Loan workouts: insights from the UK

Introduction

In the UK, the handling of financially stressed business customers by RBS’ Global Restructuring Group (the loan workout unit) has been highly controversial, and attracted a great deal of media attention.

However, very few disputes between borrower and lender have actually progressed through to final judgement, until the December 2016 decision in Property Alliance Group Ltd (PAG) v The Royal Bank of Scotland plc.

In that case the borrower claimed (amongst other things) that RBS had breached a duty of ‘good faith’ in its conduct of the loan workout.

In the judgement the Court held that there was no such common law duty in the UK, and so there could be no breach – but is there such a duty in Australia? That’s a difficult question: one academic said the answer was “incoherent”! Perhaps the answer does not matter, however, because the Australian Code of Banking Practice includes a requirement to “act fairly and reasonably.” *

The decision will be of interest to Australian lenders and their advisers, even more so because the conduct at issue goes to the heart of allegations about ‘constructive default’ that have been raised in the PJC Inquiry into the Impairment of Customer Loans and the forthcoming Senate Select Committee on Lending to Primary Production Customers.

Background

PAG is a property investment and development business – still trading today – that operates primarily in the North West of England. It borrowed money from RBS, and entered into a series of interest rate derivative products (‘swaps’) prior to 2009.

In the aftermath of the GFC LIBOR fell significantly and by December 2009 sat at 0.60%, and consequently the swaps were ‘out of the money’ by more than GBP9m. A fall in the value of PAG’s real estate portfolio, on top of the liability for the break cost, resulted in a loan to valuation ratio of more than 90% – and led to a transfer to GRG. After extensive negotiations in June 2011 the swaps were closed out a cost of GBP8.2m. Part of that cost was absorbed by RBS, but most of it was funded by an additional loan.

PAG remained under the control of GRG until July 2014 when it refinanced to another lender, shortly after initiating the legal proceedings against RBS.

Three elements to the claims

PAG claimed that the swaps were mis-sold. Instead of providing a hedge as represented, PAG argued, in fact they left PAG in a worse financial position than otherwise.

PAG’s claim also involved the widely reported allegations that LIBOR had been manipulated by RBS and other LIBOR participants. PAG said that it was unfair that RBS knew of the manipulation, but PAG did not.

The last claim, and the part most relevant to this discussion, was that by transferring management of PAG into GRG – and by what occurred after that transfer – RBS had breached an implied duty to act in good faith.

What did the RBS workout team actually do?

Arguably, GRG (referred to by some critics as the Grim Reaper Group!) did not quite live up to its apparently fearsome reputation (discussed in more detail here).

GRG did not appoint an Investigative Accountant, or appoint receivers. It did obtain updated valuations and seek a one-off debt reduction to improve the LVR, but even the deputy Chairman of the borrower, who lead the negotiations for re-financing, described RBS’s role amongst other things as ‘reasonable’, ‘friendly’, ‘helpful’ and ‘constructive.’

Alleged breach of good faith #1 – the transfer to GRG

PAG claimed that the stated reason for its transfer to GRG control was a pretext: it said that it had little need to restructure because there was ‘no risk of default.’ PAG said that the real reasons for transfer were to stifle anticipated litigation over the swaps mis-selling, and to extract as much revenue from PAG as possible.

The Court held that there was no contractual right to be managed by a particular team, and so it was open to RBS to transfer management control to GRG, and there was ‘substantial documentation’ which showed the transfer clearly as being within RBS policy. Secondly, the Court found that at the time of the transfer RBS was not really aware of PAG’s mis-selling complaints, and so could not have made a decision to attempt to stifle them.

Finally the Court said that there was simply no evidence that there was an intention to extract as much as possible from PAG.

Alleged breach of good faith #2 – retention in GRG

PAG claimed that it was ‘wrongfully retained’ in GRG, to impose a 100% ‘cash sweep’ in order to maximise value for RBS and (continue to) deprive PAG of funds for litigation.

The Court held that there was simply ‘no evidence’ to support those contentions. The Court accepted that RBS policy required an updated valuation before the customer could be returned to the frontline team, and information about an associated entity. RBS’ failure to address these reflected a far more mundane reason: overwork.

Alleged breach of good faith #3 – Demanding an unnecessary and onerous ‘Security Review’ at PAG expense

The Court said that the requirement for a security review was not capricious, it was a condition of the very significant new lending that RBS provided to fund the close out the swaps.

Alleged breach of good faith #4 – Calling for updated valuations of PAG’s portfolio in both 2010 and 2013.

There was a clause in the loan documents that allowed RBS to call for an update of valuations at borrower expense, but it had opted not to exercise this right until 2010, and then again in 2013. The Court held that the decision to seek valuations was not ‘capricious’ – the bank needed valuations to make an informed assessment as to whether PAG met the criteria for transfer back to the front line, or refinance by another bank.

Alleged breach of good faith #5 – applying improper pressure on the valuers to manipulated the result of the 2013 Valuation

It was true that RBS had raised queries about a draft valuation, which had led to a 1.5% reduction in the valuation, and thereby increased the amount of the payment that PAG had to make to improve the LVR. However, the valuer had not challenged the legitimacy of the questions, and there was nothing in the valuer’s evidence to suggest that he had been placed under improper pressure.

Alleged breach of good faith #6 – a threat to appoint receivers

It was clear that there had been discussion about the possible appointment of receivers – although it was less clear what the context was. The Court accepted that an RBS staff member did threaten to appoint receivers, and that ‘the incident amounted to an improper threat,’ but found that single incident by itself did not justify a conclusion ‘that the alleged implied duties were breached.’

Bank wins 3 – nil

PAG was unsuccessful on all counts. The Court held that RBS had a ‘non-advisory’ role, and that the terms of the contract between PAG and RBS prevented PAG from claiming otherwise, and so the misspelling claim was doomed.

