1 year Bankruptcy and Debt Agreement Reform: The Senate Committee Reports

Today the Senate Standing Committee on Legal and Constitutional Affairs issued reports about two separate bills, both intended to reform personal insolvency regimes.

Debt Agreement Reform

Importantly, the Bankruptcy Amendment (Debt Agreement Reform) Bill 2017 (discussed in more detail here) will strengthen the regulation of Debt Agreement Administrators, more closely aligning it to the regulation of bankruptcy trustees.

Another, seemingly less well understood aspect will limit the length of payment arrangements to three years.  It is a well intentioned measure, but there is a risk that in practice it will operate to restrict a debtor’s ability to negotiate a Debt Agreement, because many creditors will not vote for a proposal unless it meets a minimum return requirement.

In the Inquiry hearings, one Debt Agreement Administrator referenced a minimum return requirement of 60 cents in the dollar.  Using this as an example, a DAA would tell an debtor with liabilities of $70,000 that they need to create a fund of $42,000.  A debtor with capacity to contribute $2,000 per month would be able to do this in 21 months – within the proposed three year limit, but a debtor who could only contribute $1,000 per month would need 42 months – outside the three year limit.

It may be that creditors will reduce their minimum return requirements, but if they do not, a measure presumably intended to offer debtors relief may operate in practice to stop some of them from entering into a Debt Agreement at all.

One Year Bankruptcy

The Bankruptcy Amendment (Enterprise Incentives) Bill 2017 (discussed in more detail here) will shorten the default bankruptcy term from three years to one year.

The proposal echoes a previous initiative which allowed some bankrupts to apply for discharge after six months.  That measure was  scrapped in 2001 due to concerns that early discharge did ‘not reflect the serious nature of the decision to become bankrupt’ and that an ‘easy way out’ acted to ‘discourage debtors from trying to enter formal or informal arrangements with their creditors to settle debts.’

The Government proposes to maintain the current three year term of the income contribution regime – ie two years post-bankruptcy – but will leave trustees without any practical measures to collect information about a debtor’s income in the two years after discharge.  Without that information the trustee will be unable to calculate income contributions, none will be collected, and so returns to creditors will diminish.

The Report

The report (available here) does recognise that these issues, and others, were raised in the various submissions – but gives higher weighting to the original policy intentions.  The committee recommended:

  • that the Government give positive consideration to ASIC greater scope to impose director disqualifications, discussed in more detail here.
  • that the government consider amending the debt agreement reforms to allow debt agreements implemented under a three year cap to be extended by up to two years, by agreement.
  • identification of a range of specific factors that should be taken into account when setting a maximum payment to income ratio for a debt agreement.
  • that with those adjustments made, the legislation should be passed.

Other posts about the Bankruptcy and Debt Agreement reforms:

Back where we started? Director disqualification

Last week the Senate Standing Committee on Legal and Constitutional Affairs conducted joint hearings into two separate pieces of personal insolvency legislation.  One Bill (discussed here) is intended to implement Debt Agreement Reform and align the regulation of Debt Agreement Administrators to the regulation of bankruptcy trustees, the other will shorten the default bankruptcy term to one year.

Reducing the bankruptcy term to twelve months will implement the second and last stage of the 2016 National Innovation Agenda – improving Australia’s bankruptcy and insolvency laws program (the first stage was the Safe Harbour and ipso facto reform legislation, discussed here).

According to the original proposal paper the one-year bankruptcy measure is intended to promote entrepreneurship by reducing the penalty and stigma associated with business failure.

Notably, although the bankruptcy term will be reduced to one year the income contribution regime will continue to apply for three years – presumably reflecting an intention to maintain returns for creditors.  However, as discussed in Q: How does a 3 year contribution regime fit into a 1 year bankruptcy? A: badly in practical terms a bankruptcy trustee will have very limited options to deal with a former bankrupt who ignores requests for information about his or her income, and so it is likely that a one year term will reduce returns to creditors.

Government submissions on the Government proposals

It seems that there are other concerns.   The Australian Criminal Intelligence Commission made a submission which referred to intelligence suggesting:

“reducing the default bankruptcy period from three years to one year may increase the potential for serious and organised crime groups to exploit bankruptcy provisions for their own advantage.”

ASIC also made a submission expressing concern about what it described as the ‘possible unintended consequences’ of the proposed changes.  It seems that the measures identified in the original proposals paper as a problematic ‘penalty and stigma’ are measures that the corporate regulator regards as sound policy, intended to keep an unsuitable person away from the ‘controls’ of a company, as well as to provide a deterrent effect.

ASIC told the inquiry that their enforcement activity took into account the fact that bankruptcy triggered an automatic three year director disqualification.  They said that if the ‘automatic’ disqualification was reduced to only one year then they might need to take more active steps to seek longer disqualifications, and might ask Parliament to amend the Corporations Act ‘to extend the period of automatic disqualification where the person is an undischarged bankrupt.’

Right back to where we started from?

