Debt Agreements Review

REVIEW of DEBT AGREEMENTS UNDER THE

BANKRUPTCY ACT 1966

SUBMISSION

By


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Section 4: KEY ISSUES

The regulation of administrators

Section 185LD merely requires that an administrator establish a ‘separate bank account’ into which debtor’s monies must be paid. The bank account is not required to be subject to external audit.

We submit that the term ‘trust account’ in this context is erroneous.

Additionally, we submit that there should be no thresholds applied that diminish the power of the Inspector-General to verify the accurate accounting of public monies and legislation should be introduced to strengthen regulatory control over contributions held in trust by administrators, including the introduction of annual external audit.

New statutory duty for administrators

Option 3. We submit that the term ‘client’, referred to in the Consultation Paper, and applied to the relationship between debtor and administrator is not defined by interpretation in the Act.

Since inception of Part IX, it has been understood generally that the obligation of the administrator is to the debt agreement thereby ensuring that both stakeholders abide by their respective undertakings.

Option 4. In the event it be interpreted that a debtor is a client of the administrator, conflict may arise:

  • The term client infers a principal agent relationship. The obligations imposed on an agent include:
    • Loyalty to the principal (the debtor)
    • Obeying the reasonable instructions of the principal
    • Refraining from placing oneself in a position that would encourage a conflict of interest between the interests of the principal and the agent
    • Keeping the principal fully informed of material facts that affect the relationship.
  • An agent may seek indemnity from a principal.
  • An agent may be held liable by the principal for resulting loss or damage.

Accordingly, under these circumstances, it would be the debtor who directed the administrator as to the adequacy of an offer; or conversely the administrator would be bound to the debtor to seek the lowest return possible.

  • The administrator would be bound to avoid termination for non payment of contributions most likely by way of variation proposals;
  • Other than self interest in administration fees, there would be little or no motivation for an administrator to pursue delinquent contributions or endeavour to track absent debtors.

Our understanding is that trustees consider that they ‘work for the creditors, to obtain the best return possible’. No doubt this position is borne from the bankrupt nature of the debtor and the fact that assets have been vested.

A debtor’s assets are not vested to a debt agreement administrator under Part IX.

This ‘grey area’ could be overcome by the introduction of a pro-forma Contract of Appointment which could be promulgated to proposing debtors, outlining the relationship between the parties.

A debtor is a free-agent. It is a debtor who approaches either a facilitator or an administrator seeking assistance and it is the debtor who provides the financial information required to collate and formulate a debt agreement proposal. Across the board, it would not be unreasonable to state that a debtor’s approach is based solely on a desire to avoid bankruptcy and make a settlement. In a majority of instances alternatives have already been exhausted.

The interests of a debtor should be decided by the debtor.

In many instances, it is a lack of good faith on the part of the individual debtor that creates difficulties in dealings.

The registration of administrators

Option 5.

We submit that there is a general lack of accounting and insolvency education in the profession.

Further we submit that education and training standards could be elevated by introducing the following process:

  • New employees to the industry should be subject to a practitioner’s investigation which may include:
    • Reference checking;
    • NPII search
    • Criminal history check; followed by
  • A pro-forma introductory written examination, provided by the regulatory body, should be sat within the first 6 months of employment for those intending to deal with debtors’ debt distress. The practitioner could be required to provide the written test; or it could be provided by the peak body Debt Agreement Practitioners Association.

Upon seeking registration, after a two (2) year employment history with a practitioner, the registrant should be required to:

  • Sit a further examination with a delegate of the Inspector-General.

Material for consideration could include:

  • Business ethics
  • Guidelines to advertising
  • Principal & Agent relationship
  • Duties of an Administrator
  • Debt apportionment, actual and principles and practices
  • Cash & cash flows
  • Alternatives to bankruptcy, principles and practices.

We do not consider financial counselling, as it relates to the methods of community based financial counselling, to be relevant.

Option 6. We submit that relevant employment, on a full-time basis, of not less than two (2) years working in the practice of a registered administrator would be highly desirable.

Education and associated costs are generally borne by the student and with this in mind we are not disposed to believe that such costs would be borne by the stakeholders as such cost would be a personal expense.

The qualifications of registered administrators

Option 7 is acceptable however it fails to address the issue of insolvency training which, in our opinion, should be a prerequisite to registration. Administrators are accountable for considerable sums of public money and we consider it crucial that registrants be Australian citizens, or at least residents. This is an issue not currently evident in the legislation.

Option 8. Stakeholders have, for many years, derided administrators and their perceived lack of credibility.

The qualifications required for registration should be fully expressed and should not be discretionary.

We also support the mandatory membership of registrants with the Debt Agreement Practitioners Association.