The rejection of the LIBOR claim was comprehensive. The Court said that linking a transaction to the LIBOR rate did not automatically give rise to any implied representation, but in any event there was no evidence that PAG had relied upon such representations.

Finally, even though there is no general duty of good faith under English law, the behaviour complained of would not have breached any hypothetical breach.

What should Australian Lenders and their advisers take from the decision?

The judgement is unusual in revealing some of the inner workings of a loan workout team – but what it does reveal is fairly mundane. It highlights that banks are best prepared for challenges to conduct by having policies that set out what is expected, and ensuring that where discretion is exercised there is contemporaneous documentation to explain how it was exercised.

*My thanks to Michael Murray of Murrays Legal for guiding a non-lawyer through the complex issues of good faith!

Update: For more recents developments please see The beginning of the end? The RBS – GRG saga

Restructuring Reforms: Safe Harbour and ipso facto

On 28 March 2017 the government released draft legislation for comment, to implement the Safe Harbour and ipso facto reforms, available here.

Safe Harbour proposal – simple, practical and useful

The Government has opted for a carve-out from the civil insolvent trading provisions – a ‘model B’ approach.

Directors will have a ‘safe harbour’ unless it can be shown that they had failed to start a course of action “reasonably likely to lead to a better outcome for the company and its creditors as a whole.”

That immediately raises the question: how will we know whether a course of action is reasonably likely to lead to a better outcome? Helpfully, the draft legislation set outs what amounts to a checklist for directors, as to whether they are:

taking appropriate steps to prevent misconduct that could affect the company’s ability to pay all its debts.
taking appropriate steps to ensure that the company is keeping appropriate financial records.
obtaining appropriate advice from an appropriately qualified person holding enough information to give appropriate advice.
is properly informing themselves of the company’s financial position.
is developing or implementing a plan for restructuring the company to improve its financial position.

There is disqualifying criteria: if the company is fails to provide appropriately for employee entitlements, or fails to attend to its obligations to lodge income tax returns or other tax lodgements then the safe harbour is not available – so we can add those to the checklist too.

Ipso Facto – Linkage to an appointment type rather than a state of insolvency?

The draft legislation provides a very precisely phrased stay, which blocks termination on the grounds of two specific types of formal insolvency appointment: voluntary administration and schemes of arrangement.

The legislation is silent about a termination on the grounds of insolvency. There is an argument that a termination on the grounds of insolvency – which is actually evidenced by the appointment of an administrator – is unaffected by the stay.

Termination at will remains

The implementation of a stay on ipso facto clause enforcement will make it easier for a voluntary administrator to keep a business together – an enhancement over and above the current moratorium – by preventing the termination of contracts simply by reason of the appointment. But the stay will end when the administration ends, meaning that the underlying insolvency event will provide the other party to the contract with a free option to terminate the contract at will. Knowing, for example, that a landlord will be able to terminate a lease if they ever receive a better offer will make it challenging to raise finance, secure equity or sell a business.

The better option would be to make the stay permanent, or introduce some kind of override so that if the insolvency has been cured by a restructuring, then it can no longer be relied upon for the purposes of an ipso facto clause enforcement.

Extension to schemes of arrangement

In a theoretical sense the extension of the ipso facto stay to Schemes of Arrangement is significant, because unlike voluntary administration there was no moratorium. In practice however this change will have little impact, because schemes are so slow and so hideously expensive that they are used only infrequently, to restructure the very largest companies.

No ipso facto stay for receiverships

The proposals do not extend the ipso facto stay to receiverships. Secured creditors will consider whether it is possible to access the stay by the parallel appointment of an administrator, just as they do now to access the voluntary administration moratorium, but [as Paul Apathy has pointed out] this may not be viable. A better option would be a stay which applies to insolvency rather than nominated appointment types. Not only would that apply the benefit of the stay to all forms of appointment type, it would avoid an argument that termination on the grounds of insolvency was unaffected.

Impact on a secured lender’s ability to appoint a receiver

In the 2015 NSW Supreme Court Bluenergy decision, discussed in more detail here the Court held that a deed of company arrangement limits a secured creditor’s security to those assets existing when the deed took effect – which means that the charge will no longer capture “future assets” (such as the receivable that is created when stock is sold).

As a result, the assets captured by a secured creditor’s security will steadily diminish over time. Currently, secured creditors can avoid the risk of diminution by appointing a receiver when a voluntary administrator is appointed, but they must do so within the 10 day decision period set out in section 441A.

The proposals appear to stop secured creditors making such appointments if relying solely on the grounds of the appointment of a voluntary administrator.

Secured creditors concerned that there is a risk that their security is trapped within a deed of company arrangement may decide that it is in their interests to:

Decline to waive defaults, so that they will not need to rely on an insolvency event to make an appointment
Take care not to alert borrowers that an appointment is possible
Seek to appoint receivers at an earlier stage, to avoid the risk that directors might “beat them to” an appointment.

In other words there is risk that measures intended to promote restructuring may provide secured lenders with reasons to refuse to waive defaults, be cautious about communicating their concerns, and appointing receivers at an earlier time.

Ipso facto commencement

It is proposed that the stay will apply only to contracts entered into after 1 January 2018. It will therefore operate fully for businesses that start up after that date, but for existing businesses there may be a very gradual transition.

Overall

The draft legislation has appeared earlier than expected, with a short timetable for implementation – it is proposed that the new laws will take effect from 1 January 2018 – which is welcome. My view is that the safe harbour mechanism is very useful and very practical. The ipso facto regime has great potential, but there are a number of issues requiring further consideration and analysis, most notably the closing the gap which currently provides counterparties with a free option to terminate at will – even after insolvency has been cured.

The closing date for submissions on the proposals is Monday, 24 April 2017.

