Update on Insolvency Law Reform Bill

Speech notes for address to Corporate Insolvency Conference. Maritime Museum, Auckland

Thank you for the opportunity to address the conference today. Insolvency law is an area I take a special interest in and I welcome this opportunity to update you on progress on the Insolvency Law Reform Bill, which I introduced into Parliament just before Christmas, and which had its first reading this week. It has been referred to the Commerce Select Committee.

Reasons for the Reform
Changes to the Insolvency Act are overdue given that the legislation was enacted in an era of almost no unemployment and limited access to credit. Although the former of these conditions has improved markedly over the last term of government, access to credit has grown exponentially in the forty years since the Act was passed. This means that the Act does not reflect the shift from sole trader bankruptcies to consumer related bankruptcies.

The number of company liquidations and personal bankruptcies has increased substantially over the last two decades. Although the statistics relating to insolvency are not available in a consistent form, we can make some comparisons. Personal bankruptcies have increased from around 500 in 1980 to close to 3,000 in 2004. And there were just over 500 liquidations in 1980 and just over 2,000 liquidations in 2003.

I intend to look at the record keeping in this area because it is important to be able to map trends and better inform the policy-making process. However, in both instances returns to creditors continue to be low.

Reform that enables debtors to seek alternatives to bankruptcy, providing better results for both debtors and creditors, are required, along with the need to reflect international standards in bankruptcy administration and to provide for early intervention by debtors.

Government’s agenda for economic transformation and the objectives of the reform
On 14 February, the Prime Minister presented her Opening Statement to Parliament. In it she confirmed that it is time to move to the second level in the economic transformation agenda.

The passage of the Insolvency Law Reform Bill is part of that agenda. I appreciate this may seem somewhat surprising given that corporate insolvency and personal bankruptcy are about financial failure. However, it is clear that the enhancement of regulatory frameworks is one of the keys to achieving economic transformation. This becomes evident when you look at the objectives we established in undertaking the reform. These are:

• a predictable and simple regime that can be administered quickly and efficiently in the event of financial failure. It should not impose unnecessary compliance costs or stifle innovation, responsible risk-taking and entrepreneurial spirit by excessively penalising business failure. It is a balancing act.
• an insolvency regime that distributes proceeds to creditors in accordance with their pre-insolvency entitlements and maximises returns to creditors. In order to achieve this we require a regime that provides flexible and effective methods of administration and enforcement.
• encouraging early intervention when financial distress becomes apparent, while providing alternative avenues of administration and opportunities for individual bankrupts to participate fully again in the economic life of the community.
• promotion of international co-operation in cross-border insolvency cases where assets are being held in different jurisdictions has long been an objective. As business interests grow between our countries and ease of travel increases population flow, alignment with Australian legislation in order to facilitate greater trans-Tasman co-operation has become a more pressing priority.

In order to achieve economic transformation, the Prime Minister has pointed out that we need higher productivity, higher business investment, higher skills levels and greater innovation in the economy. Through reforming our insolvency regime with the objectives I have identified, we are clearly contributing towards these high level outcomes.

A sound insolvency regime will give confidence to local and overseas investors. Providing for Voluntary Administration, tightening the usage of phoenix companies and providing for the UNCITRAL Model Law are some of the ways investor confidence will be enhanced.

The Voluntary Administration process will encourage responsible risk-taking and innovation. Directors will take comfort in the fact that liquidation is not a foregone conclusion when the company heads towards insolvency.

The adoption of the UNCITRAL Model Law will send a clear signal to our trading partners, and investors, that we support a predictable process for initiating cross-border insolvency proceedings.

Recognition of foreign insolvency representatives, and foreign proceedings where assets are held in another country, will give overseas investors confidence in the strength of the New Zealand insolvency regime.

Process / timeframe
In a culmination of these objectives, the Insolvency Law Reform Bill was introduced to the House of Representatives on 21 December 2005. The Bill went through the first reading in the House on Tuesday and, as I said, has been referred to the Commerce Select Committee.

