Allan Hubbard's Life and Death

Death forces us to confront the meaning of life, which is perhaps why death is so full of euphemisms and other ways of sugar-coating its sting. The death of Allan Hubbard is no different: it forces us to think of not just what he did, and the trouble he faced, but who he was.

Who he was to those who knew him personally, to those whose lives he touched by his donations, his financial accommodation, to those who counted him dear and to those who admired the good things he did, is, to some extent, not the answer to this question. It is these people, and their image of him, or personal experience with him, that we do not want to upset by speaking ill of the dead. We don't want to take away who he was to them by contradicting how they wish to remember him.

Of course those who knew him personally, or whose lives were touched by his dealings, and came away with adverse perceptions of the man exist, but take his death as an opportunity to show some tact and restraint towards those for whom Allan Hubbard was a different man. They don't speak ill of the dead but not because it changes their perceptions.

More than most, Allan Hubbard was a man who, when in financial trouble and accused of an expanding list of misdeeds, created a gulf between those who were convinced he was an honourable man and those who thought he was intentionally engaged in serious and complex fraud over a long period of time. This polarisation of opinion highlights the difference between who he really was, and who he was to those who knew him or knew of him.

In reality the man was an enigma. We don't know who he was, or what was really going through his head when he was doing the doings that earned him praise or those that resulted in criminal charges. In the same way we don't know what was really going through the minds of those who are accused of persecuting him either.

I've always analysed Mr Hubbard's affairs and accusations with the nagging doubt that I can't figure the man out. Sure I've got theories, but none have the status of knowledge, and few would even have the status of belief. The biggest unanswered question about is about the man himself rather than his conduct: Is Allan Hubbard a fraud, is the perception and image just a handy facade for building a business empire operated with widespread corner cutting, obligation breaching and trust-abusing practices? If I answered this in the affirmative, it would have to be the most total dismissal of the man and his life and work. Of course I never answered my question, probably never would have, and now never will.

Being unable to answer the question of who Mr Hubbard really was with any confidence brings me to two places:

1. back to who he was to us, and
2. what lessons can we make from his life (and possibly, his death).

Out of respect for those who knew or admired the man, I'll not comment any further about who Mr Hubbard was to them, or how they wish to remember him. If they want to believe that he died with a clear conscience, I'll not question their warrant for believing it. Likewise for those who want to remember him as being one of the finest or most honourable men in New Zealand.

This leaves us with some more general lessons we can take from his life and death:

No one forced us to trust Mr Hubbard or invest money with him. Even if Mr Hubbard let down people who trusted him or invested money with him, it is not solely Mr Hubbard's fault. We should be careful who we trust and how much we trust them. This applies not only to money, but with power. As absolute power corrupts, blind trust in anyone is an invitation to be visited by human frailty. (I should write a lenghty rant about governance here but I'll save that for another day).

The virtue of simplicity of affairs is also a lesson from Mr Hubbard's life. Whether it was a complex web of deceit or a complex web of mismanagement (or a complex web of mismanagement and deceit), the result of complexity is often poor. Complexity can hide both mismanagement and deceit. Simplicity and transparency are the anti-dote.

If we're going to have a government, and I'm not a fan of the idea despite its popularity, it should keep well away from regulating and supervising and guaranteeing or insuring financial instruments or financial institutions. Many of the highly questionable transactions and practices of South Canterbury Finance while it was distressed would not have happened if the Crown Retail Deposit Gurantee had not been put in place. Sure the company would still have failed, but sooner and with a lower toll of financial and social loss.

The final lesson is that we should question the merits of punishing people who are associated with business failures. Punishment is expensive, and its effectiveness is questionable. That is not to say there should not be consequences for failure, but those consequences need not involve trying people on criminal charges, putting people in jail and so forth. I'll not elaborate on the manner in which investors can get remedies from wrongdoers or avoid suffering wrongdoing in the future, as they are manifold and complex. The point is that the use of criminal prosecution and punishment involves a regressive and legalistic approach to our problems in life and to those who do wrong or are accused of it. This approach polarises people and creates needless contention in society. It raises the stakes and creates a highly adversarial and legalistic environment rather than promoting an open-ended process of seeking composure of disputes, work out of problems and restoration of peace to the community.

