Voluntary Administration – is it working?

It is over a year since voluntary administration was introduced into New Zealand. Based on the first year's experience, some will be questioning just how well the regime is working.

Statistics

In the first year approximately 20 companies were placed into voluntary administration – only a tiny fraction of the number of companies placed into receivership and liquidation in New Zealand during the same period. By contrast use of the creditors compromise provisions under Part 14 of the Companies Act appears to have increased over the same period. Not only has the voluntary administration procedure been rarely utilised, it also appears there has only been one case where a rescue plan in the form of a deed of company arrangement (DOCA) has been approved as a result of voluntary administration.

These statistics compare unfavourably with the experience in Australia, from where the New Zealand regime was largely copied. In Australia hundreds of companies are placed into voluntary administration every year. Australian statistics show that voluntary administration results in a rescue plan in the form of a DOCA being approved in approximately one third of all cases.

These statistics do not necessarily show that voluntary administrations are not working. It must be remembered that the Companies Act states that the objective of the voluntary administration regime is:

"to provide for the business, property and affairs of an insolvent company to be administered in a way that:

(a) maximises the chances of the company, or as much of its business, continuing in existence; or

(b) if it is not possible for the company or its business to continue in existence, results in a better return for the company's creditors and shareholders that would result from an immediate liquidation of the company."

So the fact that a company does not execute a DOCA does not mean that the voluntary administration was a failure. However, even taking this into account, experience to date suggests that voluntary administration is not yet working well in New Zealand.

The role of the Inland Revenue

This apparent lack of success will not come as a surprise to some. Prior to its enactment there were many who predicted that the regime would not work. However, the reason given as to why the regime would not be a success by most of these people does not appear to have been a factor to date.

In introducing the regime the government retained the Inland Revenue's status as a preferential creditor in liquidations. This differs from Australia where the Inland Revenue no longer has priority in the company liquidation for tax instalment deductions from salaries and wages. Many have argued this means that the Inland Revenue has no incentive to support a rescue plan by voting in favour of a DOCA as, in most cases, it will be able to recover all or most of its debt as a preferential creditor in the liquidation.

This has not been the reason for the regime's relative lack of success so far. There do not appear to have been any cases where a rescue plan has been voted down by the Inland Revenue. In the one case where a DOCA was put to creditors, the Inland Revenue voted in support of it.

While it has not been a significant factor in administrations to date, the preferential status given to the Inland Revenue could remain a stumbling block to the success of voluntary administration in New Zealand in the future. Reform may yet become necessary if voluntary administration is to succeed.

Failure to act early

Australian experience suggests that a key factor in the success or otherwise of an administration is how early directors act to invoke the procedure. An effective business rescue plan is much more likely when directors act early. Failure to act early may have played a factor in the administrations in New Zealand to date.

Some of the incentives for directors in Australia to invoke the procedure early are missing under the New Zealand regime. In Australia, in return for the Inland Revenue losing its preferential creditor status company directors have been made personally liable for the company's tax liabilities if not paid by the company itself. Directors can avoid this personal liability if they have appointed an administrator.

The New Zealand Government refused to accept that company directors should have personal liability for their company's tax liabilities if they fail to put the company into administration. Directors therefore do not have the same incentive to put companies into voluntary administration.

If the preferential creditor status of the Inland Revenue does prove to be a stumbling block to the success of voluntary administration in New Zealand, making directors personally liable for tax liabilities if they do not place the company into administration should be considered as part of any reform.

The reaction to voluntary administration by secured creditors

So far it appears the main reason rescue plans have not successfully been put together in more cases has been the response to voluntary administration taken by secured creditors.

An important feature of the regime is the moratorium placed on creditor claims while the company is in administration. However, secured creditors with a security interest in substantially the whole of a company's property can avoid this moratorium if they enforce their security by appointing receivers within the first 10 days of a company being placed into administration. Typically the receivers then move quickly to realise the assets of the company for the benefit of the secured creditor. By the end of that process there is often no business left to be rescued. As a result, rather than voting to approve a DOCA, creditors will instead vote to place the company into liquidation.

This has been a notable feature of the voluntary administrations in New Zealand so far. Receivers have been appointed in the majority of administrations, including the two most high profile administrations to date, that of the listed group of companies, ICP Bio, and Icon Digital Entertainment Limited, the company behind the Sounds and Blockbuster stores.

How secured creditors react to voluntary administration will be key to how successfully the regime is utilised in the future. If secured creditors who have a security interest in substantially the whole of a company's property continue to reject administration and appoint receivers, then voluntary administration will only ever have limited value. However, as general awareness of voluntary administration in New Zealand increases, and secured creditors become more comfortable with the process, we anticipate that the regime will successfully be utilised in a much greater number of cases than seen in the past year.

For more information, please contact:

Murray Tingey
Partner