Friday, 09 November 2018 14:00

Insolvency Lawyer or Insolvency Accountant

As it is in all areas of business, when you are seeking advice or input on insolvency matters it is important to go to the right source.

There are lawyers and accountants that specialise in insolvency but, depending of the circumstances, and what you are looking to achieve, who you choose is important.

Under the current legislation, the Companies Act 1993, anyone, without conflict of interest, and with a few other exceptions, can take an appointment as an Insolvency Practitioner and be appointed as liquidator or receiver of a company. They do not have to have any formal qualification and do not have to be registered or subject to any particular code of conduct. This situation is likely to change with current law changes being considered but for the time being the current provisions of the Companies Act apply.

So both lawyers and accountants can be appointed as liquidators or receivers and can be referred to as Insolvency Practitioners.

There are also Insolvency Practitioners who may be neither a lawyer or an accountant, who can also be appointed as liquidators or receivers.

Generally speaking, there are two ways that a business could be involved with an insolvency matter – either as a creditor seeking to recover a debt, or as the business owners deciding on a course of action because of the financial situation the business is in. The information or advice you would need from a lawyer and / or an accountant is different in each case.

Insolvency Lawyer:

If you are a creditor of a business that has failed to pay its debts as they fall due, you may decide to take action to have the debtor company liquidated.

To do this, we recommend you consult a lawyer experienced in the insolvency field to prepare statutory demands for service on the debtor company and, in due course, to prepare and file the application in the High Court to have the debtor company liquidated.

The lawyer will, prior to the matter being heard in Court, obtain the written consent of  Insolvency Practitioner(s), to be appointed,

If you are a director/shareholder of a debtor company that has been served with a statutory demand or liquidation proceedings, you may want to consult with an insolvency practitioner to gain an understanding of your rights and obligations and the options that are available to you.

Insolvency Accountant:

Many of the insolvency practitioners practicing in New Zealand have formal accounting qualifications or accounting backgrounds. This is understandable given that a lot of the work carried out by insolvency practitioners involves the review and analysis of accounting information.

IP's often then engage lawyers. Some of the larger accounting firms will have an insolvency practice as part of their firm’s structure. McDonald Vague, are Chartered Accountants specialising in business recovery and insolvency

If you are the shareholders or director of an insolvent company, your business accountants, who prepare your annual financial reports etc, may identify the fact that you are technically insolvent but, under those circumstances, they cannot be appointed as liquidator of your company. You would need to appoint an independent insolvency practitioner.

Accreditation Protection:

Accreditation for insolvency practitioners acknowledges IPs with appropriate experience. The main benefit is, accredited IPs are subject to the code of ethics, CAANZ rules and standards, CPD, practice review and a disciplinary body. If the practitioner is a CA and accredited, the designation is CAANZ accredited IP, whereas a non-CA but member of RITANZ is RITANZ IP Accredited by CAANZ. Dealing with an accredited practitioner provides more assurance to the appointor that the appropriate actions will be taken.

You can check the accreditation status of a particular IP or look for an accredited IP by following the links to the RITANZ or CAANZ websites 

Conclusion:

Getting the right advice at the right time and from the right person can make a big difference to the final outcome in any given situation.

If you need legal advice in relation to an insolvency issue, then see a lawyer with expertise in that area of law.

If you need practical advice in relation to insolvency options and processes and the related accounting issues, then speak to an experienced insolvency practitioner.

The team at McDonald Vague are experienced and independent insolvency practitioners with the formal qualifications and experience to be able to provide good practical advice on your situation.

Shareholders are the foundation of our listed company system. One of the key protections given to shareholders is the right of minority shareholders to be treated on an equal footing to majority shareholders.


Under section 174 of the Companies Act of 1993, every minority shareholder in a company has the right to seek relief from the court if it feels its rights have been unfairly prejudiced or if they believe the officers of the court have been conducting the affairs of the company in a manner that is oppressive, unfairly discriminatory, or unfairly prejudicial to the interests of the shareholder.
"The Institute of Directors’ guidelines says “Directors should ensure fairness to all shareholders in disclosure of information, general communications and in any transaction potentially affecting the value of securities in the company”.

Relief From Unfair Prejudice

Common examples of unfair prejudice include directors exceeding their authorised powers, misapplication of company funds and selective share issues. The Act provides that a company, a director, shareholder or an entitled person may apply to the court for an order restraining a company or a director of a company from engaging in conduct that would contravene the Act or the companys constitution.
"A prejudiced shareholder may apply under Section 174(2) to the Court to appoint a receiver of the company or to put the company into liquidation to enable independent practitioners to take control. These applications will only succeed if the Court is satisfied that it is just and equitable to make such an order."


The Act provides that a company, a director, shareholder or an entitled person may apply to the court for orders requiring a director of the company, or the company itself to take any action that is required to be taken by the constitution of the company or the Act.
As well as the power to apply for an injunction, shareholders are entitled to apply to the court for orders requiring a director of the company, or the company itself to take any action that is required to be taken by the constitution of the company or the Act.
Shareholders are also entitled to bring an action against the directors of their company for a breach of the duty of care owed to them. These duties owed to shareholders include an obligation to supervise the company share register and to disclose their financial interests and share dealings.
Duties which directors owe to the company and not to shareholders include acting in good faith, exercising a director’s powers for a proper purpose, not trading recklessly, not incurring certain obligations, exercising a proper duty of care and using company information in accordance with the Act.

Past Conduct Not Included In The Act

An order cannot be made in relation to past conduct. This provision is intended to provide a minority shareholder with an opportunity to bring the proposed actions of the Board under the scrutiny of the court as well as providing shareholders with an opportunity to ensure the company is being run in line with its constitution. Under the 1993 Act, a company’s directors are directly accountable to the company’s shareholders.

Final Observation

It is important for minority shareholders to remember the Court is conducting a delicate balancing act. Misconduct on the part of a minority shareholder may result in prejudicial conduct by a majority shareholder not being ruled unfair. Moreover even though there is no strict time limit for a minority shareholder to bring its claim, a delay in proceeding, particularly when combined with accepting benefits from the company in full knowledge of the facts, carries with it the risk of the court deciding the minority cannot really have been prejudiced or has accepted the unfairness.

Let us help you make the right legal decision regarding appointing a receiver or liquidator, call to request a consultation now!

Wednesday, 19 September 2018 08:56

Personal Liability In Company Insolvencies

A question that will often arise in discussions with the directors and shareholders of companies facing financial difficulties is what their personal liabilities are.

The initial response to the question is, if the company is a limited liability company, you are not personally liable for the debts of the company BUT… and it is a reasonably big “BUT” because there are a number of ways in which an individual can become personally liable in relation to an insolvent company.

The purpose of this article is to identify some of the ways in which you can become personally liable and the steps you can take to avoid or mitigate that liability.

Personal Guarantees:

It is common for trade suppliers to require the directors of a company seeking to open a credit account with them to provide a personal guarantee (PG). To be enforceable, the terms of the guarantee must be in writing, must be brought to the guarantor’s attention and must be signed by the guarantor as accepted. The terms of the PG are often incorporated in the trading terms and conditions for the account so be careful to read ALL the small print before you sign the acceptance at the bottom of the page.

Generally, the guarantee will require the guarantor to settle the debts of the company to the supplier from personal resources if the company fails to do so.

If the company is placed into liquidation, the creditor can make a call on the guarantor to meet their obligations under the guarantee without having to wait for the liquidation process to be completed.

You can try to avoid providing guarantees however you may have to if you want a credit account with that particular supplier. You could also seek to limit the guarantee to a specified maximum amount.

Shareholder’s Current Account:

A shareholder’s current account records the advances made to the company by the shareholder as credits and the drawings taken out of the company by the shareholder for personal expenses as debits.

It is common for directors and shareholders who work in a company business to take drawings rather than paying themselves a wage or salary with PAYE and other payroll deductions taken out and declared to the Inland Revenue Department.

Providing the accounting process is followed properly, there is nothing wrong with doing this.

The problem arises if the company is insolvent and the shareholders have taken out more than they have put into the company. An overdrawn shareholder’s current account is a debt owed to the company and is payable on demand. As it is an asset of the company, a liquidator would seek payment of the overdrawn amount from the shareholder concerned.

If you take more funds out of the company than you put in it creates a liability. To mitigate that liability, make sure your accountant attributes an annual salary to you in your current account when completing the annual financial reports for the company. This will require you to declare that salary in your personal tax return and pay tax on it.

Director’s Duties:

The Companies Act 1993 (‘the Act”) sets out the duties and obligations of a director to the company and, if the company is insolvent, to its creditors.

Those duties are set out in sections 131 to 137 of the Act and include the duty to –

  • Act in good faith and in the best interests of the company (s. 131);
  • Exercise a director’s powers for a proper purpose (s. 133)
  • Not trade recklessly by agreeing, causing or allowing the business of a company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors (s. 135);
  • Not agree to the company incurring an obligation that it will be unable to perform when due (s.136); and
  • Exercise the care, diligence and skill that a reasonable director would exercise in the performance of duties as a director (s.137).

If a director breaches one or more of those duties and obligations, they can be held personally liable for some, or all, of the company’s debts.

To avoid the potential liability, make sure you know what your duties and obligations are, who they are owed to and how that position can change depending on the financial state of the company.

Tax debts

The failure to pay GST, and PAYE, and other payroll deductions that have been taken from an employee’s wages, to the Inland Revenue Department can lead to a prosecution being undertaken by the IRD and result in the company directors being held personally liable for the debts.

The penalties imposed on conviction for failing to pay on the taxes deducted from employee’s pay can be severe, including terms of imprisonment.

To avoid this potential personal liability, keep a separate tax account into which you put all GST and payroll deductions payable to the IRD and make sure you pay it on when due.

If you have cashflow issues, then you may be eligible to apply to the IRD for hardship relief or an instalment plan. Acting early will reduce your potential personal liability.

Phoenix Company

The Phoenix Company provisions of the Act were put in place to ensure that, if a company fails, the directors cannot just set up a new company with the same name, or a similar name (a phoenix company), and carry on trading without their creditors or suppliers being aware of what has happened.

