Scheme of Arrangement Rip-offs
This article first appeared in MG Business in 1999
We know a gentleman who did a law degree many years ago (with one of the authors of this article). A successful businessman before he arrived at university, he made it quite clear why he was there: he wanted to know how to beat the system. In the decade that followed, those of us who worked in debt collection came up against him on a regular basis, either as a debtor or as a director of debtor companies throughout New Zealand.
However, we weren't directly involved when he applied for a scheme of arrangement under the Insolvency Act. Many creditors will be familiar with an informal creditors pool, a situation where all the creditors of a particular debtor are paid off pro rata (that is, with everyone getting the same percentage of their debt paid off over time). Sometimes it will be agreed that everyone will write off a certain percentage of their debt.
A scheme of arrangement is a formalised creditors pool, agreed by a majority of creditors and signed off, so to speak, by a High Court Judge. (Much the same option exists for companies under the Companies Act.) Where there is an informal arrangement, one creditor may be bloody-minded and continue to take legal action. Where there is a formal scheme of arrangement, all creditors have to live with the deal. Whether they agreed or not, they can't carry on with legal action, providing a majority of creditors by number and 75% by value approved the arrangement. For example, if there are 10 creditors owed $100,000 in total, then five in number and $75,000 in value must approve for the scheme to go ahead.
The scheme might have creditors accepting much less than they are owed - under similar legislation Australia's most famous debtor, Alan Bond, paid .0008 cents in every dollar of the billions he owed - and waiting a long time to get it. The insolvent debtor uses the scheme to avoid personal bankruptcy.
In the case of our erstwhile fellow law student, some very large creditors popped out of the woodwork and voted to support the scheme. This was not surprising given that they were family members, long-time business associates, and companies of which the debtor was a director. There was a strong suspicion that the debts these "friendly" creditors claimed to be owed did not really exist. What could the creditors have done?
Well, they could have argued to have the "friendly" votes discounted. After the two majorities of creditors agree to approve the scheme, the High Court still has to approve it, and it can refuse to do so. This is rare, but when it does happen it is usually on the ground that "the terms of the proposal are not reasonable or are not calculated to benefit the general body of creditors" (Insolvency Act, section 143(3)(b)).
For example, in Re Whimp, in the High Court in Christchurch last year, the most substantial creditor of the debtor was a company operated and controlled by his brother. Not surprisingly, the company voted for the proposed scheme of arrangement. If the debts of that company and the insolvent's brother had not been taken into account, the proposal would not have been carried by the requisite three-fourths majority. The judge decided that the proposal was not calculated to benefit the general body of creditors and declined to approve it.
In this case there was some doubt as to whether the debts were genuine, but even if a "friendly" debt was accepted as genuine, it might still be discounted. In Re McGarry in the High Court in Auckland in 1990, the judge said that "some creditors may carry less weight" because they have a "special inclination to assent to the scheme." In this case the debtors father was owed $150,000. The judge pointed out that a father might be prepared to accept a scheme which was not in his, or the other creditors' interests, rather than see his son made bankrupt. In this case, the son owed over $2 million so the father's vote was not that significant. The scheme was approved.
One of the interesting things about the cases in this area is that many of the creditors seem to be fighting a losing battle. We suspect that they have gone to court because of their sense of outrage at the debtor getting away with this, rather than because they thought there was a good chance of winning. In many of these cases, even if the friendly votes were removed, there was still a sufficient majority of independent creditors supporting to the scheme. It's all very well to send your lawyer down to the High Court to argue against a scheme, but if you haven't done the work to marshal enough votes opposing the scheme from the other creditors, you are probably just wasting the Court's time and your money.
Even if you do have the votes, there may be difficult issues of proof. We know of cases in this area where it is reasonably obvious that the debt does not really exist because there is no documentation and the numbers just don't add up. But in other cases, a more convincing fraud will have been put together, with forged documents and people prepared to lie under oath.
And what happened in the case we started this column with - the law graduate who wanted to beat the system? Our recollection is that he got away with it.
Finally, after years of false hopes and broken promises, the Personal Property Securities Bill has reached Parliament's select committee stage. This is where interested parties have a chance to put their two cents worth in. (Unfortunately, your chance to do this has passed. It was slipped in over the Christmas holiday period and the closing date for submissions was 22 February, before many of the interested parties, including Hattaway & Associates, knew about it.)
The Bill aims to make the law relating to personal property securities clear and simple. Personal property securities is the area of law currently (mostly) covered by the Hire Purchase Act, the Chattels Transfer Act, the Motor Vehicle Securities Registration Act, parts of the Companies Act, and the common law relating to retention of title ("Romalpa") clauses. It's an area of the law which is difficult, confusing, complex, inconsistent and generally messy.
Among other things, the Bill proposes the creation of a single register of securities in personal property. The Select Committee report is due on 7 June 1999. This will be the most important piece of legislation effecting creditors this year, and probably the most important piece of legislation to impact on creditors since the Privacy Act and Companies Act in 1993.