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.’

Restricting Related Creditor Voting Rights

One of the worst problems caused by the Insolvency Law Reform Act 2016 – the ability to remove an insolvency appointee without Court scrutiny – appears to have been partly addressed by changes to the Insolvency Practice Rules effective from 7 December 2018.

It will no longer be possible for related parties to buy debt cheaply and then vote the full face value to replace an external administrator.  Instead, the related parties’ voting rights will be limited to the amount paid to acquire the debt.

This will be similar to the long standing position in personal insolvency – however in personal insolvency the restriction to the amount paid to acquire the debts applies to all debt sales, not just debt acquired by related parties.

Replacement by non- related creditors

There is still no Court scrutiny on liquidator replacement, so those unrelated creditors who work together to replace liquidators seen as too aggressive in pursuing preferences will not be affected by the changes.

Is ‘assignment’ broad enough?

The rules only apply to assignment of debt.  In modern financial practice there are a range of ‘sub-participation’ and risk sharing arrangements which may achieve a similar outcome but perhaps be outside the scope of the rules as drafted.

Impact on debt traders

Some active debt traders will take equity positions as well as acquiring debt.  In some cases that could mean that they have become a ‘related party,’ with the consequence that their voting rights will be very different under a scheme of arrangement (i.e. intact) compared to a deed of company arrangement (reduced).

Some market participants will recognise the differential treatments, and adjust their strategies to take advantage.  The form of restructuring vehicle may become the next battlefield!

What’s next?

It’s pleasing to see an effort made to fix some of the damage done by the ILRA.  Hopefully work is now underway to fix the other problems such as the  impractical cash handling rules and the odd requirement for registered liquidators to have bankruptcy experience, to name a few.

The impact of draft anti-phoenix measures on restructuring and corporate turnaround

‘Phoenixing’ – the process by which the assets of an insolvent company are transferred to another company so that creditors miss out – is a significant problem in Australia.  On budget night the government announced several headline anti-phoenix measures, with greater detail provided last week through the release of draft legislation for consultation.  Although the measures are aimed at those who act unscrupulously, they have a wider ambit, and there is the potential for them to have a broader impact if they do become law.

Overview of the measures

There is more detail here but in summary, the key concept is a ‘Creditor Defeating Disposition’ (‘CDD’).  A CDD is a transaction entered into either:

  • when the company was insolvent; or
  • in the twelve months prior to the company entering formal insolvency administration;

which prevents, hinders or significantly delays the property of a company from becoming available for the benefit of creditors.

If there is a CDD:

  • Officers whose conduct resulted in a CDD will commit an offence.
  • Those involved in ‘procuring, inciting, inducing or encouraging’ a company to engage in a CDD will commit an offence
  • Both ASIC and the Courts will have power to make orders to reverse the transaction to recover the property.

A CDD will not be voidable if the sale was for market value consideration, or was entered into by a liquidator, under a deed of company arrangement or scheme of arrangement, or as part of a Safe Harbour restructuring plan.

Market value

‘Market value’ sounds like an objective measure but in the absence of a public sale process it will be assessed retrospectively.  By comparison, the duty of care imposed upon receivers requires them to conduct an effective sale process but it does not mandate an outcome.

Safe Harbour is a defence

Specific protection for transactions entered into by liquidators and deed administrators is obvious and as expected.  A similar exemption for companies in Safe Harbour (more detail here) is a sensible and consistent policy alignment.

Application to transactions with third parties

Many would think of a phoenix transaction as a sale to a related party, but significantly it seems that the draft legislation has the potential to apply to sales to third parties, if the proceeds of sale are ‘diverted.’

The type of transaction described in an extract from hypothetical email from a CFO to a CEO highlights some of the real world issues:

We have a received an unsolicited offer for our New Zealand operations.  The offer is less than I think we would get if we took the business to market but that would take another six months, and a sale now would leave us one less headache to manage, so I recommend that we accept….

If those sales proceeds are used to pay the trade creditors of the New Zealand business, and the Australian business collapses a month later with employees unpaid, should that transaction amount to a CDD which can be reversed?  Is that email the ‘smoking gun’ which might expose directors and advisers to the transaction to the risk of prosecution?

Potential purchasers who believe a vendor to be under financial pressure may be concerned about whether they can take clear and irreversible title to business assets, or whether there may be a risk of later claw back.  Such a purchaser has a theoretical access to the general good faith defence that is available to purchasers without ‘knowledge of insolvency’, but they may need to think carefully about when exactly a suspicion about financial stress might amount to ‘knowledge of insolvency.’   Some potential acquirers may decide they need more information, or details of how the funds will be dispersed, and some may decide that it is safer to walk away and wait for a formal insolvency to deliver clear title.

Conclusion

Measures to address the serious problem of phoenixing are appropriate, and alignment with Safe Harbour measures is commendable. However, phoenixing by its very definition involves transaction with related parties. Extending the ambit of anti-phoenix measures so that they also apply to transactions with third parties risks the ability of stressed companies to promptly execute genuine sales, and should be implemented with great care.  If anti-phoenix measures need to be applied beyond those currently defined as ‘related parties,’ perhaps a better approach might be to broaden that definition.

