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Economics References Committee - 28/09/2015 - Insolvency in the Australian construction industry

MELLUISH, Mr John, Professional member and former president, Australian Restructuring, Insolvency and Turnaround Association

MURRAY, Mr Michael, Legal Director, Australian Restructuring, Insolvency and Turnaround Association

ROBINSON, Mr Mark, Professional member and former president, Australian Restructuring, Insolvency and Turnaround Association

WINTER, Mr John, Chief Executive Officer, Australian Restructuring, Insolvency and Turnaround Association


CHAIR: I now welcome representatives from ARITA. It seems like there has been quite a lot of leadership change going on there! I will mistake you guys for a political party!

Mr Winter : We wanted to—

CHAIR: I just want you to explain how we should handle these things!

Mr Winter : We just call it the coalition!

CHAIR: Thank you, Mr Winter and the team, for being here with us today. We have a fair few questions, but do you have any opening remarks or statement before we get to them?

Mr Winter : I do have an opening statement. Just by way of quick introduction and so you do understand the lineage of the past presidents: John Melluish is a past president of ARITA, but he also worked particularly closely with the Collins inquiry in New South Wales. That is why we thought it was very appropriate for him to come along. He is also a registered and official liquidator, and a registered trustee. He is also a partner with Ferrier Hodgson, and has done a number of construction industry matters.

Mr Robinson, equally, worked closely with the Collins inquiry. He is a partner at PPB Advisory, and also a registered and official liquidator. He worked on the Reid Construction liquidation, which I think would be of particular relevance to the inquiry. Mark is also the Global President of INSOL International, which is the international insolvency peak body. And Michael is our legal director. He is also a visiting fellow at QUT and he is the co-author of the seminal insolvency textbook in Australia.

Just to be clear, ARITA's membership includes registered liquidators who are appointed to insolvent building and construction companies and also trustees in bankruptcy who handle bankruptcies of individuals in that industry. Other lawyer members are involved in advising or pursuing court proceedings in the area. Our members also work in restructuring and turnaround of financially troubled companies. Obviously, that is going in earlier in that financial distress cycle. We have mentioned that the current president of ARITA, Mr Mike McCann, gave evidence to you at your Brisbane inquiry in his capacity as the liquidator for Walton Constructions, and he offered further assistance.

I would like to point out that ARITA has been closely involved in much of the law reform debate and assistance to the Commonwealth government and to the national regulators in insolvency generally, and in relation to this particular issue for the industry. We have also worked closely with the ATO on this issue in relation to unlawful phoenix activity.

Significantly since our submission which we wrote for you in April 2015, our law reform proposals have been the subject of detailed consideration in the draft report of the Productivity Commission that was released in May. These include the provision of greater flexibility for corporate restructuring and a more streamlined approach to smaller liquidations. The Productivity Commission is due to report to the government by 30 September and we are also awaiting the response to the financial systems inquiry, where our proposals were also considered.

While not directly specific to the construction industry, our proposals would result in better creditor outcomes. We also propose reforms directed at unlawful phoenixing, including—and this was mentioned by the Veda people before—a director identity number. We think this is a critical reform in addressing the issue. This has also been recommended by the Senate report into tax fraud and is likely to be a final recommendation of the Productivity Commission inquiry. We cannot emphasise enough how important we think the director identity number is.

Although insolvency law is a Commonwealth based regime, the construction industry is largely regulated by state laws. In that respect ARITA worked closely with the Collins inquiry in 2015 in New South Wales, which led to the insolvency related reforms here in New South Wales. But Mr Robinson and Mr Melluish were acknowledged as giving considerable assistance at the time.

