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At the Edge of the Insolvency Cliff: The new small business restructuring process
What area(s) of law does this episode consider? | In this episode we discuss the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (Cth) and specifically, the new small business restructuring process which it will introduce. |
Why is this topic relevant? | The small business restructuring process is Australia’s first debtor-in-possession regime, and one of the Commonwealth government’s policy responses to the economic effects of the COVID-19 pandemic. If the number of distressed businesses requiring turnaround and rescue next year is anything like media predictions, it’s important for commercial lawyers to understand all of the tools that are available. |
What are the main points? |
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What are the practical takeaways? |
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Show notes | Corporations Amendment (Corporate Insolvency Reforms) Bill 2020: |
David Turner:
1:00 | Hello and welcome to Hearsay, a podcast about Australian laws and lawyers for the Australian legal profession, my name is David Turner. As always, this podcast is proudly supported by Assured Legal Solutions, a boutique commercial law firm making complex simple. In this year of extraordinary economic pressures, insolvency law and policy has been a popular topic of law reform. Many of our listeners will know about the temporary changes to the Corporations Act, which suspended insolvent trading liability and in practical terms deferred the issue of creditor’s petitions until next year, as well as the similar changes to the Bankruptcy Act. Those measures have drawn a mix of commendation and condemnation, with some insolvency professionals suggesting that when these measures and temporary financial supports like the JobKeeper payment and compulsory rent relief come to an end, many Australian businesses will all at once crumble under an unbearable weight of debt, the so-called ‘insolvency cliff.’ Now whether the insolvency cliff is nigh or whether it’s more likely to be more like a set of stairs, Parliament clearly anticipates that many Australian businesses will need some help to survive the financial aftershocks of the COVID-19 pandemic, and that help at least in part comes in the form of the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020, Australia’s first corporate debtor-in-possession formal insolvency process. Joining me today on Hearsay to talk about the Bill, and to make some predictions about how the regime will work in practice and how successful it’s likely to be, are Mark Wellard, senior lecturer at the University of Technology Sydney, and I also welcome back to Hearsay Professor Jason Harris from the University of Sydney. Mark and Jason, thanks so much for joining me today on Hearsay. |
Mark Wellard: | Thank you David, it’s great to be here. Great to be with you Jason. |
Jason Harris: | Thanks very much. |
DT: 2:00 | Now let’s start with the very basics, when we say a debtor-in-possession model what do we mean by that? How is that different to the insolvency processes that we currently have available to businesses in distress in this country? |
JH
3:00
4:00 | So, the standard insolvency process that we have in Australia, like in many common law countries, is one of external administration. So the idea that we bring in an independent experienced insolvency practitioner who effectively takes over the management of the company during the insolvency proceedings. TIP: Now when we’re talking about external administration, we’re talking about:
A deed of company arrangement is also described as a kind of external administration in the Corporations Act; in a deed of company arrangement the company is under the control of its directors but the ‘deed fund’ or ‘deed property’ to be distributed to its creditors remains under an external administrator’s control. Receivership is another process where the control of the company’s property is taken away from its directors by an external appointee; but it’s not technically an insolvency process per se – it’s just one means by which a secured creditor can enforce their rights. Now this new process we’re talking about is so different to all of those because the small business restructuring practitioner doesn’t actually take control of the company away at all, which is something completely new in Australia. Debtor-in-possession is different to that because whilst there might be a range of external advisors, including insolvency practitioners, bankers, lawyers, accountants, et cetera, in fact the debtor company’s management remains in control during the insolvency case. So it’s a completely different way to run an insolvency matter, and the big concern with it of course is that it’s effectively leaving the people who potentially caused the company to get into that precarious financial position to remain in control. So some people have some issues with it on that basis. |
MK:
| “Leaving the lunatic in charge of the asylum” it’s sometimes put, rather unkindly, but that I think is a layman’s term which aptly describes I think the creditor-friendly attitude of many common law countries, as Jason said that there’s scepticism, an element of mistrust in leaving the existing management in control of the show. So, at a more technical level in all those external administration procedures, as Jason mentioned, there’s a provision in the Act which effectively disempowers the managerial role of the directors and puts the insolvency practitioner in charge. So you’ve got this sort of ‘honest broker’ in the process which is something we’ll probably talk about later when we’re talking about the streamlined procedures as well but yeah I think it’s an interesting way to describe, I think, the creditor friendly attitudes of some jurisdictions. |
DT: 5:00
6:00 | And Australia’s insolvency laws certainly have been very creditor-friendly in the past. There has been a slightly earlier move towards a somewhat more debtor-friendly approach to insolvency with the safe harbour provisions a few years ago, but this is obviously a much larger step. TIP: The ‘safe harbour’ defence to insolvent trading liability commenced in September 2017. Directors who rely on the defence can allow their company to continue to trade whilst it’s insolvent, provided that they do so whilst developing or implementing a course of action that is reasonably likely to lead to a better outcome for the company when compared to its immediate liquidation. Now there are some other prerequisites to reliance on the safe harbour defence – tax lodgements have to be up to date, and so do employee entitlements, they have to be paid on time – but the safe harbour defence certainly marked an intentional shift towards a more debtor-friendly insolvency regime in Australia. The stated purpose of the safe harbour defence according to its explanatory memorandum, was to encourage entrepreneurship and reduce the stigma associated with insolvent trading. What’s the one benefit, I suppose, to leaving the lunatic in charge of the asylum? Why have a debtor-in-possession model at all? |
JH: | Well notionally it provides an incentive for managers to act early. So if we think about small business for example, one concern that small business people might have with engaging an insolvency practitioner is that perhaps they’ve spent their whole life building up this business, it might be part of a family business that goes for several generations and they’re effectively giving up control under the current regime. So providing debtor-in-possession, it’s in some ways a gentler way to deal with the financial problems because you can say “well you’ll have some expert advisors on hand, but you’ll still be in charge, you’ll make all the key decisions,” obviously subject to statutory obligations and duties, transparency in reporting and the like. But it’s supposed to provide an incentive for management to act earlier than they would if the choice was simply handing the keys to an administrator. |
DT: 7:00 | And I suppose theoretically the lighter touch of the insolvency practitioner is supposed to reduce cost, though the practical aspects of that we might come on to a little bit later. |
MW:
| Yeah that’s a good point, I mean if you are, for instance, an external administrator conducting a trade-on for the reasons we just discussed taking over the managerial role, that comes at a significant cost – quite apart from the honest broker role the external administrator plays in the system if they’re actually running the business. And as we all know, there’s strict independence requirements on administrators and liquidators and the collective procedure they’re coming into that business with little prior knowledge. Depending on the size and complexity of the business, doing that trade-on and the commercial aspects comes at a very significant cost as well. But I think Jason summed it up well. A debtor in possession procedure in theory appears little less unpalatable, if I could use that term, to a director wanting to seek advice rather than handing over control and the perception that they’re going to lose control in the process. |
DT: 8:00 | And I suppose that incentive is a response to a complaint that I’ve certainly heard from many insolvency practitioners and no doubt policymakers have as well, that many owners and directors of businesses leave it much too late to seek insolvency advice and that really affects the ability of what’s presently the voluntary administration regime to rescue a business. Now this is Australia’s first corporate debtor in possession model, I mentioned that earlier but it’s certainly not the world’s first. There’s a similar regime in the United States, which everyone has been mentioning when comparing this model to that, the Chapter 11 regime though it’s probably not quite the same. There’s CVAs in the United Kingdom which came in relatively recently, and there’s a similar regime also in Singapore. From what we’ve seen of the Australian small business restructuring regime, how does it compare to some of these international examples? |
JH: 9:00 | Not well. So it’s called a debtor-in-possession regime and the Treasurer has mentioned in several media interviews that it’s borrowing the best bits of Chapter 11, but it’s really a hollow claim. Because this is effectively a VA-lite, voluntary administration-lite procedure. It’s not going to be effective as a debtor-in-possession regime because to do almost anything during the proceeding, you’ll need to get the permission of the small business restructuring practitioner or the court. Certainly if you want to try and change the business to deal with the financial problems, you’re going to need permission, things have to be reviewed by the practitioner and so it’s not debtor-in-possession in the sense of in North America or some of these other procedures. It’s a modified, slightly pared-down voluntary administration. |
DT: | I mean that’s certainly an observation that I gleaned from the… |
