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.

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

Cozy relationships? Not much uncovering required!

Last week the Australian Financial Review reported the Small Business Ombudsman Kate Carnell as having said that the Banking Royal Commission had missed an opportunity to uncover ‘a cozy relationship’ between banks and the administrators and receivers who work for them.

Most service providers and suppliers work very hard to have a good relationship with their customers, and restructuring and turnaround professionals are no different – but presumably the ASBFEO is concerned with something improper.

Significantly, the ASBFEO Act requires (section 69, here) the Ombudsman to transfer matters to another agency if:

‘the request could be more conveniently or effectively dealt with by the other agency’

ASIC has both the legal powers of compulsion and the technical expertise to investigate the Ombudsman’s concerns. More importantly however, ASIC already receives copies of the Declaration of relevant relationships and declaration of indemnities (DIRRI)* which a registered liquidator must prepare on each occasion he or she is appointed as liquidator or voluntary administrator. The DIRRI – which is also given to creditors – provides considerable detail about an appointee’s relationship with those who appointed him or her, as well as relationships with significant creditors.

That wealth of public disclosure means that neither ASIC nor the Royal Commission would need to do a great deal of ‘uncovering’ to understand the nature and extent of the relationships between banks and the restructuring professionals they appoint, were either to decide that an investigation was warranted.

All of which stands in marked contrast to the situation as regards pre-insolvency advisers: no licensing, no regulation, no regulator, no standards, and no disclosure about their relationships!

*The DIRRI is now an online form accessible via a portal available to registered liquidators, but for those interested the ARITA Code of Practice includes a template (at page 100).

Restructuring & Turnaround professionals and the Royal Commission

In December (here) I suggested that the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (‘FSRC’) had the potential to become the seventh inquiry in the last seven years to examine the conduct of Restructuring and Turnaround practitioners.

The third round of hearings which commence on 21 May specifically allocates time (the agenda is here) to considering the “approach of banks to enforcement, management and monitoring of loans to businesses.”

On 7 May the FSRC published its 10th background paper: Credit for small business – An overview of Australian law regulating small business loans. The paper does extremely well to condense a very broad subject into 41 pages but surprisingly makes no mention whatsoever of the PPSA – which is surely significant, if only for the fact that it imposes a duty comparable to section 420A.

Two days later the FSRC released background paper 11 (both papers are available here) prepared by Treasury at the request of the Royal Commission to provide an “overview of reforms to small business lending.” There is likewise no mention of the PPSA regime, but the paper does include comment about the ILRA legislation, as well as brief reference to safe harbour and ipso facto.

There have not yet been any reports of Restructuring & Turnaround professionals being asked to appear – but we may be getting closer.

Receivers: escaping the One Nation ‘net’?

On 28 March Pauline Hanson’s One Nation party proposed amendments that were intended to make receivers and managers, investigative accountants, and valuers, all subject to the Australian Financial Complaints Authority scheme.

AFCA is a single external dispute resolution scheme that will replace three existing schemes: the Financial Ombudsman Service, the Credit & Investments Ombudsman, and the Superannuation Complaints Tribunal, discussed in more detail here.

The ‘technical difficulties’ with the PHON proposals, referenced by Senator Cameron in speaking against the proposal, might include that:

Valuers and Investigative Accountants only provide opinions – they do not ‘take action,’ and so any redress for wrongful action taken by others should not be borne by them.
In any event, it would be quite difficult to develop a process by which an opinion could be mediated or arbitrated.
AFCA would need to develop and maintain very significant technical skills to undertake a meaningful assessment of the work performed by valuers, restructuring and turnaround professionals.

Senator Fierravanti-Wells rebuffed the PHON assertion that receivers were ‘largely unregulated’ – noting that receivers were ‘registered with and directly overseen by ASIC, the companies regulator.’ As discussed here, ASIC has allocated $10.196m to the regulation of 711 registered liquidators – almost double the amount it spends regulating six times as many registered auditors.

The proposal was defeated comfortably: 43 – 2. But the discussion (copy below) highlights that the technically complex insolvency regimes can be confusing to outsiders, and clearly demonstrates the challenges for the restructuring & turnaround profession as we try to educate the general community about the problems caused by ‘non-mainstream’ and pre-insolvency advisers.