Finally, in this area around phoenixing: this is a particular issue on which ARITA has made many law reform submissions and comments in the past, since Treasury's last major discussion paper in 2009. ARITA has generally said that there are existing laws to deal with phoenix breaches of the law. It is a matter of those laws being enforced—in particular by the ATO and ASIC. Those breaches are usually by directors of their statutory duties and of other insolvency provisions under the Corporations Act—in particular insolvent trading. We do acknowledge the cost of investigating and pursuing such proceedings, particularly in the context of a large number of companies that are without assets in their liquidation. We have supported greater powers to the ATO in their pursuit of tax debts, given that tax is usually a debt in insolvencies. In particular, we would like to commend the recent work the ATO has been undertaking. We have been working very closely with Mr Cameron Sorensen, who is one of your later appearances.

The committee may not appreciate fully that in every liquidation insolvency practitioners are required to investigate and report unlawful misconduct to ASIC, including phoenix misconduct, and ASIC may request further investigations and assistance from the liquidators. We also report alleged unlawful phoenix misconduct to the ATO. Arising from approximately 10,000 insolvencies that occur each year, typically liquidators report around 18,000 breaches by directors each year. Possible misconduct is reported in about 76 per cent of all external administrations. Despite this, we only see around 20 actual outcomes against directors by ASIC each year—only 20. In stark contrast, we see strong action against directors in other jurisdictions like New Zealand or the UK. This sends a strong signal to those directors in those markets that inappropriate activity will not be tolerated. The same is not true in Australia, where a culture has developed that says to directors that the consequences of misconduct are mild if by some remote chance they are actually pursued for those actions by the regulator.

ARITA has closely followed the research of the University of Melbourne on phoenix conduct. We are aware that you are hearing from them at your Melbourne hearing session. We would highly commend their very important work to you.

Senator CAMERON: Thanks, everyone, for coming along this morning. It is obviously very important that your organisation makes a submission. From reading the ASIC submission, listening to your submission and reading your submission, we have a bit of a blameathon going on. The ASIC submission is pretty clear that you guys—well, not you guys but some of your members—do not come to this with clean hands. Is that correct?

Mr Winter : I think that it is fair to say that, like all professions, we have some bad eggs. We work very hard to try and bring in standards of professional conduct. Indeed, ARITA membership is around 75 per cent of all registered liquidators. We hold our members to a far higher standard of account than the regulator holds generally for registered liquidators, and our standards of professional conduct are actually those that are now adopted by the courts. It is something that we work very hard to do because we are aware of the huge level of trust that is placed with liquidators, as in fact they are officers of the court.

Senator CAMERON: On page 27 of the ASIC submission they say that unscrupulous liquidators 'can and do facilitate illegal phoenix activity'. They give three examples:

(a) advising directors or officeholders on how to fraudulently remove assets from one company to another;

(b) advising the directors or officeholders on how to structure companies to avoid paying their liabilities; or

(c) registered liquidators not meeting their statutory duty to properly investigate a failed company's affairs, adequately record their external administration and report offences to ASIC.

They are very serious allegations against your profession. What are your comments on that?

Mr Winter : I think the principal comment is that, if that is ASIC's claim, their numbers do not really back it up. There is no doubt that there are some unfortunate players in the profession, and we work very hard with ASIC to try and clean that up, but in truth ASIC has a very limited success rate in trying to track down and stop these sorts of people. On the other hand, as I said in my opening statement, liquidators make 18,000 recommendations to ASIC a year around director misconduct. Our contention is obviously that that is the root cause issue. If directors were properly targeted and followed up for their inappropriate behaviour, there would not be any facilitation. Equally, I would add that there is a large and growing market of what we call pre-insolvency advisers who are completely unregulated, who are the ones who, as their business model, give that very type of advice. They give advice to people in distressed businesses on how to strip assets out. Their recommendation, by and large, could be summed up as saying, 'If you strip all the assets out, ASIC won't do anything.' Because there is nothing left, they will not be able to pursue it, and ASIC has a track record of not following those things up. As I said in the opening comments, in stark contrast, in New Zealand or in the UK, every day there are announcements of substantial actions against directors that send a market signal that says that the regulator will pursue people who undertake this illegal activity. We do not get that market signal here in Australia.

