the 2015 productivity commission report on business set-up ... › ... ›...

1 Michael Murray, Visiting Fellow, Commercial and Property Law Research Centre, QUT

The 2015 Productivity Commission Report on Business Set-up, Transfer and Closure, 2015: should insolvency reform have

expected more?

Corporate Law Teachers Association Conference, UNSW,

1 February 2016

Michael Murray, QUTi

This paper reviews the 2015 Productivity Commission Report, explains its approach and recommendations and comments on its quality. The lack of data on insolvency and how it operates, at least in corporate insolvency, makes it difficult to objectively agree or disagree with the PC 2015. In any event, while the Report purports to state insolvency law principles and aims, it does so inadequately, making its recommendations and analysis more suspect. The paper nevertheless attempts some rationale for the PC 2015, drawing on health policy

concepts. In the end, a road map for insolvency reform, and some drafting guidance, is offered. The PC 2015 offers something, but insolvency reform should expect more. To start with, the answer is “yes”, the Productivity Commission could have offered much more about the needs of the insolvency regime, in particular given its broad legal, economic and social

focus. And this is so even in the constraints of the terms of its reference, to examine insolvency in terms of the large picture of business set up, and possible failure.

Six points

For the purpose of this presentation, I have these six headings, the final being what insolvency does need by way of examination and reform.

1. What the 2015 Productivity Commission Report (PC 2015) is, what it recommended, and what the government has so far agreed.

2. Lack of data, such that agreeing with or disagreeing with PC 2015 is difficult. 3. What are the current aims of insolvency and issues needing to be addressed? 4. The PC 2015 proposals in more detail 5. A bad heart analogy 6. A road map for insolvency reform, with some drafting requirements.

1. What PC 2015 is, what it recommended, and its status

The current government focus in 2016 is on encouraging some entrepreneurial spirit in what seems to be a tired and anxious business community.

The socio-economic focused Productivity Commission was given the task, to look at the full spectrum of a business, from its start-up, to its end - the insolvent ending. The inclusion of insolvency is based on its relevance to the motivations of a person in going into a new business, and the necessary assessment of risk that that should entail.


National Innovation and Science Agenda

The government released PC 2015 on 7 December 2015, at the same time that it released its grand plan for the future – the National Innovation and Science Agenda. Apart from many proposed initiatives – in technology, tertiary research, business incentives – it included a focus on three areas of insolvency reform found in the PC 2015 report – safe harbour protection for directors, limitations on the rights under ipso facto clauses, and reduction of the period of bankruptcy to one year.

The government is now commencing discussions to implement those changes. It is yet [as at 1 February 2016] to announce its view on the other recommendations of the PC.

What PC 2015 broadly recommended

The Commission said that some specific reforms to Australia’s corporate insolvency regime are warranted:

formal company restructuring through voluntary administration should only be available when a company is capable of being a “viable” business in the future.

a “safe harbour” defence should be introduced to allow directors of a solvent company to explore, within guidelines, restructuring options without liability for insolvent trading.

a simplified liquidation process should be introduced to reduce the time and expense of winding up SME businesses with few or no recoverable assets.

all directors should be required to obtain a director identification number.

And in personal Insolvency

bankruptcy should be reduced to one year. But the obligation to repay debts should continue for 3 years.

Current position

This is therefore the current insolvency law reform status, liable to change any day or week. In addition, not covered here, the Insolvency Law Reform Bill 2015, is due to be debated, and perhaps passed, in the federal parliamentary sittings beginning in 2016. It would commence operation some time in 2017.

Current status of PC 2015

PC 2015 proposals Decision to proceed announced in the National Innovation and Science Agenda, or a decision is awaited?

Safe harbour yes

Ipso facto yes

Streamlined SME awaited

Public interest administration fund awaited

Pre-positioned sales awaited

Voluntary administration limited to solvent companies awaited


One month for a company to show it viability awaited

One month to show viability awaited

Scheme of arrangement moratorium awaited

Receiver’s duty to unsecured creditors awaited

Review of the Fair Entitlements Guarantee (FEG) awaited

Director identity number awaited

ASIC regulatory guide on the changes awaited

One-year bankruptcy yes

Bankruptcy contribution s to continue after bankruptcy awaited

Some of these are explained in more detail at attachment A to this paper.