Tripe on OBR de minimis

Today's news article Freezing deposits plan slammed, David Tripe criticises the RBNZ's Open Bank Resolution policy as causing 'widespread hardship'. This is fairly surprising, as the proposal incorporates a facility for a de minimis that would shelter small depositors from taking any losses. The figure I've heard suggested was $20k, but David Tripe suggests a figure of $50k which he suggests would 'ring-fence 30 per cent or 40 per cent of the bank's assets'.

The problems with a discretionary, political and de facto de minimis are numerous:

• The impact of the policy in shifting risks and losses, if David Tripe's suggestion of 30-40% of bank assets, is far more than de minimis. This amounts to a major redistribution of the bank's losses and would very substantially reduce recoveries for large creditors.
• The discretionary and political nature of the de minimis is a licence to screw institutional investors to save 'mum and dad investors.' In this environment the bank's capacity to raise money in wholesale markets at reasonable costs could be compromised.
• The pre-positioning policy, especially with the Settlement Before Interchange system for retail payments, means that it is feasible to apply the haircut to all deposit accounts en masse with minimal disruption to bank customers and the financial system.
• The policy lacks a sound legal basis. Bank customers and depositors are creditors of the same class and rank, and must, according to law and equity, be treated equally, i.e. according to the pari passu principle. It is necessary to change the de jure ranking of small depositors in order to safely implement the de minimis scheme.
• Even Allan Hubbard's statutory managers, who are not directed to consider preserving the ranking and position of creditors (under the Companies (investigations and management) Act rather than the Reserve Bank of New Zealand Act), recognise that they cannot play favourites with creditors of a person in statutory management (see http://www.lostsoulblog.com/2011/07/statutory-managers-no-longer-playing.html )
  

See section 5 of my submission to the RBNZ for more on this.

Statutory Manager's SCF claim: WIll it pay off?

The Seventh Aorangi Statutory Manager's report states that Aorangi will be making a major claim on assets that were contributed as capital to South Canterbury Finance. I believe the principal means by which this transaction took place as the issue of $67.2m in preference shares in South Island Farm Holdings Ltd (SIFHL). The transaction was reported as follows in the 12th April 2010 SCF prospectus in notes 25 (i) and 26 (v).

There appears to be two ways this transaction could have been done improperly, and the results in terms of remedies are opposite.

Before explaining the posible course of the transactions, the history of the company and its shareholdings and directors will be explained. The company was incorporated on 9th March 2009, with 10,000 shares held by Forresters Nominee Company Ltd and Mr and Mrs Hubbard as directors. Forresters Nominee Company Ltd was directed by Mr Hubbard and 2 other directors at the time. This shareholding was then transferred to Mr Allan Hubbard on an unknown date before 15th June 2009. On the 4th May 2009, 67,200,000 preference shares were issued to SCF (see the second page of this for the share register copy).

The first way is as follows: SIFHL was set up as an entity to hold 21 farms, and Mr Hubbard or Forresters Nominees Ltd held the shares in the company as nominee or trustee for Aorangi or other outside investors. Mr and Mrs Hubbard, as directors, we'll assume in this illustration, then stripped out the ordinary share equity by way of an issue of preference shares for nil consideration, and either did not comply with section 44 of the Companies Act or more likely this section didn't apply (the company either has no constitution or it failed to comply with section 32). Alternatively, Mr Hubbard may have signed the approval as shareholder despite this being a breach of trust.

The first way gives the investors, as far as I can find, only one remedy under the Companies Act: a claim under section 298 (2) against SCF. However, this would amount to an unsecured claim on an insolvent company that is going to pay unsecured creditors 0c in the dollar. The investors would also have a claim against Mr Hubbard personally for any losses caused by breach of trust or other wrongs, which claim would be paid possibly some dividends from Mr Hubbard's personal insolvency. (Mr Hubbard could also be criminally liable for breach of trust or fraud.)

The second way is this: SIFHL held the farms as nominee or trustee on behalf of Aorangi or other investors. This would mean that SIFHL would not have any substantial equity in these farms. Mr and Mrs Hubbard, under this scenario, may have nevertheless included the assets and liabilities as company assets and liabilities, and not disclosed the trust or nominee relationship with the investors, and thereby booked the equity in the farms as belonging to SIFHL. The issue of the preference shares to SCF could therefore be a valid transaction except that the company didn't have the equity purportedly injected into SCF, i.e. SCF got apparently worthless preference shares. In this scenario, the investors still have beneficial ownership of the farms and SCF has nothing. SCF would have a claim on Mr Hubbard for deceit, and Mr Hubbard could also be criminally liable for fraud, and so SCF would share in any dividends from Mr Hubbard's insolvency.

