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Brief Counsel

The 'big five' insolvency issues for 2013

08 March 2013

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Several issues of far-reaching significance in the world of restructuring and insolvency will be decided by the courts, and by Parliament, this year. 

Some have yet to surface but others are already in the pipeline.

We look at what we consider to be the “top five”.

Litigation funding

The Supreme Court will be asked to determine the appropriate level of disclosure in cases involving litigation funders.  Last year, the Court of Appeal held that key details of litigation funding agreements (LFAs) should be released to the other party, as well as to the court.1   Chapman Tripp’s earlier commentary on the Court’s decision is available here

Until recently, litigation funding was prohibited as it affronted the antiquated torts of maintenance (assisting a party to sue) and champerty (taking part of the proceeds of the litigation).  However, more recently the Commonwealth courts have accepted that access to justice for the public2 should trump such concerns: pennilessness should not disqualify litigants from bringing justified claims.

At this fledgling stage in New Zealand, there is debate around how LFAs should operate and how should they be controlled. 

An unregulated litigation funding market could leave litigants exposed to an impecunious or ruthless funder.  There is also a risk that LFAs could assist parties to bring claims without merit in the hope of bullying a defendant into settlement.  Many funders are based offshore and are therefore outside the reach of the New Zealand courts.  On the other hand, over-regulation may impede potential litigants’ access to justice.

The Court of Appeal hesitated to intrude on the funded party’s LFA, but nevertheless recognised that some scrutiny was necessary to safeguard the process.  The question was the proper extent to which the other (non-funded) party should be informed of the terms of the LFA. 

Because of the strategic advantage that such information could provide, the Court ultimately required disclosure of only a few key details, namely:

  • the identity and location of the litigation funder
  • the funder’s financial viability
  • the law governing the LFA and which courts have jurisdiction, and
  • the terms on which the funding can be withdrawn and the consequences of a withdrawal of funding.

The Supreme Court has granted leave for the funded party to appeal. 

New Australian legislation3 effectively exempts litigation funding from all forms of regulation, save for a requirement adequately to manage potential conflicts of interest. 

Will our Supreme Court be persuaded by the Australian approach, or will it be more cautious and maintain a level of supervision?

The defence to insolvent transactions claims by liquidators

In a hearing on 7 February this year, the Court of Appeal was asked to clarify the extended good faith defence for creditors trying to retain payments made by an insolvent company against the liquidators’ powers of claw-back.

The High Court’s interpretation4 of the amended good faith defence (see box below) was good news for creditors, but may make it more difficult for liquidators to recover genuine insolvent transactions.  For our previous comments on the High Court decision see here.

Good faith defence expanded in 2007 amendment

The 2007 amendment (the Amendment) expanded the good faith defence in section 296(3) of the Companies Act. 

The defence had previously been limited to a creditor who acted in good faith and relied on the validity of the payment to its detriment.

This was extended to protect a creditor who had acted in good faith and who “gave value” for a payment.

The question before the Court was whether the Amendment saved only payments made in return for value given after, or at the time of, the alleged voidable transaction, or whether it also applied to value given beforehand?  The arguments are finely balanced.

Previous thinking was that the defence could apply only to value given at the same time as, or after, payment by the debtor.  But the High Court said that the Amendment was intended to align our law with the Australian position, even though the words of the provisions are not identical, and that the defence therefore applied to value given prior to payment by the debtor as well as fresh value given after payment. 

According to the High Court, the real concern of the amended good faith defence is whether there is a direct relationship between the payment received and the value given.  The Court looked at the policy behind the Amendment and concluded that it would be inequitable to allow a company in liquidation to keep what it has received and, at the same time, to recover what it paid for it.

However, the liquidators argued that the plain wording of section 296(3) requires the creditor to provide fresh or new value after the payment is made.  The liquidators also pointed out that, if the Amendment included value given beforehand, the requirement to have provided value would be redundant, because a creditor will have always provided some prior value (otherwise it would not be a creditor and would therefore not be susceptible to having payments set aside).  The liquidators’ interpretation would also be more in line with the concept of pari passu sharing which underlies insolvency law.

The Court of Appeal’s decision will greatly affect the ease with which liquidators are able to claw back insolvent transactions.

Banks liable for knowingly assisting directors to grant securities while insolvent

Last year, one of Australia’s longest running pieces of litigation hit another milestone when the Court of Appeal of Western Australia delivered its judgment on the Bell Group Appeal (the Bell Appeal).  The Court’s decision was over 1,000 pages long and the result of almost a decade of litigation. 

The upshot of the case was that a syndicate of 20 banks (the Banks), who took securities while the Bell Group was insolvent, have been ordered to pay back all the money they recouped from the securities, together with compound interest.  All up, that could amount to almost AUD$3 billion.

Besides the impressive sums and names involved in the case, there are a number of aspects which may prove interesting to New Zealand insolvency law: 

  • The case could give creditors another legal avenue against banks.  The court said that lenders can be liable for knowing assistance in the directors’ breach of duty and knowing receipt.  The Banks were unable to rely on the directors’ assurances that the Bell Group companies were solvent.  Because the Banks knew of circumstances which would cause an honest and reasonable person to suspect that the directors were acting in breach of their fiduciary duties, they were liable for knowingly assisting in that breach of duty. 
  • The case introduces directors’ duties in respect of creditors' interests which are arguably tougher than we have had in New Zealand to date.  At least one judge spoke of a duty “not to prejudice” creditors.  Is this tougher than the New Zealand requirement that, where a company is insolvent, or nearing insolvency, directors must take creditors’ (as well as shareholders’) interests into account?
  • If granting a security results in existing creditors eventually receiving a lesser payout than would be achieved under an immediate liquidation, directors may well have breached their duties.

