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Speech to Business Law Forum on Insolvency Review

Hon Laila Harre Speech Notes

Speech to Business Law Forum on Insolvency Review - “Tier One decisions and where to from here”

10.45am

Rangimarie Rooms

Level 3

Te Papa

Good morning, and thank you Mark for the introduction. I’m here this morning to share with you the first round of decisions that have been made regarding a core part of my work as Associate Minister of Commerce, namely the Insolvency Law Review.

Many of you will have contributed to these outcomes by making submissions during the recent review process, and I’m aware that some here today will have been waiting to see action on insolvency law since the need for change was first identified in the late 80s and early 90s.

Issues regarding corporate insolvency were given significant attention at that time by the then Department of Justice and the Law Commission. Despite raised expectations, nothing was done , and the call for reform was repeated when the Companies Act was enacted in 1993. But again decisions were deferred until a comprehensive review of insolvency law could take place.

That review is now well underway, and is in fact more than half way to completion. It also covers bankruptcy or personal insolvency law, of which there has been no significant review since 1967.

There are a couple of reasons that the review, and resulting policy decisions, finally got of the ground.

Firstly, when the Labour-Alliance Government came to power two years ago there was broad agreement between the coalition partners that Insolvency Law should be looked at as a matter of priority. It also gained momentum through the release of a succession of reports and papers put together by the Law Commission and the Ministry of Economic Development.

The result is that the government has now taken decisions on the first tier of issues in the review, and aims to make decisions on the second and final group of issues early next year. More on these shortly.

So why was insolvency law identified as a priority?

At its simplest, insolvency law regulates financial failure. It provides a regime that defines the rights and obligations of debtors and creditors when a debtor becomes unable to meet its financial obligations. It represents an important part of the business life cycle, and as such, is a core component of the financial system. As it determines what happens when an individual or business fails financially, the insolvency law regime plays an important role in creating and maintaining the confidence of investors.

But insolvency laws are not easily formulated, either domestically or in the international arena. This is because by its nature, insolvency is about the distribution of little amongst many. There is no way of avoiding the fact that regulatory choices will result in winners and losers, but they are decisions that must be made if a fair and coherent framework is to be developed. That’s why in making these decisions we need to be very clear about what we hope to achieve.

OBJECTIVES OF THE REVIEW

- To provide a predictable and simple regime for financial failure that:

- can be administered quickly and efficiently;

- imposes the minimum necessary compliance and regulatory costs ;

- does not stifle innovation, responsible risk taking and entrepreneurialism;

- distributes to creditorsas per pre-insolvency rights, unless public interest requires otherwise;

- maximises returns to creditors;

- allows bankrupt individuals to start again

The government has a number of objectives for the review. These objectives are geared towards improving our current insolvency law regime and achieving the best possible outcome for debtors and creditors.

They will also ensure that other public policy objectives are achieved. It’s important that our insolvency law framework is balanced with and reflective of the government’s overall social and strategic objectives and vision for NZ society. I’m talking about the need to strike a balance between things like innovation, entrepreneurialism and responsible risk-taking; providing a flexible insolvency administration within a predictable and certain regime. It also means supporting the “pari passu” principle, which states that like creditors should be treated equally, but we also need to protect the rights of vulnerable groups, such as employees.

POLICY DEVELOPMENTS TO DATE

The government has taken decisions on four issues in the review. These are:

- Cross-border insolvency;

- Bankruptcy administration;

- Voidable transactions; and

- Priority debts.

Decisions on cross border insolvency:

- adopt UNCITRAL model law;

- not to come into force until Australia has adopted the model law;

- existing provisions amended

The Government has decided to adopt the United Nations Commission on Trade Law (UNCITRAL) model law on cross-border insolvency. The model law is an international instrument designed to provide an efficient, effective and equitable framework to facilitate cross border insolvency proceedings.

A cross-border insolvency occurs where a business is placed in insolvency administration in one country but has assets or debts in other countries. Because the insolvency laws of countries differ, many complex issues can arise. Adopting the model law will reduce the risks currently faced by any NZ business that enters into cross-border transactions, especially trade creditors. This is because, in the event of a foreign business becoming insolvent, any NZ creditors of that business will face shorter, simpler and less expensive proceedings in seeking to recover their finances.

We want to ensure a level playing field for NZ companies that do business overseas. While there hasn’t been a large number of cross-border insolvency cases involving New Zealand companies to date, the number of cross-border transactions is steadily increasing, meaning increased risks for those innovative companies which seek trade opportunities overseas. This law change will help NZ businesses grow through trading across international borders by reducing the risks of doing so.

