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Speech to Butterworth’s Insolvency Law Conference

Hon Laila Harre Speech Notes

Keynote speech to Butterworth’s Insolvency Law Conference

Quay West Hotel

8 Albert St;

Auckland Central

I am pleased to be here today to give an overview of the work that the government has completed on the current insolvency law review and also to give you a preview of issues that we will be working on over the coming year.

Most of you will be aware of the streams of work that have fed into the current review. The Ministry of Economic Development has consulted widely on various issues and I would particularly like to extend my appreciation to The Law Commission. The Commission has released reports on a number of insolvency related issues, and has made a significant contribution to the policy development work.

The input of insolvency practitioners and the insolvency profession has, of course, also been an essential part of the policy development process. I appreciate the time and resources you have contributed and I can assure you that the outcomes of the review to date do, to a significant extent, reflect the feedback you have provided.

Late last year I announced a series of decisions arising out of the review so far. I intend to outline these for you today. I am also taking this opportunity to set out a further set of decisions taken on the role of the state in insolvency. As insolvency practitioners, I expect that these decisions will be of some interest to you.

Finally, I intend to discuss the next stages of the review, focussing particularly on the key issue of whether we should introduce a business rehabilitation regime. I will be releasing a discussion document on this topic next month and I would like to take this opportunity to canvass some of the key issues that it raises.

Scope and Objectives of the review

Insolvency is, inherently, about what happens when things go bad. Insolvency law is often about distributing very little among many.

Because of this, it’s important for all those involved in an insolvency that the law is clear and effective. Capital and credit are core features of both business and the economy. The cost and availability of credit is driven by a number of factors, including the confidence that investors have in the processes that will kick in if a business fails.

If our laws are not effective, it could deter people from investing in New Zealand. This means it’s important that New Zealand’s insolvency laws operate in a way that effectively creates and maintains the confidence of investors.

Confidence can be strengthened by having insolvency laws that are in line with international best practice. In developing the objectives for the insolvency law review, we have looked to international standards and norms, such as those developed by the IMF, the World Bank and UNCITRAL.

Many of you will be aware of the objectives for the review, which are:

- 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 on its users

- Does not stifle innovation, responsible risk taking and entrepreneurialism by excessively penalising business failure;

- To distribute the proceeds to creditors in accordance with their relative pre-insolvency entitlements, unless the public interest requires otherwise;

- To maximise returns to creditors;

- To enable individuals in bankruptcy again to participate fully in the economic life of the community; and

- To provide international co-operation in relation to cross-border insolvency.

These objectives must, in some cases be balanced with each other and other objectives of the Government. Examples of this include:

- Promoting innovation and entrepreneurialism but also responsible risk-taking;

- Providing a flexible insolvency administration within a predictable and certain regime; and

- Support the pari passu principle, that like creditors should be treated equally, but also protect the rights of vulnerable groups such as employees.

Tier one decisions

The decisions we have taken to date reflect this balance. A good example is in the area of priority debts. Most of the reform in this area is aimed at increasing certainty in the legislation and setting up a framework to make sure any future changes to the order of priorities are done so in a coherent way.

The key priority debts decisions are:

- The introduction of a new priority to provide an incentive to creditors to financially assist a liquidator in recovering or preserving a business’s assets. This was created in response to concerns that liquidators do not proceed with many viable recovery actions due to a lack of funds. The priority is one way to help increase the returns to creditors overall;

- The current employee priority will include redundancy payments and be increased from $6,000 to $15,000. The changes to the employee priority are designed to provide a fairer outcome for employees. The rights of employees do, of course, have to be balanced against the rights of unsecured creditors in insolvency, many of whom comprise small businesses that share a lot of the vulnerable characteristics of employees - hence the decision to put a cap on the amount employees can 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.

- The priorities afforded to PAYE, GST, witholding tax and customs duties will be retained. This decision is based on the need to maintain the Government’s revenue base to further other objectives of the government. Again, in most cases, this will have little effect on creditors.; and

- The priorities under the Fisheries Act and the Radiocommunications Act will be removed.

To illustrate the practical effect of these decisions, it’s useful to look at the collapse of Tasman Pacific last year. In that case, 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.

The government has also taken decisions on several other tier one issues:

- To implement the UNCITRAL model law on cross-border insolvency;

- To bolster the role of the Official Assignee in bankruptcy proceedings and bring statutory dollar amounts under the Insolvency Act more up to date; and

- To replace the current “ordinary course of business” exemption for voidable preferences with a new test based on Australian provisions.

I expect that the last of these, the voidable preference changes, will be of particular interest to insolvency practitioners.

Our main goal with voidable transactions reform is to remove current uncertainty and inconsistencies. The key decision taken was to remove the “ordinary course of business” exemption, which has been problematic and the subject of a significant body of jurisprudence. The new test will not make voidable these transactions that take place as part of a continuing business relationship. The net effect of all the transactions between the parties will be considered in determining whether there is a preference.

I believe this change will produce fairer outcomes for businesses in trading relationships. For example, where a business has made a payment to another party of say, $20,000 shortly before becoming insolvent, before that transaction can be voided, it must be offset by any goods and services, that could amount to say $30,000, that the other party may have continued to supply to the insolvent business.

