6. Problem Definition
There are several issues that require consideration. These include the starting point for the bankruptcy administration procedure, sufficiency of incentives for early intervention and that the current regime attempts to provide one system to process all types of estates and bankrupts.
6.1 Defining Bankruptcy
The point at which bankruptcy occurs, and the nature of bankruptcy, will affect the application of the bankruptcy procedure. Currently, the Act provides confusion and uncertainty.
There are two parts to this issue: the doctrine of relation back, and the current definition of the acts of bankruptcy in the Act. The two are linked, particularly in the case of creditor-filed petitions.
At present, bankruptcy begins for creditor-filed petitions when the debtor makes the act of bankruptcy (see 6.1.1), not at the point of adjudication. This is due to the doctrine of relation back. For debtors, bankruptcy begins at the time of filing or, if the bankrupt is proved to have committed an act of bankruptcy, at the time of the act.
6.1.1 What Is an Act of Bankruptcy?
For the purposes of adjudication, section 19 of the Act defines bankruptcy as one of several acts set out in that section. A debtor commits an act of bankruptcy in each of the following cases:
- Where in New Zealand or elsewhere the debtor makes a disposition of all or substantially all of their property to a trustee for the benefit of all or any of his or her creditors.
- Where, in New Zealand or elsewhere, the debtor fraudulently, or with intent to give any creditor a preference over other creditors,
- Makes any disposition of his or her property or any part of it; or
- Creates any charge on it or gives any security over it; or
- Makes any payment; or
- Incurs any obligation.
- Where, with intent to defeat or delay his creditors, the debtor leaves, attempts to leave or is about to leave New Zealand, or (being out of New Zealand) remains out of New Zealand, or leaves his or her home, or otherwise absents himself or herself, or keeps to any premises or to part of premises to avoid his creditors:
- Where a creditor has obtained a final judgment or final order against the debtor for any amount and execution of it has not been stayed, and the debtor has a bankruptcy notice under the Act served on him in New Zealand (or, by leave of the Court, elsewhere) and does not, within the required notice period, either comply with the requirements of the notice or satisfy the Court that he or she has a counterclaim, set-off, or cross demand which equals or exceeds the amount of the judgment debt or sum ordered to be paid, and which the debtor could not set up in the action in which the judgment or order was obtained or the proceedings in which the order was obtained.
- Where the creditor gives notice to any of his or her creditors that he has suspended, or is about to suspend payment of his or her debts.
- Where at any meeting of his or her creditors, the debtor admits insolvency and either
- A majority (in number and value) of the creditors present at the meeting by resolution at the meeting require the debtor to file a debtor's petition; or
- He or she consents to file a debtor's petition and does not do so within 48 hours (excluding any holiday) from the time of his or her consent file the petition.
- Where possession has been taken under execution issued against the debtor or his or her property on any legal process and the judgment or order in respect of which the execution is issued is not satisfied within seven days after possession has been taken. (However, where an interpleader summons has been taken out in regard to the property seized, the time between when the summons is taken out and when the proceedings on the summons are finally disposed of, settled, or abandoned is not taken into account in calculating the seven-day period.)
- Where a writ of sale directed against any of the debtors land or any interest in it has been delivered to a Sheriff, and that land or interest has been advertised for sale under that process.
(However, if the judgment or order for which the writ of sale was issued is satisfied within seven days after the writ of sale has been delivered to the Sheriff and advertised, no act of bankruptcy is committed.) - Where a return of nulla bona (insufficient goods found on which to levy) has been made to any execution issued against the debtor or his or her property on any legal process.
- Where, with intent to prejudice his or her creditors or to prefer one creditor above another, the debtor removes or conceals any of his or her property or attempts to do either.
- Where the debtor is required by law to keep a trust account any court has given judgment against him for non-payment of trust money and the judgment is unsatisfied for seven days.
Such a list of acts of bankruptcy is needed to provide guidance for creditors and debtors as to what an act of bankruptcy is and when the bankruptcy administration procedure can be initiated. The common theme that runs through most of the listed acts of bankruptcy is that of an outstanding debt which has not been paid even after a creditor has used their available remedies to pursue the debt.