Wanted: Regulation of pre-insolvency advisers

ASIC appears to have been quite active over the last few months. Sydney Insolvency News reports the three year suspension of one liquidator’s registration by CALDB, an application for orders prohibiting two others from practising, and voluntary undertakings from another two practitioners.

The circumstances that the CALDB reasons (available here) describe are disappointing, but they do not make very interesting reading in their own right. There was no controversy because everything was agreed: the issues, the facts, and the penalty.

What has more significance is the reason why there was so much agreement. Much of a liquidator’s duties are set out in the Corporations Act: requirements to make public disclosure, maintain bank accounts, arrange for remuneration approval, and so on. Those statutory requirements are supplemented by an ARITA Code of Professional Practice which sets standards not just for the work to be done, but critically, the documentation of that work.

For most of the issues dealt with in the CALDB decision it was pretty clear not just what should have been done, but whether the liquidator could show that it had been done.

Those standards are supported by a broader framework which includes:

ASIC powers to seek an audit of a liquidator’s accounts
Court power to undertake an inquiry into a liquidator’s conduct
New rules in the ILRA which will allow for the appointment of a ‘reviewing liquidator’ by ASIC or the Court. (Creditors may similarly appoint a reviewing liquidator by resolution, but only in relation to matters of remuneration and costs).
A statutory registration regime which assures the skills, experience, and professional indemnity insurance of those seeking entry into the profession
Processes by which registration can be suspended, or even revoked – forcing an exit from the industry if appropriate.

Altogether, it is quite clear that that there is now quite a comprehensive regime supporting the regulation of insolvency practitioners.

There is a clear contrast between the regime supporting the CALDB decision, and the complete absence of any regulatory framework governing the pre-insolvency adviser in the Asden Developments case, whose client ended up a bankrupt after following his advice. In Asden there was no investigation by a regulator, and therefore no consequences for the pre-insolvency adviser. The adviser is now a bankrupt, but only because he was unable to pay back the large fee that was paid to him. There is no restriction on his re-entry to the provision of pre-insolvency advice – even whilst he is a bankrupt.

None of this can be a criticism of ASIC. ASIC is not the regulator of pre-insolvency advisers, because there no regulation of pre-insolvency advisers.

The potential customers of pre-insolvency advisers are those by definition seeking assistance at an extremely stressful and challenging time. It must be extremely difficult for them to make an assessment of the quality (or even legality) of the advice that they have been given, by a self-proclaimed expert – but there should be no need.

Twenty years ago there was no such thing as a pre-insolvency advice industry. It is an industry that has developed and grown, at the same time as the professional associations have lifted the standards of their members, and as ASIC has raised the bar on the regulation of liquidators. Some (but not all) of those involved are the former registered liquidators and former solicitors no longer able to practice as such. It is clear that the regulatory framework has been left behind.

The restructuring and turnaround profession needs to work hard to explain the problems, and advocate for an appropriate licensing and regulatory regime for the pre-insolvency advisers who currently operate without being subject to any scrutiny or review.

For comment on some other problematic advisers: “Non-mainstream advisers”

The 2017 Inquiry impacting Restructuring and Turnaround professionals

The latest inquiry to examine the conduct of Restructuring and Turnaround practitioners – the sixth in the last seven years – is a Senate Select Committee Inquiry, initiated on Thursday 16^th February.

The stated purpose of the Select Committee on Lending to Primary Production Customers is to ‘inquire into and report on the regulation and practices of financial institutions in relation to primary production industries.’

The first term of reference deals with financial institutions:

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

Whilst the second deals with the role of restructuring and turnaround professionals (as well as valuers):

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

The 2017 Inquiry has a narrower focus on primary producers, but otherwise there is significant similarity to the terms of reference of the 2015 Parliamentary Joint Committee Inquiry into The Impairment of customer loans, which examined:

(c) practices of banks and other financial institutions in Australia using non-monetary conditions of default to impair the loans of their customers, and the use of punitive clauses such as suspension clauses and offset clauses by these institutions;

(d) role of insolvency practitioners as part of this process;

If ‘the same question’ is in fact being asked again, then the restructuring and turnaround profession needs to think carefully about how we respond.

Inquiries dealing with the conduct and performance of restructuring and turnaround professionals since 2010:

2017 – Senate Select Committee on Lending to Primary Production Customers

2016 – Parliamentary Joint Committee Inquiry into The impairment of customer loans

2015 – Senate Inquiry into Insolvency in the Australian construction industry

2014 – Senate Inquiry into Performance of the Australian Securities and Investments Commission

2012 – Senate Inquiry into The post-GFC banking sector

2010 – Senate Inquiry into The regulation, registration and remuneration of insolvency practitioners in Australia

The Carnell Report – implications for turnaround and restructuring professionals

[First published on Linkedin.com on February 3, 2017]

The report from the Small Business Loans Inquiry conducted by the Australian Small Business and Family Enterprise Ombudsman (‘the Carnell Report’) available here includes some recommendations that will be relevant to restructuring and turnaround practitioners.

The report recommends that from 1 July 2017:

Borrowers should be provided with a copy of instructions given to an investigating accountant, and a full copy of the final report.
Banks should not appoint a practitioner as a receiver if the practitioner has previously undertaken an investigative accountant’s review.
Banks should select receivers through a competitive selection process.

The report suggests that there should be a requirement for receivers to provide a ‘flow of information’ to keep company directors ‘abreast of developments’ – although there was clear recognition of ‘legitimate concerns and limitations on the receiver releasing information around certain asset sale activities’ – but there was no specific recommendation addressing this point.

It appears that the intention is that these recommendations be implemented via changes to the Code of Banking Practice – which would avoid the need for legislation.

In addition, the report recommends that external dispute resolution schemes be expanded to cover investigative accountants and receivers (as well as bank valuers). It would seem likely that an expansion of EDR schemes to cover third parties would require legislation.

