Introduction
In August 1999 I submitted to the Ministry an Issues Paper as part of the Insolvency Law Review. It was envisaged that a final paper would be submitted in 2000, which, in particular, would take into consideration comments of the Ministry in response to the initial paper. I now submit this final paper, which I understand will form part of the background to further work to be undertaken by the Ministry with the assistance of the Law Commission.
The approach I have adopted is to incorporate large sections of the initial paper, so that it is not necessary to cross-refer to it. In particular, the explanation of the major rescue procedures in other jurisdictions and the background explanation of existing New Zealand procedures, are incorporated into this paper. However, this paper has added new material for the purpose of (a) answering the queries raised by the Ministry in a letter from Lucy Dome dated 28 September 1999 and (b) updating you on developments in policy work and research internationally.
Summary of Specific Issues Raised by the Ministry in Response to Initial Paper
The four points below are summaries of matters raised by the Ministry in response to the initial paper, and will be dealt with at the appropriate points below.
- What is the purpose of a voluntary administration regime1, and what is the gap that such a procedure would fill in New Zealand?
- Anecdotally, informal arrangements produce the best return for creditors, so consider the implications of such a regime crowding out informal arrangements.
- Evaluation of existing regimes elsewhere.
- New Zealand is pro-creditor, whereas voluntary administration regimes are pro-debtor. Would the introduction of such a regime therefore create "inconsistencies in the law".
Need for Review
Corporate insolvency law is about regulating and minimising the costs of failure. The principal statutory method by which this is done is by providing for liquidation, in furtherance of the fifth goal in the preamble to the Companies Act 1993, "to provide straightforward and fair procedures for realising and distributing the assets of insolvent companies". It is implicit in the objectives behind liquidation that maximisation of returns to creditors and other stakeholders is inherent in this process. However, other expressed objectives in the Preamble are to encourage the taking of business risks, and to allow directors of companies a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against abuse of management power.
A debtor company and its creditors and shareholders ( whether the company is solvent or insolvent) are free to reach a contractual compromise amongst themselves without the assistance of any regulatory framework. Such contractual "rescues" will always happen, notwithstanding the provision of such a framework. Informal rescues may be suited to a variety of situations. Their principal advantage is secrecy, avoiding the stigma of a more public formal procedure (and possibly avoiding investigation and challenge of directors' conduct). Several large group restructurings happen in this way. The second advantage is cost savings and the third is flexibility.
Any statutory rescue procedure should be facilitative, complementing informal rescues. Other means of promoting rescues outside of a legislative framework could take the form of education, exhortation or facilitation through guidelines, usually promoted by a body such as the Reserve Bank or professional bodies such as accountants. (In the UK, Hong Kong and recently several South East Asian jurisdictions, central banks have pioneered rules of conduct to encourage informal rescues in large-scale group failures where major banks are exposed.) The main disadvantages of informal rescues are twofold. First, inability to bind dissenting creditors means there is no legal means to prohibit dissenters from pursuing their legal remedies, including petitioning to liquidate a company. Secondly, there is no moratorium provision preventing them from pursuing such remedies.
The Companies Act 1993 provides mechanisms (in Parts XIV and XV) for restructuring and compromise arrangements to be made between debtors, creditors and shareholders. When applied to insolvent companies, the objective of these procedures is to facilitate a consensual arrangement between debtor and creditors in order to minimise losses by a consensual distribution of net assets. To some extent these provisions enable a company to avoid liquidation by reaching an agreement which is given statutory binding effect, even on dissenting minority creditors or shareholders. However, as presently drafted, the extent to which they provide an effective rescue procedure is limited. Not only do they contain no moratorium to allow a brief "breathing space" during which a company can formulate a proposal, and its viability can be assessed by professional advisers. They are also not designed to allow either the company or an independent professional to continue to trade while investigating the possibility of selling or restructuring the business or its viable parts.
Many leading world economies with relatively sophisticated corporate insolvency regimes have enacted legislation in the last twenty years providing for a formal corporate rescue procedure, and several other jurisdictions, particularly in the Asia-Pacific region and Eastern Europe, are reforming insolvency law to include one.