Senator CAMERON: I do not know whether that is a market signal or a government signal.

Mr Winter : A government signal.

Senator CAMERON: I am not quite sure. Yes, that is fine, but you do concede that those three critiques from ASIC are legitimate critiques?

Mr Winter : I think they are a legitimate critique of a very small portion of the market. ASIC's own enforcement statistics give light to how little there is of it.

Senator CAMERON: If we could remove this stain on your profession, how would we do it? Do we need to do it by regulation or legislation or do you guys deal with it? If you were writing the recommendation for us on this issue, how would you deal with it?

Mr Winter : I think it is simply around better enforcement of existing law. As I said, we invest substantially so that as a professional association, as opposed to an industry association, we place very significant responsibilities on our members to meet a high professional standard. We investigate those who are members. Obviously, we cannot investigate people who are not members and we cannot investigate those in that pre-insolvency space who are completely unregulated. Certainly ASIC can and ASIC should, and we would encourage that they do it to the fullest extent of the law.

Senator CAMERON: Again, you have not got to the question that I asked. How do we deal with these people that are a stain on your professional—

Mr Winter : As I said, the law is already there and it can be enforced. It is up to ASIC to do it. ASIC spends $9 million a year on trying to get that enforcement but, in truth, their performance on that is very limited. If I look at what their enforcement outcomes are, there were 6.3 actions against liquidators per year. Most of those are simply administrative remedies. They tend to focus on compliance of paperwork rather than the big issues that they claim to talk about in the submission. I would suggest that if it is there, it is clearly not widespread if ASIC are spending $9 million a year and not achieving this cleaning out. The tools are there. I would question why it is not more successful.

Senator CAMERON: Is it section 206 of the Corporations Act?

Mr Winter : Yes.

Senator CAMERON: That refers to disqualification of directors?

Mr Winter : Sorry, are you talking about whether that is properly used in terms of the phoenixing activity?

Senator CAMERON: Yes.

Mr Winter : Again, I come back to the statistics. There are about 10,000 external administrations a year and we report 18,200 breaches out of each of those. Most of those are around breaches of the corps law, particularly trading while insolvent, and keeping proper books and records et cetera.

Senator CAMERON: What about section 596AB—employee entitlements. Sorry, Mr Murray, I am trying to help you. The employee entitlements are part of the Corporations Act.

Mr Murray : That is a provision—as I understand it—that was brought in about 10 years or so ago in respect of director conduct that was aimed at disentitling employees from their entitlements. It was a well-meant provision. My understanding, though, is that it has not been used much, so it may well be that it is not as an effective provision as was originally anticipated. It is certainly a section that you do not see much in law reports.

Senator CAMERON: We cannot afford to have a position where one group says that it is the other groups problem—I am sure ASIC will come in and give a very robust defence of their position—so we will have to work through what the problems are. Given that some of your members behave in what is a morally bankrupt way and in a manner that skips the law, what checks and balances do you have in place to deal with these people?

Mr Winter : First of all, there is a distinction between our members and non-member registered liquidators as well. We have a comprehensive conduct system. It is based on both complaints and concerns. We can investigate issues where we think that there are problems with a registered liquidator; but equally, members of the public, creditors primarily, can complain about the conduct of any registered liquidator. We deal with those things through a very clearly laid out conduct process. As I said, the courts have recognised the standards that we bring in terms of our professional standards requirements. We work very actively to do that.

Senator CAMERON: What about PKF Lawler and their behaviour?

Mr Winter : I am not sure how to respond to that. PKF Lawler are well-established accounting firm. Some of their staff are our members.

Senator CAMERON: Have you any comment on the full Federal Court's comments on their conduct?

Mr Winter : No. For a start, I would not make any comment about any matters where we have complaints. Those things are necessarily confidential unless we have followed through and made a public determination on them.

Senator CAMERON: This is one of your members, and a big player.