The hansard proof is available here and is reproduced below (with some minor formatting changes):

“Senator GEORGIOU (Western Australia) (17:34): On behalf of Pauline Hanson’s One Nation, I move amendment (1) on sheet 8383:

(1) Page 45 (after line 26), after Schedule 2, insert:

Schedule 3—Amendments relating to the appointment of receivers and valuers in the AFCA regime

Corporations Act 2001

1 After paragraph 1051(2) (a)

Insert:

(aa) the membership of the scheme is open to every person who is appointed to act in the capacity of a receiver and manager, investigative accountant or a valuer, of an entity mentioned in paragraph (a); and

2 Application

The amendment made to the Corporations Act 2001 by this Schedule applies in relation to the appointment of receivers, investigative accountants or valuers made after the commencement of the item.

Senator CAMERON (New South Wales) (17:34): Labor will not be supporting this amendment. This amendment would amend the legislation regarding the Australian Financial Complaints Authority. When the Treasury Laws Amendment (Putting Consumers First—Establishment of the Australian Financial Complaints Authority) Bill 2017 was debated, Labor noted that the bill would unfortunately not make much difference in relation to the way banking disputes were handled. The average banking customer would not see much difference between the Financial Ombudsman Service and the government’s Australian Financial Complaints Authority once it is established. We noted that, in relation to banking disputes, the bill was basically a rebadging exercise and the name ‘authority’ was a misnomer. This amendment seeks to include valuers, investigating accountants and receiver managers in the AFCA scheme. However, stakeholders, including the Institute of Public Accountants, in their reply to the Ramsey review, raised a number of technical issues with regard to including such third parties in the AFCA framework. While we cannot support this amendment today, we acknowledge concerns about the conduct of banks, which is why we have fought so hard for a royal commission.

Senator GEORGIOU (Western Australia) (17:36): This amendment includes valuers, investigating accountants and receiver managers in the Australian Financial Complaints Authority, AFCA, scheme. Bank appointed valuers, investigating accountants and receiver managers act in a largely unsupervised environment. Misconduct in this sector has been raised in numerous past government and Senate inquiries. The Australian Small Business and Family Enterprise Ombudsman has recommended changes, and so have various other inquiries.

If we are serious about stopping white-collar and banking misconduct in Australia, we should support these changes, and we call for your support to do this with us. The problem is that the new AFCA, in its current form, will not investigate misconduct by bank appointed valuers, investigating accountants and receiver managers. The Financial Ombudsman Service, FOS, will not investigate cases of misconduct by valuers or accountants or receivers, even when the bank is aware that there has been misconduct. AFCA will be the same under the existing proposals. So, in some respects, it is a toothless tiger. As an example, I have a letter from FOS showing they will not investigate because, once the receiver is appointed, the receiver acts as an agent for the company and not the person who appointed it. In other words, the bank could appoint the most corrupt and incompetent receiver and be aware of misconduct and yet be totally unaccountable. The ombudsman cannot help unless the bank gives the regulator permission to investigate the crime. In the example submitted, Bankwest informed FOS that it is not prepared to waive the issues that may exist to enable a fresh dispute to be considered by FOS. So, if the bank wants to prevent an investigation, it can do so with a loophole in the legislation.

To add insult to injury, if the damage caused by the misconduct is greater than the limit of FOS, it can fall outside the jurisdiction. This limit could encourage greater misconduct. To avoid investigation, a bank or the agent has to ensure that they create a level of damage above the limit. With the banking royal commission now underway and further cases of misconduct being exposed, now is the time to strengthen legislation and regulate this troubled industry. The Australian Small Business and Family Enterprise Ombudsman has confirmed in discussions that there is very little regulation on these banks and appointed entities. They admit that, in some cases, receivers just refuse to provide details of their work to the owners of companies they are appointed over. They often charge hundreds of thousands or millions of dollars for their work, with no accountability for what they have done. We have seen cases where receivers have employed the same lawyers the banks employed and then they act for the companies they are the receiver over—a conflict of interest in itself—and then they refuse to disclose to the owners and companies what the lawyers have done.