Adoption doesn’t require NZ to change its substantive law, and the model law won’t apply where the other country has not adopted the model law, or has done so but carved out the relevant industry. While we intend to enact the model law at the same time as the other reforms arising from the insolvency law review, it will not come until force until Australia has adopted it. As our major trading partner, the benefits for New Zealand creditors will not be fully realised until Australia adopts the model law.

Decisions on bankruptcy administration include:

- transfer administration from courts to Official Assignee;

- greater advice to debtors;

- amendment of current statutory limits e.g.:

- cap for SIOs from $12,000 to $40,000;

- debt level for creditors petition from $200 to $1,000;

- increase value of assets bankrupt can retain.”)

Personal insolvency law was last reviewed in the 1960s and no longer provides an efficient solution for the majority of debtors or creditors. The reform decisions taken have been made with two purposes in mind - to encourage early intervention by debtors, and to modernise the bankruptcy administration procedure. This involves making a large number of technical and procedural amendments to the current bankruptcy regime.

All formal options currently available to debtors who are facing bankruptcy carry high costs associated with court processes, including delays and lack of information on the available options. By shifting administrative functions from the courts to the Official Assignee, there will be cost savings for both debtors and creditors.

Also, a debtor will now have to provide greater information when they initiate bankruptcy or an alternative.

At present, more than half of all debtors who become bankrupt initiate the process through filing a debtor’s petition. They do so by going to the court and filing a simple form. They may do so without being provided with any advice of the consequences of bankruptcy, or the alternatives available to them. This is clearly wrong. It does not assist debtors, or creditors who could receive returns under the current alternatives to bankruptcy. When a person is in financial difficulty, they need advice for their own sake and the benefit of those they have a financial relationship with.

A debtor will now have to provide the Official Assignee with a statement of affairs, outlining their financial position, before they can be adjudged bankrupt, rather than after, as at present. This will allow debtors to receive advice from the Official Assignee, to be made aware of the available options and to make an informed decision of what option might produce the best result for them. We want to help people get back on their feet and to start again, and, to be effective, that assistance needs to be provided at as early a stage as possible.

Decisions on voidable transactions:

- minor amendments to five types of voidable transactions;

- sixth type, voidable preferences:

- removal of “ordinary course of business’ exemption;

- adoption of Australian test and defences

Voidable transactions regulation is a highly technical area of the law that recognises that individuals and businesses are generally insolvent prior to formal insolvency, and therefore reverses some transactions made during this “twilight’ period, to support equality amongst creditors.

Our main goal with voidable transactions reform is to remove current uncertainty and inconsistencies.

A number of amendments will be made to achieve consistency between the procedures, timeframes, tests and onuses of proof contained in the various voidable transaction provisions.

The key decision taken was to remove the “ordinary course of business’ exemption for voidable preferences that has been problematic, and the subject of a significant body of jurisprudence. A new voidable preference test will be introduced along the lines of that in Australia, which does not void transactions that take place as part of a continuing business relationship. The net effect of all the transactions between the parties is considered in determining whether there is a preference.

The government wants to encourage businesses in financial difficulty to seek solutions by fronting up to their creditors earlier. This law change will produce fairer outcomes for businesses in trading relationships. For example, where a business has made a payment, say of $100,000, to another party shortly before becoming insolvent, before that transaction can be voided, it must be offset by any goods and services that other party may have continued to supply to the insolvent business. If, during the same period, these amounted to $80,000, it would be unfair to allow the insolvent company to recover $100,000 from the other party.

The Australian test has proved to be effective in that jurisdiction, and introducing that test here with the defences in the Australian legislation will give us recourse to the relevant Australian case law.

:Decisions on priority debts include:

- New priority for creditors who assist liquidators;

- Employee priority - includes redundancy and increased from $6,000 to $15,000;

- Priority afforded to PAYE, GST, withholding tax and customs duties retained;

- Priorities under Fisheries Act and Radiocommunications Act removed

A creditor with a priority debt will be paid ahead of unsecured creditors. Priority debts elevate certain creditors claims for public policy reasons.

As elsewhere in the review, most of the reform in this area is directed at increasing certainty in the legislation, and setting up a framework to ensure any future changes to the order of priorities are done so in a coherent way. A number of changes are worth noting.

At present, it appears that liquidators must forego many viable recovery actions due to a lack of funds. We have created a new priority to provide an incentive to creditors to financially assist a liquidator in recovering or preserving a business’s assets. This is one way to help increase the returns to creditors overall.

A significant change will also be made to the current employee priority. The government has a strong commitment to safeguarding employee rights on insolvency, and has decided to increase the current cap for the employee priority from $6,000 (which was set in 1988) to $15,000. We have also decided the priority will include any entitlement to redundancy payments, in addition to the current allowance for unpaid wages, salary and holiday pay for the four month period prior to liquidation.

