Why an external administration in Australia can turn into a Seinfeld episode
Seinfeld is famously referred to as a sitcom about ‘nothing’. Sometimes liquidations and voluntary administrations in Australia lose the plot and directors would be well served to conduct thorough due diligence before appointment and understand the dynamics at play.
Here we explore in detail why exactly external administrations could get lost, looking at the obligations and experiences of insolvency practitioners who take these appointments.
There is an inherent tension in the insolvency practitioner’s role. They are torn between satisfying individual creditor claims, maximising the pot for creditors as a whole and their own self-interest in maximising professional fee recovery. This is compounded by the appointment process where the insolvency practitioner needs to canvas the debtor directors for appointments and somehow persuade them to pick them over other candidates.
And when it comes to legal and professional obligations, these are diverse, complicated and may be too vague to guide action. Insolvency practitioners have obligations under statute (primarily the Corporations Act 2001 (Cth) and associated Insolvency Practice Schedule and Insolvency Practice Rules), common law (including obligations under equity and tort law) and industry guidelines and codes (such as the Australian Restructuring, Insolvency and Turnaround Association or ‘ARITA’ standards and the Chartered Accountants Australia and New Zealand Code of Ethics (CAANZ)).
Why liquidations get lost
Australian company liquidation is based upon the imperative of closing down a business and recovering assets for the benefit of creditors. Also, the liquidator exercises investigative functions to oversee the integrity of our economic system and take legal action on behalf of creditors for the recovery of civil claims.
QUT law academic Elizabeth Streten recently dug into the frustrations of insolvency practitioners in Australia by undertaking wide-ranging interviews across the profession. Her work reveals a deep sense of frustration felt by many practitioners about the way that they are treated. As one practitioner put it:
“a lot of directors blame insolvency practitioners and all that … it’s like blaming the funeral director because your brother died. It’s the same thing.”
Where does this frustration come from? We can pintpoint several characteristics of the insolvency profession that contribute.
First, in an insolvent liquidation, liquidators operate with an understanding that returns for unsecured creditors will likely be very low. In more than 95 percent of liquidations in Australia, unsecured creditors receive between 0 and 11 cents on the dollar (read more about these poor returns in The Ultimate Guide to Liquidation Part 2: Preparing for Liquidation). This means that it is very unlikely that liquidators will have any good news for creditors.
At the same time, liquidators can feel pressured to charge large amounts to ‘make up’ for assetless liquidations where they will not get paid. In effect they are pressured into write-offs of billing for low-asset liquidations and billing high on appointments that have more significant assets. This is not uncommercial (or unforeseeable) because every business has different profit margins between the services and products they offer. A sensible business will focus their efforts on the most profitable areas of their business and minimise effort in the least profitable areas (see the Pareto Principle). This commercial incentive is, however, in direct conflict to the liquidator’s legal obligations.
Compounding the pressure, the appointed liquidator has an investigative role, but is usually not funded for that purpose. Liquidator firms are not organised or trained to fulfil a public role – they are essentially private practice accountants. They are not assessed on outcomes as are others performing a public function, such as police officers or social workers.
On top of that, liquidation is not the most exciting of jobs compared to some other public functionaries. The day-to-day work consists mostly of administrative tasks done in the office. As the saying in Sydney goes; “Insolvency practitioners don’t go over the Blue Mountains — even when they have a job there.”
Ben Affleck is reported to be returning for a sequel to ‘the Accountant’, but it is unlikely to be subtitled ‘the insolvency practitioner’. All in all, the ‘boring’ reputation makes it hard for liquidation firms to attract good staff. This will have long term negative effects on the capabilities of insolvency firms to perform their investigatory functions because they will be unable to recruit good accounting graduates and retain them.
The typical scenario when a liquidation gets lost is where, after the liquidator is selected by directors, there are insufficient assets to pay for investigations. The creditors, demanding answers, become frustrated and the liquidator themself has a positive incentive to reduce work unless further funding is provided by creditors.
Why voluntary administrations get lost
Insolvency practitioners are not just liquidators. What of other appointments, such as voluntary administrators? Are they any more confident in their role?
The theoretical goal of the voluntary administration is to arrive at a Deed of Company Arrangement (‘DOCA’) which settles existing debts, and revives the company as a going concern (see Part 5.3A of the Corporations Act 2001 (Cth)). But this happens rarely, and voluntary administrators are aware of this. This is also reflected in the fact that voluntary administrators are not obligated to do any pre-planning as if the business will continue.
Another complication is that voluntary administrators have to canvas debt company directors for work, even though they have no legal obligations to directors once appointed. An unfortunate consequence of this is that ‘bait and switch’ sales strategies, where directors believe that the appointed voluntary administrator will work in their interests, are common. The bait is a promise to save a company and the switch occurs after appointment when it is obvious that this is not feasible.
A ‘bait and switch’ strategy to obtain work would best be dealt with by allowing prospective voluntary administrators to conduct due diligence and then require this to be documented. In the financial planning industry a ‘Statement of Advice’ is required to be given to consumers as a protection against poor and conflicted financial advice. Prospective voluntary administrators are prohibited from providing detailed advice to company directors and therefore debtor company directors should engage an independent insolvency practitioner or insolvency lawyer to assess whether a voluntary administration is optimal for the debtor directors.
In addition to their theoretical goal to arrive at a DOCA, voluntary administrators are also appointed to take over and manage the actual trading of the company, even though they may have little relevant expertise in that industry. As mentioned, they spend most of their days sitting in the office writing reports and filing forms. This is not relevant experience for being the effective CEO of a major trading business.
To be blunt, firefighting isn’t done in the office – you need to pick up a hose to put out fires.
This has meant that often voluntary administrations are non-trading. They are used for the preparation of the DOCA only, and to avoid insolvent trading allegations and voidable transaction recovery.
The inevitable tension between the stated aim of voluntary administration, the way in which voluntary administrators are appointed and their limited experience as pencil-pushers leads to frustration amongst insolvency practitioners, debtor company directors and creditors. Insolvency practitioners don’t see their role as being emergency doctors for troubled businesses but they are also unenthusiastic pathologists.
The best way to avoid a lost voluntary administration is for debtor company directors to undertake thorough due diligence about voluntary administration and then appoint an ethical, experienced and hardworking insolvency practitioner if there is a prospect of a decent outcome through voluntary administration.
Insolvency practitioners are often frustrated in their job, and, arguably, this is a result of three conflicting pressures:
- They are appointed by people they have no obligations towards (directors);
- They have a public function (including investigating wrongdoing in a company), but no public funding; and
- They are empowered to do things outside their expertise and working preferences (such as running large trading businesses).
However, there may be hope on the horizon. The new role of the restructuring practitioner has a more focused obligation to actually revive a company, rather than to terminate it. In addition, increased education and registration requirements for insolvency practitioners may mean that the ‘new class’ of insolvency practitioners are better qualified to deal with the tasks that they are faced with.