I refer to a letter from the Australian Small Business and Family Enterprise Ombudsman to Senator Jane Hume, Chair of the Senate Economics Legislation Committee, dated 29 September 2017. It reads: ‘Despite the welcome step of establishing AFCA, we believe there are important considerations which are still missing from the jurisdiction of the proposed authority, namely the role of third party agents such as valuers, investigating accountants and receivers.’ The ombudsman’s inquiry report into small-business loans dated 12 December 2016 made a series of recommendations, including recommendation 13 that:

External dispute resolution schemes must be expanded to include disputes with third parties that have been appointed by the bank, such as valuers, investigative accountants and receivers …

Current state

The jurisdiction of the FOS does not allow consideration of disputes:

(a) between a small business and a third party such as valuers, investigative accountants and receivers appointed by the bank … … …

The only alternative for small business in these cases is the court system, yet:
small businesses do not have the expertise to challenge banks through the court system
there is a substantial asymmetry of power between banks and small businesses
small businesses do not have the financial capacity to hire expert legal advice to help them balance this asymmetry of power.

Recommended change

That the independent EDR – external dispute resolution one-stop-shop – that is, AFCA – have jurisdiction to consider disputes between small businesses and banks, where disputes relate to the conduct of third parties appointed by banks.

This clearly indicates that our amendments need to be supported. The Australian Small Business Ombudsman said:

Many problems identified during the Inquiry relate to the conduct of third parties appointed by banks.
Currently, there is no realistic way to seek redress for these actions. ASIC does not take action on behalf of individuals and the court system is not a viable alternative.
The lack of accountability must be addressed.

The Australian small business ombudsman would support legislative changes to the AFCA to make banks responsible for the conduct of their appointed valuers, investigative accountants and receivers.

The LNP have argued that these changes are unconstitutional. However, the Senate Procedure Office have said they can’t see any constitutional problems with this amendment and they believe it is compatible with corporations law. Also under section 51, heads of power, banks, financial institutions and service providers are covered federally. We have run this by the Parliamentary Library. They have advised that our amendment is a solution to the issues raised by the ombudsman and they cannot see any constitutional reason why it can’t work. The government objects to this amendment on the basis that it is unconstitutional. We have repeatedly asked the government to identify any reasons that this amendment may be unconstitutional and they have failed or refused to clarify these reasons. The only explanation can be that this amendment in fact is constitutional.

This amendment needs to be supported if we want to help those affected by bank misconduct. Given the bank and receiver misconduct covered by numerous past government inquiries and the misconduct now being revealed by the banking royal commission, we request the Senate support the proposed constructive changes to bring this largely unregulated sector under control. This chamber should take the word of the Parliamentary Library, the ombudsman and the Senate Procedure Office ahead of a government who would rather protect their banking mates.

Senator FIERRAVANTI-WELLS (New South Wales—Minister for International Development and the Pacific) (17:43): The government will not be supporting this amendment. Valuers and accountants are regulated under state and territory based professional conduct frameworks. Receivers and liquidators are registered with and directly overseen by ASIC, the companies regulator. They are subject to the regulatory framework contained in the Insolvency Law Reform Act. The new AFCA scheme provides an out-of-court dispute resolution scheme for consumers who are in dispute with a licensed financial product or service provider. Valuers, accountants and receivers are not licensed providers of financial products or services to retail clients.

Senator HANSON (Queensland) (17:44): Everyone has been calling for a royal commission into the banking sector, and the coalition government have actually instigated that. Labor say they’ve been calling for a royal commission into the banking sector, as have the Greens and One Nation and, I believe, Senator Hinch and others, and we were very pleased to see it happen. Now we are talking about the valuers and liquidators involved in this. In the Senate inquiry that One Nation had last year, it came out that they played a very big role in the devastation that shut down a lot of people in the farming sector who lost their properties, yet nothing was done about it.

We are now proposing an amendment to include those people in this bill. We have confirmation that it can be done under this bill. If Labor are so much for all the battlers out there, why don’t they want some accountability to ensure that these people are taken to task for their actions? Why aren’t Labor prepared to stand up for this? This is an amendment that calls for accountability, so that they cannot just do what they want to do and destroy people’s lives. The government, from the minister’s office, is saying that this is unconstitutional. We have asked: which part of the Constitution? Absolute silence! Nothing has come back to us. They can make a comment like that, but they can’t back it up with evidence.

