Some Recent Insolvency Developments

Law Council of Australia

Insolvency Committee Workshop 2012

NSW Session

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Session was going to cover

• ASIC’s power to wind up• ASIC notices website• Price signalling• Civil Dispute Resolution genuine steps• Director penalty notices• The future for official liquidators• The future for CALDB and practitioner discipline• Virtual meetings

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One Recent Insolvency Development – the CAMAC Report on Managed

Investment Schemes(Dated July 2012; publicly available since Tuesday 7

August 2012)

Law Council of Australia

Insolvency Committee Workshop 2012

NSW Session3

Managed Investment Schemes

• Economic significance of MIS

• Pooled schemes / Common Enterprise schemes

• Sole function REs / Multi-function REs

• Distinction between scheme itself and the RE

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Salient features of current legal structure

• The scheme itself is not a legal entity

• A scheme must have, and can only act by a RE, which is a public company with an AFSL and, if listed, governed also by ASX rules

• RE holds the scheme property and incurs all obligations of the scheme as principal (as the scheme is not a legal entity it cannot be principal)

• RE may be able to limit liability to third parties if it can negotiate limited recourse provisions

• Otherwise, RE will have right of indemnity from scheme assets, provided it hasn’t acted in breach of duty/beyond power etc

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Salient features of current legal structure

• On a change of RE the new RE automatically succeeds to all the rights and liabilities of the old RE relating to the scheme (s.601FS and 601FT)• Consequences include – need for incoming RE to

conduct detailed DD – often difficult in urgent situations

• Neither Pt 5.1 nor Pt 5.3A applies to schemes

• There are only limited provisions in the Corporations Act dealing with the winding up of schemes – use of trust laws also necessary

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Main issues which the report addresses

• Facilitating a change of RE - the RE’s personal liability and ss.601FS and a number of other matters make it difficult to find an RE willing to take over as RE of a scheme when there is a need to change RE – eg because the existing RE has become insolvent

• Protection of third parties dealing with schemes - counterparties contracting with ‘the scheme’ do not have direct recourse to the scheme assets. They must sue the RE. But if the RE has acted in breach of duty, it will have no reight of indemnity against the scheme assets to which the counterparties can be subrogated

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Main issues which the report addresses

• Restructuring schemes - there is no efficient and effective means of facilitating a restructure of a scheme

• Winding up schemes - the fact that both corporations law and trust law have to be used where a scheme and its RE are being wound up, and other factors to do with the intermingling of the affairs of both make winding schemes up uncertain and needlessly complex

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The Big Idea – SLE

• The scheme itself will be a legal entity

– not a company, but an entity sui generis

– no directors or officers – mindless

• The scheme itself will hold its property

• The scheme would and could only still act through the RE, but the RE would contract as agent for the scheme, not as principal

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The Big Idea – SLE

• RE would have to disclose it was acting for the scheme to avoid personal liability

• Counterparties would then have rights only against the scheme (no risk of losing access to scheme assets because of RE’s breach of duty)

• Indoor management rule for benefit of counterparties• RE would owe its duties to the scheme; enforceable on

behalf of scheme by replacement (including temporary) RE, external administrator, ASIC or member (derivatively)

• Insolvent trading for directors of RE if cause insolvent scheme to incur debts

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Why is the Big Idea a Good Idea?• Achieves almost full separation of the scheme’s

affairs from those of the RE (especially important with multi-function REs)

• Gives counterparties direct rights against scheme property rather than having to rely on RE’s rights of indemnity & subrogation which may be lost through RE misconduct

• Simplifies conforming treatment of schemes to ordinary companies for things like winding up, administration etc

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Why is the Big Idea a Good Idea?• Should overcome reluctance of parties to take over from

an outgoing RE as the RE will not be taking on all the (sometimes unknown) liabilities of the scheme

– Proper liabilities of scheme will be liabilities of the SLE

– Liabilities improperly incurred by outgoing RE will be enforceable against outgoing, but not against the SLE or incoming RE

• Makes for simpler enforcement of remedies against RE as obligations are clearly owed to RE (constitutional provisions exempting RE from liability to be limited)

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The Big Idea – plus a bit more

• Tax changes necessary to ensure no tax charge on conversion of existing schemes to SLE and SLEs are treated as tax neutral