Mr Winter : We only have individuals as members, not companies.

Senator CAMERON: A lot of your individual members would be in PKF Lawler, wouldn't they?

Mr Winter : We have a couple. I cannot tell you the number off the top of my head.

Senator CAMERON: The Federal Court found there was a conflict in their behaviour. Did your organisation have a look at this conflict, as to what principles you might have to bring to bear to fix this type of conflict in future?

Mr Winter : I will hand to Mr Murray to talk about some of our practices around how we handle conflicts. But I would say that we will not comment specifically around individual cases where we might or might not be reviewing conduct. You can imagine that that would be very inappropriate for us to do. But the court's ruling on that was fairly clear. We noted the court's report. Indeed, as you well know, it was another of our members, who appeared before you in Brisbane, who has taken over that liquidation.

Senator CAMERON: To clean up the mess.

Mr Murray : Could I explain briefly the principles of independence, which I think is what your question is aimed act. Any practitioner appointed as a liquidator or administrator has very high standards of independence. As Mr Winter said, they have serious fiduciary responsibilities. Therefore, their independence from any prior engagements with the company or other parties is a very central part of their responsibilities. There was important law reform introduced in 2007 requiring disclosure of issues in relation to independence, and in fact our code of conduct was very much based on the introduction of those laws. We have now quite a substantial body of information and guidance for our members in relation to those independence requirements in the law and in our code. Essentially, they require full transparency and disclosure to creditors and others of any relationships that they might have that do not affect their independence but which nevertheless may raise queries by creditors.

Senator CAMERON: Or queries by legislators, as we are raising queries now about behaviour of some of your members that are employed by PKF Lawler.

Mr Murray : As Mr Winter said, I do not think we wish to respond on that particular issue except from a legal perspective. That matter involved a decision before a trial judge in the Federal Court which went one way. It went up to the full court and it decided another way. As a matter of law, they are interesting legal propositions explained in that from a legal perspective and for the guidance of our members. Beyond that, I do not think we would like to comment on the details. I think you could understand that.

Senator CAMERON: What I am trying to understand is how we make it better for these medium-sized companies that become the victims of Walton Constructions, PKF Lawler and the Mawson Group, when they collude to remove assets from one company to another, leaving many small businesses totally exposed and eventually insolvent. That is what we are interested in.

Mr Winter : Coming back to our original statement, our real concern is that the signal that is sent to the market is that if you are a director of a business that is under some financial distress and you do not want to follow a proper course of action then you are unlikely, as a director, to be prosecuted. That market signal is a concerning one. If we want to address the root cause problem, the root cause is sending that message. It does not matter what advice you get, you will be pursued—that is what should be being said to the broader market. That would head off that behaviour. As I have suggested before, that signal is what is sent in other markets like New Zealand and the UK.

Senator CAMERON: What about the ATO? What role can they play?

Mr Winter : The ATO has significantly upgraded their phoenixing work. I acknowledge Cameron Sorenson and his team and the work that they have undertaken. That work has been significantly elevated in recent times. It is a step that we have substantially applauded. Our members work very closely with the ATO on those things once appointments are undertaken. Their anti-phoenixing work is sending that very good market signal.

Senator CAMERON: Do you have members in the Mawson Group?

Mr Winter : No, we do not.

Senator CAMERON: Do you know of the Mawson Group? You must.

Mr Winter : Yes, we do.

Senator CAMERON: There seems to be this turnaround business model. What is your view on how we could resolve another Walton-type tragedy for lots of small companies? Does it simply come back to you claiming that ASIC do not do their job?