It is hard to say which of these scenarios, if any, are the more likely. I'd guess some lawyers will be busy for a while getting us some answers.

Statutory managers no longer playing favourites

The seventh Aorangi Statutory Manager's report dated 29th June 2011 records a reconsideration of their previous plans to allow Mr Allan Hubbard, also in statutory management, to play favourites among his creditors. The sixth report dated 4th March 2011 presents the plan as agreed in principle and pending formalisation:

'The formalisation of this process is in progress. This is being conducted in three parts:

1. A global “pledge” by Mr and Mrs Hubbard is to be sent to their solicitors to confirm acceptance and to formalise the promises Mr Hubbard has made.
2. The annulment of transfers of shares to Charitable Trusts in conjunction with the other farming shareholders.
3. Mr and Mrs Hubbard’s interests in various assets are to be transferred to Aorangi for the benefit of investors. These assets have a recorded value in the region of $50-60 million, and are already included in the Aorangi portfolio.'

But in seventh report, the deal has been called off:

'In our introduction to this report we commented on the difficulty being encountered with the purported introduction of Hubbard Interests into Aorangi. Most of the Hubbard Interests recorded in Aorangi were introduced by way of journal entry. There are no records of cash transactions in return for the introduction of the Hubbard Interests. Legal advice provided to us means that we cannot rely upon the purported transfer of Hubbard Interests into Aorangi at this time and as a result, and given the financial position of Mr & Mrs Hubbard, Aorangi investors may face a large shortfall. This means that any proceeds from the disposal of these assets cannot be repaid to investors until the financial position of Mr Hubbard is known, which may take some time and may be subject to dispute from personal creditors.'

So what happened between the 4th March and the 29th June? I've been expressing reservations about the legitimacy of the distribution of Mr Hubbard's estate, for example in a comment 26th May 2011 here and on the 30th May 2011 I wrote to the statutory managers an email as follows:

Hi,

I'm wanting to ask the Statutory Managers of Mr Allan Hubbard about the subordination of his interest in Aorangi Securities to investors. As the Statutory Manager has reported Mr Hubbard as being insolvent, this use of Mr Hubbard's assets benefits some creditors at the expense of others. I'm interested in the Statutory Management of failed registered banks under the RBNZ Act rather than the Corporations (Investigations and Management) Act, and the RBNZ's proposal to apply a de minimis to depositor haircuts. Other than this case of Mr Hubbard's interest in Aorangi Securities, I am unaware of any other cases where a statutory manager has systematically and intentionally favoured some creditors of a person or entity under statutory management at the expense of others. I understand that in other insolvency contexts such as receiverships the insolvency practioners have no liberty to favour some creditors at the expense of others as compared to their rights and rankings under insolvency law. So, I would like to hear from one of the Statutory Managers about their perspective on the issue of fairness between different creditors in the Statutory Management context and in the context of other insolvency institutions such as company liquidations and receiverships. E.g.:

1. Concerns of the Statutory Manager in allowing Mr Hubbard's disposition of his interest in Aorangi Securities, such as what level of concern did this create, did they seek legal advice on the issue, what were the factors considered in allowing this disposition etc. Or, put another way, how close were the Statutory Managers from refusing the disposition?
2. Comments on the extent to which statutory management law/practice differs from company liquidations, receiverships and bankruptcies etc. (e.g. does or should the legal contrast impact on the practice, or to what extent?)

I also note that the Reserve Bank of New Zealand Act includes 'preserving the position of creditors and maintaining the ranking of claims of creditors' as a consideration for Statutory Managers (http://legislation.govt.nz/act/public/1989/0011/latest/DLM144947.html ) but no such provision applies under the Corporations (Investigations and Management) Act (see http://legislation.govt.nz/act/public/1989/0011/latest/DLM144947.html ). If the statutory managers were appointed to a failed registered bank, would this difference be significant to the issue raised in my email?

The reply from the statutory managers was:

The points you raised will be covered in the next report to investors due out at the end of this month.

On the 30th June I made a submission on the RBNZ's Open Bank Resolution policy that included the following criticism of the RBNZ's de minimis plans:

5. Dubious de minimis

The proposed de minimis rests on shaky ethical, policy and legal grounds. It firstly offends against the most fundamental concept of equity in insolvency law: the pari passu principle. Equitable treatment within a class of creditors or shareholders is a pervasive requirement of company law and insolvency law. It offends not only against company law to pay dividends to shareholders of the same class on any basis other than shareholding, but against equity and common sense as well. The same applies to payment of creditors of the same class other than on a pari passu basis.