The acts of bankruptcy become very important in creditor-filed petitions, and sometimes in debtor-filed petitions. The occurrence of the act of bankruptcy will determine when the bankruptcy begins for the purposes of asset realisation, a situation that is termed the doctrine of relation back. The doctrine means that although the bankruptcy procedure began at the point of adjudication, the scope of the bankruptcy can extend back to transactions before adjudication. How far back may depend on when the act of bankruptcy that the creditor's claim was initially tied to occurred. This doctrine overlaps with the role of voidable transactions, also a topic under Tier One of the insolvency review.
6.1.2 What Assets Are Available to the Collective Pool of Creditors?
Statistics show that most estates have few, if any, assets for distribution to creditors. Relation back allows the Assignee access to those assets held before adjudication, but after the point of insolvency, that the debtor may have distributed in favour of certain creditors. This doctrine is hardly used, as it is difficult to determine when insolvency begins. However, relation back should not be discounted due to its current lack of use.
Bankruptcy administration facilitates compulsory and collective realisation of a debtor's assets, which is regarded as more efficient in maximising the pool of assets available to all creditors than would be the case were creditors left to pursue their individual remedies. It also allows for distribution to creditor groups equally, thus upholding the pari passu principle. Relation back allows all assets that should be in the central pool to be used for equal distribution to the groups of creditors.
The other option available to the Assignee for realisation of assets that should be used for all creditors is voidable transactions. This is a separate topic under the insolvency review, looking at approaches to improving the application of these rules. Voidable preference law is designed to support this system of collective realisation and the underlying pari passu principle. By discouraging, or reversing the effect of one creditor's gain at the expense of creditors generally, provisions avoiding these types of transactions ensure that there is a "level playing-field" for all creditors and that there is something left to play with.
The overlap between voidable transactions and the doctrine of relation back provides for two methods of achieving the same aim. The problem is that debtors and creditors need certainty as to when bankruptcy begins. It does not provide certainty to have two rules fulfilling the same purpose.
6.2 Insufficient Incentives for Early Intervention
When considering the issues of insufficient incentives for early intervention, one option is to focus on incentives for debtors and creditors. Improving incentives for debtors would involve providing them with a benefit they would not otherwise receive if they did not seek early intervention. Incentives can include access to alternatives to bankruptcy, a shorter time period for bankruptcy, or support and advice financial management. Another option is providing a "breathing space" for debtors that are insolvent and facing legal action by creditors. A mixture of these would increase the incentives for debtors to seek early intervention.
6.2.1 Debtor Incentives
Encouraging debtors to seek help before bankruptcy would improve the opportunities to avoid the stigma of bankruptcy and the financial inevitability of a poor credit rating that continues after discharge. Increasing the availability of information will increase access to available options.
6.2.2 Creditor Incentives
Early intervention could benefit creditors because the insolvency framework will focus on retaining assets within estates for repayment to creditors. As indicated in the statistics for the year ended June 2000, usually little or no money is currently repaid to creditors from a bankrupt's estate. This is because by the time the bankruptcy starts, most of the debtor's assets have been used to try to stave off the bankruptcy. Early intervention, without the costs of court action, could maximise creditors' returns.
6.2.3 Education and Dissemination of Information
Debtor education comprises three main roles: decision-making, resource management and community participation. Decision-making is influenced by the factors surrounding the debtor at the time of the decision. It is important information to provide a debtor with education and information on choices and responsibilities, especially in relation to credit. Financial planning, money management, prudent purchasing habits and sensible risk taking skills are all necessary tools for debtors. A sound working knowledge of business and Government processes will provide individuals and communities with the tools to make sensible decisions. Information on the procedures and options when financial difficulties occur is valuable as information. Information on the benefits of early intervention will provide awareness of incentives.
6.3 The Existing Regime Is Not Appropriate in All Cases
The problem may be stated as the existing regime is not appropriatein all cases. There are essentially two types of bankruptcies and different considerations apply to each, yet the existing regime does not take account of these differences. The two types are debtors with little or no assets and estates with assets.
