09 August 2016

Proposed insolvency reforms

Treasury issued a discussion paper on improving bankruptcy and insolvency laws in April 2016.

Aside from a proposal to shorten the period of bankruptcy, the majority of discussion has been around the introduction of a safe harbour regime to allow directors to participate in “good faith restructuring” and on the operation of “ipso facto clauses”.

Safe harbour reform

Treasury’s discussion paper floats two options in relation to safe harbour reform:

  • model A creates a new defence in respect of insolvent trading, if the directors have appointed a restructuring advisor; and
  • model B is a less prescriptive alternative and applies to directors who have taken reasonable steps to maintain or return the company to solvency.

Rather than following the lead of the United States, where there is no equivalent director’s liability for insolvent trading, the reforms seem more directed at a UK model which imposes risk only once there is no reasonable prospect of avoiding what it terms “insolvent liquidation”.

The need for reform is said to arise because companies often enter voluntary administration prematurely, rather than risk personal liability.

Model A

This model adds to section 588H of the Corporations Act by creating a defence to section 588G claims if at the time when the debt was incurred, a reasonable director would have an expectation, based on advice provided by an appropriately experienced, qualified and informed restructuring advisor, that the company can be returned to solvency within a reasonable period of time, and the director is taking reasonable steps to ensure it does so.

It is a condition of the defence that the restructuring advisor:

  1. is provided with appropriate books and records within a reasonable period of their appointment date, to enable them to form a view as to the viability of the business; and
  2. is and remains of the opinion that the company can avoid insolvent liquidation and is likely to be able to be returned to solvency within a reasonable period of time.

The government has suggested that accredited members of organisations such as a law society, CPA Australia, Chartered Accountants Australia and New Zealand, Arita and the Turnaround Management Association would be approved to act as restructuring advisors.

The restructuring advisor must exercise their powers and discharge their duties in good faith in the best interests of the company and inform ASIC of any misconduct that they identify.

A criticism of this model centres, for the most part, upon its limited scope (it does not apply more broadly to voidable transactions) and it does not provide any certainty of defence, given the reasonableness of elements that must be satisfied if the defence is to be enlivened.

Model B

Under Model B, section 588G of the Corporations Act will not apply, if:

  1. the debt was incurred as part of reasonable steps to maintain or return the company to solvency within a reasonable period of time;
  2. the director held the honest and reasonable belief that incurring the debt was in the best interests of the company and its creditors as a whole; and
  3. incurring the debt does not materially increase the risk of serious loss to creditors.

Model B provides a greater degree of flexibility, and is less constrictive (particularly in relation to the appointment of an external restructuring advisor).

This model is similar to the UK legislation, and mirrors in some ways the business judgment rule enshrined in section 180 of the Corporations Act.

Any comprehensive analysis of this proposed reform obviously depends upon the terms of the legislation, once amended.  That observation notwithstanding, we do note that:

  1. the defence will be available even if a return to solvency was not achieved;
  2. it may be difficult for a director in a company of any size to demonstrate an honest and reasonable belief that incurring every underlying debt is in the best interests of the company and its creditors as a whole; and
  3. any assessment of whether or not the incurring of the debt materially increases the risk of serious loss to creditors must not (one presumes) include an analysis of the impact upon each particular creditor, but rather creditors as a whole.

Ipso facto clauses

An ipso facto clause is a contractual provision which allows one party to exercise rights upon the happening of an identified event which is prescribed as being an insolvency event.  For example a clause in a contract which enables one party to terminate a contract if a voluntary administrator is appointed to the other party.

These clauses are common provisions in documents ranging from leases and supply contracts, through to trust deeds.

The clauses are problematic because they afford a party an opportunity to take a commercial advantage, even in circumstances where the subject is not in material breach of contractual obligations.  The proposed reform would specify that any term of an agreement that allows for termination by reason only that an “insolvency event” has taken place, would be void.  The term “insolvency event” would encompass:

  1. voluntary administration;
  2. schemes of arrangement;
  3. the appointment of a receiver or controller; and
  4. entry into a deed of company arrangement.

The reforms do not appear to be directed at underlying incidents of default.  For example, the appointment of a receiver might no longer be grounds for terminating a lease, but a failure to deal with rental arrears would be.

Protections of this nature are already available, to a degree, through the voluntary administration process.  In that instance, the restriction on the rights of owners of property are balanced by the imposition of personal liability on the part of a voluntary administrator.  It remains to be seen how this balancing exercise will be effected, particularly if it is proposed that insolvency event protections extend to other incidents which positively identify underlying insolvency.

As usual, there would be exceptions.  Mooted exceptions include:

  1. certain contracts entered into after an existing insolvency event (for example if a company subject to a deed of company arrangement subsequently enters receivership); and
  2. aircraft leases, which are governed by the Mobile Equipment (Capetown Convention) Act 2013 (Cth).

For further information please do not hesitate to contact Tim McGrath or Melanie Husband on 4036 9700.

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