They come under the Corporations Act—and that’s fine—but there is no reason why either side cannot pass this amendment. Do you really want to stand up and ensure accountability in this country from the banking sector? They hire these liquidators and receivers. They don’t pay for them, though; it’s the people who are going under who have to pay the bills for this. They rack up hundreds of thousands of dollars, and that’s why people lose their properties. But you sit here in deafening silence and you’re not prepared to make them accountability to the public. You sit there and say that you’re for the battlers and you call for a royal commission into the banking sector. Is this Labor? Is this what you really want?

Labor constantly accuses One Nation of being out there grandstanding and not being prepared to stand up for the battlers and the farmers. Yet, here we are, moving an amendment to legislation that is going to be so beneficial to people in this country. It will make them accountable, and Labor just sits there and does absolutely nothing about it. You know who’s really fighting for the people of this country, the battlers. It’s One Nation.”

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.

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.

Building a better buggy whip? The Debt Agreement Reform legislation

On 7 December the Senate referred an exposure draft of the Bankruptcy Amendment (Debt Agreement Reform) Bill 2017 to its Legal and Constitutional Affairs Legislation Committee.

From their introduction in 1996, Part IX Debt Agreements have provided individuals with a low-cost alternative to bankruptcy. Part of the cost saving structure was a mechanism that operated without the involvement of Bankruptcy Trustees, and it seems that it was originally anticipated that Debt Agreements would be implemented and managed by debtors themselves, their friends or relatives, or by not-for-profit financial counsellors.

In fact, commercial operators leapt into the vacuum, and a new industry was created. Probably in part due to aggressive promotion by those commercial operators, as Michael Murray has identified, today Part IXs almost rival bankruptcy in popularity.

There was significant reform in 2007, with changes intended to adjust the regime to reflect the widespread involvement of commercial operators. These latest reforms (draft legislation available here) some ten years later will further regulate those commercial operators, but there are other, significant changes.

Access to the Part IX process

Probably the most important change is a very significant expansion of access – the maximum asset limit will be doubled, to $223,350.

Restrictions on debtor contributions

Another significant change is the introduction of limits on debtor contributions, with a limit on the time frame over which payments can be made – 3 years – as well as a percentage limit (not yet set) referenced against the debtor’s income. Those limits will apply to original proposals and any later variations. The Official Receiver will also have a new power to reject proposals even within these limits if they would cause ‘undue hardship’ to the debtor – although this is to be used only in ‘exceptional circumstances.’

Alignment to bankruptcy

There are a number of changes that will align the regulation of Debt Agreement Administrators to the regulation of Bankruptcy Trustees. Debt Agreement Administrators will be required to:

Consider whether a debtor has committed any offences under the Bankruptcy Act and, if so, refer the matter to the appropriate authority.
Follow the same funds handling procedures as Bankruptcy Trustees, with failure to constitute an offence.
Maintain ‘proper books and records’ to the same standard as Bankruptcy Trustees, with failure to constitute an offence.
Obtain and maintain appropriate professional indemnity insurance to the same level as Bankruptcy Trustees.
Refrain from charging expenses to the debt agreement fund unless there is specific prior disclosure in the Debt Agreement.

The Inspector-General’s investigation and inquiry powers will be extended to encompass ‘any conduct of a Debt Agreement Administrator’ and the grounds on which the IG can issue a ‘show cause’ notice – seeking a written justification of continued registration – will also be expanded.

Brokers, referrers, and conflicts of interest

The explanatory memorandum refers to concerns that ‘an unscrupulous administrator is in a position to exploit a debtor’s lack of knowledge,’ and several measures appear intended to address this:

Proposed Administrators will be required to disclose broker or referrer information to the debtor, and creditors.
The Debt Agreement Administrator and related entities will be unable to vote on the acceptance of the proposal, or any resolution to modify or terminate the debt agreement.
It will be an offence for a Debt Agreement Administrator to provides creditors with an incentive to vote in a certain way.
Debtors will be able to seek termination of the debt agreement where an administrator has committed a breach of duty.

Professionals only!

The industry will be fully professionalised – only a registered Debt Agreement Administrator or registered Bankruptcy Trustee will be able to administer a debt agreement – but this is really only a symbolic change, because in practice these are the only parties who do such work now.

