ASBFEO at the ARITA National Conference

The Inquiry into Small Business Loans report issued by the Australian Small Business & Family Enterprise Ombudsman in December 2016 included specific recommendations concerning restructuring & turnaround professionals:

Recommendation 9 – Every borrower must receive an identical copy of the instructions given to the investigating accountant by the bank and the final report provided by the investigative accountant to the bank.

Recommendation 10 – Banks must implement procedures to reduce the perceived conflict of interest of investigating accountants subsequently appointed as receivers. This can be achieved through a competitive process to source potential receivers and by instigating a policy of not appointing a receiver who has been the investigating accountant to the business.

Those recommendations led to an invitation to speak at the ARITA National Conference in Melbourne this week, followed by a media release – set out in full below.

The media release included a call for receivers to avoid giving the appearance that they ‘work for the biggest creditor, which is usually a bank.’ Of course, most of those reading this post will know that in fact receivers usually are working specifically for the secured lender.

The comment highlights for me just how difficult it can be for outsiders to understand the technically complex world in which the restructuring and turnaround profession operates, and the need for the profession to engage and educate.

For that reason ARITA should be commended for inviting an apparent critic to speak, and Ms Carnell should be commended too, for her willingness to participate and be involved.

Postscript: Some interesting commentary on the ASBFEO position on EDR, by Michael Murray.

ASBFEO media release 9 August 2017

Insolvency sector urged to embrace accountability

The Australian Small Business and Family Enterprise Ombudsman has called on the insolvency sector to improve its accountability and transparency or face louder calls for increased regulation.

Speaking at the Australian Restructuring Insolvency and Turnaround Association (ARITA) conference in Melbourne, Ombudsman Kate Carnell said there should be an external dispute resolution process or tribunal to hear complaints.

“Small business operators are often confused about the role of receivers, how they charge and what their timeframes are,” she said.

“There needs to be greater accountability and a simple way to resolve disputes.”

Ms Carnell said insolvency practitioners were required under legislation to work in the best interests of the business.

“We hear from small business people and farmers the reality is somewhat different; it often appears that the receivers work for the biggest creditor, which is usually a bank,” she said.

“There is sometimes a potential conflict between the interests of a creditor and those of a distressed business.”

Ms Carnell said submissions to the Select Committee on Lending to Primary Production Customers echoed some of those heard by her inquiry.

The business of Queensland prawn farmer Sam Sciacca suffered after Cyclone Larry. Mr Sciacca told the select committee that receivers lacked expertise to manage his aquaculture operation and he was left with substantial debt as a result.

Property and livestock agent Andrew Jensen claimed that receivers often lacked farm management skills and didn’t always achieve the highest possible price.

“What’s disturbing about these accounts and others is the lack of accountability,” Ms Carnell said.

“There’s nowhere for farmers or small business people to go if they’re unhappy with the actions of a receiver.

“In my view there needs to be an external dispute resolution process.”

Ms Carnell said insolvency fees should be clearly stated and explained.

“Going into receivership is a stressful event for any business operator,” she said.

“A good insolvency practitioner can help a struggling business achieve a good outcome.

“The problem is that a bad insolvency practitioner can’t be held to account.”

Receivers: are “crooks”?

The registered liquidators I speak to have a real sense of being under close and careful scrutiny. ASIC is an increasingly active regulator – as evidenced in the most recent enforcement report (available here). The roughly 85% of registered liquidators who are ARITA members must also comply with its comprehensive Code of Professional Practice (available here), or risk facing its Professional Conduct Committee. And many would say that FEG – an active and well-resourced priority creditor – provides additional scrutiny to receiverships where employee priorities are involved.

It is clear from the evidence provided to the Senate Select Committee on Lending to Primary Production Customers (available here) however, that some of the borrowers subject to receivership do not see – or do not appreciate – the level of scrutiny and supervision.

One borrower claimed that asset sale proceeds “finish up in the receiver-manager’s accounts” and do not reduce the farmer’s debt – a “systemic misappropriation of those funds” by the “most corrupt, the most unscrupulous, the most unethical industry in Australia.”

Another debtor said that receivers “are crooks down and out,” and a former rural agent described the insolvency profession as “the greatest bunch of virtually bloody criminals and they get away with it.”

Insolvency practitioners may argue that those giving evidence are the most vocal of an unrepresentative minority, but it seems that their evidence may be having an impact. The committee chair closed the Perth hearing with a reminder that the inquiry was “not only into lending practices, including default, but also into other service providers associated with this sector, including receivers, brokers and agents.”