The test is based on the Australian test and has proved to be effective in that jurisdiction. Introducing it here, with the same defences as in the Australian legislation, will also give us recourse to the relevant Australian case law.

Role of the State decisions

Since the tier one decisions were announced last year we have made further decisions on the role of the state in the insolvency regime. The state has a number of functions in both the personal and corporate insolvency areas - most visibly as an administrator and enforcer of insolvency law provisions. As well as those functions, the state, as legislator, must consider the incentives for creditors to become involved in insolvency processes, and consequently whether its role should be to facilitate or initiate actions.

Four key topics were considered as part of this review and these were canvassed in the discussion document released by the Law Commission last year:

- The state’s monopoly in bankruptcy administration;

- The state’s role in enforcement of insolvency law;

- Requirements surrounding the appointment of liquidators; and

- Incentives for insolvency litigation funding.

The government intends to retain the state’s current monopoly in bankruptcy administration. The Law Commission recommended that private practitioners should be able to act as a trustee of a bankrupt estate, provided an adequate supervisory regime was put in place. On balance, though, we consider that the interests of debtors are better observed by the state than by the private sector, primarily because the Official Assignee is not profit driven.

This is particularly so given that there are no assets involved in a majority of bankruptcies. If there are no assets in the estate, there will be no money to meet the administration costs. The private sector will only be interested in administering the small number of bankruptcies that could meet their costs. This could result in real disincentives for efficient bankruptcy administration.

Further issues were raised surrounding the enforcement of insolvency law. In response to these, the Commission has proposed the establishment of an Inspector-General of Insolvency. While I agree that enforcement of some matters has been weak in recent years, recent evidence suggests that this is largely a transitional, rather than an institutional problem.

The New Zealand Insolvency and Trustee Service established the National Enforcement Unit in 1999. Since then, it has successfully undertaken a range of prosecutions under companies, insolvency and securities law. As an example, as at 31 January this year, the Official Assignee had 23 investigations underway and 10 cases before the courts. Current levels of enforcement are good by international standards and the NEU has made significant steps towards clearing the backlog it inherited. Given these factors, we do not propose to make any changes to the structure of the NEU.

The consultation undertaken by the Law Commission identified two problems with the appointment of liquidators. First, there is widespread concern that liquidators are not always impartial. Second, smaller creditors and debtors do not always have access to information to assess the skill, competence and impartiality of liquidators. This means that liquidators could be appointed that favour the interests of those appointing them, rather than the interests of creditors as a whole, or that the particular liquidator does not have the most appropriate expertise for the job.

To address these issues, we will improve the appointment procedure for liquidators by requiring that there has not been a continuing relationship between the debtor company and the liquidator. This will ensure that liquidators maximise the assets available to creditors as a whole, rather than favouring any particular party.

The final issue considered under this part of the review was the incentives for creditors to fund litigation by a liquidator. It is difficult to interest creditors in funding insolvency litigation - the prevailing view tends to be that it is throwing good money after bad. This means that there are some actions that could be taken that aren’t.

I have already mentioned the priority we are going to give to creditors who financially assist liquidators. We also intend to allow assignment of the liquidator’s right to sue. Currently the statutory rights of a liquidator or the Official Assignee to sue cannot be assigned or sold. Problems arise where the liquidator or the Official Assignee doesn’t have the funds to take action on the claim. For example, a liquidator might have a claim against the directors of a company for reckless trading, but no funds to pursue it. At the moment, this action would not proceed. Allowing the liquidator to assign the right to sue to another party would provide the means for the court action to be pursued.

Insolvency law review: future work

There are three main issues remaining as part of tier two of the insolvency law review:

- Issues surrounding the abuse of phoenix company arrangements;

- The possibility of implementing a business rehabilitation regime; and

- The statutory management regime.

Potentially the most significant of these issues is the question of whether to implement a business rehabilitation regime. I expect that this is also a topic of particular interest to insolvency practitioners.

Under a business rehabilitation regime, viable businesses may be able 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 moratorium or stay of proceedings while the proposal is put together.

Such a regime potentially has a number of objectives, both economic and social. These objectives tend to be focussed beyond any narrowly defined concept of economic success.

There are a number of arguments for and against such a regime. 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.

The Ministry of Economic Development will release a public discussion document next month that canvasses the potential benefits and costs of introducing a business rehabilitation regime in New Zealand. I will be interested in your views on the issues set out in the document and I would like to encourage you to read the document and make a submission once it is released.

The information provided by submitters will be important to the development of policy in this area. Once submissions have been received and fully considered, I hope to be able to make announcements on this and the other tier two issues by mid-year.

Conclusion

The decisions I have discussed today reflect the government’s objective to implement an insolvency regime that effectively balances the interests of debtors and creditors. As I mentioned earlier, this is not a simple task. It is, however, an objective that we will continue to strive to achieve over the next stage of the review.

I would like to finish by thanking you again for your input into the insolvency law review to date. Your feedback has been valuable to date and I hope that the dialogue between industry and government on these issues will continue in the future.


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