Unregistered administrators

It is submitted that unregistered administrators be proscribed for the following reasons:

  • Lack of accountability to the regulator;
  • Lack of accountability for debtors’ contributions;
  • Unprofessional standards of workmanship;
  • There is no rational purpose to this role.

Option 9. We submit that consideration should be taken of the role of facilitators working in direct conjunction with registered administrators. Their role encompasses preparation and formulation of debt agreements. These entities are required to hold a credit licence pursuant to legislation.

The qualifications of many consultants employed by some facilitators exceed those of many administrators.

We recommend that such facilitators be included in legislation to be required to hold sub-licences to the registered administrator.

The role of qualified facilitators in the process serves to ensure an arms length transaction and conflict free dealings.

Option 10. The ability for an individual desirous of engaging in the administration of their own affairs should be continued.

ITSA’s powers to investigate potential misuse of client monies by unregistered administrators.

Option 11. We subscribe to this option, be reiterate our submission that the activities of unregistered debt agreement administrators should be abolished.

Option 12. We also subscribe to this option.

We submit that there should be no necessity for the Inspector-General to seek Court intervention and it should be legislated that the Office be empowered at any time where there is reasonable suspicion of malpractice.

Advertising by administrators

It is difficult to support the suggestion that a debt agreement can be misconstrued as a debt consolidation loan. Documentation provided to and executed by a debtor proposing a debt agreement is full, complete and explanatory. Misrepresentation is actionable.

Option 13. We strongly support the suggestion that all advertising should carry the identification of the service provider, encompassing:

  • The registered name of the administrator
  • The registration number of the administrator;
  • The physical address of the administrator; together with
  • The Australian Credit License number of the facilitator, if applicable; and
  • The physical address of the facilitator.

We further strongly recommend that any business name in operation and utilized by an administrator or facilitator be required to be registered with ITSA.

Option 14. Advertising Guidelines expressed in both DAPA and IPA Codes are clear as to the expectations of practitioners. We do not consider it necessary to expand on those guidelines beyond 13.

The provision of advice by unregulated entities

SRMC Ltd supports the proposition that only qualified practitioners who are subject to regulation by ITSA should provide insolvency advice; however facilitating services operated by registered administrators should be included in the mix. A number of these organizations employ highly capable and qualified staffs who are fully conversant with insolvency practice. Sub-registration of facilitators would be highly regarded.

In our view, community based financial counsellors have at their disposal very few qualified ‘financial’ counsellors. Whilst it is appreciated that federal, state and local governments provide funding to these organizations, some $57M in 2009, and have an expectation of some return by way of community service they do not engage in administration opting often for bankruptcy.

Consultation answer

Unless the provision of insolvency advice is limited to practitioners and associated facilitators, many of those entities granted an Australian Credit Licence may well see an opportunity to engage insolvency matters for monetary reward. ITSA will be unable to maintain regulatory control because that control will have shifted to ASIC.

Insurance requirements for registered administrators

Licensees under the National Consumer Credit Protection Act 2009 are required to hold Professional Indemnity Insurance at a base minimum of $2,000,000.

Option 15. Due to the significant funds managed by administrators, we support the introduction of insurance for administrators.

Option 16. We support this option.

Remuneration of administrators

Remuneration

It is our view that there is scant understanding by stakeholders and government of the costs associated with operating a professional practice. The list of operational expenses reads like any other commercial business operation.

Set-up fees

Administrators differ in their method of fee collection. Some will not lodge proposal documents until such time as their set-up fee is paid in full. Others include the fee in the debt agreement, as a creditor and draw down the fee over the period of the debt agreement, apportioned amongst the balance of creditors.

In the first scenario the administrator obtains the benefit of strong cash flow but the debtor suffers delay in obtaining creditor relief. In the second scenario, the administrator suffers from cash flow deficiency, but the debtor gains immediate debt relief.

In the first scenario, the administrator has been paid and relies thereafter on administration fees, as prescribed.

In the second scenario, fees due are accrued. If a debt agreement fails, the balance of fees are lost, to the disadvantage of the administrator. If rejection occurs there are no fees available.

We offer the following example:

Proposed set-up fee $3,423.00
Less add back 21%  719.00 (Offer 70%)
$2,704.00
Less GST  246.00
2,458.00
Less cost of acquisition   2,037.00 (indicative)
Actual return   $   421.00

This minimalist net return is subject to all contributions being made by the debtor. The average period taken to discharge all obligations may be 4-5 years.

Those administrators who do not charge set up fees may well be those who do not advertise and rely solely on referral work. The portfolios would be minimal and they are most likely sole trader operations.

In contrast, ITSA’s fees are not subject to the cost of advertising which escalates on 1 July, each successive year.  In addition to the stated 20%, charges such as $191 lodgment fee and 4.4% Realisations Charge are recovered from debt agreements. ITSA does nothing to promote insolvency alternatives beyond its website which is not commonly known to the public at large.