The director of a failed company is banned from operating a new company with the same or similar name for a period of 5 years unless they have the permission of the Court or one of the exceptions set out in sections 386D to 386F apply.

The 3 exceptions referred to are –

  • The issuing of a successor company notice; or
  • A temporary trading period allowed whilst application is made to Court for approval; or
  • Where the phoenix company has been known by the failed company’s pre-liquidation name for at least 12 months and it has not been dormant during that 12 month period.

If the director of a failed company sets up a phoenix company and does not have Court approval or meet the requirements of one of the exceptions, then the director can be found personally liable for debts of the phoenix company and could also, on conviction on indictment for the breach of the Act, be liable to fine of up to $200,000 or imprisonment for 5 years.

To avoid falling foul of the phoenix company provisions, make sure that you obtain good professional advice on whether your proposed course of action will be in breach of those provisions and what needs to be done to correct that position.

You can restructure and trade with the same or similar name, if you follow the right steps.

Conclusion:

There is the potential for liabilities of your insolvent company to become your personal problem if you have not paid attention to your duties as a director of the company or you have used funds from the company in breach of your obligations.

If you would like more information on your personal position and how you can best protect yourself from personal liability, please contact one of the team at McDonald Vague.

Colin Sanderson

September 2018

As a landlord of commercial property it is important for you to understand your rights and responsibilities to ensure you don’t inadvertently breach legislation and obligations. If you do, you may face significant liability.


A Deed of Lease details the relationship and terms/conditions between a commercial landlord and tenant. The Property Law Act 2007 (“PLA”) defines rights and obligations of landlords and tenants. The Unit Titles Act 2010 can also apply if the property is a unit title.


A commercial landlord has obligations to comply with the Building Act 2004 and Building Code and to complete a building warrant of fitness for Council.


A commercial landlord also has obligations to maintain the building, comply with health and safety standards. A tenant has obligations to maintain the premises and the Deed will often extend to obligations as to damage/loss, painting, floor coverings, rubbish removal, etc.


When can a landlord terminate a lease?


If the tenant is in breach of its obligations to the landlord, the landlord may be entitled to terminate the lease.  Where a landlord wants to terminate a lease, the PLA requires notice to be served on the tenant in accordance with section 245 of the Property Law Act 2007.


The notice of intention to cancel a lease must expire before a landlord re-enters the premises. A notice must be sent setting out the nature of the breach and remedy required and the rights of the tenant.


The PLA says a landlord may only cancel a lease for non-payment of rent, if rent is at least 10 working days in arrears. A landlord may also cancel for reason of insolvency, liquidation or bankruptcy of the tenant. Once the statutory timeframe expires the landlord can re-enter and seek to mitigate its loss by re letting the premises. The landlord however needs to be wary of the rights of secured creditors to the company assets.  There are however a myriad of priority issues that need to be considered and the landlord must give notice and reasonable time for the chattels to be removed.


What If Your Commercial Tenant Goes Bust?


A good commercial lease contains ‘ipso facto’ clauses, which specifically provide for insolvency, which is usually triggered by the tenant entering into liquidation or administration or receivership or becoming bankrupt. The lease usually survives the appointment of an administrator or receiver but may end on liquidation.


A landlord can seek judgment against the guarantor and following judgment issue bankruptcy proceedings against a guarantor on failure to pay.


If the Commercial Tenant Fails To Pay?


Tenants by vacating the premises and leaving rents in arrears are not released from their legal liability. While the lease remains on foot, rent continues to accrue, and the tenant and guarantors are liable. The tenant under the Deed of Lease may be required to continue the lease obligation for the balance of the term of lease and can be liable for reasonable costs incurred in re-tenanting the premises. If the company has no ability to pay, a guarantor may be pursued.


A landlord can issue a statutory demand and following failure to make payment under that demand issue winding up proceedings against their tenant company if there is a failure to pay, a default under the terms of the lease and suspicion of insolvency.


Often landlords protect their position by requiring some form of deposit or a bank guarantee to avoid the more costly recovery options and for better protection.


A landlord has no right to take possession of the tenants’ belongings and sell them to cover unpaid rent. Some more current deeds of lease however can now require the tenant company to grant a GSA at the same time as granting the lease. Depending on the wording, this can provide the landlord with the entitlement to recovery of fixtures and fittings and potentially chattels. A well drafted Deed that grants security in assets can provide protection to the landlord in the event of insolvency of their tenant.


If The Commercial Tenant Faces Liquidation or Receivership


Most Deeds of Lease provide for the termination of lease in the event of the tenants’ company being placed into liquidation. If there are arrears, the landlord is entitled to file a claim in the liquidation.


Often a liquidator will seek to trade or to occupy the premises for a period to realise value in the company assets.


If the company occupies the premises then the liquidator can be liable for payment of rent from the date of liquidation. A liquidator may disclaim the lease at which time the rights and obligations of the tenant end.


In Receivership, a receiver has no right to disclaim a lease and can be held personally liable for rent and lease payments from 14 days after the appointment date until the occupation ends or receivership ends.


Most Deeds of Lease will allow the landlord to cancel the lease if a Receiver is appointed.


Liquidation or Receivership will more often than not end the landlord and tenant relationship.


Final Observation


Overall, a Landlord’s rights depend on the terms of their Lease Agreement. Always include specific provisions for liquidation or receivership or administration in a commercial lease. Remember, if the lessor has not given the tenant the notice specified in a commercial lease before enforcing a right of re-entry, the tenant may have remedies against the lessor and apply to the court for relief.


A well documented Deed of Lease will provide for a deposit or bank guarantee, a personal guarantee and/or general security over specific assets such as fixtures and fittings.


If your commercial tenant has vacated leaving rent arrears, or is potentially trading insolvently contact McDonald Vague as an option may be to start the winding up process.

 

From time to time we are approached by persons or companies pursued by liquidators of other insolvency firms. We are also asked to provide guidance or opinions on how a liquidator should act, what is reasonable and how to respond to demands/requests.

Insolvency specialists take different approaches and some Insolvency Practitioners ("IP") do not always act in the best interests of the company creditors. There have been several reported instances in recent years.

At McDonald Vague our objective is to maximise the return for creditors. We do not always achieve a return for unsecured creditors but have a good reputation for taking a firm and fair approach and getting returns. Cost/benefit is always a consideration.

This blog post discusses the skills and competence required of an IP, the differing approaches of liquidators, reasons why applicant creditors or shareholders should appoint an accredited IP, or a member of CAANZ or NZLSA and what should be considered in taking an action.

Competent liquidator and principal duty

A reasonable and competent liquidator should take into account the amount owed to creditors, the prospects of recovery and consider the cost versus benefit of advancing claims and legal actions. It is a liquidator's obligation to maximise the return to creditors and to act in a reasonable and efficient manner.

Underlying principles to regard

Every liquidation is different but the underlying principals are the same. In all liquidations, the liquidators should have regard to:

  1. Duties imposed on liquidators by the Companies Act 1993;
  2. Schedule 6 of the Companies Act 1993;
  3. Companies Act 1993 Liquidation Regulations 1994;
  4. Insolvency Engagement Standards issued by NZICA;
  5. Court decisions (eg. Peace and Glory Society (in liq) v Samsa [2010] 2 NZLR 57);
  6. The value of the assets available to be realised (if possible);
  7. The probable claims and creditors to pay from asset realisations.

Benefits of governing bodies and regulation

Liquidators who are members of the CAANZ or the New Zealand Law Society have a governing body they need to report to. The Insolvency Engagement Standards ("IES") issued by the Board of the CAANZ apply to a firm's conduct on any insolvency engagement. IES provides the required standards of a CAANZ insolvency professional.

These standards should be required of all liquidators. IES is not binding on non-Institute members. A member of the Institute acting as a liquidator is required to comply with Rule 10 of the Code of Ethics 2003 which relates to timeliness and to the Insolvency Engagement Standards SES-1 and paragraph 22 of IES. The New Zealand Law Society have their own high standards for conduct. Many IP's are now CAANZ accredited insolvency practitioners.

Key standards for CAANZ members

Key standards include:

  1. An Insolvency Practitioner has a duty to apply the degrees of specialised skill, knowledge, judgment and competence required to perform a job in a timely manner. A liquidator has a professional responsibility to carefully plan the liquidation and perform in an efficient and effective manner and assure quality of work performed.
  2. A liquidator is required to ensure that all personnel engaged in insolvency work adhere to the principles of objectivity and integrity.

Companies Act 1993 - obligations and duties

The duties, rights and powers of liquidators are set out in Sections 253 to 279 of the Companies Act.  The principal duty of a liquidator is recorded in Section 253 as follows:

Section 253 - Principal duty of liquidator

Subject to Section 254 of this Act, the principal duty of a liquidator of a company is - 

  1. To take possession of, protect, realise and distribute the assets, or the proceeds of the realisation of the assets, of the company to its creditors in accordance with this Act; and
  2. If there are surplus assets remaining, to distribute them, or the proceeds of the realisation of the surplus assets, in accordance with Section 313(4) of this Act - in a reasonable and efficient manner.

In undertaking an investigation, a liquidator must bear in mind a duty to act in a reasonable and efficient manner.

Liquidators have different approaches to recovery actions often driven by creditor attitude/requirements. Some liquidators will be compelled to bankrupt directors. In the absence of other recoveries, the net costs of these actions should be borne by the liquidators or a particular creditor if that creditor has agreed to fund the cost.

A liquidator also has a duty to have regard to the views of creditors and shareholders under Section 258 of the Companies Act 1993.

Considerations for liquidators when taking actions

These are always judgment calls and a balancing of the various interests.

A liquidator should consider the financial position, the likely prospects of recovery, and public interest (if pursuing bankruptcy) and the costs in advancing an investigation and legal action.

A liquidator should consider the likely return to creditors against the costs, and if spending money that could or should otherwise be distributed to creditors the likely increased return for creditors by advancing the action.

Along with the economic factors above, there is also sometimes a feeling that other enforcement action is required, such as bankruptcy, which affects all of the creditors of the individual who owes money. A bankruptcy option should recognise that this will stop any chance of future recoveries being made.