The Committee will call for public submissions and there will be a chance for submitters (you) to appear in front of the Select Committee to present your views.

As the Bill moves through the legislative process we can be confident that the issues addressed in the legislation are being scrutinised to ensure a fair and effective regime. The legislative timeframe for progress through the House has not yet been set for the year. Officials will continue work on regulations to give proper effect to the proposals in the Bill.

Voluntary Administration
Many changes have been proposed to modernise, clarify and improve the workability of the personal and corporate insolvency regimes.

Some of those changes are driven by the Australian experience and the desire to align our jurisdictions in this area.

Adopting the Voluntary Administration regime will bring New Zealand into line with other OECD countries as well as facilitating trans-Tasman business rehabilitations.

Voluntary Administration is an alternative to liquidation for companies with the potential for rehabilitation.

The application of this regime places a mandatory stay on proceedings, allowing the administrator to assess the financial position of the company before pursuing liquidation or placing the company into administration.

When the company enters into Voluntary Administration, a "watershed" meeting is held where the Deed of Company Arrangement is executed. The company continues trading through the administration, meaning that payment of debt is managed throughout.

Australian studies suggest that Voluntary Administration can produce a significantly higher average return to creditors so I am very hopeful that we will achieve a similar result here.

Phoenix Companies
There are concerns that phoenix company structures are being abused by directors who are seeking to defeat the legitimate interests of creditors. Measures adopted in the Insolvency Bill to deal with this problem focus on the role of the director.

Providing a restriction on directors re-using the name of a failed company will go some way toward preventing abuse of the phoenix structure.

The Bill introduces greater deterrence measures. The director of a failed company cannot be the director of a company, or take part in the business activities of a company, that has the same or a similar name as the failed company.

Also included is a restriction on the use of trade names. This restriction applies for 5 years from the date of the company failure and a director can apply to the court for an exemption to this rule. The effect is that the creditor is put on notice that they are not dealing with the insolvent company but a totally new entity. The proposal also ensures that the value of the business is not lost to the directors through non-payment of goodwill associated with the insolvent company’s name.

The Bill introduces further enforcement of criminal penalties where directors have acted in bad faith to defeat the legitimate interests of creditors. Criminal sanctions will act as a deterrent, and by limiting or eliminating the potential benefits of the use of phoenix company structures to directors, there is less incentive for abuse.

The United Kingdom has similar provisions in their legislation, which have led to a reduction in abuse of phoenix company structures there.

I should mention in this context an item that has been specifically highlighted for further work in the signing of the updated MOU on the Coordination of Business Law in Melbourne this week and that is the proposed adoption of a mechanism which would allow for the disqualification of persons from managing corporations in one jurisdiction to apply in another. For the same reason that I support the cross border insolvency initiatives I am very keen to pursue this line of work.

No Asset Procedure
The No Asset Procedure introduced in the Bill is an alternative to bankruptcy, aimed at consumer debtors who have accumulated debts primarily from domestic liabilities.

These are borderline debtors who are managing their debts until some life event occurs, interfering with their ability to pay their creditors.

Many of the restrictions, which apply to bankruptcy (such as overseas travel and owning a business), are not applicable to such debtors. This prompted the need for an alternative process.

A NAP lasts for 12 months, cutting the administrative time involved in the administration, and saving costs.

This is not an easy way out, and entry to NAP is not automatic. The Official Assignee has strict guidelines on entry. It is also a one-off procedure – once a candidate has been through a NAP process, they cannot enter one again. Personal bankruptcy would be the only option if they were to enter financial difficulty again.

I should mention under this heading that the Bill provides for the Summary Instalment Order threshold increase from $12,000 to $40,000 worth of debts, which will make this option much more accessible.

Cross – Border Insolvency
Consultation undertaken by officials with the insolvency industry revealed that there were problems in accessing foreign insolvency regimes where an insolvent company’s assets were held in overseas jurisdictions. In order to address this, the Bill adopts the United Nations Commissions on International Trade Law (UNCITRAL) Model Law on Cross Border Insolvency.

