Safe harbour and ipso facto reform in Australia

by DLA Piper

DLA Piper

Long-awaited law reform to bring Australia's insolvency regime into step with many of its trading counterparts is slated to be enacted in the second half of 2017. The text of the law is currently before parliament for debate. If passed, Australia will see:

  • A new safe harbour: following assent, directors will no longer be personally liable for debts incurred while the company is insolvent, if the debts are incurred as part of a course of action that is reasonably likely to lead to a better outcome for the company
  • Ipso facto reform: from July 2018, a moratorium will be imposed during voluntary administration; schemes of company arrangement to avoid insolvency and receivership, which prevents counterparties from enforcing pre-existing rights under company contracts by reason only of the company's voluntary administration; schemes of company arrangement; receivership or financial position

Macaire Bromley has been an influential advocate of this law reform since her return to Australia from London in May 2014, and the proposed law incorporates her key submissions relating to:

  • The need for the law to better facilitate and encourage corporate turnaround
  • The role of the law in prescribing conduct which is expected of directors of financially distressed companies, in turn to promote cultural reform
  • The importance of access to good financial information and expert advice, in the context of preparing a turnaround plan

This article provides an overview of the proposed law, highlighting what those involved with distressed companies in Australia need to know in order to be reform ready.

A new safe harbour for directors who pursue restructuring efforts

Director's duty to prevent insolvent trading

Currently in Australia, if directors allow the company to incur debts while insolvent, they are contravening the law and can be held personally liable for a company's debts. Directors may be subject to civil penalty and criminal sanction applies if the contravention was dishonest. A number of limited defences apply, with a focus on proving that the director expected solvency, actively took steps to avoid the incurrence of the debt or can prove that, for good reason, she or he was not involved in the management of the company at the relevant time. None of the defences promote restructuring efforts with a view to turning the company around.

Proposed safe harbour reform

Under the new law, directors will not be liable for insolvent trading if, after suspecting insolvency, they begin to develop "one or more courses of action" that are "reasonably likely to lead to a better outcome for the company". A better outcome for the company means better than the immediate appointment of an administrator or liquidator.

The safe harbour will be available in respect of debts incurred in connection with such courses of action, from the time when they commence developing the courses of action until the earliest of:

  • The end of a reasonable period of time - if they fail to then take such courses of action
  • The director ceasing to take such courses of action
  • Such courses of action no longer being reasonably likely to lead to a better outcome or
  • A liquidator or administrator being appointed to the company

The proposed safe harbour sets out guidance on whether a course of action is reasonably likely to lead to a better outcome. In making that assessment, regard may be had to whether the director has done any of the following things:

  • Properly informed themselves of the company's financial position
  • Taken steps to prevent misconduct by officers and/or employees of the company that could adversely affect the company's ability to pay its debts
  • Taken steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company
  • Obtained advice from an appropriately qualified entity who was given sufficient information to give appropriate advice
  • Been developing or implementing a plan for restructuring the company to improve its financial position

The safe harbour will generally not be available to a director if the company is failing to pay its employees' entitlements when due or is not substantially compliant with its taxation reporting obligations. The safe harbour is intended to promote early engagement and reduce the risk of companies not meeting these obligations as they start to experience financial hardship.

Additionally, a director will not be entitled to rely on books and records in proceedings if the director fails to deliver them to an administrator or liquidator upon request.

Continuous disclosure obligations

A listed company's disclosure obligations are not altered by this law reform. The company will need to abide by its disclosure obligations including in respect of solvency, going concern, breach of lender covenants and any restructuring plans, in line with current practice. That is, once an entity is or becomes aware of any information that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately provide that information to the Australian Stock Exchange (ASX). The information does not have to be disclosed if:

  • One or more of the following five situations applies:
  • It would be a breach of a law to disclose the information
  • The information concerns an incomplete proposal or negotiation
  • The information comprises matters of supposition or is insufficiently definite to warrant disclosure
  • The information is generated for the internal management purposes of the entity
  • The information is a trade secret
  • The information is confidential and ASX has not formed the view that the information has ceased to be confidential
  • A reasonable person would not expect the information to be disclosed

How will the new law assist restructuring efforts?

The proposed safe harbour reform will greatly assist restructuring efforts in Australia, with the text of the law:

  • Identifying things that a director of a company facing financial difficulty ought to be doing, thereby encouraging and facilitating behaviours that represent best practice in pursuing corporate turnaround
  • Allowing advisers to guide directors on how to avoid liability for insolvent trading, beyond ceasing to incur debt, appointing an administrator or resigning
  • Allowing directors to more openly discuss the solvency position of the company including obtaining accurate data, even if the data evidences insolvency, subject to disclosure obligations
  • Being sufficiently plain, while balancing the need to prescribe some necessary aspects of conduct required of directors if they are to be permitted to trade while insolvent

Companies are encouraged to implement protocols to ensure that at the first sign of financial decline, well ahead of actual insolvency, steps are taken in accordance with the statutory guidance and a record of such steps is maintained.

Ipso facto reform

In jurisdictions such as the US, Canada and France, ipso facto clauses or provisions in contracts which give rights to a counterparty upon the company's insolvency (for example to accelerate debt or terminate the contract) are unenforceable, subject to exceptions. This law is intended to promote restructuring efforts, by protecting a debtor from losing valuable contract rights in the event of insolvency, including in liquidation.

The proposed ipso facto reform in Australia is more limited. It is intended to facilitate restructurings and business sales by receivers. Specifically, the law provides:

  • During voluntary administration, schemes of company arrangement to avoid insolvency and when a managing controller (i.e., a receiver or other controller) is appointed over all or substantially all of the company's property
  • Counterparties will not be permitted to enforce rights under pre-existing company contracts
  • By reason only of the company's voluntary administration, scheme of company arrangement, managing controller appointment or financial position
  • Unless in the case of voluntary administration or where a managing controller is appointed, the administrator or managing controller expressly consents

The moratorium will be subject to exceptions to be set out in regulations and will include certain financial arrangements, rights of set-off and personal services. The court will be empowered to expand or restrict the moratorium in appropriate cases.

The law reform will not apply more broadly, for example to liquidation. If passed, it is proposed the law would come into effect from July 2018, providing parties with time to consider what variations to existing contracts and standard form agreements might be desirable.

Next steps

The proposed law is set out in the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 and is currently before Parliament for debate. It is anticipated that the bill will be passed and receive assent this year, possibly as early as July 2017.

We will watch developments closely. Given our role in making submissions on the text of the law and consulting with the government on this important law reform, we are well placed to advise those involved with distressed companies in Australia on the specific changes that might be made in respect of the approach to restructuring and the operation of ipso facto clauses in contracts.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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