The extent of input from the turnaround and restructuring professionals who undertake such assignments is not clear from the report.

The inquiry was part of the Government’s response to the Parliamentary Joint Inquiry into Impaired Loans. Similar issues, albeit on a broader scale and of a more significant nature, were raised in the UK, as discussed here.

Update: For further developments on the EDR scheme please see Consultation on the Industry wide EDR for Business Credit disputes: AFCA

Bad Reputation? …Reputational issues for lenders and their advisers

[First published on Linkedin.com on January 23, 2017]

Brand and reputation may be intangibles in an accounting sense, but the latest development in the long-running investigation into the Royal Bank of Scotland’s Global Restructuring Group shows that there can be real and significant costs arising from their loss.

In November 2016 RBS announced a complaints process for GRG SME customers, as well as the automatic refund of so-called ‘complex fees.’ RBS estimated that the total cost of the scheme administration and likely refunds would be as high as £400m.

Closer to home, claims about ‘artificial’ loan defaults have been raised in Australia via the Parliamentary Joint Inquiry into Impaired Loans, and so the issues and outcomes are important for Australian lenders and their advisers.

The Large Report

In 2013 RBS commissioned an Independent review of lending standards and lending practices. The 95 page report (‘the Large Report,’ named for the main author) released in November 2013 mostly dealt with origination issues, but there was some discussion about GRG – RBS’ workout function – which had been raised by a submission from the Department for Business, Innovation and Skills (‘BIS’) written by Lawrence Tomlinson, and others. The report referred to allegations that RBS was working against the best interests of customers, but explained that an inquiry into individual cases was outside its scope, and recommended that RBS conduct a formal forensic inquiry.

Tomlinson, and his report

Lawrence Tomlinson is the owner of the LNT Group, which employs over 2,000 people. In April 2013 he was appointed as an ‘Entrepreneur in Residence’ for BIS – an honorary position intended to assist BIS in policy formulation.

On the day that the Large Report was released, Tomlinson distributed a paper (available here). Effectively a modified version of the BIS submission, the Tomlinson report was highly critical of GRG, and the insolvency professionals who advised it. The key claim in the report was that RBS was using so-called ‘technical defaults’ to move customers into GRG, so that it could charge much higher fees. If it could not find an existing default, then apparently RBS might ‘engineer’ one, with the assistance of complicit valuers.

Even though secured creditors in the UK can no longer appoint receivers (as explained here) they may still call in loans if there is a default. Tomlinson claimed that defaults were called without consideration of the impact on the customer, and in fact if the customer’s business failed then it might even create an opportunity for a bank subsidiary (West Register) to buy the assets at undervalue.

The Tomlinson report is concise – only 21 pages long – and provides a number of starkly-phrased conclusions, for example describing some bank action as ‘utterly disproportionate at best and manipulative and conspiring at worst,’ and the media certainly responded.

Media and Political response

It seems that it was easy for journalists to find case studies supporting the report’s conclusions, and there was widespread media coverage. A Daily Mail headline ‘A State-owned Bank that kills small firms to feed off their corpses. And still not a hint of shame!,’ was perhaps the most striking example, but it seemed to capture the general mood, and the BBC current affairs show Panorama also ran the story (available here).

There was also an immediate political response leading to an appearance by Tomlinson before a Treasury Select Committee in January 2014. It is clear from that hearing (shown live and still available here) that his report resonated with the members of the committee, with several referring to complaints received from their own constituents.

Queries over Tomlinson’s motivation and method….didn’t seem to matter

It was soon clear that Tomlinson was not asked to conduct a review. Neither the government nor RBS was aware it was being undertaken, as neither had the opportunity to provide any input into his report.

There was some criticism of Tomlinson’s method, and suggestions that he himself was a disgruntled RBS customer, unhappy about fees levied against his business. Tomlinson admitted that he was an unhappy RBS customer, but said that that the criticisms were valid regardless, and maintained that the focus on RBS was appropriate because it was the subject of the greatest number of complaints.

By and large, the claims about bias and the queries about his methodology were lost in the media and political storm. RBS was left to deal with the issue – whether that was fair, or not.

RBS commissions Clifford Chance

RBS responded within two days, announcing it would instruct panel law firm Clifford Chance to investigate ‘the most serious allegation’ that ‘RBS conducted a “systematic” effort to profit from customers in financial distress.’

The April 2014 Clifford Chance Report available here concluded that there was no evidence of a systematic program to take advantage of RBS customers. Some parts of the report were less helpful however: Clifford Chance said that they were unable to assess whether fees were fair or not because it was ‘difficult to understand’ how fees were calculated ‘in any particular case.’

The Clifford Chance report did not seem to help to close the issue. Some challenged the firm’s independence (for example The Huffington Post: 7 Things RBS Hoped You Would Not Notice In Its Clifford Chance Report), and it gave Tomlinson the opportunity to point out that the focus on the most extreme allegation left the others unaddressed.

Regulatory Response

The FCA is an independent government authority responsible for protecting and enhancing the integrity of the UK financial system. The FCA issued a statement explaining that the allegations gave rise to concerns about governance and culture, and announced an independent ‘Skilled Person’ review of the allegations by consulting firm Promontory Financial Group and accountants Mazars.

Project ‘Dash for Cash’

The controversy didn’t go away, but it seemed to quieten – until a joint investigation by BBC NewsNight and Buzzfeed in October 2016 which released RBS documents alleged to show that ‘under pressure from the government’ (an interesting sidebar for those who argue that Australia should have a government owned bank: the Tomlinson complaints relate to conduct after the government took a 63% stake in the bank), RBS had:

Provided staff with financial incentives (called ‘Project Dash for Cash’!) to force customers into GRG, so that it could extract higher fees.
Transferred businesses into GRG for reasons that had nothing to do with financial distress.
Not maintained proper Chinese walls between GRG and West Register, and instructed staff to conceal conflicts of interest from customers.
‘Generated a profit’ of more than a billion pounds in a single year through GRG fees and rate increases.

