Key Points
Importance of insolvency reform: The current round of insolvency reform will simplify proceedings and provide creditors with a greater oversight role.
Future issues: Sons of Gwalia, long-tail liabilities and cross-border insolvency.
Future benefits: As a result of the current reform package, creditors will have greater incentives to monitor insolvency proceedings, insolvency practitioners will be more accountable to creditors, and (in turn) costs and delay should be reduced. Looking forward, there is continuing debate about who should be treated as a creditor.
Thank you, Richard [Fawcett, Partner, Blake Dawson Waldron] for your very kind introduction.
I’m delighted to be here this morning and would like to thank the Banking and Financial Services Law Association for the important role you play in informing discussion about legal issues relevant to the banking community, including insolvency law.
Today, I have been asked to speak about the insolvency reform package that has been before Parliament.
I think this package will result in a number of changes to the role of creditors in insolvency. I would like to draw out some of the themes underlying the bill and some of the practical changes we may see after its implementation.
Before I delve into the details of the reform package, I would like to outline some of the general context in which the Government approaches this important policy area.
The Government is committed to improving the efficiency of the economy, in order to improve living standards and promote the general wellbeing of all Australians.
To that end, the Government has pursued a number of initiatives. We have delivered Budget surpluses in nine of the past ten years… established a Future Fund… eliminated net debt, and net interest payments have fallen around $8.8 billion since 1996‑97… cut tax… reformed superannuation… and created a more efficient and workable industrial relations environment.
These achievements were not the result of a complacent approach to the task of economic reform. They required strength of commitment and an absolute determination to do what was right for the country. To do the things that needed to be done. And we continue to work today with that same degree of commitment and dedication.
Under the stewardship of this government, the Australian economy is performing well.
The Australian economy is now in its longest recorded period of expansion. Australian GDP is over a trillion dollars, nearly 50 per cent bigger than it was in 1996 and real incomes are higher than ever before.
Unemployment is at near historical lows, opening up new opportunities for many Australians. Many commentators suggest we are approaching full employment.
But we cannot afford to be complacent. Looking forward, the Australian economy faces a number of challenges.
One challenge is our ageing population. It is not a situation that is unique to Australia. Many other developed nations also face this challenge. Nevertheless, the ageing population represents a significant economic dilemma for Australia over both the medium and long term.
Earlier this year, the Treasurer released the second Intergenerational Report. The report looks 40 years into the future, and provides a long-term view of the Australian economy. The report reveals that an increasing proportion of our population will be in the older age cohorts. And this will result in slower economic growth.
There are other challenges that loom large. They include climate change and water. Of course, the water issue looms very large here in South Australia, where the Murray-Darling Basin forms one of the most productive agricultural regions.
In light of these challenges, we are working with business to identify reforms that can further improve the economy.
And, in an economy with close to full employment, productivity is a clear priority for Government action. One way to improve productivity is to reduce red tape and enhance the quality of market regulation.
I characterise market regulation as part of the nation’s “soft economic infrastructure”. Just as roads and railways are critical infrastructure for product markets, a sound insolvency regime is essential for the credit market. Without this kind of infrastructure in place, a modern economy would be severely hampered.
Corporate insolvency laws are an important part of our economic infrastructure. They are important because they have the capacity to improve the availability of capital and its allocation across the economy.
Of course, it is an inescapable reality that businesses will fail from time to time, despite the best efforts of those involved. Sound insolvency laws promote the efficient redistribution of the assets of these businesses, allowing those assets to be put to the most productive use.
They also facilitate the provision of finance for business start-ups and restructures and they allow credit providers to conduct an assessment of credit risk.
In short, sound insolvency laws are central to creating certainty in the market and promoting economic stability and growth.
This economic focus drives many of the measures in the current round of insolvency reform, which is being implemented through the Corporations Amendment (Insolvency) Bill 2007.
As many of you would be aware, I introduced the Bill into the House of Representatives in May this year.
As the Bill is so important to the broader economic framework I am pleased to inform you that the Bill passed through Parliament yesterday so we have achieved the first substantive reforms to insolvency laws in fifteen years.