JH: | …the hundreds of pages of legislation. |
DT:
10:00 | Yes, yes, the not-so concise regulations, is that if you have to do anything outside the ordinary course of the business you obviously need the restructuring practitioner’s say-so, the restructuring practitioner has to investigate the affairs of the business to determine whether or not they’re going to give that consent, and if the ordinary affairs of the business were capable of producing a cashflow-positive, solvent business, then they wouldn’t be in the process in the first place. Mark is there anything you want to add in terms of how the restructuring process compares to its international cousins? |
MW:
11:00
12:00
13:00 | One thing that occurred to me was, and I wrote an article on this a couple years ago, there was a World Bank report produced in 2018 which addressed design features of small business restructuring proceedings. TIP: The report Mark’s referring to is called “Saving Entrepreneurs, Saving Enterprises: Proposals on the Treatment of MSME Insolvency.” Now a link to that report will be in this show’s show notes, but if you’re curious, that extra ‘M’ in MSME stands for Micro – so that’s Micro, Small and Medium Enterprises. It was a report which talked about the treatment of MSME insolvency and there’s an interesting chapter in that report which indicated that, and it looked at other jurisdictions like the United States, Singapore, Korea and Japan I believe. And the takeaway point or conclusion, the observation of the report, was that MSME restructuring procedures have been a tough nut to crack in terms of designing it successfully. Like, even in the United States and I know Jason’s doing a PhD which focuses on Chapter 11 in large parts, he might have something to say about this, but the World Bank report anyway made the observation that the small business US Chapter 11 proceeding is under-subscribed. The reality and the difficulty in MSME insolvency is finding viable candidates or a low strike rate in terms of finding viable candidates, and the US Chapter 11 small business procedure seems to be very much a procedure focused on weeding out unviable candidates rather than something that’s prevalent and being used. It’s a similar experience in the United Kingdom where there’s been a small company moratorium in existence for years I think since the Enterprise Act, and that hasn’t really been used much. And recently in the United Kingdom we’ve had another reform introducing a standalone, what’s called standalone moratorium procedure which doesn’t necessarily act as a gateway to any other type of insolvency procedure. That’s something I think is interesting to compare with this new procedure Part 5.3B in Australia, because it does seem to be a standalone procedure in the sense that there’s no automatic transition to a liquidation if the restructuring plan is rejected. I personally have problems with that design feature, given that the company is taken to be solvent if it instigates this procedure, I tend to think in Australia there’s more of an acceptance of the procedure having to lead to some outcome, a finality one way or the other rather than sort of letting things drift. A company that uses this procedure that plan’s voted down and then control simply reverts back to full control reverts back to the directors and you have an insolvent company which may or may not then use one of the other procedures. It would be, in my view, a little bit absurd if a company goes through part 5.3B, the plan is voted down, and then goes through part 5.3A! The takeaway point I guess I want to make is that overseas there seems to have been according to the World Bank report anyway not a particularly great degree of success in designing these types of procedures, and I do wonder sometimes whether that’s born out of the reality that amongst MSME insolvencies it’s hard to find viable candidates. |
JH:
14:00 | It’s tricky as to how we define success, because if we define success by say confirmed plans, business still trading five years later, returns to creditors, those sorts of things, for small businesses that just don’t have the asset base to start with. So, I’m not even sure that it’s really a problem about starting too late or leaving it ‘til the last minute, they just don’t start with very much. So if you’ve only got a few thousands in assets, if that, I mean it’s almost nonsensical to talk about restructuring. Really, you’re talking about resolving a debt dispute with someone like the ATO; that’s what it’s about. And this new procedure, it’s just it’s laughable to call it debtor-in-possession I think, this is just my opinion I don’t want to verbal you Mark, but I think it’s going to be “ATO-in-possession”. Because they’re the main creditor who’s going to vote. And so they’re the one that’s going to determine the plan. |
MW:
15:00 | I agree with that, in the sense that I think the design has sort of lost its way in terms of starting out with what sounds like a great idea in theory, but then as the appreciation develops of the potential for abuse and the need to safeguard creditors’ interests, you get the safeguards, the checks and balances built back into the system, which is these things like the ‘out of the ordinary course’ consent dealings and so forth, and you end up with a procedure which is not particularly streamlined and not going to achieve the original objective that was anticipated. So I think that’s sort of from my standpoint, I agree with Jason, it’s not really a debtor-in-possession and from my perspective, I don’t really care if it’s debtor-in-possession or not. I think the main point this came out of that World Bank report as well, is trying to arrive at a streamlined procedure if you can accept less bells and whistles, less reporting, less checks and balances than we currently have in say voluntary administration, you can then design a procedure which is quick, albeit relies very heavily on the ethics and the competence of the practitioner, which is another point we’ll probably come too, but you arrive at a procedure which might actually achieve its objective which is lowering the cost, speed, efficiency, but I agree with Jason that from what I can see this procedure we have just gone round in circles sort of taking out the commercial aspects of a trade-on but putting the practitioner back into the frame in terms of responsibility, cost which doesn’t really give you a procedure which is inexpensive. In fact, it’s arguably more complex. |
DT:
16:00 | That need for a streamlined process, whether it’s a debtor-in-possession or an external administration something we discussed in your earlier interview Jason about the efficacy of voluntary administration regime, some of our listeners might remember that episode, if they haven’t listened to it yet they should, it’s a great episode. I want to dive into the regulations now and some of the discrete issues that we’ve been pointing out here, but I’ll start with a caveat, which is the regulations are in exposure draft stage, they’ve been out for about 6 days I believe there’s one day left for submissions in response to those, so they’re not in their final form by the time this episode releases that may have changed. Subject to that caveat, let’s start with eligibility requirements. Because it seems to me there’s really a Goldilocks kind of business here, and I anticipate not many businesses fit that Goldilocks model. They can’t be too big – they can’t have more than $1,000,000 in liabilities; they can’t be too small because as you say Jason, they don’t have the assets to justify a restructuring. And like businesses that want to avail themselves to safe harbour, they need to be up to date with tax lodgements and they need to be up to date with employee entitlements. Maybe I’ll start with you Jason, how many businesses does that describe? |
JH:
17:00 | Not many small businesses. And we also have to add to that fact that related party debts are excluded from voting, and the fact that this offers very little protection for director personal guarantees that they might have given over the company’s debt. So when you include all of those things cumulatively, there’s probably very few small businesses that will actually be able to use that. And the cynic in me thinks that that’s quite intentional. That this provides a good marketing message from the government to say “here, look, we’re doing something, recovering from the Coronavirus, you know we’re helping small business” without actually helping small business because that would then require them to face up to the reality which is probably the majority of small businesses are insolvent, and were insolvent before the pandemic hit. So they don’t want to admit that. I mean that the going joke around town is that the biggest lender to small business in Australia is the Taxation Office. So the profit margin of many small businesses is not compliant with the law, and not paying their debts on time. So until we face up to that reality, we can’t effectively help these businesses. |
DT: | It’s a joke, but there’s a kernel of truth in that joke. |
JH: 18:00 | It’s mostly truth. |
DT: | Yes, and I should say not only just director’s guarantees but in the context of businesses at this size directors guarantees supported by a mortgage over the family home and there’s really no negotiating on that kind of exposure… |
JH: | …and directors lending their own money to the company as well. Directors, aside from the ATO, are often the largest unsecured creditors of small business. |
DT: | Yes, which is an important distinction to the voluntary administration, where of course they can vote. |
MW:
19:00
20:00 | I’ve had similar reactions from practitioners that these eligibility requirements having to pay your employees, that is the debts presently due and payable, not contingent employment entitlements and also having your tax lodgements up to date will disqualify many small businesses. I guess I just wanted to perhaps ask a rhetorical question at that point and perhaps throw it to Jason, do we think we should remove that eligibility requirement? I mean just philosophically wonder whether that’s an unreasonable condition to ask of directors? Looking at things, I guess, from a reciprocal obligation perspective, if we want the State to help out with a small business restructuring procedure, a streamlined procedure, one that’s able to be used and is inexpensive, is it unreasonable to ask that the directors of these companies are ensuring that their tax lodgements are up to date and that their employees are being paid? Because we’ve seen the same obstacle with safe harbour as well, I mean I think I just read a good note Jason published online in the last couple of days about a recent Victorian Supreme Court decision on safe harbour where the directors were not able to obtain relief because of the failure to have their tax lodgements up to date. TIP: That case is Re Balmz Pty Ltd [2020] VSC 652. A 2020 decision of the Victorian Supreme Court. Now safe harbour wasn’t dealt with at length in that judgment, although the directors were excluded from its protection because the company’s superannuation guarantee payments weren’t up to date, and neither were its tax lodgements. The Court did give consideration to an order under s 588GA(6) which allows the Court to excuse noncompliance with those requirements on the basis of exceptional circumstances, but the Court found that no exceptional circumstances existed. I mean I’ve heard this sort of over and over about how it disqualifies many entities, but I haven’t heard so many opinions on whether it’s an unreasonable condition or not. I certainly think it’s not going to cater for the majority of small businesses who find themselves in trouble today, but is it something which, you know, we should stick to our guns in the hope that sort of the next generation of turnarounds might be a different story? But I don’t know what Jason thinks about that. |