2. Lack of data

My overall concern is that we don’t know much about how our corporate insolvency regime operates or what it produces because we don’t have sufficient current data to make an informed assessment.

The idea of the Commission examining the regime, at least from its more economic focused perspective, was therefore encouraging.

But even with its expertise it has not substantiated its recommendations, by way of core information that is available, but is not fully extracted.

Prior data and reports

A. Business Failure and Change: An Australian Perspective 2000

The PC 2015 paid little regard to this earlier Commission report in 2000, which not only provided data, but which gave a good economic analysis of the merits of debtor focused and creditor focused regimes, and principles which might guide the future direction of insolvency reform. That 2000 Commission report was, and remains, a good basis for any examination of the insolvency regime.

It gives the last clear set of core data on insolvency system that is available. It uses this to draw various conclusions.

As the 2000 Commission paper says, some of its key findings are contrary to common perceptions. For example:

It is widely thought that most new businesses will die in the first few years of their operation. In fact, most survive for a considerable time - around two-thirds of businesses are still operating after five years. Most businesses that cease operations are not 'failures'- they are solvent businesses closing for other reasons.

Only around 2 per cent of businesses cease operations each year because the owners, while solvent, are unable to secure a sufficient return.


And less than 0.5 per cent of businesses cease operations each year due to insolvency - down significantly from the rate applying in the early 1990s.

“Common misperceptions about the level of business failure and the chances of survival may lead some entrepreneurs to overestimate the risk of failure, reducing their willingness to

commence new businesses”.

But as the report says,

“unfortunately, empirical evidence about the comparative effectiveness of the Australian system is lacking”.

It discusses the two competing options

Creditors first

The 2000 Productivity Commission Report says that the underlying rationale of Australian insolvency to place creditors’ interests first and foremost has several consequences. A benefit is that, if a business can be saved, the focus on creditors’ rights encourages a relatively speedy reorganisation. Strict timetables are applied to the administration and debt agreement processes, with the result that struggling businesses are not kept in limbo for lengthy periods. Resources are quickly rearranged within the business or redeployed elsewhere.

“The categorisation of the Australian insolvency code as ‘creditor-oriented’ may come as a surprise to some, as there appear to be perceptions in the community that the current

insolvency law allows debtors to escape too lightly. Indeed, addressing community concern is the principal argument put forward to justify foreshadowed legislation in Australia to

toughen bankruptcy laws …”.

This perception is relevant today and is a factor in these reforms being able to proceed.

But there are concerns with a creditor driven process,

“the fact that creditors are in control of the insolvency process means they will tend to exercise the option that maximises their return — even if there may be broader adverse

economic and social consequences. And by favouring creditors, the insolvency law places the interests of other stakeholders — such as employees of affected businesses — in a

vulnerable position. It also tends to overlook the potentially specialised human capital of the debtor/owner”.

A further concern is that

“a creditor-oriented system may reduce the value of the business by encouraging premature liquidation to the disadvantage of unsecured creditors such as employees, sub-contractors and other trade creditors. For example, secured creditors may choose to liquidate, even if a

business is worth more as a going concern to all creditors, with a positive present value”.

One conclusion its makes is important, and possibly remains relevant today, that

“while current legislation provides opportunities for insolvent businesses to survive as going concerns, it is not designed for this purpose — it is designed primarily to serve the best

interests of creditors”.

Some research does suggest that the ultimate positive outcome of a restructuring, of the business resuming operations and perhaps developing further, is not common.


Debtors first

A broad alternative to a creditor-oriented regime is one that is debtor-oriented. This approach to assisting businesses to avoid insolvency is principally underscored by the rationale that the business in question may have the potential to earn long-run profits under either its existing owner/managers or under a new team.

The 2000 Commission report says that by favouring business owners and debtors, a debtor-oriented scheme can provide businesses with greater opportunities to restructure their operations and their relations with creditors. The reorganisation procedures associated with such schemes are designed to give businesses a considerable amount of time to recover from more permanent debt problems”.

It examines US Chapter 11 and finds that the consequences of its debtor focus are not satisfactory.

That of course is an assessment made some years ago, as are the 2000 Report’s comments on the Australian regime. Nevertheless, many of its comments appear to remain relevant today.

