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Australia’s current insolvent trading laws and lack of protection against “ipso facto” clauses can make certain restructurings and workouts far more difficult than they need to be. Reform is necessary to ensure Australian businesses maintain a commercial edge in a fast-changing economy affected by digital and other disruption.
This article examines the proposed changes contained in the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 (Cth) which, at the time of publication, is before the Senate. It also provides some practical guidance for directors facing financial difficulties.
Australia’s current insolvent trading laws mean directors (including non-executive directors) face personal liability when their company is in severe financial difficulties and they are confronted with a necessary financial restructure. In recent years there has been a dramatic increase in restructures undertaken by restructuring and turnaround professionals in Australia drawing upon experiences in the US and UK: for instance Alinta Ltd and McColl’s Transport.
Currently a director must prevent their company from incurring debts where the company is insolvent or becomes insolvent by incurring the debt, and at that time there are reasonable grounds for suspecting the company is insolvent, or would become insolvent. Failing to guard against insolvent trading may result in the director being personally liable for debts incurred while the company was insolvent.
Recently, the federal government introduced the Bill into parliament which proposes to:
In short, if directors take appropriate steps such as obtaining expert advice and preparing a restructure plan that is reasonably likely to lead to a better outcome than an insolvency appointment, they can protect themselves from liability for insolvent trading.
Under the proposed reforms, directors will enjoy protection (a safe harbour) if they take a course of action that is reasonably likely to lead to a better outcome for the company and the company’s creditors as a whole than proceeding to immediate administration or liquidation. The inclusion of certain conditions (eg, the need to maintain books and records and pay employee entitlements as they fall due) should help guard against abuse of the provisions.
In determining whether a course of action is reasonably likely to lead to a better outcome for a company and its creditors, the following actions by directors may be considered:
It is not necessary for all factors to apply and other matters may be considered. Interestingly, the Explanatory Memorandum to the Bill explains that the phrase “reasonably likely to lead to a better outcome for the company” does not require a better than 50% chance of a better outcome than the immediate appointment of an administrator or liquidator.1
The Explanatory Memorandum states that “‘reasonably likely’ here requires that there is a chance of achieving a better outcome that is not fanciful or remote, but is ‘fair’, ‘sufficient’ or ‘worth noting’”.2
One would expect that seeking appropriate advice from a restructuring or turnaround adviser will become an important factor in practice. In my view, the proposed safe harbour reforms should provide numerous benefits by:
The safe harbour reforms will also apply to holding companies. They will protect a holding company from liability for debts incurred by a subsidiary where the directors of the subsidiary qualify for the safe harbour protection, and where the holding company takes reasonable steps to ensure the directors had the benefit of the safe harbour protection.
In broad terms, an ipso facto clause allows one party to terminate or modify the operation of a contract upon the occurrence of a specific event (eg, the appointment of an administrator).
Ipso facto clauses can lead to the destruction of value in a restructuring and can prevent the successful sale of a business as a going concern. The proposed changes to the enforcement of ipso facto clauses will assist in restructuring businesses in financial trouble. For instance, if the restriction on the enforcement of ipso facto clauses were applicable at the moment, it could assist the administrators of Network Ten in preventing US networks from terminating content agreements which are vital to the ongoing operations of the television network.
The proposed legislation applies to stay on the enforcement of ipso facto clause rights in relation to:
The stay will apply regardless of whether the right to terminate or amend the contract is self-executing or triggered by one of the parties to an agreement. However, the courts will have the discretion to allow a right to be enforced if doing so would be in the interests of justice. Further, rights can be enforced with the consent of the relevant administrator, managing controller or scheme administrator.
Subject to a court ordering otherwise, the stay on ipso facto clauses will have no impact on a party’s right to terminate a contract for any other reasons. The courts will have the discretion to restrict such enforcement if it appears likely those rights will be exercised merely because of an insolvency event.
Importantly, the federal government has indicated that the changes will not affect some contracts and instruments, including bank loan documents and other financial products (eg, swaps).
The protections against the enforcement of ipso facto clauses will only apply to contracts, agreements or arrangements which are entered into after the commencement of the provisions, which is currently expected to be on 1 July 2018. Therefore, it will take some time before we see the provisions having an impact on any administrations or receiverships.
Reform to Australia’s insolvent trading laws and ipso facto provisions are very important in the current climate of business disruption. I call upon Federal Parliament to support these important reforms as I strongly believe they will assist with the successful restructure of businesses and ultimately save jobs.
In the meantime, regardless of whether or not the proposed reforms are passed, it is important for directors to know what to do if they find their company in financial difficulty due to changes in economic conditions, disruption from a new competitor or poor decisions being made.
The message to directors of a company in financial difficulty is simple: “Act early and apply the five golden rules.”
The precise steps that directors will need to take in any particular case will depend on the circumstances, but what is crystal clear is the importance of acting early. Doing so can dramatically increase the chances of a company trading out of financial difficulty, and also reduce the risk that a director may be held liable for insolvent trading.
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