A “War zone”?

Rather than continue the committee’s earlier scrutiny of the role of “non-mainstream advisers,” the final hearing of the Senate Select Committee Inquiry into Lending to Primary Production Customers returned to an examination of the work of receivers (transcript here).

A focus on one case in particular highlighted the most difficult and challenging aspects of a receiver’s work, and provided outsiders with a clear understanding as to why the Court officials responsible for taking possession of properties will sometimes involve the local police.

One receiver gave evidence about ‘personal threats’ made to ‘numerous parties’ – including a contract truck driver who had his arm broken.  When asked why the farm in question had been left idle for four years the receiver explained that although he had found tenants to farm the property, they withdrew because they believed that they would not enjoy quiet occupation of the property.  He likened the situation to ‘trying to plant wheat in the middle of a Balkan war.’

His partner addressed some of the broader issues raised in earlier hearings, pointing out that:

  • Although in theory the costs of a receivership were charged to the borrower ‘in the majority of cases, where there’s a shortfall, the cost is paid by the bank and borne wholly by the bank’ – who scrutinised those costs very carefully.
  • Comparing a sale price to a valuation was problematic. Not only because valuation can move – with examples of ’40 per cent in a year for grazing properties’ – but the reality was that receivers ‘can’t force people to pay more’ than they think a property is worth.
  • There was an ‘expectation gap’ between the value of a property bought ‘when it was going well,’ and sold when it was not.

One committee member raised the idea of a prohibition on the appointment of receivers to ‘family farms’ – an idea which is discussed in more detail in End of the line?…..should we ban receiverships? – but which is problematic for at least two reasons.

The first is that the core problem is severe financial stress.  Preventing a lender from appointing a receiver may only mean that the enterprise will trade a little longer until it is wound up by another creditor – quite possibly the ATO.  The failure of the business will not be any more pleasant for the proprietors simply because it is a liquidator rather than a receiver who sells the farm, and in many cases, other creditors will be in a worse position because ongoing trading has increased the amount they are owed.

The second issue is that – as one of the witnesses explained – if lenders are unable to take the steps to recover debts due it seems likely that it will impact their lending decisions.  Higher risk operators may find themselves paying a higher rate, or unable to borrow as much as they wish.

The final report is due on 29 November 2017.

Other posts about the hearings of the Senate Select Committee Inquiry into Lending to Primary Production Customers:

“Non-mainstream advisers”

The Senate Select Committee Inquiry into Lending to Primary Production Customers began with an obvious focus on lenders.

However, as the hearings proceeded, that focus seemed to shift.  One member’s view was that ‘when you look at what’s come before this committee, the big banks have come out pretty well.’  By contrast, as the chair noted, ‘the number one area…standing out for complaints is the receivers’ (more background here).

To those following the hearings it was therefore no surprise that the 20 October hearing was dedicated to evidence from restructuring and turnaround professionals and their professional association, ARITA.

Those giving evidence (listed below) did a tremendous job in explaining the extensive regulation to which they are subject, the duties and reporting obligations imposed by the Corporations Act, and the challenges of dealing with farmers and small business operators in moments of greatest stress and difficulty.

Through the course of evidence on 20 October, the beginnings of a new line of inquiry appeared: those described by one witness as ‘non-mainstream advisers,’ often without appropriate qualifications, whose involvement was a ‘consistent element of matters which become protracted and difficult to resolve.’

The witness referred to the use of ‘arguments, which have no legal substance,’ as well a routine by which a ‘promissory note’ is tendered purportedly in satisfaction of the debt. Other devices (albeit not the subject of evidence) include the promise of offshore refinance or funding, and of evidence purporting to show that a loan has been ‘securitised’ (which is somehow said to invalidate the loan), both of which seem to require a significant and non-refundable up-front fee.

As another witness explained, those purported ‘strategies’ provide borrowers with false hope, when more realistic advice would lead them to negotiate with creditors.

One of the committee members noted his personal experience with non-mainstream advisers, one ‘pretty good’ – but others ‘not so good,’ and raised the question of whether they should be regulated.  The committee chair also raised concerns: ‘we can see the damage of non main-stream advisers.’