One of the key themes of the reform package is providing creditors with greater oversight of insolvency processes.
This reflects the views expressed by stakeholders on how the insolvency proceedings can be streamlined – in terms of how quickly the procedures can be resolved and their overall efficiency.
The consensus was that a more efficient management of the process could be achieved by placing less reliance on intervention and oversight by courts and regulatory authorities. Instead, this responsibility should shift toward creditors.
There are very good reasons for doing this.
Creditors have a direct economic interest in the conduct of insolvency proceedings. Ultimately, it is they who are in the best position to determine whether a course of action is most likely to be in their interest.
The reform package seeks to maintain and promote the integrity of insolvency proceedings, while also allowing creditors greater scope to influence the course of the proceedings.
As with many areas of market regulation, it is important that insolvency law strikes the right balance between promoting integrity… and allowing market participants to act efficiently.
The reforms draw on the insights provided by the Australian Government’s Taskforce on Reducing Regulatory Burdens on Business, better known as the Banks’ Taskforce.
The Taskforce noted that governments are often attracted to interventionist regulatory solutions as a tangible demonstration of government concern. The costs to government for such intervention are typically “off-budget” and difficult to measure.
The cumulative impact of a swathe of Federal, State and local government regulation for business and individuals imposes significant direct costs. It also diverts management from their core business activities.
As I have said many times before, the damaging impact of over-regulation on competition must not be underestimated. Not to mention the significant costs it imposes on business.
Providing creditors with a greater role in determining the course of insolvency proceedings will achieve a number of important goals.
It will remove unnecessary regulatory interventions.
It will reduce compliance costs.
And, to those with the greatest economic interest in proceedings, it will deliver more scope to protect their own interests.
For creditors, the reforms will also improve the predictability of insolvency proceedings and provide a clearer recognition of their rights.
Of course, it is important that these reforms do not come at a cost. Specifically, it would be counter-productive for the reforms to cause the independence of insolvency practitioners to be surrendered.
To prevent this, the reform package includes a range of measures to improve practitioner regulation and oversight.
Current reforms – Corporations Amendment (Insolvency) Bill 2007
The current legislative proposals provide some practical examples of how this has been achieved …
The new Insolvency Bill is, quite simply, the product of the most comprehensive review of insolvency law since the Harmer Report in 1988.
The review benefited from a number of reports into the insolvency framework.
Of particular assistance were the reports by the Corporations and Markets Advisory Committee (CAMAC) and the Parliamentary Joint Committee on Corporations and Financial Services.
To a large extent, the recommendations of these reports reflected the consensus view emerging from the business community. And that consensus was that reform was needed to reflect the evolution in markets over the last two decades.
The measures in the new Insolvency Bill were then drafted in consultation with the Insolvency Law Advisory Group, which is a team of practitioners, legal advisers and academics.
The Bill continues the work that the Government began with its response to the report of the Banks’ Taskforce and the Simpler Regulatory System Act.
So today I would now like to outline some of the main aspects of the Bill . . . the treatment of employee entitlements… practitioner independence… practitioner fees… measures to deter misconduct… and finally the new pooling regime.
Employee entitlements
One of the most important issues the Bill deals with is the protection of employee entitlements.
Insolvency law has always sought to protect employee entitlements where an employer becomes insolvent — and this is exactly as it should be. Currently, the law provides a level of priority to employee entitlements that is higher than unsecured creditors generally.
The Government is very serious about protecting the rights of employees.
Early in its term, the Government recognised the reality that an employer's insolvency is likely to have a greater impact on employees as a group than on any other group of creditors. We believe there are a number of reasons for this.
First, wages are likely to be the only source of income for employees, while other creditors may have access to other sources of income…
Second, employees are involuntary creditors.
And third, when negotiating the terms of their employment, employees are rarely able to seek provision for protection against employer insolvency.
The Government has, from time to time, put forward options to grant employees an even greater priority in insolvency proceedings.