In the initial paper it was submitted that it was timely, in August of last year, for New Zealand to review whether it should include such procedure in any package of insolvency reform measures for several reasons:
- The issue has been examined in the 1989-1994 period of submissions on insolvency law reform and detailed submissions have been made by the Joint Insolvency Committee and others;
- Any review of statutory management and related procedures should be considered in the context of this issue;
- When considering whether New Zealand should adopt the UNCITRAL cross-border insolvency Model Law, it should be recognised that many of our major trading partners either have such a procedure or are in the process of including one in their statutory provisions, not least the Australian Voluntary Administration procedure. Reciprocity is a factor, which will be taken into account under the Model Law or in giving effect to it in signatory countries.
There is a wider point, which relates to the Ministry's policy of providing an infrastructure for overseas investor confidence in New Zealand. Sophisticated business laws are part of that. The most developed insolvency regimes have a corporate rescue procedure and the developing regimes are implementing such procedures.
- Many law reforms in this area (as presently with insolvency law reform in Asia, and with statutory management in New Zealand or examinership procedure in Ireland) are passed as a reaction financial crisis in large companies, or those that threaten the wider financial infrastructure. More considered and less problematic reforms are likely to emerge from review in outside of, but in preparedness for, such crisis.
Since then, the timeliness of the question of whether or not to enact some formal rescue procedure has increased. Indeed, it is not overemphasis to say that New Zealand is in danger of being left behind and categorised as a country with a relatively unsophisticated insolvency system.
Spurred on by the Asian crisis as well as the globalisation of insolvency law and the strengthening of international insolvency bodies such as INSOL and the work of UNCITRAL, most of the world is now in the process of having reviewed or reviewing its insolvency laws, and inclusion of a form of rehabilitation procedure is being regarded as fundamental. It is true that in part, this development has come about because of the unsophisticated state of many jurisdictions' insolvency laws at the time of the Asian financial crisis in 1998, and in many of those jurisdictions reform if being "forced" upon them by international organisations such as the World Bank, IMF and Asian Development Bank. Nevertheless, out of this crisis has emerged a series of international and regional initiatives which have led to some consensus as to what constitutes the core features of a modern insolvency system, including not only the essential features of core procedures (liquidation and rehabilitation) but also the nature of the court system and professions responsible for administering that system. Ironically, having been given the impetus to embark on insolvency law reform, the Asian region is now in a position to benefit from the wealth of experience of insolvency laws in developed countries, which experience is being harnessed under the aegis of international bodies. The result is that some of the Asian countries will soon have (on paper at least) sophisticated insolvency laws. The danger for New Zealand is that all its major trading partners will soon have insolvency laws which are more sophisticated, and this has wider implications in terms of reciprocity issues and the international reputation of our financial infrastructure. Moreover, Australia has been very active in "exporting" the services of its policymakers and professionals in shaping the laws and applying the existing laws in the Asia-Pacific region. While one would not wish to undervalue the role and contribution of New Zealand professionals and policymakers in these arenas, it is suggested that the narrowness of the range of procedures which currently exist in New Zealand would affect the perception of New Zealand's authoritativeness to speak on such issues, and the relative marketability of the services of insolvency professionals in this region.
By way of example, the following countries have recently introduced more sophisticated corporate rescue procedures: Thailand, Vietnam, Indonesia. In addition, Hong Kong and Malaysia are well advanced in reform proposals that include reorganisation procedures; Korea has announced a review of insolvency law, and the latest country to announce a thorough overhaul of its antiquated insolvency laws is India. Work has begun on the difficult review of People's Republic of China's insolvency laws. Outside of the Asian region, the opening up of Eastern Europe to the market economy has led to review of insolvency law in many jurisdictions, though in most cases that happened about five years ago. In Africa, the first ever harmonised law for a group of countries, the OHADA project, came into effect in signatory countries2 in January 1999, and included both a pre-insolvency rescue procedure as well as the possibility for a court-ordered rescue in appropriate cases.
