liquidation – Page 4 – ░░░ INSOLVENCY INTERFACE

Trustee for Liquidation of Bernard Madoff’s company castigates J P Morgan Chase

Insolvency Laws, Offences, Regulation, White collar crime Comments Off

Feb 042011

Details were released today of the $US6 billion lawsuit brought in December 2010 against JPMorgan Chase (JPMC) by the Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC (BLMIS).

The lawsuit, brought under the US Bankruptcy Code, the Securities Investor Protection Act (SIPA) and other laws, seeks to recover fees, profits and damages. JPMorgan Chase was the primary banker of Mr. Madoff’s firm. The Trustee further alleges that the bank aided and abetted his fraud.

The Trustee, Irving H. Picard, has sued J P Morgan Chase & Co., J P Morgan Chase Bank NA, J P Morgan Securites LLC, and J P Morgan Securities Ltd.

Many of the words, phrases and concepts contained in the Causes of Action – of which there are 21 – will be familiar to Australian insolvency practitioners.

For example, claims are made for Preference Period Initial Transfers (“a preferential transfer avoidable by the Trustee”); Two Year Initial Transfers (“a fraudulent transfer avoidable by the Trustee”); and Six Year Initial Transfers (“made by BLMIS with the intention to hinder, delay, or defraud the creditors”).

Also, it is alleged that “BLMIS did not receive fair consideration for the Six Year Initial Transfers. BLMIS was insolvent at the time it made each of the Six Year Initial Transfers or, in the alternative, BLMIS became insolvent as a result of each of the Six Year Initial Transfers”.

JPMorgan Chase strenuously denied the allegations, calling the suit meritless and “based on distortions of both the relevant facts and the governing law.”

“J.P. Morgan did not know about or in any way become a party to the fraud orchestrated by Bernard Madoff,” the bank said in a statement. “Madoff’s firm was not an important or significant customer in the context of J.P. Morgan’s commercial banking business.”

JPMorgan Chase says it will “defend itself vigorously against the unfounded claims brought by the trustee.”

In the Nature of the Action, the Trustee uses strong language and is severely critical of JPMC (see below).

Full details of the lawsuit may be found at http://documents.nytimes.com/madoff-trustees-lawsuit-against-jpmorgan-chase?ref=business

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Irving H. Picard (“Trustee”), as trustee for the substantively consolidated liquidation of the business of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq. (“SIPA”), and the estate of Bernard L. Madoff, by and through his undersigned counsel, as and for his Complaint against JPMorgan Chase & Co., JPMorgan Chase Bank, N.A., J.P. Morgan Securities LLC, and J.P. Morgan Securities Ltd. (collectively, “JPMC” or “Defendants”), states as follows:

NATURE OF THE ACTION

1. The story has been told time and time again how Madoff duped the best and the brightest in the investment community. The Trustee’s investigation reveals a very different story—the story of financial institutions worldwide that were keen to the likely fraud, and decidedly turned a blind eye to it. While numerous financial institutions enabled Madoff’s fraud, JPMC was at the very center of that fraud, and thoroughly complicit in it.

2. JPMC was BLMIS’s primary banker for over 20 years, and was responsible for knowing the business of its customers—in this case, a very large customer. JPMC is a sophisticated financial institution, and it was uniquely situated to see the likely fraud. Billions of dollars flowed through BLMIS’s account at JPMC, the so-called “703 Account,” but virtually none of it was used to buy or sell securities as it should have been had BLMIS been legitimate. But if those large transactions that did not jibe with any legitimate business purpose triggered any warnings, they were suppressed as the drive for fees and profits became a substitute for common sense, ethics and legal obligations. It is estimated that JPMC made at least half a billion dollars in fees and profits off the backs of BLMIS’s victims, and is responsible for at least $5.4 billion in damages for its role in allowing the Ponzi scheme to continue unabated for years, with an exact amount to be determined at trial.

3. In addition to being BLMIS’s banker, JPMC also profited from the Ponzi scheme by selling structured products related to BLMIS feeder funds to its clients. Its due diligence revealed the likelihood of fraud at BLMIS, but JPMC was not concerned with the devastating effect of fraud on investors. Rather, it was concerned only with its own bottom line, and did nothing but a cost-benefit analysis in deciding to become part of Madoff’s fraud: “Based on overall estimated size of BLM strategy, . . . it would take [a] . . . fraud in the order of $3bn or more . . . for JPMC to be affected.” JPMC also relied on the Securities Investor Protection Corporation (“SIPC”) to protect its profits: “JPMorgan’s investment in BLM . . . is treated as customer money . . . and therefore [is] covered by SIPC.” By the Fall of 2008, in the midst of a worldwide economic downturn, the cost-benefit analysis had changed. JPMC, no longer comfortable with the risk of fraud, decided to redeem its $276 million in investments in BLMIS feeder funds. JPMC also received an additional $145 million in fraudulent transfers from BLMIS in June 2006. The Trustee seeks the return of this money in this Action.