It is not surprising that there is absolutely no precedent for any insolvency procedure to systematically and intentionally undertaking post hoc re-ordering of creditor claims. (footnote 1) It is important to note that in the wider policy and legal context, preserving the position and ranking of creditors is normally considered inviolable. Not only are exigencies considered inadequate to violate creditor rights within classes, insolvency law goes as far as voiding transactions to "support the system of collective realisation and thereby the underlying pari passu principle‟ (MED, 2005). In this context the proposed casual and back-door violation of the principle is rather puzzling.

The statutory manager is required to resolve the affairs of the failed bank and to consider "preserving the position of creditors and maintaining the ranking of claims of creditors" as far as possible. (footnote 2) Elsewhere in insolvency law and policy there is absolutely no room for any liquidator, receiver, administrator or bankruptcy trustee to effect a post hoc discretionary re-ordering of creditor claims, regardless of exigencies. A de minimis also has not been anticipated in discussions on insolvency procedures including Statutory Management, for example the Law Commission's 2001 report to the Ministry of Economic Development on insolvency law has no mention of it as a criticism of statutory management or elsewhere in the report.

Finally, it would appear that the pre-positioning of a bank would enable it to treat all time-critical liabilities of the same ranking equally, regardless of size, further undermining the rationale and justification for applying a de minimis.

Clearly a de minimis would make the following statement in the consultation document
false: "The haircut process has no impact on the ranking of creditors that would apply in
a conventional liquidation." (25)

This leaves only one official argument in favour of a de minimis that I know of:

a de minimus [sic] limit could effectively deal with a large number of small
accounts that would be costly and time-consuming to separate into frozen and
released funds. In New Zealand the statutory manager has the power to impose
a de minimus [sic] limit and have a non-parri passu [sic] treatment (see Section
3.2) provided it is consistent with the considerations he or she must have regard
to when exercising his or her powers. (Pre-positioning for effective resolution of
bank failures, RBNZ, 2007, 3.4.1 (i))

This argument indicates that the issue is not the balance of the account, nor even the
number of accounts affected per se but the number of transactions in progress at the
time the statutory manager is appointed. In section 3 I provided an alternative approach
to processing pending payments that should be feasible to perform for all transactions
on all accounts. This means that the haircut procedure can be applied pari passu to all
bank customer account balances, eliminating the need for the statutory manager to
balance competing objectives. Also the Settlement Before Interchange (SBI) procedure
will significantly reduce the number of transactions "in the pipeline" at the point of failure.

It would appear that the de minimis policy is being suggested or justified on other –
unstated – grounds. Perhaps it is a market discipline efficiency argument: small
depositors have less incentive to monitor the bank's creditworthiness and therefore
provide less market discipline as compared to larger investors. A de minimis for small
depositors shifts the risks to larger creditors and "enhancing the disciplines on banks
which are naturally present" (Statement of Principles Bank Registration and Supervision,
6)) . Alternatively, a political/compassionate argument that smaller depositors ought to
be sheltered from losses. It can be good politics to shift the losses to the "rich" and
institutional investors rather than "mum and dad" investors/households.

However, neither of these two arguments are strong, and the second shows a distinct
danger: if the government can set the de minimis amount, it is basically a political
licence to screw institutional investors and the rich to save "mum and dad" investors by
setting the de minimis at a high level (e.g. $500k). The first argument is also too weak to
be sound, as it is not a consideration listed in s 121 of the Reserve Bank of New Zealand Act.

This leaves policy makers with two options:

1. Abandon the policy and go back to pari passu. This would also reduce the scope of pre-positioning requirements.
2. Increase the de jure creditor ranking of small depositors to by a provision in the security trust deed or by a statutory preference.

footnote 1

That is other than the subordination of Mr Allan Hubbard‟s interest in Aorangi Securities Limited to investors in Aorangi Securities Limited by the Statutory Manager – an instance I find dubious rather than an example to follow. I have sought comment from the statutory manager about this and have been told a response will be included in the next Statutory Manager‟s report due 30 June 2011. This report will be released in early July. It is also possible that the Statutory Manager of Idea Services Limited and Tamatia Hou Limited may be paying, or may intend to pay, its suppliers ahead of the class of employee creditors owed money for under-paid sleep-overs, However this cannot be determined as Sir John Anderson, the Statutory Manager, has not issued any reports and the resolution of its affairs is incomplete.

