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Proposed ‘safe harbour’ for insolvent trading

18Dec 2015

  • Zac Zahner
  • Effective Governance News

One of the proposals announced in the Australian Government’s National Science and Innovation Agenda statement is a ‘safe harbour’ for company directors from personal liability for insolvent trading, if they appoint a restructuring adviser to develop a turnaround plan for the company.[1]

The current law

The purpose of the current insolvent trading provisions in theCorporations Act 2001(Cth) is to provide a direct pathway for creditors against directors who cause their companies to trade while insolvent, thereby bypassing limited liability provisions. If a company is found to have continued trading when insolvent, its directors face serious penalties ranging from orders to pay the creditors for the debts involved to full civil and criminal fines.

Section 588G of the Corporations Act applies to impose liability upon a person if:

  • the person is a director of the company when the company incurs a debt;
  • the company is insolvent when it incurs the debt or becomes insolvent because it incurs the debt;
  • when it incurs the debt there are reasonable grounds for suspecting that the company is insolvent or would become insolvent if it incurs the debt; and
  • the director is aware at the time the debt is incurred that there are reasonable grounds for suspecting that the company is insolvent or would so become insolvent (as the case may be) or a reasonable person in a similar position in a company in the company’s circumstances would be so aware.

However, even if a director has breached section 588G, there might be a defence for the director. Section 588H of the Corporations Act contains four defences:

  1. There were reasonable grounds to believe the company was solvent;
  2. The director reasonably believed a competent person provided sufficient and adequate information and, on that basis, reasonably believed the company was solvent;
  3. Through illness or some other good reason, the director did not take part in the management of the company when the relevant debt was incurred; and
  4. The director took all reasonable steps to prevent the company from incurring the debt.

Proposed reforms to the insolvency regime

Opinions on the current Australian insolvency regime are divided. Those who support the duty to prevent insolvent trading argue that it provides appropriate protection for the unsecured creditors of companies. Those who oppose the duty argue that it has the effect of making directors unduly risk averse. This can result in directors too quickly putting companies into voluntary administration or liquidation for fear of personal liability, which may have a negative financial impact on unsecured creditors.

Various concerns about the operation of Australia’s insolvent trading regime have been raised since its inception. For example, an Australian Treasury discussion paper released in 2010 canvassed three options for reform, which were:

  1. Retain the status quo;
  2. Introduce a modified business judgment rule defence;
  3. Give directors a moratorium from the duty not to trade whilst insolvent for the purpose of attempting a reorganisation of the company outside of external administration.[2]

More recently, the Productivity Commission acknowledged in a report released in December 2015 that the threat of directors’ personal liability, together with uncertainty as to when a company actually becomes insolvent, encouraged a culture of risk aversion among directors with the consequence that directors were forcing companies

into voluntary administration when that company may, in fact, only be experiencing temporary financial difficulties.[3]

As part of its National Innovation and Science Agenda, the Australian Government intends reforming insolvency laws to encourage entrepreneurship and innovation. This includes:

  • reducing the current default bankruptcy period from three years to one year
  • introducing a ‘safe harbour’ for directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company
  • making ‘ipso facto’ clauses, which have the purpose of allowing contracts to be terminated solely due to an insolvency event, unenforceable if a company is undertaking a restructure

The Australian Government’s innovation statement, together with the publication of the Productivity Commission’s report, signifies real change ahead for corporate insolvency law and foreshadows further public discussion, consultation and scrutiny in the area. Indeed, the topic has been generating comment since the Productivity Commission released its draft report in May 2015.[4] For example, anAustralian Financial Reviewarticle in May 2015, highlighted the deep divide over the issue, with a member of the Australian Shareholders’ Association stating that:

‘We’ve got serious doubts that safe harbour would work, in that it relies on the quality of the adviser and the ability of the company to restructure. It may just allow directors to delay taking decisions. Delay in the process reduces the assets that are eventually available to the shareholder.’[5]

The Australian Institute of Company Directors, however, was behind the reforms due the current law encouraging directors to go into administration and stifling innovation.[6]

A more measured approach, and one which calls into question the Productivity Commission’s report, comes from Lachlan Greig and John Anderson of law firm Baker & McKenzie, who note that:

‘The problems perceived by the Productivity Commission are based on anecdotal commentary in the submissions, not by quantitative information, and the submissions to the Productivity Commission were not always unanimous as to the existence and extent of those perceived problems. It is difficult to justify significant changes to the existing laws without understanding their current operation in practice. Conversely, a comprehensive review may establish that appropriately targeted change is highly desirable.’[7]

The Australian Government will release a proposal paper in the first half of 2016 with a view to the introduction and passage of legislation in mid-2017. As such, there are interesting times ahead for those with an interest in corporate insolvency law including directors, employees, creditors, shareholders and insolvency practitioners to name but a few.

Notes

[1] Australian Government, 2015, ‘Insolvency laws reform’, National Science and Innovation Agenda, accessed 16 December 2015, http://www.innovation.gov.au/page/insolvency-laws-reform.

[2] Department of the Treasury (Australia), 2010, ‘Insolvent trading: A safe harbour for reorganisation attempts outside of external administration’, accessed 16 December 2015, http://archive.treasury.gov.au/documents/1713/PDF/Insolvent_Trading_Safe_Harbour_DP.pdf.

[3] Productivity Commission, 2015,Business Set-Up, Transfer and Closure ,Inquiry Report No. 75, 30 September 2015 , accessed 16 December 2015, http://www.pc.gov.au/inquiries/completed/business/report.

[4] Productivity Commission, 2015,Business Set-Up, Transfer and Closure, Draft Report, May 2015 , accessed 16 December 2015, http://www.pc.gov.au/inquiries/completed/business/draft/business-draft.pdf.

[5] Misa Han, 2015, Directors applaud safe harbour but concede it could create ‘zombie companies’,Australian Financial Review , 26 May, accessed 16 December 2015, www.afr.com/business/accounting/directors-applaud-safe-harbour-but-concede-it-could-create-zombie-companies-20150524-gh8qm3.

[6] ibid.

[7] Lachlan Greig & John Anderson, ‘Productivity Commission’s recommended changes to Australia’s corporate insolvency laws’, Lexology, accessed 16 December 2015, www.lexology.com/library/detail.aspx?g=3c61da7a-e908-45fa-babe-e0a69b001386.


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