4. JPMC allowed BLMIS to funnel billions of dollars through the 703 Account by disregarding its own anti-money laundering duties. From 1986 on, all of the money that Madoff stole from his customers passed through the 703 Account, where it was commingled and ultimately washed. JPMC had everything it needed to unmask the fraud. Not only did it have a clear view of suspicious 703 Account activity, but JPMC was provided with Financial and Operational Combined Uniform Single Reports (“FOCUS Reports”) from BLMIS. The FOCUS Reports contained glaring irregularities that should have been probed by JPMC. For example, not only did BLMIS fail to report its loans from JPMC, it also failed to report any commission revenue. JPMC ignored these issues in BLMIS’s financial statements. Instead, JPMC lent legitimacy and cover to BLMIS’s operations, and allowed BLMIS to thrive as JPMC collected hundreds of millions of dollars in fees and profits and facilitated the largest financial fraud in history.

5. In addition to the information JPMC obtained as BLMIS’s long-time banker, JPMC also performed due diligence on BLMIS beginning in 2006, using information it obtained from those responsible at JPMC for the 703 Account, as well as information provided by various BLMIS feeder funds. At some point between 2006 and the Fall of 2008, if not before, JPMC unquestionably knew that:

a. BLMIS’s returns were consistently too good—even in down markets—to be true;

b. Madoff would not allow transparency into his strategy;

c. JPMC could not identify, and Madoff would not provide information on, his purported over-the-counter (“OTC”) counterparties;

d. BLMIS’s auditor was a small, unknown firm;

e. BLMIS had a conflict of interest as it was the clearing broker, sub-custodian, and sub-investment adviser;

f. feeder fund administrators could not reconcile the numbers they got from BLMIS with any third party source to confirm their accuracy; and

g. there was public speculation that Madoff operated a Ponzi scheme, or was engaged in other illegal activity, such as front-running.

6. JPMC looked the other way, ignoring the warning signs, even in the aftermath of other well-known frauds. In response to those who, prior to Madoff’s arrest, found it “[h]ard to believe that [fraud] would be going on over years with regulators [sic] blessing,” REDACTED Risk Officer of JPMC’s Investment Bank responded, “you will recall that Refco was also regulated by the same crowd you refer to below and there was noise about them for years before it was discovered to be rotten to the core.”

7. JPMC’s due diligence team was further concerned about fraud at BLMIS in the wake of another well-known fraud, the Petters fraud. Some of these concerns centered on BLMIS’s small, unknown auditor, Friehling & Horowitz (“Friehling”):

The “DD” [due diligence] done by all counterparties seems suspect. Given the scale and duration of the Petters fraud it cannot be sufficient that there’s simply trust in an individual and there’s been a long operating history . . . . Let’s go see Friehling and Horowitz the next time we’re in NY . . . to see that the address isn’t a car wash at least.

8. In or about September 2008, as JPMC was re-evaluating its hedge fund investments in the midst of the worldwide financial crisis, REDACTED [JPMC Employee 3], of JPMC’s London office, had a telephone call with individuals at Aurelia Finance, S.A. (“Aurelia Finance”), a Swiss company that purchased and distributed JPMC’s structured products. During the course of that call, the individuals at Aurelia Finance made references to “Colombian friends” and insisted that JPMC maintain its BLMIS-related hedge. That conversation triggered a concern that Colombian drug money was somehow involved in the BLMIS-Aurelia Finance relationship, which led to an internal investigation at JPMC of BLMIS and Aurelia Finance for money laundering. Significantly, it was only when its own money was at stake that JPMC decided to report BLMIS to a government authority.

9. As reported in the French press, by the end of October 2008, JPMC admitted in a filing of suspicious activity made to the United Kingdom’s Serious Organised Crime Agency (“SOCA”) that it knew that Madoff was “too good to be true,” and a likely fraud:

(1) . . . [T]he investment performance achieved by [BLMIS’s] funds . . . is so consistently and significantly ahead of its peers year-on-year, even in the prevailing market conditions, as to appear too good to be true—meaning that it probably is; and

(2) the lack of transparency around Madoff Securities trading techniques, the implementation of its investment strategy, and the identity of its OTC option counterparties; and

(3) its unwillingness to provide helpful information.

None of this information was new to JPMC—it had known it for years. It was only in an effort to protect its own investments that JPMC finally decided to inform a government authority about BLMIS. JPMC further sought permission from SOCA to redeem its Aurelia Finance-related investments and admitted that “as a result [of these issues with BLMIS] JPMC[] has sent out redemption notices in respect of one fund, and is preparing similar notices for two more funds.”

