New Statement on Professional Ethics in Liquidation and Insolvency
From 1 April 2012 Hong Kong insolvency practitioners will have to contend with a much expanded statement on “Professional Ethics in Liquidation and Insolvency” in the HKICPA’S Code of Ethics for Professional Accountants (the “Code”).
The new statement on “Professional Ethics in Liquidation and Insolvency” is contained in Section 500 of the Code (the “New Statement“) and replaces the statement previously contained in Section 432 of the Code (the “Old Statement“). The New Statement was issued in February 2012 with an effective date of 1 April 2012. As part of the Code, the New Statement is an enforceable professional standard for members of the HKICPA and failure to comply with it may lead to disciplinary action which could potentially include an order that the name of the offender be removed from the HKICPA’s membership register. Of course, the great majority of insolvency appointments do not require the appointment taker to be a member of the HKICPA, but that issue touches on general matters of regulation of insolvency practitioners which are beyond the scope of this article.
The old statement
The Old Statement was mercifully short. It contained a short statement on the importance of integrity, objectivity and independence followed by examples of specific situations where these values may be compromised. These examples were supplemented by a catch-all provision that a member should not accept any appointment unless “objectivity is unlikely to be compromised by a prospective conflict of interest or otherwise”.
The new statement and its position in the code
In contrast, the New Statement is much lengthier, about 5 times as long as the Old Statement, and is integrated much more fully into the revised Code which took effect on 1 January 2011. Part 1 of the New Statement (“General Application”) sets out how the New Statement fits in to the overall Code.
While the Old Statement only specifically mentioned a few categories of insolvency appointment, the New Statement explicitly includes a much broader range of appointments. The categories of appointment mentioned specifically for the first time in the New Statement include the administrator of a scheme of arrangement and an administrator under the Securities and Futures Ordinance (Cap. 571).
The professional values to which insolvency practitioners must have regard when considering appointments have been expanded from the Old Statement. The New Statement now requires an insolvency practitioner to comply with five specifically identified fundamental principles set out in paragraph 100.5 of the Code, namely:
- Professional Competence and Due Care
- Professional Behaviour
The New Statement stresses that the intended approach is to maintain general compliance with these fundamental principles, rather than to merely focus on any specific examples set out in the New Statement. Insolvency practitioners are to follow the conceptual framework for dealing with threats to the fundamental principles which is set out in paragraphs 100.6 to 100.11 of the Code. The conceptual framework is a threefold process of (i) identifying threats, (ii) evaluating threats and (iii) addressing threats.
As regards identifying threats, the New Statement makes clear that “[m]any threats fall into one or more of five categories”. Given the importance that the New Statement places on complying with the fundamental principles, it is worth quoting here in full the description set out in paragraph 500.13 of the New Statement of these five categories of threat to the fundamental principles:
- Self-interest threat – The threat that a financial or other interest will inappropriately influence the insolvency practitioner’s judgement or behaviour;
- Self-review threat – The threat that an insolvency practitioner will not appropriately evaluate the results of a previous judgement made or service performed by him, or by another individual within his practice or employing practice, on which the insolvency practitioner will rely when forming a judgement as part of providing a current service;
- Advocacy threat – The threat that an insolvency practitioner or an individual within the practice will promote a position to the point that the insolvency practitioner’s objectivity is compromised;
- Familiarity threat – The threat that due to a long or close relationship with others, an insolvency practitioner or an individual within the practice will be too sympathetic to the interests of others or too accepting of the work of others; and
- Intimidation threat – The threat that an insolvency practitioner will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the insolvency practitioner.”
The New Statement goes on to give some specific examples of safeguards to address threats to the fundamental principles (stage three of the conceptual framework). According to the New Statement, potential safeguards generally fall into two broad categories:
- Safeguards created by the profession, regulation or legislation.
- Safeguards in the work environment, which can be either (i) appointment-specific or (ii) safeguards introduced across the practice.
Various examples of practice-wide safeguards are then given, which include such measures as “policies and procedures to implement and monitor quality control of appointments” and a “disciplinary mechanism to promote compliance with policies and procedures”.
