A Platform for Recovery 2014 – ARITA’s Law Reform discussion paper is damn good

Somewhat belatedly, I thought I would make some comments on a paper issued by ARITA  (the peak professional body for Insolvency Practitioners) called A Platform for Recovery 2014: Dealing with Corporate Financial Distress in Australia: A Discussion paper.  It’s very good.  You’d be aware that there is constant talk of further regulation needed in the world of insolvency.  I am regularly dismayed that most of the discussion in the mainstream media focuses on regulating Liquidators (the piano players in my view) rather than on the actual issues of insolvency laws and how they might be improved.  Well, ARITA has raised seven real world problems and proposed seven real world solutions.  Most refreshingly, it considers the perspectives of not only the big end of town (about 1% of actual insolvencies) but also the SME sector, which is the other 99% of insolvencies.   

You can obtain a copy of the Discussions Paper from the ARITA website. Let me summarise for you the main issues and the suggested solutions

Issue 1: Lack of a Restructuring culture in Australia

Solution: Safe Harbour provisions

The basic problem is that Insolvent Trading Laws do not have the desired effect.  At the big end of town, directors know when their company is in some difficulty and they obtain good legal advice.  They then face the problem that if they have insolvency concerns, which they clearly do, then the only logical thing to do is put the company into Voluntary Administration – push the emergency button too early.  Conversely at the SME end of town, directors are already “all-in” with their company and so insolvent trading laws don’t matter – hence they push the emergency button too late.  In both cases, pursuing logical restructuring options is not appealing.  Hence, ARITA suggests “safe harbour” laws which essentially provide a “good faith” defence to actions against directors.

Issue 2: Value Destruction as a result of entering external Administration

Solution: Informal Restructuring, combined with the “Safe Harbour” provisions

This one is for large enterprises, that will often have a bundle of Bank, bond and other creditors.  The prospect of Voluntary Administration just doesn’t work well in that situation.  Most large restructurings are done behind the scenes – so back to problem number one.  Everyone is better off with an Informal Restructuring deal but the directors run a significant risk if they do so, but fail.  So again, Safe Harbour defences would assist greatly.

Issue 3: No “Chapter 11” style regime to aid in the rehabilitation of large enterprises

Solution: Rework Schemes

The US style Chapter 11 has developed a somewhat mythical crown.  It ain’t that good but the grass does seem greener at times.  ARITA is of the view that combining the above two issues with some tweaks to Schemes of Arrangement and Voluntary Administrations should do the trick.

Issue 4: Critical supplier contracts automatically terminate on VA inhibiting restructuring

Solution: Extension of moratorium period to ipso facto clauses

At present, there is some restriction, but not a lot, on key contracts being cancelled as a result of the appointment of a VA.  Crucially, there is nothing to stop a key supplier simply cancelling a contract due to the default provisions surrounding the appointment of a VA.  ARITA is suggesting that the law be amended so that key suppliers can not use those cancellation provisions to cease supply.  That would apply for at least the period of the VA.  Bear in mind that in a Voluntary Administration the Administrator is personally liable for goods and services provided so the Administrator has a strong incentive to only seek supplies that can be paid for!

Issue 5: Maximising the chance of saving a viable but small company

Solution: Micro Restructuring

Love this one.  The simple fact is that VAs are too expensive for a small company.  The proposal is for a mini-VA if debts are under $250,00.  It could be quicker and with fewer built in controls so that costs are minimised.  Bring it on I say.

Issue 6: Maximising returns to creditors where companies with minimal creditors fail

Solution: Streamlined Liquidation

Again, love it.  The proposal is that where liabilities are under $250,000 then the liquidation is streamlined by eliminating the need for Creditors Meetings, reducing the Proof of Debt hoops and setting fixed fees for the liquidator (which I note Dissolve already does!).

Issue 7: Enabling better returns for creditors via sale of business prior to appointment

Solution: Pre-postioning or “pre-pack

It is regularly the case in SMEs that the only logical buyer of a business in distress is the existing directors or management.  At present it is not possible to arrange a “pre-pack” sale – being a deal agreed before the appointment of the VA and consummated just after the VA is appointed.  That process reduces costs and the damage done to the business as a result of the VA.  Essentially the business is sold on Day 3 or 4 of the VA.  I like it.  Yes, there are a bundle of safeguards that must be built around pre-packs but they are an excellent idea.

So, some really good ideas in there.  As someone at the coal face I can see significant benefits from the last three in particular.  I suspect that Regulators and the media may see too many ghosts in them but we’ll wait and see.