For some years there has been criticism of administrators’ fees. Creditors are cognizant of commercial operating expenses and should give due consideration these costs.

In this group, consultants dealing with consumer enquiry and formulating debt agreements have engaged in debt solutions for many years. All hold a tertiary qualification.

We consider that there is a resolution to the issue of set-up fees that could be acceptable to all parties:

It is submitted that

  • Set-up fees should return to being a preference payment, after the Realisations Charge;
  • Pre-payment of set-up fees should be proscribed ie payable before submission; but
  • The fee should be recoverable from the debtor, even in bankruptcy; and
  • An allowance should be made for collection of initial out of pocket expenses borne by the facilitator or administrator. Such amount to be deducted from the over-all fee.

Likely benefits:

  • Immediate lodgment of documents;
  • No delays in debtor obtaining relief
  • Improvement of cash flow for administrator
  • Prior pre-paid fees become contributions.
  • A competitive leveling. across the board,  of charges.

Possible disadvantages:

In some instances a slightly longer wait, in some circumstances, for the first dividend to creditors.

What effect does the level of fees have on acceptance rates?

Creditors are not required by give reasons for rejecting debt agreement proposals.

This submission agrees with ITSA that creditors appear to judge acceptance as much on the quality of the proposal as on the quality of the administrator.

It should be noted that the set-up fee is a charge levied before acceptance of the debt agreement proposal, by creditors, and is therefore a matter of private treaty between the debtor and the facilitator.

Should administration fees be regulated?

Creditors, it appears have no understanding of the ‘mark up’ strategy adopted by those administrators who finance their fees into a debt agreement. It is the mark up percentage that appears to make the disclosed amount unacceptable even though all the elements to support it are obvious in the Explanatory Statement.

Option 17. There may be an option to regulate set-up fees if the charge was reverted to preference collection. In that scenario, we have reason to believe that set-up fees would be competitively set in the vicinity of $2,000 plus goods and services tax.

Option 18. Otherwise, there should be no regulation as to fees. Creditors have the power to reject proposals that they find unacceptable – and it is a matter for the creditors. Regulation of fees may also:

  • Stifle quality of workmanship;
  • Stifle competition;
  • Reduce the ability of administrators to employ qualified staff;
  • See good administrators leave the profession.

Administration fees

We offer the following example:

Expenses encompass:

  • Labour costs
  • Secured trust account cheques
  • Advertising – apportioned
  • Accounting & auditing
  • Telephone & facsimile – apportioned
  • Registration fees – ITSA
  • Insurances including Professional Indemnity – apportioned
  • Office rent, power & utilities
  • Stationery – apportioned
  • Postage – apportioned
  • Computer & IT maintenance including software upgrades – apportioned
  • General expenses, staff amenities – apportioned.

Corporate expenses are excluded.

Fee return is based upon contributions received. Accordingly for each contribution received the administrator may draw down the percentage stated in the proposal – eg: 25%.

Contribution: $100.00
Contribution: $100.00
Less: Realisation charge @ 4.4% 4.40
$ 95.60
Less: 25% gross – administration fee (22.73)
GST (2.27)
Income to dividend distribution: $70.60

Of the 25% gross received, the administrator must compensate for all of the aforementioned expenses, which include ongoing collection and compliance duties. The following issues effect the collection of the administration fee:

  • Arrears of contributions reflect a loss of fees claimable;
  • Termination eliminates all fees.

Where an account becomes delinquent, the cost of managing it can be substantial. Creditors themselves will be aware of the cost of recovering arrears. Just one letter or one telephone contact can diminish the anticipated 25% fee return to a zero return.

Consultation submission

It has been shown in examples that the return to an administrator is minimal even at what may appear to be relatively high fee charges. The reality is completely different when a socially responsible administrator includes the set-up fee into a debt agreement.

  • If the full fee, as shown in the debt agreement, is to be recovered over the life of the agreement an adjustment must be made for the apportionment of return – it is a legal obligation. If the set-up fee is included into the debt agreement the administrator may only recover the fee in apportionment with the balance of creditors. If the offer is 70% then the administrator will only be permitted to recover 70% of the fee. And, because the set-up fee is more than likely the smallest debt in the mix the percentage return from contributions allocated will also be the smallest percentage. On average, our return is 3.5%, payable only when all creditors receive a distribution, which is quarterly.
  • Where there are difficulties with receiving contributions, the administrator suffers  from cash flow;
  • Where termination is effected, the fee is lost, as is the administration fee.

No consideration appears to be given to these matters, perhaps for lack of a clear understanding of the processes being applied in the market place. Few, if any creditors, review a proposal and arrive at the conclusion that “the return is 70% so the administrator is adding back the shortfall of 30%”.

Recommendation:

The fees of administrators should be such so as to enable them to undertake their role professionally and service the needs of creditors and consumer whilst returning a reasonable profit.