A better buggy whip?

The changes impose additional work on Debt Agreement Administrators, most notably the requirement to investigate and report offences. That additional work will probably translate to additional costs, which will be charged to the deed fund and ultimately be borne by creditors. Whilst that represents a shift away from the low cost objective that led to the introduction of Part IX, it is otherwise hard to argue against changes which do no more than align to the standards currently imposed on Bankruptcy Trustees.

But however worthwhile the changes are, they may have limited practical impact. If the one-year bankruptcy discussed here is implemented then it is hard to see why many debtors would bother with a Debt Agreement. It seems likely that the unscrupulous ‘non-mainstream advisers’ will tell their clients that they can simply ignore any efforts that a bankruptcy trustee will make to assess and collect income contributions in years two and three – which means that a twelve month bankruptcy will be not only far quicker but also far ‘cheaper’ than a three-year debt agreement.

Submissions

The committee is seeking submissions by 16 February to gather stakeholder feedback on ‘issues of concern’ and to allow the committee ‘to consider expert views on impacts,’ and is due to report by 19 March 2018.

Update: The first (and only, at the date of writing) submission to the inquiry, by Vivien Chen, Lucinda O’Brien and Ian Ramsay, provides a link to their thoughtful & structured analysis on insolvency reform. ‘An Evaluation of Debt Agreements in Australia’, available here.

Report handed down: Senate Inquiry into Lending to Primary Production Customers

Background

On December 6th the Senate Select Committee on Lending to Primary Production Customers released its report, available here, after gathering evidence at eleven separate hearings around Australia.

Established in February 2017 to ‘inquire into and report on the regulation and practices of financial institutions in relation to primary production industries,’ the terms of reference of the Committee included:

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

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

As discussed in Receivers: are “crooks”? and Receivers: are “inhuman”? much of the early evidence was highly critical of the role of restructuring and turnaround professionals. However, as explained in “Non-mainstream advisers” and A “War zone”?, in later hearings some of the practitioners whose work was the subject of the early criticism had the opportunity to present the other side of the story, and also provide evidence about the damage caused by some of the non-mainstream advisers.

Twenty seven recommendations

The final report includes twenty seven recommendations which address the following areas:

National FDMA scheme

As universally expected and supported, the report calls for a National Farm Debt Mediation system, based on the NSW scheme. For reasons not explained however, it is proposed that scheme will only apply to loans less than $10m, which is disappointing.

Changes to the Code of Banking Practice

The reports recommends specific changes to:

Apply the responsible lending obligations contained in the National Consumer Credit Protection Act, and Unfair Contracts terms protections, to primary production loans of less than $10 million.
Oblige lenders to ‘commence dialogue’ with a borrower at least six months prior to loan expiry.
Ensure that lenders provide farmers with full copies of signed loan applications and ‘other relevant documents.’
Keep families on farms during a sale process, with vacant possession sought only in ‘extenuating circumstances.’

Who should the Code of Banking Practice apply to?

Recommendation 6 proposes that the CoBP be incorporated in loan contracts – but this is already the case for bank lending. It may be that the committee intended to extend the CoBF to non-bank lending, but this recommendation is not as clear as it might be.

Changes to bank procedures

The report recommends various changes to banks’ internal processes to:

Provide at least 90 days notice where a bank has decided that it will not further extend a loan.
Similarly, provide 90 days notice before acting on a default – albeit this would become superfluous if a National FDMA scheme was in place.
Prevent banks from making ‘fundamental, unilateral changes’ to loan terms.
Forbid bank staff from helping farmers to prepare projections or other financial information used in a loan assessment processes.
Improve controls to ensure that farm finance is only provided through appropriate agribusiness products.
Offer ‘better training and more comprehensive supervision’ of frontline staff to help them deal fairly and reasonably with farming customers.
Ensure that customers are aware of the Code of Banking Practice.

Default Interest rates

The report recommends that default rates be contemplated only in ‘the most exceptional of circumstances,’ but additionally recommends that default interest should not:

Be charged at all in the first 12 months after default.
Exceed an additional 1% in months 12 to 24.
Exceed 2% from month 24 onwards.