DT:
21:00 | I would be interested to hear from you on that Jason because before we started recording. At least in the safe harbour context, as you described Mark, that there is a larger category of business that is up to date with tax lodgements that can pay employee entitlements superannuation guaranteed on time, but it’s not yet of the size where continuous disclosure obligations make safe harbour unattractive, but it’s of a sufficient size and sophistication that it can use that regime. And at least anecdotally, what I’m hearing in the market is that it’s those larger businesses who are using safe harbour, who have sophisticated boards that have identified it as something they need to do. Jason as you were saying before we started recording there’s a $1,000,000 cap on liabilities which excludes all those businesses from using the debtor-in-possession model. |
JH:
22:00
23:00
24:00
25:00 | So I think when we focus on this, we need to be careful about how we’re grouping very different companies together. So if we think about these two classes of obligations which are effectively gateways to the procedure, and we might draw a distinction between employee entitlements being paid and tax lodgements being up to date. Because the ABS statistics say that the vast majority of small businesses employ no workers; it’s the people running the businesses, they’re not even employees, they own the business, they’re running the business. And I don’t know what the exact percentage is but the ABS stats on counts of Australian businesses say it’s more than 60%. So a lot of these small businesses would have no employee entitlements that are outstanding anyway. But on the employee entitlements, what I can’t understand is why the government is pushing so hard on the entitlements being paid up to date when, if the whole purpose of this procedure is to get the business back on track, why can’t you make up what’s been unpaid in the duration of the plan? So I think that would be a sensible reform, I’ve put that to Treasury, it’s been flatly rejected. This is a very clear policy of government that they don’t want to be seen to be facilitating what they classify as kind of quasi-phoenix activity. Again, the cynic in me might say this is all about protecting the government’s revenue in terms of the Fair Entitlements Guarantee program, because if we require employee entitlements to be fully paid once you present a plan then it means there are fewer companies that then end up in liquidation which are going to be calling on FEG. There will still be some obviously, but that will be reduced. So again, I think this is a rather cynical move to try and protect government revenues. Tax lodgements are a different category though, and here I can see different sides to this argument. Because on the one hand, I might say, as Mark you’re suggesting here, that, you know, everyone needs to comply with the law. And if you’re wanting the protection of this type of procedure, then you have to comply with the law. If you don’t comply, well you can’t expect the government to be giving you protection here. But I think the other angle on that is, we’ve seen businesses both small and large that have entered into payment arrangement after payment arrangement after payment arrangement with the ATO. I’ve heard of as many as 24 payment arrangements with a corporate debtor who hasn’t paid their tax. So I think part of the responsibility, not all of it, maybe not even most of it, needs to go back on the Tax Office. If a taxpayer, like in the case that Mark referred to that I wrote about recently, if the Tax Office hasn’t received anything for years, what are they doing? Why aren’t they being more active? Why does it take five years to actually prosecute a company that hasn’t lodged anything in five years, even though it’s continuing to trade? So, I don’t want to shift all the responsibility from small business owners, but that irresponsibility is facilitated by a lax attitude of our corporate regulatory agencies and a lack of coordination between the regulatory agencies. The fact that we’ve got ASIC, which is covered by Treasury, we’ve got ATO, we’ve got other government departments that are also involved, we need a coordinated approach to deal with these things because most businesses don’t become insolvent overnight. It really isn’t a cliff, it’s a slow decline. And the company that I mentioned in that article, it was years in the making. There were so many red flags along the way, if the relevant gatekeepers had done their job, they might have had a very different result. |
MW:
| And I’m very sympathetic to one point Jason made about the distinction between the requirement to have your employee entitlements paid up to date and tax lodgements. The first, it goes very much to the heart of financial distress – an inability to pay. The second, the tax lodgements, isn’t a requirement that the tax be paid, it’s a requirement that your returns and lodgements are up to date. So I have had the same thought, and I agree with that, it seems counterintuitive that you can’t deal with that inability to pay through the restructuring plan, which is the whole point of the procedure. |
DT:
26:00 | Let’s move from eligibility now to the role of the restructuring practitioner, we’ve touched on a little bit of what their role is, namely, to give consent to changes in the business, they investigate the affairs of business, investigate for the purposes of approving or not approving the restructuring plan. Now we’ve mentioned earlier the cost of an external administration to small businesses and that theoretically a debtor in possession model might result in reduced costs. Under part 5.3B the restructuring practitioner has to investigate the affairs of the company and approve or not approve a restructuring plan. Are the extent of those investigations likely to create substantial costs to a small business using this? |
MW:
27:00
| I think this is one of the real tensions in the procedure and it’s something that the industry, the profession, practitioners, are trying to get their head around because, and this goes into the way the remuneration of the practitioner is going to be fixed and it is a fixed fee agreed by the board prior to the appointment of the practitioner and that sits in tension with the potential role functions, the checks and balances in the procedure which fall upon the restructuring practitioner. So you are agreeing a fixed fee at the front end, at the starting line, cognizant of the fact that things may not be as simple as you perhaps anticipate and there’s also as you mentioned that requirement not necessarily to approve the plans as I understand it, but to verify the statement that goes out with the proposal. There does seem to be an obligation on the practitioner to verify the schedule of debts and liabilities, do some sort of investigation to verify that the information that should be in the statement is in there. And then, going back to my earlier point, if the creditors take issue with the quantum of their claim as disclosed in that statement, the practitioner then has a role to sort that out with the creditors. So there’s that sort of process and what could be quite a messy process of disputes. Creditors can possibly vary their vote after the schedule is amended if the practitioner thinks that’s required. How all that plays out with having your remuneration and your fee fixed up front is I think something that everyone’s trying to get their head around because if you’re going to be drawn into every one of those potential messy milestone events, the fee that you agreed is probably not going to be enough. And so will practitioners then sort of try and compensate for that by seeking a higher fee which then makes the procedure anything but inexpensive? |
DT: 28:00 | That is a good clarification you made Mark – it isn’t an approval of the plan; it is an approval of the accuracy of the statement prepared by the directors. Jason, what do you think about that? Do you think that there is going to be a reticence on the part of practitioners to offer this service? |
JH:
29:00
30:00
31:00 | Yes, unless they’re able to charge $20-30,000 or more, I don’t see what practitioners would want to be undertaking this work. If we compare it to say a pretty standard, ‘vanilla’, creditors’ voluntary liquidation, you can find firms around town that will do that for about $10,000. Now some would say that’s too low. But there are firms that advertise at those sorts of rates. So, if this procedure which is supposed to be more streamlined, is supposed to be an alternative, more attractive for directors, they remain in control, if that’s going to cost them two or three times a liquidation, where is the incentive for the directors to use this? So if the government thinks that it’s going to be a lot less than $10,000 to do this sort of work, then the hundreds of pages of amendments that they’re putting into the Act and the Rules would suggest otherwise; that there’s so many things that the practitioner is expected to do. And what I think is completely inappropriate, which I’ve raised with Treasury, is the proposal that they be criminally liable – the practitioner – if they fail to take reasonable steps to verify the information. So the practitioner is going to see this as effectively a voluntary administration report, so I just don’t see how that’s going to work. TIP: This ‘fixed fee only’ approach is a big change for the current state of affairs. Under our current forms of external administration, remuneration can be set on a number of bases, including by fixed fee, but much, much more commonly by time-charging. However, remuneration can only be paid if it’s approved by the company’s creditors or failing that, by an application to the Court. It’s this approval process that the draft regulations are probably trying to remove, in the interests of simplicity. One important thing to note about remuneration approvals at the moment is that voluntary administrators, liquidators and the like, are entitled to be remunerated for reasonably and properly performed work, even if the work performed doesn’t lead to an augmentation of the funds available for distribution. That makes sense because the multiplicity of roles external administrators play –as a manager, as an adviser, an investigator, a broker, a quasi-judicial officer of the court – mean that the work they need to do to fulfil their statutory duties and their fiduciary duties, won’t always be done in aid of enhancing returns to creditors, and isn’t always capable of anticipation either. The small business restructuring practitioner will also have a lot of competing responsibilities, so you can see how it would be difficult to determine a reliable fixed fee upfront, unless this work was being done in a really commoditised, systematised way. If you want to brush up on how external administrators’ remuneration is approved, you might want to take a look at the NSW Court of Appeal’s decision in Sanderson, as liquidator of Sakr Nominees Pty Ltd (in liq) [2017] NSWCA 38. That’s a good summary of the principles that currently apply. I don’t see the incentive for the directors who don’t get any protection for their personal guarantees, who probably at least at the small end, probably aren’t that worried about insolvent trading in the first place, who aren’t going to get to vote for the outcome, who are going to have to ask for permission for every second thing they want to do from the practitioner, who are no doubt going to have to provide cash up front for the practitioner to take the appointment in the first place – where’s the incentive here? And where’s the incentive to not just go with a CVL, where effectively you buy the main asset of the business off the liquidator? |
