Part A - Background
What Is Business Rehabilitation?
20. In its widest sense, a business rehabilitation regime provides an alternative to liquidation under which a debtor company or individual can enter into a binding compromise or arrangement with its creditors and keep trading, with a view to maximising returns to creditors.
21. In its advisory report to the Ministry of Economic Development, Insolvency Law Reform: Promoting Trust and Confidence, the Law Commission noted, from the work of the United Nations Commission on International Law (UNCITRAL) that:
"(business rehabilitation) schemes in other jurisdictions typically contain the following elements:
- Voluntary submission by an entity to the process, which may or may not involve judicial proceedings and judicial control or supervision;
- Automatic and mandatory stay or suspension of actions and proceedings against the property of the entity affecting all creditors for a limited period of time;
- Continuation of the business, either by existing management, an independent manager or a combination of both;
- Formulation of a plan which proposes the manner in which creditors, equity holders and the entity itself will be treated;
- Possibly the judicial sanction of an accepted plan; and
- Implementation of a plan."1
22. Many different terms are used to describe the general concept of a process of either rehabilitating or putting together a plan to rehabilitate a business entity. These include "corporate rescue", "corporate rehabilitation", "voluntary administration", "business re-construction" and "company re-organisation". For the purpose of consistency and to avoid confusion the term used throughout this paper to describe the general concept of a legislative rescue regime for companies is business rehabilitation. Otherwise, all mechanisms that currently exist in New Zealand and in other jurisdictions are referred to by their actual name.
What Are the Benefits Ascribed to Business Rehabilitation?
23. There are a number of potential benefits of having a regime that facilitates the continuation of a business rather than its liquidation. These include:
- The preservation of the economic value of the company as a going concern for all stakeholders in that business;
- Minimising the loss for creditors, including employees, and others who deal with the insolvent company from having to re-establish relationships with another entity; and
- A business rehabilitation procedure can also provide for a more measured distribution of the assets of a company if it does eventually fail, thereby increasing returns to all creditors.
24. There are, however, also potential costs associated with such a regime. These include:
- An increase in the cost of credit as a result of the inability of creditors to enforce contractual rights during a stay on proceedings against the company;
- The cost of allowing a company to trade on which, in some cases, may further erode its value; and
- The financial costs to the company of the administration of a business rehabilitation procedure.
25. Most international research concerned with business rehabilitation focuses on the use of regimes and levels of returns to creditors. These studies indicate that creditors receive a range of levels of returns under business rehabilitation. In Australia for example, empirical studies provide evidence that eventual returns to creditors after voluntary administration are slightly higher than returns after company wind-ups. These Australian studies suggest that voluntary administration produced an average return to creditors of between 21.5% to 10% compared to the average return of 7.35% in wind-ups.2
26. The design of a business rehabilitation procedure can act to maximise the instances where, in relation to particular companies, the benefits of rehabilitation will outweigh the costs involved. The discussion of options and design features for a business rehabilitation regime presented later in this paper includes consideration of the extent to which those features identified could maximise the benefits and minimise the costs of a regime.
Business Rehabilitation in Other Jurisdictions
27. Business rehabilitation regimes have been previously adopted in a number of other developed countries. In recent years there has been a growing international trend towards countries reviewing the effectiveness of their existing business rehabilitation procedures and adopting new regimes.
Australia
28. In 1992 Australia introduced a voluntary administration procedure in its Corporate Law Reform Act 1992. Until 1992 there had been a rescue procedure known as "official management", which required a high threshold of proof that the company could be rescued.
29. Administration is "voluntary" in Australia since it is the company or its directors that usually initiates the procedure. The procedure does not require any initial court hearing. Secured creditors with charges over all, or substantially all, of the assets may initiate appointment of an Administrator. An automatic stay of 21 or 28 days is imposed and the company is placed in the hands of a qualified administrator who must be a registered state-licensed liquidator. The Australian voluntary administration procedure is explained in more detail in Appendix I, Appendix II and Part D of this paper.
The United Kingdom
30. In 1985 the United Kingdom made provision for two forms of rescue procedure, which are interrelated. Following the Cork report in 1982, an administration order was conceived as filling the gap where there was no secured creditor with power to appoint a receiver over all or most of the company's undertaking. Receivers were generally seen to be doing a good job in ensuring survival or sale of viable businesses as going concerns, however the duties of such receivers were slightly increased in 1985 to make them more accountable to general creditors.
31. In the United Kingdom the administration order is a court order which can be made on various grounds, by petition of the directors, the company or creditors (in most cases). In addition to satisfying the court that the company is, or is nearly, insolvent, it has to be demonstrated that one or more of four purposes would be served by the order. One purpose relates to the other new procedure introduced in 1985, the "Company Voluntary Arrangement" (CVA). This was conceived as a simple form of compromise procedure whereby a debtor company could put a proposal to creditors, supervised by an independent practitioner who would report to court on the viability of the proposal. The other purposes of an administration order are the survival of the company as a going concern, an "old style" court sanctioned composition or arrangement and lastly, if it can be shown that there is likely to be a better realisation of assets than if a liquidation occurred.
32. The CVA is very similar to Part XIV of the New Zealand Companies Act 1993, though without the need for class meetings. However, unlike the procedure introduced at the same time for individuals in the United Kingdom, the CVA does not have a moratorium against creditor action attached to it.
33. Within the United Kingdom legislation the court has discretion whether or not to make an administration order, and will expect a report by an independent insolvency practitioner (usually the proposed administrator) to be filed. A person entitled to appoint a receiver who would have control over all or most of the company's assets can effectively "veto" the administrators appointment by appointing a receiver in a five day decision period, similar to the ten day period in Australia. The moratorium imposed from the time of an administration petition is quite large compared to that on liquidation, extending to all proceedings, enforcement of security and other legal processes. However, it is not as wide as the moratorium in the United States (see below).
The United States
34. The United States formal rescue procedure contained in Chapter 11 of the Federal United States Bankruptcy Code is the oldest of the formal rescue regimes discussed here, being enacted in 1978. Chapter 11 has now become the major insolvency procedure in preference to Chapter 7 liquidation (there are various specific procedures under other Chapters for agricultural industry and municipalities for example). Chapter 11 filings at court trigger an extremely wide automatic stay under Section 362 of the Code. The conversion process between reorganisation and liquidation proceedings is relatively straightforward, unlike in jurisdictions such as the United Kingdom. In practice, most Chapter 11 filings are voluntary.
35. The distinguishing feature of Chapter 11 over many English-speaking jurisdictions' procedures, other than Canada, is that there is no automatic appointment of a professional "outsider" to any management role. The company retains control and management functions, subject to a raft of duties and powers which distinguish it from the corporate entity pre-filing. The powers include the ability to challenge preferences and unperfected security interests. The duties are fiduciary in nature. The court must sanction any disposals outside the ordinary course of business. In addition, there is provision for the appointment of a trustee and/or an examiner by the court, but this is rare, such as in cases of fraud. The examiner would usually be appointed at the request of creditors to conduct an investigation as to the viability of reorganisation, or where the assets are over $5 million, but the functions of the examiner are largely at the discretion of the court.
36. Within the United States regime there is no requirement that an entity be insolvent for Chapter 11 to be initiated, so that the automatic moratorium triggered by filing can be used tactically. However, it has to be borne in mind that in some cases filing for reorganisation may be a genuine attempt to deal with anticipated insolvency and might follow from a major philosophical commitment to the concept of "fresh start" which seems to extend to corporate as well as individual debtors, and to pre-date the 1978 reforms. This means that once a debtor files, the wide moratorium protects the debtor from almost any creditor action for a relatively lengthy "exclusivity period" of 120 days during which the debtor is supposed to put together a reorganisation plan. The court may extend this period of exclusivity.
37. In the United States regime the debtor must put any reorganisation proposal to class meetings of creditors, so that all classes of creditors whose rights have been impaired by the proposal get a chance to vote. The debtor generally has at least 60 days after the 120 day period in which to negotiate. Dissenting classes after voting can be "crammed down", in other words bound by the scheme despite voting against it. However, this happens rarely in practice. In addition, the plan has to be approved by the court, which applies a number of fairness criteria and has to be satisfied that the scheme is "feasible" and that individuals who dissent will receive at least as much as they would on a liquidation.
Canada
38. Along with Australia, Canada has passed legislation designed to avoid most of the problems of delay and abuse possible under Chapter 11 in the United States, yet avoiding the costs involved in the United Kingdom approach.
39. The main features of the Canadian Bankruptcy and Insolvency Act procedure are that a debtor may file either a proposal for a reorganisation (for example if the company is already in receivership), or a notice of mere intention to file one (creditors cannot file for a debtors reorganisation, unlike in the United Kingdom and Australia). A wide moratorium against creditor action is triggered for an initial 30 day period. However, a trustee has to attest to creditors the accuracy of the debtors cash flow projections. The trustee's role is deliberately "light-handed", though he must report to the official receiver any "material adverse change" since the original filing. The court is not involved in initiation of the procedure, but where more than light monitoring is required, may be involved in defining the trustee's powers that can be quite wide.
40. In the Canadian regime there is a very strict timetable during which the debtor must effect a proposal and, if it is not approved by creditors, automatic liquidation follows. While there is some judicial flexibility for extensions of the moratorium period, there is a maximum cumulative period beyond which the court cannot go under any circumstances.
41. Unlike the situation in the United Kingdom and Australia, in Canada a secured creditor who wishes to appoint a receiver over all or most of the company's business and assets, must give the debtor company ten days notice, during which time the company can file for protection. If the charge holder is genuinely concerned that assets may disappear in that time, it can apply to the court for the appointment of an interim receiver to safeguard the assets.
International Trends and Adopting Best Practice
42. As previously stated, there has been an increasing trend internationally towards countries reviewing and modifying their existing business rehabilitation regimes or adopting new regimes. The 1998 financial crisis in South-East Asia has, with the assistance and encouragement of organisations such as the World Bank and UNCITRAL (the United Nations Commission on International Trade Law), triggered the review and development of insolvency laws in many jurisdictions.
43. As can be seen from the discussion above, the business rehabilitation regimes of other countries are all in different stages of development, with arguably the best developed regimes being those of Canada and Australia.
44. If New Zealand is to review its current business rehabilitation laws and develop a new regime, then it is important that the new regime conforms to international best practice in the area. This is because overseas investors may be deterred from investing in New Zealand if they perceive differences between New Zealand's business rehabilitation regime and that of other jurisdictions. Co-ordinating with the Australian approach to business rehabilitation would also mean that it would be easier and less costly to conduct rehabilitations for the growing number of businesses that operate on both sides of the Tasman.
Linkages with Statutory Management
45. Stakeholders have previously noted the linkages between business rehabilitation and the existing statutory management procedures contained in the Corporations (Investigation and Management) Act 1989 (the "CIMA").
46. These existing statutory management procedures enable the Governor General in Council to replace the management of a company with a statutory manager in certain situations. Currently, the statutory management procedure is commenced by Order in Council on the advice of the Minister of Commerce. The Minister can only do this on the recommendation of the Securities Commission. In practice, decisions are normally made on the recommendation of the Securities Commission following an investigation by the Registrar of Companies.
47. The Securities Commission may recommend that a corporation be placed in statutory management:3
- To preserve the interests of stakeholders, creditors, beneficiaries, or the public interest;
- To enable the corporation's affairs to be dealt with more quickly or in a more orderly way; or
- If they believe that the corporation was acting fraudulently or recklessly.
48. The CIMA only applies where the public interest or the interests of members, creditors or beneficiaries of a corporation cannot be protected under the Companies Act 1993 or in any other lawful way.4
49. Statutory managers are granted wide powers under the CIMA to manage the corporation and an extensive moratorium is imposed on claims against the corporation.
50. If a new business rehabilitation regime were introduced, the potential scope of the application of statutory management will be arguably reduced because there would be an extension of member, creditor and beneficiary interests under the Companies Act in accordance with section 4 of the CIMA.
Back to Top