The parties to the North American Free Trade Agreement, Mexico, United States and Canada have recently co-operated on a cross-border insolvency agreement, paving the way for closer co-operation between those important trading partners.
It should also be mentioned that, aside from the rapid emergence of rescue procedures in the Asian region, several key trading nations already have such procedures in place. In particular, Singapore, with whom we have just entered into Closer Economic Relations, have had judicial management, a court-ordered rescue procedure closely modelled on the UK system of administration orders, for several years now. Japan, which already has several different rescue procedures, is undergoing a further review of its insolvency laws in order to improve them in the light of the Asian crisis.
International Initiatives
It is trite to mention the globalisation of business, or even the globalisation of insolvency law. The UNCITRAL cross-border insolvency Model Law, which was by no means the first of such initiatives, illustrates what can be done when there is a commercial need for an international solution and frustration at problems raised by national territorial differences. As stated above, the UNCITRAL Model Law initiative is itself relevant for the debate on Corporate Rescue, given the widespread adoption of such procedures noted above. It should be noted that the UK government will, in a few weeks, pass into law an enabling provision for the UK to incorporate the Model Law, and some Asian jurisdictions are doing the same, for example Hong Kong.
Aside from Cross-Border Insolvency, there have been the following relevant initiatives of which the author is aware. The Asian Development Bank launched its RETA project3 in 1998 to assist insolvency law reform in Korea, Japan, Taipei, China, Hong Kong, Singapore, Malaysia, Thailand, India, Pakistan and the Philippines. As well as serving to assist in the understanding and derivation of those countries' existing insolvency laws, the Bank has prepared standards of good practice which can be applied to assess a countries' conformity with the essentials of a modern insolvency law, and ways to assist in development of informal workouts. In addition, the ADB has produced a report on the Need for an Integrated Approach to Secured Transactions and Insolvency Law Reforms, prepared by Ron Harmer, lawyer and architect of the Voluntary Administration system in Australia. This report, arising out of the ADB's two day symposium in Manila in October 1999, contains some useful conclusions on how to deal with the problem of secured credit in a reorganisation, which will be discussed below.
In 1999 the IMF4 Legal Department produced a report entitled "Orderly and Effective Insolvency Procedures" which contains significant sections on the crucial detail required for an effective rehabilitation procedure, and the relationship between liquidation and rehabilitation.
The IMF has also done work on out of court insolvency workouts or restructurings, as has INSOL (Society of International Insolvency Practitioners), whose Lenders Group has recently produced a draft Statement of Principles for a Global Approach to Multi-Creditor Workouts.5 In addition the International Insolvency Institute, which works closely with UNCITRAL, has produced a draft Model Voluntary Out of Court Restructuring Statute.6
Further reports can be expected in the near future from the World Bank and the OECD.7 As you will know, the OECD, in conjunction with the World Bank, APEC and Australian Treasury Department, held a symposium in Sydney in September 1999, attended by representatives from the Ministry. This will lead to a report, but a draft World Bank Principles and Guidelines on Building Effective Insolvency Systems is influential in the thinking of how policy makers should approach the design or reform of insolvency laws.
Lastly, the UK Government produced in 1999 a Consultation Paper, A Review of Company Rescue and Business Reconstruction Mechanisms8 and following public consultation, a final report was published on 2 November this year. 9This report, which will be subject to a further round of consultation, makes important recommendations and suggestions as to how to improve existing rescue procedures in the UK. The most controversial suggestion is that floating chargeholders should no longer have a veto on the appointment of an administrator. In the meantime, the UK Government has promoted an Insolvency Bill, which improves existing rescue procedures for smaller companies, in particular by providing a 28 day moratorium against action by secured and unsecured creditors (without court involvement), and this will be enacted in the next two months. An earlier proposal in that Bill that a floating chargeholder should have to give notice to the company before appointing an administrative receiver, was removed after it proved controversial among stakeholders and practitioners.
