Insolvency Reform Edition 14 | Independence: The sky is not falling

This article of Insolvency Reform discusses the recent Network Ten decision and its implications on independence requirements for insolvency practitioners. 

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The published judgment in the Network Ten case[i] demonstrates the Courts do not intend to create a free for all for safe harbour navigators to sail into the role of external administrator of the company they were assisting skirt the shoals of bankruptcy[ii].

The issue considered

The Judge identified the principal issue in the case as the terms upon which administrators appointed pursuant to Part 5.3A may continue to act, when in their prior capacity as potential administrators they have had a recent, long term, remunerative involvement with the company or companies to which they are appointed.

Safe harbour navigator & administrator?

The evolution of the turnaround culture and rise of pre-packs in the UK is discussed by the Judge. A number of publications that highlight the perceived conflicts of interest that arise in some pre-packs with the pre-insolvency adviser becoming the appointee in the external administration are considered.

The Court’s decision makes it clear a potential administrator may only perform limited tasks. They may not be involved in concluding an agreement in advance of a formal insolvency administration. The work performed and advice given by a potential administrator varies from that allowable in overseas jurisdictions.

The potential administrators in the Network Ten case did not provide advice to the Board, the directors or the management, or to any of its creditors or other stakeholders, in relation to the management of the group, its affairs, its insolvency or the obligations and duties of the board, individual directors and management.

The Court concluded a potential administrator may take steps to prepare an administration contingency plan for an administration if it were to occur. The importance of clearly drafted retainer and a proper record of tasks performed by the potential administrator are highlighted by the decision. The potential administrator can talk about what the administration will involve but must ensure they remain outside the inner sanctum of decision making.

A reasonable apprehension of bias?

ASIC identified three grounds that the pre-appointment work performed might be considered to give rise to an apprehension of bias.

1. Sheer volume of work performed prior to the appointment by the potential administrator
2. The referral relationship between the law firm who appointed and paid the potential administrator and possibility the potential administrator may be required to investigate the law firm upon being appointed as administrator or liquidator;
3. The possibility the potential administrator may be required to investigate payments made to him by the law firm upon being appointed as administrator or liquidator.

In regard to the first ground, it was agreed that subject to relevant safeguards being put in place to guard against the appearance of any conflict of interest, significant, long term paid work undertaken for the purposes of planning and preparing for a prospective administration should not of itself give rise to a reasonable apprehension of bias.

It was ultimately determined that a fair minded lay observer might reasonably apprehend the administrators might not bring an impartial mind to the resolution of ASIC’s second and third grounds. It was decided that the two potential conflicts of interest did not warrant the removal of the administrators. The Court’s earlier appointment of an independent registered liquidator with the consent of all parties quarantined the issues associated with these potential conflicts.

The independent registered liquidator was empowered to prepare a limited report for inclusion with the administrators’ s439A report on potential recoveries for creditors arising from:

• the conduct of the directors, officers and advisors prior to the appointment of the administrations, and
•  payments received by the potential administrators firm for pre-appointment work.

The Court made two other material findings in regard to the issue of a reasonable apprehension of bias:

• a fair-minded observer is not restricted to a fair-minded creditor; and
• voluntary disclosures do not cure an apprehension of bias.

ARITA code

The ARITA Code of Professional Practice was mentioned favourably by the Court as its utility to practitioners in determining whether in accepting an appointment they are and are seen to be independent. However, the Court found that questions relating to the appearance of impartiality must be determined according to law. Further, it was not the Court’s function to apply or interpret the code.

What now?

The Court has upheld the requirement that an administrator be both independent and be seen to be independent. A limited exemption for paid pre-appointment activities by a potential administrator has been articulated. The exemption is limited and may be considered sensible as we move into a world with a safe harbour.

It would appear legislative change will be necessary for a safe harbour navigator to be permitted to take the wheel during a formal administration to effect a restructuring plan.

To avail oneself of the exemption the potential administrator must be able to provide evidence of the scope of the engagement in the retainer and document the activities performed whilst in the safe harbour. The potential administrator cannot be the navigator in the safe harbour. Safeguards are essential to ensure the activities performed do not expose the potential administrator to the existence or appearance of a conflict. Planning and preparing for a prospective administration is allowable, notwithstanding the time period of involvement or the fees received. 

ARITA in revising their code may wish to consider documenting a further exception to the 2 year prohibition on provision of services before an appointment to reflect the Court’s decision.

Pre-packs for Australia?

The Association of Independent Insolvency Practitioners (“AIIP”) with Mr Richard Fisher AM, a co-author of the Australian Law Reform Commission’s 1988 General Insolvency Inquiry Final Report (“Harmer Report”), are promoting a pre-insolvency discussion paper that proposes adapting overseas experience with pre-packs to the Australian environment. The proposal provides for a pre-pack approved liquidator to monitor the process but leave the work in the hands of the company’s directors. A good contribution to the current debate worthy of consideration.

The UK have created a Pre Pack Pool www.prepackpool.co.uk/home in response the Graham Report on pre-pack administrations.