The 2000 Commission Report makes no recommendations but does wisely say that

“An insolvency regime cannot fully protect the interests of all parties and its prime intent is to create incentives for prudence among business owners and for a willingness for creditors to

provide funds”.

B. Some twenty to thirty other government reports on insolvency reform

During the last 15 years there have been upwards of 30 government reports where the reform of corporate insolvency has been central or it has been an aspect of larger issues – on penalties, the construction industry, shareholder rights, insolvent trading, banking, tax, phoenix companies, prudential regulation, banking, insurance companies, and more.

Two or three, only, have received government attention or even response. Current inquiries are beginning to recommend recommendations in earlier inquiries – the director identity number (DIN) now has several endorsements; regulation of the insolvency profession continues to recur, less so of directors and management.1

Many of these inquiries ask for data, which is not available. This is despite numerous recommendations to government over the year to address this. That is not to say that these reports are not worthwhile, but their recommendations could be better substantiated.2

1 “Progress” on Insolvency Law Reform, CCH Law Chat, 27 July 2015, Michael Murray. See also Insolvency reform: The ugly duckling and the swan, David Kerr, RSM, 18 January 2016.

2 The 2014 Senate Committee Report into the Performance of ASIC asked academics what data was needed, a submission was made, but no reference to or recommendation was made to this issue in its final report. That Senate Committee continues to ask for data and information in its later insolvency references.


C. A personal insolvency data comparison

As an aside, while many worthy academics have extracted some useful corporate insolvency figures and trends, and ASIC is doing more, we should see and compare what is available in personal insolvency, in relation to each type of Bankruptcy Act administration, based on factors such as the debtor’s age, trade or profession, gender, and location, and showing the respective assets, liabilities, costs and dividend outcomes. It is obviously useful to know that debt agreements produce twice the dividend return than bankruptcies.

Type of personal insolvency data available from AFSA

Numbers of bankruptcies, location, age gender, cause

Total assets, total receipts, nature of assets

Cost of sale – trustee remuneration, expenses, government charges

Litigation costs

Recoveries by income contributions vs recoveries by voidable transactions

Dividends, including priority dividends

Total liabilities discharged

Number of objections to discharge

In summary, this core data, and more, is available: debts – assets – costs – dividends = x

As well,

“AFSA will give favourable consideration to requests from organisations that are undertaking not for profit research into areas that build knowledge and

understanding about the effectiveness of the personal insolvency and personal property security regimes”.

The PC 2015 may have come to some correct conclusions, but we should have expected more by way of explanation and substantiation.

It does, helpfully, but obviously, say:

“The existence of quality data would assist regulators and policy makers in identifying changes and trends in business set-up, transfer and closure as well as the performance of

the current regulatory and legislative arrangements”.

The PC 2005 could have recommended that attention be given to the collection, analysis and dissemination of more statistics. This would be in line with the government’s focus on technology and the freeing up of information held by government.

3. Current purposes and aims of, and major issues in, insolvency

While the real question is “is there a problem?” let us assume for the moment that there is one, or that there is much room for improvement. What is it, and what needs to be done?

The “problem” would be a case of insolvency not meeting the purposes it is meant to address. These various purposes include:


Purpose of insolvency Does the current law meet this?

Protecting the debtor Yes

Allowing a fresh start Yes

Gathering in and selling off the assets, so they may be used more profitably; or resurrecting the business

Problematic as to retained value

Saving the core business, to a greater or lesser extent Problematic as to long term outcomes

Paying creditors their share of those proceeds. Limited

Consistent with and accepting of other legal principles Yes, largely

The regime allowing the upholding and enforcing of insolvency law Limited

Doing so at an experienced and independent standard. High, perhaps too high

The law being modern and efficient Limited

The law being clear Limited in many areas

With the costs of the regime clearly delineated? No

And those costs commensurate with the level of attention expected by the law.

Difficult to assess

With delineation between government and professional roles being satisfactory and clear

Limited

Comprehensive, in attending to all insolvent entities, given the harm it is said they inflict.3

No

The PC 2015 reform proposals, thus far, address these to only a limited extent, and avoid or ignore others. Any final assessment of the PC 2015 recommendations awaits the government’s full announcement of its views on them and its acceptance or otherwise of the 2015 PC Report.