In summary, the international perspective is relevant in two ways. First, it is crucial for New Zealand to have a system in place which inspires confidence overseas, which it will do if it is a relatively sophisticated insolvency system and one which can deal efficiently and fairly with the growing international nature of insolvencies. Secondly, the international organisations and professional bodies have done much work, some of which is overlapping, to identify fundamental building blocks of a modern insolvency system.
It is not suggested that other the insolvency systems and laws of other jurisdictions with inevitably differing economic and cultural histories should simply be transplanted into our system. However, while it is recognised that an examination of the issue of whether we need a rescue procedure and what form it should take, must start from the existing New Zealand structure and take into account the economic, cultural and financial framework in New Zealand, the identification of key objectives and constituent elements of a rescue regime can be done by drawing on these international resources and evaluation of existing systems.
The Evolution of the Rescue Culture
One must always caution against the "build and they will come" syndrome. The phrase "rescue culture" has been used frequently over the last ten years, and increasingly so. Cultures cannot be imposed, and take years to evolve. Having said that, it is relevant to point out that the nature of insolvency laws and insolvency work has changed in the last few years. In the past, insolvency was largely cyclical within a domestic economy. When the economy was doing well, insolvency professionals turned their minds to advising businesses how to be more profitable, rather than just dealing with the effects of insolvency. While insolvency always will retain that cyclical element, it is clear that the emphasis of insolvency laws and insolvency work has widened beyond liquidation and receivership, which are both concerned with recovery of the maximum return from the wreck of a clearly insolvent company.
The globalisation of business, hedging against currency fluctuations, and the shock of severe financial crises, have combined to mean that insolvency law and insolvency professionals have to respond with a wider array of tools than those which have served them well in the past. Both at an international and domestic level, insolvency practices are changing their focus. This has been happening for some years, but is now becoming more pronounced. The best way to illustrate it is by reference to the nomenclature of many insolvency organisations and units. Most large worldwide accountancy practices stress the "rescue" or "reconstruction" side of their work in the title of their groups, and professional organisations are moving away from the "insolvency" label. Thus, in the last few months, the major UK professional organisation, which covers lawyers and accountants, the Society of Practitioners of Insolvency, has changed its name to "R3", which stands for Rescue, Renewal and Reconstruction.10 In addition, the last two years has seen the emergence of a worldwide movement of turnaround specialists, organised through the Turnaround Management Association, which now has a New Zealand branch. The English organisation is shortly to introduce specialist examinations for turnaround professionals.
Of course, too much emphasis should not be placed on the efforts of professionals to rebrand themselves in the market place or to emphasise the less stigmatised aspects of their work, 11 but the combination of these trends around the world serves to emphasise that what is emerging is a specialist profession who will soon have specialist training in rescue procedures in their home jurisdictions and contribute to the international debate. The idea of "turnaround" is to deal with the companies who are not insolvent, because they have not yet reached that stage; indeed it can be concerned with solvent companies in a bid to make them more profitable in the long term. But even where it is concerned with companies who are financially distressed, the emphasis is on early diagnosis and treatment. To the extent that rescue procedures, whether formal or informal, will reinforce this culture, they should be encouraged.
Further Research
When considering the appropriateness of overseas approaches to distressed businesses, the extent to which they are relevant or helpful as guides to the direction which New Zealand law should take would be assisted by empirical research into several aspects of the current New Zealand law and practice. In the absence of such evidence, there is a danger that anecdotal evidence and interest-group positions will displace it. (The lack of empirical evidence on insolvency law and practice is a worldwide problem, though where it exists, it has been incorporated into this report.)
Specific areas in which research would be useful in New Zealand are:
- The use of Part XIV Companies Act;
- The prevalence of informal workouts, the characteristics of the debtor, and the outcomes of such workouts;
- The basis upon which decisions to take security from private companies are made, and the nature of that security in different circumstances;
- The basis upon which a decision to appoint a receiver is made, and what steps and practices exist to monitor distressed businesses prior to that point,
- Recovery rates for different types of creditor under existing insolvency procedures, and for different business sizes.
