and pre-insolvency advisers, and the importance of any regulatory framework extending to business and corporate ‘debt management.’

The 2019 Inquiry impacting Restructuring and Turnaround professionals?

Last night the Senate asked the Legal and Constitutional Affairs Legislation Committee to conduct an Inquiry into:

The ability of consumers and small businesses to exercise their legal rights through the justice system, and whether there are fair, affordable and appropriate resolution processes to resolve disputes with financial service providers, in particular the big four banks

The terms of reference include inquiry into whether “banks generally have behaved in a way that meets community standards when dealing with consumers trying to exercise their legal rights,” which has the potential to extend into the appointment and conduct of receivers.

The Committee is due to report by 8 April 2019. The full terms of reference are below

(a) whether the way in which banks and other financial service providers have used the legal system to resolve disputes with consumers and small businesses has reflected fairness and proportionality, including:

(i) whether banks and other financial service providers have used the legal system to pressure customers into accepting settlements that did not reflect their legal rights,

(ii) whether banks and other financial service providers have pursued legal claims against customers despite being aware of misconduct by their own officers or employees that may mitigate those claims, and

(iii) whether banks generally have behaved in a way that meets community standards when dealing with consumers trying to exercise their legal rights;

(b) the accessibility and appropriateness of the court system as a forum to resolve these disputes fairly, including:

(i) the ability of people in conflict with a large financial institution to attain affordable, quality legal advice and representation,

(ii) the cost of legal representation and court fees,

(iii) costs risks of unsuccessful litigation, and

(iv) the experience of participants in a court process who appear unrepresented;

(c) the accessibility and appropriateness of the Australian Financial Complaints Authority (AFCA) as an alternative forum for resolving disputes including:

(i) whether the eligibility criteria and compensation thresholds for AFCA warrant change,

(ii) whether AFCA has the powers and resources it needs,

(iii) whether AFCA faces proper accountability measures, and

(iv) whether enhancement to their test case procedures, or other expansions to AFCA’s role in law reform, is warranted;

(d) the accessibility of community legal centre advice relating to financial matters; and

(e) any other related matters.

The Committee is due to report by 8 April 2019.

Inquiries dealing with the conduct and performance of restructuring and turnaround professionals since 2010:

2017 – Senate Select Committee on Lending to Primary Production Customers

2016 – Parliamentary Joint Committee Inquiry into The impairment of customer loans

2015 – Senate Inquiry into Insolvency in the Australian construction industry

2014 – Senate Inquiry into Performance of the Australian Securities and Investments Commission

2012 – Senate Inquiry into The post-GFC banking sector

2010 – Senate Inquiry into The regulation, registration and remuneration of insolvency practitioners in Australia

The Final Report of the Banking Royal Commission

Business and Agricultural lending accounts for only 30-odd pages of the almost 500 page volume 1 of the final Report of the Banking Royal Commission.

Most significantly, the Report recommends broadening the application of the Code of Banking Practice to small businesses with debts of up to $5m (currently $3m).

Notably, the Report recommends against extending the application of the National Consumer Credit Protection legislation to Small Business.

Lending to Agribusiness

The report recommends that internal valuations should be conducted by bank staff independent of the loan origination and loan decision processes. That may add a little to costs, and cause some delays for remote regional customers, but is otherwise hard to argue against.

The Report also recommends that valuations of agricultural land should be conducted:

in a manner that will recognise, to the extent possible:

the likelihood of external events affecting its realisable value; and
the time that may be taken to realise the land at a reasonable price affecting its realisable value

The first adjustment would seem to be a complex calculation, and arguably unnecessary – many would say that the market implicitly adjusts for such factors, and so there is no need to make an explicit adjustment.

The second adjustment seems to seek an allowance for holding costs that would result in a modest decrease in value – but it would have been very much easier if the Report had identified a specific period: six months perhaps?

Dealing with Distressed Agricultural Loans

The Report recommends that banks dealing with ‘distressed agricultural loans’ should:

ensure that those loans are managed by experienced agricultural bankers;
offer farm debt mediation as soon as a loan is classified as distressed;
manage every distressed loan on the footing that working out will be the best outcome for bank and borrower, and enforcement the worst;
recognise that appointment of receivers or any other form of external administrator is a remedy of last resort; and
cease charging default interest when there is no realistic prospect of recovering the amount charged.

The Report does not provide a definition of ‘distressed,’ and it is not a technical term defined in APS 220, and so unfortunately the practical application of these recommendations is probably not as clear as its author intended.

Currently Farm Debt Mediation is only available where enforcement action has commenced. The call for earlier availability – which will be supported by banks – will require legislative amendment.

Lastly, least surprisingly, Commissioner Hayne adds his voice to the unanimous calls for a National Farm Debt Mediation Scheme. The Government has said that it will ‘take action on all 76 recommendations.’ Perhaps we will finally see a National Farm Debt Mediation scheme.

Disclosure of lender-imposed conditions

The 2019 Financial Reporting season has thrown up examples of very specific disclosure of the conditions imposed on listed borrowers by their lenders.

Case 1 – The amount and timing of an equity raise.

Case 2 – A requirement to conduct a ‘strategic review’ of ‘funding options.’

Case 3 – The timing and requirement for an equity raise to meet a balance sheet ratio.

Two-edged sword

Such disclosure is a two-edged sword.

Certainly, potential purchasers of the shares will be very well informed – but at the same time, the disclosure is likely to make it harder for management to achieve a turnaround. Perceived financial fragility may lead key staff to look elsewhere, and will probably make it harder for the businesses to win new business. In some cases, it will also create liquidity problems if suppliers decide to reduce trade credit limits.*

Why is such disclosure required?

Listed companies have multiple disclosure requirements. The Listing Rules impose a continuous disclosure regime, with limited exemptions – for example where negotiations are underway, or are confidential to another party. The Accounting Standards also impose further disclosure requirements.

If disclosure was made to comply with the continuous disclosure regime then arguably it should have been made earlier – when the companies received notice of their lender’s requirements.

Disclosure in the Annual Report suggests that the disclosure was prompted by the auditor’s review of the financial statements – but for an outsider it is difficult to say whether it reflects a belated ‘catch up’ of continuous disclosure, or whether it is intended to ensure compliance with Accounting Standards.

Theoretical arguments about the reasons for the disclosure and whether it is strictly required may not be much help up for companies up against a deadline. Two of the case studies had audit reports signed on the latest possible date – perhaps they simply ran out of time?

How should directors mitigate harmful disclosure?

Of course it is important that directors ensure that investors are adequately informed – but they should try to avoid do so in a way that makes it harder for the business to achieve a turnaround.

Harmful disclosure can be mitigated – but it becomes so much harder after balance date.

Businesses in turnaround mode should be projecting their compliance with covenants as part of their normal board reporting. If non-compliance seems likely, then it is important to negotiate with lenders well ahead of any deadline. Of course, those negotiations are far easier if supported by a well thought-out and comprehensive turnaround plan that will provide comfort that any underlying issues have been identified, and will be addressed.

First published here