The Government’s Innovation Statement issued on 7 December 2015 adopted 3 recommendations from the Productivity Commission’s report ‘Business Set-Up, Transfer and Closure’ (released on the same day) aimed at promoting entrepreneurial activity and encouraging business restructuring to help businesses deal with financial distress.
The 3 recommendations were:
- Make the default period of personal bankruptcy 1 year (from the current 3 years)
- Introduce a safe harbour for directors engaged in good faith restructuring
- Nullify the effect of ipso facto contract clauses that allow for termination or variation of contracts when a company enters voluntary administration and a scheme of arrangement.
After a period of industry consultation, Treasury released its draft law reform measures on Friday 29 April 2016, with the period of public consultation ending on 27 May 2016. You can read the discussion paper here:
I’ll focus on the corporate insolvency reforms for the moment.
Questions about whether insolvent trading discourage good faith restructuring efforts have been a regular feature of Australian insolvency law debates for some time. I wrote about this back in 2009:
There have been a number of other articles, particularly on whether there needs to be better defences so that directors can be more confident when engaging in good faith restructuring efforts.Treasury previously looked at this during 2010-2011, but the Minister decided there was ‘no evidence’ to support a change and the reform idea was dropped in September 2011. The 2010 discussion paper and submissions can be found here:
I’ve supervised a number of honours law students on these themes over the years and 2 of my former students have published their thesis papers as articles:
- Karen Petch, ‘Insolvent trading in Australia: the case for advance relief’ (2011) 29 Company & Securities Law Journal 197. Karen examined the idea from the Cork Report that an advance relief order could be given to allow directors to engage in good faith restructuring.
The Productivity Commission’s inquiry in 2015 generated more than 100 submissions over 2 rounds of consultation and many of these advocated for reforming insolvent trading law. The Commission’s report recommends this, but mainly discusses the ARITA proposal which was based on an earlier submission by the Law Council of Australia, the Turnaround Management Association and IPA (ARITA’s then name). This involves a lengthy new defence being inserted into the Corporations Act that would operate against insolvent trading under s 588G provided that certain conditions were met.
The 2016 Treasury discussion paper provides a revised safe harbour defence (referred to as Model A) but also offers the possibility of reforming s 588G itself (referred to as Model B). Model A is contained in Proposal 2.2 (on p 11):
It would be a defence to s588G 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 adviser, 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.
The defence would apply where the company appoints a restructuring adviser who:
(a) is provided with appropriate books and records within a reasonable period of their appointment to enable them to form a view as to the viability of the business; and
(b) 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 restructuring adviser would be required to exercise their powers and discharge their duties in good faith in the best interests of the company and to inform ASIC of any misconduct they identify.
One of the key elements of this defence is that the restructuring advisor would need to be an accredited member of a professional association (such as ARITA, state law societies or CPA or CAANZ). Treasury has not adopted ASIC’s suggestion that restructuring advisors be registered with ASIC or ARITA’s suggestion that they be limited to registered liquidators. While competition for restructuring advice is a good thing, I favour registration with ASIC because this is an opportunity to address concerns about the conduct of pre-insolvency advisors. Requiring registration would set minimum education requirements and provide the impetus for lifting standards in the industry. I should disclose that I am the director of the ARITA advanced certificate training program offered by the UTS Faculty of Law. I also favour requiring membership of ARITA so that regulation and supervision is not dispersed between too many bodies. I also believe that all insolvency practitioners should be required to be ARITA members for the same reason. It’s not a criticism of the accounting bodies, just a view that a clear, simple and consistent regulatory system would provide better outcomes for stakeholders than our current diffuse model of regulation.
Model B makes the following proposal:
Section 588 does not apply:
(a) if the debt was incurred as part of reasonable steps to maintain or return the company to solvency within a reasonable period of time; and
(b) the person 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
(c) incurring the debt does not materially increase the risk of serious loss to creditors.
I really like this proposal as it addresses the core concern-that our insolvent trading laws are too harsh. They are harsh because they ignore good faith attempts to save the business in favour of bringing down the hammer on directors for trading whilst insolvent, even if the directors acted reasonably and did everything they could to save the business. The current regime is not solely focussed on culpable behaviour by directors who recklessly or deliberately run the company into the ground in spite of the creditors (only the criminal offence in s 588G(3) does this), but in my view it should be.
Imposing liability on the failure to prevent debts being incurred due to the mere reasonable suspicion of insolvency (whether you had the suspicion or not) is too harsh a rule and needs to be changed if we are to truly shift public perception that it is ok to fail and start again. Insolvency is not a crime, and being a director of a failed business is not an indictment on your business acumen. Business failure is a natural part of a capitalist economy. Removing draconian penalties for not shutting down the business at the first sign of trouble is long overdue!
The discussion paper raises a number of potential conditions for the safe harbour proposals to work, particularly having up to date reporting obligations and not gaining protection where employee entitlements and certain tax payments (such as PAYG and superannuation) are outstanding. I see the goal here, but this may be too strict. Sometimes viable businesses fall behind, but can be turned around with good advice and reasonable creditors. We mustn’t set the entry point so high that only perfect and profitable businesses get access to the safe harbour. I would support a mechanism that allowed for the restructuring advisor to help get the books up to date.
There is lots more to say about this proposal and I will certainly be putting this into a submission to Treasury as well as finishing off my article comparing insolvent trading with other director liability regimes around the world.
The discussion paper proposes to amend the law so that ‘any term of a contract or agreement which terminates or amends any contract or agreement (or any term of any contract or agreement), by reason only that an ‘insolvency event’ has occurred would be void’ (Proposal 3.2). An insolvency event would include:
- the appointment of an administrator or a deed administrator
- the company undertaking a scheme of arrangement in order to avoid administration or insolvent liquidation
- the appointment of a receiver or controller
The first 2 categories make sense but extending this protection to a receiver or controller seems an odd move. Receivership and controllership are fundamentally different processes to administration, schemes or liquidation. The former (court appointed receivers excluded) are for the benefit of a particular secured creditor while the latter are collective insolvency processes. If the proposal was to extend the protection to all external administration (including liquidation) on a consistent policy basis then fine, but to exclude liquidation and include receivership is not to the way to go. Either do a blanket voiding of ipso facto on pari passu grounds, or target restructuring specifically (i.e. VA and schemes).
The discussion paper also suggests a general anti-avoidance measure to nullify any provisions in an agreement that has the effect of providing for, or permitting, anything that in substance is contrary would be of no force or effect. This seems sensible on its face.
Lastly, there would be exclusions for ‘prescribed financial contracts’ which is consistent with the provisions in both Canada and the US. No doubt there will be much litigation to come regarding whether a contracts falls within or outside any prescribed exception, as has been the experience in North America.
For a good discussion of ipso facto clauses and restructuring see the article published by my former honours student (and now my co-author) Nicholas Mirzai, ‘Ipso facto clauses: Should they be enforceable under Pt 5.3A?’ (2011) 19 Insolvency Law Journal 4 (this was his honours thesis-still the best mark I’ve ever given!). Also see the recent note from Lindsay Powers in the Journal of Banking and Finance Law and Practice: ‘Ipso facto clauses: a law reform challenge’ (2016) 27 JBFLP 72.
I’m currently putting the finishing touches on an article on ipso facto clauses that compares Australia with the law in Canada and in the US. I’ve held off releasing this until I saw what Treasury was proposing. If you would like a copy of this please email me (firstname.lastname@example.org).