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Episode 09 Buy Episode

The Voluntary Administration Regime

Law as stated: 5 August 2020 What is this? This episode was published and is accurate as at this date.
This interview with Professor Jason Harris explores the effectiveness of the voluntary administration regime in Australia since its introduction in 1993.
Substantive Law Substantive Law
5 August 2020
Jason Harris
University of Sydney
1 hour = 1 CPD point
How does it work?
What area(s) of law does this episode consider?This episode centres around Jason’s PhD research which focuses on the effectiveness of the voluntary administration (VA) regime set out in Part 5.3A of the Corporations Act 2001 (Cth).
Why is this topic relevant?As at 30 June 2019, the Australian Bureau of Statistics reports that there were 2,375,753 actively trading businesses in Australia. The success and future of these businesses are not guaranteed. The COVID-19 pandemic is a threat to many businesses as is evident by the recent appointment of voluntary administrators to Virgin Australia, TM Lewin, Seafolly, LJ Hooker and the Sydney arts centre Carriageworks.

One of the most common forms of insolvent external administrations for companies, and one path to a business turnaround, is the VA regime. VA is a process where an independent person is appointed to take control of a financially distressed company for a short period of time to consider restructuring options; during this time a statutory moratorium operates to provide the company with breathing spaces to consider its options.  Having a high-level understanding of the process and effectiveness of the VA regime is important for all commercial lawyers – particularly at the moment, with predictions of increased corporate and personal insolvencies on the horizon.

What legislation is considered?Part 5.3A of the Corporations Act 2001 (Cth)

Chapter 11 United States Bankruptcy Code

A brief overview of Jason’s thesis

 

Jason’s PhD research involves a study of 5% of all voluntary administrations from 1993 to 2018 – which is a sample of 2440 companies – to analyse the effectiveness of the regime in achieving the object of Part 5.3A.

The object of Part 5.3A is to provide for the business, property and affairs of an insolvent company to be administered in a way that maximises the chances of the company continuing in existence, or if it is not possible for the company or its business to continue in existence, results in a better return for the company’s creditors and members than would result from an immediate winding up of the company.

Jason has completed extensive research which includes conducting interviews with insolvency practitioners and general accountants and ascertaining their views on the different processes available to companies experiencing financial distress, such as the Safe Harbour regime under s 588G introduced in 2017.  He also analyses data extrapolated from records maintained by ASIC; in addition to developing a survey for ARITA and CPA members, from which he received 500 responses.

What are the main points or findings Jason discussed?
  • Is the VA regime effective for SMEs?  While the regime is generally considered appropriate for larger businesses, it is not as effective for SMEs. While the VA regime typically lasts 20-25 business days; this timeframe can be increased. For example, the voluntary administration of ABC Learning lasted for 19 months. The stringent reporting requirements and the sheer cost of the VA process often makes it inaccessible for SMEs who may instead opt for a liquidation process. This could include a creditors’ voluntary liquidation, a process which is a fait accompli in the sense that it provides no mechanism to consider any form of a turnaround or compromise with creditors.
  • The cost of the VA regime: A VA will cost upward of $40k, being a cost that is generally paid in priority before any payment to creditors. This creates a challenge for both insolvency practitioners and directors. For insolvency practitioners, they may be reluctant to accept an appointment and the obligations needed to comply with the VA regime unless they are comfortable their fees will be paid.  After all, no one wants to work for free! For directors of businesses, there may not be sufficient assets to cover this cost, so unless the directors are willing to provide an indemnity to the insolvency practitioner for the estimated fees, they may be faced with no other option but to liquidate the company.
  • Comparative analysis: Jason compares insolvency regimes in the US and UK to that of Australia. Chapter 11 of the Bankruptcy Code in the US enables a company to operate as a “debtor in possession” and maintain its board of directors as well as management throughout the case thereby preserving a continuity of operations. This is a key difference to the Australian VA regime, where the company’s directors are deprived of any power during the administration process, which is conducted by an independent insolvency practitioner. In the UK, a company can enter into a company voluntary arrangement (often referred to as a CVA) which is implemented under the supervision of an insolvency practitioner, and similar to the Chapter regime in the US, the existing management remains in place throughout the term of the CVA.
  • The obligation to investigate: Much of the cost associated with administering a VA relates to the statutory obligation to investigate. A voluntary administrator is expected to investigate the reason(s) why the company is financially distressed, any inappropriate conduct of the directors and also identify where external third parties, such as creditors, have been preferred.  Recently, there is an increased focus on identifying phoenix activity during these investigations.[1] These investigations can take up an extensive amount of time and, as a result, increase costs. The purpose of such investigations is to identify potential claims that could be brought by the company/it’s voluntary administrators.  Even when claims are identified and reported to creditors, often there are insufficient funds to enable the voluntary administrators to pursue such claims. Jason poses a very interesting question: should we be relying on insolvency law, and the VA regime, to address these issues, that is instances of directors breaching their duties and/or engaging in phoenix activity?
  • What about a ‘debtor in possession regime?’: Jason discusses how the introduction of a ‘debtor in possession’ regime in Australia, where the director(s) remains running the business under the supervision of an administrator, could reduce both costs and risk for the insolvency practitioner. Some insolvency practitioners have expressed doubts about the effectiveness of such a model, where the flow of information to the administrator depends on the individual director in control.
What are the practical takeaways?
  • Broadly speaking, the VA regime is effective when dealing with large-scale corporate insolvencies. Whereas directors of smaller and medium sized companies have to grapple with the cost of the VA process – including potentially giving indemnities to administrators for those costs.
  • 10-15,000 companies experience an external administration process each year; 50-60% of these companies show contraventions by directors, whether that be trading whilst insolvent, or failing to maintain books and records, or engaging in transactions intended to defraud creditors. Who should investigate these contraventions, ASIC or insolvency practitioners? Should the VA regime be used to police directors or should it be used to try to turnaround and rescue businesses?
  • Insolvency practitioners, once appointed, are somewhat viewed as ‘gatekeepers’ by ASIC, but Jason proposes that insolvency practitioners focus more on turnaround and business rescue, leaving issues of compliance and misconduct to ASIC and the ATO.
  • In terms of reform, Jason suggests that building more flexibility into the system with regard to reporting obligations and the way information is delivered to creditors, could make the regime more cost-effective and practically more useful for creditors. Utilising technology, shortening reports and rethinking engagement with creditors will help to achieve a more accessible system.

 

[1]  Phoenixing refers to a practice where a new company is created to continue the business of an existing company that has been deliberately liquidated to avoid paying outstanding debts, including taxes, creditors and employee entitlements. Ordinarily, the liabilities of the existing company are segregated with assets being transferred into the new company. The Economic Impact of Potential Illegal Phoenix Activity Report found that illegal phoenix activity costs employees between $31 and $298 million in unpaid entitlements and costs the government around $1,660 million in unpaid taxes and compliance.

 

 

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.

Just a quick note before we begin, the episode of Hearsay you’re about to listen to was recorded in the midst of the coronavirus crisis and as a result of social distancing measures we had to conduct this interview over remote technology such as Zoom or Google Meet, the audio quality might be a little different than what you were expecting. Still we think it’s pretty good in the circumstances and we hope you enjoy the episode.

Joining me today on Hearsay to discuss the voluntary administration regime in Australia is Professor Jason Harris, professor of corporate law at the Sydney University Law School. Jason is one of the preeminent insolvency law academics in Australia, having published 13 books on the subject and over 90 articles in practitioner and academic journals, he is also undertaking his PhD studies at Adelaide Law School in this area. Professor Jason Harris, thanks for joining me on Hearsay.