A liquidator should therefore question whether it is reasonable to issue proceedings against an individual when there is a good prospect of bankruptcy but no likelihood of a return from bankruptcy, particularly where there are competing claims likely in the bankruptcy estate, and where the party is clearly insolvent, or where another creditor could, with minimal cost, advance bankruptcy proceedings.

Certain actions require funding. Creditors can be approached and litigation funders are an option.

Estimating costs when litigation is involved is a difficult exercise as some legal costs are reactive to positions taken by the defendants. Settlement can avoid legal costs associated with discovery, interlocutory matters and trial preparation.

While we recognise that insolvent individuals and companies are a risk to their creditors there are recovery avenues available for the insolvent. They are referred to in our articles on our website, but include:

  1. Part 5 subpart 2 proposals;
  2. No asset procedure;
  3. Summary instalment orders;
  4. Settlements.

The McDonald Vague approach to debt collection and legal action

Our approach in collecting debts is some money is better than none.  

To that end, our aim is to:

  1. Assess the likely ability to collect;
  2. Set a game plan and budget;
  3. Write claiming as quickly as possible;
  4. React/report any dispute;
  5. Consider legal action if the benefit has more than reasonable prospects of exceeding the costs of pursuit and will more than likely provide a return to creditors;
  6. If appropriate, appoint a professional debt collection agent; and
  7. Consider settlement and repayment options.

We do not typically bankrupt individuals for overdrawn current accounts, particularly when they can show in sworn statements of position that there would be no benefit to creditors in doing so. Each case is considered on its merits and we often agree to repayment plans.

For those directors/shareholders who have acted with a clear intent to defraud creditors, we take the appropriate action. In any action, a liquidator needs to consider the cost and benefit and the public interest and risk.

To find out more about how McDonald Vague can help, or for confidential advice please contact This email address is being protected from spambots. You need JavaScript enabled to view it..

Due to both a lack of sufficient legislative regulation and in order to bring New Zealand Insolvency Practitioners further in line with Australia and other jurisdictions, the Restructuring Insolvency and Turnaround Association of New Zealand (RITANZ) working alongside Chartered Accountants Australia New Zealand (CAANZ) has developed a framework of self-regulation.

Under the various acts Insolvency Practitioners are charged with administering, there are only negative licensing regimes in effect. These regimes only exclude individuals from acting as Insolvency Practitioners if they fail to meet a specific set of criteria. These include the Insolvency Practitioner being:

  1. over the age of 18;
  2. of sound mind;
  3. not currently an undischarged bankrupt;
  4. and having no continuing business relationship with the insolvent company.

 

This new framework requires Insolvency Practitioners that are members of RITANZ to provide evidence of their relevant experience, skills, and that they are a ‘fit and proper’ person in order to become Accredited Insolvency Practitioners.

Under this framework you will be able to expect a consistent approach between Insolvency Practitioners and reliable and fair outcomes for all parties affected by an insolvency. As a part of the new framework, Accredited Insolvency Practitioners are now subject to CAANZ rules and its complaints/disciplinary procedures. In addition there is a public register established and maintained on the CAANZ website.

McDonald Vague is pleased to advise that the directors are Accredited Insolvency Practitioners under the recent framework. McDonald Vague is a Chartered Accounting Practice and also subject to practice review. Many insolvency practitioners that practise do not have disciplinary bodies that monitor their work nor a professional body providing guidance, resources and expertise.

Please contact us if you have any queries in relation to the new Accredited Insolvency Practitioners framework or any insolvency related queries.

Statutory demands - minimising bad debts is critical for any business 

Debt collection is difficult for business owners.  Pursuing bad debts early on improves any chance of receiving payment.  A creditor that puts the most pressure on a debtor will most likely receive their money before others; however, they need to be conscious of the voidable transaction regime when they are dealing with an insolvent company. 

If you are owed a debt and that debt is not in dispute and you suspect the company you have been trading with may be insolvent, you can issue a statutory demand against the company.  Depending on your terms of trade, a statutory demand will require the debtor to pay you the outstanding debt, interest on the debt, and the legal costs for issuing the statutory demand.  The purpose of a statutory demand is to determine whether the creditor can pay and not that they are liable to pay. 

The statutory demand process provides a quick procedure for ensuring payment, or for at least achieving some knowledge on whether payment is possible.  This process is intended to be a first step in making an application to put a company into liquidation when a company genuinely cannot pay. 

It is important to get the process right and it is advisable to instruct a lawyer who has ethical obligations to ensure the correct steps are taken rather than issuing the demand yourself or a debt collection agency taking responsibility.  It is however an abuse of process if the statutory demand option is taken when there is no prospect of the company being placed into liquidation. 

The cost of issuing a statutory demand should not be taken lightly.  If there is a substantial dispute and the creditor is successful in its challenge, Court costs will be awarded against the creditor.  If a creditor gets this process wrong, not only are they out of pocket for additional costs but months may have passed and they are no closer to collecting the debt. 

Sections 289 to 291 of the Companies Act 1993 deal with statutory demands. 

The process 

Before serving a statutory demand it is sensible to ensure that the debt is not in dispute.  Sending a formal demand so any dispute can be raised will give you an opportunity to settle the debt without any further action being taken.  If, however, the debt is disputed you can file proceedings at the District or High Court and seek judgement on the claim. 

Step 1 - Serve a statutory demand for the debt 

The demand must be in writing and should be served on the debtor company's registered office.  The demand must require the company to pay the debt or to secure the debt or to settle it in some way.  If the debtor does not pay the amount claimed within 15 working days, you can apply to put the company into liquidation.  This is a powerful tool as it is quite likely the debtor will go to lengths to ensure that other creditors are not aware of liquidation proceedings pending or in progress.  The company has 15 working days after being served to comply with the notice. 

The statutory demand must specify exactly what amount is owed (and it must be over $1,000).  The document specifies when the sum must be paid and provides the alternatives to full payment such as to enter into a compromise (Part XIV of the Companies Act 1993), or otherwise compound, or give a charge over property to secure payment of the debt to the reasonable satisfaction of the debtor, all within 15 working days of the date of service of the demand, or such longer period if the High Court order. 

Once a statutory demand is served on the debtor company, the debtor has 10 working days to dispute the debt by filing an application to set aside the demand or pay the debt within 15 working days. 

Step 2 - Applying to the Court to place the debtor into liquidation 

In the event the debt is neither disputed nor paid, then, on the expiry of 15 working days the debtor is deemed to be insolvent and the creditor can apply to the Court to place the debtor into liquidation.  The onus is then on the debtor to satisfy the Court that it is solvent.  If the company is unable to pay then a liquidation with a Court appointed liquidator will follow, or, the shareholders within 10 working days of being served have an ability to appoint a liquidator by a shareholder resolution. 

A liquidation application can only be issued by certain persons and the order for the appointment can only be made on grounds specified in section 241(4) of the Companies Act 1993.  The decision on whether the company is placed into liquidation is at the Court's discretion.  The Court may only put a company into liquidation by the appointment of a liquidator if the Court is satisfied that the company is unable to pay its debts, or the company, or the board of the company, has persistently or seriously failed to comply with the Companies Act 1993, or the company does not comply with section 10 (essential requirements), or it is just and equitable that the company be put into liquidation. 

The alternatives to paying a statutory demand in full 

Compounding means "coming to an agreement with a creditor".  The most usual form of compounding is an acceptable offer of payment by instalments.  It can also be an offer of a deferred payment or a request to defer filing of a winding up proceedings. 

Company Compromise (Part XIV Companies Act 1993) is an agreement between the company and various classes of creditors that give the company an opportunity to survive by avoiding liquidation and trading out of financial difficulty.  In order to reach a compromise a majority in number representing 75% in value of each class of creditor voting in favour of such a resolution is required (at a meeting of creditors).  Once agreement is reached, all debts are frozen and no creditor can take action against the company during the term of the compromise.  The outcome could be creditors are repaid either in full or in part and over time.  It is specifically a good option if the business is solid and is in financial difficulty but customers and suppliers are prepared to provide support.  Find out more about Company Compromises

Another remedy upon receiving a statutory demand is to reach a full and final settlement.  However, it is always important to bear in mind voidable transactions when dealing with an insolvent company.  A payment from a third party or the director or a personal guarantee are wise. 

How to serve a statutory demand 

A statutory demand to qualify as being served on the company either must be delivered to a person named as a director on the New Zealand Companies register, to an employee of the company at the company's head office or principal place of business, be left at the company's registered office or address of service, and in accordance with directions as to service by the Court, or in accordance with any agreement made with the company.  It is recommended that the document is served by a document server.  The service of a statutory demand by facsimile cannot be relied upon. 

Disputing a statutory demand 

If a debtor can show that a defence or a counter claim or a set-off equal to the amount claimed in the demand exists, not only will a demand be set aside but the aggrieved creditor will be ordered to pay the debtor's costs and will be no closer to collecting the debt. 

A Court may set aside a statutory demand if the application is made within 10 working days of the date of service of the demand and the application was served on the creditor within 10 working days of the date of service of the demand.  The Court may grant an application to set aside the statutory demand if it is satisfied that there is a substantial dispute, whether or not the debt is owing or is due, or the company appears to have a counter claim, set-off, or cross demand and the amount specified in the demand, less the amount of the counter claim, set-off or cross demand is less than the prescribed amount or the demand not to be set aside on other grounds. 

A demand will not be set aside by reason only of a defect or irregulatory unless the Court considers that substantial and injustice would be caused if it were not set aside.  Under section 291 of the Companies Act 1993, if a Court is satisfied that there is a debt due by the company to the creditor that is not subject to a substantial dispute, or is not subject to a counter claim, or set off, or cross demand, the Court may order the company to pay the debt within a specified period and that in default of payment, the creditor may make an application to put the company into liquidation, or dismiss the application and make an order putting the company into liquidation on the grounds that the company is unable to pay its debts. 

The service of a statutory demand process can give great leverage to get paid quickly, however if a debt is disputed or the company that owes the money is not in financial difficulty the process is used at your own peril.

