No conspiracy in UK GRG case

The conduct of RBS’ loan workout unit GRG in the aftermath of the GFC was highly controversial, attracting media and Parliamentary attention, and resulting in a series of inquiries and reports (discussed here and here), as well as litigation by unhappy borrowers.

Some of the judgements have provided insight into the inner workings of bank restructuring teams, such as the claims pursued by PAG (discussed here), and most recently, a case in which the borrower claimed conspiracy on the part of the Lender arising from the involvement of a borrower-side adviser (the Adviser) engaged and paid by the borrower but nominated by the lender.

Background

The claims were brought by a chiropractor and his wife, and various associated entities which operated sixteen chiropractic clinics and owned property (the Claimants).

Banked by RBS since 1999, control of the account was transferred into GRG in 2009, and shortly thereafter GRG proposed a strategy which included the engagement of the Adviser.

A range of measures were tried, including a restructure in 2011, but none were successful. In February 2013 RBS appointed administrators following an attempt by the chiropractor to liquidate the companies, and in due course the Claimants commenced action for damages in respect of three claims alleging:

Mis-selling of an interest rate swap in 2007 which locked in a base rate of 5%, resulting in an interest cost £100,000 per year higher it would have been with a variable rate.
Mis-selling said to arise from the 2009 restructuring of the 2007 swap.
Conspiracy to exploit a claimed “breach by [the Adviser] of her duties of loyalty.”

A contrast in witness credibility

The Court found that the chiropractor “had become obsessed with blaming the Bank for the collapse of his business…[which] meant that it was difficult for him to give evidence comprising his best recollection…[some parts were] at best wishful thinking, mis-recollection and bluster, and at worst (as the Bank submitted) an obvious lie.”

By contrast the Court found that the Adviser was “an impressive witness” whose evidence was comprised of “honest and (usually) brief and clear answers to questions,” and that it was “easy to see why…[she] had been held in high regard by RBS.”

Findings

In CJ & LK Perks Partnership & Ors v NatWest Markets Plc [2022] EWHC 726 the Court found, in relation to the mis-selling claims:

There was no complaint by the chiropractor at the time when advised that loan approval was subject to interest rate hedging.
There was no evidence to support the conclusion that a claimed misrepresentation – that interest rates were going to rise – was made at all; and there was no evidence that the chiropractor relied upon it, because the chiropractor “wanted to expand the business and wanted the loan which RBS was proposing” and he was “happy to enter a swap if that is what the Bank wanted.”
There was no misstatement in the information provided by RBS, who in fact had warned him of significant risks which were associated with the swap.
There was no evidence to support the existence of other purported unadvised risks, and no evidence that those purported risks had actually impacted the Claimants – but even if there had been, the chiropractor would still have entered the swap, because he wanted the loan.
A claim for improper advice also failed. Not only had the RBS banker recommended that the chiropractor seek independent advice, but there was no causation grounds because the chiropractor “would still have entered into the swap, because [he] wanted the loan.”
The more limited claim in respect of the 2009 swap was also unsuccessful because there was “no substance to the case that the [relevant] risks…were not sufficiently explained.”

In relation to the conspiracy claim, the Court held:

There was no evidence whatsoever to support the allegation that the transfer to GRG “was driven by an ulterior motive on the part of RBS.”
A payment default was “obviously a serious matter” and together with clear evidence that the business would not be able to meet future obligations, justified transfer to GRG.
It was true that the Adviser had put moderate positions to RBS, but that was because she recognised that a favourable outcome for the businesses required the agreement of RBS, and that “it was unproductive to take positions which were likely to be rejected.”
Not only was there “no substance in the case of conspiracy” it was appropriate to “exonerate” the Adviser and the RBS staff, who had “acted with integrity.”

The Claimants were unsuccessful.

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.

Concessional RIC loans for farmers impacted by Drought or Flood

The Federal Government established the Regional Investment Corporation in March 2018 to administer concessional farm business loans. This began with Farm Drought loans, and in 2019 was expanded to also include AgRebuild loans for farmers affected by the North Queensland floods.

The AgRebuild loans are very tightly targeted, but eligibility for the Farm Drought loans is broader than many might expect.

Loans for working farmers

The loans are available owners of farms that are Australian citizens or permanent residents – although it is important to understand that the farms can be held through companies or trusts.

Not all members of a farming partnership must work on the farm, but at least one person must contribute at least 75% of their labour to the farm business under normal circumstances, and at least one partner must rely on the farm for their income – so the loans are not available for corporates.

Terms and pricing

As of 1 August, the year loans are currently at a variable interest rate of 3.11%, with no application or other fees,

Drought loans are interest only for the first five years. AgRebuild loans are interest free for the first two years, then interest only for the next three years.

Support of the current lender

Although the loans can be used to reduce bank debt, they can’t be used to completely replace it – normally a farmer must keep 50% of their debt with a “commercial lender.”

It’s worth highlighting that RIC will often agree to take second mortgage security. This means that in practical terms the commercial lender’s security cover (i.e. loan-to-value ratio) can significantly improve, and so they might be quite happy about RIC becoming involved!

One other point is that even if the current lender isn’t prepared to confirm support, it may still be possible to get a conditional offer from RIC. With a much better LVR to offer the incoming lender it may be easier for farmers to secure a refinance.

Drought loans

Drought loans are up to $2m, available to farmers across Australia, which can be used to:

Prepare for drought or recover from the effects of drought.
Pay down debt.
Invest in productivity or water efficiency measures.

Farmers will need to provide a copy of their drought management plan.

Flood loans (AgRebuild)

The AgRebuild loans have a much tighter eligibility criteria. They are for farmers affected by the flooding caused by the Monsoon Trough from 25 January to 14 February 2019 North Queensland.

The AgRebuild loans are for a maximum of $5m, but rates and other terms are the same.

There are some key differences to the drought loans:

As noted, the loans are interest free for the first two years.
RIC might waive the requirement that 50% of the debt stays with a commercial lender – but only in cases of “extreme hardship,” and will be assessed on a case by case basis.
The loans are only available until 30 June 2020.

Restrictions

There are some restrictions:

RIC is not a lender of last resort and will not lend unless it is satisfied that the farm is viable and has capacity to repay the loan.
RIC will require a drought management loan for drought loans.
As above, the ongoing involvement of a commercial lender is required, although this can be a new lender in some cases.

Summary

For eligible farmers the RIC loans can be a great option and it is well worth checking availability. There is a lot of useful information at www.ric.gov.au, or you can contact the author on 0404 885 062. You can also get structured assistance through a website that I have a link to, via my involvement with Ecosse Capital Partners: ricloan.com.au.

This article first appeared on my Harbourside Advisory website

Disclosure of lender-imposed conditions

The 2019 Financial Reporting season has thrown up examples of very specific disclosure of the conditions imposed on listed borrowers by their lenders.

Case 1 – The amount and timing of an equity raise.

Case 2 – A requirement to conduct a ‘strategic review’ of ‘funding options.’

Case 3 – The timing and requirement for an equity raise to meet a balance sheet ratio.

Two-edged sword

Such disclosure is a two-edged sword.

Certainly, potential purchasers of the shares will be very well informed – but at the same time, the disclosure is likely to make it harder for management to achieve a turnaround. Perceived financial fragility may lead key staff to look elsewhere, and will probably make it harder for the businesses to win new business. In some cases, it will also create liquidity problems if suppliers decide to reduce trade credit limits.*

Why is such disclosure required?

Listed companies have multiple disclosure requirements. The Listing Rules impose a continuous disclosure regime, with limited exemptions – for example where negotiations are underway, or are confidential to another party. The Accounting Standards also impose further disclosure requirements.

If disclosure was made to comply with the continuous disclosure regime then arguably it should have been made earlier – when the companies received notice of their lender’s requirements.

Disclosure in the Annual Report suggests that the disclosure was prompted by the auditor’s review of the financial statements – but for an outsider it is difficult to say whether it reflects a belated ‘catch up’ of continuous disclosure, or whether it is intended to ensure compliance with Accounting Standards.

