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.