 

 

 

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Text of an address to a colloquium "Chinese Insolvency Law Symposium: Developing an Insolvency Infrastructure" held at the University of Hong Kong, 17-18 November 2000

The colloquium was organised by the Asian Institute of International Financial Law and co-sponsored by the Department of Politics and Law, China University of Politics and Law, Duke University Global Markets Centre, Hong Kong Society of Accountants, Inter-Pacific Bar Association, and Pepperdine University School of Law. The colloquium involved discussions among academics, insolvency practitioners, judges and government officials from mainland China, Hong Kong SAR and overseas, on issues of PRC insolvency law reform and cross-border insolvency between China and Hong Kong SAR.

Paul Heath QC
Law Commissioner1

Introduction
The New Zealand Law Commission2 is currently involved in the review of New Zealand's insolvency law. To date, two substantive reports have been presented by the Commission: NZLC R52 Cross-Border Insolvency: Should New Zealand Adopt the UNCITRAL Model Law on Cross-Border Insolvency?3 and NZLC SP2 Priority Debts in the Distribution of Insolvent Estates.4 The latter was an advisory report prepared for the Ministry of Commerce (as the Ministry of Economic Development was then known). The Ministry of Economic Development is the lead Ministry for insolvency law in New Zealand.

As part of the Commission's involvement with the reform of New Zealand insolvency law, I had the privilege of attending the December 1999 session of the United Nations Commission on International Trade Law's (UNCITRAL) Working Group on Insolvency Law as a New Zealand delegate. I draw on that experience when discussing the direction of UNCITRAL's future work on insolvency law.

This Symposium addresses cross-border insolvency issues at two quite distinct levels. First, there are the particular issues of cross-border insolvency involving the Hong Kong Special Administrative Region and the People's Republic of China. When addressing that issue it is necessary to have regard to matters which would affect an approach to domestic insolvency law reform. In that context the special relationship which exists between the People's Republic of China and the Hong Kong Special Administrative region (the "one country, two systems" approach) is an important factor to bear in mind. The second issue, however, is wider in its scope. It concerns the direction of future international work about to be undertaken by UNCITRAL on insolvency law and the factors to which reference should be made when considering insolvency law from an international perspective.

It is helpful to consider the two issues together because the factors which are relevant to domestic insolvency law reform can be compared to the factors which should be taken into account at an international level. A joint consideration of the issues also tends to focus upon common goals and the need for domestic laws to work adequately within what has become a truly global market place.

This commentary addresses two issues:

1. An approach which could be taken by UNCITRAL in its future work on insolvency law which would both encourage greater harmonisation in the use of insolvency regimes yet assist States to tailor domestic insolvency laws to meet their own economic, legal, commercial, social and cultural needs.5
2. Whether there are any lessons to be learnt from the recent judgments of the Courts of the Hong Kong Special Administrative Region in the Chen Li Hung6 litigation which involved an attempt by trustees in bankruptcy appointed by the District Court in Taipei to gain access to assets of the bankrupt in the Hong Kong Special Administrative Region. These decisions will be noted because they raise an unusual issue in the context of cross-border insolvency law. My questions are: (a) Have the Hong Kong courts resolved the issue adequately? and (b) what lessons can be learnt from the litigation?7
Future UNCITRAL Work
Background
On 15 December 1997, the General Assembly of the United Nations passed a resolution (inter alia) recommending that all States review their legislation on cross-border aspects of insolvency to determine whether the legislation met the objectives of a modern and efficient insolvency system. The resolution went on to ask that States give favourable consideration to enacting the Model Law on Cross-Border Insolvency which had been developed by the Working Group on Insolvency Law and adopted by UNCITRAL, "bearing in mind the need for an internationally harmonised legislation governing instances of cross-border insolvency".

The Model Law did not attempt any substantive harmonisation of insolvency law. Indeed, it was recognised in the course of the Working Group meetings that, in some cases, it was necessary to defer to national laws (for example on the questions of priority debts) in order to achieve agreement on processes which would enable the efficient and effective resolution of cross-border insolvency cases. The Guide to Enactment of the Model Law noted that while the increasing incidence of cross-border insolvencies reflected continuing global expansion of trade and investment, national insolvency laws had not kept pace with that trend and were often ill-equipped to deal with cases of a cross-border nature. The Guide went on to note a number of consequences flowing from these inadequate and inharmonious legal approaches which:8

a. Hampered the rescue of financially troubled businesses;
b. Were not conducive to a fair and efficient administration of cross-border insolvencies;
c. Impeded the protection of the assets of the insolvent debtor against dissipation;
d. Hindered maximisation of the value of the assets of the insolvent debtor.
Further, it was noted that the absence of predictability in the way in which cross-border insolvency cases were administered both (i) impeded capital flows and (ii) acted as a disincentive to cross-border investment.9

Another problem was the increase in fraud by insolvent debtors and the increasing ability (and ease) for fraudsters to conceal assets or to transfer them to foreign jurisdictions. The Guide to Enactment noted that this was an increasing problem both in terms of frequency and magnitude. The Guide continued:10

The modern, interconnected world makes such fraud easier to conceive and carry out. The cross-border co-operation mechanisms established by the Model Law are designed to confront such international fraud.

In order to deal with these difficulties, the Model Law provided better access for foreign insolvency representatives to the courts of the State in which assets were located.11 It also devised processes designed to recognise foreign insolvency proceedings and to give effect to them within the State in which assets were located.12 These processes included the ability for the courts of the States in which application was made to grant relief on the application of the foreign insolvency representative.13

Another important element of the Model Law was the emphasis placed upon co-operation between courts in different jurisdictions and the insolvency representatives themselves.14 The whole topic of direct communication and co-operation is one on which a lengthy article or commentary could be written but it is sufficient for my present purposes to note that the Model Law has acted as an impetus to the holding of joint audio and video conferences among courts in different jurisdictions in an endeavour to deal in a pragmatic way with the difficult issues which arise in cross-border insolvency cases. In particular, these rules assist in the expeditious completion of an insolvency regime and facilitate early payment of dividends to creditors. A good deal of work has already been done to build upon this aspect of the Model Law: in particular I refer to American Law Institute's Transnational Insolvency Project which, in appendix 2, sets out suggested guidelines applicable to Court-to-Court communications in cross-border cases.15

The Next Phase of UNCITRAL Work
The UNCITRAL Working Group on Insolvency Law met in Vienna, 6-17 December 1999. In its report the Group made the following recommendation to UNCITRAL:16

The Working Group recommends that the Commission give it the mandate to prepare: a comprehensive statement of key objectives and core features for strong insolvency, debtor-creditor regime, including consideration of out-of-court restructuring; a legislative guide containing flexible approaches to the implementation of such objectives and features, including a discussion of the alternative approaches possible and the perceived benefits and detriments of such approaches. A legislative guide similar to that being prepared by the Commission for privately financed infrastructure projects would be useful and could contain model legislative provisions, where appropriate.

Should the Commission decide to undertake such a project, the Working Group should be mindful in carrying out this task of the work underway or already completed by other organizations, including the International Monetary Fund, the World Bank, the Asian Development Bank, the International Bar Association and INSOL International. The Working Group should seek their collaboration in order to benefit from the expertise these organizations can provide and to build on their efforts and should commence its work after receipt of the reports currently being prepared by the World Bank and the Asian Development Bank.

That recommendation was received by UNCITRAL at its plenary session held in June and July 2000 in New York. There was general agreement in the Commission that a single model law on insolvency was neither feasible nor necessary. Nevertheless, it was accepted that a legislative guide similar to that adopted by UNCITRAL for privately financed infrastructure projects would be useful and could contain model legislative provisions, where appropriate. Further, the Working Group was directed to be mindful of the work underway or already completed by other organisations, including the International Monetary Fund (IMF), the World Bank, the Asian Development Bank (ADB), INSOL International and the International Bar Association. The Secretariat was asked to organise a colloquium before the next session of the Working Group17 in co-operation with INSOL International and the International Bar Association.18

A number of the reports to which UNCITRAL referred, stress the need for strong insolvency systems to act as important pillars of support for the financial system as a whole and the efficient flow of international capital in particular. By way of example, in the report by the Legal Department of the IMF, Orderly and Effective Insolvency Procedures: Key Issues it was said:19

Over the years, the IMF has become increasingly involved in the promotion of orderly and effective insolvency systems among its members. Experience has demonstrated that reform in this area can play a major role in strengthening a country's economic and financial system.…Insolvency reform can be particularly relevant for economies in transition, where it can play a critical role in addressing the problems of insolvent State-owned enterprises. In the context of financial crises, an orderly and effective insolvency system can provide an important means of ensuring adequate private sector contribution to the resolution of such crises. Finally, although insolvency procedures are implemented through the courts, the very existence of an orderly and effective insolvency system establishes incentives for negotiations between debtors and their creditors, which may lead to out of court agreement being reached "in the shadow" of the law.

In the New Zealand Law Commission's report on Cross-Border Insolvency20 we, in an endeavour to add value to the Model Law, sought to identify factors in favour and against reform of the law by adoption of the UNCITRAL Model Law. We identified three factors in favour of reform:21

•Globalisation Factors: these factors arise from the desirability to synthesise international commercial law given the nature of the global markets in which trading entities operate; special consideration needs to be given to the ease with which many enterprises may carry on cross border trade through the use of modern communication technologies;
•Fiscal Factors: these factors impinge upon policy reasons for not discriminating against foreign investors or lenders. In particular, we referred to analysis by economists stressing the need for fair treatment of foreign creditors.22 In this context the ability to obtain credit from foreign companies may be undermined by an approach to cross border insolvency which does not include an element of reciprocity. As matters presently stand article 8 of the Draft Bankruptcy Law of the People's Republic of China would deny a foreign insolvency administrator access to Chinese assets located within the territory of the People's Republic of China.
•Efficiency and Fairness Factors: these factors go to the process by which relief can be sought when cross-border insolvent issues arise.
Two factors were identified which militated against reform:

•Adequacy of Existing Legislation: plainly, if existing legislation was adequate there is unlikely to be a need to reform the law;
•Sovereignty Factor: this factor goes to the question whether it is appropriate for a particular country to adopt an international regime rather than a domestic regime which may better suit or protect its citizens.
Building on the Model Law
The report of the UNCITRAL Working Group on Insolvency Law's December 1999 meeting concentrated on two distinct issues: the identification of -

a.key objectives for insolvency law23 and
b.core features of an efficient and effective insolvency law.24
The Working Group Report makes it clear that objectives of insolvency law should not be treated as polarising insolvency laws into liquidation (on the one hand) and rehabilitation procedures (on the other). What was more important was:25

… a more broadly phrased 'arrangement' or 'method' which was aimed at maximising the return and minimising the effects of insolvency and [which] would include the range of possible insolvency techniques.