4. More detail on the PC recommendations

Principles adopted

Some principles offered by the PC 2015 are that the insolvency regime should:

operate so as to not create incentives for self-serving strategic behaviour by business owners/directors or creditors, or a creditor race to the recovery of assets;

reduce the extent to which physical and environmental assets of a failing business are left to deteriorate prior to sale;

3 This table is being developed further


result in lower transaction costs and higher returns overall through a coordinated approach; and

engender confidence in the system for business owners, employees and creditors.

These statements are satisfactory, if not fully applied in the PC recommendations. But the PC 2015 then proceeds to make this blithe statement, that

“The Commission heard that, overall, Australia’s insolvency regime is operating well. However, there are:

flaws in restructuring processes due to risk aversion and negative perceptions;

long timeframes for corporate liquidations, and (at times)

disproportionately onerous reporting and appeal processes suggest that some reform is necessary”.

In any event, the recommendations in more detail are at attachment A to this paper.

5. A bad heart analogy

If there were one problem or issue to be resolved or dealt with, it is the fact that attention is given to looming or actual insolvency of a business far too late, by which time, the body is dead or it has only a faint pulse.

Drawing some analogy with health, it is not that unusual a human response to try to look on the bright side, to downplay the negative indicators of a health concern because it is probably nothing, it will go away, I can live with it for a while to see how it goes, I don’t have the time or money to see a doctor, or I am afraid of what I might be told.

Health messages respond by starkly showing the consequences of delay, and at the same time putting out positive messages of what can be achieved by a more attentive lifestyle. But some illnesses happen only in the distant future, say for a teenager, and the message can be hard to make real; so other approaches have to be taken.

How is this related to the PC 2015 Report?

One startling recommendation is that unless a company is solvent, it cannot seek the protection and assistance of the voluntary administration (VA) regime.

To the extent there is a reason behind this, it might be influenced by the fact that many VAs end up, or have ended up, in liquidation, with little pulse at the end. Whether one could say that if a VA had been appointed at an earlier point in time, there would have been something worthwhile to salvage, is unknown.

Many companies should fail.

Perhaps the PC view is that the purpose of insolvency is to quickly and efficiently dispose of the body and unless it can show some signs of life, out it goes; possibly with some last minute ability to finally attend to its difficulties.

The view of the PC might also express some frustration that companies fail because the directors focus too much on their own skill base – but not enough on the finances of the company; or if they do, they approach the developing illness as they would in relation to their own health. Another unhappy reality is that directors, or managers, of businesses do not have sufficient financial and strategic knowledge to run a business in a demanding competitive environment.


Is the insolvency regime being seen as too severe and unapproachable?

On the appointment of a VA by a director, the director immediately loses control of their company, and contact with their staff and customers. An independent and largely unknown administrator is called upon to pore over the company records, review the directors’ conduct and refer any offences committed by them to the regulators.

Such an appointment might be approached with some hesitation, in the same way that a person might feel apprehensive about going to a doctor about their failing condition whom the person knows will want to admit them to hospital.

And while the law may need adjusting, the insolvency profession itself might need to do the same, just as doctors and dentists and even the ATO have all worked to create a new persona from the strict one of the past.

Partly that might involve a change of culture and perception of what the insolvency, or some better term, is about. Doctors handle death, but ultimate demise is not at the forefront of their marketing image.

It would obviously involve a change in the law, and some concept of debtor in possession might assist. Rather than directors being confronted by the prospect of a what is involved in voluntary administration at present, a more collegiate approach, allowing the director to stay in charge or at least be involved, might assist; in the same way that that treatment as an outpatient might be less confronting to our sick patient, rather than hospital.

This is at least one way of interpreting some of these PC recommendations.

The particular PC 2015 recommendations, described in these terms.

So, re-stating the PC’s reasoning, insolvency is properly an aspect of any “start-up” inquiry, and this has sound academic support. An ‘entrepreneur’ entering business will, while being interested or excited by their new venture, at the same time have an underlying unease about the consequences of failure. By ameliorating those consequences, the entrepreneur is more ready to venture their money, and ideas.

With that in mind, the Commission has proposed to improve the process of that possible exit by giving the entrepreneur some incentive to properly monitor their business for signs of decline, which if left unattended, will require them to face up to their dramatic failure.