In its 2004 report, the Parliamentary Joint Committee on Corporations and Financial Services recommended against what is known as the “maximum priority” proposal. In short, that proposal would have required that, on the winding up of a company, the payment of certain employee entitlements be made out of the company’s secured assets.
As a consequence, the Government decided not to proceed with the maximum priority proposal.
This decision reflects a view that protecting the rights of secured creditors in insolvency proceedings will improve commercial certainty and facilitate the provision of credit. Clear rules for the ranking of priorities are important to provide predictability for lenders and to allow for the management of risks.
Alternative mechanisms have therefore been developed to improve the protection of employee entitlements.
A key factor the Parliamentary Committee took into account when making the recommendation not to proceed with the maximum priority proposal was the success of the General Employee Entitlements and Redundancy Scheme — better known as GEERS. This important initiative was introduced by the Government.
Since the Government introduced employee entitlements assistance in January 2000, nearly 68,000 Australian workers have received more than $770 million in assistance for the entitlements they lost due to the insolvency of their employer.
The first Federal employee entitlement safety net scheme, the Employee Entitlements Support Scheme (EESS), was implemented in 2000. The scheme applied to employees who were terminated due to insolvency between 1 January 2000 and 11 September 2001. The General Employment Entitlements and Redundancy Scheme (GEERS) replaced it in September 2001.
The safety net scheme was designed so that Federal and state governments would share the costs of the scheme. However, regrettably the States have declined to support these schemes in any way.
GEERS is funded solely by the Federal Government and covers unpaid legal entitlements to wages, accrued annual leave, long service leave, payment in lieu of notice, and up to eight weeks redundancy for eligible employees.
As part of the insolvency package, the Government allocated an additional $62 million over four years to enhance the range of entitlements under GEERS.
The Bill also includes measures to prevent the priority of employee entitlements being downgraded in deeds of company arrangement without the agreement of employees.
The Bill provides that an administrator will be able to propose a Deed of Company Arrangement that does not observe the priority only if they first secure the agreement of a majority — assessed by number and value — of affected creditors at a meeting of eligible employee creditors.
Creditors as a whole would then vote on whether the deed should be executed at the major meeting of creditors in a voluntary administration — otherwise known as a section 439A meeting.
The Bill also clarifies the status and priority of the Superannuation Guarantee Charge in external administrations.
So, in the area of employee entitlements, we see three themes emerging…
First, social objectives like the protection of employees are being promoted through mechanisms such as Government funding rather than by altering the priorities in insolvency. In other words, priorities should generally be based on commercial bargains struck prior to the insolvency.
Second, proposals to alter the rights of creditors should be subject to the agreement of affected creditors, rather than simply leaving this to insolvency practitioners.
And third, insolvency processes are clarified and streamlined where possible to reduce costs and improve returns to creditors.
Practitioner independence
The next area of the Bill is the section relating to practitioner independence.
This is one of the key issues that creditors raised during the consultation phase.
There is a concern that the current framework may allow for directors to appoint so-called “friendly” administrators. These “friendly” administrators may have a reputation for not examining the conduct of directors too closely in the lead up to the corporate failure.
The response to this concern, consistent with other reforms in the Bill, has been to provide creditors with better information and more power to manage external administration processes.
The Bill will require administrators to provide creditors with a statement disclosing any “relevant relationships” prior to the first meeting. This will allow creditors to prevent the appointment by directors of a “friendly” administrator in the first place.
In addition, creditors will be granted the power to appoint a new person as liquidator if the company proceeds to liquidation after an administration or deed of administration ceases.
This will allow creditors to appoint a new practitioner to investigate the conduct of the previous directors and administrator, if, for example, concerns have emerged about independence.
Of course, this may be quite costly for creditors, as any new administrator will take time to familiarise herself or himself with the business. However, on balance, the Government considers that if creditors believe the cost is warranted, they should have the legal right to put this change into effect.
So, the reforms in the area of practitioner independence provide a good example of one of the key themes of the Bill - that integrity concerns should be addressed where possible by providing creditors with improved information.
