Growers dealt the poor hand in MIS house of cards

The recent collapse of Timbercorp and Great Southern, the two biggest players in the agricultural managed investment scheme (MIS) industry, has stirred debate on a number of fronts. For all the contention surrounding the schemes’ generous tax treatment, their agricultural merit and the corporate governance of the companies administering them, it appears the scheme investors, known as growers, are to be worst affected by the industry’s implosion.

While media reports have intimated that the growers stand little chance in the face of significant secured bank debt, a largely overlooked decision of the Victorian Supreme Court earlier this year suggests that the prognosis for growers could be worse than first feared.

In ordering that insolvent MIS company Environinvest’s eucalypt schemes be wound up, the court held that despite the property rights to the trees contractually vesting with the growers, the trees in fact formed part of the scheme assets that were to be wound up and liquidated. This liquidation will satisfy, in the first instance, the debt of Environinvest’s primary secured creditor - the Commonwealth Bank.

The decision is pending appeal later this year, which is telling given this area of law is still in a nascent phase, however the similarities between the Environinvest scheme and those spruiked by Timbercorp and Great Southern should raise serious alarm. Environinvest had a markedly similar MIS structure to that of Timbercorp and Great Southern, albeit on a much smaller scale. Growers paid upfront application fees for an allotment of trees, which Environinvest cultivated on the growers behalf until the trees reached maturity. Once harvested, the growers received the proceeds of the sale less the fees and costs of Environinvest. Fundamental to this structure was that the grower, supposedly, owned the product.

It was this purported ownership that appeared to provide the only solace to investors at the initial creditor meetings of Timbercorp and Great Southern. At both meetings the respective administrator neatly avoided any reference to the decision in Environinvest (perhaps because no creditor posed the question) and spoke opaquely about the complexities of the insolvency and the conflicting interests of a number of different parties.

There is no doubt these schemes represent a complex breed of insolvency, nor that there are conflicting, if not irreconcilable, interests. The administrator also has the added difficulty of being in relatively unchartered territory. Alongside Environinvest, Western Australian wine and grape company Palandri Wines stands as the only instructive example of a winding up application for a failed agricultural scheme.

The public failure of managed investment schemes is nothing new but the agricultural schemes possess a key point of difference to failures such as Westpoint or Storm Financial - the growers are granted an interest in a tangible commodity. This added complexity led Timbercorp’s administrator to recently take the unusual step of applying to the court for protection from any future claims by growers in the event that certain schemes are wound up.

Adding insult to injury for growers is that an analysis of the underlying causes of the current maelstrom demonstrates the MIS structure so fiercely embraced by these companies was doomed to fail. In fact, the closer these insolvencies are analysed, the more they begin to resemble elaborate Ponzi schemes - repaying growers not through profits but via the application monies of new MIS investors. When the financial crisis led to sales drying up and banks strictly enforcing loan covenants, the MIS empires crumbled.

But like so many of the financial crisis’ casualties, the MIS industry had its time in the sun. There was a period when investors flocked and the industry purchased tracts of land to accommodate hectare after hectare of scheme produce, ranging from mangoes to cattle. Certain elements driving these sales raise questions, including the legitimacy conferred upon the schemes by product rulings of the Australian Tax Office and the role of accountants and financial advisers who encouraged their clients to invest in the schemes.

Seen as a method to defer the payment of tax, many investors took out loans for the application money, often from the financial arm of the MIS companies themselves (and often at an above-market interest rate) in order to attain an upfront tax deduction. By virtue of the ATO’s product ruling, payment of tax would be deferred until the project generated a return - 12 years in the case of many forestry investments.

While sold to their clients under the guise of their tax effectiveness, hundreds of accountants and financial advisers received commissions of up to 10 per cent from the MIS companies for generating sales. Between 2000 and 2008, Great Southern paid $344 million in commissions and marketing. Further, many of these advisers and accountants were deemed “authorised representatives” of either Timbercorp or Great Southern and exclusively marketed that company’s products to their clients.

Products that are now, according to the Environinvest judgment, worthless.

While both the tax treatment and role of advisers in the MIS industry warrants assessment beyond the insolvency administrations of Timbercorp and Great Southern, one thing is certain: MIS is a dirty word. An industry that relied upon referrals and investor appeal is now like financial swine flu. The quarantining exercise underway was exemplified by Adam Redman, spokesperson for Elders owned forestry company Integrated Tree Cropping - “we are an integrated forestry company that uses MIS, not a MIS company who uses forestry”. I suspect most investors couldn’t care about the difference, they just want some return on their investment.