Part 1 having set out how the New Statement is intended to fit in to the overall Code, Part 2 (“Specific Application”) then proceeds to illustrate how the New Statement might apply to different aspects of an insolvency practitioner¡¦s work. Practitioners should particularly take note of the section on whether or not to accept appointments, which provides (among other things) that generally an appointment should not be accepted “where a threat to the fundamental principles exists or may reasonably be expected to arise” unless (i) disclosure is made to the court or to the creditors on whose behalf the insolvency practitioner would be appointed to act and no objection is raised and (ii) safeguards are or will be available to eliminate or reduce the threat to an acceptable level.
The section on accepting or not accepting appointments also includes examples of how to deal with the following matters in the context of accepting appointments:
- Conflicts of interest
- Practice Mergers
- Professional competence and due care
In addition to dealing with the question of whether or not to accept an appointment, Part 2 also sets out illustrations of how to apply the New Statement in the following further areas of a practitioner’s work:
Professional and Personal Relationships – A noteworthy aspect of this section is that instead of the Old Statement category of “material professional relationship” it creates a category of “significant professional relationship”. The Old Statement specifically required practitioners to consider “material professional work” carried out in the period of two years prior to the relevant appointment. The New Statement, however, adopts a less rigid approach, and requires practitioners to consider any work carried out, with an emphasis on more recent work and offers as guidance the comment that “it is likely that greater threats will arise… when work has been carried out within the previous two years”.
Dealing with the Assets of an Entity – Interestingly, this section appears to be aimed directly at a pre-pack insolvency (“Where the assets and business of an insolvent company are sold by an insolvency practitioner shortly after appointment on pre-agreed terms”) and implies that this in itself is a threat to objectivity unless safeguards (such as an independent valuation) are in place.
Obtaining Specialist Advice and Services – This section includes the consideration that threats such as familiarity threats and self-interest threats may arise if specialist advice or services are provided from a regular source. Safeguards should achieve that, among other things, relevant relationships are reviewed periodically to ensure that best value and service are being obtained in relation to each appointment.
Fees and Other Types of Remuneration – Among other things this section provides that, while an insolvency practitioner should not accept referral fees or commissions, amounts paid on account of liquidation costs (including the insolvency practitioner’s fees and expenses) should not be regarded as referral fees or commissions.
Obtaining Appointments – This section includes guidelines as to the form of advertising and marketing a practitioner may use to promote his, or his firm’s, services or as to insolvency appointments.
Gifts and Hospitality – This section includes guidelines as to when an insolvency practitioner may both give and receive gifts and hospitality. The test is, in our view, a common sense one in that it refers to what view would be formed by a “reasonable and informed third party” but the threshold is low, referring to gifts or hospitality that such person would consider “trivial and inconsequential”.
Record Keeping – This section requires an insolvency practitioner to keep contemporaneous records regarding how threats were dealt with, which should be enough to “enable a reasonable and informed third party to reach a view on the sufficiency of his actions”.
The application of the framework to specific situations
The final part of the New Statement (Part 3 – “The Application of the Framework to Specific Situations”) sets out some example situations where a threat may arise. The examples are generally the same as those which made up the bulk of the Old Statement, although several new examples are also added (such as “Trustee in bankruptcy following appointment as nominee of an individual voluntary arrangement”).
Points to remember for practitioners
The New Statement represents a major revamp of the professional standards for insolvency practice in Hong Kong and all insolvency practitioners would be well served by taking time to fully digest the New Statement in its entirety. However as we appreciate that not all practitioners will have the time to do so immediately, we would regard the following as some of the most important points to take heed of immediately following the effective date of 1 April 2012:
- The requirement to disclose to the court or to the creditors on whose behalf the insolvency practitioner would be appointed to act the existence of an actual or potential threat to the fundamental principles.
- The requirement to keep sufficient contemporaneous records of how threats to the fundamental principles are dealt with.
- The requirement to have in place practice-wide safeguards such as policies and procedures to implement and monitor quality control of appointments.
Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.