It is highly recommended that the set-up fee become a priority payment from contributions.

Increasing the information available to debtors

Require administrators to provide comparative information on fee levels.

SRMC Limited submit that neither Option 19 nor Option 20 are an acceptable remedy to the issue of providing beneficial information to intending proposers.

Option 19. The fees are not the issue. One cannot have professional involvement without cost.

Option 20. The publication of statistics could be destructive and may only benefit the largest of operators and disenfranchise more professional but smaller operatives.

We are not opposed to information being made available on ITSA’s website however we would point out that:

  • The website has a tendency to obscure debt agreement administrators; whilst
  • Financial Counsellors appear to be highly visible; and
  • ITSA’s website is not commonly known to the public at large.

We submit that of greater importance to both debtors and creditors is information that supports professional and ethical operators. We consider that a rating system could be introduced and published based on over-all performance and encompass:

  • Set-up fee charges
  • Administration charges
  • Acceptance rate
  • Complaints from debtors
  • Complaints from creditors
  • Systems integrity
  • Auditing of funds
  • Veda rating
  • Professional competence
  • Regulatory performance rating

The rating of each administrator could be published ranging down from AAA to Z.

Expenses recovered by administrators

Option 21. We concur with the Consultation Paper that any legitimate expense will be borne from the behaviour of a debtor.

Administrators are cognizant of the effect of ‘skips’ and delinquencies in administrations.

The Act expresses that an administrator must maintain ‘a separate bank account into which contributions are to be paid’. Interpretations interprets ‘bank’ to be an authorized deposit taking institution.

Dishonour charges are one expense that can not be reasonably foreseen. However the Explanatory Statement was amended to permit dishonour charges to be deducted from the balance of contributions received. The proviso being that the transaction takes place with an ADI.

Locating a debtor who has left employment or the address is a further concern. There should be a legislative requirement that a debtor inform an administrator of any changes in personal contact information. Costs associated with the exercise of location should be recoverable.

Disclosure of expense claims in debt agreement proposals

We concur with Option 21 – amending the Act to include possibilities of unforeseen expenses incurred. We also concur that an expense should not be recovered before expended.

Option 22. We do not consider it reasonable that legitimate expenses be banned.

Access to debt agreements

How high should the thresholds be?

Option 23. An increase in the gross income, asset and liability thresholds to a range in the vicinity of $120,000 – $130,000 would assist capture some debtors who currently find it necessary to appoint a Controlling Trustee. Fees levies by trustees to undertake this role are significant and often required upfront.

An increase of 20% or even 30% would reflect the growing levels of indebtedness and earning capacity within the community.

In or around May 2011 a number of banks changed policy regarding the acceptance of Personal Insolvency Agreements advising that they would no longer consider Personal Insolvency Agreement offering a return of less than 60%.

Option 24.  SRMC considers an increase in the thresholds to be a natural development in order to meet changes in economic circumstance.

How long should former bankrupts be barred from proposing a debt agreement?

Option 25.  The timelines should be brought into line with commercial realities.

An individual declaring insolvency suffers a credit reference file annotation for a period of 7 years. The NPII is annotated ad infinitum.

A tenet of insolvency law is to rehabilitate debtors and return them to the community having learnt a degree of financial wisdom.

We submit that:

  • That the 10 year bar period is probably too long a period; and
  • A 5-7 years period is adequate. This would leave a 2-4 years gap after automatic discharge.
  • An individual completing their obligations to a debt agreement should be entitled to submit a new proposal 2 years after discharge.

Option 26. If the NPII is to remain as a permanent record of insolvencies in Australia
it should be noted that there are no major bars to a discharged bankrupt obtaining credit after the 7 years credit file annotation is removed. Accordingly, it seems that the NPII is not an effective medium for creditors to weigh the value of a credit application. Creditors rely heavily on commercial credit file information.

The Exposure Draft on Credit Reporting recently promulgated by the Senate should also be considered.

Consider introducing additional services for debtors

Option 27.  SRMC Ltd is of the opinion that offering a free counselling service to debtors, as suggested, is fundamentally sound however there is only limited faith in the professional approach to insolvency by Australian based community financial counselling services. There is a deficiency of insolvency education in that area and few, if any, qualified counsellors.

We note that in 2009, some $57 million in public funds was allocated in support of community based services. There appears to be no public accountability for these monies.

We have concerns that community based financial counsellors do not propagate the range of viable insolvency alternatives available, and appear to have a preference for bankruptcy.

If an additional service were to eventuate, it should be essential that information providers acquire adequate knowledge, preferably by qualification, in insolvency law and accounting.

An advisory organization would be better serviced by enhancing ITSA to deal with it or forming a distinct organization that included trustees, debt agreement administrators and community based financial counsellors working uniformly under the direction of ITSA.

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