The reputation of the insolvency profession remains an ongoing issue, and we should not take outsiders’ understanding – of a technically complex function – for granted.

Postscript: Some comment on the later deliberations of the Inquiry is here: Receivers are ‘inhuman’?

Senate Inquiry releases Report into the Safe Harbour legislation

The Senate Economics Legislation Committee today released its report (available here) into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 – the Safe Harbour legislation – following referral on 15 June, as discussed here.

The committee acknowledged that a number of submissions had identified potential improvements to the legislation – but it declined to recommend any changes. The Committee noted that there had been ‘broad support’ for the bill, and explained that it had formed the view that matters raised in submissions ‘would best be clarified in regulations.’

In practical terms that appears to eliminate any possibility that the ipso facto stay will be extended to apply to contracts entered into before the commencement, which in my view (as discussed here) is a very significant missed opportunity.

There was a single recommendation “The committee recommends that the bill be passed.”

Submission to the Senate Inquiry into the Safe Harbour and Ipso Facto Legislation

[This is a copy of my submission to the Senate Economics Legislation Committee Inquiry into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017]

My Background

I am a Chartered Accountant and former registered liquidator, with more than 25 years’ experience in financial and professional services at Nab, ANZ Bank, and Ernst & Young.

In my current role I lead complex loan workouts across the Institutional and Corporate platforms at Nab, and I am member of the ARITA Vic./Tas. State Committee and ARITA National Board.

I very much appreciate the opportunity to provide a submission to the Inquiry into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017, which for clarity represent my personal views, and is not made on behalf of either my employer, or ARITA.

Summary

In my view those responsible for drafting the legislation should be commended for the care that they have taken to balance different policy objectives and minimise unintended consequences, resulting in a package of very meaningful and worthwhile reforms.

My submission has a single focus, the commencement of the ipso facto protections. The reforms are so beneficial that I believe we should move away from the proposed very gradual implementation, and implement them more quickly.

Issue: that the ipso facto protections will be introduced only very gradually

The ipso facto protections will apply only in respect of rights under contracts entered on or after the commencement (refer Explanatory Memorandum 2.99).

That means that companies incorporated after the commencement will have comprehensive protection against ipso facto clauses. By contrast, companies in existence prior to the commencement will not receive the benefit of ipso facto protection, unless they enter into a completely new contract.

Many contractual counter-parties currently holding ipso facto termination rights will avoid entering into new contracts. Instead they will seek to vary existing contracts, to preserve those termination rights. Those with greater negotiating leverage are most likely to be successful, i.e. by definition, extension will be more likely to occur where there is an imbalance of power. There will be some cases where contracts with ipso facto termination rights continue in existence for many years – with variation after variation after variation – and for most businesses, in practical terms the implementation will therefore be gradual.

There may be some argument for maintaining the position of those who currently hold ipso facto termination rights, to recognise freedom to contract and avoid retrospectivity – but there can be no other policy reason to deny the very clear benefits of ipso facto protection to all businesses.

The argument for limiting ipso facto protection

My understanding is that the limitation of ipso facto protection to only those contracts entered on or after the commencement date reflects a policy objective to avoid the retrospective removal of contractual rights that parties have independently negotiated.

The argument against limiting ipso facto protection

There was no suggestion that the Safe Harbour reforms be only available to those directors appointed after the commencement date – even though the safe harbour regime impinges on an individual creditor’s right to make an insolvent trading claim. I believe that reflects a clear recognition that the benefits of safe harbour are so significant that they should be universally available. Exactly the same argument applies in relation to ipso facto protection – the benefits are so significant that they should likewise be universally available.

If there is a residual concern about taking away rights that parties have independently negotiated, that should be balanced by consideration of three other issues:

First, ipso facto termination rights are something that a well-informed party would avoid if possible. They are more likely to exist in a contract where one party is less well-informed as to the risks they engender, and/or where there is an imbalance in negotiating position – such that a party cannot refuse their inclusion. We should be cautious about protecting rights that may have been secured through knowledge imbalance or power imbalance.
Secondly, ipso facto clauses provide a right to terminate where there is no other default. By definition therefore, they are only useful to a party that has suffered no loss or damage. There may be an argument to preserve the rights of a party that has suffered loss or damage – but it is harder to mount an argument to protect the rights of a party that has not suffered any loss at all, especially where the exercise of those rights may cause significant damage to the other party.
Finally, it should be noted that there is no way for employees to understand whether an employer’s contracts are protected against ipso facto. Similarly, there is no way for those who trade with a company to understand whether their credit risk is exposed to ipso facto termination.