DT: | Mark did you want to add anything? |
MW:
32:00
33:00 | No, no, I think that’s right. I mean it’s all risk and no reward potentially for practitioners that may be the way that many of them look at it and that’s putting the one side the other aspect of the amendments which is to open up the category of restructuring practitioner to a new ilk of registered liquidator with lower education/knowledge/experience requirements than is currently the case for applicants for registration as a liquidator, which according to the explanatory memorandum is justified on the basis that look this procedure is simplified and less complex, which I find almost laughable. There are many seasoned practitioners now trying to understand these hundreds of pages of regs and legislation. There are so many questions of statutory construction which arise that you’re going to have to not only have, in my view a practitioner who is just as competent as the existing class of registered liquidators, you’re going to have to have a practitioner who is aware of when they need legal advice, because there are a lot of ‘known unknowns’ in this legislation, some of which we may come to. But I think that’s another problem. Whilst I’ve sort of got concerns about the lowering of the standards of accountants in terms of the accountants who can now apply for registration, we may not even get to that problem because I suspect for the reasons that Jason just mentioned, why would you want to register to do this work when you’re potentially criminally liable if things don’t go according to plan and if there’s allegations later that the small business owners have tried to pull a fast one, why would you want to register to do this kind of work? There may be another answer to that which may not be the answer I want to hear, which is that this is all intended to be done quickly with less safeguards, less checks and balances, less investigations, in which case, it can be done cheaply, but then you’ve got the risk of abuse. So if it’s going to be done properly, this is my sort of take away, if it’s going to be done properly it’s going to be too expensive; if it’s going to be done inexpensively, it’s not going to be done properly which is going to create its own problems. So we seem to have fallen in between two stools here where we’re not really going to achieve, I think, the outcome that was intended. |
JH:
34:00
35:00 | I would’ve been fine if the government had come out and said we’re concerned about potentially tens of thousands of businesses going under, we need a totally different approach, a completely streamlined approach, it’s going to be less than what we get in liquidation, so there’s going to be less transparency, there’s going to be less accountability, but it’s the economic reality. We need to do something about this because we don’t have a publicly funded liquidation process, so this is going to be a bare bones procedure, it really is just ‘guide on the side’ stuff and there will be various exit points, you know, if creditors want to put their hand in their pocket. I would have been totally fine with that. But what the government has tried to do is try to placate opposition and I don’t mean the federal opposition, but opposition calls from the community ‘oh well this is a free kick to phoenix operators.’ So it’s tried to keep as many of the bells and whistles from voluntary administration as possible, and also tried to assuage concerns from the business community and the legal community by saying ‘oh look at all these procedures from VA that we’re including in this new part.’ So that you end up with 100 pages of amendments and it’s just so complex that no one’s going to be able to use it. So we’ve taken what’s a good idea, I think you said this earlier Mark, we’ve taken what’s fundamentally a good idea and we’ve just piled on so many bits to it that it looks nothing like what we started with. |
MW:
36:00 | I think I made this point to Jason when the government first made its announcement that they were going to introduce this procedure was that I’m all for streamlining the VA procedure to make it fit for purpose for small businesses, but the other side of that coin in my view, this is just my view, is that you’ve got to have a competent ethical professional at the heart of the process. And that was another point that the 2018 World Bank report on MSME insolvency made, that you’ve got to have a quality professional at the heart of the process to try and provide that check and balance. You won’t necessarily have the reporting requirements, but you’ve got someone who’s experienced, competent and ethical looking out for creditors and is able to verify that, in effect, small business operators aren’t trying to pull a fast one. And that’s where I have concerns about lowering the standards for entrance into the profession to run these procedures because I think it raises question marks as to their, not only incompetence, but also their ability to know what they don’t know. |
DT:
37:00
38:00 | Yes and I think those sorts of half-dozen topics that we just touched on all are a delta into one topic that I now want to cover, Jason you said earlier that small businesses might be comparing this to a much cheaper CVL product, there’s another product – an entirely illegitimate one – that they’ll compare this option to, which is to phoenix the business. TIP: Let’s have a quick recap on phoenix activity. Phoenixing, as it’s sometimes known, is a form of illegitimate business rescue. It involves the transfer of business assets out of the hands of the insolvent company, for little to no value, to a new ‘clean’ trading entity, leaving the insolvent company’s creditors high and dry. Phoenixing is illegal, and it’s basically stealing what little the unpaid creditors of a business should otherwise have received. The ATO and ASIC are both on the lookout for phoenix activity – since 2014, the ATO’s Phoenix Taskforce has returned more than $580 million to the community from audits and reviews of illegal phoenix activity. Now there’s clearly aspects of the regulations that have been designed to prevent that result occurring through this process. For one thing one of the only restrictions on what the restructuring plan can involve is the transfer of the business of assets to another entity. And I believe that the criminal sanction on the restructuring practitioner themselves is probably intended to be an answer to illegal phoenixing occurring under their nose. But lowering the standards for a small business restructuring practitioner, recognising that many small businesses don’t have an awareness that phoenix activity is illegal, that they’re doing it on the advice of someone they believe to be a trusted advisor, who tells them that that is going to be much cheaper than what reputable practitioners are offering for this sort of service, do we anticipate a great deal of phoenix activity coming out of this economic crisis caused by COVID-19? And is this process likely to prevent any of it? |
MW: | I tend to think it’s not going to have a great effect either way. I would tend to think Jason mentioned the CVL procedure, I mean I would’ve thought if people want to perpetrate a phoenix that’s the procedure that they would use. I mean it’s going to be a lot cheaper and simpler to just use a CVL, that’s a very instinctive response. So I understand the concerns with the procedure as it’s drafted, and lowering the standards for the practitioner, I just tend to think that the worst of the worst are going to use the existing CVL procedure if they really want to pull a fast one. |
JH: 39:00
40:00
41:00
42:00 | So, I think we need to be mindful of some of the implicit assumptions that we make when we talk about how insolvency works. Because I think that we are operating on essentially a false premise about corporate insolvency, particularly at the small end of town. And that is, the false premise is, that I say, is that our current system works, and that it’s effective and that it is transparent and that it’s not in any way a criticism of a practitioner, because the problem that I think we have in our current system is that there is very little disincentive to simply abandon the company. So if we take as an example, the numbers of external administrations in Australia each year, leaving COVID here to one side because it’s at historic lows, and we say that in most years there’s probably between about eight and a half to about thirteen thousand companies going into external administration about every year for at least the last 15 years. Now during, say, the last 8 1/2 years, particularly since ASIC commenced the Insolvency Notices website, each year we have more than, on average, more than 60,000 companies are voluntarily deregistered by ASIC every year. Now why are they being deregistered? Now the law will tell you that they’re only supposed to be deregistered on a voluntary basis if they have basically no assets, less than $1,000, and no debts, and they’re not involved in any litigation. But who verifies that? Where’s to stop the person who’s racked up debts in their company from simply abandoning the company, using the assets in another business, not involving a liquidator at all, just simply taking the assets and making the assumption that the creditors are not going to throw good money after bad, aren’t really going to chase them, and a few months later or perhaps a few years later they put in a de-registration form. And if no one objects, then in two months the company is deregistered! So, the false assumption that I think we have in our law, is that liquidation works. And I would suggest that if even a significant fraction of those numbers that I’ve mentioned involve effectively phoenixes, not through official channels using liquidation, but simply by taking the assets – whether it’s a coffee machine or a truck or a customer list or whatever it is – and simply using it in new business. I reckon that happens thousands of times every single day in Australia. And our current system relies on creditors to put their hands in their pockets, to go off and make a winding up application. Now OK if it’s the ATO or if it’s a government revenue authority or something that’s one thing, maybe if it’s a repeat player like major leasing companies that’s another thing, but if you’re a trade supplier or a subcontractor or something, you’re not going to do that. You’re going to write it off as a bad debt, move on with your life. And the people who are involved in this phoenix activity know that that’s what’s likely to happen. So the idea that insolvent trading is going to put a lot of these small business people to use this new procedure, it’s a fantasy. Where’s the incentive for anyone to use this procedure? |