ASIC provided more detail at the Sydney hearing (the transcript is here).  They propose that:

  • A person who becomes bankrupt should be unable to act as the sole director of a company for three years.
  • There should an extended disqualification period for ‘egregious conduct.’  It was not clear whether this would apply only to bankrupt directors, or to all directors.
  • Automatic disqualification should be applied to those involved in ‘repeat conduct’ – four corporate failures in seven years.  Again, it was not clear whether this measure would relate to all directors or only bankrupt directors.

Implementation of the ASIC proposals would reverse some of the effects of the proposed bankruptcy changes.  The net result would be measures that are a little more targeted, but some would argue that the overall outcome would be close to the position as it is today: back where we started from.

PAG v RBS: Calling for Valuations – A final outcome

Pacific Alliance Group is an ex-customer of the Royal Bank of Scotland so unhappy about its treatment by GRG – RBS’ workout unit – that it took legal action against the bank.

Some of the issues raised by PAG concerned an interest rate hedging program entered into before the transfer to GRG, and are not relevant to restructuring and turnaround practitioners.  However, PAG also complained about management by GRG, including decisions to seek updated valuations, which resulted in breach of a loan to valuation ratio, and led to a subsequent renegotiation of terms.

As discussed here, PAG was unsuccessful in its first attempt before the UK High Court, but it kept on fighting, with an appeal.  PAG argued that the judge at first hearing was wrong to decide that RBS’ contractual power to call for a valuation was completely unrestricted – PAG said that there were implied terms which meant that for example RBS could not call for a valuation capriciously or vexatiously.

In a judgement (available here) handed down last week, the Court of Appeal agreed with PAG that the power was ‘not wholly unfettered’ – but it found that RBS was free to seek an updated valuation if it was for a purpose related ‘to its legitimate commercial interests.’

On that point, on the facts the Court held that it was

 ‘very far from apparent, however, that the Judge would have held the valuation at issue to have been pointless, lacked good or rational reason or been commissioned for a purpose unrelated to RBS’s legitimate commercial interests or when doing so could not rationally be thought to advance them…’

After providing some rare behind-the-scenes glimpses of a loan workout, it appears that we have now reached a final resolution, leaving the law probably as most impartial observers expected the position to be.

Other posts about the RBS/GRG saga:

Bank support for small business turnaround

The ongoing political scrutiny of the treatment of distressed small business customers by the Royal Bank of Scotland (some background here) led to a letter from the Treasury Committee on 27 February 2018.

Amongst other things the committee asked RBS to confirm whether it supported the Principles for Best Practice in UK business support banking promulgated by the UK’s Institute for Turnaround.

The principles are:

i.  The primary focus of Business Support Units is to protect the Bank’s capital by working consensually with customers to promote and support viable recovery strategies:

  • Business Support Units will work openly and constructively with customers, with the aim of returning the business to viability in a timely and cost-effective manner, wherever achievable.
  • The need for Business Support Unit involvement will be kept under continuous review.

ii.  Business Support Units will treat customers fairly, sympathetically and positively, in a professional way with transparent processes and procedures.

iii.  On transfer to a Business Support Unit, the Bank’s concerns and the proposed next steps will be clearly communicated to customers.

iv.   Business Support Units will ensure that any formal property valuations required will be undertaken by independent advisers on the Bank’s panel.

v.   Business Support Units will seek appropriate fees and margins taking account of the customer’s financial circumstances and ability to pay:

  • Fees and interest margins will be appropriately priced to reflect the risk, the additional management time required and the financial circumstances of the customer. These will be set out in writing, will be discussed with the customer and agreed with the customer wherever possible.

vi.  Business Support Units will manage complaints in line with clearly defined policies and procedures:

  • The process for making a complaint will be clearly set out ensuring recognition and a timely response.
  • Customers should always feel able to complain (and know that any complaint will be treated fairly in accordance with published complaints protocols)

vii.  Occasionally equity stakes in a customer may be acquired through a debt for equity restructuring. Business Support Units will handle equity stakes in customers under their management in the spirit of the ‘primary focus’ – to protect the Bank’s capital by working consensually with customers to promote and support viable recovery strategies.

viii.  Business Support Units will monitor their turnaround statistics with a focus on returning customers to a normal banking relationship.

For some time Insol has provided guidance for the workout of large syndicated loans (discussed here) but these principles, supported by  Lloyds, HSBC and Barclays, appear to be the only guidance for support of small business lending.

Other posts about the RBS/GRG saga:


Is there a User Pays shock coming for auditors?

ASIC was very careful to highlight the risk of sample error when it briefed the Parliamentary Joint Committee on Corporations and Financial Services about the outcome of a 2017 review of audit quality – but still came firmly to the conclusion that ‘ongoing attention to this area is warranted.’

ASIC told the 16 February hearing that:

“in 25 per cent of the 390 key audit areas that we reviewed across the 93 audit files at firms of different sizes, auditors did not obtain reasonable assurance that the financial report as a whole was free from material misstatement.”

