Chapter 8Administration of liquidations and insolvency
8.1The impact of insolvency practitioners on Australia’s corporate insolvency regime cannot be understated. Upon appointment, insolvency practitioners become custodians of what may be the livelihood, not just of the directors of the immediate business, but also potentially of many others.
8.2Insolvency practitioners must wear many hats: they may be advisors, accountants, auditors, investigators, debt collectors, litigators, and distributors. They usually enter people’s lives at when they are at their most vulnerable and must balance many interests with often scarce resources to share around. This great responsibility is reflected in the requirements that must be met in the registration and conduct of insolvency practitioners, and for good reason.
8.3Evidence to this inquiry recognised that the complexity and idiosyncrasies of the task of insolvency practitioners deserves further reflection. Primarily, this would help ensure that the current policy settings are optimal for ensuring that this profession can best serve the Australian economy.
8.4This chapter focuses on five areas in particular:
registration requirements;
insolvency practitioner regulation;
remuneration of insolvency practitioners;
independence requirements; and
pre-insolvency advisors.
Background
8.5‘Insolvency practitioners’ is an umbrella term used to refer to practitioners that specialise in advising on, or being appointed to formal roles within insolvency, restructuring and turnaround processes. While this term is commonly accepted as including liquidators and administrators, it does not have a clear definition, including in statute.
8.6Figure 8.1 contains a diagram provided to the committee by the Business Law Section of the Law Council of Australia (BLS LCA) that sets out and describes the various insolvency and restructuring advisors in both corporate and personal insolvency.
Figure 8.1 Descriptions of insolvency and restructuring advisors
Source: Business Law Section, Law Council of Australia, Submission 30, Annexure 1.
8.7Insolvency practitioners appointed to an administration or a liquidation take on a variety of tasks, including those identified in Figure 8.2 below, which was provided by the Australian Restructuring Insolvency and Turnaround Association (ARITA).
Figure 8.2Responsibilities of insolvency practitioners
Source: ARITA, Submission 36, p. 62.
8.8Insolvency practitioners, once appointed to an administration or liquidation (other than in small business restructuring), assume control of the company— the subject of the appointment to ‘secure and recover its assets’— with the end goal being to either ‘maximise the chances of the company or its business continuing in existence and/or maximise the returns to creditors’. In doing so, insolvency practitioners become personally responsible to the company’s creditors and may be held personally liable for the company’s actions. Insolvency practitioners also have duties to investigate a company’s affairs and report to ASIC if necessary.
8.9The highest level of the insolvency profession is made up of registered liquidators, which practice in corporate insolvency, and bankruptcy trustees, which operate in relation to personal bankruptcy. ARITA told the committee that as at 31 October 2022, there were 652 registered liquidators and 209registered (bankruptcy) trustees, with a degree of overlap between the two.
8.10Responsibility for the regulation and supervision of insolvency practitioners in the context of corporate insolvency rests with the Australian Securities and Investments Commission (ASIC), while the Australian Financial Security Authority (AFSA) oversees the personal bankruptcy regime.
Registration requirements of insolvency practitioners
8.11The registration regime for liquidators is set out in Subdivision B of Division 20 of the Insolvency Practice Schedule (Corporations) (Schedule 2 of the Corporations Act).
8.12The Schedule provides that applications for registration as a liquidator must be considered by a committee convened for the purposes of considering such applications, to be constituted by representatives of ASIC, a registered liquidator chosen by a prescribed body (which is the Australian Restructuring Insolvency and Turnaround Association (ARITA)), and a person appointed by the Minister. In considering an application, the committee must determine whether, among other things, the applicant has met the prescribed qualification, experience, knowledge and abilities requirements.
Small business restructuring practitioners
8.13The reforms that introduced the small business restructuring arrangements also introduced a new sub-class of registered liquidators who may only take appointments as restructuring practitioners, with lesser registration requirements than for full registration as a registered liquidator. The committee was informed that as of January 2023, one small business restructuring practitioner had been registered, with six applications for registration having been rejected.
8.14Two competing views were put to the committee about this. On the one hand, ARITA raised concerns that the lessened requirements ‘undermines much of the progress made to increase the competence and capability of the profession through the Insolvency Law Reform Act 2016’ and ‘fail[s] to recognise the specialised expertise of insolvency practitioners’. Given the complexities associated with the small business restructuring regime, ARITA ‘strongly’ recommended that equivalent academic requirements be imposed on restructuring practitioners as those on registered liquidators, while experience requirements could remain lessened.
8.15On the other hand, noting what appears to be a limited take up of this particular category of registration and the high number of rejections relative to the number of applications granted, Professor Harris and Mr Murray proposed expanding the scope of who may serve as a restructuring practitioner to assist in expanding the number of these practitioners.
Gender diversity amongst registered liquidators
8.16During this inquiry, the imbalance in gender representation amongst registered liquidators was a focus for inquiry participants. Table 8.1 below sets out data adapted from ASIC’s submission and its Series 4 data which shows the proportion of female registered liquidators against the total figure.