The PC 2015 proposes this by way of denying the entrepreneur access to voluntary administration if their company is already insolvent; or, put positively, to offer the incentive of assistance and protection only to those entrepreneurial directors who act and seek advice promptly.

While the Productivity Commission gives the standard jingoist rejection of any ideas from the US, its idea is more based on the encouragement to directors to act early, which the more accommodating US ‘debtor in possession’ model offers.

This would be further supported by those entrepreneurial directors having ‘safe harbour’ protection while they endeavour to forestall their (borderline solvent) company’s decline, its brilliant ideas notwithstanding.

And even if our entrepreneur’s business does fail and liquidation follows, the Commission recommends a quick simplified liquidation process to churn their company through. This would properly involve a process to save the brilliant idea for further development, under an older and wiser business approach, for the future.


The final bonus offered our entrepreneur is that, if having given personal guarantees such that personal bankruptcy is inevitable, their ”time-out” will only last one year and not three, and the restrictions on them may be limited in any event.

How viable all this is, and how sound the reasoning, and whether we should have expected more from the Commission, and indeed whether that’s all insolvency reform can expect, is open for discussion.

In my view, insolvency law reform should have expected more but the limited forum for its review by the PC, valid as it was, did not allow that. Even in terms of what the Commission could and did examine, we should have expected more.

6. A road map for reform

Insolvency reform has suffered over the years by reactive attention depending on the issues of the day, which, if implemented, often make bad law and policy; or, if the issue fades, so too do the reform ideas generated. CAMAC’s review of the management of long term tort liabilities in insolvency arising from the James Hardy case is but one example of inaction; the misconduct of Stuart Ariff is one of over-reaction.

My road map for reform is this:

I. The gathering of proper data on insolvency. That is, the collection of all existing data, and at the same time, implementation of a process, under AFSA, of the gathering of statistics in corporate insolvency comparable to those offered in the personal insolvency statistics. AFSA should become the Collector of Insolvency Statistics (CIS).

II. Clean up the law. Both Chapter 5 of the Corporations Act and all of the Bankruptcy Act could be readily streamlined already - culled, refined and modernised - without any or only minimal change to the fundamentals. We need to get rid of the clutter - does bankruptcy really need to deal with tenancies in tail? Or retain concepts that the Harmer Report described, in 1988, as “fictitious, artificial and abstract … rarely understood”? Should corporate insolvency have two parallel regimes for liquidators, court appointed and voluntary?

III. If we must, keep the separate laws of personal insolvency and corporate insolvency separate, but aligned. This will require close attention to the operation and administration of the implementation of the Insolvency Law Reform Act 2016 and its rules.

IV. Rethink and then restate the principles of insolvency, in light of our 21st century world, and decide which should be discarded, reformed, or added. And as to discarding, we should decide on parameters for what businesses should simply be allowed to fail without much ado. We should also decide as a threshold, what is expected of the insolvency regime and its practitioners, courts and regulators; and of government.

V. Convene a task force comprising lawyer/s, economist/accountant/s, IT specialist/s, and drafter/s. They should read the 30 reports from the last 15 years, including PC 2015, and present us with draft Bills. There is little need for any further consultation before that; it has all occurred


Drafting

Three approaches, at least, should be adopt in drafting the Bills.

i. The law should be principles based, without the black letter approach of the 2016 Act.

ii. The law should allow flexible criteria to be stated in the regulations. These criteria might need to be adjusted as economic circumstances change, including as revealed by CIS data; there are comparable approaches in all regulations.

iii. An advisory board should be established to oversight the regulations. iv. The drafting of the Bills should implement processes based on IT advice that allows

ready collection of data along the way, as well as on-line communications with creditors and responses by them, accurate calculations of entitlements and dividends, with full regulator access.

v. The Bills should legislatively require an ongoing review and consultation process be established, based on CIS and other data, to allow such point in time or on-going assessment as is feasible based on trends in insolvency from the CIS data.

The PC 2015 might not have taken insolvency reform to another level, but with some enterprise and innovation, others can still do so.

**************


Attachment A

The PC 2015 recommendations in more detail are these.