How will the decision affect work-outs in New Zealand?  We would expect financiers to adopt more prudent lending practices as a result of this decision and be unwilling to rely on directors’ assertions of solvency alone. 

Almost without doubt considering the sums involved, this decision will be appealed to the High Court of Australia.  We look forward to hearing what the High Court makes of it.

The regulation of insolvency practitioners

It has been quiet on the Insolvency Practitioners Bill front for some time.  The expectation initially was that the Bill would come into force last year but it has still not made it through its second reading.  The delay seems mainly due to the Select Committee’s rejection of negative licensing in its report back to the House.

The previous Government considered that a positive registration regime would be overly expensive given New Zealand’s small number of insolvency practitioners (estimated at the time to be fewer than one hundred).  The Explanatory Note to the Bill as first introduced said that such a system would cost several thousands of dollars a year, per practitioner, to maintain.

The Select Committee, however, was not satisfied that a negative licensing system (whereby anyone can practise unless specifically prohibited) would adequately address the risks associated with insolvency practitioners who were dishonest, or who were not independent.  The Select Committee said that it wanted to prevent such individuals from practising “before the damage is done” by requiring them to be suitably licensed. 

The Select Committee recommended a registration model as a middle-ground between negative licensing and the more invasive and expensive options of a formal licensing system or a co-regulation model.7  This is projected to cost $200,000 to establish, and around $190,000 a year to maintain, and while it will require practitioners to be registered, will not require any formal qualification.

A practitioner will be registered if he/she is at least 18 years old, is not subject to a mental health treatment order, and has not been:

  • prohibited from practising by the Court
  • expelled from any relevant professional body
  • prohibited from being a director
  • declared personally insolvent, or
  • previously convicted of a dishonesty crime.

The Cabinet Business Committee has given its approval to the Select Committee’s recommendations.  We expect that the second reading of the Bill will not be far away. 

The reform of section 280 of the Companies Act 1993

The Insolvency Practitioners Bill also amends section 280(1)(cb) of the Companies Act 1993.  This currently prohibits the appointment of insolvency practitioners as liquidators or administrators where they (or their firm) have had a “continuing business relationship” with the insolvent company, its major shareholders, or any of its directors or secured creditors. 

The Bill proposes to remove “secured creditors” from the list.  We welcome this amendment. 

The inclusion of “secured creditor” has proven to be unduly restrictive, and does not achieve its apparent aim of avoiding conflicts of interest.  Section 280 was probably originally drafted with related-party security holders in mind. 

However, in practice, the provision has disqualified competent and well-regarded practitioners from acting as liquidators.  Section 280(1)(cb) prevents all insolvency practitioners from acting as liquidators or administrators who have, in the two years prior to liquidation or administration, worked for any secured financier of the company (including the major trading banks).

Trading banks often appoint insolvency practitioners as investigating accountants, which arguably creates a continuing business relationship between the practitioners and the banks.  It is also arguable that the repeated appointment of a practitioner, or those in the same firm, as receivers for particular banks also creates a continuing business relationship.  The more reputable and experienced the firm or practitioner, the higher the likelihood that the firm or practitioner will have a “continuing business relationship” with the trading banks. 

When a substantial company falls over, there are relatively few firms in New Zealand who have the resources to administer large liquidations or receiverships.  The existing rule therefore keeps out the very practitioners who are best resourced and most reputable to carry out the work required. 

The current restriction in section 280(1)(cb) has resulted in insolvency practitioners routinely applying to Court for orders exempting them from disqualification.  These orders, which are generally unopposed and uncontroversial, are an unnecessary expense, ultimately borne by the creditors.

The Commerce Select Committee did not alter the proposal to amend section 280 – this is another reason to look forward to the long delayed second reading of the Insolvency Practitioner’s Bill.

Our thanks to Beth Murphy for writing this Brief Counsel.  For further information, please contact the lawyers featured. 

Footnotes

  1. Contractors Bonding Limited v Waterhouse [2012] NZCA 399, [2012] 3 NZLR 826
  2. Including insolvent entities, for which LFAs are common, particularly in Australia
  3. Corporation Amendment Regulation 2012 (No. 6): the new regulation comes into force in July 2013
  4. Farrell v Fences & Kerbs [2012] NZHC 2865; see also Meltzer v Hiway Stabilizers New Zealand Limited (2012) 11 NZCLC 98-013 (HC)
  5. Westpac Banking Corporation v The Bell Group (In Liquidation) [No.3] [2012] WASCA 157
  6. Since the advent of the Global Financial Crisis, the Select Committee has stated that the number of insolvencies, and therefore insolvency practitioners has increased substantially.  The Committee estimated that a mandatory registration regime would cost $200,000 to establish, and a further $190,000 to maintain per annum. 
  7. A co-regulation model would have required insolvency practitioners to be a member of an approved professional body (APB) in addition to registration.  APBs, which would be approved by the Registrar based on minimum criteria, would be “front line” regulators.   The Select Committee concluded that, while co-regulation would provide greater oversight, it would potentially force smaller players out of the market.