Mr Winter : I think there are two aspects to that. One is certainly that director enforcement becomes very important. You talk about turnaround. I think the other aspect is that there should be a far more positive connotation to restructuring turnaround in Australia. That is that if directors sought expert advice early on and did not get their businesses into this level of distress, and there was a framework for them to work through that period to achieve the protection of jobs and to achieve as great a protection of creditors as possible, that would be one of the most significant reforms that could be undertaken to the Australian insolvency regime. That is certainly what we have called for. It is in the draft report of the Productivity Commission. We think that is one of the most positive ways to undertake that. Would it have necessarily saved Walton? I do not think we can particularly speculate on that. Perhaps Mr Robinson or Mr Melluish might be able to give you some insights around other construction failures that they have dealt with, or indeed the work they dealt with with Collins, to try and find ways to help provide a better environment to protect those sorts of entities. I think that is our biggest challenge.

Senator CAMERON: Just let me come back to assets. You have heard lots of criticisms of ASIC. ASIC's criticism of liquidators, I think, is pretty damning. If you have members who are advising directors or office holders how to fraudulently remove assets from one company to another, shouldn't they be stripped of their membership, at least?

Mr Winter : Without question.

Senator CAMERON: Have you ever done that?

Mr Winter : Yes.

Senator CAMERON: How many?

Mr Winter : I do not have the statistics off the top of my head.

Senator CAMERON: Could you give us that on notice?

Mr Winter : We certainly can.

Senator CAMERON: You are critical of ASIC in terms of their enforcement. I would be keen to know that it is not the pot calling the kettle black—

Mr Winter : Definitely.

Senator CAMERON: and that you guys are actually dealing with these issues.

Mr Winter : Yes.

Senator CAMERON: What about advising directors or office holders how to restructure companies to avoid repaying their liabilities? What happens if you find out that one of your members is engaged in that?

Mr Winter : Those sorts of things are certainly covered in our professional standards requirements. We do take action against members on that basis.

Senator CAMERON: Can you also give me details of how many have been removed on that basis, and liquidators not meeting their statutory duty to properly investigate a failed company's affairs? Can you give me details of how many have been—

Mr Winter : We do publish all of these on our website. It is just that I do not have those statistics on hand.

Senator CAMERON: Can I just go back to one of the reasons that I was keen to establish this inquiry. Have you heard of the Kingsway corporate insolvency report?

Mr Winter : No.

Senator CAMERON: They did some analysis based on liquidators reports to ASIC. I would have thought you might have seen this. Their estimate is that $2.64 billion is lost annually by creditors in construction related insolvencies. Does that figure sound out of the ballpark to you?

Mr Winter : No, it does not, but—

Senator CAMERON: The figures we are getting are higher, because it does not include superannuation and other employee entitlements. So it is even more. Some are saying this is a $3 billion problem in the industry. The reasons cited for the corporate failures, and this is by your members—so I am surprised you do not know this—reporting to ASIC under that important procedure, are: inadequate cash flow or high cash use; second, poor strategic management of the business; third, poor financial control, including lack of records; fourth, poor economic conditions; fifth, trading losses; and, sixth, undercapitalisation. They are the six key issues. This report is probably two or three years old now. Is that still relevant in the current circumstances?

Mr Winter : Those are actually ASIC statistics, and they are regularly reported on ASIC's website.

Senator CAMERON: They are ASIC statistics but they are from your members' reports.

Mr Winter : Correct. We submit those reports. A registered liquidator has to do that for every liquidation they run.

Senator CAMERON: How do we fix these six key issues? Give it to ASIC? Blame them!

Mr Winter : No! Certainly, I think there are significant issues around the financial literacy of a lot of directors. Undoubtedly, there is behaviour in certain sectors that is less than adequate, in terms of how management is approached and whether or not organisations are indeed set up to fail from the first instance. It is also important to point out that those statistics are around causes of failure. Whether or not there is particularly an issue of negligence, or particularly an issue of malfeasance in there, are different issues again. Business needs to fail in order to have an efficient allocation of capital within the market. But how you turn those businesses around—

Senator CAMERON: Businesses need to fail for a proper allocation of capital?

Mr Winter : They do.

Senator CAMERON: You must concede that the theoretical arguments really are not much help for the workers who lose their jobs, are they?