Table 8.1Statistics of registered liquidators by gender
| | | |
2019-2020 | 633 | 55 | 8.7% |
2020-2021 | 649 | 57 | 8.8% |
2021-22 | 646 | 59 | 9.1% |
As at 31 March 2023 | 651 | 60 | 9.2% |
Source: Adapted from ASIC, Submission 29, pp. 68–69 and ASIC Series 4 statistics Table 4.4- Registered liquidators–Gender by region, ANNUAL, QUARTERLY, released April 2023, Tab 4.4 <https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-series-4-quarterly-registered-liquidator-statistics/>
8.17While ASIC noted that there had been a slight increase in the number of female insolvency practitioners over the past 10 years (from five per cent), there was a shared view amongst inquiry participants that more needs to be done to ‘ensure that the profession is more reflective of the community that it serves’.
8.18The major reason provided for this imbalance is the current qualification requirements for registration as a liquidator with ASIC. The Turnaround Management Association (TMA) explained that the current requirement to demonstrate 4,000 hours of relevant experience within the five years prior to applying for registration is problematic, particularly for applicants that have caring responsibilities or take parental leave.
8.19KPMG echoed TMA’s concerns that the current restrictions are problematic and discourage people with caring responsibilities from coming back into insolvency. It recommended that this requirement be amended to take into consideration career breaks and part time work. KPMG did not express a view as to alternative minimum experience requirements, other than it possibly being a ‘significant reduction’, but it expressed a willingness to work with the relevant parties to make a recommendation. It supported the development of a competency-based framework to determine the appropriate level of skill required.
8.20ASIC agreed that the experience requirement ‘can be challenging for applicants who have or anticipate having parental leave or carers duties’. It identified that changes that came into effect on 1 January 2021 provide liquidator registration committees with broader scope to consider what may be determined to be relevant work experience. It explained that following the introduction of these measures, some applicants, both male and female, were granted registration despite not having completed 4,000 hours of directly related work experience within the previous five years. These applicants had demonstrated that they were otherwise suitable for registration.
8.21ASIC pointed out that there is capacity to apply for a variation to these requirements. While acknowledging that there is some capacity to vary these requirements, TMA stated that this is ‘very ad hoc, and a lot of women didn’t even know that they could actually make that application in the first place’.
8.22Both ARITA and ASIC suggested that the lack of female representation in the registered liquidator population may be the result of broader systemic issues.ASIC pointed out that the gender imbalance also exists in other jurisdictions (such as the United Kingdom and New Zealand), suggesting that the problem extends beyond the Australian experience requirement. ARITA told the committee that it is seeking to improve diversity and inclusion through its Balance Taskforce, which is initially focusing on gender and age diversity.
Committee view
Small business restructuring practitioners
8.23The limited number of registrations for small business restructuring practitioners is a cause for reflection. While these reforms have only been in place for two years, the committee is of the view that further consideration of the reasons for this would be beneficial and may lead to improvements in these figures. However, the committee agrees that any changes to this process would have to be undertaken carefully so as to not compromise the integrity and quality of the broader profession.
8.24The committee is cognisant that the limited number of registrations for the position of a small business restructuring practitioner is likely to be related to the broader criticisms of the small business restructuring pathway. For that reason, the committee is of the view that it is appropriate to reflect on this issue in the course of any wider consideration of the pathway itself.
8.25The committee recommends that the comprehensive review consider the requirements for the registration of small business restructuring practitioners to understand the reasons for the limited number of registrations to date.
Gender diversity amongst registered liquidators
8.26While many other industries and professions have managed to improve diversity among their ranks, registered liquidators appear to have been locked in a time capsule that was buried decades ago.
8.27The fact that female representation amongst registered liquidators has improved to one in ten over the past decade is alarming. It appears that we are not alone in facing this issue. There are clearly broader cultural or systemic factors at play, and they must be reflected on and addressed.
8.28A great place to start is the current experience requirements. These requirements are a significant barrier to anyone with caring responsibilities. They can be changed, and they must if we are to have an insolvency profession that reflects the economy and the country that it serves. While the committee acknowledges that there is capability for flexibility amongst the registration application process, reliance on ad hoc decision making is not enough if we are to achieve this goal.
8.29The committee is of the view that prompt reform of the experience requirements is necessary. This review should consider whether the current requirement to demonstrate 4,000 hours of relevant experience during the previous five years is appropriate and necessary. It should also consider whether this requirement could be revised to allow for greater inclusivity while still ensuring that practitioners are appropriately qualified for registration.
8.30The committee recommends that the government reform the experience eligibility requirements for registered liquidators, to address the inequity of the requirements and the gender imbalance in the population of registered liquidators. Reforms could potentially include:
increasing the period over which experience is demonstrated, or
replacing part of the required hours with a competency-based exam.
