Australia’s Insolvency Laws
Submission to the 
Parliamentary Joint Committee on Corporations and Financial Services 
by
Pacific Capital Corporation Ltd

Background information. 

The Australian economy is losing many billions of dollars each year due to companies becoming insolvent. As well as the high profile collapses (HIH, FAI, Ansett, Harris Scarf, UMP and OneTel) there are hundreds of other medium and smaller companies that cause as much damage to the economy and personal lives as the large collapses.

This submission concentrates on 5 areas

1.	Comments on existing Insolvency Laws
2.	New Model of dealing with companies with financial and management problems.
3.	Establishing a Business Turnaround Industry in Australia
4.	Notes on Business Turnarounds in Australia
5.	Background – Pacific Capital Corporation Ltd

1.	Comments on existing Insolvency Laws

Our comments are not aimed at the process of winding up companies that have no commercial future and need to be liquidated to return the remaining assets to creditors nor are they aimed at companies where there major fraud has taken place and the majority of the asset value has been destroyed.

If companies go into a formal insolvency scheme such as provisional liquidation, liquidation, receivership or even voluntary administration it is generally accepted amongst the insolvency profession that these insolvency schemes themselves destroy value in the company. This is often because contracts, which benefit the company, can generally be terminated and many extra liabilities become due to be immediately paid (i.e. employee entitlements).   

The Voluntary Administration scheme which was introduced in the early 1990s was certainly an improvement on the more restrictive options of provisional liquidation or liquidation for most insolvent companies.  A major shortcoming of the Voluntary Administration scheme is that it is normally impossible to perform a business turnaround within I month in which the voluntary administrator has to put a formal scheme to the company's creditors.  In addition voluntary administrators who are accountants by profession often do not have the skilled business turnaround experience. 

The VA scheme generally relies on performing some “financial engineering” or selling off the company’s assets very cheaply as it is generally impossible to “turn” a company around and/or promote its sale at a price that gets all creditors paid 100 cents in the dollar in the allowed time. We believe that the vast majority of VAs, which are considered successful, involve creditors (usually unsecured small creditors) having to agree to forgive a majority or substantial amount of the money they are owed. 

It is appreciated that not all companies which go in to insolvency administration would be capable of being a "turnaround”, this is often the case when fraud has been involved or when the Board of Directors has been consistently mislead.

2.	New Model of dealing with companies with financial and management problems

None of the methods under Australian Law of dealing with companies that get into very difficult financial positions are, in practice, designed to encourage companies to be “turned-around” with no or minimum financial loss to creditors (especially unsecured creditors) 

We believe that serious consideration should be given to this issue so that it is debated and considered by all the proper stakeholders (including parliament, financial institutions, commercial organisations and other industry professionals).

In the United States there is a system referred to as Chapter 11 where companies, which have large financial problems, can seek the protection of the Court to gain a period of protection from current creditors while the company undergoes a reconstruction or “turn-around”. A common period of protection is 1 year.   

Although many companies come through the Chapter 11 system successfully, it appears that the Chapter 11 system could be improved and it is sometimes exploited by Directors and management of companies seeking protection. A major reason for this is that we understand that the control of the company is mostly vested in the existing directors who were in office when the company developed its financial problems. 

There is considerable merit we believe in Australian Corporation Law authorities investigating the establishment of a new Turnaround or Insolvency model with some of the characteristics of the US Chapter 11 model. The major difference with Chapter 11 should be that a majority of new Directors and a new CEO should be appointed to the company. If the company complied with other criteria then it would have a moratorium on paying existing creditors for six months.  After this time if the company has not re-established its commercial and financial viability then it would be dealt with under normal insolvency legislation.

The model could apply to companies who may be close to or are actually insolvent. The major issue is could the company be turned around and in doing so pay back all creditors.

We believe such a model for dealing with companies in financial difficulties should save many more companies and their creditors from losing many hundreds of millions of dollars a year and provide a cumulative benefit to the Australian economy.

For this model to work, it would be essential for Australia to develop a culture and a substantial group of experienced business turnaround professionals. These would include, CEOs, directors, lawyers and accountants. 

Other legislative changes that would help foster and encourage a “turn-around” industry would be addressing the question of indemnities for directors and chief executives specifically undertaking turnaround roles. Another issue which may need to be addressed is that of shareholders being deemed to be acting in concert if they co-operated to bring about a needed Turn-around (including the appointment of the necessary directors to achieve this).

3.	Establishing a Business Turnaround Industry.  

The benefits of a successful Turnaround industry in Australia would be huge even if in the short term there were no legislative changes to establish an Australian version of the US Chapter 11. Business failures cause Australia enormous cost: both economic and personal (in the years 2001 and 2002 the cost of business failures including the companies above is estimated to be about $10 billion). 

Occasionally a major adverse event can occur that good management would not normally plan for, however the vast majority of business failures are due to bad management.