DT: | Yeah that’s such a good point that the alternative to using this procedure is… |
JH: | …is nothing. |
DT: | …is to do nothing… |
JH: | …which is what happens now. |
DT:
43:00 | Let’s talk now about the restructuring plan, this is kind of the linchpin of the restructuring process, it’s how the business is supposed to return to health. Now the Bill provided that the regulations could make provisions for what was going to be in the restructuring plan. At least when I read that, I assumed that there would be some detail about what a restructuring plan was going to set out because if there’s not that imposes quite a lot of work on the restructuring practitioner to assist the directors to prepare it. It doesn’t have very much at all, other than the aforementioned restriction on phoenixing, that the plan doesn’t involve a transfer of assets to another company and that it doesn’t involve a payment plan that’s longer than five years in duration. That does seem to create, putting a positive spin on it, a lot of flexibility in terms of what a restructuring plan can involve, it’s also a bit of a tabula rasa in terms of how to get started on a restructuring plan, and I imagine again a lot of that will come down to the restructuring practitioner’s advice. But for a business of this size what would you expect to see in a good restructuring plan? Mark I’ll maybe start with you. |
MW:
44:00
45:00
46:00
47:00 | I think my answer to that question drives into what I see as one of the fundamental flaws in this entire procedure which lies at the heart of the plan which is the ultimate outcome, is that a good restructuring plan should deal with the insolvent company’s financial distress and set it on a path to viability. That’s the ultimate objective of the restructuring plan. And one feature I’ve noted in the legislation is that the company won’t be able to compromise contingent liabilities or claims. So it will only be able to compromise, as I see it, presently due and payable debts. So whilst I take your point that there seems to be, maybe on its face, a degree of flexibility in the plan, I actually sort of see it in narrower terms that the restructuring plan by dint of the legislation which defines admissible claims, that is the claims of creditors that can participate in the restructuring plan, narrowly such that if for example the company is a guarantor and that guarantee hasn’t been called up at the time the restructuring procedure is commenced, there is no way this procedure or the plan can deal with that contingent liability. TIP: Contingent liabilities are liabilities the payment of which are, well, contingent on something which may or may not happen in the future. For example, liability under a guarantee is often a contingent liability – the guarantor will often only be liable if the borrower defaults and if the guarantee is called on by the lender. A contingent liability should be distinguished from a future liability, where there’s absolutely no doubt that the liability will become payable at a future time – for example, a loan that expires on 31 December 2020 isn’t contingent, because there’s no real question, leaving aside Aztec doomsday predictions of course, about whether or not the passing of 31 December 2020 will occur. Contingent liabilities that are admitted to proof in a liquidation usually have to be given what’s called a fair estimate of value by the liquidator, rather than their face value, to take into account the possibility that they won’t crystallise in the future. The exclusion of contingent liabilities from the small business restructuring process is curious not only for the practical reasons Mark has just explained, but for a legal one as well. Contingent liabilities are to be taken into account for the purposes of determining whether a company is actually solvent or not. See, for example, section 459D of Act which states that contingent liabilities have to be taken into account by a court when considering a winding up application. That sort of creates an inconsistency, doesn’t it? What if a company initiates the small company restructuring process because taking into account their contingent liabilities they consider of that they’re insolvent, or going to be insolvent at a future time, but then using the small restructuring process they can’t actually compromise any of those contingent liabilities that led to the process in the first place! So if you can’t deal with all the potential claims and liabilities and obligations that are a feature of your financial distress, what is the point of this entire procedure? Which is why I see this is such a fundamental issue. If you look back at the Bankruptcy Act procedures like debt agreements, personal insolvency agreements, they enabled the debtor to deal with all provable claims as defined, that is to say claims that would be provable in a straight bankruptcy. In this procedure for reasons best known to parliamentary draftsmen or Treasury, they’ve defined the admissible claims, that is the claims that can be compromised by the restructuring plan, to include everything that’s provable in liquidation except contingent claims and debts. That gives rise to all sorts of questions about what a contingent liability is in that context. But putting that to one side, well, that’s great for the lawyers who will be asked to advise all those questions, putting that to one side, what’s the point of a restructuring plan if you can’t deal with contingent liabilities that might lie at the very heart of why you’re in trouble and in fact why the directors took the view in the first place that the company is likely to become insolvent? So, I think going back to the original question of a successful restructuring plan needs to deal with the heart of the matter which is the company’s insolvency and to do that you need to deal with all your creditors presently, the ones with presently due and payable claims or the ones who have contingent claims which they may not have crystallised yet. |
DT: | It is a curious exclusion in part 5.3A contingent claims are approvable because voluntary administrators know there’s no small degree of consternation in determining just how much they should prove for voting purposes, that’s another matter. Jason can you speculate on why they might have been excluded? |
JH: 48:00
49:00
50:00 | I think the government’s trying to keep it notionally as simple as possible. Because the idea is that the business owner will formulate the plan with some guidance from the small business restructuring practitioner. But simply excluding it doesn’t make the problem go away. It’s still there, as Mark said, not on an economic basis but it’s still there on a legal basis because you still have to make that determination ‘well this is a contingent claim so it’s out, and this isn’t a contingent claim and it’s due and payable therefore it’s in.’ And if some of these business people can’t work out when to lodge their tax forms on time, or how to pay their employees on time, how on earth are they going to work out whether something’s a contingent claim or not? Well they won’t. Will they go off and see a lawyer? Probably not because all of that then just adds more to the expense of using this procedure. So they’ll probably ignore it, which will then mean that it will get challenged, so we then end up with more legal costs, more complexity, more delays. So in trying to make it streamlined they’ve actually made it more complex and more difficult. To go back to your original question about what sort of things can we expect to see in these plans, clearly the ATO is going to be in most of these cases the largest unsecured creditor who’s not the director or a related party. The draft regs do provide for some standard form terms that are to be inserted into every plan, but there’s only I think six or seven of those and they’re pretty fairly broad. TIP: Those prescribed provisions appear at draft reg 5.3B.25, and they are: (a) all admissible debts and claims rank equally; (b) if the total amount paid by the company under the restructuring plan in respect of those debts or claims is insufficient to meet those debts or claims in full, then those debts or claims will be paid proportionately or pari passu as we like to say in Latin; (c) a creditor is not entitled to receive, in respect of an admissible debt or claim, more than the amount of the debt or claim, which sense with that elaboration; (d) the amount of an admissible debt or claim will be ascertained as at the time immediately before the restructuring began; and (e) if a creditor is a secured creditor, for the purposes of working out the amount payable to that creditor under the plan, they’re a creditor only to the extent by which the amount of the creditor’s admissible debt or claim exceeds the value of the creditor’s security. Or if they are a secured creditor who’s already realised their security, only to the extent of any balance due to that creditor after deducting the net amount realised. In other words, the prescribed provisions aren’t very controversial or exciting and they’re pretty much exactly what you’d expect. |
MW:
51:00