And, more importantly, creditors will have the power to act on that information.
Insolvency practitioner fees
The next issue relates to insolvency practitioner fees.
This is probably the second most important issue that has been raised with me in consultations with creditors.
The cost of external administrations is a significant consideration for creditors.
The Bill addresses this concern by requiring practitioners to provide additional information about the basis of their fees when seeking agreement from creditors.
This information should enable the approving party to assess whether the proposed fees are reasonable.
The Government will also introduce reforms to address practical obstacles which make it difficult for insolvency practitioners to obtain approval from creditors in relation to their fees.
Among other things, these reforms will…
clarify that a deed administrator’s remuneration must be fixed in a separate resolution. In other words, a vote in favour of a deed should not automatically be taken as approval of remuneration…
and allow creditors, including a committee of creditors, or the court increased flexibility to approve remuneration.
- These reforms provide another good example of the approach I outlined earlier. That is, addressing integrity concerns by providing creditors with improved information and the power to act on that information.
- Insolvency processes are also being clarified and streamlined, where possible, to reduce costs and improve returns to creditors.
Deterring corporate misconduct
As I mentioned earlier, the reforms in the Bill are designed to strike the right balance between promoting the integrity of the insolvency regime, and allowing market participants greater scope to act in an efficient manner.
For example, concerns are frequently raised about systemic integrity. In some areas, these concerns cannot be addressed by providing creditors with more information or stronger rights. So the Bill includes a number of reforms to improve the powers of the ASIC.
In relation to insolvency practitioners, the Bill extend ASIC’s investigative powers in monitoring registered liquidators and improving the processes of the Companies Auditors and Liquidators Disciplinary Board. It also updates and improves the registration process for insolvency practitioners.
In relation to corporate misconduct, the Bill restores the longstanding position that privilege against exposure to a penalty does not apply in proceedings where ASIC is seeking disqualification or banning orders and no other penalty.
Banning and disqualification orders, and orders to cancel or suspend a licence under the Corporations Act, are powerful tools for deterring phoenix companies.
The reforms in the Bill will complement the $23 million assetless administration fund that the Government has already implemented to combat phoenix company activity.
The assetless administration fund will finance preliminary investigations by expert liquidators of companies, selected by ASIC, that have been left insolvent with little or no assets.
As at 30 June 2007, the fund had resulted in the disqualification of 46 directors for a total of 154 years with another 53 potential bannings in progress.
In these cases, it is appropriate and necessary that ASIC take on a stronger oversight role. The Government has provided ASIC with the powers and funding it needs to carry out this work.
Pooling of companies
The next area, albeit briefly, is the area of pooling.
The separate legal entity principle would ordinarily require that creditor claims be satisfied out of the assets of the company that each creditor had a contract with.
However, in order to facilitate the efficient administration or liquidation of a group of companies, the Bill allows assets held by all members of an insolvent corporate group to be used to satisfy the debts owed by each member of the group.
Pooling will reduce administrative costs, increasing the returns for creditors as a whole. For example, there will be scope to conduct meetings as a pooled group.
Pooling will be particularly useful in situations where the assets and liabilities of a group have been entwined and are difficult to separate out.
In a voluntary pooling, the winding-up of a group of companies may only be the subject of a pooling determination if supported by 50 per cent of members by number and 75 per cent by value. However, creditors always have the option of taking the issue to court if they are materially disadvantaged by a pooling determination.
In practice, this means that insolvency practitioners will need to design pooling determinations in such a way that all creditors benefit from any reduced administration costs or other benefits.
The Bill also will empower a court to determine, by order, that a group of companies is a pooled group for the purposes of the Corporations Act.
A court may make such an order if it is satisfied that it is just and equitable to do so. But it will not have the power to make an order if this would materially disadvantage a creditor and that creditor does not agree.
Again, this approach recognises the primary importance of having the priorities in insolvency cases reflect commercial bargains, rather than social or other concerns.
So, if we look at the pooling proposals we see, again, three familiar themes…
First, priorities should generally be based on commercial bargains struck prior to the insolvency.