Needless to say, there are other specific issues on which evidence would be of assistance, but the important point is to build up an objective picture of the occurrence and characteristics of corporate distress in New Zealand, and the factors which impact on outcomes under current law.
Objectives and Reasons for Rescue Procedures
The issue of whether there should be a formal corporate rescue procedure, and if so in what form, cannot be divorced from wider questions as to the scope and philosophy of corporate insolvency law. The most controversial debates have revolved around whether an objective of corporate insolvency law should be to facilitate rescue or rehabilitation of companies. It is common ground amongst all commentators that a procedure for a fair and orderly realisation and distribution of assets to creditors and other stakeholders, is the minimum objective of corporate insolvency law. Some commentators are of the view that this is the most that it should do, as well as the least. While they may concede that the law should encourage rehabilitation of individual debtors, this is not extended to companies (since they have no soul or body).
Whether the law should facilitate the survival of businesses (as opposed to companies as such) in trouble is keenly debated amongst academics, particularly in the US. At one extreme, the view is taken that rehabilitation of businesses should be an independent goal of corporate insolvency law because of the social or socio-economic costs of business failure, (for example loss of jobs or infrastructure, investment in human capital) and its effect on a local or wider community. At the other extreme, there is a view that businesses should only be assisted to survive if "they are worth more alive than dead", the objective being to maximise returns to creditors. To some extent, these academic standpoints are reflected in different countries' insolvency laws, though it is difficult to find examples at both extremes. Most practical examples of rescue procedures tend to sit somewhere between these two, insofar as any objectives are expressed or divinable. France is an example of a country where preservation of employment is placed at the forefront of insolvency laws. South Africa, on the other hand, has a procedure which can only be used if a court can be convinced that a business will return to solvency.
Maximisation of Creditor Returns
Those that propound the view that corporate rescue should not be seen as an independent goal of insolvency law for its own sake usually agree that if, in an appropriate case, a greater maximisation of returns to creditors could be obtained by enabling survival of a business as a going concern, this would be a legitimate goal of insolvency law, and one that creditors would wish to achieve, if possible by agreement. This is the major reason why rescue procedures, both informal and formal, have been promoted and implemented, and why they have received the approval and co-operation of stakeholders in insolvent or distressed businesses.
It is widely accepted that this is the major objective of insolvency systems. Some debate could be conducted about whether it is simply returns to creditors that should be focused on, as opposed to other stakeholders. But given that the edifice of insolvency law is based on credit, and given that a company in distress is unable or may be unable to pay its debts, the return to creditors is a tangible goal which displaces any issue of returns to investors (that is not to say that the latter should be forgotten in any rescue procedure) let alone the intangible interests of the wider community.
Thus there seems little point in disputing that the primary goal of insolvency laws is wealth maximisation, or loss minimisation, in the form of maximising returns to creditors as a class. (This goal says nothing about priority amongst different groups of creditors, which may impact on rescue, and will be mentioned briefly below). Indeed, when one considers that the traditional justification for collective insolvency in the form of liquidation is the inefficiencies of individual creditor behaviour which may deplete the common pool of assets from which claims can be met, collective corporate rescue procedures are simply a natural extension of this to achieve another, sometimes better, way of maximising the value of the debtor's assets for the benefit of creditors.
The Limits of Liquidation
Liquidation will usually be the most efficient and expeditious method of pursuing that primary goal, where an insolvent business clearly cannot continue trading. A liquidator has powers and duties to act on behalf of all creditors to conduct an orderly realisation of the company's assets, and to distribute them in accordance with statutory and contractual priority rules.
In practice, this will be done by a speedy sale of the company's assets at the best price that can be obtained for them in the circumstances, combined with a disclaimer of unprofitable contracts or leases and clawback of any voidable transactions. If a liquidator trades, it will be a short-term holding position in order to preserve value of assets or fulfil key orders pending break-up of the business and assets.
