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.