In January 2014 I published an article titled “Directors Duties – Insolvent Trading: Five rules to deal with a company in financial difficulty” in which I called upon the Federal government to reform Australia’s harsh insolvent trading laws and bring in some protections against ipso facto clauses in order to facilitate the restructuring of businesses.
The Turnbull Government’s National Innovation and Science Agenda seeks to implement changes including research, education and taxation, all with the aim of reinvigorating Australia’s economy.
Fundamental to this era of economic change is support of and investment in innovation and new ideas. Investment in unproven enterprises will however be stifled without some protections.
A more flexible approach to restructuring and turnaround implementation is one such protection key to removing barriers to entrepreneurship. It should also assist existing businesses deal with digital disruption.
The Government will make some significant changes to bankruptcy and insolvency law aimed at encouraging entrepreneurship and removing some of the barriers regularly faced by start-ups, while still protecting creditors.
Proposed key reforms:
1. Reducing the current default bankruptcy period from three years to one year.
Individuals will be able to get back on their feet more quickly following the failure of a venture. Importantly, flexibility will also be given to insolvency practitioners and authorities to extend the minimum period where fraud or misconduct have occurred.
2. Introducing a ‘safe harbour’ defence for directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company.
Unfortunately, Australia’s current insolvent trading laws mean directors (including non executive directors) face personal liability when their company is in severe financial difficulties and confronted with a necessary financial restructure that may return the business to a financially sound state.
Directors of start ups, and initial investors, often face difficult periods until a new business can stabilise. And directors of established businesses can also find themselves facing financial difficulties as their traditional business model is faced with digital disruption. Confronted with this dilemma directors are often forced to appoint Administrators in fear of breaching insolvent trading laws, rather than engage in a planned restructure outside of an external appointment. The appointment of an Administrator can result in dramatic value destruction and normally allows third parties to terminate key contracts.
Under the proposed reforms, directors will enjoy protection, “a safe harbour”, if they appoint a suitably qualified restructuring adviser to develop a turnaround plan for the company. This should provide companies with an opportunity to restructure their businesses and hopefully emerge in a stronger financial position. The inclusion of certain conditions (for instance, the need to engage an appropriately qualified insolvency adviser and provide him or her with full access to books and records) should help guard against abuse of the safe harbour defence.
3. Making ‘ipso facto’ clauses unenforceable if a company is undertaking a restructure.
In broad terms, an ipso facto clause allows a contracting party to terminate a contract due to an insolvency event, or an appointment of an external administrator to a counter party. This can cause major operational disruption to a company at a time when it needs to stabilise. Protection against ipso facto clauses is a key feature of the US Chapter 11 bankruptcy regime. The government proposes to make ipso facto clauses unenforceable if a company is undertaking a restructure. We hope this protection will be extended to include any restructure undertaken during a voluntary administration.
This proposed reform has caused some disquiet amongst certain business groups. In order to balance the needs of different stakeholders it may be a compromise is reached prohibiting enforcement of ‘ipso facto’ clauses without Court approval. A Court would not grant leave where it is not in the interests of all creditors to do so. This is similar to the regime currently in place under voluntary administration where the rights of lessors are restricted during an administration subject to the permission of the Court.
Bearing in mind there are two types of businesses in Australia; those that have already been impacted by digital disruption and those that will be impacted, these proposed reforms designed to facilitate innovation and encourage start ups, particularly during the difficult period between initial investment and generating revenue, will also be invaluable to established businesses dealing with digital disruption across all sectors of the economy.
In short, the Turnbull government’s proposed reforms are well overdue, they will assist the successful restructure of many businesses, increase the return to creditors and, importantly, will save jobs.
The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.