PJC recommendation – pre-insolvency advisers – Part 1

The PJC Report on Corporate Insolvency 2023 has responded to concerns expressed about “untrustworthy pre-insolvency advisers”, those that are said to offer and facilitate unlawful conduct by debtors to avoid the consequences of insolvency.  It found that such operators were “more identifiable by the harm they perpetrate rather their job title or profession”, but that the harm caused needed to be better understood – its impact, and the nature and number of those involved, and the causes of the conduct.  “Only then can we properly consider solutions for addressing it”. 

The PJC therefore referred the issue to be included in its proposed broader review of the insolvency framework. The committee further recommended that in the interim, the government take prompt action to improve the regulation and active enforcement of pre-insolvency advisers.[1] A related recommendation [6] concerned insolvency pathways along which the debtor might be advised to proceed.

A comprehensive approach would be to look at all pre-insolvency advice and define the requirements of the trustworthy advice and its pathways, and then the demerits of the remainder.  The first might be the more difficult, and contentious, the second – ‘the unscrupulous, unregulated and unlicensed advisors who prey around the edges of the insolvency system’ – easier to identify.  The first is discussed here; the second will follow.

Pre-insolvency advice

The types of concerns about pre-insolvency advisers are nothing new.  Many professions over the years and now have to contend with those operating on the edge who offer services encroaching upon the relevant professional discipline.  All professions have a history of protecting their patch and resisting outsiders and marketing strongly in doing so. In the 19^th century, accountants prevailed over lawyers for insolvency work and even among the accountants, early bankruptcy trustees were said to be “persons of a very shady description” compared with official liquidators who were “accountants of high standing and integrity”.[2] And as for now, and in the present context, we have turnaround vs insolvency practitioners, with TMA referring to “an amorphous group called pre-insolvency advisors who promote phoenixing, [but] no evidence has been put forward as to precisely who these people are. Tellingly, the only way to effect a phoenix transaction is via liquidation and the engagement of a registered liquidator”.[3]

 ‘Trustworthy’ pre-insolvency advice?

The marketing contests between IPs can impact what purports to be proper pre-insolvency advice and make it questionable if it is not comprehensive and objective but is slanted to the particular expertise of the person giving the advice.  As the PJC says, the focus is on the harm done by the advice, not who perpetrates it.  The information asymmetry of insolvency services as credence goods, whereby the debtor depends on experts to diagnose their situation and recommend the optimal course of action to resolve their problem, exacerbates that.[4]

For example, it may be that advice given by a restructuring practitioner to a small business about Part 5.3B ‘small business [corporate] restructuring’ is too narrow, if personal liabilities are also involved: Businesses are rarely neatly arranged when insolvency strikes – Murrays Legal. Even then, there is the issue that an IP would tend to give advice in terms of their learning and background; that is, to a person with a hammer, no matter how well intentioned, everything looks like a nail, with an insolvency appointment the obvious option: A new system for SME restructuring: is there a business doctor in the house? | Australian Insolvency Law.

Independence

And pre-insolvency advice given to a debtor by the prospective IP in Australia is qualified because of the strict independence requirements of IPs.[5]

That intersection of independence and pre-insolvency advice explains recommendation 15 of the PJC Report, as to whether the current independence requirements for insolvency practitioners are achieving their intended purpose, and/or whether there should be a separation of the roles of advice and restructuring from formal insolvency appointments.[6]  One could say that IPs having made their independence requirements so strict, they have left a vacuum that is inevitably filled, and not always filled well. 

Also, there is the related perverse incentive issue, that an appointment as liquidator or administrator to the debtor’s company would produce far more work, and remuneration, than an informal work out with creditors. One would like to think that the advice given by the IP would be objective and lacking in self-interest in such a case.  This is an issue with IPs in the UK, discussed below.  

An experienced insolvency lawyer or other qualified adviser whose advice is not dependent on being appointed as an IP might be better, but not if their own work is acting as a safe harbour adviser, or in some paid advisory role, where their interests are to avoid a formal appointment, when that may in fact be the best option for the company. 

Separation of advice and restructuring from formal insolvency appointments

In order to address that issue, the PJC suggests looking at the advantages and disadvantages of formally separating the roles of advice and restructuring from formal appointments.  That would also create a cohesive group of valid pre-insolvency advisers who could be regulated.   

The PJC said that the case for some such regime was explained by one submission in these terms, that there should be

“a split of the profession, a bit like barristers and solicitors, where you have the restructuring side and then the investigative side. … you would have one set of consultants who would come in to try and restructure and work as hard as they could to get that over the line, and if that failed then the team B would come in to go through the wind-up process”.

There will be many views on that.

These are not so unfamiliar issues in other professions.[7]  Nevertheless, a client with a monetary claim should expect their lawyer to advise on a range of options from mediation to litigation.  Likewise, a doctor should be expected to advise a patient on less interventionist remedies before surgery.  Professional standards and commercial morality are some safeguards, as are informed clients or patients, or debtors.