The current regime attempts to provide one system to process all types of estates and bankrupts. The result is that it focuses on the bankruptcy administration procedure at the expense of alternatives to bankruptcy. As a consequence, estates that would be better suited to the alternatives end up in formal bankruptcy proceedings. When debtors become bankrupt, their ability to participate in the market-place, contributing to the economy as a whole, is removed. The Ministry wishes to develop a system which maximises returns to creditors, provides certain and predictable outcomes and, where appropriate, provides alternatives to bankruptcy. To fulfil this objective, the current system needs to be "re-balanced" to accommodate the dual functions of rehabilitation and deterrence and to address the distinct problems posed by debtors with assets, debtor without assets, and dishonest debtors.
6.3.1 Debtors with Assets - Appropriate Alternatives
In certain circumstances, where a debtor has assets it is more appropriate for stakeholder interests to rely on alternatives to bankruptcy, leaving an increased proportion of assets for distribution to creditors. This results in the debtor avoiding the penalties of bankruptcy.
The current bankruptcy regime provides alternatives to bankruptcy for payment of creditors. These alternatives are effective in themselves but, placed within the context of bankruptcy as a whole, fail to achieve the desired effect. This is due to the strong focus on bankruptcy, but not the formal alternatives, and on the costs of court involvement and the lack of information or awareness about these options.
The problem with these procedures is, first that the regime requires High Court proceedings at certain stages and, secondly, that such court proceedings are costly and subject to time delays.
Alternatives are not widely used in New Zealand. The lack of information available on alternatives to bankruptcy means debtor's often do not know about them until after they are adjudged bankrupt.
The specific deficiencies surrounding summary instalment orders are due to a combination of reasons including the low ceiling permitted for the total amount of indebtedness, the lack of supervision and administrative support (i.e. trustees and supervisors), the unsuitability of debt repayment schemes, and the lack of punitive provisions for breach of agreements.
The specific problems with proposals under Part XV of the Act include the high levels of court involvement, with the ensuing time and cost prohibitions, and the difficulty of managing creditor expectations. These proposals require creditor approval but do not deliver adequate supervision, administrative support and punitive provisions for breach of agreements to ensure creditor agreement.
The current alternatives aim to provide formal arrangements for the debtor to repay debt. There are two alternatives under the Act, one of which is aimed at debtors with low total debt while the other is a general alternative. Currently, neither is meeting the aims of providing formal arrangements for debtors to repay, as debtors are not using them. However, the principles behind the alternatives are necessary for a balanced bankruptcy system.
6.3.2 Debtors without Assets
Where debtors have little or no assets for distribution to creditors, the formal alternatives are not available to them. Where a debtor cannot pay their debts and does not have the requisite amount of enough remaining assets to use an alternative the only option available to them, is the bankruptcy administration procedure.
The procedure is designed at present to deal with all debtors, regardless of their financial position. The time frame for bankruptcy is set at three years, partly to provide sufficient time to process the estate and partly as a deterrence to other debtors.
Administration by the Assignee for estates without assets is usually fast-tracked and dealt with in six months.
A function of the duration of bankruptcy is deterring debtors from commercial misconduct and safeguarding the community from debtors that do become involved in commercial misconduct. It is difficult to balance the need for deterrence and the desire to encourage innovation and entrepreneurial activity. There is no empirical evidence that the current term does or does not achieve the correct balance. The current three-year time period was designed to fit a situation that existed before the enactment of the Companies Act 1993. Before the 1993 changes, one-person businesses could not be incorporated as a company, and most bankruptcies were a result of these small businesses failing. Currently, most estates without assets are consumer bankruptcies, i.e. where a person incurs debt and becomes insolvent as a consumer, as opposed to in a business context.
The role of safeguarding the community is important. However, the number of debtors who are involved in fraud or commercial misconduct is relatively low compared with the number of debtors who are "honest" but poor at managing credit and commercial affairs. The Assignee has tools to restrict certain debtors from re-entering the community in a business capacity.
There is an increasing international trend to reduce the time frames for bankruptcy, with the United Kingdom suggesting a reduction to six months, Australia recommending a move from three years to two years and the United States at six months.
As part of this review, the Ministry seeks comment on ways to reduce the number of debtors who are left with no alternative but bankruptcy. Comment on this area should take into account the role of deterrence and protection of the community, bearing in mind the focus on sensible risk-taking and innovation by New Zealanders, and the changing nature of the "typical debtor".
The procedure could be designed for ease of processing of estates without assets. In doing so, it could fast-track the legislative administration period. The trade-off would mean less deterrence for debtors to avoid bankruptcy.
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