Liquidation also carries with it a stigma, suggesting terminal illness on the part of the company. It is for this reason that companies often try hard to prevent advertisement of creditors winding up petitions. This will affect the price obtainable by the liquidator for the company's assets, and the perception of those dealing with the company and its business. Indeed, such is the stigma attached to liquidation that in some jurisdictions consideration is being given to whether or not rescue procedures should be removed from Insolvency statutes and relocated in separate statutes. For these reasons, liquidation is not the appropriate procedure within which to attempt to rescue any viable parts of a business, nor is it equipped to do so.
The price available for the assets of a company in liquidation, which will usually have ceased trading, is affected by the fact that the valuation of those assets is done on a "break up" basis, i.e. as separate assets. In contrast, where a business is continuing to trade, as it may do under a receiver or in a rescue procedure, assets are valued on a going concern basis where it is possible to sell the business as a whole, or at least parts of a business, as an ongoing trading entity, with the added possibility that a bundle of assets essential to the running of the business or part of it by a purchase, can be sold together and thus will attract a greater aggregate value than the sum from the sale of the separate parts.
It is this last factor which means that it is sometimes possible to achieve a greater maximisation of return to creditors through receivership or a rescue procedure. Thus, even if the narrowest objective of a rescue procedure was taken, viz. maximisation of returns to creditors, there are many situations in which use of a rescue procedure will achieve a greater realisation than on a liquidation. Indeed, this is so crucial an aspect of rescue procedures that it is built into many of the purposes of such procedures, such as in Australia and the UK. In one recent UK case the court made an administration order simply because it was shown that the rate of interest obtainable by an administrator from the government's Insolvency Services Account, into which all realisations must be placed, was higher than on a voluntary liquidation. This adopted a wide view of better realisation than on a liquidation.
However, aside from the possibilities of achieving a greater realisation than on a liquidation because of advantages of the rescue procedures and the lack of stigma affecting price of assets, the more important way in which a rescue procedure can achieve a greater realisation for creditors than on liquidation is because in some appropriate cases, the rescue of a business or its viable parts may be possible, under the umbrella of the rescue procedure, either by the sale of the business or parts as a going concern, or by a restructuring of debt and equity by agreement amongst creditors, conducted under the umbrella of a moratorium on creditor action and a framework of legislation which facilitates creditors to reach a consensual solution.
Rescuing Businesses, Not Companies
As pointed out by the Cork Committee, society has no interest in rescuing companies, which are mere abstract legal shells. Unlike individual debtors, they have no body and soul. Directors may well have an interest in preserving corporate structures since the dissolution of the company usually coincides with the end of their involvement with the business. Debt restructuring designed to preserve corporate structures does happen, and can be a valuable form of short-term assistance to companies or groups that while not necessarily insolvent, need "turnaround" treatment. However, it is important to make the distinction between businesses and companies because it is sometimes argued that company law (as opposed to private bargaining) should not get involved in rescue or rehabilitation of insolvent companies. The argument is along the lines that in a market economy, many companies fail. Failure is a fact of business life, and insolvency is a fact stemming from the credit economy. If companies fail, that is generally because they are unviable and therefore it is a good thing that they fail, thereby making way for other, presumably successful and solvent, companies to take their place, and for investors' funds, employment etc. to flow into those latter companies. It is pointed out that many companies become insolvent in the first few years of incorporation, and that this is a method by which weak companies or those with uneconomic ideas are weeded out. This "Darwinian" view of company and insolvency law finds some support in the academic writings at one extreme of the spectrum of views, in the writings of those such as Douglas Baird.12
However, on closer examination it becomes clear that, no matter how true it might be in a market economy that some element of failure is essential to private enterprise, even writers such as Baird have taken on board the distinction made by the Cork Committee between companies and businesses.
So it is largely true that insolvency law should not attempt to rescue insolvent companies, as opposed to businesses. It is not completely true because there are some circumstances where insolvent companies may need to be rescued (at least in the short term) in order to rescue viable businesses. This is particularly likely to be the case with group structures. Since group borrowing facilities are often linked, so that events of default in one company may trigger insolvency of other group companies, or trigger cross guarantee obligations, there are occasions when rescue procedures are necessary for preserving the structure and financing of companies, as opposed to just businesses.