Footnote 2
This clause is in the Reserve Bank of New Zealand Act, which provides for Registered Bank Statutory Managements, but is not in the Companies (Investigations and Management) Act under which the possible cases of post-hoc re-ordering of creditor claims occurred in Statutory Managements.

Royal Justice: A Litigant's Experience

Yesterday we resolved a dispute with a former boarder from late last year, and the experience illustrates the consequences of the dominance of royal courts on dispute resolution, and the organisation of the royal courts into a formal hierarchy applying a body of rules under the stare decisis doctrine. I will contrast this experience with the alternative of a non-royal tribunals resolving disputes under customary law (i.e. anarchist institutions).

We had a private boarder staying with us who proved unsuitable for our household and family, so we gave him 3 weeks notice to leave, as per the contract terms. After about a week, his behaviour became intolerably obnoxious so we asked hm to pack up his things and leave immediately. He refused to leave so we called the police, who refused to remove him and threatened to arrest me. We then locked him out and packed his things for him and put them out for him to collect. He packed them in his car and parked up in our driveway next to our house. When he left the car we had it towed. He got his car back and parked it up again, and so we had it towed again. About a month later we received a Disputes Tribunal case in the mail claiming for his bond, missing and damaged personal items, tow fees and damage to his car, about $2,500 all up.

Although the substantial law the case was decided on was nothing unusual or controversial, what was remarkable was the quality of the service provided and the process that was followed. Our former boarder, Mr Greening, tried to file the case in the Tenancy Tribunal, and here is where the issue of jurisdiction started: under the royal courts, competition between royal courts has been eliminated as each court's jurisdiction is non-overlapping. The Tenancy Tribunal rejected Mr Greening's case as he didn't provide a tenancy agreement -- a document Mr Greening appeared to have lost (actually it was a boarding contract). The Tenancy Tribunal told him to file in the Disputes Tribunal.

The Disputes Tribunal hearing was conducted by a referee Mr Gower, a very strict man who liked to use a lot of legal jargon without explaining it. I'm sure Mr Greening had no idea what the terms 'repudiation' or 'bailment' meant and Mr Gower didn't explain them. He also liked to apply common law and statutory legal rules with a very high degree of strictness (despite not being 'bound to give effect to strict legal rights and obligations or to legal forms and technicalities'). Soon after opening the proceedings, when he found out that I wanted my wife to be joined as a party to the case and that I intended to set off the bond against damage caused by Mr Greening, he threatened to award costs against me for not having filed a counterclaim or a request to join my wife as a party. The legal rule, Mr Gower said, was that only undisputed debts could be set off, and this rule was to be applied strictly. Mr Gower was also an adjudicator in the Tenancy Tribunal.

Mr Gower became concerned that the Disputes Tribunal may not have jurisdiction to hear the case, as the Tenancy Tribunal may have jurisdiction. Despite being a Tenancy Tribunal adjudicator, he felt it necessary to refer the matter to the Tenancy Tribunal to rule on whether or not it had jurisdiction - this being the designated tribunal to make such a ruling on jurisdiction. Mr Greening duly re-filed his case in the Tenancy Tribunal and we filed a counterclaim and requested both my wife and I to be parties to the case.

The Tenancy Tribunal adjudicator was a lady who appeared to have some difficulty in deliberating on whether or not the Tenancy Tribunal had jurisdiction. Mr Greening had nothing to submit, and I submitted two arguments, one that we were a 'boarding house' and came under the recent legislation (which allowed us to terminate a boarding house tenancy immediately for a serious breach) and another that we were exempted by a provision for properties primarily used as the landlord's residence, which would send us back to the Disputes Tribunal. She appeared to want to avoid putting us under the provisions of the Residential Tenancies Act and decided that we had discharged the burden of proof to show the house was primarily the landlord's residence. The decision appeared to stretch the otherwise rigid legislation and common law rulings under the stare decisis doctrine.

Yesterday, back at the Disputes Tribunal, the substantial issues were resolved by a new referee, Mr Kay. Mr Kay told us Mr Gower had asked for the case to be re-assigned because he was a Tenancy Tribunal adjudicator also. Somehow, we are supposed to have a better service from someone who is less familiar with the area of law concerned. Mr Kay's style was very different from that of Mr Gower. Mr Kay used little legal jargon, and he explained the terms he did use. Mr Kay looked for a prompt, reasonable resolution rather than attempting to follow every particular legal rule strictly. He appealed to custom rather than legal rules in allowing us to set of the loss caused by Mr Greening's breach of contract against the bond balance of Mr Greening. He also found the easiest way to resolve the case: he said Mr Greening's case was too weak, and that he did not discharge the burden of proof (a nice legal way of telling Mr Greening he didn't believe him).