If bad management is recognised early enough and corrective action taken, businesses can generally be saved and made to prosper. In most cases if a business fails the Chief Executive Officer (CEO) generally has made a major contribution to the problems, this failure can come about because of bad judgment, not focusing on responsibilities and/or dishonesty. 

The group that have the immediate responsibility to monitor the company and CEOs performance is the Board of Directors. History has shown though that Directors are often not effective in monitoring the CEO and good corporate governance in a company particularly where the CEO has a strong personality. 

In our opinion the effectiveness of Directors for large companies would be assisted if the Corporations Act re-addressed items such as:
•	The composition of Boards (including Non Executive Directors)
•	The composition, powers and responsibility of the Audit Committee
•	The process of Board appointments and a Board Effectiveness Review
•	The relationship between the Auditors and the company.

If the Corporations Act did tighten up on the above issues it would hopefully identify and reduce major business failures. Being realistic though, we will always have failures as our society if based on encouraging free enterprise and innovation and not all business ventures will be successful. What would be helpful is to have a commercial system that identifies these failing businesses before they lose too much money and cause large losses to creditors. 

Until now there has not been a recognised “Business Turnaround” industry in Australia where there is a group of professional and experienced executives who are available and capable of being commissioned to take charge of a failing company and “turning it around” to be profitable.

The major banks have for some time used “workout” systems where if a client owed a substantial amount to the bank, the bank may give the company the guidance of a specialist bank team. This team would provide advice to improve the company’s financial position and hopefully the bank can then be repaid.

In addition several of the larger accounting firms have had a successful record of business turnarounds and there are a few private investment banks (including Pacific Capital) and consultants who operate in the business turnaround or reconstruction area from time to time.

The non-existence of a recognised and effective Business Turnaround industry is unfortunate, as an effective Industry should save many hundreds of millions of dollars a year. To rectify this in January 2003 Pacific Capital’s directors were part of a group of interested Industry executives who formed the Business Turnaround Association (registration number INC 9879114) The executive who were also part of the working group were. Peter Hedge (PwC), Rob Sauer (Dibbs Barker Gosling), John Leftwich (GE Commercial) and John Hannaford (ex Attorney General NSW)

The central objective of the Association will be to advance Australia’s capacity for business turnarounds and reconstructions thereby saving the country the cost of businesses failures and increasing our economic productivity. To achieve this goal, the Strategic Objectives of the Association are:
•	assist in the creation of a certain and consistent environment which is favourable to the development of business turnarounds and reconstructions;
•	create a group or groups of members that will assist businesses to understand the issues involved in business turnarounds;
•	promote a bi-partisan political agenda in which Members may participate and be at the forefront of the development of long-term and consistent public policy for business turnarounds and reconstructions;
•	promote greater public awareness of the benefits associated with business turnarounds and reconstructions; 
•	represent the interests of Members in dealings with Government Ministers, departments and agencies, members of Parliament and with any other persons or organisations deemed appropriate by the Committee

The Specific Initial Objectives of the BTA are:

•	Provide a forum for and coordinate all the supplier and support groups/organisations that are able to make a positive contribution to companies requiring business turnaround skills.

•	Make the availability of these member services known to shareholder groups and directors of companies

•	Put in place systems that can be used by shareholders/directors as information and discussion points regarding companies that need some form of reconstruction

•	Allow shareholders and/or directors access to member groups of the association and for them to conduct their own evaluation of the appropriateness of the association's members.

It is proposed the association would initially comprise the following member groups:
•	Chief executive officers
•	Non executive directors and chairmen
•	Accountants
•	Lawyers
•	Communication and financial public relations firms
•	Financiers/investors
•	Shareholder groups
•	Consultative reference groups
·	·	·	·	
At this stage it is believed that there should not be any "insolvency" member group, as the prime aim of the association is the turning around of companies before they require the services of insolvency practitioners to deal with the company under corporate insolvency legislation.  If a company is being dealt with by an association member and needs to be dealt with under a formal insolvency arrangement then these companies should be referred to say, a member of the Insolvency Practitioners Association.  The BTA would be keen to have as members accountants who have had insolvency experience, so as to use these skills as investigating accountants and consultants.

The association would initially have small consultative reference groups (probably in Sydney and Melbourne) who could have discussions with significant shareholders and/or directors needing advice.  
The major beneficiaries of a successful turnaround are generally the shareholders of the company and it is recognised that being in this position the shareholders are the main influencing body in the structure of the company.  The directors of the company of course control the day-to-day activities the company and it is their decisions on policy and management which determine the success or otherwise of the company.  This being the case it is sometimes difficult for directors to acknowledge that they are not able to solve issues that may cause the failure of the company. Hence it is recognised that sometimes directors of a company would not be the group to come forward to an association such as ours and admit that they are not able to solve major issues.  The association therefore has to also make its presence known to shareholder groups and significant individual shareholders.  