Rescuing Insolvent Businesses
Bearing in mind, then, that the primary objective of collective insolvency proceedings is to maximise creditor returns, and bearing in mind that it is with businesses, not companies, that rescue procedures should be primarily concerned, how is the case for rescue procedures established?
Rescue procedures, and legislative or executive involvement in the facilitation of out of court rescues or restructurings, are justified where they may result in a better maximisation of creditor returns than on liquidation. It is not suggested that rescue procedures should be used for all companies. Clearly the comments above in relation to weeding out unviable entities, apply to businesses. Rescue procedures should not exist to "prop up" or prolong the life of unviable businesses. To quote from the UK DTI report on Business Rescue:
"Corporate rescue mechanisms are not intended to maintain inefficient firms that are not economically viable, or to protect debtors from creditors except for time-limited and short periods to facilitate the orderly restructuring of the corporate entity and/or its business."13
In addition to the wealth- maximisation justification for provision of a rescue procedure to complement existing procedures, there are other justifications.
First, it is often said that directors of companies would like the ability to initiate assistance at an early stage of financial distress, before formal liquidation becomes inevitable. Facilitation of early intervention, and avoidance of formal liquidation in some cases, furthers more than one goal of insolvency law. First, it is likely that in some cases creditor loss will be minimised if directors feel assured that they can trigger formal procedures rather than continue trading to the detriment of, and at the expense of, creditors. Hence, encouraging early "treatment and prevention" of failure should further the primary goal of creditor wealth- maximisation.
Secondly, it is often claimed to be a goal of insolvency law that the law should encourage, promote and facilitate high standards of integrity and accountability among directors. (The Preamble to the Companies Act 1993 mentions encouraging efficient and responsible management). There are many provisions and mechanisms currently in place in New Zealand which indicate that this is a goal of company and insolvency law. In particular, sections 135 and 136 Companies Act 1993 impose duties upon directors (widened considerably in 1993) which expose directors to liability for incurring obligations or trading beyond the point when they knew or ought to have known that the company could not avoid liquidation and meet its liabilities. It is implicit in these provisions that directors are encouraged to seek advice and take steps to minimise loss to stakeholders, in particular creditors where the company is insolvent or near-insolvent. A formal corporate rescue procedure would allow directors to further minimise loss to creditors by preserving any going concern value in the business, and, by involving outside independent financial assistance or management, this preservation is more likely to be long- term.. Incentives and deterrents can be built into insolvency laws so that directors are encouraged to utilise rescue procedures, even where they may perceive this as relinquishing some control over the company or admitting failure. Insolvent trading liabilities should deter directors from continuing in business past the point where they should have sought early advice, and directors initiation of rescue procedures can be made a defence to insolvent trading allegations, as in Australia.
A third possible goal of corporate insolvency law is to investigate the causes of company failure in a particular case, in order to ascertain what steps, if any, may be taken against those involved in the management of the company. It is implicit in current legislation that this goal exists, given that the statutory management regime includes investigatory powers, and given that there are executive powers to disqualify delinquent and defaulting directors. Just as with liquidation, rescue procedures involving an independent expert afford an opportunity to pursue such inquiries in the interests of the public, creditors and other stakeholders. (This last goal is only relevant if any proposed rescue procedure involves an independent outsider. If all that is proposed is the facilitation of consensual compromise, then no investigatory opportunity arises. Conversely, absence of any outside professional involvement in any rescue procedure may enable directors to avoid investigation or intervention.)
The fourth objective of corporate insolvency law should be to provide a "menu" of procedures from which creditors, directors and others and/or the court, can select. The circumstances of each particular case of financial distress mean that a variety of procedures should exist which can be selected as appropriate. Neither liquidation, receivership nor corporate rescue will be appropriate in every case. Provided that there are adequate checks and balances to ensure that the right selection has been made from the menu14, and to allow for variation or change of direction if circumstances change or were misjudged, the role of State intervention through provision of an insolvency regime should be largely to facilitate consensual solutions.