Regulation of insolvency practitioners
8.31ASIC told the committee that it undertakes regulation of insolvency practitioners through various means, including:
supervision, including:
dealing with reports of misconduct lodged with ASIC regarding alleged registered liquidator misconduct;
using real-time data to identify possible areas of concern for consideration;
using a natural language processing algorithm to allow real-time review of declarations of independence, relevant relationships and indemnities;
monitoring conditions imposed on liquidator registrations; and
exercising ASIC’s registered liquidator regulatory powers under Schedule 2 of the Act (further information on this is set out in Appendix 1).
enforcement action, including:
referring registered liquidator misconduct to disciplinary committees convened under Schedule 2;
entering court enforceable undertakings, where necessary; and,
engaging in court proceedings either as an intervener or amicus curiae where necessary.
guidance, including:
publishing detailed regulatory guides on relevant topics and issues (including registration and discipline of registered liquidators); and
developing and updating forms to enable compliance with duties and obligations, such as forms following the 2017 and 2020 law reforms.
education, including:
publishing information sheets to assist registered liquidators to comply with their duties and obligations (such as INFO 29);
publication of quarterly newsletters on relevant topics; and
authoring articles for publication in journals published by professional organisations.
stakeholder engagement, including:
issuing emails to registered liquidators and other interested parties on specific topics and issues;
conducting surveys on topical issues; and
facilitating and engaging in liaison meetings with registered liquidators, government and statutory and professional bodies.
policy work, including:
providing data and feedback to government on proposed reforms;
implementing systems and processes to enable registered liquidators to comply with their duties and obligations following law reform; and
implementation of new laws[.]
8.32Figure 8.3 below identifies the number of supervision cases finalised by ASIC in the 2019–20, 2020–21 and 2021–22 financial years.
Figure 8.3Number of finalised insolvency practitioner cases, by state and financial year
Source: ASIC, Submission 29, p. 16.
8.33ASIC noted that ‘[a] significant portion of [its] supervision activities result in a change in behaviour of the registered liquidator and their staff without formal enforcement action’.
8.34In 2021-22, ASIC considered 351 reports of misconduct in relation to registered liquidators (being 4 per cent of the total reports of the 8,688 misconduct received in that period). Of these:
12 per cent were referred for further action;
3 per cent resulted in a warning letter being issued to the registered liquidator;
approximately 25 per cent related to ‘a lack of understanding of the insolvency process on the part of the reporter or communication issues’; and
a further 60 per cent were analysed and assessed for no further action.
8.35As well as being regulated by ASIC, insolvency practitioners are subject to further standards and oversight arrangements under their relevant professional body. Registered liquidators are also subject to the ARITA Code of Professional Practice.
8.36Disciplinary action may be taken against a registered liquidator following consideration of a committee, constituted by representatives of the same organisations that may sit on a committee considering registration applications (ASIC, ARITA and a nomination by the Minister).
8.37Mr Ben Sewell raised questions about the presence of ARITA on these committees, stating that this presence ‘muddies the waters in terms of the model of who is the arbiter’. He explained:
Where you have a professional association that both has some hand in whether its members get appointments and how they get punished and also basically collects fees from them and advocates on their behalf, I think that's a short-sighted process. If the real issue is the integrity of the system as a whole—that's one problem that you're being called to deal with—then avoiding conflicts of interest is something very important.
8.38Mr Sewell recommended that ARITA be removed from this position on the basis that it ‘lacks the impartiality to perform this kind of public service role’.
8.39Mr Michael Brennan, Liquidator and Bankruptcy Trustee at Offermans, described the uneasy relationship between ASIC and the population of insolvency practitioners that it regulates. He described a ‘high level of distrust between the two groups’, which in his view ‘at best could be classified as a wary détente’. Mr Brennan compared this to the dynamic between AFSA and its regulated population, describing that relationship as ‘very collaborative and collegiate’.
Remuneration of insolvency practitioners
8.40In a report tabled in June 2004, this committee commented that it had received feedback that ‘clearly indicated a widespread perception that fees for insolvency services are high and may be unnecessarily so’. Evidence to this inquiry also focused on the expense involved in engaging insolvency practitioners, but most of this commentary noted the degree to which the complexity of the task, and the amount of public interest work involved contributes to this expense. Indeed, the committee was told that much of insolvency practitioners’ work is not fully remunerated.
8.41Remuneration for external administrators appointed to a company must be approved by either a resolution of that company’s creditors, a committee of inspection or a court.
8.42Evidence from the Hon Bruce Billson from the Australian Small Business and Family Enterprise Ombudsman (ASBFEO), indicated that concerns remain about the extent of company assets that are consumed by meeting external administrators’ costs and remuneration. He described the sentiment as follows:
Where the beneficiary of a business [is] in trouble, once engaged in the insolvency process, people sort of wonder, 'What's the outcome for people?' We like to use the word 'stakeholders'. It's not only about secured creditors but also about business owners who have put their life into it, employees who would love to see the business going, and investors who kind of wonder, 'Where's my spot in this conversation?' at times when significant proportions of residual assets end up going to the practitioner.
8.43Mr Murray explained that a thorough review of issues surrounding insolvency practitioner remuneration goes beyond simply regulating excessive charging:
Remuneration highlights a range of idiosyncratic features of insolvency law and practice that should be acknowledged when remuneration is being assessed, and which should provide some springboard for efficiency-based law reform.
8.44In addition to Mr Murray’s general response, a number of specific factors which are discussed in more detail below, were raised as contributors to the cost of insolvency practitioner remuneration, including the:
the degree to which insolvency practitioners undertake work for which they do not receive remuneration;
complexity of the task;
personal risk taken on by insolvency practitioners upon appointment;
burden imposed by reporting obligations to creditors and regulators.
