Bank support for small business turnaround

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

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

The principles are:

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

Business Support Units will work openly and constructively with customers, with the aim of returning the business to viability in a timely and cost-effective manner, wherever achievable.

The need for Business Support Unit involvement will be kept under continuous review.

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

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

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

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

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

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

The process for making a complaint will be clearly set out ensuring recognition and a timely response.

Customers should always feel able to complain (and know that any complaint will be treated fairly in accordance with published complaints protocols)

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

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

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

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:

“Non-mainstream advisers”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Responses are sought by 20 November 2017.

The beginning of the end? The RBS/GRG saga

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

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

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

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

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

The High Level summary

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

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

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

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

More detail: a sixty-nine page summary

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

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

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

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

The specific findings included:

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

Where next?

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

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

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

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

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

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

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

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

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

Receivers: are “inhuman”?

In Receivers: are “crooks”? I commented on some of the most quotable evidence given to the first two hearings of the Senate Select Committee Inquiry into Lending to Primary Production Customers.

The transcripts from hearings three and four are also now available here.

Notably, in the fourth hearing one senator asked whether “receivers have professional standards bodies?” Neither the bank to whom the question was directed, nor the other members of the committee, were able to identify ARITA’s role or the fact that ARITA had already lodged a submission to the inquiry.

Towards the end of the hearing the Chair referred to having seen conduct by receivers that ranged from “fraudulent—through to things that we could possibly describe as inhuman.”

If the committee does continue to pursue its present line of investigation it would not be a surprise to see a further Senate Inquiry into the conduct and regulation of receivers.

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’?