10. Incredibly, even when it admitted knowing that BLMIS was a likely fraud in October 2008, JPMC still did nothing to stop the fraud. It did not even put a restriction on the 703 Account. It was Madoff himself who ultimately proclaimed his fraud to the world in December 2008, and the thread of the relationships allowing the fraud to exist and fester began to be revealed as well. JPMC’s complicity in Madoff’s fraud, however, remained disguised, cloaked in the myth that Madoff acted alone and fooled JPMC. But that is the fable. What follows is the true story.

Does deregistration short cut conflict with Court judgment?

ASIC, Forms, Insolvency Laws, Regulation Comments Off

Nov 252010

A controversial ASIC-approved short cut to deregistration in a creditors’ voluntary liquidation seems to be at odds with sentiments expressed in a decision of the Federal Court of Australia.

In my post headed “Obscure short cut through insolvency law on company deregistration” (24/11/2010) I questioned whether this officially sanctioned short cut or escape mechanism – which allows liquidators to bypass sections 509(1) to (5) of the Corporations Act 2001 (the Act) in loosely defined and very common circumstances – was warranted.

Now it stikes me that it might actually be unlawful.

His Honour, Jacobsen J, examined section 509 of the Act in considering the case of Emergen X Pty Ltd (In Liquidation) ACN 114 579 510 [2010] FCA 487.

His Honour’s written judgment (May 2010) illustrates the importance attached to the requirements to convene a final meeting and to let 3 months elapse after that date.

A shareholder of the company applied to the Court for an order under section 509(6) to bring forward the date of deregistration by shortening the 3 month period that is otherwise required to elapse. (The shareholder wanted deregistration to occur on the earlier date so that it (the shareholder) could obtain a tax benefit, under CGT rules, by being able to claim a loss on the shares in the current tax year.)

His Honour took the view from examining legal authorities that the 3 month period is a “period of grace”, designed to allow “for claims by creditors or other aggrieved parties so as to ensure that they can make a claim against a company without having to go through the process of seeking an order reinstating it.”

I find it difficult to see how the sentiments expressed by His Honour sit in harmony with the short cut – as ASIC has approved with companies Form 578 – which allows liquidators to bypass giving notice of a final meeting of creditors and also removes the 3 month period of grace.

Let’s have a debate.

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Note: The following quote is from His Honour’s judgment in Emergen X Pty Ltd (In Liquidation) ACN 114 579 510 [2010] FCA 487:

“The reason why there is a period of grace of three months allowed after the filing of the return seems to be explained in a Victorian authority from the nineteenth century. The decision, which is relevant, is John Birch & Co. Limited v The Patent Cork Asphalt Co. Limited (1894) 20 VLR 471 (“John Birch”). In that case Madden CJ said at 472 that the suspension of a dissolution for three months in the then relevant section of the legislation means that a purpose is to be served. His Honour said the only easily understandable purpose is to enable persons who are affected to come in and make a claim. Thus the period of grace is allowed for claims by creditors or other aggrieved parties so as to ensure that they can make a claim against a company without having to go through the process of seeking an order reinstating it.

Although the decision of Madden CJ in John Birch was reversed on appeal, the discussion of the Full Court does not affect the primary judge’s explanation for the rationale of the three month period, see John Birch & Co. Limited v The Patent Cork Asphalt Co. Limited (1985) 21 VLR 268.”

Note: For the full text of this judgment, issued in May 2010, click HERE.

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The comments and materials contained on this blog are for general information purposes only and are subject to the disclaimer.

Obscure short cut through insolvency law on company deregistration

ASIC, Insolvency Laws, Regulation 1 Response »

Nov 242010

Here’s a tip for the student of insolvency law and practice. Don’t look to legislation or legal judgments for all the answers. Some of the official rules are contained in “regulatory guides” which can easily escape your attention.

But even more problematic is the occasional, obscure, almost unwritten, rule which is the result of a pragmatic arrangement between regulators and insolvency practitioners.

A good, current example , is deregistration of a company following a creditors’ voluntary liquidation. Here, the pragmatic twist to the law dwells in the text on a non-prescribed form, and in the text of an even more obscure document, a statement issued by the Insolvency Practitioners Association of Australia (IPAA or IPA) to its members.

But I’m getting ahead of myself.

Look up Part 5.5 of the Corporations Act 2001 (the Act), under the heading “Final meeting and deregistration”, and you will find law (section 509) which states that “ASIC must deregister the company at the end of the 3 month period after the (final) return was lodged.” This requirement is sometimes referred to as “automatic deregistration”.

To get to this point in a creditors’ voluntary liquidation where the liquidator lodges a final return, the Act states that the liquidator “must convene a general meeting of the company, or, in the case of a creditors’ voluntary liquidation, a meeting of the creditors and members of the company, for the purpose of laying before it the account and giving any explanation of the account” .