Secondly, proposals to alter the rights of creditors should be subject to the agreement of affected creditors. This is far preferable to simply leaving these decisions to insolvency practitioners.
And, third, insolvency processes should be clarified and streamlined where possible to reduce costs and improve returns to creditors.
Future reforms – Corporations Amendment (Insolvency) Bill 2007
There is much more in the Bill that I could talk about. However, at this point I would like to stop and turn to look briefly at some of the policy issues on the horizon.
Sons of Gwalia
The first issue — and one which I am sure many of you are interested in — is the Sons of Gwalia decision.
This decision reinterpreted a longstanding provision of the law. The decision made it easier for shareholders to recover funds in circumstances where they acquired shares as a result of misleading conduct before the company became insolvent.
It is worthwhile pointing out that the approach to shareholder claims varies across jurisdictions. For example, the United States and United Kingdom take very different positions on this issue.
I should also point out that this decision does not affect all companies or all shareholders.
Only those shareholders induced to buy shares as a result of misleading statements would be treated as unsecured creditors. And each shareholder would face a considerable burden of evidence in establishing that they relied on that statement in making the decision to buy shares.
Where it does apply, the “Sons of Gwalia” decision transfers risk from shareholders to creditors. This raises an initial question about which party is best able to manage the risk of misleading statements that have been made by a company prior to insolvency.
Commentators have made a number of additional points in relation to the commercial impact of this decision. One point of view has been that it may have a positive impact on standards of commercial conduct, as more attention is paid to disclosure practices by companies and creditors.
Other commentators say that the decision will increase the complexity of insolvency proceedings, and in some cases lead to increased costs and delays.
I have asked CAMAC to look into the practical consequences of this decision, and whether law reform is required to change or clarify the law in this area. I understand CAMAC will be issuing a discussion paper in a few weeks, with a final report due later this financial year.
A key issue for the Government is how any reform will assist productivity. As always, considerations of equity and complexity are also very important. A range of alternative arguments have been put to me on this issue, and they will be considered in light of the CAMAC report.
Long-tail liability
The second policy issue on the horizon in this area is the protection of personal injury claimants.
The James Hardie Inquiry found that the current external administration mechanisms do not give adequate recognition to the existence of long-tail liabilities arising in the case of unascertained future creditors.
These claimants may include people who have suffered injury through exposure to products, where the injury does not manifest itself until after the time of the external administration.
Due to the uncertain nature of personal injury claims, reform in this area needs to balance competing policy objectives.
On one hand, equity considerations suggest there is a need to provide some protection for personal injury claimants where there is a long latency period for an injury.
On the other, it is recognised that in the normal course of business, companies will have little information about the likelihood or magnitude of all future claims that may arise from their conduct.
If all companies were required to make provisions for these types of future claims, it would introduce significant uncertainty.
The Government has developed an initial proposal for reform in this area, including a requirement for some insolvency proceedings to put funds aside for future claimants.
Again, CAMAC is examining this issue. As many of you would be aware, it has recently issued a comprehensive discussion paper on the topic. I would invite all of you to consider that paper and provide input to the CAMAC process.
I believe there are a number of issues arising out of the Sons of Gwalia and long-tail liability issues that need to be very carefully thought through.
For example, both reforms seek to expand the types of person treated as a creditor for insolvency proceedings.
The practical effect of bringing new stakeholders into insolvency proceedings is that the rights of conventional unsecured creditors may be adversely affected.
Another issue common to both reviews is whether external administrations would be made more complex by having to take into account additional categories of claims and, if so, how those complexities could be mitigated.
I think it’s fair to say that balancing these competing equity and complexity considerations will be no easy matter.
Cross-border insolvency
The next issue is the proposal to adopt the UNCITRAL model law on cross-border insolvency.
A discussion paper was issued in 2002 as the eighth phase of the CLERP reforms.
For a small, capital-importing economy like Australia, it is important that foreign investors are confident that their interests in domestic insolvency proceedings will be protected.