According to the most recent ASIC Cost recovery implementation statement, available here, ASIC allocates $5.003m to regulating the auditors of disclosing entities, and $1.013m towards general regulation of 4,367 registered auditors.

The cost of regulating disclosing entity auditors will be prorated based on fees earned, so there will be considerable variation around the average figure of $43,885.  The other costs will be recovered by a flat levy, which means that most auditors will pay a levy of around $250.

It seems likely that ASIC will allocate more resources to the regulation of auditors – if only to ascertain whether or not the 25% deficiency rate is representative of overall audit quality, or whether it is a statistical anomaly.

ASIC allocates $10.196m to regulating 711 registered liquidators.  The notional average recovery is therefore around $14,300 – but in practice some liquidators will pay the $2,500 minimum, and some will pay considerably more.

If ASIC increases the budget for the auditor regulation to a level near that for liquidator regulation, there may be some very significant User Pays charge increases on the way for auditors.

Open-ended investment vehicles: how should they be restructured?

In August 2017 Treasury invited consultation on a plan to introduce a new form of company: Corporate Collective Investment Vehicles.

CCIVs are intended to replace trust-based managed investment schemes – currently the only collective investment vehicle providing a flow-through tax treatment – with ‘a more internationally recognisable’ structure, similar to the UK’s ‘Open-ended Investment Vehicle’ regime.  By doing so, the Government hopes to make it easier to attract international investment and inbound capital flows.

Key features of a CCIV

Details of the regulatory framework for the CCIV are on the Treasury website here, but in summary:

  • The CCIV itself will be an ‘umbrella entity’ with at least one, and probably several, sub-funds (in the UK: ‘protected cells’).
  • The CCIV will create and allocate a new class of shares for each sub-fund, but those sub-funds will be notional and will not be separate legal entities.
  • A CCIV must have a single corporate director, which itself must be a public company holding an Australian Financial Services License.  The duties of a corporate director will align to those currently owed by the responsible entity of an MIS scheme.
  • A CCIV which accepts investments from retail investors must hold its assets via a separate ‘depositary’ company – also a public company with an AFSL.
  • Each sub-fund will be ‘ring fenced’ or ‘bankruptcy remote.’  The assets of a sub-fund belong exclusively to that sub-fund, and are not available to the creditors of any other entity – including the umbrella CCIV.

What will happen to an insolvent sub-fund?

Treasury has adopted a phased approach to development of the new CCIV framework, and consideration of restructuring issues has been deferred until later.

There appear to be three main options:

  1. Apply the current MIS framework.  MIS schemes are wound up by Court order made under section 601ND, with almost any other issues addressed by an application for directions under section 601NF.  Reliance on court directions – rather than a legislative framework as for liquidation and administration – has led some to describe MIS wind ups as the closest that Australia has to the cumbersome and expensive Chapter 11 process.
  2. Follow the UK approach.  The UK legislation provides that a sub-fund is to be wound up ‘as if it were an open-ended investment company‘ treated ‘as if it were a separate legal person for the purposes of winding up.’  Like the current Australian regime, winding up is the only option – there is no scope to restructure a sub-fund.
  3. Allow a broader range of restructuring options.  If there is a policy reason why MIS schemes and sub-funds must be wound up and cannot be restructured, it has not been articulated.  There should be some consideration given to allowing sub-funds to have access to a broader range of restructuring options such as voluntary administration and schemes of arrangement.

Treasury has flagged future consultation on winding up of CCIV funds, likely to be later this year.

Superannuation Guarantee Integrity Package – consultation underway

On 24 January 2018 Treasury released details of a proposed ‘Superannuation Guarantee Integrity Package’ – including an exposure draft of the Treasury Laws Amendment (Taxation and Superannuation Guarantee Integrity Measures) Bill 2018 (available here).

The package includes some aspects that will be of interest to restructuring and turnaround professionals:

  • The ATO will have power to issue a notice to an employer requiring payment of a superannuation guarantee charge amount within a nominated period not less than 21 days.  Failure to pay within time would be a criminal offence of strict liability by the employer – but not the individual officeholders.  Liquidators undertaking a review for possible unfair preferences will be very interested in identifying such notices: it would seem hard for the ATO to argue that receipt of funds after such a notice was issued was ‘in the ordinary course of business.’
  • The ‘Single Touch Payroll Reporting’ system – which requires the real time reporting of withholding payments – will be extended.  The regime currently applies to employers with more than 20 employees from 1 July 2018, but will apply to all employers from 1 July 2019.  Insolvency appointees who continue the employment of staff will need to ensure that they also comply with these requirements.
  • The ATO will have power to issue a Directors Penalty Notice in respect of SGC amounts at an earlier point in time than is currently the case.  This will be achieved by amendments that will impose a theoretical obligation to cause a company to pay an SGC estimate before the company has an actual obligation to pay the estimate!

Responses to the consultation should be submitted by 16 February 2018.

Commentary on related reform, to address corporate misuse of the FEG scheme, is here.