The revised SIP 9 removes the old requirement to have some disbursements approved by creditors and replaces it with a requirement to have more expenses approved. The old SIP focussed on category 2 disbursements, where the office holder had paid for something that included an element of shared or allocated costs and was seeking reimbursement. Those disbursements had to be approved by creditors before they could be drawn. In IVAs and some other cases, it was common to see creditors routinely vote against category 2 disbursements. As a result, many IVA specialists waged a constant war of attrition in an attempt to find new ways of excluding expenses from the definition of category 2 disbursements, so that they could draw them without needing to seek approval.
The new SIP 9 splits all expenses into two categories. Whether an expense is paid direct from the insolvent estate or paid by the practice and reimbursed is no longer relevant. Although disbursements are still mentioned as a sub-set of expenses, there are no separate provisions for them. Instead, the new SIP 9 splits expenses into category 1 and category 2, with new definitions for them.
Category 1 expenses are payments to persons providing the service to which the expense relates who are not an associate of the office holder.
Category 2 expenses are payments to associates or which have an element of shared costs. Before being paid category 2 expenses require approval in the same manner as an office holder’s remuneration.
That is a pretty significant change in itself, but there are two more points that complicate matters further. First, the new SIP 9 redefines “associates” to align with the Insolvency Ethical Code, so that you have to go beyond the strict statutory definition of “associate” and look at those who may be perceived to be associated. We think that this is likely to result in more expenses having to be treated as category 2 expenses.
Potentially the biggest can of worms, however, is created by paragraph 19(c) of the new SIP 9, which says, “The following are not permissible as either remuneration or an expense…c) the recovery of any overheads other than those absorbed in the charge out rates.” Despite its potentially huge ramifications, the SIP does not define “overheads”. We have already received a large number of queries about how different expenses should be treated and we have asked the regulators for some clarification, but with the new SIP’s implementation date less than three weeks away, we need to flag the issue up now. Without giving answers to some points, because, frankly, we don’t have any, we have taken a few of the more common expenses that we see on our reviews and tried to see how the new SIP might affect them:
Specific penalty bond – on the face of it, this should be a category 1 expense, because you pay an independent insurer for a case-specific bond premium. However, could the bond be an overhead? We don’t think so. Overheads are usually costs that a practice has to pay regardless of whether it has a specific appointment and we don’t think this qualifies. Alternatively, could the bond provider be an associate? In most cases there is an ongoing commercial relationship with the bond provider and although you review that relationship each year to ensure that you are getting the best deal, there is an argument that creditors could see them as associated. On balance, we think that your specific penalty bond is a category 1 expense that does not need approval, but even that is not certain.
Gazette costs – another “obvious” category 1 expense, or is it? As with the bond, it is only incurred because of the case, so we are happy that it is not an overhead. The only potential problem area is the ongoing commercial relationship with the provider. While that might be perceived for those of you that use advertising agents, we think it is unlikely. For those of you that instruct the Gazette direct, even that small risk is negated. We think that you can safely put Gazette costs into category 1.
Advertising costs generally, including web sites, circulars, etc. – now we start getting into dangerous territory. Adverts other than Gazette notices are not always required and there is no monopoly provider, so there is more chance of an association being perceived. If you are publicising a potential business sale or similar through websites or agents, the chances of the provider being perceived as an associate increases. We are happy that they are not an overhead, as you only commit to them in specific cases under certain circumstances, but you will have to consider your relationship with the person that you are instructing and it may well be necessary to treat them as a category 2 expense that requires approval before it can be paid. This may be less of an issue in, say, administrations, where you are used to having to seek approval for pre-appointment costs before paying them, but you may find that more of your post-appointment use of agents is caught by this. We expect that relationships with agents will come under increased scrutiny and it may be necessary to get such costs approved, as a precaution.
Asset disposal agents, site security, lock changes, etc. – extending the argument above into situations where you instruct agents to realise assets or take other specific action, then if the agent is already deemed an associate, you will have to get all of their costs approved, which will include the case specific costs that have never required approval in the past. If you don’t want to have to seek approval every time, you may have to take additional steps to demonstrate that the relationship with any agent does not make them an associate. It is not clear how far you may have to go yet, but you may need to conduct some form of informal tender process between several agents before any formal instructions. In urgent cases, where you want to use your “usual” agent, you may have to bite the bullet and treat them as category 2. Thankfully, this sort of charge clearly is not an overhead, so at least it is a recoverable expense, as long as it is approved.
Other specialist agents – most of the agents that we see IPs using could, if they are not treated as an expense, be treated as sub-contractors and payable without approval, subject to disclosure in accordance with the new SIP 9. However, the SIP is unclear about the difference between the expense of a professional advisor and a sub-contractor. We have asked the regulators to clarify how they would expect such agents to be disclosed. For example, if you use a specialist pensions agent because of the complexity of the pensions legislation and regulation, are they an expense, or are they doing work that you could do yourself, so that they qualify as a sub-contractor? If they have to be treated as an expense, then the above discussion about their possible status as an associate becomes relevant.
Storage, and other potentially hybrid expenses – there are a range of expenses that might be category 1 expenses, but could have an element of category 2 and may even be practice overheads that cannot be recharged. Possibly the most common one in emails that we have received to date is storage. In its simplest form, if you have a case with one box of books and records that you have to store for one year after the case is dissolved and you use an unconnected external agent to store it, with them charging you for the storage of that one case year by year until destruction, we think you can safely call it a category 1 expense. However, we see all sorts of departures from that scenario that could make it a category 2 expense requiring approval, or simply an overhead that you cannot recharge. For example, if the agent that you use rents you a storage unit and you allocate the cost of the storage unit to each box, then that becomes a category 2 expense, because the charge to each case includes an element of shared cost. You would need approval before recharging the case. However, if you have space at your offices and have traditionally recharged storage to each case, that would no longer be allowed. The space at your offices is part of your overhead. You are not only taking it on for that case. This can get really messy, if you have some internal storage and some that you pay for. Given that the penalty could be quite severe if you reclaim storage costs from an estate when the records were actually stored in your internal storage that you could not recharge, it might be safer not to recharge the expenses at all, or stop using your internal storage completely.
