Department of Liquidation? The possible creation of a Government Liquidator…

The anti-phoenix consultation paper released by Treasury last week (available here) raises the possibility of a “Government liquidator.”

The proposal is intended as an alternative to the ‘cab rank’ proposal (discussed here), to address concerns about phoenix promoters ‘hand-picking’ registered liquidators likely to cooperate in a strategy to ‘facilitate their client’s interests to the detriment of creditors.’

(Before moving on it is worth highlighting, here too, that a liquidator who did act to the detriment of creditors in such a way would be in breach of their duties both under the Corporations Act and the ARITA Code of Professional Practice, and should be subject to prosecution by ASIC and disciplinary action by ARITA, if a member).

To outsiders, the idea of a government agency operating in a market where there is no shortage of competitive players may seem unusual, but to turnaround and restructuring professionals it is more familiar. A similar system operates in the UK, where by default the ‘Official Receiver’ is appointed to companies unless a private liquidator has been arranged, and in Australia where the Official Trustee (via AFSA) acts as the trustee of an insolvent individual’s affairs – unless a private bankruptcy trustee has been arranged.

The paper does not set out a view as to whether the Government liquidator would be appointed only where a person designated as a “High Risk Phoenix Operator” by the Commissioner of Taxation (under the criteria and process outlined in the proposals paper) is involved, or whether it would be an option in all liquidation proceedings – feedback is sought on that question.

Likewise it is also unclear whether the Government liquidator would manage the liquidation through to completion, or the involvement would only be temporary, pending a transition to an independent liquidator – as happens now with many, but not all, of the more complex personal insolvencies handled by AFSA.

The paper seeks feedback as to how a government liquidator should be funded. One part of the answer to that question is the fee charging model to be adopted. If the AFSA model (a flat fee of $4,000 per file and commission of 20% of money received) is deployed, then there is likely to be a larger shortfall than if an hourly rate model is used. The most significant question however is the scale of operation – a national team that undertakes any and all liquidations through to completion will be quite large, and quite expensive.

Feedback is due by 27 October 2017. It can be provided direct, and ARITA is also seeking member feedback.

Queensland is pursuing other measures to address phoenixing, discussed here

Taxi! A cab-rank system for insolvency appointments?

Treasury yesterday released a consultation paper (available here) to provide further detail, and seek input, on the anti-phoenix measures announced on 12 September, and discussed here.

One of the most noteworthy proposals is option 9 – appointing liquidators on a ‘cab rank basis.’ This proposal is intended to address concerns that phoenix promoters will hand-pick a registered liquidator to ‘facilitate their client’s interests to the detriment of creditors.’ (Before moving on it is worth highlighting that a liquidator who did act to the detriment of creditors in that way would be in breach of their duties both under the Corporations Act and the ARITA Code of Professional Practice, and should be subject to prosecution by ASIC and disciplinary action by ARITA, if a member).

The proposal is to introduce a cab-rank for companies associated with a person designated as a “High Risk Phoenix Operator” by the Commissioner of Taxation (under the criteria and process outlined in the proposals paper). Rather than select a liquidator of their choice such companies would be allocated a registered liquidator from a regionally based panel. That liquidator would effectively be guaranteed a minimum level of public funding to ensure that matters were investigated and properly reported to both the creditors and to ASIC.

The paper notes that it is intended that the cab rank mechanism be restricted to circumstances where an HRPO is involved, but seeks feedback as to whether the cab rank should apply to all appointments. It appears that the cab-rank mechanism is intended to apply only to liquidation appointments – HRPO-associated directors could appoint the voluntary administrator of their choice, but if the company passes into liquidation then that person will be automatically displaced.

There is no discussion of any restriction on the ability of HRPO-associated entities to arrange the replacement of the cab-rank liquidator. Without such anti-abuse measures it would seem to be open to phoenix promoters use the simplified replacement regime to bring in a hand-picked appointee shortly after the initial appointment.

The paper also seeks feedback as to who should administer the cab rank. There is a further question, albeit not asked here: what is the panel criteria? ASIC already administers a stringent registration process (and an exclusion process where necessary), so presumably there will be no plans for another organisation, or another part of ASIC, to second guess that work.

Feedback is due by 27 October 2017. It can be provided direct, and ARITA is also seeking member feedback.

Queensland is pursuing other measures to address phoenixing, discussed here.

“Fixing” Section 420A

Earlier posts (Receivers: are “crooks”? and Receivers: are “inhuman”?) have noted that receivers have been the subject of strident criticism in many of the nine public hearings of the Senate Select Committee Inquiry into Lending to Primary Production Customers.

One of the areas of specific and regular complaint has been the sale of assets at – it is claimed – a significant discount to their reported value.

However, none of the valuations referenced in the evidence appear to have been tabled, and so it is difficult for outsiders to understand whether the reference is to sworn valuations conducted by independent valuers, or whether the reference is to something less structured and formal. Likewise it is also unclear to outsiders whether those reported valuations reflect the seasonal and market conditions at the time of the sale, or whether they are framed against different conditions present at an earlier time.

Nonetheless it seems that at least one of the committee members is concerned about the effectiveness of section 420A – which imposes an obligation upon receivers to:

“take all reasonable care to sell [mortgaged] property for:

(a) if, when it is sold, it has a market value–not less than that market value; or

(b) otherwise–the best price that is reasonably obtainable, having regard to the circumstances existing when the property is sold.”

At the 18 September hearing (transcript available here) a bank was asked to comment on a proposal that would require receivers to take a fresh valuation on appointment, and prevent them from selling ‘for less than 80 per cent of that current valuation.’

It was not clear whether the hypothetical requirement would apply only where the sale was other than by public auction, or whether it would apply to all sales.

Regardless, the response (admittedly, off the cuff) did not raise concerns about the proposal – which suggests a greater degree of confidence in the sales programs conducted by receivers, and the outcomes they deliver, than some of the borrowers who gave evidence may have expected.

New anti-phoenix measures

Not to be outdone by the Queensland Government – which tabled legislation in the last week of August to safeguard against construction industry phoenixing, discussed here – the Federal Government today issued a media release announcing a range of measures intended to address ‘illegal phoenixing.’

The most developed initiative appears to be a proposal to introduce a unique Director Identification Number (DIN) – a reform proposed by Professor Helen Anderson and advocated by ARITA. Although the release does not address this point it, seems that there will be some kind of bank-style 100 point identification regime; and the release did refer to the use of the DIN to cross-reference against government databases, to allow ‘mapping’ of relationships.

The announcement also flags consultation about a range of other possible measures intended ‘to deter and disrupt the core behaviours of phoenix operators,’ including:

The introduction of specific ‘phoenixing offences’
A single point of contact for reporting illegal phoenix activity
Extension of the director penalty provisions, to cover GST liabilities
Applying tax avoidance promotion penalties to those promoting phoenixing
Prohibiting related entities to the phoenix operator from appointing a liquidator.

There will be a focus on identifying ‘high risk individuals’ – if not a ‘blacklist, a ‘greylist,’ it seems – who may:

Be required to provide the ATO with a security deposit.
Not be allowed to appoint the liquidator of their choice.
Be the subject of immediate recovery action following the issuance of a Director Penalty Notice.

It is not completely clear what ‘Prohibiting related entities to the phoenix operator from appointing a liquidator’ means – but laws that prevent the appointment of a liquidator to an insolvent company will require careful thought, especially given their potential to intersect with the laws that require directors to make an appointment to avoid personal liability.

A proposal to prevent ‘high risk individuals’ from appointing the liquidator of their choice may be less effective than hoped. The ILRA changes that made it easier for creditors to replace a liquidator surprisingly did not include any anti-abuse measures, and so a restriction on appointment may need to be accompanied by a comparable restriction on replacement.

The release explains that the government intends to open a consultation process shortly.

Update: The consultation process began on 28 September 2017, with responses due by 27 October 2017. Two of the specific measures are discussed in Taxi! A cab-rank system for insolvency appointments? and Department of Liquidation? The possible creation of a Government Liquidator…

Safe Harbour: We’ve arrived!

As discussed here, the Senate Economics Legislation Committee concluded its 8 August 2017 report into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill – aka the Safe Harbour legislation – with a recommendation that the bill be passed as tabled.

However, when debated in the Senate tonight there were two sets of proposed amendments.

First, the Government tabled amendments to the proposed ipso facto protections that were intended to strengthen the anti-avoidance regime, most notably measures intended to address ‘self-executing’ clauses – provisions that ‘can start to apply automatically.’ Those amendments were accepted by the Senate.

Secondly, the Opposition proposed their own amendments to:

Change the nature of the safe harbour from a ‘carve out’ to a defence, putting the onus of proof on company directors, rather than on the liquidator. This proposal aligns to the position advocated by ARITA and recommended in the Productivity Commission report.
Turn what were effectively best practice guidelines into mandatory requirements, only allowing the protection to those directors who:
- Keep themselves informed about the company’s financial position
- Take steps to prevent misconduct by officers and employees of the company
- Take steps to ensure the appropriate financial records were maintained.
- Obtain appropriate advice from an appropriately qualified adviser
- Take appropriate steps to develop or implement a plan to restructure the company to improve its financial position.
Mandate a review of the effectiveness of the legislation after it has been in operation for two years.

The first two Opposition amendments were rejected, however the proposal for a two-year review was successful.

It appears that the Safe Harbour reforms are still ‘on course.’

Update: the amendments were passed in the lower house on 12 September 2017, the consolidated Bill is available here

Further Update: The Act received Royal Assent on 18 September – so the Safe Harbour is now available to directors.

There is more detail on the Safe Harbour legislation here.

Opposite directions: Phoenix busting or second chance?

In the last week of August the Queensland Government tabled legislation which is intended to better protect construction industry subcontractors from the risk of non-payment.

The Building Industry Fairness (Security of Payment) Bill 2017 available here includes a number of measures.

Project Bank Account Regime

PBAs are effectively trust accounts which operate to quarantine money paid to a head contractor that is expected to be on paid to their subcontractors.

Initially the PBA regime will apply only to Queensland Government projects, and will only protect ‘first tier’ subcontractors – it will not extend to those subcontractors who directly or indirectly work for the first tier subcontractors.

However, the legislation provides a mechanism for extension of the PBA regime to all construction projects over $1m- ie whether government or private – by proclamation. Likewise there is a mechanism to extend the regime to all subcontractors – not just tier 1 subcontractors – by a separate proclamation.

Dispute Resolution and adjudication

The legislation incorporates the existing Subcontractors’ Charges Act 1974 regime, but it tightens the rules which require a head contractor to respond to a sub-contractor’s ‘payment claim’ with a ‘payment schedule.’

The extent to which criminal sanctions will apply is noteworthy. Head contractors apparently commit an offense if they do not:

Provide a payment schedule on time.
Pay an amount owed when it falls due.
Pay an adjudicated amount within five business days of receiving a written decision.

Financial Reporting

The legislation will reinstate requirements for licensed builders to provide financial information to the Queensland Building and Construction Commission. The QBCC will also be given power to require the production of financial information so that it can better assess whether a builder continues to meet the minimum financial requirements.

Phoenix-busting

The legislation includes a measure that is described as clamping down on ‘corporate phoenixing’ – by restricting those involved with a recent financial failure from holding a QBCC license.

The current licensing regime already bars those who were a director or secretary of a construction company in the twelve months prior to its liquidation or administration from holding a building license. The amendments will extend the period to cover the two years prior to liquidation or administration. Further, the exclusion mechanism will also take into account the activities undertaken by a person – not just the office they occupy – including those who:

act as the chief executive officer or general manager
give instructions to officers of the company which are generally acted upon
participate in making decisions that affect a substantial part of the business
present themselves to others in such a way as to lead them to believe that they control or influence the business.

The intention is to ensure that the regime also captures ‘shadow directors’ – those who manage companies without holding the office formally. Whilst the Corporations Act extends the definition of directors to those who act in the position of a director, as demonstrated most recently in the Akron Roads decision that extension may not cast the net as widely as once thought. In Akron Roads it was held that a person who:

dealt with creditors,
attended executive meetings,
negotiated with the bank and attempted to obtain finance,
had financial accounts prepared and was responsible for short-term cash flow, forecasting and cash management

was not a shadow director, because none of those activities ‘involve a board decision or fall within the responsibilities of the directors…[who] do not carry out managerial tasks.’

The exclusion will also apply to those who directly or indirectly control 50% or more of a class of shares in the company.

Opposite Directions?

The Federal Government is undertaking reforms that are intended to de-stigmatise business failure, and encourage entrepreneurialism.

The Queensland government appears to be moving in the opposite direction however, by introducing a ‘one-strike’ regime specifically aimed at preventing those involved in a financial failure from going straight back into business.

The new focus on activities will require a qualitative assessment, and so it will be critical that the QBCC has the skills and resources to take the assessment process in a new direction.

If the Queensland initiative is successful in tackling phoenix activity, there will some who use its success to argue the framework should be applied more widely in a universal director-licensing regime.

Update: on 12 September 2017 the Federal Government announced its own anti-phoenix measures, details here.

Further update: The Building Industry Fairness (Security of Payment) Act 2017 was passed on 26 October 2017, with some measures to be effective from 1 January 2018, however most of the measures await proclamation. The 143 amendments to the original draft legislation detailed here are mostly matters of clarification, correction of typographical errors, or the consolidation of definitions. However there are some noteworthy changes: allowance for ‘reasonable excuse’ into some offence provisions, and a review of operation after 12 months.

And another update: On 12 June 2018 the Queensland government announced that the commencement of security of payment changes had been changed from 1 July 2018 to 17 December 2018.

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.

Undercover Administrators?

In 2016 the Dutch Lower House passed legislation which if confirmed by their Senate would initiate quite unique reforms to their restructuring laws.

According to an unofficial translation of the explanatory memorandum, the Continuity of Enterprises Act 1 was intended to facilitate so-called ‘pre-packaged’ insolvency administrations (‘pre-packs’). Pre-packs describe a sale that is negotiated in anticipation of a formal insolvency administration and implemented immediately after the appointment is made, thus structured to bypass some of the issues caused by formal insolvency:

Suppliers shortening or even cancelling credit terms
Key customers switching to suppliers seen as more financial
Key staff seeking alternate employment.

However, pre-packs usually occur without a comprehensive sale program, and so raise questions about whether the best outcome for creditors is achieved. A UK study found that pre-packs provided unsecured creditors with a ‘paltry benefit’ – with no distribution in 60 percent of cases. The same study found that 63% of pre-packs resulted in a sale to a ‘connected party,’ which many Australians would describe as a ‘phoenix.’

Ordinarily, Dutch Courts appoint an insolvency practitioner as a ‘bankruptcy trustee,’ whose conduct and decisions are supervised by a judge of a specialist bankruptcy Court.

Under the proposed reforms, the intended trustee and judge would be appointed up to two weeks before the expected formal appointment. The pre-appointment appointment will allow them to supervise and assess the sale process, thereby addressing some of the questions otherwise raised. The application would be made without any public notice, and there would be no public disclosure of any appointments.

Legislation in limbo

The Dutch Senate had put the legislation to one side, apparently waiting on the outcome of litigation initiated by employees of a company who claimed that a pre-pack sale was a transfer of business, thereby resulting in the automatic transfer of the employees and their entitlements to the acquirer.

The Court found in favour of the employees in June 2017, which means that Dutch employers (and possibly others in Europe, because the ruling reflected an EU-wide directive) will not be able to use pre-packs to rationalise a workforce, or renegotiate employment conditions.

At the time of writing it is not clear whether the legislation will be permanently shelved, or whether it might still be taken forwards, perhaps with modification.

How does that compare to Australia?

In Australia formal insolvency via a voluntary administration is far quicker than the painfully slow (and horrendously expensive) US Chapter 11 procedure, but even a quick administration will last for some months. For that reason, most large restructuring is done ‘informally’ – out of Court – which avoids the issues arising from loss of confidence.

The position under Safe Harbour

As Australia moves towards implementing the Safe Harbour reforms discussed here, one of the questions being raised is whether entering the Safe Harbour regime will require public disclosure.

At first glance it seems hard to think that entering Safe Harbour would not require disclosure, but it is important to remember that directors of ASX-listed companies already have significant disclosure obligations, some of which are discussed here. Those rules impose an obligation on directors to ensure that the market is kept informed as to the financial position of their company. Arguably, if a company is insolvent then that should have already been disclosed, whether there is a safe harbour mechanism or not.

Is there anything in the legislation that requires an additional disclosure?

There are two notable aspects to the Safe Harbour mechanism which suggest that it may have been specifically designed to avoid any additional disclosure. First, there is no requirement for appointment of a restructuring adviser as a pre-condition. Although the involvement of a ‘restructuring adviser’ would bring advantages, it would be a very clear reference point in any later analysis about the adequacy of disclosure.

Secondly, by structuring the safe harbour as a carve out to the existing directors’ duty rather than a defence against a breach, arguably all the directors are doing is continuing to ensure that they comply with their duties, which surely is so unexceptional as to not require disclosure.

Others may have different views, but my own is that it is arguable that there is no need for special disclosure that a board is accessing the safe harbour. That would be a good thing, because advisers will be able to operate ‘undercover’ – with a successful turnaround more likely in the absence of negative publicity.

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’?