Mr Winter : No, certainly not, particularly if those people are working for businesses that are very poorly run. Tying up assets in those poorly run businesses is actually not in the interests of the economy, or anyone.

Senator CAMERON: To summarise your arguments here this morning and in your submission, one is that there is no need for any regulatory or legislative change. The checks and balances are there and, simply, if ASIC did its job then that would solve a mass of problems?

Mr Winter : We have made extensive submissions around how the regime could be far more effective and how it could support better turnaround and better sustenance of jobs. You will find all of those in the Productivity Commission—they picked up all of our recommendations quite comprehensively. What I was saying, though, is that I do think ASIC has a much greater responsibility to pursue directors than they are currently fulfilling.

Senator CAMERON: Instead of my having to check the Productivity Commission report, which I will do if you cannot, could you summarise, on notice, your submissions and your recommendations in terms of regulation and legislative change?

Mr Winter: We can actually provide you with copies of the policies and of our leadership on the whole process. Absolutely.

Senator CAMERON: That would be helpful.

Mr Murray: Could I get a reference to the report you mentioned? I will get it from the secretary later—

Senator CAMERON: I think the secretary has it. If not, I will have it forwarded to you.

Mr Murray: Thank you.

Mr Robinson: In terms of preventing the train smash, so to speak, in the construction industry, there are the issues of encouraging early intervention, and encouraging directors to come forward earlier in the case to seek professional advice, such that the best plan can be put in place. At the moment there is a fairly 'punishment style' regime that, if directors feel they might be guilty of insolvent trading, might cause them to hide rather than come forward, in terms of airing their problems with a professional to try to seek a turnaround. That is the substance of these broader submission that ARITA has made to the Productivity Commission.

Senator CAMERON: I am not sure if you heard the exchange between Veda Advantage Ltd and me on some of the issues? It goes to a question that I want to put to you. When does it become morally necessary for you to advise the regulators of a problem, even if it is not legislated, if, for example, you know that there is a Waltons type problem that is going to affect thousands of families and hundreds of businesses across the country. NAB knows there is a problem and takes steps to fix its position. When does an obligation arise for NAB or any other organisation to advise the regulators or the police of a problem?

Mr Winter: I think the moral question and the legal one are obviously two very different ones. I am surprised this has not come up in any of the evidence you have received so far. But, obviously, banks and other commercial parties are limited in what they can disclose, outside of having to report a criminal activity, by the Privacy Act and by other obligations that are placed on them. If you come across material like this within a contractual relationship you simply can't just send it on. Our members, on the other hand, have a statutory responsibility to report on those things, if they are formally appointed.

The other aspect of working with a business that has put its hand up and said, 'We are in financial distress and we are trying to turn it around,' is that if there is an environment where they are seeking that support and they are proactively trying to get good advice to rebuild the organisation and avoid the financial destruction that occurs in an insolvency, there is a challenge around whether or not it is a good thing to have that information out there, because it might end up having a run on a company that you would otherwise be able to turn around. So we do talk about whether or not, just like in the US, there is a safe harbour provision. In Australia we know part of that as chapter 11—that is the way we talk about it. But if there is a safe harbour for an organisation to turn itself around, that protected period becomes very important in being able to take that advice and rebuild the organisation and get it back on its feet.

Senator CAMERON: There are negatives in terms of chapter 11.

Mr Winter: Absolutely. Indeed, we do not—

Senator CAMERON: I do not want to leave it hanging that chapter 11 is the answer to the problems.

Mr Winter: We could not agree with you more. We do say that bringing that regime to Australia simply would not work. But there is a concept in there around providing that moratorium to allow a restructuring to occur. If you look at some of the big construction failures I think there is plenty of evidence to suggest that if there were that period of grace where they did take expert advice some of those companies could and should have been saved.

ACTING CHAIR: Thank you for your evidence.

Proceedings suspended from 11:29 to 11: 41