RSM Australia

Insolvency Reform Edition 10 - April 2017

A plethora of issues

A great deal has occurred since our last Insolvency reform newsletter.

View the past edition -
[Insolvency Reform Edition 9 - February 2017] here

  • Release of third and final report of the project, Phoenix Activity: Regulating Fraudulent Use of the Corporate Form (“Phoenix Project”) undertaken by staff at Melbourne Law School and Monash Business School. 
  • ASICs release of the revised user pays.
  • Amerind Pty Ltd (receivers and managers appointed) (in liq) [2017] VSC 127 (“Amerind”).
  • Treasury’s release of the exposure draft to implement the safe harbour proposal and addressing ipso facto clauses.

Phoenix problems

The Phoenix Project has released its third and final report “Phoenix Activity: Recommendations on detection, disruption and enforcement”. The report contains 32 recommendations to detect, disrupt and punish and deter harmful phoenix activity.

The problem of harmful phoenix activity is a continuing problem made worse by the proliferation of the pre insolvency advice market. The report contains a number of historical estimates of the extent of phoenix activity. The scale of the problem is enormous. Estimates range from 2,000 to 3,000, up to 6,000 companies per year. The cost of illegal phoenix activity was estimated at between $1billion and $2.4 billion a year by the ATO in 2009. A report prepared by a major professional services firm for the Fair Work Ombudsmen in 2012 estimated the cost to be $1.78 billion to $3.19 billion per annum.

Reports on the problems associated with harmful phoenix activity have been produced regularly by various Parliamentary inquiries, Government bodies, inquiries, professional associations and academic institutions for over 20 years. Considered proposals and recommendations to address the problems have been given lip service and largely ignored by consecutive governments of all political persuasions.

The cost of harmful phoenix activity is borne by competitors of those engaging in the activity. Phoenix activity distorts the market and places businesses not engaging in those activities at risk of failure. This leads to far broader ramifications in society through the failure of otherwise viable businesses. The direct loss of government revenue and bad debts for businesses who deal with phoenix companies is just a fraction of the impact of this form of commercial immorality.

One of the recommendations contained in the report calls for the Government to expressly target professional and other pre-insolvency advisers who facilitate this activity. This is now in stark contrast to the new safe harbour proposal discussed below at “The Trojan horse”.

We consider it is time for the Government to act to curb this activity.  

Treasury and user pays

ASIC have worked with the ideologues at Treasury following public consultation on the ASIC industry funding model for registered liquidators. A revised levy methodology has been proposed.

The revised proposal provides for a lower fixed levy of $2500 per year and graduated levy based on each registered liquidator’s share of new and existing appointments and notifiable events. Notifiable events include notices published on ASIC’S Published Notices Website and certain lodgements with ASIC. ASIC estimate each administration and notifiable event will attract a levy of approximately $110.

A spokesman for ARITA described the revised proposal as “putting more lipstick on the same pig”. The revised proposal fails to address the concerns of registered liquidators. Registered liquidators are being asked to pay to administer impecunious administrations and undertake the regulatory reporting activities associated with each administration.

We are not aware of any other profession who must pay to undertake pro bono activities. We fail to understand why Treasury are unable to accept an asset realisations charge and/or interest charge as is implemented by AFSA on bankrupt estates as an appropriate method of cost recovery.

Australia’s 900 registered liquidators and ARITA do not have the lobbying strength to resist these proposals.  The fallout from user pays, the ILRA, the safe harbour proposal and The Commonwealth Department of Employment (“DOE”) review of the fate of the proceeds of circulating and non-circulating assets is likely to have a detrimental impact on restructuring and insolvency professionals.  

The problem of trusts

You may recall this issue was the subject of our Insolvency Reform edition 4 in February 2016. We called on the legislature to implement the recommendations of the Australian Law Report Commission’ s General Insolvency Inquiry in regard to trading trusts.

The recent decision of the Supreme Court of Victoria in Amerind may focus the Government’s attention to these long called for reforms. Nothing like lost revenue to focus the mind of the Government. The DOE, the department responsible for the conduct of the Fair Entitlements Guarantee Scheme, paid out the claims of employees. The DOE was denied the priority they anticipated for their claim as a result of the conduct of the business via a trading trust with a corporate trustee.

The Court apparently without opposition accepted the application of the principles contained in the Waters v Widdows [1984] VR 503 in approving the allocation of the receiver’s costs, expenses and remuneration across the circulating and non-circulating assets pools.

The Trojan horse

The much anticipated safe harbour proposal has reached exposure draft status. We discussed the government’s proposals paper in Insolvency reform edition 7 in May 2016. The Government has chosen to proceed with a variation of “Model B – The carve out”.

A director will not be liable for insolvent trading in regard to a debt if after suspecting the company is, or may become insolvent, the director starts to take a course of action reasonably likely to lead to a better outcome for the company and its creditors.

The person seeking to rely on the defence will bear the onus of the proof. The test a person must satisfy is a reasonable standard.

One of the tests proposed to establish whether a course of action is reasonably likely to lead to a better outcome for the company and its creditors is seeking advice from an appropriately ‘qualified entity’ who has been given sufficient information to give appropriate advice. What is a qualified entity?

It would appear that a deliberate decision has been made to open up those who may provide the advisory function for directors seeking the protection of the safe harbour. There would appear to be no guidelines for the qualifications and experience of those who will be allowed to assist and advise company directors.

Those insolvency and restructuring professionals who have been licking their lips in anticipation of these changes may now find themselves in a completely unregulated market place. Competition may now come from nonbank financial institutions, management consultants, solicitors and large accounting practices to name just a few.

Further, in the small to medium sized business sector the lack of defined qualifications and experience for a qualified entity may give oxygen to the pre-insolvency advisers who have been the subject of a concerted campaign by ASIC. See our commentary above regarding “Phoenix problems” and the call for active efforts to pursue professional advisers and pre-insolvency advisers.

This is why from the perspective of restructuring and insolvency professionals this proposal may prove to be a Trojan horse. Instead of providing opportunities for restructuring and insolvency professionals to assist in genuine efforts to restructure companies in an environment that protects and encourages pro-active steps, it may provide the opportunity for unscrupulous operators to further erode confidence in the restructuring market.

Ipso facto & formal restructuring

The exposure draft dealing with safe harbours also proposes changes to restrict the enforcement of ipso facto clauses during voluntary administration (“VA”) and schemes of arrangement (“Schemes”). These changes are welcome and may assist in preserving value in restructuring efforts undertaken utilising a VA or Scheme.

The elephant in the room is what will be the fate of the VA regime. Its use has declined since the initiation of creditors voluntary liquidations have been simplified. The safe harbour provisions provide protection to directors to informally restructure however no changes have been proposed to address the personal liability of administrators (we previously discussed these issues in Insolvency reform edition 7 in May 2016)  who seek to undertake a formal restructuring utilising the VA provisions. What incentive is there for insolvency and restructuring professionals to implement creative restructuring options through the VA process?

Those who attended INSOL 2017 would be aware that Singapore have implemented amendments to their laws relating to Schemes of Arrangement adopting some elements of Chapter 11 in an effort to make Singapore a preferred venue in Asia for formal restructuring.
 

If you have any questions in relation to this article, please contact your local RSM adviser or David Kerr.


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