Unpaid work
8.45The point was made to the committee that in many cases, liquidators forego full payment of their fees due to the inadequacy of available assets to cover them and the statutory obligations imposed on insolvency practitioners to undertake work even where assets are not available to remunerate them for it.
8.46While the committee was told that there is a degree of poverty of data and a lack of transparency about how the insolvency profession charges its work, some statistics were cited as providing an idea of the scale of this issue. ASIC told the committee that 29.7 per cent of forms lodged at the end of external administrations and controllerships between 1September 2017 and 30 September 2022 stated that no remuneration had been received during that appointment. Referring to statistics from 2018/19, ARITA said that ‘around 37% of the businesses being liquidated had no assets and a further 31% had less than $20,000 in assets’, which is not enough to cover the full amount of practitioner’s fees. Mr Murray and Professor Harris cited a 2013 study which quantified the amount of unfunded work undertaken by liquidators at $47million.Professor Harris described this situation, being one where professionals are expected to take on jobs in which they may not be paid for 40per cent of their work, as ‘market failure’.
8.47A significant contributing factor in the creation of these circumstances is that insolvency practitioners are required by statute to take on a significant amount of ‘public’ work in the course of an administration or a liquidation, such as investigating the history of the company it has been appointed to, the activities of that company’s directors and the preparation of reports on misconduct to ASIC. However, the nature of this work increases pressure on the costs charged by insolvency practitioners, particularly because a great deal of this work is unlikely to generate financial returns for insolvency practitioners. BlueRock described this as ‘free’ work. ARITA estimated that the value of this work to be around $100 million per year.
Cross subsidisation
8.48Some inquiry participants, such as Professor Harris and MrMurray, suggested that in response to the quantum of unfunded work, there is a practice of cross-subsidisation occurring, wherein higher rates are charged in some administrations in order to cover lost funds on other accounts.Professor Harris noted that judges had referred to ‘the well-known principle of swings and roundabouts—that you might charge less on low-value jobs, and you charge more on high-value jobs’.
8.49The BLS LCA took a different view. They agreed with the economic proposition that where practitioners are not remunerated for aspects of their work, they must be able to receive enough funds from other work to ensure the viability of their business model. However, it did not take the view that cross-subsidisation was occurring as a result. It stated:
It is not a necessary consequence that the system involves material “cross-subsidisation” as has been put to the Inquiry in some submissions. Ultimately that is only the case if creditors should be charged (or perhaps would be charged if liquidators were fairly remunerated for other work or not required to perform unfunded work).
It is expected that creditors being paid a low cents-in-the-dollar return would scrutinise or feel aggrieved by a material portion of available funds being used to fund the work necessary to restructure or wind up the affairs of the company that owes them money. The public conversation about insolvency remuneration and consideration of stakeholder comments on those matters must be seen in that light.
8.50Chartered Accountants Australia New Zealand (CA ANZ), the Institute of Public Accountants (IPA) and CPA Australia described the notion that registered liquidators charge higher fees to businesses with sufficient assets as a gross misrepresentation, emphasising that liquidator remuneration is subject to approval by creditors. They stated:
In setting that rate, a registered liquidator must consider contingency for unfunded work, just as other service provides price in bad debts when providing services. This is simply pricing services at a rate that sustains a viable business, not cross-subsidisation.
Public funding
8.51It was put to the committee by some inquiry participants that government should fund these public functions performed by liquidators. ARITA told the committee that this would reduce the need for practitioners to cross-subsidise in other accounts. On this view, the existing Assetless Administration Fund required further funding, and the threshold for accessing it to be too high, for it to be adequately working as intended.
8.52Mr Richard Fisher, a consultant to Ashurst Australia, noted that the Harmer Report, on which he was a Commissioner, recommended the creation of an assetless administration fund funded through an annual levy on companies. MrFisher explained:
If you want a proper regime in terms of the costs of administration, then you put into place a regime funded by the corporate world to ensure that when companies fail there is at least a base level of investigation into the reasons for the failure for the purpose of identifying whether claims ought to be pursued as a result of misfeasance or on other bases.
…
The policy question, if I might put it in those terms, seems to us to be should there be a regime which facilitates the effective investigation of companies that fail. If I might put it in this way: so long as liquidators are expected to act as corporate policemen, at least in the first instance, that won't happen under the current regime simply because, in most cases, there are insufficient funds to support the investigation.
8.53Others supported the creation of an official receiver for corporate insolvency, reflecting the Official Trustee in Bankruptcy, however, this view was not universally supported.
8.54Discussion regarding the Assetless Administration Fund and other questions relating to public funding for insolvency are discussed in chapter 9.
Complexity
8.55Mr Murray added that the fact that insolvency practitioner remuneration absorbs so much of the funds in a liquidation ‘is perhaps indicative of the reality that winding up and investigations takes time and skill, and that any funds or assets that remain are difficult to locate and retrieve’. ARITA, expressing a similar view, cited the views of former High Court Justice, the Hon Michael Kirby AC CMG who stated that:
…the task of insolvency administration is inherently expensive. Principally this is so because of the intensive nature of the investigation of accounts (sometimes in a shambles and sometimes deliberately deceptive) that the insolvency practitioners must analyse and understand. … It is unreasonable to demand that skilled professionals should perform their functions at low cost.