52:00 | There’s, in my view. an interesting question which arises on the face of the regulation, I think it’s 3B(27) which provides for the binding effect of a restructuring plan. It largely dovetails or mirrors the section in voluntary administration which we currently have which provides that secured creditors and landlords are not bound by a deed of company arrangement, in this case a restructuring plan, in terms of their rights to enforce against the property, or repossess the property, unless they voted for the plan. The regulation largely repeats that but excludes the mention of landlords, which is interesting. I query whether there’s some intention in the legislation that you may be able to use restructuring plans to bind landlords and compromise a future debt payable under release. By omitting an aspect of the provision which we’re accustomed to seeing operate in VAs, another question of statutory construction arises. So, I guess there’s two points there, 1) the substantial one, can you use these restructuring plans to renegotiate your rent with the landlord, but 2) just shows you how this procedure is anything but simplified and streamlined, it’s actually complex. And the explanatory memorandum unfortunately doesn’t shed any light on the reasons for these changes, same with the contingent liability point I made earlier. There’s no explanation for these, we just have to speculate on what the operation of it might be. But I think that’s an interesting question, because that would be a very relevant matter for a lot of these businesses even with presently due and payable debts under $1,000,000. |
DT:
| Especially because some will have been fortunate enough to receive their compulsory relief under the code as a waiver, but many as a deferral, and they’ll have quite a bit of aged debt in terms of rent when that eventually becomes payable. |
MW: | I don’t know whether Treasury has assumed that future debt payable under release is a contingent liability. This sort of goes back to the point I made earlier because contingent liabilities are excluded, is the omission of landlords in that regulation born of the fact that it’s seen as a contingent liability? I’m just speculating there, I don’t know that it is. |
DT: | It doesn’t strike me as contingent. |
MW: 53:00 | No but that again is the confusion because we’re accustomed to assessing contingent and prospective liabilities in the context of provisions that we’ve been working with for years. This legislation expressly carves out contingent liabilities from the notion of provable debts, and without going into all the details, a very different context. So it could just mean any debt that’s not certain. There’s an argument I think to that effect which could cover what we’ve commonly understood to be prospective debts. Because any prospective debt has at its core an element of a negative contingency, it may or may not come to pass. So all interesting questions which arise from the legislation, but I think the potential effect of the plan on landlords is an interesting one. I’m not sure why landlords are excluded from that regulation but if I was a landlord advocate, I’d be a little bit concerned about that. |
DT:
54:00 | Now one of the other responsibilities of the restructuring practitioner is that they can decide whether to blow the whistle and bring an end to the whole experiment by terminating the restructuring plan. Jason maybe I’ll start with you, what would you anticipate to be a warning sign on which a restructuring practitioner will act to say, ‘enough is enough, I’m terminating the restructuring plan?’ |
JH:
55:00
56:00
57:00 | Well, if the director is no longer complying, if they’re trying to change the business in a material way, perhaps if the practitioner thinks that they’re not being given all the relevant information. I think the provisions both in the Bill and in the regulations are far too wishy-washy on this point. So in my personal submission I advocated that I think there should be a duty on the practitioner that if they think it’s no longer in the best interests of creditors, they should terminate. That should be a statutory duty imposed on them, and I personally think that that would be preferable to making them officers of the company, given that they’re supposed to be just advising from the side rather than actually running the business themselves. But Treasury didn’t take that position, so they are officers of the company. As to what that will mean in this context that remains to be seen. Yeah, I mean if we think about the sort of terminating events that can come up for deeds of company arrangement, I would expect to see something similar. Where it’s going to be very interesting is we’ve certainly seen plenty of DOCAs that are really about doing over the Tax Office and will we see plans in the same way? I’m sure we’ll see some people who will try that but given the exclusion of related party votes here which we don’t have in voting for deeds of company arrangement, it’ll be easier for the tax office to defeat a proposed plan by voting against it. And I mean the voting rules themselves are kind of interesting because it’s not majority number and majority in value, it’s majority in value but it’s only majority in value of those, essentially, who respond. So it’s not even the majority in all of the value, it’s just those who respond. So if the ATO which of course is a creditor in every single company that gets into financial distress, so if they’re able to keep on top of it and they vote against them, these plans that are really just trying to dud over the ATO, then most of these plans won’t work. And that’s why I said at the start I think this is not debtor-in-possession, this is really supply creditor, ATO creditor-in-possession. I mean one aspect of complexity in this proposal that we haven’t discussed so far is ipso facto provisions. Because this effectively incorporates the ipso facto provisions in. So again, the idea that the small business owner who’s then trying to negotiate a deal with the main creditors, some of whom might say ‘oh well, we’ve got the benefit of exceptions to the ipso facto protection, so if you don’t give us what we want we’re going to take action.’ So the small business owner, what are they going to do? Are they going to go and see a lawyer to run over the contracts? Are they going to go back to their small business restructuring practitioner and ask for their advice on this thing? So there’s just so many things that add to the complexity and uncertainty here, and not just because it’s a new procedure but because we’re kind of borrowing bits from different parts of the Act and putting them together. So it’s saying that it’s supposed to be cheap and quick and streamlined, 100 pages of changes belies that assertion. So again, I don’t see any incentive. If I was advising small company directors, what’s in it for them? |
MW:
58:00 | The other interesting point that I think can be reflected upon when you’re asking about the role of the practitioner in terminating the plan, there’s that earlier right to terminate the procedure during the restructuring period if – I keep using this term, pulling a fast one – in short, if the practitioner decides that either this company is not eligible or I believe that there’s a sort of general interests of creditors test and the provision as well the practitioner can just terminate the procedure. Now that’s a pretty significant power. Again I just don’t know how that’s going to play out. And again, the responsibility and the expectations of the practitioner I think bear reflection. And really it’s taking a step back and looking at it from the bird’s eye view, I see the potential for the regulators to expect quite a lot of the practitioner in being the safeguard, being the honest broker, whilst the legislation is driving the practitioner to a low fixed fee that is a tension which I think is a problem. I can just see, as I said, the regulator expecting a lot of the practitioner and then when things don’t go according to plan and someone’s pulled a fast one, trying to pin it on the practitioner for not having acted appropriately to prevent this happening, when the whole idea of the procedure is to be quick, inexpensive and streamlined. I mean, how do you square that circle? |
DT: | It’s certainly not a power you’d exercise lightly, I imagine the investigations that practitioners are likely to do before they exercise it, are going to look pretty similar to the investigations conducted in a voluntary administration, and that’s not a cheap process. |
MW: | I think the professional body ARITA has made that whilst at first blush it might look like a lower reporting requirement, a lot of the investigations that seem to be expected of the practitioner, mirror what they’re required to do in a voluntary administration. |
59:00 | I think I think one of the problems though is that that’s not entirely clear. I think that it’s going to be a problem when these fees are negotiated – what exactly is required? That’s what a lot of practitioners I’m speaking to are asking, how much can we charge for these? Well we don’t really know because we’re not sure yet what’s really expected of us. On one level the legislation puts us front and centre of sort of being the honest broker in the process and making sure that everything’s got integrity and is pure and no ones being dudded. On the other hand, it’s supposed to be cheap and simple. So yeah as Jason said, and I agree, what’s the incentive to play in this space? |
DT:
1:00:00 | My next question is one that we’ve anticipated throughout our discussion today and I anticipate I know the response, so I’ll try to break it down in a way that makes it two distinct questions. I want to ask you about the expected efficacy of the process, how you think it will work in practice. And I suppose I want to break that down into how will it work responding to businesses that are facing an extraordinary economic pressure from COVID-19 that is not a reflection on their business model, there’s nothing fundamental that needs to change about this small business, it’s a good small business and they’re facing an extraordinary degree of pressure by a once-in-a-lifetime event? How is the process likely to respond to that scenario compared to the scenario of a business which is disrupted by cyclical pressure, which is disrupted by innovation, which is disrupted by problems in its capital structure, which does need real restructuring steps to change? Jason, maybe I’ll start with you. |
JH:
| So I don’t really think it’s going to help either of those businesses. If you’re in the former category, what’s the central problem with the business? is it just COVID-related? Is it just, you know you’re running a retail business, you know, you’re not getting enough foot traffic in, you need to transition maybe more to a mixed online and face-to-face presence or something? So, I’m not sure that this is going to address that. The sort of creditors that you need to do a deal with are not necessarily the creditors who are going to determine the outcome of this plan because of the way that it’s been written and it’s trying to focus on only certain unsecured creditors, not all, and it isn’t focused largely on secured creditors. Their capacity to vote for example is limited only to the extent that they are under-secured in respect of their debt. |
DT: 1:01:00 | If we’re talking about retail businesses, their lessors, we’ve talked about the difficulties with how the process deals with lessors already, but many of their creditors are secured in the form of PMSI security over non-perishable stock. |
JH:
1:02:00 | Exactly, which again is why I think it’s really ATO-in-possession. They’re going to be in the driving seat here. OK so if your problem really is with the ATO, this isn’t an appropriate process for that. I don’t know what the appropriate process is, but going into this, if they’re in the driving seat and they come out with, let’s say they amend their enforcement policy to say ‘we’re not going to approve any of these that don’t have these characteristics,’ I just don’t think it’s going to work for that. And as to the latter category where you’re really talking about a proper financial restructuring, well this is totally inappropriate for that. It’s supposed to be a streamlined procedure. As Mark said it’s not dealing with some of the financial problems that many of these businesses will have, so a VA is going to be more appropriate in those circumstances, which again brings me back to: where’s the incentive for directors to do anything more than nothing? You know, ‘this is just all too hard, OK I’m just going to abandon the business, let’s set up Acme Pty Limited No. 2, and we’ll keep carrying on, and if people want to sue me, well you’re going to have to throw good money after bad’. |
MW:
1:03:00
1:04:00
| I agree with that, and an observation a number of practitioners have made to me in my travels is that perhaps in the COVID context we should be looking more at honourable failures through CVL, which are quick and inexpensive, I’m not talking about phoenixing or anything untoward, but your ‘vanilla’ CVL allowing people to fail, resolve the issue, and move on and start again. That’s what a number of practitioners have told me we should be thinking more about. Again, I think the procedure is a great idea in theory, but I think I would agree with Jason, it’s not really appropriate for either of those two categories of businesses. It was only ever I think going to be more appropriate for the first category in my view. I think we’ve got safe harbour for insolvent trading flexibility there to get the sort of advice you need for an operational turnaround or a restructuring turnaround with multiple aspects and facets. But this procedure was always driven towards a debt restructuring outcome, but it doesn’t allow you to compromise all of your liabilities. So I don’t see, really, what incentive a director has, or the director’s advisors have, the companies’ advisors have, to seriously consider the procedure. Unfortunately, I think we’re going to see a lot of directors, their advisors, sitting around a table poring over these hundreds of pages and concluding that it’s not suitable. Which again doesn’t do a lot of mischief, I don’t think the procedure sitting there in the statute books is going to do a lot of mischief, but I think it’s looking more and more likely to me that’s going to be in an utter dead letter, and a waste of everyone’s time and money unfortunately. And I think again there are some flawed design features and design decisions which were made at the outset which have made this procedure very difficult to succeed. And from my own experience, and I was legal director of ARITA for a couple of years, I’ve seen this movie before with bad legislation errors and there are a lot of technical errors which people have already identified in the legislation, and if the Insolvency Law Reform Act experience is any guide, we can’t expect those errors to be fixed anytime soon. I would actually like to see Treasury focus on fixing some of the errors that have been sitting in the legislation for two or three years, things like proposals without meetings, which again going back to the issue about avoiding costs, there are some very basic errors in the legislation which came about because of that reform process, which have not yet been fixed. So my concern is technical errors in the legislation, some which we haven’t had time to approach in this conversation, may sit there for years without being fixed. And so we end up with more broken legislation, more complexity and a dead letter. |
DT: 1:05:00 | I wonder if some of those technical issues might be the result of the limited consultation that was available for the Bill and the Regulation. I have to say I had a particularly busy week at work when the Bill was released, I had intended to write something about it but, unfortunately, I missed the one week that it was open for consultation. Is this a bit of a trend in lawmaking particularly in the corporate and financial space at the moment? Fairly little consultation on new laws and how is that impacting on the quality of the reforms? |
JH:
1:06:00
1:07:00
1:08:00 | It’s a trend that’s been around a long time. I mean proposing amendments through interviews with the Fin Review is a feature we’ve seen of corporate law reform from both sides of parliament over the years. So that’s very unfortunate. The abolition of the Corporations and Markets Advisory Committee a few years ago is also very unfortunate because it means that we don’t have a corporate law (including corporate insolvency) expert body that can actually advise considered opinions on these things. It’s well overdue for the Australian Law Reform Commission to be given a holistic insolvency inquiry to undertake. If we think the last time that happened it was commissioned in the early 1980s, reported in 1988, how much has the economy changed since 1988? How much has business changed since 1988? We need a holistic review, rather than this continual ‘someone is whinging about how this particular law works, so let’s announce some change to it that we think is going to meet that, and we want everything done yesterday, so we will only have a week’s consultation.’ In fairness to the policy people in Treasury, where I think they’ve been really good during these processes is they have been reaching out a lot to industry associations, so even though the public consultation might only be a week or two weeks or a month or whatever, often there are a lot of informal consultations that go along. For example, the public draft of a piece of legislation that might actually be draft 40 or 50 that’s been discussed with various people in the lead up to it being released. And we saw that in particular with the safe harbour for example. The end format of the safe Harbour came about through rounds of consultation with various industry bodies. You know, that that ended up with the procedure that we have now. So I think they are swings and roundabouts, but having short public consultation isn’t helpful. And also the government clearly has made up its mind on certain policy points. Things like whether your tax lodgements have to be up to date, your employee entitlements have to be fully paid, and it just doesn’t budge on those things. They are open to minor consultation but nothing on the major policy points, and certainly with these reforms, in my view, it’s these major policy positions that underpin this reform that include all the, what I think are the largely unnecessary complexities. You know if we had actual public consultation on what the law should look like as opposed to ‘here’s what we’re going to do, tell us what you think and then we’ll mostly ignore it,’ which is what we’re seeing with this process. So the Treasury people are very open, it’s just I think there you know they don’t even have one hand to fight with, both hands are tied behind their back because government has effectively made up its mind. |
MW:
1:09:00
1:10:00
1:11:00 | I would agree with Jason generally. I think though, in my view having been through the insolvency law format process when I was the legal director of the professional body, I’m becoming a little fatigued and frustrated with the quality of legislative drafting. Putting aside all the valid points Jason just made, and I completely endorse the idea of a root and branch review of our insolvency system, I think one of the difficulties with this kind of reform as Jason just mentioned is that there are so many moving parts. I know in the past Jason and I have sparred on sort of the ‘debtor-friendly, creditor-friendly’ line. How to get the balance right, what do we expect of directors? I have a number of ideas which would expect more of directors, but you have to take into account that they’re already subject to all sorts of other obligations and it’s just one example of how we need, I think, a holistic review of how all the moving parts operate together. How changing one part affects the other, and that, I think, is a long overdue process. But I mean getting back to the minutiae of the legislation, I think the double negatives, the technical errors, the problems that those mistakes and errors, particularly when they are left unfixed as they have been from the Insolvency Law Reform Act experience, is not helping anyone. And I think saps confidence in the ability of the legislation to achieve its purpose. There’s one technical error in terms of the possible effect of a liquidation on dealings of the company during the restructuring period which could potentially mean that everything that happens in that period is void if a liquidation follows. And that’s a pretty fundamental technical error. It was pointed out by many parties in the submission process, including my submission, and has been completely ignored. TIP: This technical error that Mark is talking about is a little concerning. Basically, if a court-ordered winding up immediately follows the restructuring period, then the winding up is taken to have begun on the day the restructuring began – that’s what the new s 513CA, combined with amendments to the existing s 91, say. Now when you combine that with the existing s 468, which says, and I quote, “any disposition of property of the company, other than an exempt disposition, made after the commencement of the winding up by the Court is, unless the Court otherwise orders, void.” Now that means that any disposition of property made by the company during its restructuring, unless it was done with the express consent of the small business restructuring practitioner – and remember that that consent is usually only for things outside the ordinary course of business – is void. That obviously creates a pretty big disincentive to say, buying anything from the company in restructuring, even in the ordinary course of business, in case the restructuring fails, and a liquidator tells you later that they want the company’s stuff back. Now you would think that’s not intentional, and you have to assume that that will be fixed by the time the bill becomes law… right? So people are doing their best to comply with a very narrow window of consultation and give the technical and expert assistance that they can when it’s not listened to and you still end up with broken legislation. I think that’s frustrating and I think we’re entitled to expect better. |
DT:
1:12:00 | You’ve both mentioned the need for a comprehensive review of Australia’s insolvency system, I think it’s clear from our discussion today that the small business restructuring process doesn’t meet our expectations of what our insolvency system needs, but it’s clear that we do need another tool in the toolbox other than the one-size-fits-all voluntary administration regime. Jason, put away the crystal ball, take out the wish list, if there were three things that you would change about the insolvency system in Australia perhaps you can jury-rig this small business restructuring regime to do it, perhaps you can’t, what would those three things be? |
