The Federal Government has released draft legislation for the long-anticipated reform of Australia’s insolvency laws with the proposed introduction of:
- a safe harbour for directors from personal liability for insolvent trading if the company is undertaking a restructure; and
- a stay on the enforcement of ipso facto clauses against a company that enters voluntary administration or a scheme of arrangement.
Safe harbour defence to insolvent trading
Directors have a duty to prevent insolvent trading by a company under section 588G of the Corporations Act 2001 (Cth) (Act). Section 588G of the Act provides that a director must not allow a company to incur a debt or debts when:
- the company is insolvent or becomes insolvent by incurring the debt or debts; and
- at that time, there are reasonable grounds for suspecting the company is insolvent, or would become insolvent.
A director who contravenes this provision may face civil liability unless he or she can establish a defence under section 588H of the Act.
The draft legislation proposes, in addition to the defences available under section 588H of the Act, the introduction of a ‘safe harbour’ defence in a new section 588GA.
Under the proposed section 588GA a director will avoid civil liability for insolvent trading if, after he or she starts to suspect the company is or may become insolvent, he or she takes a course of action that is reasonably likely to lead to a better outcome for the company and its creditors as a whole than proceeding immediately to a formal insolvency process. If the company incurs a debt in connection with that course of action during that period, the director will enjoy protection from liability under section 588G.
The draft legislation sets out the following (non-exhaustive) list of factors that may be taken into account in determining whether a course of action is reasonably likely to lead to a better outcome:
- taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the ability of the company to pay all its debts;
- taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
- obtaining appropriate advice from an appropriately qualified entity who was given sufficient information to give such advice;
- properly informing himself or herself of the company’s financial position; and
- developing or implementing a plan for the restructuring of the company to improve its financial position.
Ipso facto clauses
An ipso facto clause is a contractual provision which allows for a contract to be terminated or otherwise modified by one party if the counter-party experiences an insolvency event.
Currently under Australian law, there is no moratorium to prevent a party from enforcing an ipso facto clause against a company that enters any form of external administration. This means that the prospect of a successful company restructure or sale of a company’s business as a going concern is significantly reduced, particularly when the company is heavily reliant on service or supply contracts.
The draft legislation will introduce a stay of the enforcement of ipso facto clauses in the following circumstances:
- Schemes of arrangement: Under the proposed section 415D, a contractual right (to terminate, for example) which is triggered merely because the company enters into a scheme of arrangement is unenforceable whilst the company is the subject of the scheme, provided that the scheme application states that it is made for the purpose of the company avoiding being wound up in insolvency.
- Administration: Under the new section 451E, a contractual right (to terminate, for example) which is triggered merely because the company is under administration is unenforceable whilst the company is in administration (subject to any court extension to the stay).
Certain categories of contracts and contractual rights are proposed to be excluded from both restrictions. These are listed in the draft explanatory document accompanying the draft bill and include, for example, rights of set-off, flawed asset arrangements and debt factoring agreements.
Impact of the reforms
The reforms are expected to:
- encourage directors to engage early with possible insolvency, and take reasonable risks to facilitate the company’s recovery rather than prematurely placing the company into voluntary administration or liquidation; and
- preserve value in a company that becomes subject to a scheme of arrangement or is placed into administration and facilitate a successful restructure or sale of the business as a going concern.
The draft exposure bill and accompanying explanatory memorandum and explanatory document are available on the Commonwealth Treasury website.
Interested parties have until 24 April 2017 to make submissions in relation to the draft legislation.