Jason Harris:It’s my pleasure.
DT:

 

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Now I’m fascinated to talk about your PhD topic because the voluntary administration regime has been around for, well just shy of 20 years now, but there is still so much speculation about the capacity of the regime to achieve legitimate business rescue.

TIP: Voluntary administration or as its more colloquially known a VA, is a term I’m sure we have all come across at some stage or another whether or not we practice insolvency law – and in the media you might have most recently heard it in regards to Virgin Australia or Seafolly.

Voluntary administration is a process designed to give a company ‘breathing space’ from the demands of its creditors usually when the company’s directors believe that the company is or will become at a future time insolvent although some other parties can appoint voluntary administrators as we will discuss later. During a voluntary administration the administrator takes over control of the company and over a period of 20 to 25 business days manages the affairs of the company with a view to maximise returns to the company’s creditors. At the end of the VA process the administrator recommends that the company either execute something called a Deed of Company Arrangement or DOCA a proposal usually involving a compromise of creditor’s entitlements which can result in the company being recapitalised, turned around and rescued or go into liquidation in which case a liquidator may be able to pursue voidable transactions claims for the benefit of the company’s creditors. Technically there’s a third option, where the administrator recommends that the company be returned to the control of the company’s directors but that almost never happens.

When did you start your PhD studies?

JH:I started in 2012 but really, I’ve been looking at this topic over my whole academic career. So, I started as an academic in 2000 and I’ve always been really interested in corporate insolvency. I think it’s an area of the law that really brings together multiple interests, multiple areas of law. To be a good insolvency lawyer you really need to have a good understanding of contract law, equity, property, tax, so yeah I’ve always been really interested in it.
DT:

4:00

I’m so glad you said that actually. I’ve always found the area fascinating from a social utility perspective, that it’s one of these areas of commercial law that’s really about the allocation of scarce resources amongst a set of stakeholders, who by definition aren’t going to receive what they’re entitled to and that’s always fascinated me about this area; that degree of focus on social utility and I guess, to a degree social good and the economic distribution of resources. But I interrupted you, please go.
JH:And it’s really about people.
DT:Absolutely.
JH:As an insolvency practitioner you are possibly shutting down the business. As you say, people aren’t going to get paid, that has flow on consequences for suppliers and other creditors, employees, that can affect their individual creditors as well and we’re certainly seeing that now with the pandemic response. Seeing landlords going through a lot of problems with tenants, tenants of course having a lot of problems.
DT:

5:00

Well I explained this to non-insolvency lawyers, I think about the town of Whyalla.

TIP: Whyalla is a South Australian town, located about 4 hours from the capital of Adelaide, with a population of 21,000. In 2016, one of the largest employers in the town, Arrium – a steelmaker and iron ore miner listed on the ASX was placed in voluntary administration by its directors. Voluntary administrators from Grant Thornton assumed control of Arrium’s day-to-day operations immediately, while working with lenders, staff, suppliers and the government to review its business model. Incredibly, Arrium was in about $4b worth of debt. The employees took a 10% pay cut to make the plant more attractive to potential buyers, in an effort to save it. The administrators were successfully able to secure a buyer for the company, saving thousands of jobs in South Australia.

With the Arrium collapse and really the fate of that entire community rested on the success of the insolvency regime in rescuing that business.

JH:

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Yep and there certainly is a different dynamic to insolvencies and restructurings in regional Australia compared with those in the big cities and that’s been one of the interesting things, doing the PhD research, getting out and talking to people about their experience of working with voluntary administration. Some insolvency practitioners mentioned to me how different it is, just the dynamic of going into regional town where you might be dealing with a major employer and just that sense of community support to try and get a deal done if possible, and this sort of, you know, the flexibility that creditors will show, that going the extra mile, that employees will try and keep that business operating just because it means so much to the local community. So, I mean that’s something that I found really interesting over the years, is how different areas of the law operate or are changed during insolvency and restructuring and really, what that says about us and what we value as a community. So for example, the priority that employees get and then how that’s protected by the government safety net with the Fair Entitlements Guarantee, the way that the major banks deal with large insolvencies and the kind of flexibility that they show during restructuring processes and very much being mindful of the optics of what they’re seen to be doing. So now we’ve just come through the Royal Commission and banks have had a pretty bad name over the last few years but we’re really seeing now how valuable they can be in supporting restructuring efforts and trying to help businesses stay afloat. So while people like to pick on the so called big bad banks, we need them to be big because that allows them to offer this support and say, you know, you don’t have to worry about your mortgage payments for the next six months because we got the balance sheet to support that. It’s just a really interesting kind of vortex for all these different interests interplay during very condensed circumstances, and it’s also one of the few times when the statute just comes in and says, well you know, a lot of these rights that existed outside of insolvency, we’re just going to change them because we know we just need to. The nature of the problem is such that we just have to have someone else come in, takeover and ‘I know you were due money, well sorry that’s just going to get put on hold’.
DT:Yeah and I suppose having that interest in the way rights and remedies are changed so profoundly in an insolvency process, that must be one of the reasons why you selected the voluntary administration regime as the topic of your PhD studies because it perhaps, more than any other insolvency regime, affects the rights of creditors and other stakeholders.
JH:

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Yeah absolutely. You know the idea that you can leave something of yours on someone else’s land, for example like say you parked car or something, and then the company that owns the land goes into administration, there are provisions in the Act that then say, you’re not allowed to go back and take collection of that without the administrator’s permission. The administrator doesn’t want your car, they’re not going to sell your car, but just this idea that this is such a unique problem and in so important to society that we provide the right set of tools to get the best possible outcome, that we just need to compromise everyone’s rights and I find that really interesting, and it’s also an area where every jurisdiction is dealing with this problem, you know. Failure is part of a capitalist economy, so we have to have a procedure that provides a way for us to deal with this in a way that we think as a community, is the best, most efficient and fairest system. So there’s really interesting parallels and contrasts in other jurisdictions and we see that most clearly in the debate about insolvency reform with the constant comparisons with Chapter 11 Bankruptcy in US,

TIP: A reorganisation under Chapter 11 of the US Bankruptcy Code is often referred to as a ‘reorganisation bankruptcy’. Chapter 11 is typically used to reorganize a business, which may be a corporation, sole proprietorship, or partnership. The Bankruptcy Code works on a  “debtor in possession” model which means it maintains its board of directors as well as its management throughout the case thereby preserving continuity of operations and management This is a key difference to the Australian voluntary administration regime, where the company’s directors are replaced by the voluntary administrator and are deprived of any power during the administration process.

And the idea that it’s some sort of restructuring nirvana, where sick companies go to be rescued. That’s something I’ve been fascinated in for a while and very much the idea that, that’s the perfect system and we should be aiming to strive towards that. So one of the things I’ve been doing as part of my PhD is looking a little bit deeper into Chapter 11 and I’ve read quite a lot of finance and economic studies about how Chapter 11s actually work in the sort of outcomes that they get, and it seems to work really well for very large companies with large asset bases and very large amounts of debt. It doesn’t seem to work very well for anyone else. The actual numbers on Chapter 11 in the US are tiny, in that kind of context of well over a million bankruptcies a year, and that’s personal and corporate bankruptcies under the Bankruptcy Code. Now the numbers of business Chapter 11s are 8,000, 10,000, 12,000 a year and even of those, it’s really only about a third of those cases actually go through to the restructuring phase. Even then the numbers of repeat Chapter 11s, or the Chapter 22s or the Chapter 33s where you’re coming back multiple times, as we’ve seen with some airlines, it works really well for a very narrow type of company.