And, to emphasise the point, the Working Group later noted, in the context of discussing the relationship between liquidation and rehabilitation procedures, that:26

… what was required was a balance between different insolvency procedures, however they may be arranged in the insolvency law (such as unitary proceedings or otherwise). As noted in the discussion on key objectives, there should not be a polarisation of proceedings into liquidation on the one hand and rehabilitation on the other, but inclusion of a range of possible insolvency techniques that could be used to achieve the objective of maximising the value of the assets.

I interpolate some comments about terminology. The literature refers to "reorganisation", "rehabilitation" and "rescue" procedures almost interchangeably. Indeed, there is some inconsistency in the UNCITRAL material in that article 2(a) of the Model Law on Cross-Border Insolvency (which defines the term "foreign proceeding") refers to the notion of "reorganisation" whereas the Working Group discussion in December 1999 focused upon "rehabilitation". Whichever term is used, it is necessary to focus attention on the business of the entity rather than on the entity itself. In truth, it is more likely that the business operated by the entity can be saved by utilising a procedure which enables it to be sold as a going concern. It is important not to fudge the distinction between salvaging a business (which may involve sale of the business by the insolvent entity as a going concern with resulting liquidation of the entity) and resuscitation of the insolvent entity itself. For consistency, I use the term "rehabilitation".

There was general agreement at the UNCITRAL Working Group on Insolvency Law as to the core features of a liquidation regime. Thus, I propose to leave those matters to one side. I do that because, in my view, it is far more important for UNCITRAL to debate and reach conclusions on the essential nature of a rehabilitation regime both to assist States in developing their domestic rehabilitation regimes and also to ensure that those States which adopt the Model Law on Cross-Border Insolvency have laws in place which will be effective when one comes to deal with them under the Model Law.

It is the collective nature of an insolvency procedure which is the cornerstone on which the Model Law on Cross-Border Insolvency is built. Foreign insolvency proceedings will only be recognised if they fall within the definition of the term "foreign proceeding" set out in article 2(a) of the Model Law. Use of the term "collective" distinguishes between a regime operating for the benefit of creditors as a whole and a regime which operates for the benefit of a particular creditor. An example of the latter is a floating charge debenture pursuant to which a secured creditor may appoint a receiver and manager over the undertaking of the debtor business. Such a security, while well known in insolvency systems based on the United Kingdom model, is not a creature known to United States' law.

The definition of the term "foreign proceeding" is:

A collective judicial or administrative proceeding in a foreign State, including an interim proceeding, pursuant to a law relating to insolvency in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganisation or liquidation:…

The elements of the definition (in the context of a rehabilitation regime) can be summarised as follows:

•The proceeding must be a collective proceeding in nature; such a proceeding is designed to give effect to what has been called the "creditors' bargain" - the implicit agreement between creditors that there are economies of scale in having one office to administer the proceeding and pay creditors according to a set statutory schedule of priority.28
•The collective proceeding must arise out of a law relating to insolvency;
•Pursuant to that law, the assets and affairs of the debtor must be subject to control or supervision by a court for the purpose of a rehabilitation regime.
The different constituent elements of a rehabilitation procedure were emphasised recently in the ADB report.29 I retain the references in paragraphs 37-39 of that report to "rescue" rather than "rehabilitation":

37. In the context of this report "rescue" means any form of process, by whatever name called, which provides for the continuation (and not the liquidation) of an insolvent corporate debtor. This may take the form of a composition, by which the debtor and creditors agree to a simple compounding of debts. For example, the creditors agree to receive a percentage of the debts they are owed in full, complete and final satisfaction of those debts. The debts of the corporation are thus reduced or satisfied, it becomes solvent and may continue on.
38. A rescue might also take the form of a complex reorganisation under which, for example, the debts of the debtor are restructured (extended length of loan, extended period in which to make payment, deferral of payment of interest, possible change in the identity of lenders and so forth); the possible conversion of some debts to equity together with a reduction (or, even, extinguishment) of existing equities; the sale of some of its non-core assets; and the closure of non profitable business activities.
39. However, rescue does not imply that the corporation, its creditors and its shareholders are or will be completely restored. Nor does rescue necessarily mean that ownership and management of an insolvency corporation will maintain and preserve their respective position. In general, however, rescue does imply that under whatever form of plan, scheme, or arrangement is agreed, the creditors will eventually receive more than if the corporation was immediately or soon liquidated.

The ADB report acknowledges that a rehabilitation process is not as universal as that of liquidation and, therefore, does not follow a common pattern or process. Nevertheless, the authors suggest that "key or essential elements" include:30

•the voluntary submission by a corporation to the process (which may or may not involve judicial proceedings and thereafter judicial control or supervision);
•an automatic stay or suspension of actions and proceedings against the property of the debtor affecting all creditors for a limited period of time;
•the continuation of the business of the debtor either by the existing management, an independent manager or a combination of both;
•the formulation of a plan which proposes the manner in which creditors, equity holders and the debtor itself (including its business and assets) will be treated;
•the consideration of and voting on acceptance of the plan by creditors;
•possibly, the judicial sanction of an accepted plan; and
•the implementation of the plan.
At paragraph 43 of the ADB report it is suggested that legal theory maintains that rehabilitation procedures require laws which:

•permit quick and easy access to the process;
•provide sufficient protection for all of those involved in the process (which primarily includes the corporation and its property and the various ranks and classes of creditors);
•provide a structure which permits the negotiation of a commercial plan;
•enables a majority of creditors in favour of a plan or other course of action to find all other creditors by the democratic exercise of voting rights; and
•provide for judicial or other supervision to ensure that the process is not subject to unfair manipulation or abuse.
In paragraphs 44 and 46 of the ADB report there are three propositions put forward:

1.It is of critical importance to the rehabilitation process that the opportunity, whether prompted by possible sanction or encouraged by possible benefit, should be available to a debtor in financial difficulty to commence the process before it is too late.31
2.It is critical to the modern rehabilitation process that attempts by creditors, whether secured or otherwise, to intervene upon the process and pursue their independent individual rights should be restrained, by automatic operation of the legislation, as far as possible.
3.While, in a market based economy, liquidation and rehabilitation should not be the subject of political or government influence or intervention, the presence of some exceptional economic, social or other such circumstance might sometimes justify a special process and the involvement or intervention of Government; eg where the banking sector is itself in financial difficulty.
It is helpful to have these three propositions as a starting point and the work of the ADB should be applauded for providing a platform from which further analysis can be undertaken.

In my view, the primary task of UNCITRAL in its future work will be to determine whether the three ADB propositions to which I have referred have sufficient support to justify acceptance as core (or minimum) features of a rehabilitation process. A particular issue arises in respect of the second proposition and its reference to automatic stays against both secured and unsecured creditors.32

There is no doubt that a number of countries operate collective rehabilitation procedures which fall squarely within the propositions put forward in the ADB report. Nevertheless, there are also countries which operate rehabilitation procedures which do not fall within those criteria. New Zealand is one.

Yet, I would argue that New Zealand, while needing improvements to its insolvency law, has a sound structure in place which generally meets the needs of those doing business in the country.33 There is no provision under New Zealand's insolvency law, whether for individuals or companies, for either an administrative or judicial collective process which would create an automatic stay so far as secured creditors are concerned. The New Zealand approach has always been to regard secured creditors as falling outside of the insolvency law framework as they, in effect, contract out of insolvency laws by taking security and reserving to themselves the right to take action against some or all of the assets of the debtor should the debt not be repaid on due date or should there be some other default under the security arrangement. There are, I accept, two exceptions to that general proposition in New Zealand. Both are termed "statutory management" but fall to be determined under different statutes. The first is the statute designed to prevent systemic failure (the Reserve Bank of New Zealand Act 1989); the second, and more problematic, is the Corporations (Investigation and Management) Act 1989 which is more wide-ranging in its nature. Both statutes permit Government intervention by the making of an Order-in-Council placing an entity under statutory management and, once that is done, mandatory stays arise both in respect of secured and unsecured debts.34

I do not propose to proffer an answer to the question whether the ADB propositions are correct. Rather, I prefer to raise questions about the ways in which rehabilitation regimes might be viewed from both a domestic and an international perspective. The answers to those questions (and, in particular, the differences highlighted by the answers) should help shape a statement of the minimum elements required for a rehabilitation process to be effective both domestically and internationally.

Questions from Domestic Perspective
(a) How should a particular State view its insolvency law and consider reform?

If the State has no insolvency law traditions or infrastructure, it may well be possible to start from scratch with no adverse consequences. If, however, that State has a sound insolvency system which has worked well, there is a risk that domestic financiers used to operating under existing laws might increase the cost of credit should new laws be enacted which would restrict the circumstances in which securities could be readily enforced.

There is also the risk that foreign investors would see inexperience in operating a new regime as a reason for increasing the interest rate of return sought. This may lead to a question of confidence in the necessary infrastructures. Countries such as the United States of America which have well developed rehabilitation laws also have the advantage of having worked under those laws for a long time and having specialised courts with a specialist bar to service the courts. The same cannot be said in developing or small States. For example, in a State the size of New Zealand (population approximately 3.6 million) it would be impossible to develop the type of specialist bar or bench which operates in the United States. Each State must tailor its insolvency laws to fit, primarily, its own needs while, of course, paying heed to standards required in the international arena.

