Voluntary administration - will it work?

More than a decade after the Australians did it, New Zealand has this month introduced a new insolvency regime to help financially troubled companies stay afloat.

Voluntary administration is the new insolvency framework that forms the centrepiece of the Companies Amendment Act 2006. The Act passed into law on 7 November. It's a regime that will be used to help rehabilitate companies that are in real financial trouble. It is based on an Australian model which has proved to be the most used form of insolvency procedure across the Tasman since it was introduced over 12 years ago.

Despite this, our own legislation didn't have a smooth ride with opposition from the National camp. This was mostly a result of the Government's refusal to follow two aspects of the Australian scheme that National says will make voluntary administration much less successful than it has been in Australia. A number of insolvency experts agree.

What is the new regime about?

Voluntary administration is a collective corporate rescue mechanism that can be initiated by a company's directors. They can do this by the appointment of an administrator to the company.

An administrator can be appointed if the company is insolvent or if the directors think the company may become insolvent. The object of the process is to bring the company back to financial health, or if that does not prove possible, to deliver a better return to the company's creditors than they would get if the company was placed in liquidation.

Voluntary administration works in large part because of the moratorium it imposes on creditor claims for the short time the administrator has to make an assessment as to  whether the company can survive financially. If the administrator thinks the company can survive then he or she will recommend that they enter into a deed of company arrangement - the deed being a voluntary plan to enable the company to trade on while still managing its debts. To do this, the administrator needs the support of a majority of the company's creditors in number representing at least 75% in value of the company's debt.

Continued priority for the New Zealand tax authorities

In Australia, the Tax Office no longer has priority in a company liquidation for tax instalment deductions from salaries and wages. In return for losing that priority, company directors have been made personally liable for the company's unremitted tax liabilities if not made to the Tax Office by the company itself. However the directors can avoid personal liability if they have appointed an administrator.

Here, the Government has refused to abandon the Inland Revenue's status as a preferential creditor in a company's liquidation. It has also refused to accept that company directors should have personal liability for their company's tax liabilities if they should fail to put the company into administration. It is these two aspects of the Australian scheme that the Government has declined to adopt, which has caused most of the fuss.

The National Party and many insolvency experts are concerned that the Government has not followed the Australian lead. They say that the Inland Revenue will have no incentive to support a corporate rescue through the adoption of a deed of company arrangement, when it is likely to be able to recover all or most of its debt as a preferential creditor in a liquidation. And if the company's directors do not have the "stick" of personal liability for the company's unpaid taxes, it is said that they are unlikely to move to appoint an administrator early enough. 

Are the experts right?

All of this may or may not be true. But it does assume that the Inland Revenue will, more often than not, have the voting power to stymie a proposed deed of company arrangement. This ignores the fact that the new legislation gives the administrator a casting vote. In Australia this casting vote has been used to decide whether a resolution supported by a majority of creditors by number will or will not be adopted in circumstances where that same resolution is opposed by creditors that hold the requisite majority when measured by value.

In other words the Inland Revenue may not have the power to stop a deed of company arrangement unless that deed is also opposed by a majority of the company's creditors when measured by number. If opinion is divided between the "number" creditors and the "value" creditors and the administrator genuinely considers that interests of the creditors as a whole are better served by a deed of company arrangement, then it may not be possible to stop the deed being signed. 

However this does not mean that an Inland Revenue opposed to a company deed of arrangement is without any remedy, especially if the terms of the deed of company arrangement purport to limit the priority that the IRD would otherwise have as a preferential creditor in the company's liquidation.  Under the new Act the court may terminate a deed of company arrangement if it finds that the deed is unfairly prejudicial to a creditor. In Australia it is generally understood that a deed is vulnerable to termination by the court if it disturbs the statutory priority of those that would be preferential creditors in a company liquidation. 

All of this should mean that the Government's refusal to abandon Inland Revenue's status as a preferential creditor in a company's liquidation will not necessarily result in deeds of company arrangement being blocked because the IRD holds sufficient votes to vote down the relevant creditor's resolution. But it also means that deeds that are implemented need to observe the statutory priorities if they are not to be vulnerable to premature termination by the court.

It is true that the directors do not have quite the same incentives to put a company into administration. There is no "sword of Damocles" hanging over their heads over the company's unpaid tax liabilities. However an amendment to section 301 of the Companies Act, now means that the court can take into account any action taken by a director over the appointment of an administrator when deciding whether as a result of breach of duty or negligence a director should personally contribute to the assets of a company in liquidation. This should provide an additional incentive to the directors to appoint an administrator at an early stage.

Will voluntary administration work?

This remains to be seen. It can be strongly argued that retaining the Inland Revenue's status as a preferential creditor will not by itself mean that company work outs under voluntary administration are less likely to proceed. It is true that directors in New Zealand will not have all the incentives that their counterparts in Australia have to consider administration as an option. However recent enquiries into the effectiveness of the voluntary administration procedure in Australia have revealed that the directors of Australian companies are also invoking the procedure too late in order to enable an effective business rescue.

Director education and the risks associated with insolvent or reckless trading are more likely to be factors that marginalise the use of voluntary administration here in New Zealand. Many directors are unfamiliar with the concepts of "company turnaround" and will not know much about voluntary administration until they are faced with a financial crisis. And if a work out under the auspices of a deed of company arrangement should fail, there will be arguments about when the company became insolvent and whether and to what extent the directors should have personal liability for losses incurred as a result

While there is general ongoing support for voluntary administration in Australia, submissions to a 2004 parliamentary enquiry into Australia's insolvency laws argue that another generation of corporate rescue processes being introduced in the UK (such as corporate voluntary arrangements) are cheaper and more efficient than voluntary administration. It would be ironic if New Zealand in "catching up" with the Australians after 12 years, found itself to be behind again in a few years in the adoption of best practice business rehabilitation regimes.

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.