Legislative Reform

Some of the recommendations would require legislative change:

A proposal that the statute of limitations should not apply to claims about a bank or its agents changing the details of loan documents without the customer’s knowledge, or acting ‘unethically’ in dealings with a borrower.
Implementation of “higher standards” of accountability by receivers and transparency for their costs, with monthly information on their farming management and fees to be provided to both lender and borrower.
Changes to section 420A of the Corporations Act ‘to establish a private right of action’ – presumably the intention is to provide guarantors with a right of action, because borrowers already have such rights.

Special review of the takeover of the Landmark loan book’

The report recommends that the (yet to be constituted) Australian Financial Complaints Authority undertake a special review of ‘the ANZ takeover of the Landmark loan book’ so as to ‘shed more light on the implications of this significant corporate takeover’ – although the report does not identify the specific objectives of such a review.

Government Funding

The report calls for the government to commit funding to train rural counsellors in mediation, and establish tailored initiatives that provide primary producers with guidance on financial literacy and business management, and resilience training. Both of these suggestions would be widely supported.

ABA and ARITA to work together

The report asks the Australian Bankers Association and ARITA to work together to:

Ensure that receivers, and any valuers that they appoint, have appropriate qualifications and experience. This will be uncontroversial, lenders and insolvency practitioners will believe they already meet this standard.
Require banks and receivers work to achieve the ‘maximum sale price of an asset’ – this is a effectively a ‘plain english’ rendering of section 420A, and will also be uncontroversial.
Ensure copies of bank or receiver-ordered valuations are provided promptly to farmers. This may be a problematic recommendation because of the potential impact on sale processes where a borrower has an involvement with a potential purchaser.

‘Missing’ recommendation

Although the committee spent some time understanding the considerable problems caused by “non-mainstream advisers,” unfortunately, that recognition of the issue did not lead to any recommendations about much-needed regulation.

Next steps

It is worth highlighting that there is no guarantee that any recommendations will actually be implemented – the current absence of a National Farm Debt mediation scheme is evidence that Inquiry recommendations do not always translate to action. And some may say that implementation should be deferred until it is further informed by the upcoming Royal Commission (discussed here). That may be true, but it would be a shame if the most worthwhile recommendations – the National Farm Debt Mediation scheme, and funding for skills programs for rural counsellors and financial literacy programs for farmers – were unnecessarily delayed.

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

Will the Banking* Royal Commission impact restructuring and turnaround professionals?

The Senate Select Committee on Lending to Primary Production Customers was the sixth inquiry in the last seven years to examine the conduct of Restructuring and Turnaround practitioners – will the recently announced Royal Commission be the seventh?

Unlike both the Senate Select Committee Inquiry, and the Parliamentary Joint Committee Inquiry into the Impairment of Customer Loans before it, the terms of reference released on 15 December 2017 (available here) do not directly refer to ‘insolvency practitioners’ or ‘insolvency’ at all.

However, the first term of reference directs inquiry into ‘the nature, extent and effect of misconduct by a financial services entity (including by its directors, officers or employees, or by anyone acting on its behalf).’ Whilst there may be technical legal discussion about the extent to which a receiver is acting on behalf of a lender, at a practical level it seems likely that the work of receivers may well be under review.

The definition of ‘financial services entity has been extended to cover ‘a person or entity that acts or holds itself out as acting as an intermediary between borrowers and lenders.’ This has been described as extending the Royal Commission to include the work of finance brokers – but in fact the broadened scope would appear to potentially also include the work of the “Non-mainstream advisers” who concerned the Senate Inquiry.

The terms of reference specifically allow the Commission to choose to not investigate matters where to do so would duplicate the existing work of another inquiry or civil proceeding.

That power to avoid duplication may assist the commission to meet its tight deadline, but it has the potential to frustrate those who see their previous failure in Court as defining a ‘broken’ legal system, and who use each fresh inquiry as an opportunity to re-litigate those failures.

The Commission may submit to the Government an interim report no later than September 2018, and must submit a final report by 1 February 2019.

*Although headlines have referred to a ‘Banking Royal Commission’ in fact the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry specifically extends to non-bank lenders, as well as insurance companies, and Superannuation Funds.

Posts about the Senate Select Committee Inquiry into Lending to Primary Production Customers: