5. Licensing of Insolvency Practitioners
5.1 The Problems Identified by the Law Commission
14. Neither the Companies Act 1993 nor the Receiverships Act 1993 require that persons acting as an insolvency practitioner or being appointed as an administrator of a collective insolvency regime are formally qualified, registered or licensed to carry out these tasks. The Law Commission (at para 186) identifies a "Concern about whether there are sufficient regulatory safeguards in place to ensure that only properly qualified and impartial insolvency practitioners are appointed to act as an office holder in a collective insolvency regime". In particular they note that:
- "It may be necessary for New Zealand to develop an accreditation regime to provide Australian courts with confidence that they can appoint New Zealand practitioners to deal with assets in Australia notwithstanding the lack of any licensing regime in New Zealand" para 188(a).
- "The "information asymmetry" as between the major creditors (on the one hand) and debtors and smaller creditors (on the other) about the skill and competence of those offering their services as office holders in collective insolvency regimes" - para 123(f).
- "It is too easy for directors or shareholders to appoint "friendly" liquidators who have no or insufficient knowledge of insolvency procedures or who do not carry out duties and inform creditors of their rights. Appointment of a "friendly" liquidator removes the assurance of impartiality on which creditors may be expected to act." para 188(b).
15. In our view, any case for occupational regulation must be subject to a stringent test. This is because occupational regulation may be costly (in the sense of raising transactions costs and introducing a barrier to entry to the market), and it may produce unintended or even perverse consequences (such as shortages or lower quality of service). In this section we provide an assessment of the potential for licensing of insolvency practitioners to create problems of this type, and consider whether in this particular case the benefits of occupational regulation are likely to outweigh the costs.
5.2 Current Legislative Provisions Relating to the Quality of Insolvency Practitioners
16. We begin by noting that the Companies Act provides minimum requirements for the appointment of a liquidator: specifically they must be independent (must not have been a shareholder, director, creditor or receiver of the company within the previous two years) and must not have any criminal convictions. There are in addition remedies available to creditors where there is actual evidence that liquidators have not properly performed their duties or have shown demonstrable bias towards the debtor (See section 286 of the Companies Act).
17. Current legislation also contains a penalty for demonstrably poor practice by insolvency practitioners. The High Court has the power to make an order prohibiting a person from acting as a liquidator for a period not exceeding five years, if it is demonstrated to the satisfaction of the court that a person is unfit to act as a liquidator by reason of persistent failure to comply with the obligations imposed by the Act or the seriousness of a failure to comply. Similar provisions apply to acting as a receiver or a liquidator. Para 181- 182. As a minimum this suggests that if there is a problem, it could be addressed by increasing the costs for those practitioners who do not comply with the Act. In our view it would be helpful if the Law Commission could indicate whether they have considered an increase in the penalties associated with failures to comply with the obligations imposed by the Act, and if so, why they have rejected an increase in penalties as an alternative to a licensing regime for practitioners. It may be, for example, that there are practical limitations on the penalties that can be imposed which mean that higher levels of enforcement are required if higher levels of deterrence are to be obtained.
5.3 The Market for Insolvency Practitioners: Problems of Bias and Asymmetric Information
18. As we understand it, the market for insolvency practitioners is currently made up of staff from the major accounting firms (with PriceWaterhouse Coopers having the largest share of the market), a number of well-established firms specializing in insolvency practice, and a number of small firms or individuals who undertake insolvency work. A priori, it is difficult to understand how a market such as this would be inefficient. Purchasers of insolvency services will benefit from contestability and choice in the sense that this will encourage different specialisations (niches in the market) and competitive pricing. It will also provide a choice in experience and support so that (for example) it is not necessary to purchase the highest level of expertise and pay the rates demanded by large firms in relatively simple insolvency matters.
19. This market of insolvency practitioners also provides the benefits of having some firms with substantial reputational capital at risk in the quality of the work that their insolvency practitioners undertake. Purchasers of insolvency services who choose to employ a sole practitioner or a new entrant to the market for insolvency practice presumably make a rational choice to purchase those services in contrast to those associated with one of the large firms. In our view it is simply not credible to argue that businesses that appoint an inexperienced insolvency practitioner do not understand the risks and the cost that are associated with that choice. It may be that in some smaller centers it is difficult to obtain the services of an insolvency practitioner, and only low-quality practitioners are available. Even if this claim is true, it is not clear how a licensing regime will solve the problem: by putting in place a barrier to entry for small practitioners licensing may mean that there are no insolvency practitioners at all in these centers.
20. It would be inefficient for any insolvency regime to tolerate practitioners who were demonstrably biased towards the debtor or creditor. The Law Commission expresses concerns about the impartiality of some insolvency practitioners but they do not indicate how licensing would define and test for impartiality. In our view it would be impossible and probably also inefficient to attempt to eliminate legitimate professional differences in view among insolvency practitioners: in most cases it is extremely difficult to distinguish these differences in view from bias. For example, despite the requirement that expert witnesses be impartial, some doctors almost always appear as experts for the plaintiff in medical liability cases, and some registered valuers always appear as experts for the lessee in rental rate arbitrations. In these cases there is no market failure because the particular views of different practitioners are known or relatively easily discovered by lawyers, accountants and other advisors to debtors and creditors in insolvent firms.
21. In our view, the key issue in respect of the possible bias of insolvency practitioners is the ex ante test associated with an absence of prior association (which is enshrined in current legislation). Any test designed to assess whether ex post actions demonstrate independence will be virtually impossible to reflect in the criteria associated with a licensing regime, and in cases where actions are demonstrably not independent court action is already possible.
22. Information asymmetry is ubiquitous in all human interaction, but only rarely requires legislation to deal with it. The economics literature uses as examples markets for durable assets where there is a marked difference between the knowledge of the seller and the potential buyer about the quality, performance and past investment in maintenance of the asset. Markets find different ways of dealing with this information asymmetry, ranging from the terms of contracts to investment in brand and reputation, and these market solutions are usually more efficient and more effective than regulation.
23. Even the most poorly informed of small creditors will be aware of the investment in reputation that is associated with the major accountancy practices and the largest specialist insolvency practitioners. In these firms, internal quality control mechanisms provide the assurance of quality that the Law Commission seeks because it would be inconsistent with the long-term development of the brand for these firms to allow staff to manage insolvencies unless they possessed the necessary skills, knowledge and balance of the interests of creditors and debtors. It is not clear to us how it is possible to justify on efficiency grounds regulations that would prohibit a conscious choice for an inexperienced insolvency practitioner as an alternative to these larger (and more expensive) firms. This is particularly true because all businesses have advisers (lawyers and accountants) who can assist with the identification of appropriate insolvency practitioners.
5.4 Barriers to Entry
24. The use of experience as a criterion for obtaining a license to operate in the market has many potential problems. Introducing a requirement for experience introduces a barrier to entry into the market for insolvency practitioners. It represents a barrier to entry of the strongest kind in the sense that it is clearly a cost for entrants to the market that the incumbents did not have to bear.
25. A requirement for experience begs the question "how is experience to be acquired"? A requirement for experience may result in potential entrants having no choice but to work for incumbent practitioners for some time before they establish their own practice. It is likely that this will create economic rents for existing practitioners.
26. The issue then is whether the reduction in efficiency resulting from the barrier to entry is smaller than the reduction in efficiency claimed by the Law Commission to result from the lack a of a regulatory regime. Licensing may have the benefit of ensuring greater knowledge of relevant law and practice among insolvency practitioners in New Zealand. However, it may also result in an increase in the cost of insolvency services as a result of the barrier to entry that licensing creates, and it may be inefficient in its requirement that all insolvent firms use practitioners of this standard when a practitioner who was prepared to charge a lower price would be acceptable to all parties. Overall, it is not clear that the efficiency of the market for insolvency practitioners would be improved by an experience-based licensing regime.
5.5 Insolvency Practitioners as Officers of the Court
27. The Law Commission proposes that "all persons appointed as administrators of a collective insolvency regime (whether appointed by the debtor or by the court) should be deemed to be officers of the court with all the duties attendant to that." This would mean that the court could:
- Exercise supervisory jurisdiction over all such insolvency practitioners; and
- Require insolvency practitioners to certify experience and non-disqualification to the court.
28. This proposal appears to be designed to screen insolvency practitioners and to provide a faster means of sanctioning practitioners do not meet acceptable standards. It is, however, unclear to us that these benefits warrant the resulting increase in the workload and responsibilities of the court. Making insolvency practitioners officers of the court puts the court in an invidious position given that it is not clear that the courts have as much information as the market about the qualifications of these individuals. In our view the court should not take on this responsibility for insolvency practitioners without the resources to properly fulfill the responsibility. Further, insolvency practitioners already have the opportunity to refer issues to the court or seek the guidance of the court without being officers of the court.
5.6 The License Requirement for Practice in Australia
29. The Law Commission has suggested that a licensing regime would have the added benefit of allowing New Zealand insolvency practitioners to practice in Australia. Our approach to this issue is to say that it could be addressed in two ways. First, New Zealand practitioners could acquire accreditation in Australia if they wished to practice there but not otherwise. This would offer the advantage of being low cost (avoiding the need for licensing in New Zealand) and offering an added market signal about the investment in reputation that individual insolvency practitioners were prepared to make. Second, New Zealand could introduce a licensing regime equivalent to that of Australia. We say equivalent because the Australian authorities need not recognise New Zealand qualifications where they are not equivalent to the qualification required in Australia. This means that only a regime that imposes similar requirements to that of Australia would offer any advantages, and in effect suggests that New Zealand should either adopt the Australian model for licensing and accreditation of insolvency practitioners, or not have a licensing regime at all.
5.7 Summary
30. We are not convinced that the proposal to license insolvency practitioners will provide benefits that will outweigh the costs associated with it. In particular we have pointed out that the proposal will:
- Raise the cost of employing insolvency practitioners by establishing a barrier to entry that will allow provide rents to the incumbent practitioners and by increasing the minimum level of quality in the market above the level the may be required for some simple insolvency cases.
- Will not necessarily solve the claimed problems associated with asymmetric information and bias, and will only provide for New Zealand practitioners to operate in Australia if we adopt a system equivalent to that in Australia.
- Place on the court an onerous burden in overseeing insolvency practitioners who are officers of the court, even though it is not clear that the court has any special advantages in identifying high quality insolvency practitioners.
31. We have suggested that occupational regulation should normally only be introduced where it meets relatively strong tests for the demonstration of public benefits over detriments. In our opinion, consideration of any proposal for licensing should be preceded by more evidence relating to the magnitude of the problems identified by the Law Commission, the ability of licensing to ameliorate these problems, and the costs associated with any licensing regime.
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