Anti-phoenix measures open for consultation

On 16 August the government released draft legislation intended to implement the anti-phoenix measures that were announced on budget night.

The legislation does not include the widely supported idea of a Directors Identification Number – but that is as expected, the DIN was the subject of an earlier consultation process which ended on 16 August.

The draft legislation does not go beyond the measures announced on budget night so in that sense there are no surprises. but there are some noteworthy aspects of the implementation of those headline measures.

A new type of voidable transaction

The legislation will create a new type of voidable transaction, a ‘Creditor Defeating Disposition’ (‘CDD’), defined as a transaction which has the effect of:

(a) preventing the property from becoming available for the benefit of the company’s creditors in the winding‑up of the company; or

(b) hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding‑up of the company.

which will be potentially voidable if one of the following applies:

(i) the transaction was entered into, or an act was done for the purposes of giving effect to it, when the company was insolvent;

(ii) the company became insolvent because of the transaction or an act done for the purposes of giving effect to the transaction;

(iii) less than 12 months after the transaction or an act done for the purposes of giving effect to the transaction, the start of an external administration (as defined in Schedule 2) of the company occurs as a direct or indirect result of the transaction or act;

The absence of any requirement to prove insolvency in relation to transactions entered into in the twelve months before formal insolvency may assist liquidators – although they may still need to disprove solvency if the other party claims the good faith defence.

Administrative Recovery process

The proposed amendments will create a regime by which a liquidator can ask ASIC to make administrative orders to recovery property that was transferred as a result of a CDD.

Liquidators will welcome a recovery regime which has the potential to avoid the costs and delays of Court processes, but there is little detail here about what ASIC’s own processes will be.  For example, the legislation does not seem to require ASIC to allow the other party a ‘hearing’ – but ASIC may form the view that it should.

Also worth noting is that a failure to comply with such an administrative order will expose a party to the civil penalties and offence regimes, which should assist with a more cost-effective and timely recovery.

New Offences

The draft legislation will introduce new offences for:

  • Officers who engage in conduct that results in a CDD.
  • Non-compliance with administrative orders.
  • ‘Procuring, inciting, inducing or encouraging’ a company to engage in CDDs.  This is a measure specifically targeting those Pre-insolvency Advisers who actively promote phoenixing.

These new offences go part of the way, but ASIC will need to have the resources to investigate potential offences and prosecute where appropriate.  Today ASIC is able to act on only a very small proportion of the potential offences that liquidators currently report, and so adding to the already long list of potential offences without an appropriate enforcement budget will have little real impact.

Safe Harbour a defence

Effective 16 September 2016 there is a ‘Safe Harbour’ (discussed here) which protects directors from insolvent trading claims.  The CDD recovery regime will exclude transactions which are entered into whilst a company is within that ‘Safe Harbour’ – a commendable policy alignment.

Other changes

The proposals also include:

  • A 28 day limit on backdating director resignations.
  • Prohibition on director resignations that would leave the company with no directors.
  • Related parties who acquire debt can only vote for the amount paid – not the face value of the debt – when voting on resolutions dealing with the appointment, removal or replacement of an external administration.
  • The current Director Penalty Regime will be extended to cover GST, luxury car tax and wine equalisation tax.

Details of the proposals can be found here.  Submissions are due by 27 September 2018.

Ipso Facto regulations: now with a ‘mega-project’ exemption

The ipso facto regulations – more technically, the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 – were released on 22 June 2018.

The regulations represent the last stage of reforms that are intended to limit the availability of so-called ipso facto clauses (aka ‘insolvency event’ or ‘termination for insolvency’ clauses, and discussed in more detail here), providing a list of exemptions: contracts to which the reforms will not apply.

Such clauses allow a party to terminate a contract if the other party becomes insolvent – even if there is no other default – making it harder to restructure a business that enters formal insolvency administration.

Those responsible for updating existing contracts (which disappointingly will remain unaffected by the ipso facto reforms) will say that the eight-day gap between the release of the regulations and their taking effect will leave very little time to make those changes, but perhaps that was intended.

SPV exemption tightened

The draft regulations included a very wide exemption for ‘a contract, agreement or arrangement of which a special purpose vehicle is a party.’  Sensibly this has been narrowed to securitisation, public/ private partnerships and project finance arrangements.

National Security

The final version of the regulations adds an exemption for contracts relating to ‘Australia’s national security, border protection or defence capability.’ 

Such an exemption suggests that the ipso facto reforms are seen by some as having the potential to threaten Australia’s current security arrangements and capability, when in fact they could equally operate to ensure that current security arrangements are maintained!

‘Mega-Projects’

The final version also adds a five-year exemption for construction contracts where the total payments ‘under all contracts, agreements or arrangements for the project’ is more than $1 billion. 

ipso facto racehorse
Retired racehorse Ipso Facto is unperturbed by the mega-project exemption

There is no mechanism to ensure that sub-contractors to such mega-projects will know whether the key billion dollar threshold will be reached, and whether the exemption will therefore apply.  The consequences of acting in ignorance of such an exemption would seem problematic, but thankfully in practice there will be only a small number of such mega-projects.