Suggested solution

There are some circumstances where ipso facto termination rights should be maintained, and these have been recognised in the legislation. For those circumstances where it is appropriate to provide ipso facto protection, the legislation should be amended so that it applies to all contracts in existence before, on, or after the commencement.

If this is cannot be practically achieved, a compromise would be to follow the precedent in the Unfair Contracts legislation, and provide ipso facto protection to contracts entered into, or renewed or modified, after the commencement.

There is more detail on the issues that the Senate Inquiry will be considering here. All of the submissions are available here.

Safe Harbour & Ipso Facto: Issues for the Senate Inquiry

Legislation to implement the Government’s Safe Harbour and ipso facto reforms was tabled in Parliament on 1 June 2017, and then referred to the Senate Economics Legislation Committee on 15 June 2017, as noted here.

On 22 June 2017 the House of Representatives approved the second reading of the Bill. The Opposition speakers were each careful to highlight their support for the intention of the proposed reforms, but a review of their second reading speeches (available here, from page 22) helps identify some of the issues of detail that will occupy the committee:

Carve out or defence? – The legislation proposes a Safe Harbour via a ‘carve out’ from director’s duties – effectively placing the onus of proof on a liquidator, which is a shift away from the concept of a defence as proposed in the Productivity Commission report, that would place the onus of proof on the director. The Opposition has flagged its interest in understanding the move away from the Productivity Commission recommendation.

Anti-phoenix measures – The Opposition is calling for the introduction of a range of anti-phoenix measures including the introduction of a unique ‘director identification number’ with a 100-point identification check, and tougher penalties for phoenix-related offences. It is not clear whether their intention is to seek immediate amendment of the legislation to implement these measures, or use the hearings to progress the debate more generally. The idea of a DIN appears widely supported but there would be some logistical issues to address before it could be implemented – not least the likely need to expand the ASIC register to accommodate, and link, the DINs.

Transactions depriving employees of their entitlements – The Opposition also wants to address the problems caused by transactions entered into with the intention of avoiding payment of employee entitlement liabilities. In fact, the Government has just closed a consultation on Reforms to address corporate misuse of the FEG scheme, so this is something already underway.

Model A or Model B? The Productivity Commission proposed a Safe Harbour that would be triggered by the formal appointment of an individual as a ‘restructuring adviser,’ described in the exposure draft as the ‘Model A’ approach. The legislation as tabled implements the ‘Model B’ approach which does not specifically require such an appointment, but rather expects the directors to undertake one or more ‘courses of action’ likely to lead to a ‘better outcome,’ and the Opposition has flagged that it would at least like to understand the reasons for the departure from the original Productivity Commission proposal.

The speeches did not identify any issues with the ipso facto protections, the benefits of which, pleasingly, seem well understood and acknowledged.

Submissions close 12 July 2017, with the committee due to report by 8 August 2017. A copy of my submission is available here.

Referral to Senate Economics Committee – Safe Harbour & ipso facto

The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill – which is the legislation to implement the Safe Harbour and ipso facto reforms – was yesterday referred to the Senate Economics Legislation Committee.

Those seeking to have the scope or operation of the legislation modified have one more chance to put their arguments via a submission to the committee.

This blog provides more detail on the issues that the Senate Inquiry will be considering here. A copy of my submission is available here.

Submissions closed on 12 July 2017, with the committee due to report by 8 August 2017.

Poles & Underground

One of the issues raised in the Carnell Report – or more correctly, the ASBFEO Small Business Loans Inquiry Report – was a concern about a perceived conflict of interest arising from investigating accountants being subsequently appointed as receivers.

The report noted that “Some, who submitted to the Inquiry, are concerned about the investigating accountant’s ability to recommend a course of action, such as a receivership, and then being appointed by a creditor to that role.”

To address the concern the report recommended:

(R10) “Banks must implement procedures to reduce the perceived conflict of interest of investigating accountants subsequently appointed as receivers. This can be achieved through a competitive process to source potential receivers and by instigating a policy of not appointing a receiver who has been the investigating accountant to the business.”

Those whose responses to R10 argued against the mandatory appointment of a ‘stranger’ because of the additional costs and disruption to the management of the business will be interested in a recent decision of the Federal Court: Walley, in the matter of Poles & Underground Pty Ltd (Administrators Appointed).

It appears (it is not completely clear from the judgement) that it was the directors of a company who appointed as administrators two restructuring & turnaround practitioners that had previously conducted an independent business review for the company’s bank.