RBS denied the allegations in a statement, and an in-depth interview with the NewsNight reporter the next day. Regardless of RBS denials, the Chairman of the Treasury Select Committee soon released a letter calling for the full release of the Skilled Person Report, which had been delivered In September 2016 – almost two years later than planned.

Two years on…the Skilled Person report is delivered

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

The reviewers concluded that RBS did not set out to artificially engineer the transfer of customers to GRG, and in fact reported that customers transferred to GRG were exhibiting clear signs of financial difficulty. They found no evidence of West Register targeting customer assets for purchase, and could not find any examples of property purchase by West Register that increased financial loss to the customer.

Less happily for RBS however, the FCA said that the inappropriate treatment of SME customers appeared ‘widespread’ and that ‘much communication was poor and in some cases misleading.’ It also identified a failure to support businesses ‘consistent with good turnaround practice,’ and an ‘undue focus’ on pricing increases and debt reduction rather than longer term viability of customers.

RBS response

On the same day that the FCA released the summary of the Skilled Person report, RBS released an LSX announcement outlining a response to the report, described as having been ‘developed with the involvement of the FCA.’

RBS announced a new complaints process to be overseen by a retired High Court Judge, and the automatic refund of ‘complex’ fees paid by SME GRG customers between 2008 and 2013. RBS said that the estimated £400m total cost of the program was approximately 20% of the amount it lost from lending to SME customers in that period.

An analysis by UK solicitor Cat MacLean identifies the fees which are said to attract an automatic refund, a long list including Management fees, Asset Sales fees, Exit fees, Mezzanine fees, Ratchet fees, Risk fees, Late Information fees, Property Participation fees and Equity Participation Agreement fees.

Is this the end?

RBS must hope that their response to the Skilled Person report will close the issue, but that seems unlikely:

There are still calls and campaigns for the release of the full report.
The £400m refund and compensation scheme will not resolve all claims (borrowers with debt facilities or turnover higher than £20m are excluded).
The outcomes do not appear to be binding on borrowers, so borrowers unhappy with the decisions may still pursue the normal avenues.

The total cost is already higher than £400m – UK-based claim adviser Seneca Banking Consultants claims to have recovered £100m just for its own clients – and there are other claims in the wings, most notably the RBS-GRG Action Group claims to be organising ‘group litigation’ involving more than 400 borrowers with claims reported as totalling more than £1b.

So, we should give a damn….

Three years after complaints were raised in the Tomlinson report, the worst of the allegations appear to have been discredited. But that conclusion has only been reached after considerable damage to the RBS brand and reputation, and now, very real and significant financial cost.

‘Do our loan documents allow this?’ is still a very important question for workout bankers, but it is not the only question to be asked. The RBS experience shows very clearly that lenders and their advisers are wise to address other questions around transparency and fairness before determining a final course of action – even more so given that there is no lessening in calls for the independent review of lender conduct.

Update: For more recent developments please see The beginning of the end? The RBS – GRG saga

Submission to the Senate Economics References Committee Inquiry into Superannuation Guarantee non-payment

[This is a copy of my submission to the Senate Economics References Committee Inquiry into Superannuation Guarantee non-payment]

My Background

I am a Chartered Accountant and former registered liquidator, with more than 20 years’ experience in financial and professional services at Nab, ANZ Bank, and Ernst & Young.

In my current role I lead complex loan workouts across the Institutional and Corporate platforms at Nab, and I am an ARITA Vic./Tas. board member.

I very much appreciate the opportunity to provide a submission to the Senate Economics References Committee Inquiry into Superannuation Guarantee non-payment, which for clarity represent my personal views and is not made on behalf of either my employer, or ARITA.

Summary

My submission is in relation to term of reference c (v) – employment and contracting arrangements, including remedies to recoup SG in the event of company insolvency and collapse, including last resort employee entitlement schemes.

I wish to draw the committee’s attention to a recent decision of the Supreme Court of New South Wales In the matter of Independent Contractor Services (Aust) Pty Limited ACN 119 186 971 (in liquidation) (No 2) [2016] NSWSC 106 (available online here), the consequences of that decision, and a possible solution.

Issue: that statutory priorities do not apply in respect of trust assets

At paragraph 25 of Independent Contractor Services the Court held that:

“The statutory priority referred to in s 556 does not apply in respect of trust assets.”

That means that a business that is operated through a trust structure is outside of the operation of section 556. This decision affects the priority afforded to SG debts under sub-section 556(1)(e)(i), but for clarity it also applies to all forms of employee entitlements, such as unpaid wages and annual leave. In commercial practice the use of discretionary trusts is widespread, and so the decision will impact the entitlements and superannuation administration of many thousands of employees.

There is a very large group of stakeholders potentially impacted by the decision, and if actually impacted, they will be very significantly disadvantaged.

If the level of protection afforded to employee superannuation and other priorities is dependent on the type of structure used by the employer, then in practical terms, that is:

Inequitable, because there is no business or commercial justification for such a difference; and
Impractical, because we cannot expect employees to be able to identify the type of structure by which they are employed, or understand the consequences of the structure.

Independent Contractor has been followed by the Federal Court in In Woodgate, in the matter of Bell Hire Services Pty Ltd (in liquidation) [2016] FCA 1583 (available online here).

Suggested solution

The Corporations Act should be modified so that the section 556 priorities apply in all liquidations.

This would implement the recommendation set out in paragraph 265 of the Australian Law Reform Commission’s 1988 Harmer Report (General Insolvency Inquiry [1988] ALRC 45).

An appropriate modification could be achieved by:

Amendment to section 556; or
A new provision that operates to create priority for employee entitlements and SG debts ahead of trust creditors, in the same way that section 561 currently gives priority to employee entitlements and SG debts ahead of circulating security interests.