Safe harbour rec 14.2 There should be a safe harbour defence to insolvent trading, only available when:

directors of a company have made, and documented, a conscious decision to appoint a registered safe harbour adviser with a view to constructing a plan to turn around the company

the adviser was presented with proper books and records, and can certify that the company was solvent at the time of appointment

the adviser is registered with at least 5 years’ experience as an insolvency and turnaround practitioner

directors are able to demonstrate that they took all reasonable steps to pursue restructuring

the advice must be proximate to a specific circumstance of financial difficulty, and subject to general anti-avoidance provisions to prevent repeated use of safe harbour within a short period.

The defence would operate for a period covering all actions within it

If the adviser forms the opinion that restructuring is not possible, they are to terminate the safe harbour period and advise the directors that a formal insolvency process should commence.

Pre-positioned or pre-packed sales - rec 14.3 Where:

no related parties are involved, they are presumed valid unless sold for under s 420A market value, or if it would unduly impinge on the performance of the administrators’ duties.

sales are to related parties, there is no presumption and the administrator may review the sale under existing voidable transaction provisions.

information of the sale should be disclosed to creditors.

Where the sale is the result of advice received under the safe harbour defence, that defence should also apply against voidable transactions actions.4

Ipso facto clauses – rec 14.5

Should be made unenforceable in VA and schemes of arrangement.

Rights to go to court for both parties

Moratorium for schemes – rec 14.6 A moratorium on creditor enforcement actions during the formation of schemes of arrangement.

4 This is Australia’s more cautious approach to the pre-packaged administrations that exist in England. See ‘Pre-pack administrations”, Briefing paper, House of Commons Library, L Conway, January 2016


SME liquidations – rec 15.1 A simplified ‘small liquidation’ process:

only available for companies with liabilities to unrelated parties of less than $250 000.

directors should be required to lodge a petition to ASIC and verify that their books and records are accurate.

The liquidator would need only ascertain the financial position, and requirements for meetings, reporting and investigations are to be reduced accordingly.

preference recoveries should be limited to 3 months and “material amounts”;

creditors could opt out and into a standard creditors’ voluntary liquidation; and ASIC also.

A panel of liquidators, overseen by ASIC.

Liquidator remuneration – rec 15.2 where a liquidator is unable to cover their remuneration, and where ASIC “is satisfied that the activities are not excessive”, the liquidator should be able to apply for the balance of their fees through ASIC, from a re-named Public Interest Administration Fund – EDITH - funded by increasing the annual review fee for company renewals.

Receivers – rec 15.3, 15.4 The government should instigate an independent review, to report by 30 June 2017, of the law and practices of receivers, with a view to ensuring that:

the primary role of the receiver should be to protect the value of the secured property;

if there is a substantial group of unsecured creditors affected by the receivership, the receiver should consider his or her impact upon the overall wellbeing or insolvency of the company.

A committee of inspection should have the right to basic information regarding the receivership process, the proposed sale process, its results, and costs and disbursements.

Receivers should be compelled to have regard to the views of the committee but considerations directly relating to protecting the value of the security should override any views of the committee.

The committee should have standing under s 425 of the Act to apply to the Court to seek relief in relation to the fees (but not actions) of the receiver.

Other PC 2015 corporate insolvency proposals These include

A Fair Entitlements Guarantee (FEG) review;

A Director Identity Number (DIN); and, in the end

A new Regulatory Guide (RG) - “following the implementation of these reforms, ASIC should produce a Regulatory Guide targeted at small businesses facing financial difficulty”.

Personal insolvency – rec 12.1 Where no offence has occurred, a bankrupt is automatically discharged after one year.


the trustee, and the courts, should retain the power to extend the time until the bankrupt is discharged for a period of up to eight years if there are concerns regarding the bankrupt’s conduct.

the government should work with other governments and professional bodies to ensure that any regulations or other arrangements restricting the employment of bankrupts beyond the period of bankruptcy are justified according to specific and efficient policy objectives.

The obligation of bankrupts to make excess income contributions to the trustee should remain for three years and this can be extended.

This is similar to the English regime, with its one-year bankruptcy having been adopted in 2002.

i Michael Murray, LLB, Dib Crim, FAAL, Visiting Fellow, Commercial and Property Law Research Centre, QUT. [email protected]; m 0402 248 353; to whom any inquiries can be made.
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