As part of the National Innovation and Science Agenda (NISA), the Minister for Revenue and Financial Services, the Hon Kelly O’Dwyer, has released draft legislation which reforms Australia’s insolvency laws and an accompanying draft explanatory statement for public consultation. This was on Tuesday 28.3.17.
The draft legislation will amend the Corporations Act 2001 in an effort to promote a culture of entrepreneurship and innovation and help reduce the stigma associated with business failure. The Government hopes this help drive business growth, local jobs and global success.
- The amendments will create a ‘safe harbour’ for company directors from personal liability for insolvent trading if the company is undertaking a restructure in certain circumstances. This will 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 instead of placing the company prematurely into voluntary administration or liquidation.
- The amendments will also make ‘ipso facto’ clauses unenforceable if a company has entered into a formal insolvency process. Currently, ‘ipso facto’ clauses allow contracts to be terminated solely due to an insolvency event. The aim of this reform is 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.
- The Government has also released a further explanatory document setting out the types of contracts and contractual rights, which it expects to be excluded from the broad stay on the operation of ipso facto clauses. These excluded contract types and rights will be formalised through forthcoming regulations, with the stay on ipso facto clauses becoming effective on 1 January 2018. The Minister welcomed feedback on the appropriateness of the proposed exclusions and whether further exclusions may be warranted.
The Attorney-General is the responsible Minister for the proposed reduction of the default period of bankruptcy from 3 years to 1 year, which was announced along with these reforms, and will be legislated separately.
[Treasury website: consultation announcement; Exposure Draft; Explanatory Memorandum; Explanatory Document; LTN 58, 28/3/17]
Extract from EM – safe harbour from directors liability for insolvent trading
Summary of new law
1.11 The safe harbour will operate to carve directors out from the civil insolvent trading provisions of section 588G(2) [of the Corporations Act 2001].
1.12 The Government is seeking to strike a better balance between the protection of creditors and encouraging honest directors to innovate and take reasonable risks. To this end, the safe harbour amendment focuses on the behaviour of directors in trying to turn their company around, rather than merely on the solvency of the company and the precise timing of debts being incurred as has previously been the case.
1.13 This change is intended to encourage honest company directors to remain in control of a financially distressed company and take reasonable steps to restructure and allow it to trade out of its difficulties.
1.14 The aim of the safe harbour reform is to facilitate more successful company restructures outside of a formal insolvency process where doing so would achieve a better outcome for the company and its creditors as a whole. It encourages directors to engage early with financial distress, and then actively take steps to either restructure the business or, if that is not possible, to quickly move to formal insolvency
1.15 Under the new safe harbour, directors will only be liable for an insolvent company’s debts where it can be shown that they were not taking a course of action reasonably likely to lead to a better outcome for the company and its creditors as a whole [rather] than proceeding to immediate administration or liquidation.
1.16 Whether a course of action is reasonable will vary on a case-by-case basis depending on the individual company and its circumstances. However, [mere] hope is not a strategy. Directors who merely take a passive approach to the business’s position or allow a company to continue trading as usual during financial distress, or whose recovery plans are fanciful, will fall outside the bounds of the safe harbour.
1.17 As it is intended as a protection for directors who are acting honestly and diligently, the safe harbour is open only to directors who have been taking appropriate steps so that the company complies with the obligation to maintain books and records, provide for the entitlements (including superannuation) of employees and meets its taxation reporting obligations.
1.18 To fall within the protection of the safe harbour a director will generally only be required to provide evidence about the course of action that was taken. A liquidator (or other person) seeking to make the director personally liable for any debts incurred while the company was insolvent will bear the onus of establishing that the course of action by the director was not reasonable in the circumstances.
1.19 While the change is intended to allow companies to be restructured outside of a formal insolvency process, some companies may not be able to recover and will still proceed to voluntary administration or liquidation despite the directors’ best efforts. Provided that the director was pursuing a reasonable course of action then they will still have the benefit of safe harbour in these circumstances.
1.20 Where an administrator or liquidator is appointed, a director who does not provide them with access to the company’s books or secondary evidence following an appropriate request will be prevented from using those materials as evidence of having taking a reasonable course of action for the purposes of the safe harbour. A similar provision applies where a company director does not provide a liquidator or administrator with other information about the company following an appropriate request.
1.21 These restrictions on the use of the safe harbour are in place to ensure that where a company eventually enters administration or is wound up that directors do not withhold books or information about the company in an attempt to prevent a liquidator or administrator from investigating the company’s activities and taking appropriate action. Such action may include pursuing recovery against the directors personally for the company’s debts if it appears that the directors did not take a course of action reasonably likely to lead to a better outcome than through proceeding to an immediate administration or the liquidation of the company.
1.22 The restriction also ensures that books and information that were not available at the time a liquidator or administrator is appointed are not later prepared in a way to make it retrospectively appear that a director would have fallen within the safe harbour provisions.
1.23 An exemption applies so that these restrictions will not apply in relation to directors who:
- can demonstrate they did not have the books or information and there were no reasonable steps that could have been taken to obtain the materials; or
- were not notified that failing to provide the information requested by the liquidator or administrator would prevent them from using the materials or information to demonstrate they took a course of action that was reasonably likely to lead to a better outcome.
Extract from EM – stay on ‘ipso facto’ clauses
Summary of new law
2.12 The amendments in Part 2 of Schedule 1 of the bill provide that ipso facto clauses that amend or terminate an agreement because of an insolvency event are not enforceable except in certain circumstances.
2.13 The provisions apply to stay the enforcement of these rights in relation to a Part 5.1 body that applies for a scheme of compromise or arrangement and to companies that enter into administration. The stay applies regardless of whether the right is self-executing or triggered by one of the parties to an agreement.
2.14 This stay on the enforcement of rights does not apply in relation to rights:
- in a type of contract specified in regulations[ ];
- of a kind prescribed in the ministerial determination;
- in agreements made after the commencement of a scheme of compromise for a Part 5.1 body or administration of a company;
- that manage financial risk associated with a financial product that is commercially necessary for that type of financial product.
2.15 The courts will have discretion to allow a right to be enforced if doing so would be appropriate in the interests of justice.
2.16 The courts will also have the discretion to restrict the enforcement of other rights in an agreement if it appears likely that those rights will be exercised merely because of an insolvency event.