This also comes within the PJC’s review of the pathways by which an insolvent company proceeds to the optimum external administration arrangement, which should also include avoiding any such arrangement.  Hence the PJC recommends [6] an examination of “the current system of corporate insolvency pathways from a holistic systems analysis perspective”, and it should be added, from a debtor’s perspective, not that of the industry and how it chooses to structure itself. 

As the PJC suggests, all this needs careful review.  Law changes could have unintended consequences or be ineffective.  Overseas experience can assist. For example, it may be that some regime of regulation like that which applies in the UK is needed.

UK

Debt advisers and their firms are required to be authorised by the Financial Conduct Authority in order to be able to give debt advice to clients.[8] Following lobbying by the profession, IPs are largely excluded from requiring direct FCA authorisation when acting in an insolvency appointment or in reasonable contemplation of such an appointment.  They remain regulated by their specialist recognised professional bodies. 

The exclusion of IPs is under review in light of concerns about the perceived conflict of interest between the commercial interests of the IP and the interests of the debtor, that is, that the exclusion may incentivise IPs to recommend an Individual Voluntary Arrangement under Part VIII (sections 252-263) of the Insolvency Act 1986, comparable to an Australian Part X personal insolvency agreement, instead of other, sometimes more suitable, insolvency solutions, or indeed none.  An IVA can generate more fees than other types of arrangement. The number of IVAs as a percentage of overall insolvencies has been increasing steadily over the past two decades, rising from 20.58% of all personal insolvencies in 2002 to 74%, in 2021, far exceeding the number of bankruptcies. 

The UK concerns are about misleading or poor advice, mis-selling of IVAs, lack of transparency about fees and other charges and the behaviour of some IPs and IVA ‘volume provider’ firms.

The UK government’s current consultation on reforms on the future of IP regulation recognises concerns in this area.[9]

Professional standards

Pre-insolvency advice is regulated by professional standards in the UK – the Insolvency Practitioner Code of Ethics and the Statement of Insolvency Practice 3 apply.  SIP3 provides that

“an insolvency practitioner should be satisfied … that there are procedures in place to ensure that a full assessment is made of the debtor’s personal and financial circumstances”

and requires IPs to provide debtors with balanced information to allow them to reach an informed decision about their best option. The expectation is that an IP may therefore conclude during the course of an interview that a formal insolvency is not the appropriate solution for that individual and refer them appropriately.[10]

Australia could emulate this given that its IPs are likewise excluded from the debt management regime of the Australian Financial Complaints Authority. This exclusion applies only while performing or exercising their statutory functions or powers, or work incidental.[11]  Informal work outside those parameters may constitute a debt management service to a consumer which requires registration.

Conclusion

The point discussed here is to try to assess whether what is said to be good pre-insolvency advice is in fact so or could be improved.  The aim is to ensure that any debtor should receive objective and comprehensive advice about resolving their financial difficulties, whether that be an insolvency option or otherwise, and advice that is pro-debtor, and not pro-adviser.  Insolvency itself has features that make that difficult, such as information asymmetry, which current insolvency practice might need to address.  Any comprehensive review of insolvency can examine that.   

Next: Untrustworthy pre-insolvency advisers

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[1] Recommendation 14: 8.87 The committee recommends that the comprehensive review include consideration of the operation, efficacy, and efficiency of the current independence requirements for insolvency practitioners etc.

[2] E Manson, Tinkering Company Law (1890) 6 LQ Rev 428, 432.

[3] TMA-Australia-Covering-Letter-and-Submissions-on-Small-Business-Law-Reforms-ns.pdf (turnaround.org.au)

[4] Debt, risk and forgiveness: Behavioural approaches to personal insolvency law, Imke Lammers, PhD thesis, QUT, 2022

[5] ARITA Code 3.6

[6] Recommendation 15: 8.108 The committee recommends that the comprehensive review include consideration of the nature and extent of the harm posed by ‘untrustworthy pre-insolvency advisors’ etc.

[7] Assuming insolvency is a profession: Does insolvency practice constitute a profession? – Murrays Legal

[8] Financial Conduct Authority | FCA

[9] For example, “clients have been talked into making IVA applications by IP firms without being given full advice and information about all of their other options”: Call for evidence: Review of the personal insolvency framework – GOV.UK (www.gov.uk).  See also UK insolvency practitioners to come under direct government regulation – Murrays Legal; UK personal insolvency reforms – summary of responses and next steps – Murrays Legal

[10] A reminder on Insolvency Practitioner exclusion from Financial Conduct Authority regulation | Insolvency Practitioners Association (insolvency-practitioners.org.uk)

[11] National Consumer Credit Protection Regulations 2010 – reg 20.