This will provide a fairer outcome for employees. At present, employees have no priority for any redundancy monies owed if their employer becomes insolvent. This means if an employee is owed $5,000 in unpaid wages, and has an entitlement to $20,000 in redundancy payments, at present, that employee is a preferred creditor for only $5,000. They stand in line with all other unsecured creditors for the rest of the money owed to them, which they have very little hope of receiving. That will now change.

Once the government’s decision has been implemented, that same employee will receive a priority for $15, 000 out of the total $25,000 owed by the employer. The $15,000 limit can be reached by any combination of unpaid wages, salary, and holiday pay or redundancy payments.

An employee’s entitlement to a contractually negotiated redundancy payment is a right the government intends to protect. This, of course, has to be balanced against the rights of unsecured creditors in insolvency, mostly comprising ofsmall businesses that share a lot of the vulnerable characteristics of employees- hence the decision to put a cap on the amount employees will receive as a priority debt. It should also be remembered that frequently employee debts make up a relatively small percentage of the total debt owed by an insolvent entity.

We have also taken the decision to remove a large number of unnecessary priorities or preferences to provide greater returns to unsecured creditors.

However, this does not mean the removal of all Crown priorities. The decision to retain the debts collected by the NZ Customs Service and the IRD is based on the need to maintain the Government’s revenue base to further other objectives of the government. In most cases, this will have little effect on creditors. In the collapse of the Tasman Pacific earlier this year, IRD and Customs, combined, claimed $2.7 million as preferential debts. If the existing priorities for those agencies were removed, that amount would have been available to distribute to unsecured creditors owed more than $64 million.

As noted before, insolvency law is about the distribution of little amongst many. On this issue, the government has decided it needs to retain its current revenue to ensure it can achieve other social and economic objectives.

OUTSTANDING - BUSINESS REHABILITATION

What’s happening next?

The Government has yet to take decisions on the topics in tier two of the review. Those topics are:

- business rehabilitation;

- the role of the state in the insolvency regime;

- the statutory management procedure;

- the issue of “phoenix” companies; and

- whether all corporate and personal insolvency law should be contained within a single statute.

I’d like to briefly focus on the business rehabilitation topic.

A business rehabilitation regime allows viable businesses to continue trading while a rehabilitation proposal to creditors is formulated as an alternative to liquidation. Creditors may be prevented from taking any debt recovery action by a court-ordered or automatic moratorium or stay of proceedings while the proposal is put together.

This is a matter of significant importance for our capital markets and enhancing our existing ability to rehabilitate companies could have benefits beyond any narrowly defined economic success. A business rehabilitation concept provides a framework that can integrate economic and social benefits, and further policy objectives across government.

One option I am considering is releasing a public discussion document on this issue, so further consultation can inform the government’s decision on this matter. I’d be interested in hearing what you think of this suggestion, and if it is an option that would progress debate on this issue I would welcome your comments today to help inform the development of such a document.

So the primary question is should we have a business rehabilitation administration regime?

There are a number of arguments for and against. On the one hand, a regime might:

- promote and stimulate innovation by entrepreneurs;

- retain the knowledge and expertise of management built up over a number of years and through great experience; and

- it might save, and ultimately, create more jobs.

On the other hand, any change to our current legislative framework could

- create opportunities for debtors to defeat the legitimate interests of creditors;

- allow poor managers and unprofitable companies to continue trading and,

- ultimately, drive up the cost of credit.

There are three broad policy options for government on this issue:

- To retain the status quo, which does not allow an automatic, mandatory stay of any form of recovery proceedings by creditors;

- To bind unsecured creditors only with a mandatory stay while a rehabilitation proposal is prepared; or

- To bind secured creditors also.

In considering whether New Zealand should adopt a new business rehabilitation regime, it is also important to ask whether we should adopt a regime similar to, or the same as the Australian voluntary administration procedure. There are a number of arguments for and against that proposition. In addition to the benefits provided by any rehabilitation regime, arguments for adopting something like the voluntary administration procedure might include the advantages to be realised from increased consistency in trans-Tasman insolvencies.

Arguments against might include an uneasy fit with the rest of our commercial law, as well as current credit practices in New Zealand, and that international best practice may lie elsewhere.

The government does not have a view at this stage, and I hope it is something that will warrant attention during your panel discussion later today.

I notice also that the panel will be discussing the extent to which we should be co-ordinating our capital market laws with other countries. I would also be interested in hearing your views regarding the Australian voluntary administration regime, and the other issues the Government has yet to take decisions on, such as statutory management.

I am disappointed that I can’t be here for the panel discussion today but I have asked officials to prepare a report for me on the discussion and the matters raised.

We do have a few minutes left before the panel discussion is due to start, and I’d be happy to address any questions participants might have on the review.

Thank you.

Ends


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