Another hearing has been scheduled for 17 November.  It will be interesting to see whether there is further exploration of the problems caused by non-mainstream advisers, and what can be done to mitigate the damage caused by the worst of them.

Update: Some of the relevant footage of the committee proceedings have been made available via youtube.

Witnesses who represented the turnaround and restructuring profession, in my view with great distinction, at the 20 October 2016 hearing:

  • Justin Walsh of Ernst & Young
  • Stephen Longley and David Leigh of PPB Advisory
  • Ross McClymont, Narelle Ferrier, and John Winter of ARITA
  • Jamie Harris, Rob Kirman, Matthew Caddy, and Anthony Connelly of McGrathNicol
  • Will Colwell, Stewart McCallum, Tim Michael and Mark Perkins of Ferrier Hodgson

For comment on some other problematic advisers: Wanted: Regulation of pre-insolvency advisers

Consultation on the Industry wide EDR for Business Credit disputes: AFCA

Yesterday the government opened a 17 day consultation window for input into the design of the Australian Financial Complaints Authority, and its operations.

As the consultation papers explain, AFCA is the single external dispute resolution scheme that will replace three existing schemes: the Financial Ombudsman Service, the Credit & Investments Ombudsman, and the Superannuation Complaints Tribunal.

For lenders, the most significant change is the increase in jurisdiction.  Currently, there is a cap of $309,000 on the compensation that FOS can award.  It is proposed that AFCA will have jurisdiction over small business credit facilities up to $5 million, with a compensation cap of $1 million.  Notably, there is no limit on disputes about the validity of guarantees supported by security over a guarantor’s primary place of residence.

The dual reference – facility limit amount as well as compensation cap – highlights that outcomes will not necessarily be limited solely to compensation.  In 2016/17 FOS received 2,772 complaints about lender responses to claims of financial difficulty, and many of those complainants would have been seeking slower or different recovery processes rather than compensation.

There will be some non-bank lenders (those who aim above the micro-business market with say a minimum loan of $500,000) who currently operate mostly outside the current FOS jurisdiction, who will find that AFCA has significant coverage in the future.

The consultation paper notes that AFCA has a specific objective to deploy ‘a consistent approach’ to determinations.  Elsewhere the paper references that FOS currently has regard to ‘applicable industry codes’ and ‘good industry practice.’  Taking those together, might AFCA have scope to decide that the Code of Banking Practice should apply to Bank and non-Bank lenders alike?

Responses are sought by 20 November 2017.

The beginning of the end? The RBS/GRG saga

Last week’s release of an interim summary of an independent review into Royal Bank of Scotland’s (RBS) treatment of distressed small business customers may signal the end – or perhaps the beginning of the end – of an extremely challenging period for RBS.

As discussed here, public concern about the treatment of customers transferred to the RBS workout area – the Global Restructuring Group (GRG) – followed the issue of the so-called ‘Tomlinson Report’, in 2013.

The report – highly critical of GRG, and those who advised it – generated an immediate media and political response, and led to the UK Financial Conduct Authority (FCA) seeking an independent ‘Skilled Person’ review of the allegations by consulting firm Promontory Financial Group and accountants Mazars.

Only later did it emerge that Lawrence Tomlinson, who held an honorary role as an ‘Entrepreneur in Residence,’ was not commissioned to undertake a review, and that he himself was an unhappy RBS customer.

To some extent the controversy cooled, but public interest re-kindled following a joint report by BBC NewsNight and Buzzfeed in October 2016 which seemed to anticipate the delivery of the report to the FCA.

The High Level summary

On 8 November 2016 the FCA released a statement setting out a high level summary of the main findings and key conclusions, reporting that:

  • Notwithstanding the Tomlinson allegations to the contrary, RBS did not set out to artificially engineer the transfer of customers to GRG
  • The customers transferred to GRG were exhibiting clear signs of financial difficulty.
  • There was no evidence that property purchase by RBS entity West Register had increased financial loss to the customer.
  • Inappropriate treatment of SME customers appeared ‘widespread’ and that ‘much communication was poor and in some cases misleading.’
  • There was a failure to support businesses ‘consistent with good turnaround practice,’ and an ‘undue focus’ on pricing increases.