DT:Yeah and I suppose, it’s not just the strength of that company’s balance sheet or the size of the company’s operations, but also the sophistication and qualification and diversity of that company’s board because, of course, it’s still that board under which the company operates.
JH:

 

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Yeah, I mean I think to a certain extent, that’s a bit of a popular myth about Chapter 11. It is a debtor in possession but when you go through the Bankruptcy Code, there’s so many constraints on what debtor management can actually do. The power that secured creditors there, even though the law talks about their rights being compromised, they’re compromised to the extent that you can’t do anything with this security without their permission or the court’s permission so, the idea is that the secured creditors should, where possible, be kept whole which incredibly constrains what you’re able to do. If you’ve got a company that’s got a lot of free cash and a lot of unsecured assets, then yeah, there’s a lot you can do but how many companies are like these? Talking to some US bankruptcy attorneys, they say really it’s creditor in possession because you have to go off to the court to do anything, then creditors are going to turn up and oppose what you’re trying to do, you know, it’s a balancing exercise, it isn’t as debtor friendly as people assume it is.
DT:

 

14:00

Yeah it’s interesting. It is a popular myth, it’s certainly one that I’ve always, I suppose when describing the difference between the two regimes, in a kind of glib or pithy way, that’s often one that you return to, that distinction between the control of the voluntary administrator in the control of the company’s board, but it’s interesting that you say, that in practise it’s really the secured creditors that are driving down.
JH:And I mean, they’re the ones you need to get the approval from, so if they’re not going to approve the use of the collateral or they might say, well yeah we’ll let you use the collateral to continue trading but you have to replace your management team with people that we approve, it’s those types of creditor controls.
DT:Yes. Let’s return to our own shores and the voluntary administration regime, now your PhD research involves a study of 5% of all voluntary administrations from 1993 to 2018. That must have been a mammoth task! How many administrations was that?
JH:

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So, in my 5% sample, I’ve got 2,440 companies and basically what I did was, I bought a data set from ASIC covering all 505 Form details from the middle of 1993, because that’s when administration came in, till the end of 2018.

TIP: If you’re an insolvency practitioner or insolvency lawyer, you no doubt understand what a Form 505 is and you’ve lodged a lot of them. For those who aren’t familiar, a form 505 is used to notify ASIC of the appointment or cessation of an external administrator like a voluntary administrator.

And ASIC was very good in providing that data. I did have to pay for it, which wasn’t cheap but it’s quite a valuable data set, but all that is was the company name, the ACN and the date that the Form 505 was lodged. So that then gave me a snapshot of, this essentially is a record of every company that’s gone into any form of external administration during that time frame and there’s a particular form code, as you know on the 505 Form there’s different boxes that you tick based on the type of appointment. So there’s a code for administration, so that meant that I could then filter out the data to only look at the administrations, and in the early years that was just a couple of 100, in the kind of boom times of administration, in ‘03, ‘04 and ‘05 that was several thousand companies, and then I just did a random sort and then I picked a 5%, the first 5% from that random sort. So in each year I’ve got typically a few 100 companies that I’m tracking and then what I did was put each of those companies into the ASIC names index search on the ASIC website and that gave me a list of every document that had been lodged with ASIC for that company, and then I used the form codes of documents that were lodged to try and build a picture of what had happened to that company.

DT:

 

 

 

 

 

 

 

18:00

Oh, I see. So, if, for example there’s a notification of a Deed of Company Arrangement lodged with ASIC then obviously you know that Deed of Company Arrangement’s been approved by creditors and equally you know, from the forms lodged with ASIC, whether the company is being wound up at that second meeting.

TIP: I mentioned Deeds of Company arrangement before, a DOCA is a binding arrangement between a company and its creditors, which basically governs how the affairs of the company will be dealt with during the DOCA period. It may be entered to as a result of the company entering voluntary administration and the company’s creditors at its second meeting of creditors resolving to sign the DOCA. The aim of the DOCA is to maximise the chance of the company, or as much of its business as possible continuing in order to provide a better return to the company’s creditors.

Wow it’s fantastic that that data was available.

JH:

 

 

 

 

 

 

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What I don’t have unfortunately is, I don’t have all the actual forms and that would be the more useful data. So, for example, if I had the receipts and payments for each to those companies, I could work out asset levels, I could work out debt levels, I could look at repayment levels but I don’t have that. I don’t have the copies of the deeds of company arrangement so I can’t classify them as to what they’re actually trying to achieve. So, I’m limited but really what motivated me to get into this topic was that there’s just so little information, like we’ve got this regime that, at the time when I started thinking about this was, just about becoming the most popular type of insolvency appointment. There was a few years there that VAs were the most common type of appointment, that’s now creditors voluntary liquidation and I thought I was just surprised at how little we knew about it, like so many reports over the years, particularly in that kind of ‘98 through to ’04 period, where we had a series of reports from the Parliament, from CAMAC from ASIC itself, all speaking in glowing terms of administration – ‘oh everyone loves it, it’s great, it’s got full support, works really well’ – and I thought, well where’s the evidence for that?  There’s actually no hard data and it’s continuously frustrated me that ASIC doesn’t provide, even the most basic data that it collects from the forms that insolvency practitioners lodge. So, it tells us the number of appointments each year, so we know how many companies, we know how many practitioners were appointed but that’s almost it. So we don’t know how long they last for, we don’t know what the outcomes are, so even though on ASIC’s statistical reports it will say, in this given year or this given month, there’s this number of administration appointments and there’s this number of deed of company arrangement appointments. Those numbers are not linked, so we can’t say in any given year X proportion of VAs result in this proportion of DOCAs because, of course, the DOCAs might have come from the previous year’s administration.
DT:Yes, of course.
JH:

 

 

 

 

 

 

 

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So, it’s just little things like that, that I thought we really should know this information. So it was just that curiosity and when I started this project, I thought well I’d really like to know how companies get into administration. So the popular view is its overwhelmingly directors appointing administrators, that secured creditors don’t tend to do it that often, and liquidators doing it, well we can track that through record applications but, again, there’s no hard data on that. Like how do we know what it is? How big is the proportion? So before I started my PhD, I actually went through the Australian newspaper, which has the company notices or used to have the company notices, I haven’t checked for a while and of course, that’s where you used to publish them before the ASIC Insolvency Notices website started. So I actually collected the company notices every day for six months, so that I could try and track who was appointing administrators, and what I found during that time was, almost everyone was a 436A appointment! I found a few 436C appointments, so it’s little things that made me think we should have better data on this. 

TIP: I mentioned earlier that the directors of a company can appoint a voluntary administrator but Part 5.3A, Division 2 of the Corporations Act outlines some of the other parties that can appoint voluntary administrators.

Section 436A deals with the appointment of an administrator by the company’s board where the board is of the opinion that the company is or will become insolvent.

 Section 436B enables a liquidator of a company to appoint a voluntary administrator.

And section 436C provides that a secured party holding security over substantially the whole of the assets and undertaking of the company can appoint a voluntary administrator as well. A secured party holding security of this kind often has a GSA or a general security agreement which covers all of the assets of the company.

We need better data so that we can have a more informed policy debate about how administration is working. As I was getting into my thesis, I thought you know by the time I finish this thesis it will be 25 years of administration and so therefore, we really should have a better understanding of how it works. So that’s kind of motivated me to spend the last eight years looking at voluntary administration.

DT:

 

 

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I want to come back to this idea about there being a lot of received wisdom about the voluntary administration regime that’s perhaps unsupported by data, but before I leave at that wonderful example of just going through the notices in the paper, I wondered if you had a hypothesis or why there is a bit of a dearth of 436C appointments.

TIP: Remember – this is a kind of voluntary administration where a secured party appoints an administrator. Usually under a GSA.

