News Room

by Nick Samios
Posted 11 Feb 2010 6:40 AM

http://www.businessspectator.com.au/bs.nsf/article/solving-the-insolvency-puzzle-pd20100122-zw77e?opendocument&src=blb&is=financial%20services&blog=on%20credit

The sale of Australian bonds offshore is now set to become easier courtesy of the recent overhaul of insolvency laws according to ANZ head of debt capital markets Brad Scott. He was primarily referring to the Sons of Gwalia decision course, but more reform is on its way.

We seem to review of our corporate insolvency laws fairly regularly in Australia. Anyone remember the Chapman enquiry in 2003?

I suppose with the recent increase in insolvencies and the spate of high profile collapses early on in the GFC, another review was inevitable, and so last month, The Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen, announced a package of reforms to Australia's corporate insolvency laws.

The Minister said at the time that “the reform package contains a range of reforms directed at reducing the costs and complexity of insolvency administrations; improving communications with creditors; and reducing the potential for abuse of corporate insolvency law. The reforms will include the adoption of substantially all of the recommendations made by CAMAC in its Issues in external administration report."

We have since seen responses from various insolvency practitioners in the media, all with their own barrows to push, so I thought I would get you a different perspective, and so spoke to Adrian Loader, the current President of the Turnaround Management Association. Adrian is also Managing Director of private equity firm Allegro Private Equity, and as such has plenty of hands on experience in corporate turnaround and restructuring with skin in the game.

Nick Samios: Last week, David Bell, Chief Executive of the Australian Bankers Association welcomed proposed reforms to Australia’s corporate insolvency laws. He said that “there have been examples where a company has been propelled into an insolvency administration because of the director’s duty not to trade whilst insolvent but without sufficient opportunity for good faith consideration of options that could salvage the company”. Do you agree, and if so, what needs to change?

Adrian Loader: The current trading whilst insolvency laws do not work because irrespective of the legal liability, the laws are complex and the prosecution rate for trading whilst insolvent is extremely low. It seems that ASIC only pursues the most blatant of cases and thus I question the effect of the trading whilst insolvent law.

The hardest thing about drafting legislation to deal with directors duties in insolvent situations is trying to get the balance right. If a company is being turned around, then there is a high likelihood that it is going to be loss making and probably cashflow negative for a period. If the turnaround is a success, then jobs and equity value would have been saved. If the turnaround is unsuccessful then it is likely that the creditors will end up losing more money. Trying to design a law that encourages turnarounds, yet protects creditors, is very hard, as the range of situations where distress occurs is varied.

The big issue is that size of company does matter. In large companies, shareholders, directors and management are generally different people. In small family companies it is very common for these to be the same person or from the same family (i.e. the owner, the director and the manager of the newsagency are a husband and wife team).

This leads to the situation where directors in small companies have a different risk/reward appetite to independent directors on public companies to continue trading when a company is losing money.

Any weakening of the trading whilst insolvent laws encourages shareholder directors to trade whilst insolvent as often all the family wealth is tied up in the business. At the other end of the spectrum, in large public companies, the risk/reward appetite is reversed. Any gain from a successful turnaround goes to shareholders whilst liability (which is often significant) goes to the directors. These public company directors obtain insolvency advice, which is generally conservative, and this can lead to the situation where appointments of administrators happen before options to salvage the company can be worked out.

Perhaps the simplest way to address this issue is to have different laws for different sized companies. Maybe small turnover companies (say less than $50 million) have the current laws but larger turnover stores (say over $50 million) have the changes suggested by David Bell. This would have the side benefit of allowing poorly performing larger companies to attract good quality directors who otherwise would not be prepared to join the company because of fear of trading whilst insolvent.

Samios: Every couple of years we hear calls for Australia to adopt “Chapter 11” style laws. Do you think we really need Chapter 11 in Australia? As a secured lender, personally I don’t think so, though I do see merit in Debtor in Possession finance. Critics of Chapter 11 point to the phenomenon of “Chapter 22” and “zombie companies”. What do you think? Are there good bits and bad bits in Chapter 11 we should consider/ avoid?

Loader: I am a fan of creditor led insolvencies. However the role of the administrator should change to being able to properly restructure a company rather than to sell the assets through a process. There are many issues making the current administration process efficient, of which I will discuss two:

Issue one – it is very difficult for companies to restructure through the administration process because almost all commercial contracts have a clause stating that an insolvency event leads to a termination of the contract. In the event of an administration all the contracts have to be renewed (leases, supply contracts, service contracts etc) making it very difficult for the administrator to sell a business rather than just the assets or restructure the company to make it profitable. This significantly reduces the ability of the administrator to restructure. A better way would be to legislatively ban the effect of these clauses.

Issue two – time period for insolvency. Administrators should have the power to quicken the administration process if agreed by creditors. Generally, every day a company is in administration it loses value as customers leave and suppliers stop servicing it. Flexibility for the administrator would improve the outcome for all creditors

Samios: The Japanese government has established what it calls the Enterprise Turnaround Initiative Corp to facilitate the turnaround of large companies. We are seeing it in action with JAL. Should reformers be looking at something like this for Australia?

Loader: Having funding available to assist in the bailout of companies is a good idea. Using government money is not a good idea. There are many private equity players in the market who provide this service and they are very experienced in assessing the risk and reward of participating in the bailout. Government’s would not be as clinical in their assessment and could easily be influenced by other policy goals. Additionally, the government will always be blamed for either assisting a troubled company or industry or not assisting it. Look at the criticism that the Obama administration received from supporting GM for example.

Adrian Loader was at pains to point out that the views he expressed here are his own, and not necessarily shared by the TMA, but I thank him for his valuable insights all the same.