Safe Harbour Insolvency Reforms

26 April 2017

The Federal Government has just released the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill, 2017 for public discussion. Following recommendations made by the Productivity Commission in 2015, the draft legislation seeks to:

create a "safe harbour" for company directors from personal liability for insolvent trading in certain circumstances; and
make "ipso facto" clauses unenforceable in the event the company enters into certain formal insolvency arrangements (such as voluntary administration or schemes of arrangement).

After considerable consultation with insolvency experts and other interested parties, the draft bill sees the Government adopting the Safe Harbour Model B reforms with a carve out in relation to liability for insolvent trading under the Corporations Act, 2001 (Cth) (Act). The Model A reforms involving the appointment of a “professional restructuring advisor” has not been pursued.

Essentially, under section 588G of the Act, a director may be liable if:

he is a director of a company when the company incurs a debt;
the company is insolvent at that time, or becomes insolvent by the incurring of that debt, or by incurring at that time debts including that debt; and
at that time, there are reasonable grounds for suspecting that the company is insolvent, or would become insolvent, as the case may be.

Under the proposed new section 588GA, the above provision will not apply if the director “starts taking a course of action that is reasonably likely to lead to a better outcome for the company and the company’s creditors” and a debt was incurred as part of that course of action.

As to what is meant by this, the draft legislation provides for a non-exhaustive list, such as taking steps to prevent misconduct by officers and employees of the company, taking steps to keep proper financial records, obtaining appropriate advice and developing or implementing a plan to restructure the company to improve its financial position.

Nevertheless, directors will not be afforded “safe harbour” protection in respect of any new debts the company may take on where the director does not reasonably believe the company can repay those debts or in circumstances where the company is not meeting its obligations in respect of its employee entitlements and its taxation reporting obligations.

In the event that the company is later placed into external administration (for example, liquidation or administration), directors relying on any safe harbour defence will have to demonstrate that the course of action they took was reasonable. The onus may then shift to the liquidator to prove otherwise.

In relation to “ipso facto” clauses, these are commonly found in contracts allowing the non-defaulting party to terminate a contract on the happening of certain events, including an insolvency event.

The proposed new sections 415D, E and F of the Act will provide for a stay on “ipso facto” clauses which allow contracts to be terminated if the company has gone into administration or scheme of arrangement. In the case of administration, it is proposed that the stay will last until such time as the administration comes to an end, either because the company is wound up or creditors vote to have the company execute a Deed of Company Arrangement. In the case of a scheme, the stay will last until the scheme comes to an end or in the event that any application to place the company into the scheme is withdrawn or dismissed by the court.

Nevertheless, if any party wishes to approach the court to lift any stay, they will need to demonstrate that it will be “in the interests of justice” to have the stay lifted (proposed new section 415E of the proposed bill).

We welcome the proposed amendments and believe they could allow for directors to have the confidence to trade companies out of short term financial difficulties rather than proceed to a more immediate formal insolvency appointment in order to avoid the current onerous personal liability for company debts. Furthermore, the stay on ipso facto clauses will help preserve value in companies which have entered administration or scheme of arrangement, improving the prospect of a worthwhile sale of company assets or having the company trade out of its difficulties, rather than being stripped and broken up as is often the case.

We consider that these changes could well usher in more turnaround and restructuring work in the insolvency community rather than more traditional “creditor” based work which has come about largely through a stricter insolvent trading regime in Australia compared to other jurisdictions. We also believe the proposed amendments will have an impact on the work insolvency lawyers carry out which will see a far greater focus on commercial outcomes and solutions than previously.

If you require any further information about this, please contact either Howard Chait at hc@meerkinapel.com.au or Hugh Maclaren at hm@meerkinapel.com.au or by phone on 9510 0366.