Prompted by a question at a creditors meeting the administrators (by then the liquidators) had recognised a potential conflict of interest, and quite properly applied to Court for directions, at their expense.

Noting that the liquidators had already repaid their fees for the IBR engagement, and that no creditor had raised any objection, the Court allowed the liquidators to continue in that role because the liquidators’ ‘substantial knowledge’ of the affairs of the company was ‘likely to assist in the efficient conduct of the liquidation’ and would be a benefit to creditors as a whole.

Senate Inquiry into Superannuation Guarantee non-payment: Report released

The Senate Economics References Committee Inquiry into Superannuation Guarantee non-payment report was released on May 2nd 2017.

The committee recommended that “the government consider amending the
Corporations Act to ensure that the priorities in section 556 apply during all
liquidations, regardless of whether the business being liquidated was operated
through a trust structure” (for background see my submission, here).

If implemented as recommended that will address the priority of unpaid SGT, and it will also address the current gaps in the coverage of employee entitlements (ie amounts outside the FEG scheme caps). It should also significantly improve FEG’s ability to recover amounts paid to trust employees, from their former employers.

ARITA made a submission and appeared before the inquiry. Other recommendations reflecting ARITA input include:

R20 – Consideration of a Director Identification Number scheme.
R22 – Allowance of nominal interest on SGC up to the date of liquidation.
R23 – Enabling insolvency practitioners to pay outstanding SG contributions directly to an employee’s superannuation fund.
R31 – expansion of the Single Touch Payroll system to all businesses.

Of course there is no guarantee that these recommendations will result in legislation – but it is very encouraging to see them under serious consideration.

The 2017 Inquiry impacting Restructuring and Turnaround professionals

The latest inquiry to examine the conduct of Restructuring and Turnaround practitioners – the sixth in the last seven years – is a Senate Select Committee Inquiry, initiated on Thursday 16^th February.

The stated purpose of the Select Committee on Lending to Primary Production Customers is to ‘inquire into and report on the regulation and practices of financial institutions in relation to primary production industries.’

The first term of reference deals with financial institutions:

(a) the lending, and foreclosure and default practices, including constructive and non-monetary default processes

Whilst the second deals with the role of restructuring and turnaround professionals (as well as valuers):

(b) the roles of other service providers to, and agents of, financial institutions, including valuers and insolvency practitioners, and the impact of these services

The 2017 Inquiry has a narrower focus on primary producers, but otherwise there is significant similarity to the terms of reference of the 2015 Parliamentary Joint Committee Inquiry into The Impairment of customer loans, which examined:

(c) practices of banks and other financial institutions in Australia using non-monetary conditions of default to impair the loans of their customers, and the use of punitive clauses such as suspension clauses and offset clauses by these institutions;

(d) role of insolvency practitioners as part of this process;

If ‘the same question’ is in fact being asked again, then the restructuring and turnaround profession needs to think carefully about how we respond.

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 Carnell Report – implications for turnaround and restructuring professionals

[First published on Linkedin.com on February 3, 2017]

The report from the Small Business Loans Inquiry conducted by the Australian Small Business and Family Enterprise Ombudsman (‘the Carnell Report’) available here includes some recommendations that will be relevant to restructuring and turnaround practitioners.

The report recommends that from 1 July 2017:

Borrowers should be provided with a copy of instructions given to an investigating accountant, and a full copy of the final report.
Banks should not appoint a practitioner as a receiver if the practitioner has previously undertaken an investigative accountant’s review.
Banks should select receivers through a competitive selection process.

The report suggests that there should be a requirement for receivers to provide a ‘flow of information’ to keep company directors ‘abreast of developments’ – although there was clear recognition of ‘legitimate concerns and limitations on the receiver releasing information around certain asset sale activities’ – but there was no specific recommendation addressing this point.

It appears that the intention is that these recommendations be implemented via changes to the Code of Banking Practice – which would avoid the need for legislation.

In addition, the report recommends that external dispute resolution schemes be expanded to cover investigative accountants and receivers (as well as bank valuers). It would seem likely that an expansion of EDR schemes to cover third parties would require legislation.

The extent of input from the turnaround and restructuring professionals who undertake such assignments is not clear from the report.

The inquiry was part of the Government’s response to the Parliamentary Joint Inquiry into Impaired Loans. Similar issues, albeit on a broader scale and of a more significant nature, were raised in the UK, as discussed here.

Update: For further developments on the EDR scheme please see Consultation on the Industry wide EDR for Business Credit disputes: AFCA