Lastly, and related to this, it is important to be clear that any proposal for a formal rescue procedure will not be a "cure-all". First, it is difficult to define and measure "rescue" as a successful outcome within a reasonable timeframe. Secondly, the need to maintain the "menu" approach also involves the need to maintain flexibility so that, for example, conversion between different types of procedure is relatively straightforward. In designing a formal rescue procedure, a decision has to be made as to how far it will facilitate plural objectives, such as an alternative type of liquidation, or how far it should be purely a reorganisation provision. This involves choice as to expressed legislative intent, access criteria and conversion criteria. Those choices should be informed by such empirical research on outcomes as has been done in jurisdictions which already have formal rescue procedures.
Size of Businesses
Generalisations are often made about the merits of a variety of insolvency and rescue procedures, without paying sufficient attention to the size of the businesses to which the procedures would apply. It is now becoming clear, through both policy discussions and empirical research, that size does matter. It would be difficult to design a rescue procedure which is suitable or attractive for all sizes of companies. For example, research has been conducted on informal "bank" rescues, but this research tends to suggest that while informal rescue arrangements have much merit in multibank cases, the small to medium sized enterprise generally only has one or two financiers and so quasi-informal procedures such as the London approach are not so appropriate. Secondly, the more court-orientated rescue procedures, such as the UK administration order or the US Chapter 11 procedure, seem to produce satisfactory results with large insolvent companies or groups, partly because the assets can absorb the high entry and ongoing costs of such procedures.15
There are several recent examples of legislatures recognising the need for different solutions to be available for different sized entities. As mentioned below, in Canada this has led to the legislature reflecting the market view that a more flexible court-driven procedure was more appropriate for larger entities, so that the Companies Creditors Arrangement Act can now only be used for companies with liabilities over Can $5 million. In the UK, the Insolvency Bill is enhancing the Company Voluntary Arrangement procedure with a moratorium, but, whether wisely or not, is limiting this to small to medium sized entities as defined by the UK Companies Act, which uses a mixed test of size, based on turnover, assets and employees. In the United States, there have been calls for a separate Chapter from Chapter 11 to cover small and medium-sized businesses, given that these seem to convert to liquidation far more than in the case of larger corporations under Chapter 11 reorganisation. Of course, there can be problems whenever a restrictive definition is used. Thus, the UK has suddenly realised that this legislative initiative might include some companies in a group but not others, and could give rise to problems for securitisations, which use small Special Purpose Vehicles.
The most important point to bear in mind about size is that the majority of New Zealand companies are small, by any definition. The most important consequence of this is that any rescue procedure has to be accessible to the creditors and the company itself. Costly court-driven procedures, as they have discovered in the UK and Canada, are a major disincentive to debtors to act early to initiate a rescue. Non-court procedures such as the Australian voluntary administration and the Canadian Division 1 BIA reorganisation (see below) are cheaper, and easier to initiate. The Australian system replaces the company management with an independent professional, so is not as cheap as the Canadian system. There is some evidence in Australia that size affects successful outcomes, the larger corporations being more successful, and that direct costs of the administration procedure can have a significant impact on smaller companies' success in administration.16 However, in a country the size of New Zealand it is debatable whether it would be worth distinguishing separate procedures on a size basis. Given that large companies are rare, it might be more efficient to opt for a procedure that is inexpensive and accessible for all companies and their creditors.
The point about size does not just relate to formal rescue. It is sometimes argued that there is a large amount of informal restructuring and "rescue" that is conducted without publicity or proceedings. However, there is evidence17 to support the view that while informal rescues are a vital part of the equation in any insolvency system, they tend to favour secured creditors at the expense of unsecured and trade creditors, who do not have the information advantages in an informal situation. This is particularly true in smaller companies dominated by one or two lenders. It would follow that rescue should not just be left to informal bargaining processes because of the imperfect informational position of junior creditors, especially in small firms. In larger firms with more diverse lending and equity structures it may be that junior trade creditors are paid off as a matter of necessity since information is not in the hands of so few stakeholders.
Back to Top