Controversy over the Insolvency Law Reform Bill
Like any sensible person, I try to avoid reading 300 page reports by Parliamentary Select Committees. However, recently I had to read the Commerce Select Committee's report on the Insolvency Law Reform Bill. I started it thinking that this was major change for creditors and for New Zealand business as a whole. However, I find that the National MPs on the committee are very unhappy with the bill, oppose it vehemently, and say that it's not going to work nearly as well as its promoters suggest it will. What's going on?
The big news in the bill is the voluntary administration procedure, copied from Australia. I wrote a book on credit management in Australia a few years after their "VA" process was introduced in 1993 and I've seen its significance there. Lots of failing businesses use it to try to survive and on the whole, creditors are better off because they do. There are more VAs than insolvent liquidations (which dropped from 5000 a year to less than 2000 a year!) Between 25% and 50% of companies that enter a VA, end up with a deed of company arrangement (the rescue plan) approved by the creditors. There have been various studies done which show that creditors recover more money through the VA process than they would through a normal liquidation. It's been a very good thing for Australian business.
All in all, the Australian system works better than New Zealand's current compromise process. Under this process, a failing business can try to get a compromise with its creditors approved by the courts. It's rarely used, first because it's hard to organise, and second because there's not much incentive for the directors to try. Directors who have too many businesses fail may be banned from being directors by the Companies Office. They also risk being held personally liable for reckless trading if the company continued to rack up debt when they knew or should have known that it was insolvent. This latter is some incentive to try to arrange a compromise, but obviously not generally enough.
The VA process will take the company out of the director's hands and give it to an administrator to run. He or she has a month's moratorium to work out if the business is salvageable and come up with a plan to do so which the creditors will support. If they don't vote for the plan, the company goes into liquidation.
Why would directors put in an administrator? In Australia, there are three main reasons. The first is that the process works. It allows some businesses to survive which otherwise wouldn't. The second is that the directors avoid liability for insolvent trading from the point where the company brings in the administrator. These two reasons will apply in New Zealand. However, the third reason doesn't apply, and this is what the National minority on the Select Committee are clearly not happy with. In Australia, directors of an insolvent company may be personally liable to pay group tax debts (federal tax on the salaries of employees) and GST if they do not act quickly to put the company into VA or liquidation when the Australian Taxation Office issues a default notice. That notice tells the directors they will be personally liable for the debts unless they act within a certain period. Typically, when they get this notice, directors will place the company in VA.
Here's some of what the National minority on the Select Committee said in their dissenting view:
"All the submitters on this [the VA] provision were unanimous in their view that unless the Government addresses the issue of the priority status for the IRD, the voluntary administration scheme will be severely compromised... We do not believe that Parliament should pass another piece of redundant legislation when there is a groundswell of opinion from practitioners who believe that it will not work, without the removal of Inland Revenue's priority status."
What they are talking about is the fact that when a company goes into liquidation, GST, PAYE, child support, and student loan payments get paid ahead of the debts of unsecured creditors. The perception is that because the IRD gets priority, it doesn't bother to act quickly when tax is not paid. For example, in the 1999 case re Parkway Printers Limited (in Liquidation), the Court pointed out that Inland Revenue had allowed the company to continue to trade from 1991 until 1997 despite its failure to file and pay GST. (Personally, I've long been amazed that the IRD still doesn't have an outbound collection call centre.)
The Select Committee's report noted that "other creditors, who have no knowledge that significant amounts of tax are overdue and unpaid, continue to trade with the company. [Later on] they discover that the ... tax debt owed, coupled with the crown priority, leaves them with a significant and sometimes crippling loss."
My view is that removing the crown priority is not crucial to the success of the process. It's a side issue. Director's personal liability for tax is the big issue. This would give them an early incentive to use the VA process. If we don't give them this incentive, they won't use it as much. The Select Committee considered imposing this liability but rejected it because "this procedure would significantly increase director's liability, as well as eroding the fundamental concept of limited liability."
Unfortunately, "the procedure" is one of the main reasons the Australian system works well. Voluntary administration will still be a major change for New Zealand business but it won't work as well as it should.
Peter Hattaway - www.hattaways.com - is a director of Hattaways, specialists in credit management training and consulting. This article appeared in the New Zealand Mercantile Gazette in September 2006.