 

 

The final version of the regulations is available here.

 

 

 

Safe Harbour Restructuring Plans: Would the Carillion turnaround plan pass muster?

The investigation in the UK  into the collapse of Carillion Plc by a House of Commons select committee provides rare public access to the restructuring plan for a large company.  Would the plan meet the requirements of Australia’s Safe Harbour regime?

The Collapse of Carillion

Carillion was a UK-headquartered construction company with worldwide operations employing 43,000 staff.  It was placed into liquidation on 15 January 2018 following the UK government’s refusal to provide emergency funding,

With only £29 million in cash and creditors of more than £4.6 billion the position was so dire that – according to the select committee report – the company was forced into liquidation because it could not find a administrator prepared to take on the job in light of uncertainty about whether there was enough money to cover their costs.

Investigations into the conduct of the directors and auditors by the Insolvency Service, Financial Reporting Council, Financial Conduct Authority, and the Pensions Regulator are underway.  In addition, the House of Commons Work and Pensions Committee launched an inquiry within a fortnight of the collapse.

As discussed here, the 16 May committee report (available here) is scathing in its criticism of directors, auditors, and regulators.  The Inquiry has also made public a large number of documents which would not ordinarily be available – most notably including the 100 page turnaround plan.

Australia’s Safe Harbour regime

Australia’s severe insolvent trading laws make company directors personally liable for debts incurred when a company is insolvent.

By comparison the UK’s ‘wrongful trading’ regime imposes liability if directors ‘knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation’ and did not take ‘every step with a view to minimising the potential loss to the company’s creditors.’

The Australian Safe Harbour regime provides company directors with protection against insolvent trading claims but only if their conduct and actions, and the conduct of the company, meet minimum standards.

Would the Carillion plan meet the Australian Safe Harbour requirements?

The plan does articulate an appropriate objective that is clearly a better outcome than liquidation, and it does identify the use of a big 4 accounting firm as an appropriately qualified adviser.

However the plan is silent about any steps the directors had taken to conclude that they are properly informed about the financial position of the company, or that they proposed to take to stay informed.  The document identifies a number of actions that have been taken, but it doesn’t really set out a future action plan, identify those responsible for each action, or set milestone dates.

Those omissions may not be fatal – perhaps there were other documents that provide appropriate detail.  The biggest difficulty that the directors would have in meeting the Australian criteria is that the forecasts in the plan exclude employee pension contributions from the company budgets, and paying employee entitlements ‘as they fall due’ is a key requirement of the Australian regime.

Too little, too late

Of course the Carillion turnaround plan was never designed to meet the Australian requirements, so it’s not a huge surprise that it doesn’t.  But nonetheless, that ‘failure’ highlights that it is essential for directors seeking to access safe harbour to ensure that they have a plan that is fit for that purpose.

In the case of Carillion, history shows that the plan was too little, too late: the company was in liquidation within a fortnight of the plan being finalised.


First published here

Two strikes? Queensland-only anti-phoenix regimes

As well as regulating labour hire, Queensland’s new Labour Hire Licensing Act  includes an anti-phoenix element.  This is not Queensland’s first use of industry-exclusion to address phoenixing, a similar structure was used in the 2017 Building Industry Security of Payment legislation – but the ambit of the labour hire regime is far broader than many would anticipate.

Building Industry Fairness (Security of Payment) Act 

As discussed in more detail here, the Building Industry Fairness (Security of Payment) Act 2017 implemented a range of measures aimed at protecting sub-contractors from the risk of non-payment.

The anti-phoenix element arises from exclusion from the building license regime if an office bearer of a company acted as a director or secretary of a construction company that entered into insolvency administration in the prior two years.

Labour Hire Licensing Act 2018

The Labour Hire Licensing Act 2018 which commenced on 16 April 2018 to introduce a regime for registration of labour hire participants likewise includes an anti-phoenix element.  The requirement that all directors of a company must be ‘fit and proper persons’ is hardly unusual, but the criteria includes two that are particularly focused on insolvency, referencing prior directorship of a company that:

  • entered into a formal insolvency administration.
  • has failed to pay tax or superannuation due to its employees.

The changes are noteworthy because the LHLA has a reach that is far broader than would be anticipated from its name.  The regime is not limited only to external labour hire arrangements, it appears that it extends to internal arrangements that are very common in corporate groups: the use of a designated payroll company.  As a result it seems that a group employer in any industry – whether headquartered in Queensland or not – will need to register and comply with the regime in respect of any Queensland employees.

At a time when the Federal Government is implementing changes intended to reduce the stigma of business failure, it seems that the Queensland government is heading in the opposite direction – further expanding a ‘one-strike’ regime that will restrict those involved in a financial failure from acting as company directors.

No doubt the Federal Government’s Anti-Phoenix Taskforce is aware of the Queensland approach and will be watching the outcome with great interest.  If the industry-exclusion model does appear to provide a more effective means to deal with the problem of phoenixing, there may be moves to implement it more broadly.