Is it that secured creditors are generally able to exert pressure on the boards to make that appointment themselves rather than exercise the statutory power? Is it something else?

JH:

 

 

 

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Yeah so I think it’s a mixture of things. I think certainly that’s the big one. If you’ve got security over everything, if you’re a big bank for example, you don’t need to make the appointment and I’ve had people tell me anecdotally, not a formal part of the interview process that I’ve done for my thesis but just chatting to practitioners over the years, I’ve had people tell me that, you know, working within the distressed part of the major banks say, that they can position themselves in such a way that really they leave the directors no choice. So for example, they know the company started get into distress, the directors are requesting some sort of variation to the terms alone or some sort of extension or the overdraft facility or something, so they know they can exercise their legal rights which will leave the directors with no choice but to appoint administrators or shut the business down. So they don’t need to, they can still get the outcome that they want in terms of ‘you want to get our support to extend your loan with us, well you know we think you need to consider the company’s financial position, if you wanted to get some advice here some advisers that we’ve worked with before but of course it’s all up to you, we’re not telling you what to do because we don’t want to be shadow directors, but if you want our help, you know, you need to do something’. One of the interesting things during the empirical work that I’ve done in the thesis, because I’ve gone and interviewed 40 senior practitioners, so I’ve interviewed some senior bankers, I’ve interviewed insolvency lawyers, insolvency practitioners, directors, advisers, general credit managers and one of the interesting things that I’ve found is there does seem to be a changing trend with 436C appointments. I mean, certainly a lot of big retail administrations that we’ve seen over the last few years have been dual appointments. So, I wonder if that’s starting to change? I wonder if banks are becoming slightly more comfortable with dual appointments than they were in the past and indeed, one of the statistics that I tracked in my 5% sample was, the numbers of companies that had registered security that was listed with ASIC, and the numbers of companies in administration that had a receiver appointed during the convening period, and overall, the numbers of overlapping receivership appointments were pretty small. It is only 7% but my 2,500 samples had overlapping appointments. Then what I did was look at the time frame in which the notices of appointment could be lodged because, one of the big vulnerabilities in my study is that it’s dependent on notices that are being lodged with ASIC, because people can lodge notices late. So that’s one of the things I took into account. So then I looked at basically 10 business days either side and then the percentages were more in the kind of 10-15% range. Now that would suggest that secured creditors largely support the administration process, they don’t feel the need to appoint, but certainly we’ve seen in some large high profile matters, like in Channel 10, like in some of the big retailers, we’ve seen overlapping appointments nonetheless and certainly talking to insolvency lawyers, they tell me that banks are getting more comfortable just appointing the administrator themselves because it can change the optics of a receivership appointment and you’d be aware that bank receiverships, particularly in the Agri space have had a pretty bad name over the past few years with, you know, various senate inquiries and reports and things, not suggesting that done anything wrong, but it’s certainly a lot of debtors who are very cranky about how their businesses have been conducted in receivership.

TIP: Receivership is another kind of external administration and occurs when the secured creditor of a company appoints a receiver to collect and sell the company’s assets in such a way as to repay the outstanding debts owed to that secured creditor.

DT:And so many of them, 420A cases are precisely those the Agri business cases.
JH:

 

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So from a bank’s perspective, okay we can put a receiver in, they’re going to protect our interest, but then kind of the focus is on them as well, the receiver is only there working in the interests of the bank, whereas if they appoint an administrator they can at least say to the public, well look the administrators there, they’re independent of us, they’ve got to act in the best interests of all creditors, knowing full well that at the end of the VA process if they’re not happy, then they don’t have to vote for the DoCA and they won’t be bound by it. So it just changes the optics a little bit. I wonder if that’s starting to change? We’ve also seen a lot of cases where the administrators are appointed first but then the bank will appoint a receiver within the few days after that. So it’s not the bank putting the company to the sword, it’s the directors putting it under.
DT:And once it’s in that process, there’s a greater social acceptance I suppose, of exercising those rights under the security.
JH:Yep.
DT:

 

 

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I want to return to this idea of there being a number of views in the market on the effectiveness of voluntary administration but perhaps unsupported by evidence. I hear two narratives about voluntary administration from time to time and these were narratives that came up quite commonly when discussing the Safe Harbour Regime, which commenced in 2017.

TIP: Let’s pause here for a moment to talk about the Safe Harbour which is contained in s 588GA of the Corporations Act and the following sections. The Safe Harbour regime operates on the basis that directors are excused from personal liability for insolvent trading if they adopt and implement a course of action that is reasonably likely to lead to a better outcome for the company, by which that means the company’s creditors, provided that they follow certain rules including keeping up to date with employee entitlements and tax lodgements. The purpose of the Safe Harbour regime is to prevent companies from going into voluntary administration or liquidation prematurely if they can be turned around and rescued using an informal restructuring plan.

And the narratives are competing; one says that the voluntary administration regime is invoked too late by many directors to achieve legitimate business rescue, by the time it’s invoked, virtually the only option is to wind up the company. The other narrative is that, the insolvent trading liability provisions of the Corporations Act are so draconian that directors are encouraged, perhaps forced, to place a company into voluntary administration earlier than might otherwise have been necessary to protect themselves from personal liability, and of course that latter narrative was the driving force behind the Safe Harbour Regime to allow businesses to trade through a period of uncertain solvency. Has that been the subject of any of your research and you see any evidence, either way whether it tends to be the case that directors are appointing late or directors are appointing early?

JH:

 

 

 

 

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Yeah, so that certainly came up in the interviews that I did and I was asking people about their views on Safe Harbour, whether they thought it was working or not, whether it made any difference to administration and the same with the Ipso facto changes, and I basically got the answers that I was expecting, which was Safe Harbour really only works at the large end of town. So Safe Harbour is about making public company directors feel a bit better about staying on the board while the company is going through a restructure. And the idea that directors are jumping the gun and putting companies under because they’re concerned about personal liability, I think that’s highly dubious and indeed, if we go back to some of the earlier insolvency parliamentary inquiries, we saw submissions from large insolvency firms like McGrathNicol for example. I can recall putting in a submission in, I think it was about 2015 when we first started talking about this Safe Harbour, saying that they’d gone back through their files over a period of years and you know, they couldn’t identify one single matter where they thought the company should not have been appointed, you know, that early. I mean, clearly it does happen in terms of jumping the gun and appointing a company by putting the company into administration, but it happens so rarely that it’s not really affected here, I think at the larger end of the market, the risk is more that the directors will resign. That all of a sudden, they discover that they need to spend more time with their family, because I’m sure they love their family, but it’s you know they don’t want to be on the ship when it goes under. We’ve seen large public company directors who are going for prestigious positions on boards like, shares of banks and the like, and the news media rips into them and say, this person was on the board of this company when it collapsed and, you know, the stigma of insolvency is real, not even to mention what it does to their credit rating if they’re a director of a company that then goes under. So they want to get out before it starts to sink and I think that’s the bigger risk, is we’re losing valuable talent on boards because they’re concerned about personal liability. So Safe Harbour helps them because then they can say, well we’ll bring in the Safe Harbour advisors and I’ll feel a bit better about the risk of getting sued, but that’s really the tip of the iceberg because as you know, the insolvency in Australia is all about the small business. It’s not about large public companies, thankfully we don’t have large numbers of ASX Top 200 companies going into administration each year. The vast, vast majority are the small proprietary companies, and I just don’t think insolvent trading is at all relevant for them, I don’t think that the people who are running those small family businesses give it much of a thought at all because typically, their personal assets are already tied up with the business loans through personal guarantees, so if they put the company under, okay they’ll get the temporary period of protection under 440J against their debts as guarantees, but that won’t help them once you go into a DoCA or otherwise exit administration. So from their perspective, maybe we could appoint administrator, how much is that going to cost, do we have the cash flow and the assets to support that, am I going to have to provide a personal indemnity to cover their costs, I’m going to lose control, I won’t necessarily control the sale process and then, the business might still fold, someone else will end up buying the assets and then I’m going to be left with all this personal guarantee debt. So the idea that they’re going to get sued in five years’ time for insolvent trading, even though you know, we do actually have people in Australia who’ve gone to prison for insolvent trading, there’s very few of them but there are some, I just don’t think it’s a factor at all. I don’t think insolvent trading really works against SME directors except to the extent that where the businesses are a little bit further up the decline curve, so they have a few more assets to work with, we might see situations where insolvency practitioners, once they are appointed and they then say, hey there could be some insolvent trading here, let’s do a deal, instead of me suing you for $200,000 why don’t you write me a cheque for $60,000 and that will cover the costs. I think that’s where insolvent trading works, it works through compromises of claims under insolvency practitioners’ essential work but I don’t think it’s actually a factor weighing on the minds of SME directors. I think they’re far more worried about how they’re going to make payroll next week.
DT:

 

 

 

 

 

 

Absolutely and it’s interesting that you raise payroll because when the Safe Harbour regime was first a subject of discussion, it was certainly my impression that there was a really narrow slice of businesses that could benefit from it because on the lower end, even if you take the hypothetical example of a small business director whose personal assets are somehow not a risk and perhaps the company isn’t funded through debt, I don’t know, but the prerequisites to taking advantage of the regime are to be up to date with employee entitlements including superannuation and to be up to date with tax lodgements and returns. Just as a matter of personal experience, it’s just so rare to find a small business insolvency where either of those things are the case. It’s usually very much the case that there is unpaid superannuation, it’s usually very much the case that a tax return hasn’t been lodged in years.
JH:

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Yep, so how we’ve ended up with this situation is that we had a very narrow window to get this reform through and we’ve been pushing for it for many years, and the narrow window was during Turnbull’s time as Prime Minister and he was a big supporter of this proposal, and a big supporter in providing more flexibility in insolvency and restructuring because, he quite famously talked about how much he admired Chapter 11. So there was a narrow window to get this push through, but there’s been so much talk over the last few years about phoenix operators and unethical directors’ advisers and pre-insolvency advisors and that type of adviser, who’s advertising on the Internet ‘I can show you how to not pay the ATO’, that type of people, so there’s been so much of a focus on that, that we can’t be giving them a free kick, that the government decided that the only way they could sell all this was to get it passed through the parliament, was to say that really, this is a small business measure, this will help protect small businesses from going under because they’re all going to be jumping off a cliff unless we do this, which was never right but they had to appease the opposition and really, the more popular media stance of, you don’t want to be giving a free kick to dodgy phoenix operators so that’s why they said ‘Oh well you can have great confidence but it’s only if you’ve got all these things up to date that you’ll be able to use it’, which of course means that the vast majority of businesses won’t be able to use it as everyone knows, who’s the biggest provider of finance to small business, the tax office by not actually making your payments. So it was never going to be effective for that end of the market and indeed, when I’ve been conducting interviews and asking people about their views on Safe Harbour, almost everyone has said ‘well it just doesn’t work in the SME realm and some practitioners, insolvency practitioners said to me well it’s totally irrelevant in the SME world because they’ll just never satisfy those requirements’. But I do think it’s helpful at the large end of the market, you know as much as we might say there’s not a lot of evidence to suggest that directors are at greater personal risk, the fear that they have, the concern that they have, the apprehension that they have, is real and we need to acknowledge that because, even if we might say as I think John Winter from ARITA said ‘you’ve got a better chance of getting bitten by a shark on George Street than you had with getting sued for insolvent trading’,

TIP: ARITA is the Australian Restructuring, Insolvency and Turnaround Association. ARITA is a voluntary membership body that many liquidators are members, and its code of conduct is often applied by the Supreme Court of New South Wales as a touchstone for prudent conduct by external administrators. Particularly when it comes to managing conflicts of interest.

Which I think is a great phrase, and even if, it’s so unlikely that you’ll be successfully sued for insolvent trading. We only have a handful of cases every year, very small numbers of criminal cases, it’s still a risk and people are concerned about that, so I think it does provide something useful for that large end of the market, but it’s not helping us save small business and to come back to your earlier point, and that’s because small business don’t have the information systems in place, don’t have the management skills to recognise when they’re starting to get into problems or to properly plan and budget, and so they don’t go off and see an independent adviser about these sorts of matters until they’re forced to, until they basically told by their accountant or they’re, you know, they are served a director penalty notice from the tax office and by that stage, they far too low on the decline curve, there’s not enough assets to support it if there ever was, and as a lot of people say ‘you can’t save a patient if they’re dead on arrival’.

Sorry, if I can just build on that, so to go back to your earlier point about insolvency being this really interesting space that tells us a lot about what we value in society right, so recognising that that is the majority of insolvency appointments, that they have little or no assets, actually not that much by way of debt either, maybe a few $100,000, very few employees, most of the businesses that go under and yet, we have a system that then, and this is not just administration but insolvency more generally, we have a system which I’ve said in the number of articles, is a Rolls Royce system. We have all these cheques and balances in place, we have all this transparency, and all this reporting, investigation and creditor meetings, and reports to creditors and you know, very very vigorous independence requirements, and I’ve got to say, I just wonder whether we’re actually getting the most value out of that process, you know. Are we reaching a point, if we’ve not already passed it where the cost of insolvency isn’t justified by what we’re actually getting out of the system. And this idealised view of insolvencies about accountability and working out why businesses have failed and attributing blame and making it all on the public record and full transparency to creditors, the vast majority of whom are unsecured and will get nothing out of insolvency. So, I just wonder, you know, why are we spending all this money? Why are we having all these reports and all these meetings when the people whose interests that we’re supposedly trying to protect are getting nothing out of the process, except for reams of information that the vast majority of them never read, and indeed talking to creditors, in my PhD study, one very large creditor whose a creditor in many different types of insolvencies, and I asked them you know, how much value do you get out of administrators reports? And they said, well I don’t think I’ve ever read one, why would I? Why would I waste my time reading 100 pages? I know I’m going to get nothing! So I think we have to look at the system. What are we trying to achieve here and what can we realistically achieve? Because it’s one thing for ASIC to basically fob off its responsibilities and say, oh well insolvency practitioners are gatekeepers so therefore they’ve got to give us all the information and if they don’t give us the information then we can’t do anything. That’s not acceptable, particularly when ASIC is, through its user pay system, is putting a tax on both the insolvency profession and also on creditors, ASIC should be doing more in this space when we’ve got 10 – 15,000 companies going under each year, and ASIC’s own statistics saying that up to 50-60% of those involve things like, insolvent trading, failing to keep books and records and a variety of other contraventions of the Act, why is ASIC bringing so few proceedings and it simply putting the responsibility onto insolvency practitioners, that it knows don’t have the funding base to properly prosecute those actions.