It was surely no coincidence that on the day that the summary was released, RBS announced a response to the report which included a complaints process to be overseen by a retired High Court Judge, and the automatic refund of some types of fees paid by SME customers.

However, the RBS response did not close out the controversy, and calls for release of the full report continued.

More detail: a sixty-nine page summary

Almost 12 months later the FCA has released – not the full report – but rather a sixty-nine page ‘interim summary.’  What does it tell us?

Firstly, it highlights the large scale of the review: 207 cases, including 60 in which West Register had some involvement.  The reviewers had access to 1.48 million pages of data and more than 270,000 emails, supplemented with interviews of RBS staff and customers.

Critically, the most serious of the Tomlinson allegations were not upheld by the independent review.  However, the reviewers found that inappropriate treatment of customers was widespread and systemic – evident in 86% of all cases reviewed, and 92% of the cases involving viable businesses.

The report clearly identified that GRG’s twin objectives – turnaround of businesses in distress and financial contribution to RBS – resulted in inherent conflicts of interest, and that RBS did not have appropriate governance and oversight procedures to balance the interests of RBS and its SME customers.

The specific findings included:

  • In practice RBS had failed to place appropriate weight on turnaround options, failed to manage the conflicts of interest inherent in the role of West Register, failed to handle complaints fairly, and was unduly focused on pricing increases.
  • RBS’s policies and procedures for problem loans were appropriate, and broadly reflective of normal turnaround practice – but in many aspects the policies were not actually followed.
  • GRG notionally used a ‘balanced scorecard’ approach, but in practice the generation of additional income from customers took precedence over any other aspect.
  • GRG often sought a reduction in facility levels ‘with insufficient regard’ for the impact on customers.  Extensions were typically short-term, and accompanied by fees or higher interest rates.
  • Interactions with customers ‘were often insensitive, dismissive and sometimes unduly aggressive.’
  • A target of “zero justifiable complaints” actually incentivised a lack of recording and reporting of complaints.
  • There had been previous misreporting of the turnaround success rate, in fact only around one in ten cases was returned to mainstream banking.

Where next?

The summary included a careful explanation of FCA policy around the release of skilled person reports, noting that full disclosure was ‘subject to a wide prohibition in the legislation.’  The summary further explained that an attempt to publish the full report in this case would require ‘heavy redaction’ – a ‘complex and lengthy’ process.

It appears clear that the FCA will not publish the full report unless compelled, and so it seems – no doubt to RBS’ relief – that the issue might finally be heading towards closure.

Regardless of whether the full report is ever published, the message for banks is clear: the public and political expectation is that ‘is it fair?’ is a more important question than ‘is it legal?’

Shortening Bankruptcy

Bankruptcy reform legislation, available here,  was today tabled in Federal Parliament – notably without the prior release of an exposure draft.

The legislation addresses the second and last part of the reforms outlined in the 29 April 2016 National Innovation Agenda – improving Australia’s bankruptcy and insolvency laws proposals paper, discussed here.

The headline measure is a two-year reduction in the period for which a person is ordinarily bankrupt.

Currently an individual debtor will be bankrupt for a three year period, which can be extended by two or five years (depending on the severity of the ‘wrongdoing’)  if the trustee lodges an ‘objection to discharge:’ a total of five or eight years.

The reform will shorten the initial term to one year, however the objection increments will increase by two years, to four and seven years.  In other words, the current extended five and eight year period arising where an objection is lodged, will be maintained.

The reduction in term is perhaps not as significant as it first sounds.  True, debtors will be able to travel overseas, be appointed as company directors, and incur credit when the twelve month period expires.  However, they will still need to provide information to the trustee and pay any income contributions for three years (or five or eight years, if an objection is lodged) just as they do now.  For that reason, in many cases the end of the bankruptcy period will not means the end of interactions with their trustee.

The changes will present challenges to trustees:

  • They will need to accelerate their investigations to ensure that if appropriate they can lodge an objection to discharge in that initial twelve month period, or they will miss the opportunity forever.
  • They will need to obtain information and secure payment of post-bankruptcy income contributions without the benefit of the objection-to-discharge regime – which currently provides a simple and inexpensive administrative point of leverage.