(b) To what extent are States likely to take account of competitive advantages to be derived from the way in which their rehabilitation laws are expressed?

On this point it is important to bear in mind that if a particular State sees that it can gain a competitive advantage in attracting investment due to the way in which it organises its domestic law (eg tax havens) it is likely to do so. State X may see it as advantageous to have rehabilitation regimes which are particularly advantageous to debtors (for cultural or social policy reasons) while State Y may frame its insolvency laws with a bias towards secured creditors by omitting mandatory stays from the regime as it affects secured debt.

There is also a respectable argument that the absence of an automatic stay in respect of secured debt will encourage more realistic rehabilitation plans because proponents are aware that they must pass muster with secured creditors in order to proceed.

If the absence of an automatic stay for secured creditors can be supported as a proper choice at a domestic level, how can a mandatory stay in respect of secured debt be regarded as a core or minimum element of a rehabilitation procedure at an international level?

(c) How can proper incentives be provided for debtors to take advantage of rehabilitation processes?

In Australia, abolition of the taxation debt priorities was followed by statutory requirements for directors to place companies into a form of insolvency regime if tax debts could not be met within particular times; if advantage was not taken to use an insolvency regime, the director could find himself or herself liable personally for the taxation debt. This proved to be a good incentive.

But there is a wider question. Outside of insolvency processes creditors are encouraged to act quickly so that they may gain the fruits of a judgment before other creditors. Yet, once collective procedures are put in place there are often disincentives to those who seek early payment; eg the use of voidable transaction legislation.

A policy question is whether it is more desirable to encourage debtors to face all creditors at the earliest possible time (through use of collective insolvency procedures) or to encourage creditors to obtain payment if they move quickly and efficiently. That is a major policy choice. If policy shifted towards the former, one way of achieving change would be to ensure that an examination as to means took place immediately upon a judgment being entered with the possible consequence of a collective insolvency regime being imposed if the debtor was plainly insolvent.

(d) To what extent should political or Government involvement in insolvency processes be permitted?

Different cultures and different social systems will place greater or lesser emphasis on the need for political or Government influence or intervention - even in a market based economy. The issues appear more starkly in China's "socialist market economy".

Consideration needs to be given to what constitutes a sufficient reason for Governments to intervene to prevent a collective insolvency procedure from taking effect. Examples might be protection of the financial system or other essential industries. In that regard, the UNCITRAL Model Law on Cross-Border Insolvency expressly contemplates banks or insurance companies as the types of business which may fall outside the scope of the Model Law.35 However, how far can this be taken? Can it legitimately apply to companies which manage funds in which people may invest for their retirement? Should it extend to essential industries? What about hospitals, schools and other community services? And, does it matter whether the businesses are run by the public or private sector?

Questions from an International Perspective
From an international perspective, the questions become slightly different. For example:

(a) What should be the minimum requirements for a rehabilitation regime to be given effect under the UNCITRAL Model Law on Cross-Border Insolvency?

From an international perspective one can put to one side purely domestic considerations and consider what types of proceedings should be enforced throughout the world if minimum criteria are met.

(b) How, from an international perspective, should one deal with extraordinary remedies which permit political or Government influence or intervention upon the insolvency of a debtor due to domestic circumstances in a particular State?

That question was avoided in the Model Law: for good reason because the Model Law was not an attempt to harmonise substantive law. There are plainly cases in which the Law was not intended to apply.36 I query whether the question can properly be avoided in UNCITRAL's future work.

Looking at the issues from an international perspective, it would seem appropriate for UNCITRAL to address those two questions early in its work on insolvency law. They are difficult questions but, to a large extent, individual States may find it easier to answer questions from a domestic perspective once the international solution becomes clearer. And, equally, they are questions which may be more readily answered at an international rather than a domestic level.

The Chen Li Hung Litigation
Chen Li Hung was an unusual case in the context of cross-border insolvency. It started life in the High Court of Hong Kong prior to resumption of sovereignty by the People's Republic of China over Hong Kong on 1 July 1997. Appeals to the Court of Appeal and the Court of Final Appeal of the Hong Kong Special Administrative Region were both heard and determined after resumption of sovereignty.

The facts were relatively simple. There was a bankruptcy order made by the Taipei District Court. A trustee in bankruptcy was appointed in Taiwan. The bankrupt had assets in Hong Kong. The trustee sought recourse to those assets through the Hong Kong so that the assets could be realised and distributed among creditors of the bankrupt. The question which arose in the proceedings was whether it was appropriate for the courts in Hong Kong to recognise and give effect to the bankruptcy order made in Taipei given that -

a.prior to 1 July 1997 the United Kingdom Government did not recognise authorities in Taiwan either as a de jure or de facto Government; and
b.after 1 July 1997 the authorities in Taiwan, in the eyes of a Chinese court, should be regarded as nothing more than rebel authorities having regard to the terms of the Constitution of the People's Republic of China.
In one sense the case was only a truly "cross-border" case before 1 July 1997 as, after that date, the Hong Kong courts were obliged to respect the claims of the People's Republic of China to sovereignty over Taiwan. Nevertheless, having regard to the "one country, two systems" concept it would be artificial not to regard this case as being governed by cross-border principles.

In the High Court, Patrick Chan J held that because the United Kingdom Government did not recognise the authorities in Taiwan as a de jure or de facto Government, the courts in Hong Kong should not recognise the acts of the Taiwanese courts which were not considered as lawfully and properly constituted.37 After resumption of sovereignty over Hong Kong by the People's Republic of China in July 1997, the case came before the Court of Appeal of Hong Kong. Both Mortimer VP and Godfrey JA were of the view that the appeal should be allowed because, while the Constitution of the People's Republic of China asserted sovereignty over Taiwan38 the case fell within the principles enunciated by the House of Lords, in Carl Zeiss Stiftung v Rayner and Keeler (No 2) [1964] 1 AC 853. In that case the House of Lords made it plain that even though Government X may not recognise Government Y the Courts of X should strive to give effect to the laws of Y where failure to do so would affect private rights and to give effect to such laws would not be inimical to the interests of the State claiming sovereignty or otherwise contrary to its public policy. Rogers JA took a different view which is encapsulated in the following passage from his judgment:39

… it would in my view be open to the Court to recognise the existing state of affairs even in that part of the sovereign territory where the authority of the sovereign is disputed. This would include recognition of marriages, divorces and the transfer of property. However, as I have already pointed out that is not the question which arises on the first preliminary issue in this case. The draft Statement of Claim does not rely upon an allegation that any right of property vests in the trustees but rather having referred to the Order of the Taiwan Court on 20 October 1990 the claim is that the trustees have the right and capacity to bring legal proceedings for the purpose of recovering the assets of the bankrupt. If the court were to accede to this application, it seems to me, that the court in Hong Kong would be assisting in the distribution of assets of Mr Ting being undertaken by a Government which is not merely an unrecognised Government but is exercising power in the Republic of China contrary to the wishes and intent of the sovereign Government. If the court were so to act, it seems to me, it would unwittingly become part of the judicial process of Taiwan, namely the process of administration of assets and what is, in effect, a rebel territory under the control of a court of the rebel Government. [emphasis added]

The Court of Final Appeal unanimously upheld the majority decision of the Court of Appeal for substantially the same reasons given by the majority in the Court of Appeal. The Final Court of Appeal relied upon the Carl Zeiss Stiftung case in holding that it was appropriate for the Hong Kong courts to give effect to the orders made by the Taiwanese court. In the leading judgment, Bokhary PJ held that courts in Hong Kong would give effect to the orders of non-recognised courts where -

•the rights conferred by those orders were private rights;
•giving effect to such orders accorded with the interests of justice, the dictates of common sense and the needs of law and order; and
•giving them effect would not be inimical to the sovereign's interests or otherwise contrary to public policy.
In a separate judgment Lord Cooke of Thorndon NPJ, while agreeing with the judgment of Bokhary PJ, made two observations of importance in relation to trans-national insolvency cases. First, His Lordship noted (in relation to articles 2, 8, 82 and 159 of the Basic Law of the Hong Kong Special Administrative Region of the People's Republic of China) that the common law was to be maintained in Hong Kong except to the extent that it contravened the Basic Law and was not amended by the legislature of the Special Administrative Region. Lord Cooke then said:

Having regard to those provisions and to the purposes of the Basic Law as a whole, I think that it may be inferred that, in appropriate cases, a function of a judge from other common law jurisdictions is to give particular consideration to whether a proposed decision of this court is in accord with generally accepted principles of the common law.

In the present case I have no hesitation in answering that question affirmatively together with my colleague. At international level, the relevant principle goes back at least to the 17th century and Grotius. It is sometimes described as the principle of implied mandate, but that is perhaps not a happy description, because the application of the principle does not depend on interpreting anything that the lawful sovereign says or does.

Second, Lord Cooke of Thorndon said:

Viewing the case from a different perspective, the issue is essentially between the Taiwan creditors on the one hand and Mr Ting, Madame Chen and Mr Chan on the other. It is not an issue with which national politics had any natural connection. They should not be allowed to intrude into or overshadow a question of the private rights and day to day affairs of ordinary people. The ordinary principles of private international law should be applied without importing extraneous high level public controversy.

I suggest that the Court of Final Appeal's judgment in Chen Li Hung is both sensible and in accordance with the expectations of those who invest and trade internationally. Because the case involves a balancing of competing public policy factors, it is an interesting case study in the application of both domestic and international policy factors discussed earlier in this paper in the context of insolvency law reform.

Viewed from a domestic perspective, there are three competing public policy factors at work in a case such as this. The first involves fiscal factors, including the need to encourage capital flows;40 the second involves the need to give effect to organs of a de facto regime in order to ensure that business and family life can go on without concern about over-riding political considerations;41 the third is the sovereignty factor to which Rogers JA referred in his dissent in the Court of Appeal and to which both the majority in the Court of Appeal and the Court of Final Appeal itself addressed by holding that there was nothing "inimical to the interest of the sovereign power" in giving effect to the Taiwanese order.42 There are also international public policy considerations at work. From an international perspective the focus shifts to the factors discussed in paras 13 and 14 of UNCITRAL's Guide to Enactment of the Model Law;43 ie in general terms, the need for efficient international processes (a) to resolve cross-border insolvency issues (b) to secure prompt distributions to creditors and (c) to confront increasing cross-border fraud.