On the face of it, these provisions would appear to be the law. Put simply, a company which has entered into a creditors’ voluntary liquidation is deregistered automatically 3 months after the liquidator’s return of the final meeting is lodged.

If you, the student, wanted this confirmed, you might consult a book on corporate insolvency law in Australia, where you would almost definitely find such confirmation.

But what you and the author of the book (and, of course, creditors and the general public) don’t know is that ASIC has modified the law.

How? Well not – as far as I can see – through the official process of issuing a regulatory document, such as a Regulatory Guide or Information Sheet (of which there are a great many).

Instead, the modified rule finds its expression in companies Form 578 (which is not a prescribed form). The form is headed “Deregistration request (liquidator not acting or affairs fully wound up)”. One of the two tick boxes on the form, which constitute the basis for requesting deregistration, states:

“There are no funds left in the creditors’ voluntary liquidation to hold a final meeting and also the affairs of the company are fully wound up.”

So, dear student, the “law” relating to deregistration of a company following a creditors’ voluntary liquidation has been modified by inserting an escape clause. If there are no funds left in the liquidation and the affairs of the company are “fully wound up”, the requirement to hold a final meeting is nullified or overlooked, and deregistration can be achieved by simply ticking a box and lodging a form.

This change is a result of ASIC “exercising its discretion”, says the IPAA in a submission to Treasury in 2009:

“This issue concerns the application of s 601AB of the Corporations Act in finalising a creditors’ voluntary liquidation as an alternative to holding a final meeting of the company’s members and creditors under s 509. After consultation with ASIC, the IPA issued a Practice Update in the June 2008 issue of its journal. The Update informs members that ASIC has advised the IPA that in situations where the liquidator is without funds to cover the cost of holding the final meeting, ASIC will exercise its discretion and accept lodgement of a Deregistration Request (Form 578) under s 601AB(2). It may be that the words of that subsection need clarifying to accord with what appears to be this intent of the section. “

But, dear student, you should also know that there is apparently a proviso attached to the phrases “no funds left to hold a final meeting” (ASIC) and “without funds to cover the costs of holding the final meeting” (IPAA). Whether the staff in ASIC who process Form 578 applications are aware of this proviso is not clear. Nevertheless, in a statement to members in 2008 (which was published again in July 2010 due to a number of queries from members) the IPAA states that:

“Only liquidators that are without funds are eligible to use section 601AB(2). “Without funds” does not include situations where the liquidator distributes all available funds via a dividend to creditors. Therefore, liquidators should ensure that sufficient funds are retained to cover the cost of a final meeting when a dividend is paid.”

Personally, and like most people, I am strongly opposed to obscure or unwritten rules in any area of law, and especially so when they come into being with little debate and are at odds with the principle or intention of the law as it is expressed in applicable legislation.

No doubt there are practical reasons for the procedure authorized by Form 578:

1. Liquidators receive a benefit, particularly when they are winding up a company that does not have enough funds to pay the costs of calling a final meeting of members and creditors. Without this short cut to deregistration these liquidators would be out of pocket. However, the saving in each case may not be great, given that there is (apparently) no requirement to give notice of the final meeting other than by means of one advertisement in the Government Gazette.

2. The government regulator (ASIC) receives a benefit by getting more dead companies off its Register with less “fuss”, thus reducing its workload in this area and thereby saving taxpayers some government expenditure.

But what of the creditors of the company in liquidation?

Financially, the Form 578 short cut to deregistration appears to make no difference to the creditors, for if the company is able to pay them a dividend the procedure cannot be utilized; and if the company is unable to pay them a dividend, it remains unable to pay them a dividend.

From the intangible views of justice and equity, it can be seen that, in the case of creditors of a company which is unable to pay a dividend, the Form 578 short cut deprives creditors of the right to receive a final account of the winding up and the opportunity to discuss the winding up with the liquidator and others at a final meeting.

Apart from the fact that these rights and opportunities seem to be enshrined in sections 509(1), the short cut method overlooks one of the main themes of recent attempts to reform insolvency laws, namely the need to improve information to creditors.

Is this short cut justified by the financial savings and improved efficiency? Let’s have a debate.

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The comments and materials contained on this blog are for general information purposes only and are subject to the disclaimer.

$154 million used under GEERS to pay employee entitlements.

Employee Entitlements, GEERS, Priority Debts Comments Off

Nov 092010

An annual report recently tabled in Parliament reveals that under the Australian Government’s “safety net” scheme over $154 million had to be paid out in 2009/10 to compensate 15,565 Australian workers who lost their jobs as a result of their employers’ insolvency.

This $154 million takes the total paid since the scheme began in 2001 to about $1,083 million.