Any changes should be drafted to allow for the possibility that corporate entities might be the trustee of more than one trust, or might also employ staff in their own right.

End of the line?…..should we ban receiverships?

[First published on Linkedin.com on December 17, 2016]

Following the Parliamentary Joint Committee Inquiry into Impaired Loans – established to investigate whether lenders had ‘manufactured’ defaults to enable them to call in loans – one of the questions being asked in insolvency and restructuring circles was: what if the Australian government acts to ban receiverships, as happened in the UK?

Why ban receiverships?

The critics of receivership argue one or more of the following:

Secured creditors ‘jump the gun’ and appoint too quickly – with the result that the business is either sold or closed, presumably whilst the owner still had a reasonable chance of turning it around.
Receivers sell the assets without getting the best price.
A failure to sell the business as a going concern means that jobs are lost and returns to creditors are lower.

The UK reforms

In 2003 the UK passed legislation to prevent secured lenders from appointing receivers to a business – apart from a specific exclusion for security created prior to the introduction of the legislation.

Although secured lenders with a charge over a business may not appoint a receiver, all other remedies remain unaffected. They may still:

Decline to provide any further funding
Take legal action to have the company wound up or have the court appoint a receiver
Most significantly, appoint an administrator.

Administration in the UK does not completely align to Australia’s Voluntary Administration process (most notably, a UK administration runs for twelve months, and does not lead to a DOCA), but the two processes share many similarities, and in both countries the administrator has a duty to act in the interests of all creditors – as compared to a privately appointed receiver whose primary duty is to ensure repayment of the lender.

Whilst the secured lender retains priority to the proceeds of the assets subject to its security, the administrator may sell the business as if it were not subject to the security – except for property secured by a fixed charge, or subject to a hire purchase agreement, which requires the administrator to seek court approval. A secured creditor may appoint an LPA receiver to specific assets, but has no capacity to appoint over a business.

Jumping the gun

If we followed the UK model where secured creditors could appoint an administrator, but not a receiver, would that result in appointments being made at a later time?

It is hard to think of a reason why it would, and it is quite possible that the reverse is true.

Firstly, because secured creditors typically underwrite receivers’ fees and expenses they will sometimes decline to appoint, or delay an appointment, to avoid the additional liability. There is typically no indemnity provided to an administrator.

Secondly, secured creditors will sometimes hesitate to appoint a receiver for reputational reasons – not wanting to be seen as the party forcing an insolvency appointment. Because an administrator is an independent person appointed for the benefit of all creditors, the appointment of an administrator may be seen as a less difficult from a reputational perspective.

For both these reasons, in practical terms it may be less onerous to appoint an administrator, meaning that a prohibition on receivership appointments might in fact lead to earlier insolvency appointments in some cases.

Selling Assets too cheaply?

Until 1993, Receivers in Australia were subject to a duty to get the ‘best price reasonably obtainable.’ This sounds like a simple and straightforward test but in practice it became a battle of competing valuations, conducted after the sale had already taken place and the outcome known.

In 1993, the Australian Parliament implemented the Harmer Report recommendations that there should be a focus on process rather than outcomes. The result, section 420A of the Corporations Act requires receivers and mortgagees in possession exercising a power of sale to take all reasonable care to sell the property for market value (or the best price that is reasonably obtainable if there is no market value). It is important to note that this is not a requirement to obtain market price but a requirement to run a process that should deliver that outcome – in practice a test that is far easier to assess, and litigate if need be.

A breach of the 420A duty is not of itself a criminal offence capable of prosecution by ASIC – unless it is so egregious as to constitute a breach of the receiver’s general statutory duties – but it gives rise to a potential claim of damages for loss suffered, which is available to the borrower but not a guarantor.

Although the number of 420A cases has fallen more recently, arguably this shows the impact of early litigation. There are early examples where receivers were not able to show that they had taken all reasonable care to sell assets for market value, and they (and their appointors) ‘paid the price’. The 420A duty is now clearly front-of-mind, referred to and measured against by secured creditors and their appointors, and the fact that sales processes have improved should not be taken as a sign that 420A is ineffective.

In the UK the general duty of administrators to act in the best interests of creditors has been construed to require UK administrators to take steps to secure the best price reasonably obtainable, such as obtaining independent valuations and undertaking an appropriate marketing campaign. However there is no specific statutory duty in the UK for receivers or administrators, and no such duty for Australian administrators.

Australia now clearly holds receivers to a higher standard than administrators, and to a higher standard than UK receivers. To ban receiverships and place the asset sale process in the hands of an appointee with a lesser duty would not be a appropriate response to any concerns about the asset sale process.

If there is a view that there are 420A claims that could be pursued, but have not been, then that is far more likely to reflect an inability to fund a legal action – better addressed by providing funding and support through the Assetless Administration Fund which ASIC administers.

Failure to sell as a going concern

One of the challenges for secured creditors and the receivers that they appoint is the situation of a loss making business which may still be sold as a going concern, for example to a competitor that may have scope to further reduce costs by combining back-office functions. But this is a gamble – losing money knowingly in trading on, in the hope of a sale – and it often requires funding.

To Australian eyes one of the noteworthy aspects of a UK government proposals paper released in May 2016 (discussed in detail here) was identification of the need to promote the availability of ‘rescue finance.’ The proposals paper canvassed options to help administrators to obtain finance by mortgaging the assets of the company – effectively subordinating the prior mortgage held by the existing secured creditors – without their consent.

In Australia there is little need for a rescue finance regime – a secured creditor contemplating the appointment of a receiver will almost always make arrangements to provide the receivers with sufficient funding to allow the business to continue trading until at least the prospects of rehabilitation or sale have been explored.