AML ID checks – you might reasonably think that these should be category 1 expenses, as you do a search for each individual that you have to identify on each case. However, some of you carry out the searches using a subscription platform where the cost to the case is not clearly identified, while others buy a block of tickets that allow a certain number of IDs for a set price. Both of those could be category 2 expenses and require approval, because they may include an element of shared cost.
Meeting rooms – internal meeting rooms are almost certainly not chargeable any more. Subject to what the regulators say when they respond, we expect them to be seen as overheads, as you have to pay for the building/room in any event, whether you use it or not. External meeting rooms will be category 1 expenses if they are only used for one meeting and one case. However, if you have a group of say, two or three companies, and held external meetings for all of them in the same hotel one morning, the room cost would become a category 2 expense and require approval, because of its shared nature.
Legal fees – you would have thought that instructing lawyers on a case would be a clear category 1 expense, but even here we have seen situations that would now make them category 2 expense. The first is similar to the meetings above, where the lawyer is instructed in respect of a group of estates. While the lawyer may be able to allocate some costs to specific estates, there will inevitably be shared costs and you will either need to make a clear decision to exclude any shared costs, or seek approval for them as category 2 expenses. There is, however, a second situation that we see from time to time. We occasionally see a connection between the lawyer instructed on the case and the IP or other members of their practice. These may well be relationships that don’t qualify as “associates” under the legislation, but where the ethical code would imply an association. One example that we often see is where the petitioning creditor’s solicitor approaches the OR and nominates the IP to act as liquidator or trustee, before then undertaking the legal work on the case. You will need to look beyond the strict statutory definition and seek approval for the legal costs as a category 2 expense if the lawyer is an associate, even if there is only a perceived relationship.
Legal disbursements, barristers, etc – just for the sake of argument, we considered costs that are not directly raised by the lawyer, such as disbursements for searches, court fees, or barristers. If the solicitor is an associate and their fees are to be treated as category 2 expenses and subject to approval, how should you treat these other costs? By this stage, we are wondering if it is even likely to be worth arguing about, but we think that such costs would be category 1 expenses and could be paid without approval, as long as there was no extension of the association you have identified with the lawyer to any barrister that they instruct. If you instruct your nephew as lawyer and he instructs his wife as barrister, I hope you would agree that category 2 approval would be required throughout.
IT costs and case administration software – we have only admitted it to certain clients in the past, but we’ll come out and say it publicly now, we have a problem with anyone recharging their IT costs as a direct case expense. We really struggle to see how a practice and its suppliers can agree to break up parts of the IT system and charge for them on a case by case basis. Thankfully, what we think doesn’t matter and it is the regulators that you have to listen to. There was a time when we heard that a Dear IP had been drafted to prevent IPs from recharging their IT costs to cases. We heard that it was withdrawn to seek further legal advice and it has never resurfaced. We think that might have been because of the enormous impact that it could have on some parts of the profession if IT costs were retrospectively impacted and they had to refund the lot. Looking at the new SIP 9, it appears that the whole problem fell into the “too difficult” category, as the new SIP 9 shies away from making specific reference to IT costs. The reference to overheads is vague enough to leave the matter in limbo. For those paying an independent third party for their IT software on a per case basis, they can still argue that it is not an overhead. As long as there is no relationship between the IP and the software provider, they can argue that it is a category 1 expense and they need not seek approval. Life would be more difficult if the IP or their firm had an association with the software provider, as such charges would need specific approval as category 2 expenses, because of the association. We wonder if the definition of an overhead may be tested in future and we would certainly encourage our clients to be cautions about recharging any IT costs. As a final point on this topic, we are referring here to case administration software. We see charges for publishing notices on portals and bulk postage services as separate agents or sub-contractors, not as part of any attempt to recharge routine case administration costs that might subsequently be challenged.
We could go on, (“even more?”, I hear you cry), but we have to draw this article to a close somewhere. We will try to summarise and provide some advice. Overall, the message is that you will need to change your whole approach to expenses, including how you disclose, recharge, and if necessary seek approval for them. The regulatory approach is not yet certain, so as compliance advisers we have to recommend taking a risk-averse stance. We think that unless you can be absolutely certain that an expense is not likely to be considered an overhead, you should not try to recover it. If you are sure that the expense is not an overhead, then you should consider seeking approval before you draw it unless you are equally certain that it has no shared element and the supplier is not remotely associated. At the very least, you will need to review every expense that you are used to charging and compare it to the SIP requirements and you will need to amend your existing documentation. At worst, it might be safer to stop recovering all but the most certain category 1 expenses and increase your remuneration charges to take account of the additional irrecoverable costs. We hope that this gloomy forecast may have lifted slightly by the time we are allowed back out on the golf course to discuss it.
Oh, and one final horrible thought. What if the main voting creditors don’t read the SIP in depth or take account of articles like these? What if they just see “category 2” and vote against them, or still use their old wording that disallows “category 2 disbursements”? What if they change their current blanket modifications that disallow category 2 disbursements so that they disallow all category 2 expenses? Let us all hope that the voting creditors pay attention to articles like this and spot the differences in the new SIP.