The real difference between the majority and minority in the Court of Appeal in Chen Li Hung was that Rogers JA (in his dissent) placed greater emphasis on the sovereignty factor. In Rogers JA's view if the Hong Kong courts were "to recognise" the Taiwanese order they would become "unwitting" accessories to the judicial organs of the "rebel" Taiwanese Government to an extent inconsistent with the Constitution of the People's Republic of China. Although not put this way in his judgment, in effect, Rogers JA was saying that to give effect to the Taiwanese bankruptcy order would be inimical to the public policy of the People's Republic of China. On the other hand, both the majority in the Court of Appeal and the Court of Final Appeal itself by placing more emphasis on the need to provide mechanisms to assist cross-border claimants to recover their money held expressly that giving effect to the Taiwanese order was not inimical to the public policy of the People's Republic of China.

Looking at the case from an international perspective, it would seem that the ultimate decision in the Court of Final Appeal reflected an appropriate balancing of policy factors. In effect, the decision took account of both domestic and international policy concerns. I offer no opinion as to whether that decision represented an appropriate weighing of domestic policy factors; nor do I offer any view as to whether the decision was right or wrong as a matter of Hong Kong law. I am plainly not qualified to comment on such matters. Neither is it my place to do so.

What lessons, if any, can be learnt from the decisions of the Hong Kong courts in the Chen Li Hung litigation? May I offer the following tentative suggestions:

a.Although the case may be regarded as addressing an unusual issue, recent developments in the former Yugoslavia and in Indonesia (with East Timor) suggest that fragmentation of Nation States could provide more cases in which the issue will be raised. As mentioned earlier in this commentary, cross-border mechanisms are needed to ensure fair and efficient administration of cross-border insolvencies and to maximise the value of the assets of the insolvent debtor so that those assets can be realised and distributed among all creditors. The solution offered in the Chen Li Hung litigation through the ultimate decision of the Court of Final Appeal applies a principle which recognises the need for pragmatism in dealing with cross-border insolvency cases. That, I suggest, is the right emphasis.
b.Looking at the issue from an international perspective, the judgment of the Court of Final Appeal, in placing emphasis on the rights of creditors to gain access to assets of the debtor in a different location, applied the principles which underpin the Model Law on cross-border insolvency without, in the particular case, referring to them either expressly or by necessary implication. It is interesting to note that article 6 of the Model Law only permits a Court to refuse relief if, to do so, would be "manifestly contrary to the public policy" of the enacting state; that formulation of the principle is not too different from the principles applied by the Final Court of Appeal.
c.The case demonstrates that cross-border insolvency problems arise not only in a truly international context but also in the context of cross-border claims within either a Federal jurisdiction (where insolvency jurisdiction is exercised by member States), where rebel Governments exist or indeed where local and national courts both have prescribed jurisdictions. There is no reason in principle why the same principles should not be applied equally in all circumstances.
Notes

1. Paul Heath QC, Hamilton, New Zealand; Commissioner, New Zealand Law Commission, Wellington, New Zealand. The views expressed do not necessarily reflect the views of the Commission.
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2. The Law Commission was established by the Law Commission Act 1985. Deliberately the word "reform" was omitted from its name. The functions of the Commission are set out in s 5(1); the principal functions are (a) to take and keep under review in a systematic way the law of New Zealand; (b) to make recommendations for the reform and development of the law of New Zealand; (c) to advise on the review of any aspect of the law of New Zealand conducted by any Government department or organisation and on proposals made as a result of the review; (d) to advise the Minister of Justice on ways in which the law of New Zealand can be made as understandable and accessible as is practicable. In making its recommendations the Commission is obliged to take into account te ao Maori (the Maori dimension) and to give consideration to the multi-cultural character of New Zealand society; in addition, the Commission must have regard to the desirability of simplifying the expression and content of the law, so far as that is practicable: s 5(2). Unlike many other similar bodies, the Commission can self-refer projects: under s 6(2)(a) and (b) the Commission has power to initiate proposals for the review, reform or development of any aspect of the law of New Zealand and to receive and consider proposals made or referred to it by any person. It may also initiate sponsor and carry out such studies and research as it thinks expedient for the proper discharge of its functions.
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3. NZLC R52, February 1999; this report is available on the Commission's website http://www.lawcom.govt.nz under the heading "Publications".
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4. NZLC SP2, October 1999; this paper is available on the Commission's website http://www.lawcom.govt.nz under the heading "Publications".
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5. See also Asian Development Bank, Office of the General Counsel, Law and Policy Reform at the Asian Development Bank: Report on RETA 5795: Insolvency Law Reforms in the Asian and Pacific Region (April 2000), para 22, 13.
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6. See Ting Lei Miao v Chen Li Hung [1997] 2 HKC 779 (Patrick Chan J); Ku Chia Chun v Ting Lei Miao [1998] 3 HKC 119; [1999] 1 HKLRD 123 (CA) and Chen Li Hung v Ting Lei Miao [2000] 1 HKC 461 (CFA).
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7. General Assembly Resolution 52/158 of 15 December 1997 is set out as an Annex to the UNCITRAL Model Law on Cross-Border Insolvency with Guide to Enactment (United Nations, New York 1999), 93-94.
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8. Guide to Enactment of Model Law on Cross-Border Insolvency para 13, 23-24.
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9. Above n 8.
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10. Above n 8, para 14; see also Millett, Tracing the Proceeds of Fraud (1991) 107 LQR 71.
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11. Generally, articles 9-14 of the Model Law.
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12. Generally, articles 15-24 of the Model Law.
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13. Articles 19 and 21 of the Model Law.
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14. Generally, articles 25-27 of the Model Law.
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15. American Law Institute, Transnational Insolvency Project, Principles of Co-Operation in Transnational Insolvencies Cases Among the Members of the North American Free Trade Agreement (2000).
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16. Report of the Working Group on Insolvency Law on the Work of its 22nd Session (Vienna, 6-17 December 1999) A/CN.9/469, para 140, 33.
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17. The next Working Group session is to be held in New York from 26 March to 6 April 2001. The Colloquium is being held in Vienna, 4-6 December 2000.
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18. A/55/17 Report of the United Nations Commission on International Trade Law on the work of its 33rd session (New York, 12 June - 7 July 2000), para 409.
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19. Legal Department of IMF, Orderly and Effective Insolvency Procedures: Key Issues (1999) vii.
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20. Above n 3.
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21. These factors are summarised in the Executive Summary to Cross-Border Insolvency: Should New Zealand Adopt the UNCITRAL Model Law on Cross-Border Insolvency? (NZLC R52), paras E3 and E4; see also the discussion of these factors in chapter 3.
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22. For example, Bebchuk & Guzman An Economic Analysis of Transnational Bankruptcies (National Bureau of Economic Research, Working Paper 6521, Cambridge, 1998), 19-23.
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23. A/CN.9/469, Report of the Working Group on Insolvency Law on the Work of its 22nd Session (Working Group Report), paras 21-31.
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24. Working Group Report, paras 32-124.
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25. Working Group Report, para 21.
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26. Working Group Report, para 38.
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27. Working Group Report, paras 39-62.
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28. See generally, MJ Ross Political Expediency and Misguided Insolvency Reform - The New Zealand Experience with the Corporations (Investigation and Management) Act 1989 (1994) 2 Insolvency LJ 25, 27.
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29. Above n 5.
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30. Above n 5, para 41.
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31. In this paper I propose to refer to the term "debtor" although the ADB paper is restricted to "corporations".
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32. The lack of consensus on this point was noted in para 68 of the Working Group Report.
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33. Provisions for corporate rehabilitation can be found in Parts XIV and XV of the Companies Act 1993 (New Zealand) - neither of which allow for automatic stays in respect of secured debt.
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34. I do not debate the appropriateness of those procedures; they are being considered at present as part of work on rehabilitation procedures which is being undertaken by the Law Commission at the request of the Ministry of Economic Development: the Law Commission is to report to the Ministry of Economic Development by 28 February 2001 and it is likely that the Commission's report will be published by May/June 2001. It is likely to be published in the Commission's Study Paper series.
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35. See article 1(2) of the Model Law.
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36. Above n 35.
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37. (1997) 2 HKC 779, 792.
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38. Preamble to the Constitution of the People's Republic of China.
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39. [1999] 1 HKLRD 123, 146-147.
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40. See the discussion of fiscal factors in Cross-Border Insolvency (NZLC R52), paras E3, E4 and 76-100.
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41. In the Court of Final Appeal, Bokhary PJ put it this way: "When the doctrine of public policy is raised in the courts, it is usually in regard to whether a contract should be refused effect on public policy grounds. The contractual objects which invalidate contracts on those grounds, include (as the learned editors of 'Chitty on Contracts', 28th ed (1999) put it in vol 1, 838, para 17-005) 'objects injurious to good Government either in the field of domestic or foreign affairs'. This goes to show that Mortimer VP was proceeding in conformity with established principles when he addressed the question of whether 'recognition of the rights of the trustees in bankruptcy to sue in Hong Kong [would be] in any way inimical to the interests of the sovereign power'. If I may say so, the learned Vice President's terminology expresses very neatly one of the public policy considerations which arise in situations like the present; and I gratefully adopt his terminology".
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42. Above n 41; see also, the observations of Lord Cooke of Thorndon cited above. In addition, in the New Zealand context, see the discussion of the sovereignty factor in Cross-Border Insolvency (NZLC R52), paras E3, E4 and 104-105.
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43. Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency, 23-24; see also discussion above.

 

DISCLAIMER
This article is intended to provide general information and should not be construed as legal advice.  Parties who require clarification on issues raised in this article should take their own legal advice.

There have been a number of articles in the media lately that have called into question the integrity and honesty of some insolvency practitioners ("IPs"). In one widely reported example, an IP took $80,900 belonging to a liquidated company and deposited it into his own bank account, which he subsequently used for personal and business expenses. Then there are those IPs who have prior convictions for serious fraud or have been disqualified from professional bodies such as the NZ Institute of Chartered Accountants ("NZICA").