A Turnaround Panel

A medium term objective when member numbers are built up is to examine the feasibility of establishing a Turnaround Panel. This would offer initial advice and counsel primarily to directors and large shareholders concerning company turnaround or reconstruction issues.

The Turnaround Panel will consist of experienced and respected turnaround professionals who will consult with potential enquirers of the BTA are available for consultation that it will 

The turnaround panel would be a national group that ideally would have sufficient members in each capital city so that the panel would be able to meet on the initial matters reasonably quickly.

Legislative Changes
It would be a future aim of the association to promote new pre-insolvency and insolvency legislation.  This may take some time to do and the exact form of our recommendations would have to be formulated.  We may recommend that there be special legislation to assist companies to do a turnaround providing the companies are structured in a certain manner, for example an Australian version of the US Chapter 11

4.	Notes on Business Turnarounds in Australia

4.1	Turnaround Professionals

Turning businesses around is a specialist role often senior executives who have been successful in one turnaround fail when they attempt others. We believe the reason for this is that you need extensive experience in turnarounds to be confident of probable success.  As yet there is no major recognised turnaround industry in its own right in Australia.  Despite this there are individuals who have had experience of turning a number of businesses around and there also exists in Australia experienced non-executive directors who have been on the boards of companies, which have undergone successful turnarounds.  There are also other groups of professional service providers who have had “hands on experience” in turnaround situations, particularly amongst the accounting and legal professions.  In addition many of the major and secondary banks have been involved as lenders in turnaround situations particularly where they have provided finance on specific assets of the company.

4.2	Are there some essential characteristics of successful company turnarounds?

All turnarounds are essentially different in that the position the company may find itself in is influenced by many factors including: the industry, the shareholders’ aspirations, the economic cycle and conditions and the directors’ ability and management capability. As there are major adverse issues to be addressed and corrected within a 6 to 12 month timeframe there is not generally time to make any major mistakes.  Accordingly decisions have to be made which have the best probability of producing a successful turnaround.  Every situation is different and requires individual analysis however in most situations to improve the probability of success a change of chief executive has to be made.  If the company is in serious financial and management trouble responsibility for part of this generally falls at the feet of the incumbent chief executive.

Likewise it is necessary to have a change at director level and generally it is advisable to also take on board new non-executive directors who have had successful turnaround experience. The best of the incumbent directors should be retained for continuity purposes.

Another issue that should be addressed up front is the indemnifying of Turnaround executives who have undertaken the turnaround role on a professional basis, particularly if there is a reasonable chance of business failure. Where the company is a private entity these issues can generally be overcome by appropriate guarantees. If the company is a Listed then individual arrangements have to be made.  

4.2	US TMA Association

In the United States there is a Turnaround Management Association, it has chapters in various US cities and also in several countries such as the UK and New Zealand.  We understand that many members in the US are involved in legal insolvency work and the trading of secondary debt. It has also established an Australian chapter based around a Brisbane firm of chartered accountants that specialises in insolvency work.

If an Australian Turnaround association wished to be influential with changing Australian insolvency legislation, we believe this could be best achieved by an Australian association rather than a Chapter of a US association.  In addition there are issues such as corporate governance, administration and fee arrangements, which we believe would be better, handled by an association established in its own right in Australia.  This does not preclude the Australian association having a good working relationship with the US association and its Chapters around the world.

5.	Background - Pacific Capital Corporation Ltd

Pacific Capital Corporation Ltd was formed in 1983 primarily to continue the company reconstruction and business turnaround work of its Managing Director. The company’s website gives details of its past and present activities.

Pacific Capital and its Managing Director have a record of very successful Business Turnaround and reconstructions in the UK, Australia and New Zealand.

Some of the reconstructions are:

•	1975. Appointed (at the instigation of the Bank of England), Managing Director of Slater Walker Isle of Man Ltd to undertake a reconstruction and sale. 
•	1983. Appointed Deputy Chairman James Aviation Ltd to design and undertake a reconstruction (NZ)
•	1987. Appointed CEO of Mildenhall Investment Management Ltd to undertake a reconstruction (NZ)
•	1990. Appointed as a Director of Bell Resources Ltd at the instigation of the National Companies and Security Commission. Responsible for the purchase and sale of the Tooheys, Swan and Castlemaine Breweries (Australia).
•	1991 Appointed a Director of Sedimentary Holdings Ltd to assist with a reconstruction (listed Australia).
•	1993. Appointed a Non Executive Director of Regal Salmon Ltd to assist with a reconstruction (listed NZ)
•	1999 Appointed Executive Chairman Ernest Adams Ltd to complete the reconstruction and ensure early profitability (was listed NZ).

Note all of the above reconstructions were successful and completed in the planned time.