Insolvency Law reforms and its impact on business and directors
The Insolvency Law Reform Act 2016 (Act) is due to commence operation on 1 March 2017 and is the first set of reforms proposed by the Australian National Innovation and Science Agenda (NISA).
The Act is generally a consolidation of the current rules which govern corporate and personal insolvency, as currently split between the Bankruptcy Act 1996 (Cth), the Corporations Act 2001 (Cth) (Corporations Act) and Australian Securities and Investments Act 2001 (Cth) and makes a number of changes including:
- increasing the powers of ASIC to regulate corporate insolvency;
- the registration of insolvency professionals;
- the introduction of a minimum remuneration of insolvency professionals without the need to hold a creditor’s meeting; and
- the improvement in the position of creditors to request information and review estate or external administration.
The second set of reforms recommended by the NISA proposals paper (Proposal) issued in April 2016 if adopted will have a significant impact on business given the proposals include:
Reduction of bankruptcy period
The proposal recommends that the current default bankruptcy period be reduced from 3 years to 1 year with the effect that many of the restrictions placed on bankrupts such as obtaining finance and prohibition on overseas travel are reduced to 1 year. Despite the proposed reduction in the bankruptcy period, the proposal recommends that the period for the obligation to repay the bankrupts debts remain set at three years. In addition to the above the bankruptcy period may be extended up to eight years with income contributions to continue for that period. We note that any perceived risk as result of this change is easily mitigated by conducting bankruptcy searches as is appropriate due diligence for commercial transactions such as business acquisitions and loans.
Safe Harbour proposals
In addition the proposal seeks the introduction of safe harbour provisions to protect directors from personal liability for insolvent trading. The proposal has set out two models for the safe harbour provision with one being a defence to insolvent trading whilst the other will be a carve out and would require the liquidator to prove that the safe harbour provision should not apply. The two models are as follows:
- under the Model A, the directors would be able to absolve themselves of liability by appointing a restructuring advisor to develop a turnaround plan for the company; and
- under Model B, a carve out for s 588G of the Corporations Act would be introduced to allow directors to attempt to trade out of short term losses where it is reasonable to do so and any increases in debt do not materially increase the risk of loss to creditors.
These safe harbour provisions are aimed at providing directors with a restructuring option that allows them to retain control of the company whilst receiving formal advice rather than prematurely surrendering control to an external administrator. In relation to Model A, the recommendations have also provided for the defence to not apply where the director is disqualified at the time the debts are incurred, the defence is not satisfied, business activity statements have not been lodged or where there has been a significant failure to pay employee entitlements.
Both of the models discussed above contemplate the appointment of a restructuring adviser to lead the proposed turnaround activity and provide advice on the reasonable courses of action, whether the business is in fact reasonably capable of being saved. At this point in time it is uncertain what type of professional this adviser is likely to be; however the Proposal has noted that the restructuring advisor will need to be an accredited member an organisation approved by the Minister and that such organisations are likely to include (but not be limited to) the Law Society, CPA Australia, Chartered Accountants Australia and New Zealand, the Australian Restructuring, Insolvency and Turnaround Association and the Turnaround Management Association.
The main impacts of this proposal if adopted will likely be:
- insolvent trading claims becoming even less frequent, given the difficulty and expense required to pursue; and
- encouraging businesses and directors when facing financial distress to act much earlier in an attempt to fall within the safe harbour provisions;
- greater transparency with creditors as directors attempt to take reasonable steps in an attempt to save the business; and
- directors fully investigating the possibilities of restructuring and trading out of short term losses, without penalty of trading a company whilst insolvent where under the current regime they would likely resign or cease trading and apply for voluntary administration.
Ipso Factum clauses
The last recommendation of the proposals is that clauses which allow a contract to be terminated solely due to insolvency event are made unenforceable or void where the company is undertaking a restructure. The aim of this proposal is to prevent trade creditors and suppliers undermining the voluntary administration process by refusing to provide goods and services despite them still being paid on the basis of insolvency event.
It should be noted that this proposal does not affect the termination of a contract for reasons other an insolvency event such as non-payment of fee or the non-performance of the contract.