The Department of Education, Employment and Workplace Relations (DEEWR) runs a scheme called the General Employee Entitlements and Redundancy Scheme (GEERS). The scheme is officially described as follows:

“GEERS is a safety net scheme which protects the entitlements of employees who have lost their jobs as a result of the bankruptcy or liquidation of their employers. Eligible entitlements under GEERS consist of up to three months unpaid or underpaid wages for the period prior to the appointment of the insolvency practitioner (including amounts deducted from wages, such as for superannuation, but not passed on to the superannuation fund), all unpaid annual leave, all unpaid long service leave, up to a maximum of five weeks unpaid payment in lieu of notice and up to a maximum of 16 weeks unpaid redundancy entitlement. Payments made under GEERS are subject to an annually indexed income cap, which was $108,300 for 2009–10.”

In its 2009/10 Annual Report the department lists the “notable achievements” of GEERS as:

“A total of $154,058,670 was advanced under GEERS to 15,565 eligible claimants. Of claimants who received assistance under GEERS, 87.3 per cent were paid 100 per cent of their verified employee entitlements by GEERS. More than 45,632 enquiries were received by the GEERS Hotline. Over $18 million advanced under GEERS was recovered during 2009–10.”

Note: After a payment is made from GEERS, the Government seeks to recover the payment through the liquidation or bankruptcy process (as a priority debt). As stated, the amount recovered in this way was $18 million, which apparently means that the net outlay of taxpayers’ money was $136 million.

GEERS was introduced in 2001. The following chart – prepared for this article using figures extracted from past DEEWR annual reports, and an article in the Australian Journal of Management (June 2009, pages 51-72, authors Jeannette Anderson and Kevin Davis) – shows amounts paid out over past years:

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The comments and materials contained on this blog are for general information purposes only and are subject to the disclaimer.

Taxing capital gains made during liquidation

Priority Debts, Tax debts, Tax liabilities, Taxation Issues Comments Off

Oct 152010

Asset sales during a winding up, receivership or administration may give rise to a capital gain as defined in Australia’s tax laws (mainly the Income Tax Assessment Act 1997).

The possibility that a post-appointment tax debt may arise as a result, and that such a debt may have a right to payment ahead of other creditors (even secured and preferential creditors), is a cause for concern to insolvency practitioners.

I wrote a little on this subject in my article titled “Post-appointment income tax debts of liquidator” (published on this blog on 10/10/2010).

At that time I was not sure whether revenue losses accumulated at the date of the liquidator’s appointment could be offset against a “net capital gain” made post-appointment.

I said:

“Ordinarily, an insolvent company would have revenue tax losses at the date of the liquidator’s appointment. In most cases these would be available as a tax deduction against any net revenue income made during the liquidation period. But the same may not be true for net capital gains in this period.”

Since then I have obtained some expert advice, which is as follows:

1. A “net capital gain” forms part of a company’s “assessable income”. (See ITAA 1997, Chapter 3, Part 3-1, Division/Section 102-5.)

2. An excess tax loss of an earlier year may be deducted from the assessable income of a current year. (See ITAA 1997, Chapter 2, Part 2-5, Division/Section 36-17.)

So it appears what I should have said is: revenue tax losses at the date of the liquidator’s appointment would be available as a tax deduction against any net revenue income made during the liquidation period and any net capital gains made during the liquidation period.

Although under these rules the chances of post-appointment tax debts arising would probably be reduced – as would the size of such a debt should it arise – it remains important that insolvency practitioners be aware of tax laws and the need to prepare income tax returns.

As to the remaining questions of (a) where a post-appointment tax debt would rank in priority on the Corporations Act 2001, and (b) whether the insolvency practitioner may be held personally liable for it under Section 254 of the Income Tax Assessment Act 1936, we will have to await further developments.

The Insolvency Practitioners Association of Australia (IPA) has been discussing these issues with the Australian Taxation Office (ATO). However, the correspondence between the two is not publicly available.

It appears that the ATO is seeking advice from Senior Counsel.

The IPA may also be considering running a test case in court.

Early destruction of books by liquidator

Forms, Records Management, Regulation, Retention and Disposal Comments Off

Oct 082010

With the necessary approval, a liquidator may legally destroy his or her records of a winding up soon after it is finalised. The same is true of books and records of the liquidated company. (See section 542 of the Corporations Act 2001 “the Act”.)

In the case of a creditors’ voluntary winding up approval must be obtained from creditors and then the Australian Securities and Investments Commission (ASIC). In a winding up by the Court approval must be obtained from the Court.

The provisions in the Act for early destruction make sense. Or at least they do in so far as they pertain to the books and records of the liquidated company that exist at the commencement of the winding up. At that stage a company may have a vast collection of books and records. Without special laws a liquidator would be required to store them for 5 years after the company ceased to exist. Multiply this cost by the many administrations that a liquidator may have and the sum becomes exorbitant, and needlessly so.