The model law has now been adopted by many of our major trading partners, including the United Kingdom, the United States and Japan.
Treasury is currently working on draft legislation in this area. I expect that this will be finalised in the near future.
APEC insolvency initiative
Speaking of international engagement, the Government has also been working with other economies to promote improved insolvency regimes.
A key initiative is the establishment of a Regional Network on Asian Insolvency Reform under the APEC Finance Ministers' process. This work complements the Forum on Asian Insolvency Reform — otherwise known as FAIR — coordinated by the OECD.
The regional network will provide a strengthened, ongoing platform to share information about reforms,
capacity-building and technical assistance initiatives for insolvency systems and related matters in the Asian region.
The network will produce a regular update on current developments in insolvency reform throughout the Asian region. The update will be distributed to members electronically.
It will provide members with regular information on current reform proposals and other developments in insolvency reform around the region. Therefore, it would be of value to those engaged in, or contemplating, comparable measures. The core of the network will be APEC officials, although it will also be open to officials from non‑member countries.
Australia's development aid agency AusAID has agreed to provide initial financial support for the project. Work on setting it up has already started and a launch is scheduled for later this year.
Conclusion
This morning, I have tried to provide an overview of some of the key measures in the Government’s current insolvency reform package, and the policy themes underlying those reforms.
I have also touched on some of the key elements of the future reform agenda in the area of corporate insolvency.
I would now like to draw all of this together.
The current reform package is designed to improve the efficiency and integrity of the insolvency framework.
First, it seeks to improve returns to creditors by promoting the principle that the law should be clarified and streamlined to reduce costs and improve certainty.
Secondly, it seeks to provide certainty for creditors — and, through it, the provision of credit — by promoting the principle that priorities should generally be based on commercial bargains struck prior to the insolvency, and that creditor priorities should not be varied without the agreement of affected creditors.
Third, the package is designed to address concerns about integrity by providing creditors with improved information and the power to use that information to influence insolvency proceedings.
And, finally, where this approach would not be effective, the reforms are designed to improve integrity by providing ASIC with strengthened powers and additional funding.
The Government firmly believes that these are the four fundamental design features of any effective and well-targeted insolvency law reforms in Australia.
On the other hand, I fear some members of the Labor Party will fail to appreciate the importance of these reforms and the need to balance any reforms in this area with maintaining market integrity.
In June this year, one of the ALP Shadows in effect accused me of taking a “Mickey Mouse” approach to some of the more balanced regulatory reforms to corporate and financial services law that the Parliament has seen.
Reforms do not need to be revolutionary to improve commercial certainty.
Reforms do not need to be radical to reduce costs.
Reforms need not be earth-shattering to improve integrity.
What is important is that these reforms are delivered.
I strongly believe that the cumulative impact of this reform package will be to provide an insolvency framework that is more certain… that is faster… that is cheaper… and which has an even higher degree of integrity than the current framework.
And that is the kind of reform that matters.
There is potential for these reforms to be accompanied by reforms to improve protections for personal injury claimants, clarify the treatment of shareholders and streamline cross-border insolvency.
So what does all this mean for the role of creditors?
First, creditors will have greater incentives to get involved in monitoring the conduct of insolvency proceedings. For example, creditors will have more power over appointments and remuneration.
Secondly, and flowing from the first point, insolvency practitioners will be more accountable to creditors. This should improve transparency and certainty for creditors.
And, third, I think there will be ongoing pressure on the legislature and the courts to expand the class of creditors, to encompass a greater role for shareholders in their capacity as creditors, personal injury claimants, and foreign creditors.
As creditors are granted more power over decision-making in insolvency proceedings, it becomes increasingly important that the class of creditors is representative of those with the greatest economic interest in the outcome of the insolvency process.
The extent to which creditors take up these new opportunities will be determined by many of you here in this room.
The Government will continue to monitor this area of the law closely, with a view to improving the performance of the economy for the wellbeing of all Australians.
And in doing that, I look forward to continuing the dialogue with the Banking and Financial Services Law Association.
Thank you.