8.56ARITA acknowledged that large firms that deal with high profile insolvencies receive ‘significant’ fees, although it asserted that these fees are ‘proportionate to the…cost of expert staff and technical resources they bring to the task, as well as the scale of the personal liability their principals accept’. However, ARITA told the committee that in the vast majority of cases, practitioner fees are modest. ARITA further noted that ‘in all liquidations and administrations the fees insolvency practitioners receive must be agreed by creditors or the courts’.
Personal risk
8.57ARITA, Mr Murray and other inquiry participants highlighted that insolvency practitioners take on personal financial risk upon appointment to an administration. ARITA stated that insolvency accountants are paid around 20 per cent less than audit or tax accountants despite the fact that they carry significantly greater personal financial risk’. ARITA stated that this suggests ‘that the market for insolvency services is at least workably competitive’.
8.58Mr Michael Brennan (Offermans) identified that the risk assumed by external administrators upon appointment is unique:
There is no other professional role in Australia where part of your job is to walk into a business, largely sight unseen, and take on the risk associated with being an Officer of that company immediately.
8.59Mr Brennan stated that to address this exposure, appointees require resources in order to ‘assimilate knowledge and identify risk’.
8.60Further, Mr Brennan highlighted that while appointees usually seek an indemnity out of company assets, where the assets are not sufficient to cover the exposure, or the indemnity is disputed, the appointee is left financially exposed.
Reporting obligations
8.61Another factor proffered as impacting increasing insolvency practitioners’ costs is the extent of the burden imposed by the reporting obligations. The Business Law Section of the Law Council expressed this view as follows:
…it is at least arguable that there is too heavy a burden placed on insolvency practitioners to provide comprehensive information to stakeholders (primarily creditors but also others, including government) at the expense of any consideration of the cost-benefit analysis of the investigative work necessary to realise that information.
8.62The Law Council recommended consideration on whether wholesale reform could truncate these requirements so as to improve returns to creditors. ARITA shared a similar view and noted the perception amongst creditors that ‘the extent of information provided [is] “padding” to justify the remuneration sought by the practitioner’.
8.63ARITA stated that reports provided to ASIC as required by liquidators’ statutory obligations, may cost at least $5,000. They added that the preceding investigation could cost significantly more. ARITA provided examples of such reports receiving an instantaneous response from ASIC indicating that no further action is required. This issue is discussed in further detail in relation to ASIC’s regulatory activities (chapter 10).
Committee view
8.64The issue of insolvency practitioner remuneration is a perfect example of the many competing interests that arise in a liquidation. The committee understands how, in the emotionally charged setting of a liquidation, the diminishment of an already limited pool of assets by the liquidators’ fees can become contentious for creditors and directors.
8.65However, the task of an insolvency practitioner is deeply complex, involves a great degree of personal risk and, in many cases, often goes without full remuneration. Only adding to these circumstances is the degree of public interest work required to be taken which, while of critical importance, inevitably contributes to the costs and expenses of liquidators and administrators.
8.66It seems to the committee that this issue is indicative of broader systemic factors within the insolvency system itself which deserve thorough consideration by a broad scale review.
8.67The committee recommends that the comprehensive review include consideration of the remuneration of insolvency practitioners, including:
the extent to which public interest work carried out by liquidators for no or limited pay is sustainable; and
the impact of this on all stakeholders in external administrations.
Independence requirements
8.68A number of stakeholders raised concerns around the independence of insolvency practitioners once appointed to an external administration. In particular, there were concerns around the independence of practitioners appointed to external administrations who had advised the relevant company prior to the commencement of an administration.
8.69Mr Murray and Professor Harris explained to the committee that independence requirements for insolvency practitioners differ from other professions. This is because once appointed, a practitioner occupies ‘a statutory role independent of the person appointing them and independent of the creditors’. Administrators’ responsibilities require them to investigate the performance of directors prior to appointment, which, as Mr Murray and Professor Harris explained, requires the administrator to both be, and be seen to be, independent of all parties.MrMurray and Professor Harris asserted that:
If the practitioner has given prior advice to the company or the director on a certain course of action in respect of the company’s assets or financial affairs in order to try to resolve the company’s financial difficulties, it is not possible for the practitioner to then take an independent appointment as the liquidator or administrator.
8.70Mr Murray and Professor Harris identified that at present, a ‘special purpose liquidator’ (or administrator) may be appointed where concerns are raised about an appointed liquidator or administrator.
8.71There are some practical considerations around the independence requirements. As Professor Harris and Mr Murray explained in Keay’s Insolvency, ‘not every prior association…will lead to a lack of independence’. They added:
Indeed, some prior contact is inevitable and necessary, for example, in relation to a creditors’ voluntary liquidation, where the directors must seek out a registered liquidator to consent to being appointed.
8.72Mr Murray and Professor Harris explained this differentiation further in evidence to the committee, stating:
There are circumstances which often apply where the insolvency practitioner explains the options to the individual director and suggests for example that their company should be liquidated. The relevant code and the law do not see that as impinging upon their independence. It is when that advice goes further and involves dealings in company assets that problems would arise.
8.73Importantly, the committee was told that the independence requirements increase the expense of voluntary administration trading activity. The BLS LCA stated that:
it is at least arguable that those rules overemphasise the risks associated with poor corporate behaviour by insolvency practitioners, to the detriment of creditors, whose returns are diminished by the increased costs associated with having an additional practitioner involved.