But in the case of books and records created subsequent to commencement of the winding up, the argument for early destruction is much weaker, particularly now that society seems to be demanding that liquidators be more accountable and more closely supervised. (For example, see the Australian Senate Committee Report: “The regulation, registration and remuneration of insolvency practitioners in Australia: the case for a new framework“, September 2010.)

(This aspect of the law in relation to retaining books is discussed in my earlier article headed: “Retaining books and records post liquidation”.)

Nonetheless, the main purpose of this article is to draw the attention of liquidators to an application form that I have prepared for use in applying for early destruction of books in a creditors’ voluntary liquidation. (There is no statutory form for an application.)

My standard form may be found at:

www.insolvencyresources.com.au/CvoliqPractPack.htm

Before applying to ASIC a resolution approving/directing the early destruction must be passed by creditors, either through the committee of inspection – if there is one – or at a meeting of creditors. This is usually a standard item on the agenda at the first or second meeting.

ASIC’s Regulatory Guide 81 (RG 81) sets out what information the application must contain. A little less information is required if the application is made after the company is deregistered. But an application can be made before deregistration and even up to 2 months before the final meeting of members and creditors.

Essentially the application requires the liquidator to supply a copy of the committee or creditors’ resolution and to state that:

no litigation by or against the liquidator or the company is in process, is contemplated or is expected;
no one has asked for access to the books;
no circumstances exist in relation to the company or an associate (as defined in section 11 of the Act) which may result in the books being required within 5 years of the company’s deregistration;
the liquidator has lodged his or her investigation report and received a “no further action” type clearance from ASIC;
the liquidator has satisfied all his or her lodging and reporting requirements; and
there are insufficient funds in the liquidation to meet the costs of storing the books for 5 years.

Presumably if there are circumstances which exist in relation to the company or an associate which may result in the books being required within 5 years of the company’s deregistration, a liquidator who, nevertheless, wants permission to destroy the books would have to present a submission to ASIC for its consideration.

Why are reports of misconduct shelved?

ASIC, Australian Senate 2009-2010, Offences, Official Inquiries, Regulation, White collar crime Comments Off

Sep 132010

Statistics produced by Australia’s corporate regulator reveal that it treats only 11% of the unfavourable statutory reports it receives from insolvency practitioners as serious enough to warrant any action.

Insolvency practitioners must lodge a report with the Australian Securities and Investments Commission (ASIC) when they suspect an offence under any Australian law relating to the company to which they are appointed.

In one of ASIC’s submissions to the Senate Committee’s inquiry into liquidators and administrators (see page 76 of the March 2010 submission), there is a chart showing the number of such reports – described as “reports of alleged misconduct or suspicious activity” – received in the financial years 2007, 2008 and 2009, and in the 6 months to December 2009.

See the copy of ASIC’s chart at the end of this article.

[All public submissions to the Committee may be found at http://www.aph.gov.au/senate/committee/economics_ctte/liquidators_09/submissions.htm ]

The chart in ASIC’s first submission reveals that during the period 1/7/2006 to 31/12/2009 ASIC received 20,225 “inital” statutory reports alleging misconduct or suspicious activity. Of those only 2,918 (14.4%) were flagged or escalated for further consideration.

In the 06/07 and 07/08 financial years the number of reports escalated equalled 17%. But in the 08/09 financial year and the half year to December 2009, that figure dropped to 11%.

Why are 89% of reports by liquidators and administrators not acted upon? There would be several reasons. Isn’t the public entitled to know what those reasons are and how many cases there are in each category?

Treasury’s Answer to Senate Questions

Australian Senate 2009-2010, Official Inquiries Comments Off

Sep 102010

AUSTRALIAN SENATE INQUIRY INTO LIQUIDATORS AND ADMINISTRATORS

TREASURY DEPARTMENT’S ANSWERS TO QUESTIONS ON NOTICE

Circa March 2010

Senator Williams

‘Can you take this on notice for me: how many countries actually have receivers? I believe in recent times in the UK they have actually banned receiverships. Could you fond out whether the UK has banned receivers? Could you also tell me how many countries around the world actually have a system of receivership and appointing receivers?’

Answer:

“Administrative receivership is the process in the United Kingdom where in the event of a default an a loan, a tender may be entitled to appoint an insolvency practitioner (i.e. an administrative receiver) who may have the control of the whole or a substantial part of a company’s property and wide powers over its business; for the purpose of realising the lenders security. In many ways, an administrative receivership is akin to a receiver and manager under Australian law.

“In the United Kingdom, the Enterprise Act 2002 (UK) restricts the use of administrative receivership. Subject to exceptions, rights to appoint an administrative receiver are limited to those who have a floating charge that was contractually agreed prior to 15 September 2003.