For some time now, many stakeholders have been calling for increased regulation of the insolvency profession to ensure that the interests of creditors are given the highest priority. Misconduct by a small number of IPs only serves to emphasise this need.

The current regime

Situations like those mentioned above have occurred because there are low barriers of entry to the profession. Any individual can act as an IP as long as they are not, for example:

  • Younger than 18,
  • An undischarged bankrupt,
  • Subject to the Mental Health Act 1992,
  • A related party (such as the insolvent company's director or accountant),
  • Prevented by the Courts from acting as an IP,
  • Prohibited from being a director, and
  • Have not been convicted of a dishonesty crime in the last five years.

If an IP does not properly carry out their duties creditors have various options available, however most of them have shortcomings.

  • A complaint may be made to the Official Assignee ("OA") but the OA seldom acts upon complaints due to the time and cost involved.
  • A complaint may be made to a professional body (such as NZICA) but this is only useful if the IP belongs to a professional body. Some don't.
  • A meeting of creditors may be called to replace the IP but this does not provide any recompense for damage an IP has already done, nor does it expose the IP to disciplinary action.
  • Legal action is also an option but is costly, time consuming and usually only taken by the most determined of creditors.

A need for change

There are concerns with the current regime because of the minimal oversight of the profession. This allows some IPs to favour their own interests or those of the shareholders of the insolvent company, rather than carrying out their primary duty to act in the best interests of creditors. There are also no minimum requirements regarding qualifications, experience, or level of education.

In response to market concerns the Government introduced the Insolvency Practitioners Bill ("the Bill") in April 2010. Since its introduction the Bill has been amended by the Select Committee and is now awaiting its second reading. In its current form the Bill provides for modestly enhanced appointment criteria and regulation of the insolvency profession.

Proposed legislation - Register of IPs

One of the main objectives of the Bill is to provide for mandatory registration of all practitioners. This involves a Register of IPs which will be overseen by the Registrar of Companies and is available to the public. In addition to the requirements for IPs mentioned earlier, an individual is not eligible for registration if they have had their membership revoked or suspended from a professional regulatory body.

The Registrar of Companies will have the ability to cancel an IP's registration if they fail to meet the requirements. A fine of up to $50,000 or two years in prison may be imposed on an unregistered person who acts, or holds themselves out as eligible to act, as an IP. The Bill does, however, include a provision that allows an individual who is not eligible for registration to apply for a Court order to override the disqualification criteria.

Proposed legislation - additional duties and regulation of IPs

The Bill requires that IPs perform additional duties and imposes penalties for non compliance. Additional duties include:

  • Providing an interest statement that advises if the IP has any conflicts of interest,
  • Advising creditors of the registration requirements for IPs,
  • Advising creditors of the role of the Registrar of Companies,
  • Providing additional information in the interim and final reports.

The Registrar of Companies is to be the primary regulator of the profession and will have increased powers including the ability to prevent a person from acting as an IP and requiring an IP to work under supervision. The Registrar can also cancel an IP's registration in certain circumstances, for example if they fail to comply with their statutory duties on two separate occasions. Details of practitioners that are prohibited or under supervision will be available on the IP Register.

The new Bill - how effective?

The Bill strengthens the powers of the Registrar of Companies and enables them to take action against non compliant practitioners including cancelling their registration. In addition, if an IP breaches their duties and this causes a loss to creditors, the Registrar will be able to apply to the Court for a Compensation Order against the IP.

However, if a creditor complains about a matter that is not subject to a fine or penalty in the legislation, and is not serious enough for the Registrar to cancel the IP's registration or to take other action, the creditor is left to fall back on the avenues of recourse already available.

The Bill also notably omits to include minimum educational or experience requirements for IPs, so inexperienced individuals may still enter the profession. The difference is that such IPs will be able to state that they are 'registered', thus giving the impression of government approval and perhaps creating a false sense of security for creditors.

An alternative way forward

The Bill is an improvement on the current situation but we would like to see the industry more effectively regulated so that only qualified, experienced individuals can be appointed as IPs. INSOL NZ, the NZICA administered insolvency special interest group, is looking to address the deficiencies in the proposed legislation by establishing their own standards for members. Some of the requirements will include meeting minimum entry criteria, undertaking continuing business education and being subject to cyclical practice reviews.

As a member of NZICA, McDonald Vague is already subject to their practice review process to ensure the quality of our work. In addition, we are obliged to adhere to NZICA's Code of Ethics and other standards. We are also members of INSOL and fully support the work the group is undertaking to enhance the quality of the profession.

Conclusion

The new Bill will modestly enhance the regulation of the insolvency profession. However, if appointing an IP, we urge shareholders, creditors and their lawyers and accountants to carefully consider the IP's experience and qualifications before engaging them.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

According to the business.govt.nz website, about one in ten small businesses fail in their first year, and 70 percent capsize within the first five years. These are sobering statistics.

Most directors that we meet blame the Global Financial Crisis ("GFC") as the number one reason their business failed. Although the GFC was probably one of the causes of the company's downfall it will not have been the main reason. The main reason a company fails is poor management.

It is important for directors to be aware of the bumpy road ahead when starting up their company. Many people are very good at what they do technically, however, they lack the knowledge and know how of running a company.  In our industry we meet a lot of stressed directors of failed companies. A typical interview with a director of an SME usually goes something like this:

Liquidator:  What do you think was the major reason for the failure of the business?

Director:  We just ran out of money and the bank won't lend us any more. We've got some really good jobs coming up but the account is on stop credit. If only the last job paid us on time we wouldn't be in this situation.

Liquidator:  Do you have any financial records?

Director:  They're with my accountant, they will know everything.

Liquidator:  When was the last time you filed your GST return?

Director:  My accountant handles all that.

Liquidator: What do you owe to your creditors?

Director: I don't really know?

We now focus on 3 top reasons why SMEs become insolvent.

1. Poor record keeping/financial control

Many directors do not keep good books and records. They are often too busy creating the company and getting it up and running and fail to capture important data when required. Lack of good records leads to poor and inaccurate forecasting. We find that many SME directors do not know the company's breakeven point or what it is costing them to do a job.

A combination of the above will result in insufficient cash flow for the company which leads to the inability to pay all creditors as debts fall due. This means the company will likely require further capital contribution, or loans from third parties, which will not be forthcoming without showing past results and future forecasts that lenders can have confidence in.

Many companies hire accountants to assist with the financial control of the business. However, it is still the responsibility of the director to supply timely and accurate records.  Without good primary records there is only so much accountants can do to assist.

A good example of what not to do was found on a panel beating liquidation I managed a couple of years ago. The director took over the business from his retired boss. He thought the panel beating prices in Auckland were over the top and decided to charge everyone mates' rates to attract business.  After almost a year the director realised something was wrong so he increased his prices but this led to a decrease in the number of jobs flowing through. It put the business further in debt and eventually led to liquidation. When we picked up the books and records from the office we discovered the creditor invoices were all in a box not filed and the only paperwork that was kept reasonably tidy was the debtors' schedule.

2. Lack of capital contribution

In the current economic environment it is not easy for companies to obtain business loans from banks. This puts more pressure on companies to obtain sufficient capital contributions.

Many companies go into business 'under gunned'. They expect the business to flourish from the first day and fail to take into account the potential losses during the initial growth period and that costs start from day one, while revenue can experience delays. This can also be the result of poor initial planning and due diligence.

The hospitality industry is a good example of what can go wrong from day one. Start-ups often purchase outdated equipment and cut corners on renovation due to lack of funding. This puts stress on the business down the track and results in high maintenance costs, low sales or dissatisfied customers not returning due to a poor initial experience.

We often see businesses run out of cash just when they are starting to generate sales. This can be the result of fierce business competition. Many businesses try to undercut their competitors to gain a customer base.  This can result in a short term loss for the benefit of potential long term success. When the company does not have sufficient capital to support the business during the difficult times then it will encounter cash flow problems.

We were appointed receivers of a skydiving business recently. The director felt the best way to attract customers was to offer the cheapest tandem skydives on the market, much to the amazement of his competitors. What he didn't consider were the deferred maintenance costs required to maintain his aircraft. His business failed when he couldn't afford a $500,000 bill to replace the engine in his aircraft.

3. Directors' lack of commercial acumen

Many people do not take the time to really think about what their life will be like as an entrepreneur. It can be a tough lifestyle at first. They often work twice as hard as they did before, get no holidays and do not make much money to begin with.

As alluded to in the above director interview, some directors have no control over the financial aspects of their company. They may be forced into taking on a directorship to help out a friend or simply "do the right thing" by taking over a family business. In some cases it simply could be due to pride. I have personally experienced a case where the director told me the main reason for starting the business and keeping it running for ten years whilst making losses was to be seen to be "cool" and gain respect from friends and family by owning a company.

Many SME directors are first time directors. They have no previous experience of running a business, no accounting background or prior knowledge of their specific industry. A great cake maker or builder for example, does not automatically make a good director. Without the appropriate professional financial advice and support they may find they lack the appropriate knowledge to run a company. Too often we see cases where directors find they have trusted someone who has let them down or left them exposed through a word of mouth contract. Agreements need to be in writing and signed to be fully effective.

Summary

The world needs entrepreneurs, without them we would have no businesses. We are not trying to discourage anyone from being a director of a company, however it is important they are well prepared when they start a business and seek appropriate advice to ensure the business has the best possible chance of success.

A director entering into business for the first time should seek advice on maintaining books and records and statutory compliance.

Due diligence must be done to ensure the sustainability of the business and obtain the right level of capital contribution.

Should a director or shareholder be personally advancing funds to the company then they need to consider registering securities and attending to the appropriate documentation to gain secured status.

If you or one of your clients is concerned that you may be insolvent then Take our 30 second insolvency test. If you answer yes to one or more of these questions then the company may be insolvent and you should see advice as quickly as possible.

We are always happy to offer advice on insolvency options.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

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