Theoretical arguments about the reasons for the disclosure and whether it is strictly required may not be much help up for companies up against a deadline. Two of the case studies had audit reports signed on the latest possible date – perhaps they simply ran out of time?

How should directors mitigate harmful disclosure?

Of course it is important that directors ensure that investors are adequately informed – but they should try to avoid do so in a way that makes it harder for the business to achieve a turnaround.

Harmful disclosure can be mitigated – but it becomes so much harder after balance date.

Businesses in turnaround mode should be projecting their compliance with covenants as part of their normal board reporting. If non-compliance seems likely, then it is important to negotiate with lenders well ahead of any deadline. Of course, those negotiations are far easier if supported by a well thought-out and comprehensive turnaround plan that will provide comfort that any underlying issues have been identified, and will be addressed.

First published here

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.

Continuous Disclosure, Class Action Regulation, and Restructuring

The continuous disclosure regime presents additional challenges for directors trying to turn around a listed company. The turnaround itself will probably mean that that there is more to keep the market informed about, but there is more to it than that. A perceived failure to properly disclose may well lead to a class action, adding to the workload of an already busy management team and board, as well as adding to the list of creditors.

Perhaps the most extreme example is that of Surfstitch, where on one analysis the commencement of a class action claim resulted in a majority of directors concluding – incorrectly in the view of the administrator that they appointed – that their company was insolvent. For these reasons, turnaround and restructuring professionals should have a keen interest in the outcome of a recently commenced Australian Law Reform Commission review.

Background

In December 2017, the Attorney-General asked the ALRC to inquire into the regulation of class actions and those who fund them, with a report due by 21 December 2018.

After a series of bilateral consultations with forty-three parties: regulators, funders, lawyers and other industry participants, the ALRC issued a discussion paper (available here) on 31 May 2018.

A ‘standard approach’

The discussion paper identified what it described as a ‘standard approach’ by litigation funders:

Litigation funders and/or plaintiff law firms (or their hired experts) identify a significant drop in the value of securities. This is analysed to determine whether it is likely that the relevant drop had been occasioned by the late revelation of material information.

Typically, the analysis determines whether or not it is likely that there is a sufficient basis for assuming the existence of contravening conduct during a period prior to the eventual announcement of the material information. The litigation funders and/or plaintiff law firms then determine the size of the potential loss that may have been occasioned by the suspected period of contravening conduct. The duration of that period may extend back for a considerable period, as in the recently announced class actions against AMP where a period of five years has been identified.

Once the funders and/or lawyers are satisfied that there is a sufficient basis for assuming the existence of contravening conduct, funding terms are discussed and (at least prior to the advent of the common fund order) there is an effort to sign up institutional and other group members (complex questions relating to issues of privacy and data sets are likely to arise in this context). During this developmental stage, an announcement might be made of a potential class action, attracting media attention which may augment the number of affected shareholders who wish to participate in the proposed class action

To address the problems it identifies, the discussion paper has recommended:

The Australian Government should commission a review of the legal and economic impact of the continuous disclosure obligations of entities listed on public stock exchanges and those relating to misleading and deceptive conduct contained in the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth) with regards to:

the propensity for corporate entities to be the target of funded shareholder class actions in Australia;

the value of the investments of shareholders of the corporate entity at the time when that entity is the target of the class action; and

the availability and cost of directors and officers liability cover within the Australian market.

The impact of the continuous disclosure regime is is arguably outside the terms of reference so perhaps it is difficult for the ALRC to do more than it has, but the recommendation of a further review will not quickly take us closer to a solution.

Those with practical suggestions should make a submission, due before 30 July.

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

‘Timid’ regulators, ‘complicit’ auditors, ‘rotten culture,’ and ‘ineffective’ directors

When Carillion PLC collapsed in January 2018 it had 43,000 employees and owed more than £4.6 billion, including a pension liability of around £2.6 billion.

Carillion’s financial position was so dire that it went straight to liquidation. According to the 16 May report issued by the UK House of Commons Work and Pensions Committee, insolvency practitioners were unwilling to act as administrators because there was no ‘certainty that there was enough money left in the company to pay their costs.’