In other words it seems that the UK reforms which stop secured lenders from appointing receivers may have made resulted in appointees that are less able to secure finance, because the party with the incentive and resources to provide rescue finance has been taken out of the picture – and the outcome in some of those cases is the earlier closure of businesses, and job losses.

What else can we learn from the UK experience?

In late 2013 a UK government adviser released a document that became known as The Tomlinson Report, named for its author.

There’s more detail about the report and its consequences here but in summary the report was highly critical of the conduct of the Loan workout team of the Royal Bank of Scotland and their advisers, in their dealings with borrowers post the GFC.

The report was arguably more an aggregation of bank complaints assembled by a person himself unhappy about his (earlier) treatment at the hands of RBS, rather than a structured review conducted by an impartial person. That said however, the complaints that it presents, and the public and political reaction to the report, far exceed the scope of complaints that lead to Australia’s 2015 Parliamentary Joint Committee Inquiry into Impaired Loans.

Discussion about whether all of the complaints were fully justified is beyond my scope here, but regardless, it seems that there are many UK bank customers who would say that they did not receive any better treatment at the hands of their banks as a result of the prohibition on receiverships!

The use of panels

The Wilmott Forests decision provides insight into another issue. In Wilmott Forests a sole practitioner accepted an appointment to a large agribusiness company, and later used his casting vote to defeat a resolution to replace him. An application to Court ultimately led to his replacement, with the Court determining that not only did the administrator lack relevant experience in the forestry industry, he lacked the financial resources to meet the costs of the business, and lacked professional indemnity insurance and staff resources to undertake such a large and complex assignment.

Directors confronting the appointment of an administrator are usually not well versed in assessing the capability and capacity of the proposed appointees. By contrast, as regular users of insolvency professionals, the major banks have panel arrangements which ensure appointees are free of conflict, appropriately resourced and experienced as to any industry issues, and holding appropriate professional indemnity insurance. For those concerned about the cost of insolvency proceedings it is worth highlighting that through the use of such panels, the banks have also negotiated discounted practitioner rates.

Lipstick on the pig?

Financial failure is devastating for the proprietors of a business, and often so for their employees, and their creditors.

Having a different title for the insolvency practitioner, and having them appointed by a different stakeholder, will have very little real impact – and a lesser duty of care, and additional costs imposed by an administrator’s mandatory investigation, may in fact be backward steps.

There is no doubt that insolvency and restructuring law is due for reform, but we need real reform that will improve returns and restore equality – measures such as those identified here, rather than the adoption of measures from overseas jurisdictions which may not in fact impact the issues that we are trying to address.

In Focus: Pre-Insolvency Advisers

[First published on Linkedin.com on November 16, 2016]

Asden Developments Pty Ltd (in liq) v Dinoris (No 3) is a very recent Federal Court decision which deals with a claim by a replacement liquidator that his predecessor breached his duties. Most of the public analysis of the case is focused on what the decision says about the duties of liquidators – but there is another aspect that deserves attention. The judgement also provides considerable detail about the activities of a ‘pre-insolvency adviser,’ and those activities raise significant questions about the role and purpose of such advisers.

Background

Asden was used as the vehicle by which a family conducted real estate development. According to the sole director’s evidence, the land purchase and financial arrangements were negotiated by her then father-in-law, whilst much of the construction activity was undertaken by her then husband who was apparently precluded by bankruptcy or impending bankruptcy from undertaking a role as a director.

At around the same time as the development experienced financial pressure due to delays and defects in construction, the director and her husband separated. At first the separation did not appear to affect the family’s willingness to support the financial position of the company: the father-in-law advanced $50,000, and then a further $270,000 about a fortnight later; but a day or two after the last advance she was told that there would be no more support and that the company’s debts were ‘her problem.’

Concerned about her position as a director of a company that might be insolvent, the director sought advice from her accountant, who referred her to a consultant pre-insolvency adviser.

The consultant advised her to incorporate a company, TJI Investments, and to transfer $264,000 from the main company bank account into another account in the same name with the Bank of Queensland.

There was a series of payments following her receipt of a formal demand for the return of the $270,000 a few days later. The director used $22,000 to pay for a new car, and transferred the balance of $236,500 into the bank account of a company controlled by the consultant. The consultant’s company retained $56,500, and transferred the balance of $180,000 into a bank account operated by the newly incorporated TJI Investments. Two days after the last payment the director initiated the winding up of Asden, with $10,000 from the $56,500 used to make a contribution towards the costs of liquidation.

The liquidator’s standard letters led to information from the Bank of Queensland detailing the $236,500 withdrawal, and further investigation confirmed that the director had signed the withdrawal. The liquidator called the consultant seeking further information and was told that the funds were not received by the director ‘personally,’ and that the liquidator should investigate further.

At around the same time the liquidator received correspondence from the family’s solicitor claiming that the $270,000 was not the property of the company but rather that it had been provided to the director personally, specifically to fund the payment of creditors, and was therefore subject to an express trust. Shortly thereafter the family initiated legal action against the director, and the consultant and his company, to pursue the trust claim. That legal action was successful, and the judgement led ultimately to the bankruptcy of the director and the consultant, and the winding up of his consultant’s company. They also recovered the residual balance of the TJI Investment account, which by that time had been transferred to a solicitors’ trust account and had been further depleted by the director’s legal fees.

Separately, the liquidator instructed an auctioneering firm to make arrangements to sell a boat owned by the company that was secured to a finance company. The boat was sold at auction, and net proceeds after GST, costs and commission were disbursed by three payments: $21,000 to TJI Investments – which had paid out the finance company, $9,790 to a second company associated with the consultant, and $4,933 to the liquidator.

The Federal Court judgement

The two main issues at trial were whether the liquidators’ failure to more actively pursue the recovery of the funds – most notably by personally contacting the director – and failure to prevent the $9,790 payment to the consultant’s company were a breach of his duties as liquidator.