” Treasury notes that Professor David Brown appeared before the inquiry in Adelaide on 9 April 2010 and Treasury refers to Professor Brown’s explanation of the current law in relation to receiverships in the United Kingdom.

“Non‑administrative receiverships are still available in the United Kingdom. The availability of receiverships is legislated by the Insolvency Act 1986(UK).

“Receivership in one form or another is present in most modern insolvency regimes such as Canada, United States of America and New Zealand.”

Senator Fierravanti‑Wells

‘I would be really interested to know from Treasury’s perspective how much tax alone is foregone in corporate failures on a per annum basis.’

Answer:

“The Australian Taxation Office (ATO) has advised that during the financial year ending 30 June 2008, an estimate of $1.06 billion in taxation was forgone as a consequence of known corporate failures. The estimated amount for the financial year ending 30 June 2009 was $1.3 billion. These amounts relate to known or reported taxation liabilities and do not include unpaid or uncollected superannuation liabilities.”

Senator Cameron

‘You may want to take this on notice but could you advise the committee of how many companies operate within Australia under that $10 million gross annual turnover threshold?’

Answer:

” ASIC advise that there are approximately 1.7 million companies in Australia, with approximately 32,000 required to report under Chapter 2M of the Corporations Act. Of those that report, approximately 12,000 are proprietary companies and approximately 20,000 are public companies.

“Small proprietary companies are generally not required to prepare financial reports, unless requested by their shareholders or ASIC. Even if required to prepare the reports, small proprietary companies are not required to lodge the reports on the public register. For the purpose of these provisions, a ‘small proprietary company’ is one which satisfies two of the following three criteria: having less than 50 employees, less than consolidated revenue greater than $25 million or assets under $12.5 million.

“Excluding the approximately 20,000 public companies, almost all of the companies that do not lodge financial reports have consolidated revenue of less than $25 million.”

Senator Fierravanti‑Wells

‘Following on from Senator Cameron’s question, in terms of sanctions that are imposed in this area on company directors, where does Australia rank? Could you take that on notice. For example, the stigma in this country in relation to bankruptcy and insolvency has disappeared and certainly is not comparable to the severity of sanctions that are imposed on directors in other countries where passports are removed and those sorts of things. We are nowhere near that. So, if you could take it on notice and give us a comparison, 1 would be interested in the answer.’

Answer:

“Australia has a robust system of corporate governance that is well recognised internationally.

“The principal duty of the board of directors is to act in the interests of the company as a whole. This means acting in the best interests of members, having regard to their future as well as current interests. Every member of a company has certain rights by virtue of their membership. These rights are conferred by statute and by the company’s own constitution. The Corporations Act protects members of the company from unjust treatment and provides a range of mechanisms for members to protect their rights and interests as members of the corporation.

” The Government has put in place a principles‑based framework for corporate governance to protect the integrity of the market, facilitate commerce and industry, and maintain investor confidence in Australia’s companies.

“The Corporations Act contains a range of duties setting out certain minimum obligations and responsibilities directors must fulfil. These include:

the duty to act in good faith; the duty to act in the best interests of the company;
the duty to exercise their powers with appropriate care and diligence that is reasonable in all of the circumstances;
the duty to not make inappropriate use of inside information;
the duty to not misuse their position for their own or a third party’s possible advantage (or to the possible detriment of the company); and the duty to avoid insolvent trading.

“Directors face penalties of $200,000 for civil contraventions of these provisions, and can be disqualified from managing corporations. Directors may also be required to pay compensation. Criminal contraventions face maximum fines of $220,000 or imprisonment for 5 years, or both.

“In relation to passports, where ASIC is conducting an investigation, a prosecution, or a civil proceeding against a person, the Court under section 1323 of the Corporations Act can require a person to deliver up to the Court their passport.

“Given differing legal frameworks and institutional arrangements, regulatory arrangements are not readily amenable to international comparison.”

Senator Cameron

‘Has Treasury done any analysis of the implications of phoenix companies for the overall economy? You may have to take this question on notice: does Treasury see phoenix companies as a problem generally in the economy?’

Answer:

“Phoenix activity involves the evasion of tax and other liabilities through the deliberate, systematic and sometimes cyclic liquidation of related corporate trading entities. Minister Sherry released a proposals paper Action against Fraudulent Phoenix Activity in November 2009. We refer the committee to the overview and analysis of the problem of phoenix company behaviour set out in that paper.”

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Payment Priority for Child Support Debts

Priority Debts Comments Off

Sep 102010

Australia’s Child Support Agency (CSA) is reminding insolvency practitioners of the status of pre-appointment child support deductions.

CAS says that unremitted child support deductions withheld from an employee’s wages by an insolvent employer must be paid ahead of most other debts, whether preferential, secured or unsecured.