How would this dispute have played out in an alternative legal system of competing private tribunals under customary law?

Firstly, the question of jurisdiction would be much less important: any tribunal that wanted the business and could get at least 1 party to the dispute to agree to accept its jurisdiction could have heard the case. This could have avoided the need to go back and forward between tribunals looking for the sole tribunal with the authority and capacity to resolve the dispute.

Secondly the dispute would not have been determined by appeal to legislation and case law. Put another way, the pretense of upholding the 'rule of law' would no longer apply. In the absence of legislation and binding case law would have been three approaches: negotiation, custom and innovation. Negotiation is always a possibility for resolving any particular dispute. By definition, a dispute is a disagreement, so it can be ended by agreement. Custom is applying the practices of people dealing with issues successfully or tolerably well in the past to the present dispute. Such past resolutions, if they are accepted in the community and by the parties, create valid expectations that they are likely to be applied in future disputes of the same nature. Innovation is trying new techniques or rules for resolving disputes as a feature of the service selected by the parties or for resolving new types of disputes.

Thirdly, in addressing the immediate conflict when Mr Greening refused to vacate the house, it would not be the Royal police attending, but a private security agency. Even if I was a difficult customer, I would not expect such an agency to threaten to arrest me, as the police did several times. Indeed my previous experiences with the NZ Police have also involved actual rather than threatened unnecessary and illegal use of police powers against me. A private security agency would probably perform two functions: firstly, it would seek to make or keep peace through negotiation. The NZ Police did not attempt any negotiation whatsoever in this case, we tried it several times though the ordeal, both directly and through other people including even the local MP (who accurately foretold us Mr Greening would sue us, and use the police against us). Secondly, it would assist people to exercise self-help legal remedies such as the eviction of trespassers, effecting lock outs, removal of chattels, and defence of land, people and property. The tow companies were examples of this: they both towed away Mr Greening's car on my orders and at Mr Greening's expense. Such an agency would be careful to act lawfully, because goon-squad behaviour would result in costly settlements for wrongs.

Statutory Management: Will it work for Open Bank Resolution?

Would statutory management of a failed bank actually work? It appears that this institution is so rarely used that we can't really be sure, unlike the institution of receivership which I suggested as being better suited to Open Bank Resolution.

'The main purpose of bankruptcy and liquidation systems is to provide for an orderly, compulsory and collective realisation of a debtor's assets' (MED, 2005). Statutory Management provides a compulsory and collective realisation of the assets and business of a failed registered bank that incorporates consideration of wider market and financial system damage concerns and provides an alternative to the more conventional institutions for resolving insolvent companies such as receivership and liquidation.

The key features of statutory management of failed banks are:
• It over-rides other resolution institutions by suspending creditors' other remedies.
• It provides priority to new obligations incurred after the commencement of the statutory management.

Both of these features appear to be designed to enable the statutory manager to continue the bank's access to the payment system, provision of payment services to its customers and its access to funding to restore its liquidity. I make this inference based on the assumption that the 'damage to the financial system' the regime is supposed to avoid primarily refers to the disruptive effects of a loss of payment services to a substantial portion of households and businesses that may rely on the single failed bank for access to the payments system.

The specific provisions of statutory management, as they related to the proposed Open Bank Resolution procedures are listed below with my comments and concerns.

Moratorium (s 122)
This section suspends the rights of creditors in respect of the bank's obligations as at the time the statutory management began – the exclusive remedy for creditors is to wait for the statutory manager to pay them, or to receive a claim on a successor entity that has purchased the bank's assets and assumed its liabilities. This applies to secured creditors as well as unsecured creditors. Creditor rights and remedies for obligations 'in relation to an obligation incurred or a right granted under a deed, instrument, trust, or contract entered into by a registered bank after the date on which, and the time at which, that registered bank was declared to be subject to statutory management' are excluded from this moratorium.

The concern is about the effect of a purported 'freezing' of a part of a customer's balance on current account, and a purported 'release' of the remaining balance in the customer's account as at the time the statutory management began. The statutory manager may effect this 'freezing' and 'release' by debiting the customer's account by the amount 'frozen' and enabling the customer to continue using the account to make and receive payments.

