Division 65 and the New Strict Liability Regime
With the first tranche of changes under the Insolvency Law Reform Act 2016 (Cth) (ILRA) now some 6 months behind us you could forgive the industry for thinking that the entire overhaul of its legal framework was not quite as traumatic as everyone thought it was going to be. And just when the slightly warmer days and smell of spring in the air were starting to make us think that winter was well and truly behind us, the profession has again been forced to brace itself and acclimatise to a whole new raft of changes which took effect on 1 September 2017.
In the words of Jon Snow “winter has come” and with a new set of strict liability offences making their debut, the reception is sure to be a frosty one.
Across both personal and corporate insolvency there are substantial number of new strict liability offences including such matters such as the deriving of profit or advantage (60-20) and failing to keep books of a business previously carried on or failing to make such books available for inspection by creditors (70-10(4)).
But of the new provisions, the ones that are most likely to see insolvency practitioners finding themselves on thin ice (in a practical sense) are the raft of amendments in respect of the handling of funds under Division 65 of the Insolvency Practice Schedules (IPS) for both Corporations and Bankruptcy.
Under the schedule to the Criminal Code Act 1995 (Cth) a strict liability offence is an offence for which intention or fault does not have to be present. The act of committing the offence means that a person is guilty of it whether they intended to do it or not. Given the mostly administrative nature of funds handling and the likely room for error that comes along with such administrative tasks, it is easy to see why the imposition of a strict liability regime for funds handling may make some practitioners feel uneasy.
The changes to both corporate and personal insolvency brought in by the respective new Division 65’s in relation to funds handling are for the most part identical, however this article will mostly focus upon the changes in the context of corporate insolvency appointments.
Out with the old and in with the new
The new provisions will apply to any funds received by an External Administrator (EA) on or after 1 September 2017 for both new and existing appointments, extending the current law to apply to company’s under administration (including those subject to a DOCA) and not just liquidations as was the law under the old regime. Accordingly an EA of a Company is defined under the IPS as being a person who is:
- An administrator of a company
- A deed administrator of a company
- A liquidator; or
- A provisional liquidator.
Under the new regime s 538 of the Corporations Act 2001 (Cth) (Corporations Act) along with Corporations Regulations 5.6.06-5.6.10 will be replaced by Division 65 of the IPS (Corporations) and (Bankruptcy). Section 543 of the Corporations Act in relation to the investment of surplus funds for companies in liquidation remains unchanged and forms part of the new regime. The Transitional requirements are contained in s1586-1590 of the Corporations Act. In accordance with the simplified outline set out at Division 65-1 EA’s have a duty to:
- Promptly pay all company money into an account (called an administration account); and
- Promptly deposit instruments such as securities with a bank; and
- Keep the account separate and not pay any money that is not company money into the account
- Only pay money out of the account if it is for a legitimate purpose.
As a general note section 65-1 sets out that the EA may keep a single account for a group of related companies (called a pooled group).
People with a financial interest in the external administration of a company (such as creditors) may ask the Court to give directions to the EA about the way money and other property of the Company is to be handled.
If the EA of a Company does not comply with the division, the EA may have to pay penalties, be paid less remuneration or may be removed.
Specific provisions and consequences of non-compliance
Section 65-5 – EA must pay all money into an administration account
- The EA must pay all money received by the EA into an administration account for the company within 5 business days after receipt unless a Court orders otherwise.
- Failure to comply with the section is a strict liability offence bearing a penalty of 50 penalty units being $10,500.
Section 65-10 The Administration Account
- In order to be compliant with the section an Administration Account must be a bank account maintained in relation to the external administration of the company and must comply with any requirements set out in the rules.
- At this time the Insolvency Practice Rules (Corporations) do not make any reference to funds handling or Administration Accounts. Conversely such additional requirements for Administration Accounts are set out in the Insolvency Practice Rules (Bankruptcy). It is unclear at this stage whether the Insolvency Practice Rules (Corporations) will be amended to included similar further provisions.
- The same requirements apply to the external administration of pooled groups as described above.
Section 65-15 EA must not pay other money into the administration account
- The EA must only pay money into an Administration Account if that money is received by the EA for the company on behalf of or in relation to the company or another company within a pooled group. The EA will be in breach of this section if it allows any money not received for or on behalf of the company to be deposited into the administration account unless a court directs otherwise.
- Failure to comply with the section is a strict liability offence and carries a penalty of 50 penalty units being $10,500.00.
Section 65-20 Consequences for failure to pay money into an administration account
- This section deals with a situation in which an EA fails to pay an amount into administration account in accordance with section 65-1 and such amount exceeds the amount of $50 and the Court has not made any alternative direction.
- In those circumstances:
- The EA must pay a penalty on excess at a rate of 20 per cent per year; or at any other such rate as may be prescribed for the duration of the period of non-compliance.
- The EA is personally liable for the payment of this amount and is precluded from seeking reimbursement out of the property of the company in relation to the payment of any such penalty.
Section 65-25 Paying Money Out of the Administration Account
- An EA may only pay money out of an administration account if such payment is for a purpose that is related to the external administration of the company; or otherwise in accordance with the act or at the direction of the Court.
- Failure to comply with this section will result in the commission of a strict liability offence, the penalty for which is 50 penalty units being $10,500.
- A pooled group refers to a group of interrelated companies. If an EA is appointed to such a group they are not required to open an individual administration account for each entity and may instead open the one account for the entire “Pooled Group”.
Section 65-40 Handling Securities
- The EA must deposit any negotiable instruments and any other securities with the Administration Account bank which are payable to the company or EA as soon as practicable after they are received unless the Court makes an alternative direction.