8.74BLS LCA recommended that consideration should be given to relaxing these requirements on voluntary administrations or providing more efficient mechanisms for managing them, for example, simplifying the appointment of special purpose investigators to report on pre-appointment matters.
8.75McGrathNicol also supported the relaxation of independence requirements for the following reasons:
the cost saving benefit of having an existing adviser familiar with the position of the company and the corresponding advantage of being able to more effectively plan and prepare to commence the appointment;
the impediments to giving effective advice to the company in distress when the practitioner is focused on avoiding any apprehension of a lack of independence;
lack of clarity of approach between recent caselaw and the approach of professional bodies and ASIC as to the interpretation of independence requirements, resulting in an unhelpful level of uncertainty; and
the availability of the special purpose liquidator to address any matters of controversy that present a potential conflict of interest.
8.76However, evidence from other inquiry participants indicates that some have concerns about the independence of advisors who provide advice prior to appointment. Mr David Noonan, appearing in his capacity as the then-National Secretary of the Construction Forestry Maritime Mining Energy Union (CFMMEU) (Construction and General Division), said that there is a crisis of confidence in insolvency practitioners amongst some in the construction industry due to perceptions of a lack of independence, regardless of whether or not nefarious activity had taken place. Mr Noonan called for oversight and review where such circumstances arise.
8.77The Australian Council of Trade Unions (ACTU) highlighted broader concerns with the ability of directors to appoint preferred liquidators and administrators, describing this as a ‘long standing’ issue. In expressing support for a public liquidator, the ACTU noted concerns that under voluntary administration, directors can ‘appoint their preferred administrators who are not inclined to report or disclosure director breaches’.
8.78Mr Ben Sewell noted that the business model which requires independence from, but at the same time allows directors to appoint external administrators has evident weaknesses whereby ‘insolvency practitioners find themselves under pressure to compromise their integrity in order to attract business’.
8.79KPMG Australia highlighted that:
there are some very strict rules about independence…this independence of the insolvency practitioner, the liquidator or the administrator, is really, really important. It is difficult because you do need to do a little bit of work beforehand, before you get thrown in. But there are cases and some practitioners who will do too much pre-planning and compromise their independence going forward. I think one of the ways to try and deal with that is stricter enforcement of independence.
8.80KPMG Australia pointed out that ASIC is ‘quite vigilant’ in regulating independence and has been for some time. It identified that creditors play an important role in reporting breaches of independence requirements, but acknowledged that on occasion, economic considerations may discourage creditors from pursuing these claims.
8.81There was some discussion by stakeholders of potential options to address the concerns relating to the independence of insolvency practitioners. There were mixed views as to whether there should be a formal separation between professional groups. For example, between those who provide advice to companies in relation to financial distress and might be involved in attempts to restructure, and those who may be appointed to administer an insolvency, whether it be in the form of administration or liquidation.
8.82The case for such a proposal was explained to the committee by Mr Ben Sewell:
…what I referred to in my submission was that in the…administration process you have the same appointee who's working on the restructure. They're being appointed by the directors with the promise of getting a restructure of the balance sheet to basically cut down debt, but then, on the other hand, there's an incentive for them to then work on the winding-up process afterwards and essentially be paid twice. I think that creates a conflict of interest. I believe it would be in everybody's best interests to have a split of the profession, a bit like barristers and solicitors, where you have the restructuring side and then the investigative side. This is something that was created last year with the restructuring practitioner process. What that would mean is you would have one set of consultants who would come in to try and restructure and work as hard as they could to get that over the line, and if that failed then the team B would come in to go through the wind-up process. So you wouldn't have the conflict of interest, and you wouldn't have the potential battles between the director and the people they appointed because of expectations that they're loyal to them in some way.
8.83Professor Harris and Mr Murray were dubious about the proposal stating that ‘the issues and the options are not clear’.. These witnesses acknowledged that the current environment, wherein a director seeking advice from a liquidator is unlikely to receive limited advice in order to not comprise their independence in a potential appointment ‘seems unsatisfactory’. They raised the point of whether a specialist body of professionals should be developed to provide fulsome advice without the fear of compromising independence requirements on appointment. They were of the view that a body already exists to provide turnaround and restructuring advice that does not necessarily lead to formal solvency appointments. They stated, however, that there could be better regulation in this area (see discussion in relation to pre-insolvency advisors in paragraph 8.88 below).
8.84As well as better regulation of pre-insolvency advice, Mr Murray and Professor Harris suggested that a review of the laws of independence of insolvency practitioners should be considered with the aim of legislative reform is necessary. They stated:
That would require careful consideration and would best be achieved through legislative change. At the same time, the need for the practitioner to be seen as independent, given the strong powers and authority they have, is important, and any watering down of that perception might have unwanted consequences in terms of the integrity of the insolvency process.