Among other things, the model law provides for:

• the domestic recognition of foreign insolvency proceedings;
• recognition of foreign insolvency representatives; and
• provision for co-operation between courts of different jurisdictions.

The Model law is administrative in nature. It does not alter our substantive insolvency law but provides for principles against which the Model law can be interpreted.

It does provide a modern, harmonised and fair framework to handle instances of cross-border insolvency.

The Model law will not come into force in New Zealand until Australia has adopted the law in their legislation. In October 2005, the Australian Treasury announced the adoption of the Model law as part of its insolvency law reform package. It is our understanding that draft legislation will be circulated for public comment early this year and a Bill introduced late in 2006.

Since this government’s decision to implement the Model Law, my officials have been considering how the Model Law could best operate in a trans-Tasman context.

Given the similarities between substantive New Zealand and Australian insolvency law, it would be possible to go further than the model law in respect of trans-Tasman insolvencies. The Model Law framework could be used to develop an agreement with Australia, providing for single insolvency proceedings recognised in both countries. Details of the operational aspects of this are still to be discussed between officials.

Regulation of Insolvency Practitioners
Proposals for the regulation of Insolvency practitioners in this country have been discussed with officials. What I will relate to you are potential options for the regulation of practitioners only. There is not yet any government policy on this issue.

Essentially, we are talking about people who are appointed to carry out statutory corporate insolvency processes, other than the Official Assignee. This comprises liquidators appointed under the Companies Act 1993 and receivers appointed under the Receiverships Act 1993. It also includes administrators appointed to carry out voluntary administrations, as provided for in the Insolvency Law Reform Bill.

It does not include statutory managers appointed under the Corporations (Investigation and Management) Act 1989, as they are appointed, in effect, by the government.

In 2004, the Ministry released a discussion document on insolvency practitioner regulation and received about 35 submissions. That is a significant number given how few practitioners there are in New Zealand. Officials have been analysing submissions and testing ideas with various people.

An almost unanimous theme in submissions is that the status quo in relation to liquidators is unsatisfactory.

While there was a strong theme that the great bulk of liquidations are carried out by capable and honest practitioners, concerns were expressed about the competence and integrity of a minority of liquidators and the sometimes significant harmful effects that can have on the creditors in those instances.

As mentioned previously, there is no government policy on insolvency practitioner issues at present. Therefore, it is important to note that it remains to be seen what outcomes will arise out of this work. Officials will be reporting to me on any policy proposals late this year.

However, we have used the Bill to make some changes around the appointment of liquidators, which should increase their accountability, reduce the scope for shareholders and related parties to defeat the legitimate interests of creditors and reduce the chances of appointing a debtor-friendly liquidator where the company goes into voluntary liquidation despite an impending creditors' petition. In addition, the 5-year time limit on prohibition orders is being removed altogether.

Coupled with the fine-tuning of voidable transactions provisions, I believe these changes will make a positive difference by addressing some of the key concerns that have been raised in the consultation process.

Conclusions
It is important for New Zealand to align our insolvency laws with Australia as our closest trading partner. The reform achieves this alignment through:

• the adoption of the Australian Voluntary Administration regime;
• the adoption of the UNCITRAL model law on cross-border Insolvency, which Australia also intends to adopt; and
• providing for single insolvency proceedings between the two countries.

The intention of the reform is make the personal bankruptcy system more administratively efficient, more cost effective and straightforward. Companies can avoid liquidation and continue to trade, contributing again to the economy and honouring their creditors.

We have provided for deterrence of directors who abuse phoenix company structures. And I am hopeful of progress on the trans-Tasman prohibition orders.

I am confident these changes will have a positive impact, not only on debtors and creditors, but on the business environment overall. It is an area where balance is important, because there are competing interests. I believe the balance is right and look forward to your feedback.