The customer's right to repayment of the balance at the time the statutory management began is on account of earlier deposits less withdrawals. The bank and the statutory manager has no right or power to convert a portion of a creditor's claim into a subordinated claim on the bank, so any debit the statutory manager unilaterally makes to the customer account, as part of the proposed OBR procedure, has potentially no legal basis or effect. In the same way the purported 'release' of the rest of the account balance has no legal effect as the statutory manager has no specific power of release, and any amount released was already owed to the customer before the statutory manager was appointed.

The practical effect of the part 'freeze' and 'release' of the balance is to enable the customer to continue to operate the account to receive and make payments. The rule in Clayton's case is that the bank's payments to the customer discharge the oldest deposits first when the account is in credit. The oldest deposits will include all pre-statutory management deposits, including the purportedly 'frozen' funds, before any of the post statutory management deposits. To illustrate this, consider the following hypothetical example, showing the bank's records and comparing this with the legal position if the rule in Clayton’s case cannot be avoided by the failed bank.



The customer's $100k of pre-statutory management funds has now been fully withdrawn because the second $50k withdrawal discharges the oldest funds first, and the Statutory Manager's $50k debit had potentially no legal effect. The customer can now enforce his 'inaccessible' $50k balance against the bank.

By contrast, a customer who did not operate his account has no protection against the Statutory Manager deciding to 'freeze' some more of the customer's funds in the bank later. The purported 'release' by the statutory manager does not give the customer any legal rights he did not already have against the bank, and as the bank's obligations were not incurred after the statutory management, nor were they granted to him by the statutory manager's purported 'release'. Such a customer has a good reason to withdraw his funds and re-deposit them even if the rule in Clayton's case does not apply.

The principal counter-argument is to say that the bank has a right to determine the appropriation of payments made from the account, and that by debiting the 'frozen' amount to a separate 'suspense' account that bank has made a valid election that this amount of the pre-statutory management funds are not being paid when the customer continues to operate the account. The statutory manager's right to suspend and pay debts is clear from sections 127 and 131 respectively, however the validity of this proposed use of the powers depends on the bank's right of appropriation over-riding the rule in Clayton's case. I’ll examine this next along with section 127.

Suspension of money owing (s 127)
The statutory manager may: ‘suspend in whole or in part the repayment of any deposit, or the payment of any debt, or the discharge of any obligation, to any person’ without breaching or repudiating any contract. Obligations incurred by the bank or the statutory manager after appointment of the statutory manager can’t be suspended under this section. There are several difficulties with this section.

Firstly, there is no reference to any notice given or to be given by the statutory manager when suspending payment, in contrast with section 22 of the Insolvency Act 2006 – this being the principal or only other reference to suspension of payment of debts in New Zealand legislation. Without a reference to notice, the suspension of payment would appear to be an action by the failed bank in contrast with the action of paying creditors under section 131.

Secondly, there is no indication of the legal effect of the suspension or any notice of suspension given by the statutory manager, or of any debit made by the statutory manager to a creditor’s current account. This leaves us in the dark about whether the rule in Clayton’s case applies to any subsequent current account transactions.

Thirdly, there is no safety for bank creditors on the unsuspended amounts. There is nothing stopping the statutory manager having another bite at the cherry. For example, if a creditor was owed $100,000 on term deposit, and the statutory manager purported to suspend 50% of the amount owing by public notice, the statutory manager can suspend another $20,000 of the term deposit at a later date if it has not yet been repaid.

Fourthly, the suspension of any amount owing does not change its ranking, nor the ranking of any unsuspended amounts. Combined with the power of the statutory manager to be selective, this can lead to problems in treating different creditors fairly. It would appear to be a fairer approach to have a more prescriptive and an entity wide power of suspension and release which would operate something like this:

• The suspension and release would be made with reference to the registered bank’s capital structure e.g. 100% of all subordinated creditor claims and 30% of all unsecured unsubordinated creditor claims (perhaps with a de minimis if you must)
• The RBNZ must make an assessment and recommendation on the aggregate amount of losses/capital to be provided for and the allocation as part of the recommendation to place the bank in statutory management unless this is not possible.
• The Statutory Manager must make a suspension and release order or notice within 1 business day of being appointed, and before re-opening the bank (if applicable)
• The legal effect would be to legally suspend these amounts as from the time the statutory manager was appointed, and to void any payments in contravention of the suspension, with a power to recover any amounts paid in excess of the suspended amounts and charge interest on any unrecovered amounts (to ensure fairness)
• The amounts not suspended would rank equally with new debts, i.e. in priority to other debts.
• The statutory manager could release more over time but could not suspend any more than the initial amounts suspended.