Committee view
8.85There is a balance to be struck in establishing the appropriate level of restrictions around how involved an insolvency practitioner may be in dealing with a company prior to it entering insolvency. On the one hand, having access to information about the company could lead to greater efficiencies and lower costs which may, in turn, bring higher returns to creditors. This committee has also repeatedly heard of the importance of receiving good advice and receiving it early. Therefore, placing further barriers on access to such information may seem counterintuitive. However, having confidence in liquidators and administrators is key not only to the profession by to the system as whole, and it appears that even under the current settings, there is some sense that conflicts of interest, whether perceived or actual, are detracting from that.
8.86On the current evidence, the committee is not in a position to conclude whether the current settings are appropriate. However, the committee is of the view that this issue warrants further consideration as part of any comprehensive review. Such consideration should consider whether the current arrangements are achieving the policy settings that inform them, and whether or not those policy settings themselves are best serving the Australian economy and the participants in it. The committee is of the view the comprehensive review should also consider whether there is a need to formally separate the roles of advice and restructuring on the one hand, and administration and liquidation on the other. The implications this may have for the profession, as well as for those that engage with it should also be carefully considered.
8.87The committee recommends that the comprehensive review include consideration of the operation, efficacy, and efficiency of the current independence requirements for insolvency practitioners, including:
whether the current requirements are achieving the policy settings that inform them and whether these policy settings are optimal; and
the advantages and disadvantages of formally separating the roles of advice and restructuring from formal appointments to liquidations and administrations.
Pre-insolvency advisors
8.88The lack of definition and legislative parameters around the term ‘insolvency practitioner’ becomes problematic in the context of a collection of consultants commonly referred to as ‘pre-insolvency advisors’ or ‘untrustworthy pre-insolvency advisors’. Inquiry participants highlighted that there are many trustworthy sources of pre-insolvency advice within the insolvency industry, and that companies are encouraged to seek advice from these sources prior to entering insolvency or even significant financial difficulty. However, the committee was told that the lack of regulation around who may term themselves as a ‘pre-insolvency’ or ‘turnaround’ advisor was of some concern, with the lack of regulation in this area permitting some to market themselves as such while promoting illegal activities, or methods to avoid paying outstanding obligations.
8.89Professor Harris and Mr Murray told the committee that some of the advice provided by these practitioners is ‘inappropriate and illegal advice on how to avoid paying debts, particularly tax debts’. ARITA shared a similar sentiment, stating:
Not to be confused with qualified professionals giving lawful advice, these ‘pre-insolvency advisors’ counsel their clients on how to avoid paying their debts and meeting their legal obligations. They are ‘ambulance chasers’ who prey on people and businesses in financial distress. They claim to be able to remove the worry of a dire financial situation, but they often encourage unlawful conduct such as hiding or stripping assets and illegal phoenixing.
8.90Professor Harris and Mr Murray explained to the committee that at present there is a ‘regulatory blind spot of “pre-insolvency” advisors’. Professor Harris said that these advisors may be accountants, lawyers, or ‘struck-off insolvency practitioners…who refashion themselves…and say: “I understand the system. I can show you how to beat the system”’. ARITA described that these advisors are ‘almost invariably…not registered liquidators or trustees, not lawyers or tax practitioners, typically not part of any professional body and don’t hold Australian Financial Services Licences’. They added that such advisors operate in the absence of any licensing, scrutiny and indemnity insurance, and operate knowing ‘that the regulators are unlikely to chase them’.
8.91The BLS LCA highlighted that ‘despite near universal support conceptually for cracking down on pre-insolvency advisors, there is no consensus on (indeed no real suggestion of) a set of defined characteristics of “untrustworthy advisors”’. It also suggested that these advisors, should they be lawyers, accountants, insolvency practitioners or tax agents, may already be subject to some form of regulation or professional standards requirements. It supported the creation of a clear definition of this category of advisors if attempts are made to regulate them.
8.92Pre-pandemic data presented in ARITA’s submission indicated rising concern amongst some insolvency practitioners about the influence of these advisors. This data, which was collected through a 2019 survey conducted by ARITA indicated that almost 50 per cent of respondent registered liquidators had observed an increase in the extent of influence of illegitimate pre-insolvency advisors compared to 2017, with 20 per cent of the respondents noting that this influence had greatly increased. Other data collected during this survey indicated that:
39 per cent of respondents believed that more effective enforcement action was needed to ‘shut down these dodgy advisors’; and
30 per cent said that pre-insolvency advisors should be regulated.
8.93Professor Harris stated that part of the issue with insolvency advisors is that they are readily accessible, often advertised on Google, which is a common avenue for small business owners facing financial difficulty to look for advice. He explained:
One problem, particularly for small business, is that they often don't have access to high-quality advice and information. If they don't know who to turn to or when, perhaps, the ATO or another creditor takes an enforcement action, what do they do? They go to Google. The sorts of firms that advertise on Google are the sorts that say, 'We can help you to avoid paying tax, so engage our services.' That's what AFSA, for example, calls untrustworthy advisors.
8.94AFSA identified that it also shared concerns about the activity of untrustworthy advisors, which it described as follows:
…we're particularly focused on the unregulated, unregistered operators who are seeking to exploit and take advantage. Often, it can be a financial advantage in terms of getting money from someone who's in difficulty or it can run right to the extreme in terms of creating fictitious creditors and trying to influence the outcome of an insolvency process.
