4. Reform Framework
As outlined in the insolvency framework document that accompanies this paper, the government's key goal in reforming insolvency law is to promote the public interest by maximising the business community's contribution to the New Zealand economy through increasing job opportunities and incomes. This can be achieved by fostering an environment which encourages businesses to produce goods and services at least cost, directs resources to those areas that contribute the most to the economy, and fosters innovative ways to meet consumer needs.
In essence, giving preferential status to a particular debt should occur only if there are compelling public interest reasons for doing so. That is, priority should be provided only where it can be justified by reference to principles of fairness: i.e. it will result in greater benefit to that group of creditors than the costs it imposes on other stakeholders.
When considering the costs and benefits arising from granting a priority the following key stakeholder groups, (who in many cases will have divergent interests) need to be considered:
- Insolvent debtors;
- Solvent debtors;
- Creditors;
- The Government; and
- The wider community.
In assessing whether a priority should be granted, it will be necessary to consider the possible costs and benefits outlined in sections 4.1 to 4.7 below.
4.1 The Relative and Absolute Cost of Capital and Barriers to its Supply
The cost of equity and credit (including trade credit) is determined by, among other things, the perceived risk of business performance, including the possibility of insolvency and the loss of value to creditors in insolvency. The cost of capital can be reduced by minimising uncertainty, for example, reducing the extent to which pre-insolvency rights are defeated by the debtors' actions during the insolvency process.
Creditors need to be able to assess, with some certainty, the relative strength of their claims in the event of insolvency, before investing or risking their resources with the company. This is necessary to minimise transaction costs and the cost of capital. It also helps to determine the relative cost of capital from different sources.
4.2 Company Failure (as a Result of Ineffective Incentives for Debtors to Manage Credit Efficiently)
The extent to which creditors perceive that their security in a business will be compromised by insolvency is likely to influence the extent to which they monitor the debtor company's actions. A company can be expected to lose favour with creditors if it behaves recklessly and will be discouraged from doing so if there is effective creditor monitoring of its actions. In turn, this is likely to affect the frequency of business failure.
Further, close monitoring of a debtor means it is more likely that creditors will take timely action, and well before the debtor's assets have been completely eroded.
4.3 Administration/Fiscal Costs
These are the costs the government incurs in developing, implementing, enforcing and monitoring/reviewing the regime. For example, complicated regimes generally result in high administration costs. These costs fall ultimately on taxpayers.
4.4 Transaction Costs
For the purposes of this paper, these are the costs that businesses incur in transacting with non-government entities and with individuals. A regime that promotes greater creditor monitoring of debtors, for example, will add to transaction costs.
4.5 Compliance Costs
These are the costs that businesses incur in interacting with government to comply with the requirements of the regime. A regime that gives the government a greater role in the enforcement of its provisions, or that imposes a greater level of complexity on the stakeholders it affects, for example, increase compliance costs.
4.6 Horizontal and Vertical Equity (Not Equality) between Creditors and Debtors and between Creditor Classes
As a rule, those in like situations should be treated the same. Different treatment should be justified only by direct reference to the characteristics that justify that different treatment and the likely impacts of that different treatment. For example, secured creditors tend to have long-term funds tied up in a debtor company compared with unsecured creditors, perhaps warranting a higher priority (to avoid higher financing costs for the firm).
4.7 Compliance with International Treaties
New Zealand is signatory to several international treaties which require adherence to many standards. It may be that in the future priorities will need to be provided for as a consequence of treaties. Each case will need to be considered on its own merits, and in the context of the overall benefits to New Zealand of being a signatory to each treaty.
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