Fifthly and finally the section does not apply to pre-statutory management suspension of payment. Previously there has been some suggestion that the RBNZ use its direction giving powers pre-statutory management:

In New Zealand, one way to minimise the extent of transactions “in the pipeline”
when statutory management is declared is for authorities to use their
direction-giving powers ... to direct the bank to close its customers’ access
channels prior to it being put into statutory management. Fewer transactions “in
the pipeline” at the point of statutory management reduces the scale of any
sorting of transactions into pre- and post-statutory management groups.
(Pre-positioning for effective resolution of bank failures, RBNZ, 2007)

The result is that customer remedies may differ from the situation of the statutory manager suspending payment: it will be a breach (or possibly repudiation) of contract. Of course there is always the chanceof the bank running out of cash and suspending payment before being put into statutory management.

Obligations Incurred by statutory manager (s 145)

This section provides priority to new obligations incurred by the bank while under statutory management. The resulting or desired capital structure of the failed bank from this clause is unclear. As noted, this provision does not apply to any amounts ‘released’ by the statutory manager, and may inadvertently apply to amounts ‘frozen’ by the statutory manager if the rule in Clayton’s case cannot be avoided on current accounts. This is in contrast to the situation under a receivership where the trust deed can make express position for the ranking of creditors and creditors can rely on their ranking to know their position with certainty.

The section only gives priority to new obligations in a liquidation or winding up, and there are other possible resolutions of the failed bank and its business, e.g. subsequent receivership, assumption of liabilities or amalgamation or restructuring/creditor compromise under company law.

This section should, if properly drafted and supported by pre-positioning, enable the failed bank to continue its business while the statutory manager is resolving its affairs without the need for loans or guarantees from the Crown. The issues raised above make it questionable whether the failed bank could continue to operate under statutory management.

Unwinding the Helicopters NZ transaction: an analysis

With the news that both Helicopters NZ and Scales Corp shares have been sold, South Canterbury Finance's Feb 2010 acquisition has been fully unwound. This presents an opportunity to evaluate the amounts realised as compared to the related party transaction value, and the impact on the pre-existing loan and exposure to Southbury Group and Southbury Corp.

To get started with the analysis requires a measure of the fish-hooks in the Helicopters NZ sale. I have this from a confidential source I'll not name who got it from Goldman Sachs: $145.3m. This figure was the 'net debt', being cash less borrowings, that were excluded from the deal. The borrowings included loans from SCF as well as third party borrowings (e.g. UDC).

The total proceeds were:
Helicopters NZ $160m
Scales Corp shares $44m
Total $204m

Subtracting the value of the 'net debt' excluded from Helicopters NZ and the $20m of preference shares SCF held in Helicopters NZ gives net proceeds of $38.7m. This can be compared to the $162.5m in value ascribed to the assets when they were acquired by SCF.

Here's where it gets a bit tricky in analysing the Feb 2010 acquisition transaction: if the assets are not valued at $162.5m but at their realised value of $38.7m, it makes Southbury Corp and Southbury Group insolvent and the $77.2m loan from SCF impaired. I've added a couple more columns to my spreadsheet showing what happens when realisation values are used, see here. Whether the transaction took place or not, this money was gone at these asset values. So what's the difference between the transaction happening, and it not happening? The answer is:

1. The $10m paid for the assets would have been saved, and
2. The $15.6m third party debts of Southbury Corp would have absorbed up to $3.9m in losses, saving SCF this amount
   

This analysis comes from comparing the actual realisation with the same realisation by Southbury Corp, see here for the details.

The conclusion of the analysis is that, should the values attributed to the assets not be recovered, the transaction cost SCF $13.9m rather than providing benefits of $11.8m I calculated in June 2010 using the higher values. Officials do not appear to have assessed the transaction fully: no consideration was paid to the recoverability of the loan and other exposures to Southbury Group and Southbury Corp, or the impact of lower recoverable values on the assets acquired. For all the insight and foresight Treasury displayed during this episode, they swallowed this deal hook-line and sinker. They booked $150m in benefits from the transaction that resulted in additional losses of $13.9m.