8.95AFSA views these advisors ‘as a real potential harm to the insolvency system’, adding that ‘there’s a strong correlation between their adverse impact in the personal insolvency system and in the corporate insolvency system’. In AFSA’s view, a key mechanism for addressing these activities is ensuring that information reaches those who may be the subject of such advisors’ activities to help them make informed decisions. Another is building partnerships relationships, including with creditors, to try and ‘bring decision-making forward’ in order to address some of these risks.
8.96The ATO stated that it targets pre-insolvency advisors facilitating illegal phoenixing through its work on the Phoenix Taskforce and the Serious Financial Crime Taskforce. It added that where it identifies suspect behaviour amongst registered liquidators, it refers those matters to ASIC as the regulator. The ATO informed the committee that joint activity between the ATO and ASIC has resulted in the criminal prosecution of some pre-insolvency advisors, including:
A recent joint ATO and ASIC operation resulted in a pre-insolvency advisor being sentenced to five years in prison after pleading guilty to one charge of dealing in the proceeds of crime. Another joint ATO and ASIC operation has resulted in a pre-insolvency advisor currently facing 13 criminal charges; four charges of obstruction of Commonwealth officials and nine charges for dishonestly causing a loss to the Commonwealth.
8.97The ATO informed the committee that an intelligence program undertaken by the Serious Financial Crime Taskforce which ended in October 2021 identified approximately 200 suspected high risk insolvency advisors, most of which were operating outside the regulatory regime. Additional intelligence obtained in the intervening period has not led to the identification of a change in this number.
Proposals to address untrustworthy pre-insolvency advice
8.98Stakeholders presented various strategies to address the problem of untrustworthy pre-insolvency advice. A threshold issue appeared to be the ability to define and identify who might fall into the category of ‘untrustworthy advisor’ or ‘pre-insolvency advisor’. CA ANZ, CPA Australia and (IPA) advised that the first step in addressing this problem is to identify them. These organisations referred to the requirement in personal insolvency, wherein persons are asked to identify whether they have received any advice, are asked to name the provider of that advice and state how much was paid. Similarly, registered trustees in bankruptcy are required to ask whether the bankrupt individual had received any advice, and who provided it. Such processes may produce information that assists in the identification of pre-insolvency advisors.
8.99A number of other submissions expressed support for introducing a regulation or licensing scheme.
8.100Mr Murray and Professor Harris acknowledged that a further scheme of regulation may increase the cost of advice, and in turn hinder access to advice, particularly for small businesses. They also stated that the introduction of such a system would require the creation of a designated regulator, for both personal and corporate insolvency.However, they stated that ‘greater regulation would promote greater transparency and confidence in pre-insolvency advice’. They added:
Encouraging more early action by directors and managers to seek out early advice could result in more companies being saved from insolvency or providing better returns in insolvency because the problems were addressed at an earlier time when the company was not in terminal insolvency.
8.101CPA Australia and the IPA supported regulation of insolvency practitioners, and the commencement of a public discussion of what that may look like. As for the creation of a new regulator, these witnesses suggested that the Tax Practitioners Board might be looked at as a potential model for such a body.
8.102Professor Harris and Mr Murray suggested that ‘increased regulatory guidance on who can serve as a safe harbour adviser and on practitioner registration requirements may assist’, as well as some form of licensing regime. They further suggested the implementation of the small business viability voucher initiative, as recommended by the ASBFEO in is 2020 Insolvency Inquiry Report, could guide directors seeking advice away from these advisors. Under this proposal, directors could be required to use the voucher with a list of accredited advisors, a register of which could be maintained by ASIC.
8.103ARITA also supported the introduction of a licensing scheme. It identified this measure as ‘one piece of the puzzle in fighting illegal phoenixing’. It noted that the advice provided by pre-insolvency advisors stated that existing licensing systems, such as those that regulate providers of financial, accounting or legal advice, have failed to address this problem.
8.104As opposed to introducing a new system of regulation, Mr Michael Brennan (Offermans) argued in favour of strengthening the existing legislative sanctions and the use severe penalties against persons engaged in this conduct.
Committee view
8.105The behaviour of untrustworthy pre-insolvency advisors has an impact that extends far beyond the immediacy of their actions. It undermines some of the key purposes of the corporate insolvency regime, including the efficient re-distribution of resources around the economy and the regulation of poor director behaviour. It exploits the position of creditors. It challenges the credibility of the broader insolvency practitioner profession, the majority of whom maintain high ethical standards in their work.
8.106Evidence to this inquiry indicated that these operators are more identifiable by the harm they perpetrate rather their job title or profession. In order to address this harm, we need to be able to understand the extent of the impact of this behaviour, the nature and number of those who engage in it, as well as the root causes for it. Only then can we properly consider solutions for addressing it.
8.107For these reasons, the committee is of the view that broader engagement with, and analysis of, these issues is necessary and should be included in a broader review of the insolvency framework. This analysis should consider:
the harm caused by the activities of pre-insolvency advisors;
those who engage in such activities; and
options to address these issues.
8.108The committee recommends that the comprehensive review include consideration of the nature and extent of the harm posed by ‘untrustworthy pre-insolvency advisors’, and whether further regulation or enforcement measures are needed to address this issue. The committee further recommends that in the interim, the government take prompt action to improve the regulation and active enforcement of pre-insolvency advisers.