DT:As you say it’s a Rolls Royce system and it certainly seems to be built more for the Channel 10s and Virgins of the world than it does for…
JH:

 

 

 

 

 

 

 

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And it seems to work well for them. So talking to senior practitioners, almost universally, they said that they thought at the big end of town, it works reasonably well. That there’s a lot of flexibility in the process, that you know, as one senior lawyer who’s been involved in most of the large matters recently said to me, you can pretty much do whatever you want. The court is there, you can go off and get applications to vary the operation of the regime to suit particular circumstances of your matter, it’s very flexible and if you’ve got a lot of assets to work with, going off to court and spending $50,000 to get directions on something, maybe that’s worth it. But like I said, that’s the tip of the iceberg. It’s not to say that’s unimportant because they employ a lot of people and effect the broader economy, but I do question, and this is one of the things that’s going to come out of my thesis once I finish it, I do question whether we should just have a one size fits all model. So for example, all the checks and balances that we have in the system in terms of transparency, accountability and reporting, and giving creditors lots of powers over different things, that may well work effectively in large matters where you’ve got engaged, sophisticated, repeat players as creditors, I’m just not sure that it works at the small end of the market where practitioners tell me, for example, they can’t even get a quorum to a creditors meeting, so how do they get their fees approved?
DT:Yeah, well I’ve been to plenty of those meetings that are usually someone from the ATO on the phone…
JH:

 

 

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That’s right! That’s exactly what they said. They get the ATO on the phone so they can get their fees approved. But again, the whole system is built around: we should be putting the creditors in the driver’s seat, it’s all about them, we should be giving them more and more information so they can make more informed choices. Unsecured creditors, by and large are rationally apathetic. Why would they take an interest in the insolvency process? They’ve already written off the debt, they know they’re going to get nothing. Every minute they spend thinking about it, is a minute they’re not spending on their own businesses.
DT:Good money after bad. This might be pre-empting your thesis somewhat, but if we were to fantasise about some possible alternatives to a one size fits all model, how could the small business or small to medium business insolvency regime look in the future?
JH:

 

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So that’s something that I’ve been grappling with for a while, looking at other systems. So some listeners might be aware that in the US they enacted a small business Chapter 11 process last year, the Small Business Reorganisation Act and that makes some changes to the standard Chapter 11 procedure and also tries to reduce some of the costs, and I think that that’s really key. We need to look at the costs of administration. It’s very common for administrators to say that the pretty standard administration fee is $40-$50,000, that’s just to run an administration. If you’re doing a large trade-on situation with multiple locations, it’ll be more than that. Going into a Deed of Company Arrangement, probably $50 to $100,000. To operate a Deed over a year or two years, that’s just a cost requirement put on top of your payroll and your standard business expenses that most small businesses will never be able to meet, and indeed, I spoke to some practitioners who just said, you know, if I get a small business person, I tell him to do a creditor’s voluntary liquidation because it would be much quicker and cheaper than going through administration. So I’ve looked at a number of other systems and a regime that I’m interested in exploring, and certainly I’ll be suggesting in my thesis as a potential option, which I got some support for when I was interviewing practitioners. So there were some who took the view it’s already too complicated, if we add multiple procedures and multiple in and out points, you’re just going to complicate things further and it’s not really going to help if indeed, the actual problem isn’t the complexity of the law, it’s the economic shape that businesses are in when they enter it and you can’t solve that with more options necessarily. We need to get people monitoring their financial position, facing up to their problems at a much earlier stage, but that aside, a regime that I think is really interesting is the Company Voluntary Arrangement procedure in England.

TIP: A company voluntary arrangement, or CVA, is similar to the voluntary administration process in Australia, and is intended to assist a company facing financial difficulties. A CVA is implemented under the supervision of an insolvency practitioner, and similar to Chapter 11 bankruptcies in the US, the existing management remains in place throughout the course of the CVA. Technically, there is no statutory requirement that the company proposing a CVA be insolvent or unable to pay its debts, but in practice a CVA is used where there is at least a risk of insolvency. The CVA takes effect if approved by both the creditors and the shareholders of the company.

So that’s a bit like our Deeds of Company Arrangement, and one of the interesting features about that is, that you can get to that by going through a period of administration first, but you don’t need to go through the administration. So you can actually just propose, what is in effect a DoCA, go and see an insolvency practitioner who then takes on the role, basically as who is like a supervising trustee in bankruptcy, and it’s their job to then go through the proposed DoCA or CVA, see whether they think it’s viable, then convene a meeting of creditors, put it to creditors, if the creditors approve it then it’s effectively a debtor in possession regime or be it with that supervising trustee role, who then monitors compliance with it, and really it’s just there to make sure that the payments are being made to the creditors under that. Now I think that would offer the benefit of reducing the cost that’s built into administration because it is external administration, it’s someone taking over the running the business, which means they’re taking on a lot of personal liability, which means they’ve got all the compliance costs that are involved there, occupational health and safety risks, tax obligations, there is a variety of things administrators are personally liable for, and their fees have to reflect that risk. Whereas if you had a kind of modified debtor in possession regime, then it would still be the individual owner who’d be running the business or be it under the supervision of an administrator, so I wonder if that could reduce some of the costs, would certainly reduce a lot of the risk for the insolvency practitioner and some, particularly in the SMS space when I was doing my interviews, suggested a lot of support for that that they thought that would be a successful regime, but then speaking to some other people, particularly insolvency practitioners, they expressed doubts about how effective that would be and that’s on the basis that; well, being an external administrator, you’ve got ownership of all books and records, right, so you can verify the information. If you’re just a monitor, a supervisor, you’re depending on the flow of information from the business owners. Well if they didn’t have good information systems to start with, why are they going to have good information systems in it in a debtor in possession regime. So maybe the figures that they’re feeding you aren’t the best figures and once you have to start going in a double checking everything, the costs are going to go up. So some have expressed doubt about whether that kind of modified debtor in possession regime is appropriate for small business, just because they don’t have those internal information systems.

DT:Because of those issues around the reliability of financial information?
JH:Yep.
DT:

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We’ve talked a bit about your research methodology for your PhD, first the data that you obtained from ASIC and your 5% sample size. I’d like to talk now about your survey of insolvency practitioners and general business accountants, particularly the latter. I imagine that was a really revealing exercise to find out what non-insolvency accountants think about the insolvency regime and how they advise their clients about the insolvency regime.
JH:

 

 

 

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Yeah it was really interesting. So like I said, I’ve been doing the thesis for eight years, so I actually did that research in 2015 and that was with the support of ARITA, and the CPAs and the Institute, and basically, I designed a survey and then they distributed the survey to their members. So there’s one which was just ARITA members and then one which was just accountants, and I think the Institute sent it to all their members but the CPAs had a specific small business accountant group and they said it just to them and I ended up with just under 500 responses, which in context of the number of members of those bodies is a really small response rate and that’s a weakness but it’s still 500 responses that we didn’t have before, so I think there’s still some value in it. So one of the things that was revealing from that, was that there was a reasonable degree of understanding of what voluntary administration was. That there was a level of experience with it, in terms of most of the people who responded, of course it’s a self-selecting sample, so if you knew nothing about administration then you probably wouldn’t know, but the majority of people who responded said they had at least some experience with it, that they knew some insolvency practitioners, that they understood what the legal tests for solvency and insolvency was. Most of them viewed it as being, again, a flexible regime, it was useful in some cases but the overwhelming comment that I got from that was, that they thought it was too expensive. So some of them thought that you know, it was a bit too procedural, there were too many things that had to be done and again, that theme of; but a lot of the businesses that go off and talk to an insolvency practitioner are already in pretty bad shape. So there’s a reluctance on business owners to pick up the phone and call an insolvency practitioner until really they have no other choice but by that stage then, it’s mostly just a liquidation. So the view with those small business accountants was, yeah it’s very flexible, you can get some good outcomes, you can get a better return than what you might get by just putting it straight into liquidation but in their experience most of the matters that they had engaged with, ended up in liquidation anyway.
DT:

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The purpose of your study is to determine how well the voluntary administration regime is working. I suppose there are two ways, or at least two ways to assess that, one is by the extent to which it achieves business rescue and the other is, by the extent to which it achieves results for creditors that are preferable to the result they would otherwise achieve in a liquidation. It sounds like on either analysis, from your survey of small business accountants, from the feedback received from creditors, particularly unsecured creditors, from the feedback you received from practitioners, that the impediment to improving either of those measures of success is really the cost of the regime.
JH:Yep. With the exception of the practitioners that I spoke to who do mostly very large restructuring matters, didn’t believe that it was too expensive..
DT:… Because the costs are proportionate to that scale of the matter?
JH:

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That’s right. So, those who are working on the Arriums and the Channel 10s, didn’t think that it was necessarily too expensive and thought the checks and balances and transparency and reporting and creditor meetings were all entirely appropriate given how significant those matters were. It was more the practitioners who were working with the smaller end who almost uniformly thought that it was too expensive, but then there’s kind of questions of how do we make it cheaper? So that’s why I’m interested in a kind of modified debtor in possession if the external administration model is what’s driving a lot of the costs, because there’s so many things we ask administrators to do, then I can see that’s one way we could address the cost. But that comes with trade-offs, because we have what I’m calling a Rolls Royce system, anything less than that means less transparency, less accountability to creditors and the potential that there will be some matters where dodgy people are doing dodgy things. Now my perspective is, I don’t think we should be using insolvency law to deal with those problems. I think we should be using general corporate law, criminal law, workplace law to try and deal with those problems. I think insolvency law should be about providing the best outcome for creditors that we can, in the most officious and effective way that we can do that, I think fundamentally it is about an economic question of how best can we use this quickly diminishing pool of resources, rather than, how do we use this process to reveal who’s been breaking the law. I think that’s something that ASIC should be doing in its criminal capacity rather than getting insolvency practitioners as cops on the beat. So I’m totally fine with saying, okay we’re going to reduce transparency, so that we can be more efficient, so we can lower the costs. Let’s introduce maybe a modified pre-pack regime where creditors, at least those creditors who are still in the money which as we know in almost all cases is secured creditors and not unsecured creditors, they’re going to get a benefit out of this, but there are a lot of people that won’t get a benefit out of this. And I think that’s where there’s a lot of tension in the debate because we are, from my perspective anyway, unjustifiably clinging to the view that there is still value for unsecured creditors and I just don’t think there is, except to the extent that we’ve got very large repeat player unsecured creditors in the form of the Fed programme and the ATO, and maybe some major leasing companies or, you know really major suppliers. But the general trade suppliers who are unsecured creditors, they’re going to get nothing out of this. So from my perspective, why are we designing all this law, all these procedures and all this cost with a view to giving them something that they probably don’t want, that they don’t actually seem to be using and it gives them no economic value. I just think that’s really a wasteful process. So yeah, that’s my perspective but as we were saying before about law reform and the Safe Harbour, a lot of this is driven by the ‘we can’t let the dodgy phoenix operators get more of a foothold’, well I think we just need to do a better job in law enforcement, 

TIP: Jason mentioned dodgy phoenix operators – so let’s dive into phoenix activity a little deeper. Illegal phoenix activity, also known as phoenixing, is where a new company or other entity is created to continue the business of a company that has been deliberately liquidated to avoid paying its debts. The directors of a phoenixed business will transfer the assets of the business out of its existing structure into a new structure, usually paying under value or no value at all. Once the assets have been transferred, the old company is placed in liquidation and when the liquidator is appointed, there are no assets to liquidate for the benefit of creditors. Illegal phoenix activity is a crime and can be punished not only by fines but by jail time and it’s an enforcement priority for both ASIC and the ATO.

You know, the stuff that they’re doing is already illegal and if they’re still doing it, then we’re failing to properly police that, and I don’t think insolvency practitioners should be cops on the beat.

DT:

 

 

Well if it is already illegal and it is those illegitimate business rescues, or those phoenixing activities are still happening, then it’s clearly an issue with how we detect and police those breaches of the law and it’s clear that putting that responsibility on insolvency practitioners is not an efficacious way of doing that.
JH:

 

 

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At least to the extent that we’re not properly funding them. Looking through the reports that insolvency practitioners give to ASIC, noting all the potential offences that have been committed, particularly around books and records and breaches of director’s duties, the vast, vast majority of those are going on unenforced because ASIC doesn’t do anything. And I suspect ASIC knows that it can’t do anything about this because it doesn’t have enough resources to deal with that. Even just thinking about that insolvent trading point right, so we’ve got 10 to 15,000 companies going under every year. Sure, some of those would be sole director companies, but many of them would have at least two directors. So, we could have 10s of thousands of contraventions of the insolvent trading prohibition, including criminal contraventions, happening every single year and nothing is done about it.
DT:Wow.
JH:

 

 

 

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So where is ASIC in all of this? When was the last time ASIC was running cases? Ok yeah, it’s run a big criminal case against the Kleenmaid directors. It had a few civil cases 15 to 20 years ago but ASIC has basically vacated this space because from ASIC’s perspective, insolvency practitioners are the gatekeepers now, so it’s their job to be doing this. So we end up in this kind of worst of both worlds situation, where ASIC says, well we can’t do anything because insolvency practitioners don’t give us enough information and the insolvency practitioners say, we can’t give you any more information because there’s no money, so we can’t go and find the right information because the cupboard was bare when we got here. So the serious bad guys, who know exactly how this system works, just strip the company bare knowing full well that unless the Fed gets involved, or unless the ATO funds it, of which I’ve heard is also fairly rare in court, because there won’t be any information.
DT:I was just about to ask you about ATO funding, whether any of your interviews had revealed the extent to which that’s a realistic prospect, but it sounds like they’ve revealed that it is fairly rare, that’s certainly been my experience.
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1:05:00

Yeah so I didn’t have anyone who said they thought that the ATO would be willing to fund major actions. As a few people said at best, the ATO just plays a neutral map. So, if there are other creditors who want to put forward a proposal, they won’t necessarily vote against it to support funding. The ATO was really interesting. So getting people’s perspectives on the ATO and one of the questions I asked, depending on who I was interviewing, was you know, ‘what’s been your experience with the ATO as a creditor?’, and some people were of the view that the ATO was really helpful, and again the kind of very small business end of the market, they would say the ATO is how I get paid, so that was helpful in that regard. At the larger end of the market, practitioners were complaining about the ATO being very uncommercial and how the ATO’s own enforcement policy meant that it just would not support certain types of Deeds of Company Arrangement, regardless of whether there was commercial merit in it, so that was a bit of an issue. I myself wonder whether again, if we should be focusing insolvency law on the creditors who have an actual stake in the game. The ATO, I think could be a really helpful resource in insolvency because it’s a repeat player, it’s often an unsecured creditor in every matter, and it’s not necessarily minded only about maximising its own return. The ATO should be also thinking about policy concerns and should be properly funding liquidator actions and administrator actions against dodgy phoenix operators. It should be doing that stuff, it’s an arm of the government. So, I mean one of the interesting comments I had was from someone who was a director’s advisor, who said you know, when you’re trying to do a deal with the ATO and if it’s large enough that you actually get to talk to a person, because a lot of these days it’s all automated anyway, if it’s big enough that you actually get to talk to a person, you know they said their practise was, if you put a deal to them and they’re being uncommercial, just hang up the phone and then call back a couple of hours later because if you get a different ATO officer, you might get the result. You know, which is bad…
DT:Yeah it doesn’t do a lot for the principal approach.
JH:But it reflects this idea that they can be, at least from the number of practitioners that I spoke to, some of them said that the ATO can be quite uncommercial depending on who it is that you’re dealing with.
DT:I’ve certainly heard, as a matter of personal experience, and I’ve heard this refrain from a few different people, and so much it must be something that shared, that this idea that you as an individual taxpayers should be thanking us that we don’t compromise on tax debts because this is your money, but of course there are other interests at play.
JH:

 

1:06:00

 

 

 

 

 

 

1:07:00

And of course, there’s the criticism of the ATO in some of its previous practises, I don’t think it’s doing quite the same thing anymore, about entering into payment arrangements. So you know, I was at a conference number of years ago where one of the senior people at the ATO was talking about payment arrangements and some of the trends, and they talked about a particular matter where someone had gotten 18 payment arrangements, and you know, this person was being quite sheepish about how did we give him 18 payment arrangements?! But we see again, in the small business space, I think it’s really interesting and the social interests and the political interest of overlay in this area. We saw with the Four Corner’s programme a few years ago about the ATO’s debt recovery practises and small business and we saw the fuss that Kate Carnell, the small business commissioner kicked up about the ATO. It was very interesting that, you know, one of the matters she took on was a business that was generating $100 million a year, which I thought was not really a small business but anyway, but you know, this idea that the ATO is putting businesses under, well if you are not paying your tax, you’re getting a competitive advantage against your competitors who are paying the tax. So you know, it’s a tricky one but…
DT:…incentivise a non-payment of tax…
JH:

 

 

 

 

 

1:08:00

Yeah you know and the idea that well, if you get into financial difficulty, just stop paying your BAS and stop paying your employees super and like, you know that has to change but again, I don’t see that necessarily as an insolvency issue. I think that’s a tax compliance issue. We should be dealing with that separately and really, we should be doing things to encourage business to face up to their problems much earlier on. Now where insolvency law has helped with that, again more at the larger end of the market, is I did have some comments from legal advisers who said that they felt Safe Harbour was useful because it allowed them to speak to boards about restructuring earlier than they otherwise might have been. So, one lawyer who was working at a very large law firm mentioned to me that you know, they’re working in the insolvency and restructuring team and they had found it difficult to talk to boards about potential insolvency and restructuring because some boards just took the view you know, we’re not insolvent, we don’t want to know, we don’t want to bring insolvency practitioners…
DT:We don’t want to say the word because it might later come up…
JH:

 

Yeah, whereas Safe Harbour allowed them to have a discussion with that board, that was really just about kind of you know, business planning, forward planning, general restructuring corporate advisory, so they were able to go in with their corporate partner and talk about general corporate structuring issues, without it being about insolvent trading. So that in their view, it was useful because it was getting some boards to think about these issues well in advance.
DT:

 

1:09:00

 

 

 

 

 

 

1:10:00

Yeah that’s certainly been the experience we’ve had as well, that you have the ability to talk to a board and give them the opportunity to say, well right now and even six months in the future, we’re rock solid. But let’s talk about the financial situation nine months from now, or 12 months from now, that’s the period in which we’re concerned and kind of crystallise that as a concern about the future without having to have a discussion about uncertain solvency in the present. That’s definitely been a benefit of the regime. I’ve really enjoyed speaking to you about all of these topics. It’s a fascinating area, I think and particularly when you recognise the questions of social utility and how this regime should be working for Australian businesses and the Australian economy. There’s probably little that practitioners and lawyers can do about the shortcomings of the voluntary administration regime today, but if there was something that our listeners could be doing in their insolvency work, if they are perhaps advising voluntary administrator or directors who are considering voluntary administration, to make the process work the best way it can for them, what would your advice to them be?
JH:More pre-planning.
DT:More pre-planning?
JH:

 

 

 

 

1:11:00

 

 

 

 

 

 

1:12:00

 

 

 

 

 

 

1:13:00

 

 

Yeah, so if we look at some of the recent, and they tend to be larger matters that we might say are successful, it does seem that we’ve got this common element of more pre-planning, so I mean I’m really interested in law reform, and I think looking at how we regulate the pre-appointment side of things, in terms of assessing independence, how can we try and minimise disruption, maximise the potential for a good outcome, typically by way of a sale, I think we need to be looking more at the pre-appointment stuff, and just personally, I think we need to be a bit more commercial about independence requirements. The idea that we’ve got very experienced practitioners, who are heavily regulated, who are fiduciaries, who are officers of the Court and have a whole range of potential personal and professional liabilities, the idea that they couldn’t possibly advise the company before being appointed as administrator, I just think we need to be questioning that if what we are trying to get is the best outcome, that the idea that an administrator can just come in on day one, completely fresh, have no idea about the business and then conduct an orderly restructuring process, it just doesn’t seem to happen all that often. So that’s an area where I think we could see some improvement. On the more practical side I guess would be, thinking about reporting obligations and just trying to build a bit more flexibility into the system. I’m not sure that the insolvency law reformat changes from 2016/2017 really help here, in terms of just requiring more and more information to be given to creditors and particularly, individual creditors who might have an axe to grind, and require reports and documents and things from insolvency practitioners, but the idea that you just give your 439A report to the creditors, and it’s 100 plus pages, you know 30 odd pages of that are remuneration disclosures and time sheets, I just don’t think that’s helpful. Now it was refreshing talking to a lot of practitioners who said that they don’t tend to do that anymore, and I have seen examples of reports to creditors that are maybe 15 or 20 pages, but I think that we could be looking at providing information to creditors in a more flexible way, particularly using technology. So rather than just sending out these huge reports, whether it’s a paper based report or a large PDF, but trying to report to creditors in a way that is actually useful for them, rather than thinking about it as a compliance obligation, like I have to disclose all these things, so I’ll just put that in, make sure I meet the ARITA code recommendations for the report, do the templates, with this idea – a bit like we see with company prospectuses. The kind of ticket box, everything including the kitchen sink goes in because, at least that way you won’t get sued. I think we need to rethink what it is we’re trying to achieve when engaging with creditors and providing them information in a more digestible way, perhaps using technology. So as one person I interviewed recommended for example, why couldn’t we just have everything online and the creditors log in and then we have something like a chatbot that comes up and asks them a series of questions and that kind of directs them to the parts of the report that might be most relevant for them? That’s a practical thing I think we could do but then as a number of IPs said to me when I was suggesting this, they said yeah that sounds great, who’s going to pay for it?
DT:Yeah well it doesn’t sound like ASIC is going to pay for it!

Jason, thanks so much for joining us on Hearsay!

JH:It’s been my pleasure, I’ve really enjoyed the chat.
DT:

1:14:00

 

 

 

 

 

1:15:00

You’ve been listening to Hearsay The Legal Podcast. I’d like to thank our guest Professor Jason Harris for coming on the show. Now if you liked this episode about the voluntary administration regime, why not try out our episode about court appointment liquidations of solvent companies with Jason Porter, Vince Pirina and Andy McEvoy. Or for something different, listen to my interview with Nicola Martin from McCabe Curwood about current issues in employment law like the gig economy and working from home. 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 this episode constitutes an activity in the substantive law field. If you’ve claimed 5 CPD points or more for audio content already this CPD year, you may need to access our multimedia content to claim further points from listening to our podcast. Visit htlp.com.au for more information on claiming and tracking your points on the Hearsay platform. The Hearsay team is Tim Edmeades who mixes our sound, Kirti Kumar who researches all of our educational content, Araceli Robledo who manages all our marketing and me David Turner your host. Hearsay wouldn’t be possible without Nicola Cosgrove and Chris Cruickshank, co-founders of Assured Legal Solutions, making complex simple. You can find all of our episodes as well as summary papers, transcripts, quizzes and more at htlp.com.au. That’s HTLP for Hearsay The Legal Podcast.com.au. Thanks for listening