The report follows the collapse so quickly that it cannot reflect a full forensic analysis, and it is issued under Parliamentary privilege, but the criticisms are fierce. The report says:

The was a ‘chronic lack of accountability and professionalism’ and the board was ‘either negligently ignorant of the rotten culture at Carillion or complicit in it.’
The non-Executive directors were ‘unable to provide any remotely convincing evidence of their effective impact.’
The resignation and sale of shares by a former finance director ‘were the actions of a man who knew exactly where the company was heading once it was no longer propped up by his accounting tricks.’
The auditors ‘were complicit’ in the company’s aggressive accounting judgements through their failure ‘to exercise—and voice—professional scepticism.’
The Pensions Regulator ‘failed in all its objectives.’
The UK’s Financial Reporting Council was ‘too passive,’ and ‘wholly ineffective’ in taking the auditors to task.
The committee had ‘no confidence’ in the FRC or the PR, who it said shared ‘a passive, reactive mindset and are too timid to make effective use of the powers they have.’

The full report is available here, together with video of some of the key evidence.

Draft ipso facto regulations – for consultation

The final piece of the ipso facto reform is almost in place, following today’s release of a draft-for-consultation version of the regulations.

Ipso facto clauses (also known as ‘termination for insolvency’ clauses, and discussed in more detail here) allow termination of a contract if a party to the contract becomes insolvent – even if there is no other default.

Such clauses can be immensely damaging to businesses that enter formal insolvency administration because essential assets and services can be unilaterally withdrawn: landlords can lock out insolvent tenants, franchisors can withdraw access to franchise systems, and lessors can repossess leased equipment.

It’s true that voluntary administration will ‘stay’ such action – but the effect is only temporary. The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill passed in September 2017 creates a permanent stay – albeit only for clauses in contracts entered into on or after 30 June 2018.

It was always intended that final detail – a list of exemptions – would be left to the regulations (now available here). The most notable aspects are:

The ipso facto stay will not apply to derivatives, margin lending facilities, and invoice finance arrangements. This is sensible, and as expected.
The draft regulations propose an exemption for ‘a contract, agreement or arrangement of which a special purpose vehicle is a party.’ This will be under careful scrutiny: it can’t be intended that the ipso facto stay can be defeated by simply adding an SPV entity to any contractual arrangement.
The stay will not affect contractual rights to combine, set off, or net out, multiple accounts. Again, this is sensible and expected.
As anticipated, there is a specific protection of a secured creditor’s ability to appoint a controller, and step-in rights are likewise protected.

The most significant deficiency in the ipso facto reforms – that the stay will not apply to contracts entered into before 30 June 2018 even if they are modified after that date – remains unaddressed.

Submissions on the proposals may be made until 11 May 2018.

(For those who noticed the photo: I haven’t tried Ipso Facto wines but the Cabernet gets great reviews!)

Surfstitch: Avoiding wipeout?

ASX listed Surfstitch Ltd was placed into voluntary administration by its directors on 24 August 2017, less than four weeks before the safe harbour reforms came into effect on 18 September.

The Australian Financial Review has reported the administrators’ conclusion that the company was in fact solvent when the appointment was made. At first glance it seems surprising that administrators were appointed to a solvent company, but the threshold question is whether:

“in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time”

It is the directors’ opinion at the time that matters, not the conclusions drawn later with the benefit of hindsight – and solvency is not always clear even with the benefit of hindsight.

According to an ABC interview, however one of the directors was not satisfied that Surfstitch was insolvent, and abstained from the vote for administration. This highlights the practical problems that directors face, and underscores one of the advantages that safe harbour now offers: the opportunity to more carefully assess and understand the financial position of the company.

On 4 April creditors will choose between two rival deed of company arrangement proposals. One proposal will see the business sold in return for three-year convertible notes issued by the purchaser, the other will see a debt for equity restructure and later relisting. Trade creditors and employees will be paid in cash under both proposals.

Update: on 4 April the creditors accepted the three year convertible note proposal, putting their faith in a valuation uplift over that period.