Perhaps most affected by the reforms will be those businesses that promote and administer ‘Debt Agreements’.  Debt agreements were introduced in December 1996 to provide a simpler and lower cost alternative to bankruptcy, for debtors whose income and assets did not justify the costs of a ‘Personal Insolvency Agreement.’  Their use has grown in the twenty years since then: in 2016 more than 12,000 debtors took the debt agreement option. With bankruptcy cut to just one year, it seems likely that many debtors will decide that bankruptcy is an easier and cheaper alternative to a debt agreement.

There is one aspect of the reforms that will surprise many: the one year term will apply to bankruptcies on foot at the commencement date.  As a result, the changes will be retrospective, to the advantage of individual debtors.  The decision to make the change retrospective provides a clear contrast to the approach taken with the ipso facto reforms in the first phase, which were not retrospective, to the disadvantage of corporate debtors.

‘Inhuman,’ ‘Crooks’ – Receivers’ right of reply?

Receivers: are “crooks”?  commented on some of the most strikingly-phrased evidence given at hearings of the Senate Select Committee Inquiry into Lending to Primary Production Customers, and Receivers: are “inhuman”?  discussed the responses of the committee members to the testimony (available here) that they had heard.

Some turnaround and restructuring professionals have expressed concern about the risk that the Inquiry might conclude without the benefit of an explanation of the duties and obligations of the registered liquidators who undertake such receivership roles, or information about the level of scrutiny and regulation imposed by the Corporations Act and applied by ASIC.

Those concerned will be pleased that ARITA has been invited to give evidence to a hearing in Canberra on 20 October, which should be broadcast live via the browser-based ParlView service, available here.

ARITA President Ross McClymont, CEO John Winter, and Technical & Standards Director Narelle Ferrier will give evidence at 12 noon.

Update: You can watch ‘replays’ of Part 1 (ARITA appears at 12.25) and Part 2 of the hearing online.

Department of Liquidation? The possible creation of a Government Liquidator…

The anti-phoenix consultation paper released by Treasury last week (available here) raises the possibility of a “Government liquidator.”

The proposal is intended as an alternative to the ‘cab rank’ proposal (discussed here), to address concerns about phoenix promoters ‘hand-picking’ registered liquidators likely to cooperate in a strategy to ‘facilitate their client’s interests to the detriment of creditors.’

(Before moving on it is worth highlighting, here too, that a liquidator who did act to the detriment of creditors in such a way would be in breach of their duties both under the Corporations Act and the ARITA Code of Professional Practice, and should be subject to prosecution by ASIC and disciplinary action by ARITA, if a member).

To outsiders, the idea of a government agency operating in a market where there is no shortage of competitive players may seem unusual, but to turnaround and restructuring professionals it is more familiar.  A similar system operates in the UK, where by default the ‘Official Receiver’ is appointed to companies unless a private liquidator has been arranged, and in Australia where the Official Trustee (via AFSA) acts as the trustee of an insolvent individual’s affairs – unless a private bankruptcy trustee has been arranged.

The paper does not set out a view as to whether the Government liquidator would be appointed only where a person designated as a “High Risk Phoenix Operator” by the Commissioner of Taxation (under the criteria and process outlined in the proposals paper) is involved, or whether it would be an option in all liquidation proceedings – feedback is sought on that question.

Likewise it is also unclear whether the Government liquidator would manage the liquidation through to completion, or the involvement would only be temporary, pending a transition to an independent liquidator – as happens now with many, but not all, of the more complex personal insolvencies handled by AFSA.

The paper seeks feedback as to how a government liquidator should be funded. One part of the answer to that question is the fee charging model to be adopted.  If the AFSA model (a flat fee of $4,000 per file and commission of 20% of money received) is deployed, then there is likely to be a larger shortfall than if an hourly rate model is used.  The most significant question however is the scale of operation  – a national team that undertakes any and all liquidations through to completion will be quite large, and quite expensive.

Feedback is due by 27 October 2017.  It can be provided direct, and ARITA is also seeking member feedback.

Queensland is pursuing other measures to address phoenixing, discussed here