The liquidator gave evidence that he was unable to personally contact the director because he did not have her telephone number or email address – when first approached by the consultant he had been told that the director ‘was under a lot of pressure and stress by reason of a family dispute’ and that the consultant wanted to be the point of contact.

Maddocks have provided a concise and useful discussion of the liquidator’s duties but in summary the Court held that that there was no breach of duty as regards the disbursement of the boat proceeds because the liquidator had appointed an agent to sell the boat on his behalf, and he was entitled to assume that the agent had properly discharged his duties by properly scrutinising the costs and disbursements.

The Court found that the liquidator had breached his duty as liquidator by failing to make any personal inquiry of the director about the transferred funds, but held that there was no loss because however active his pursuit the director would not have repaid the monies – notably declining to accept her evidence that that she would have repaid the monies if asked.

The role of the pre-insolvency adviser

If we extract and summarise the pre-insolvency adviser’s activities and involvement, he:

Netted $46,500 for the services provided to the director and received almost $10,000 for his involvement in the collection of the boat and arranging for the finance company’s debt to be paid out.
Constructed an ‘elaborate’ scheme which put the $264,000 out of reach of both the liquidator and the subsequent claimants.
At best – failed to assist the liquidator’s investigations by failing to provide details of the transfer when asked about the withdrawal, and apparently telling the director that she did not need to respond to the liquidator’s correspondence.

The family recovered approximately $173,000 but incurred significant legal fees, and the shortfall resulted in the director’s bankruptcy – a consequence that might have been avoided if she had acted to preserve the funds rather than disperse them. Of course, the consultant also became bankrupt, but that is hardly a consolation to the rightful owner of the funds, or the director.

If the director had consulted a registered liquidator then there would have been assurance via the statutory registration process that the liquidator was appropriately skilled and educated, supervised by ASIC, covered by professional indemnity insurance, and subject to the ethical standards of at least one professional body – rather than an unregistered, unsupervised and uninsured – but expensive – consultant.

Liquidators versus Zombies?

[First published on Linkedin.com on 17 October 2016]

It’s no surprise that ASIC’s move to a user-pays model will impact the restructuring and insolvency community, but the proposed model – reported by the Sydney Insolvency News blog (SIN) – is unexpected.

Most practitioners had anticipated that ASIC would follow the model used by the personal insolvency regulator, AFSA, to recover costs involved in the regulation of personal insolvency practitioners. AFSA charges a “realisation levy” against the value of assets recovered by the trustee, calculated by practitioners and directly charged to each insolvency administration i.e. directly reducing the pool of assets available to creditors. The applicable rate has varied over time: from 8% in 1997 when it was introduced in its current legislative form, to as low as 3.5% in 2007, increasing to the current 7% as at 1 July 2015. The concept of a levy based on asset realisations is therefore well established, and well understood by all stakeholders: creditors, practitioners, and the regulator.

SIN reports that it is proposed that ASIC will charge practitioners an annual fee of $5,000 per annum, and a further $550 for each formal insolvency appointment, to recover a targeted $9m. Notably, the $550 charge cannot be directly on-charged as a cost of the administration – practitioners must absorb that cost.

What will be the consequences if the new regime is introduced as proposed?

Rationalisation of registrations

The additional cost is likely to prompt some semi-retired and part-time practitioners to hand back their registrations.

Whilst this will reduce the number of industry participants and thereby reduce competition, it may in part be a positive if it clears out practitioners who are not properly investing in their own skills, or their practice resources. However, there are clearly some practitioners who may be temporarily sub-scale, that we should not be seeking to push out:

Start up practitioners: new entrants who will add competition once they build up scale.
Practitioners that may be temporarily scaling back a practice to accommodate a work/life balance: in reality more likely to be the female practitioners that the profession needs to improve its diversity.
The next generation: senior employed staff undertaking a transition to partnership. Again these are more likely to include the female practitioners that the profession needs to improve its diversity.

Fees will increase

Most practitioners charge on the basis of hourly rates. At one stage there was a standard (albeit suggested rather than mandated) scale of fees, however the scale was scrapped following concerns that it might be viewed as anti-competitive, and practitioners have complete freedom to charge whatever fees they set.

Some practitioners will respond to additional charges by increasing their hourly rates so that in effect the additional cost will be passed on to creditors. However, practitioners will estimate the increases required, some will “overshoot” in the absence of the upper limit imposed by a realisations charge, whilst some will fall short – so will there will not necessarily be an equitable distribution of the increase.

Zombies?

Until recently there were two classes of liquidators: “Official Liquidators” and “Registered Liquidators.” The Insolvency Law Reform Act 2016 removes the position of Official Liquidator, and with it, the previous obligation that all official liquidators had: to accept all requests to act as a liquidator absent a disqualifying conflict of interest.

If taking a liquidation is guaranteed to cost a liquidator $550 – on top of the various costs that they already incur in searches and similar, and in addition to their own time – then it seems likely that some liquidators now free to decline appointments will do so. For creditors, the end result may be that they are unable to secure a liquidator to act at all unless they are prepared to provide an indemnity to meet at least a part of the costs and/or fees that a liquidator will incur in taking on such appointments. Of course creditors will have the option of declining such requests, but if so there is the risk that some companies may never be wound up, living on as corporate zombies!

The Australian Taxation Office – which is a significant creditor of almost all companies – is the most active creditor, initiating more winding up applications than any other creditor, and therefore is potentially the most affected should registered liquidators decide to change their approach.

Where to from here?

Implementing an AFSA-style model – albeit with a realisation levy that would surely be significantly lower than 7% – allows us to side-step the risk of consequences that may impair diversity and competition, as well avoiding the risk of corporate zombies. Hopefully, at what is presumably an early stage of consultation, there is scope to bring alternate models into the discussion.