• Report also suggests various changes which will enhance the effectiveness of the Big Idea (but which would also be useful changes even if the Big Idea isn’t implemented and are recommended as standalone changes)

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Additional recommendations – proposals to assist identification of scheme assets

• Definitive register of ‘affairs’ of the scheme to be maintained by RE

• Definitive register of property of the RE to be maintained by RE

• Enforcement of obligation to maintain these registers through compliance plan, audit, AFSL licensing and depriving RE of recourse for indemnity to property not registered

• Obligation to notify counterparties / right to seek court order to register (not once new RE or external administrator appointed)

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Additional recommendations – proposals to assist identification of scheme assets

• Incoming (new or temporary) RE would be able to rely on and only be bound by matters on registers – in effect doing away with need for more due diligence

• Incoming RE or external administrator to have discretion to rectify register to add unrecorded agreements etc

• Counterparty to be able to enforce against RE and claim damages (if suffered) for RE’s failure to record in register

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Additional recommendations - changing the RE where scheme viable

• RE to assist prospective new RE if requested by 5% of members or ordered to do so

• RE only to be remunerated for period it is actually RE – must refund advance payments

• Poison pills on RE replacement to be unenforceable

• Voting thresholds to be changed• Contractual COC provisions not to be

triggered16

Additional recommendations - changing the RE where scheme viable

• Court to be able to appoint anyone as TRE not full RE)

• Greater flexibility for court in appointing TRE (grounds)

• RE to assume liability for limited scheme liabilities only

–liabilities it incurs– otherwise, liabilities to limit of assets

available to indemnify it17

Restructuring schemes – a second Big Idea

• Allow schemes to be subject to voluntary administration regime(whether or not SLE proposal implemented – but much simpler if it is than under existing legal structures

• Definition of insolvency – scheme property is insufficient to meet all the claims that can be made against that property as and when those claims become due and payable

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Restructuring schemes – VA if SLE proposal implemented

• VA of SLE would not affect RE or vice versa

• Grounds – present or likely insolvency, or purpose of scheme cannot be accomplished in present form

• Could be initiated by SLE (acting through RE or TRE) or substantial chargee

• RE and its directors at risk for insolvent trading to encourage timely appointments

• RE would remain in place but powers would transfer to administrator

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Restructuring schemes – VA if no SLE

• Creditors of ‘the scheme’ have rights against the RE personally which need to be taken into account (if RE has assets)

• Moratorium would have to extend to RE (whether solvent or not)

• May need to consider class voting – eg difference between creditors with limited recourse and those with full recourse to RE

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Restructuring schemes – VA if no SLE

• Effect of any DOSA on other parties involved in scheme (eg members in a common enterprise scheme)

• If both RE (single-function) and scheme insolvent, need to deal with affairs of both subject to emergence of conflicts

• Otherwise, clarification needed re whether affairs of RE include affairs of the schemes it operates

• Voting where parties only interested in some assets?

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Other recommendations re VA for schemes

• Wide moratorium to encompass all scheme rights however scheme structured

• Affairs of scheme to be assessed by reference to definitive registers

• Administrator to be able to make more than one proposal for DOSA – dealing with whole or part only of scheme’s affairs.

• Administrator to determine voting rights (subject to appeal)

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Other recommendations re VA for schemes

• Administrator must be registered liquidator• Administrator’s indemnity for liabilities

incurred to have priority over RE’s• Remuneration to be approved by ‘creditors’ or

committee• Section 447A type provision to be included• Where DOSA proposals involve continuation

of scheme, administrator can seek appointment of TRE

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Winding up schemes

• Court to have express power to wind up for scheme insolvency

• Combined scheme and RE winding up to be available subject to conflicts

• Only registered liquidators• Ambit of liquidation governed by definitive registers• Conform powers of liquidator to company liquidator• Voidable transaction provisions• Clear priorities of payment – TRE, then external

administrators.24

Possible problems?• The definitive registers

• Is the price of certainty too great for counterparties who are excluded from participating in the scheme assets because of RE delinquency?

• If no SLE regime is enacted – difficulties with VA procedure

• Do the proposals focus adequately on the issues caused by delinquent REs?

• Will the position regarding common enterprise schemes continue to be too complex?

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