JH:
1:13:00
1:14:00
1:15:00
1:16:00 | I’d say the first thing would be to take corporate insolvency off ASIC and have a consolidated insolvency regulator because I think ASIC is not doing its job in this space. ASIC has too many things to do, it doesn’t have enough resources to do its job properly in any of its areas, and particularly in insolvency, and I think that would provide more accountability than what we have now. Secondly, I think we should have a government liquidator’s office because a lot of the businesses that are insolvent just don’t have the asset bases to properly pay practitioners, and practitioners should not be expected to have to do a lot of this work for free, which is what they’re doing now, particularly in things like court liquidations. So I think we should have government liquidators office whether they actually perform the role of external administrator like we have in the vast majority of personal bankruptcies with the Official Trustee’s service or whether they just simply properly fund a private profession to do it, I think that’s what we need rather than what we have now which is effectively the liquidator’s begging bowl which is the assetless administration fund, which funnily enough does not provide funding for assetless administrations. Unless effectively you’ve got evidence to show there’s been some crime committed or some phoenix activity or whatever. So, we need to just completely rethink what we’re able to achieve in a modern insolvency system because we have, in my opinion, such high expectations of having what I’ve called a Rolls Royce system of maximum transparency, maximum accountability, maximum returns to creditors, and those things are mutually inconsistent. So I think we need a consolidated insolvency regulator who can just be focused on that. The third thing I’d say is, I really think we need to break the coupling of making people account for corporate wrongdoing and insolvency. So one of the features that we look at procedures like Chapter 11 and we compare that to the kind of traditional external administration procedures in common law systems, is that Chapter 11 really isn’t about failure. It’s not the role of the debtor-in-possession effectively to report on their own wrongdoing. Now that’s not to say that’s ignored, that’s just someone else’s job entirely. And I think a problem we have here, which in my opinion comes back to the inadequacy of ASIC and the ineffectiveness of ASIC in the insolvency space, is that we try and keep those two things together. So ASIC says insolvency practitioners are gatekeepers and it’s their job to report properly to us and then we can take action. Everyone knows that ASIC is not going to take action. So it only looks at the tiniest fraction of reports that insolvency practitioners send through. And in its defence when it’s criticised in Senate estimates it says, ‘well they didn’t give us enough information.’ Well why didn’t they give you enough information? Because the information wasn’t available in the first place because the assets have been stripped. So we’re in this Catch-22 situation where liquidators don’t have the funding to do their job properly, so they put in effectively pro forma documents where all the boxes are ticked. Are their offences? Yes. Is there insolvent trading? Yes. Are there proper books and records? Probably not. And nothing is done about it. And everyone knows that nothing is done about it. And that gives ASIC an incredibly convenient excuse when it’s being criticised to say, ‘well it’s not our fault; we’re not the gatekeeper, the insolvency practitioner is the gatekeeper.’ So this is just a vicious cycle where we end up in my view with the worst of all outcomes. We’ve got a system that we expect too much of, that mostly doesn’t do its job, and where all the parties blame each other. So I sheet that responsibility squarely at ASIC’s feet and I think we need to take this off them, have a consolidated regulator, have a government liquidator’s office, and try and decouple the wrongdoing side, the blame side of insolvency to effectively a white-collar crime division of the DPP. Let’s focus on dealing with the economic reality of these collapsed businesses, rather than seeing insolvency as being about blame, someone’s done something wrong, we need to prosecute them. OK, that should be someone’s job; it shouldn’t be the insolvency practitioner’s job. |
DT: | Mark, your wish list? |
MW:
1:17:00
1:18:00
1:19:00
1:20:00
| I tend to try to anyway look at the glass half full. And look at the modest success that we’ve reached in insolvency law reform over the last 30 years and try to take lessons from modest reform that’s worked well, and I think that part 5.3A voluntary administration is an example of that. I think firstly, to reiterate, number one of my wish list would be a root and branch review. As I said, I often check myself when being asked what’s on my wish list and try not to sound hypocritical by advocating a root and branch review and then saying but I actually know what the panacea is. I think a root and branch review would enable us all to look not only at how all the moving parts work together and could work better together, but to understand what we expect of our insolvency system. And I think that’s the conversation we need to have in Australia. I think, as Jason alluded to, we expect too much of the system. I think culturally Australians expect too much of the system, the law, the State, the practitioner, when there’s failure. I think intuitively we need to probably look to government a little bit less than we perhaps do for assistance. I think we need to perhaps confront failure more than we do than necessarily expecting X percent of businesses to be saved. I think the economic perspective on insolvency law or what we want to see from an insolvency law system is an area of academic research which I think needs to be progressed, and would, I think, feature large in a successful root and branch review. What do we expect from our insolvency law regime in terms of improving our economic performance? In the bankruptcy, personal insolvency context, conversations are being had at the moment about whether we reduce bankruptcy to one year to promote entrepreneurialism. Now I’m a little bit sceptical about the notion that entrepreneurs and real innovators when they’re looking to commence a great idea in business, are thinking about the insolvency law system. I’m sceptical about that, I think some of the economic powerhouses of the world like Germany actually have quite strict bankruptcy laws. So I think we need to perhaps just re-test our own assumptions and prejudices on how much of a factor insolvency law really is on economic performance and what we expect not only how it is operating, but how we expect it to operate, what do we want from our insolvency law system? The other, I think harking back to the point I made earlier, one on my wish list is legislative drafting and law that’s clear and error-free. I think again going back to the Insolvency Law Reform Act, we had you know an Act and Regulations, we have now moved to an Act, Regulations, Insolvency Practice Schedule, Insolvency Practice Rules. Now with the new Part 5.3B we’re adding to the Regulations again, having repealed a lot of them in 2017, and added rules. Our legislative canvas is just a lot more complex and difficult and burdensome and costlier than it was 20 years ago, even ten years ago. And I think again that the approach as Jason says it’s too ad hoc, it’s sort of reactionary. The Insolvency Law Reform Act primarily was designed to address perceived failings in the profession, and the practitioners, and creditor participation or lack thereof in the system, and again as I said it was more reactionary. It wasn’t part of our sort of root and branch review. And I think there are low hanging pieces of fruit which have been sitting there ripe for reform and amendment which haven’t been acted upon. Without getting too technical, they’re things like trusts, trading trusts a lot of complexities with insolvency of trading trusts, things which could be easily fixed by some targeted, elegant legislative amendment. And we could then see you know what benefit we get from those sorts of improvements. I mentioned things like proposals without meetings, things that were broken through the insolvency law reform process, things were meant to be improved but weren’t because the legislation was defective. Wouldn’t it be nice if we just fixed that first? And then see where we are? Together with a root and branch review, and I think that would give us a much more informed basis on which to make decisions about what changes to make. |
DT: | Well Mark, Jason thanks so much for joining me today on Hearsay to talk about the small business restructuring process. We’ve talked about some of the benefits, and far more of the detriments, of the legislation as it’s been introduced. Of course, it is at the exposure draft stage, there is one more day of consultation left, you never know, someone from Treasury or the OPC might be listening, but hopefully they’ve got a thick hide. So Jason and Mark thanks so much for joining me. |
JH: | Thanks very much. |
MW: | Thanks David. |
DT: 1:21:00
1:22:00 | As always, you’ve been listening to Hearsay The Legal Podcast. I’d like to thank our guests today – Professor Jason Harris and Mark Wellard – for coming on the show. Now if you liked this discussion about the new insolvency law reforms, I actually interviewed Jason in a previous episode of Hearsay about how our voluntary administration regime works, so you could try that out. Now I can’t get enough insolvency law content but if you did want to try something different, you could always listen to my interview with Simon Bennett about estate planning. If you’re an Australian legal practitioner, you can claim one continuing professional development point for listening to this episode. Whether an activity entitles you to claim a CPD unit is self-assessed, but we suggest that this episode constitutes an activity in the substantive law field. If you’ve claimed five or more CPD points for audio content already this CPD year, then you might need to access our multimedia content to claim further points from listening to Hearsay. Visit htlp.com.au for more information on claiming and tracking your points on our platform. The Hearsay team is Tim Edmeades, Kirti Kumar, Araceli Robledo, Zahra Wilson, and me David Turner. Nicola Cosgrove is our executive producer and without her you wouldn’t be listening to me right now. Hearsay The Legal Podcast is proudly supported by Assured Legal Solutions, making complex simple. You can find all of our episodes as well as summary papers, transcripts, quizzes and more good stuff at htlp.com.au. That’s HTLP for Hearsay The Legal Podcast.com.au. Thanks for listening and I’ll see you again next time. |
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