- Failure to comply with the above is a strict liability offence that carries a penalty of 5 penalty units being $1050.
- At this stage it is unclear as to how a subjective measure such as “as soon as practicable” can operate coextensively with an offence of strict liability. The wording of this section makes it difficult to determine when a breach will have actually occurred.
Section 65-45 Handling of Money and Securities – Court Directions
- Pursuant to this section the Court may, if approached by way of application, give directions regarding the payment, deposit or custody of money, negotiable instruments and other security payable to or held by and EA.
- The Court may also authorise an EA to make payments into or out of a special bank account
- Applications to the Court under this section may be made by any person with a financial interest in the external administration of the company or an officer of the company.
Section 65-50 – Rules in relation to consequence for failure to company with this division.
- The section states that the Insolvency Practice Rules may make provision for various matters such as payments of interest, disallowance of remuneration. Removal from office of the EA by a Court and the payment of expenses.
- At present the Insolvency Practice Rules (Corporations) make no reference to the funds handling provisions. It is unclear if this was an oversight or whether new rules may be added at a later stage. Conversely and as mentioned above, the Insolvency Practice Rules (Bankruptcy) do include reference to the funds handling provisions and include rules that apply to how Administration Accounts must be held, penalty interest and the review of bills of costs by the Inspector General.
It is evident from the above that the application of Division 65 is likely to have far reaching consequences for EA’s and how they manage funds received and paid out on appointments.
The most obvious of which are the imposition of strict liability penalties for:
- Failing to pay money into the administration account within 5 business days;
- Paying other funds into an administrations account
- Paying money out of an administration account for an unauthorised purpose; and
- Failing to deposit securities as soon as practicable.
The imposition of strict liability offences for breaches, whilst clearly intended to act as a deterrent for the improper handling of funds, may also see EA’s incur substantial and serious penalties for purely administrative errors regardless of whether such errors occurred as a result of a failure to properly manage their practice or as a result of pure inadvertence. Whilst the application of strict liability will leave open the defence of honest and reasonable mistake, the onus of proving that defence will ultimately rest with the EA, adding to both the time and expense incurred by the EA in dealing with that particular matter.
Such criticisms were identified by the industry early on as evidenced by the submissions made by ARITA, the Law Council of Australia, along with a number of insolvency and legal firms when the legislators called for submissions on the draft Insolvency Law Reform Bill (Cth) in 2014.
Early criticisms of some of the sections which were subsequently included in the Act include:
- The imposition of strict liability offences may result in substantial penalties being imposed upon EA’s for small administrative errors.
- The possibility that EA’s may find themselves in breach of the Act for the actions of unrelated third parties, for example a deposit made by a third party into the incorrect administration account may technically be a breach of 65-15. To that end further clarification appears to be required around what constitutes “receipt” of funds by an EA
- The imposition of a set penalty of 50 penalty units regardless of the severity of the offence committed which may expose EA’s to unfair prosecutions or disproportionate penalties.
- The new division does not appropriately deal with pre-appointment accounts maintained by EA’s and makes the continued use of these accounts an offence under the act (65-10) regardless of whether they may be more commercially convenient or suitable.
- The division does not make clear whether an EA is permitted to maintain more than one administration account on a particular matter.
- The strict liability offence for securities handling is inconsistent with the subjective requirement that EA’s deposit securities “as soon as practicable” a time limit should be set or the offence should not be one of “strict liability”
- The requirement for the opening of “administration accounts” will result in additional administration costs. EA’s are now compelled to open an Administration Account upon their appointment regardless of whether the company or the EA collects any funds.
- The Division lacks flexibility and does not appropriately deal with the commercial realities faced by EA’s on appointments. The only alternative available to EA’s who may have a reason not to comply with the division is to approach the Court. However, this is often commercially impractical.
- Additionally, the Division is unclear in some aspects but lacks sufficient flexibility to allow EA’s to make commercial judgments about their compliance without having recourse to the Court.
Why so strict?
In the explanatory memorandum to the ILRA Bill 2015 the legislature indicates that strict liability offences are appropriate in the circumstances given the need to “strongly deter misconduct that can have serious consequences for affected parties”.
It is also noted that the imposition of strict liability tends to reduce non-compliance and would be beneficial to both ASIC and AFSA in their efforts to deal with offences expeditiously and to maintain public confidence in their regulatory regimes.
Limiting insolvency practitioner discretion also appears to have been a further aim with the far reaching consequences of potential abuses of power being sighted as a justification for the imposition of tougher penalties.
A further consideration that specifically references Funds Handling appears to stem from a perceived difficulty and need for additional resourcing and investigation should the regulators be required to establish proof of intention.
Such explanations are likely to be cold comfort for insolvency practitioners who are faced with the task of ensuring that they and their staff are able to comply with the new regime.
Practical guidance for practitioners
As with any new legislation, there is bound to be a period of adjustment, however in light of the serious potential consequences for non-compliance, it is important that EA’s have in place proper systems and processes so that they can be confident that they are properly complying with the new provisions.
Given that EA’s bear the sole responsibility for compliance with the division it is important that staff working on matters are made aware of the new requirements and are given proper training and guidance about what is required.
Whilst the true impact of these provisions won’t be seen until the regulators begin to enforce their terms or matters come before the Court for consideration, it seems clear from the above that further policy and guidance is required in order to assist practitioners to be able to properly comply.
Alternatively, and in the absence of such policy or guidance, one would hope that regulators would see fit, at least initially, to afford practitioners some leniency in the enforcement of the new provisions.