It is pointing out that liquidators, receivers, receivers and managers, company administrators and deed administrators are “trustees” as defined in section 4 of the Child Support (Registration and Collection) Act 1988 (the CSRC Act).

The CSRC Act makes trustees liable to pay the child support debt to CSA (Section 50(1)). It also endows such debts with priority over other preferential, secured or unsecured debts (S.50(2)(a)).

CAS says that this section takes precedence over the priority provisions of the Corporations Act 2001 because it is made applicable “notwithstanding any other law of the Commonwealth or any law of a State or Territory”.

Fortunately for insolvency practitioners/trustees the CSRC Act ranks the trustee’s remuneration ahead of the child support debt (S.50(2)(a)). Trustees remuneration is specifically included in the only class of costs granted priority over child support debts, namely “costs, charges or expenses of the administration of the estate or of the winding up of the company that are lawfully payable out of the assets of the estate or of the company”.

Also specifically included in this special class are the “costs of a creditor or other person on whose petition the sequestration order or the winding up order (if any) was made”.

To obtain this priority both the remuneration and the costs of the petitioning creditor must be “lawfully payable out of the assets of the estate or of the company”. Presumably this means that they must satisfy all relevant requirements in the Corporations Act 2001.

According to the Insolvency Practitioners Association of Australia (IPA), CSA is seeing an increase in letters from liquidators claiming, incorrectly, that a child support debt has no priority.

Notice of appointment and clearance from CSA

Although there appears to be no specific law requiring a “trustee” to notify CSA of his or her appointment, it should be done:

where the trustee is aware that a current or former employee or contractor of the company is or has been making child support payments to CSA; and
where there is amongst the company’s records a letter from CSA titled either Schedule of Child Support Deductions or Notice Pursuant to Section 72A.

Even if such circumstances don’t appear to exist but the company has used or is using the services of employees or non-corporate contractors, trustees should – with the possibility of a high priority debt existing – take the precaution of informing CSA of the insolvency appointment and requesting written advice as to whether CSA has anyone on its books for the company.

According to Ms Sue Saunders, Assistant Director of CSA’s Employer Services division, who I spoke to today, CSA is happy to check its records and respond to such requests.

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Retaining Books and Records Post-Liquidation

Records Management, Retention and Disposal Comments Off

May 242010

Is it time for a “Guideline for Record Retention and Disposal” in corporate insolvency administration?

In Australia the insolvency practitioners association (the IPAA) has a Code of Professional Practice (COPP) of over 100 pages. A lot of it refers to the importance of maintaining proper records, especially for calculating fees and documenting proceedings at meetings of creditors. But there is no discussion or recommendation about what to do with books and records after the insolvency appointment ends.

The corporations law requires that books and records be retained for 5 years from the date of a company’s deregistration. However, when a company has been wound up under a creditors’ voluntary winding up, and creditors have directed that the books and records may be destroyed within those 5 years, the law permits early destruction in accordance with that direction provided the Australian Securities and Investments Commission (ASIC) gives its consent. [Corporations Act 2001, sec. 542]

Naturally, the IPAA expects insolvency administrators to comply with the law. But the insolvency law is dangerously imprecise because it lumps together the “books of the company and of the liquidator”.

Insolvency practitiones should be asking themselves what they should regard as the meaning of the phrase “all books of the company and of the liquidator that are relevant to affairs of the company at or subsequent to the commencement of the winding up” . [sec. 542(1)] [emphasis added]

If there are practitioners who believe that once early destruction has been officially authorised by ASIC, this wording gives them carte blanche to destroy every record to do with the liquidation as soon as the shortened period has ended, a few words from the IPAA about exercising caution and prudence might be worthwhile.

In my view, if a shortened period for retention of the books and records is authorised – and that period is less than, say, 3 years – practitioners should nevertheless retain the “core” books and records of the liquidation for a longer period .

In deciding what are the “core” books and records, the liquidator should take into account particular events and problems occurring during the liquidation, and bear in mind the normal professional responsibility to possess evidence supporting transactions and justifying decisions.

Such core books and records may include:

Liquidator’s accounting records, e.g., bank statements, EFT transaction statements, cheque books/stubs, payment and receipt vouchers, employee and pay records, journals and ledgers.
Liquidator’s budgets and financial statements.
Liquidator’s checklists, diaries, project management tools, working papers and timesheets.
Liquidator’s lists of books and records received, showing where they are stored.
Liquidator’s notes of significant telephone conversations and events at meetings.
Important written contracts.
Accident and worker’s compensation records.
Minutes of meetings, attendance registers and proxies.
Proofs of debt.

By not pointing out to insolvency practitioners the dangers present in early indiscriminate destruction, the IPAA may be doing the profession a disservice by leaving its membership vulnerable to accusations of questionable or unprofessional behaviour.

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