Time is up for stakeholders to have their say on proposed insolvency law reforms

Following the close of public submissions on Monday, it will be interesting to see stakeholder and industry responses to the proposed insolvency law reforms.

By way of refresher, in March this year, the Federal Government published draft legislation (Treasury Laws Amendments (2017 Enterprise Incentives No.2) Bill 2017) for consultation, seeking to amend the Corporations Act 2001 (Cth) by introducing:

• a ‘safe harbour’ carve out to a director’s personal liability for insolvent trading, and
• stay provisions affecting the enforceability of certain ‘ipso facto’ and other clauses during an administration or scheme of arrangement.

The reforms were introduced as part of the National Innovation and Science Agenda. They aim to assist in the promotion of a culture of entrepreneurship and innovation in Australia (and reduce the stigma associated with business failure) to help drive business growth, local jobs and global success in Australia.

Safe harbour defence

Australia’s current insolvent trading regime means that directors can be personally liable for debts incurred while a company is insolvent. The introduction of the safe harbour carve out is designed to protect directors from such liability if they are attempting to restructure the company.

The reforms provide protection to directors if they start a course of action that is reasonably likely to lead to a better outcome for the company and its creditors as a whole than proceeding to immediate administration or liquidation, and the debt was incurred as part of the course of action. In determining whether the course of action is reasonably likely to lead to a better outcome for a company and its creditors, steps that may be considered include (but are not limited to) whether the directors are:

• taking appropriate steps to avoid misconduct by officers and employees that could adversely affect the company’s ability to pay its debts
• obtaining appropriate advice
• taking steps to ensure the company is keeping appropriate financial records
• informing themselves of the company’s financial position, and
• developing or implementing a restructuring plan to improve the company’s financial position.

Subject to some statutory exclusions (for example, directors cannot rely on the defence in circumstances if the company is not meeting its obligations in relation to employee entitlements), once a director is successfully able to point to evidence to suggest there was a reasonable possibility that the course of action taken was reasonably likely to lead to a better outcome for the company and its creditors, the onus will then shift to the liquidator to prove the safe harbour defence does not apply.

A key aim is to drive cultural change amongst company directors, by encouraging them to engage early with financial hardship, keep control of their company and take reasonable risks to facilitate the company’s recovery.

Ipso facto protection

An ipso facto clause allows a party to terminate or modify a contract upon the occurrence of a specific event (e.g. the other party going into insolvency).

The reforms aim to impose:

• an automatic stay on ipso facto clauses triggered by administration or a scheme of arrangement, and
• a potential broader range of rights (for example, termination for convenience rights) where a court is convinced such rights might be exercised solely because the company has entered administration or a scheme of arrangement.

Subject to the broader discretion of the courts, the ipso facto amendments will not apply to another right to terminate under a contract, such as for non-payment. The Federal Government has also listed 16 types of contracts that it proposes to exclude from the ipso facto amendments (such as debt factoring agreements and securities underwriting agreements).

The ipso facto protections aim to prevent these types of clauses from reducing the scope for a successful restructure or preventing the sale of the business as a going concern.

Now that submissions have closed, it will be interesting to observe the market’s take on the current form of the new laws. Until the proposed reforms take effect, directors of companies in financial difficulty should continue to act early in order to maximize the chances of the company being able to successfully restructure its business and limit the risk of being liable for insolvent trading.

This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.