Safe Harbour & Ipso Facto: Issues for the Senate Inquiry

Legislation to implement the Government’s Safe Harbour and ipso facto reforms was tabled in Parliament on 1 June 2017, and then referred to the Senate Economics Legislation Committee on 15 June 2017, as noted here.

On 22 June 2017 the House of Representatives approved the second reading of the Bill.  The Opposition speakers were each careful to highlight their support for the intention of the proposed reforms, but a review of their second reading speeches (available here, from page 22) helps identify some of the issues of detail that will occupy the  committee:

Carve out or defence? – The legislation proposes a Safe Harbour via a ‘carve out’ from director’s duties – effectively placing the onus of proof on a liquidator, which is a shift away from the concept of a defence as proposed in the Productivity Commission report, that would place the onus of proof on the director.  The Opposition has flagged its interest in understanding the move away from the Productivity Commission recommendation.

Anti-phoenix measures – The Opposition is calling for the introduction of a range of anti-phoenix measures including the introduction of a unique ‘director identification number’ with a 100-point identification check, and tougher penalties for phoenix-related offences. It is not clear whether their intention is to seek immediate amendment of the legislation to implement these measures, or use the hearings to progress the debate more generally.  The idea of a DIN appears widely supported but there would be some logistical issues to address before it could be implemented – not least the likely need to expand the ASIC register to accommodate, and link, the DINs.

Transactions depriving employees of their entitlements – The Opposition also wants to address the problems caused by transactions entered into with the intention of avoiding payment of employee entitlement liabilities.  In fact, the Government has just closed a consultation on Reforms to address corporate misuse of the FEG scheme, so this is something already underway.

Model A or Model B? The Productivity Commission proposed a Safe Harbour that would be triggered by the formal appointment of an individual as a ‘restructuring adviser,’ described in the exposure draft as the ‘Model A’ approach.  The legislation as tabled implements the ‘Model B’ approach which does not specifically require such an appointment, but rather expects the directors to undertake one or more ‘courses of action’ likely to lead to a ‘better outcome,’ and the Opposition has flagged that it would at least like to understand the reasons for the departure from the original Productivity Commission proposal.

The speeches did not identify any issues with the ipso facto protections, the benefits of which, pleasingly, seem well understood and acknowledged.

Submissions close 12 July 2017, with the committee due to report by 8 August 2017.

 

Restructuring: Singapore or Australia?

In March 2017 Singapore enacted a raft of changes to its insolvency and restructuring laws, apparently with the intention of positioning itself as the dominant international debt restructuring jurisdiction for Asia.

There are two key components to the changes, which are operative from 23 May:

  • First, a move away from a predominantly informal framework to a Chapter 11-style regime, via a mechanism that Herbert Smith Freehills describe as a ‘turbo-charged Scheme of Arrangement.’
  • Secondly, adoption of the UNCITRAL Model Law on Cross-Border Insolvency, some twenty years after its introduction in 1997.

Despite its name, the Model Law does not actually prescribe an insolvency law template to apply across all jurisdictions – instead it prescribes processes for the recognition of whatever law applies in the ‘principal jurisdiction’ of an insolvent company. The end result is that the restructuring and insolvency regime of the principal jurisdiction is effectively ‘exported’ to the countries in which the business operates.

In adopting the Model Law, Singapore joins over 40 countries – a list that significantly, does not include either Hong Kong or China.

If the initiatives are successful, Singapore may displace the current incumbent – Hong Kong – as the predominant debt restructuring jurisdiction in the region. This raises the question: how can there be a choice as to which jurisdiction applies?

The answer is that the Model Law relies on an identification of the ‘centre of main interest’ (COMI) of the insolvent company, and then applies the law of the COMI jurisdiction.  In a world where operations may span across several countries, with multiple administrative locations, and shareholders and directors located elsewhere, identification of ‘the’ COMI may be far less black and white than some would think, and there may be more than one COMI to choose from.

It is in this context that Singapore has moved to create a regime that facilitates restructuring.  If the new restructuring regime becomes widely utilised through Asia, then there will be work opportunities for its professionals throughout the region.

Australia has just tabled legislation to implement a safe harbour protection for company directors of struggling companies and protect those companies from the risk of ipso facto termination of their contracts, discussed in more detail here.  When that legislation takes effect in mid-2018, where will we fit in the Hong Kong v Singapore battle?

To US investors and lenders seeking the familiar features of the Chapter 11 approach: cram downs, debtor in possession financing, and so on; Singapore may be the most attractive option.

But there is a notable divergence between the US regime and the Singapore regime, in the protection against ipso facto clauses: clauses which provide a contractual counter-party with the option to terminate if the other party to the contract becomes insolvent.  Chapter 11 provides a debtor with ipso facto protection however the Singaporean ‘turbo-scheme’ only imposes a temporary moratorium on the exercise of those rights.

The ipso facto protections in the yet-to-commence Australian regime are not just closer to the US model, in fact they will be arguably amongst the most comprehensive in the world.

For businesses where so much enterprise value is captured inside legal agreements – and therefore at risk if there is formal insolvency – that the ipso facto protection outweighs any other considerations, Australia may well be a better jurisdiction to restructure than Singapore.  It won’t be a surprise to see Australian restructuring lawyers making travel plans to visit offshore investors and owners, to explain the advantages that our modified regime will offer.

 

* There is one shortcoming: unfortunately it seems the protection will not apply to clauses in existence before the provisions come into effect, even if they are later modified.

Thanks to Michael Murray for his assistance especially with regard to UNCITRAL, and to Rachel Burdett-Baker for her helpful input and suggestions.

Referral to Senate Economics Committee – Safe Harbour & ipso facto

The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill – which is the legislation to implement the Safe Harbour and ipso facto reforms – was yesterday referred to the Senate Economics Legislation Committee.

Those seeking to have the scope or operation of the legislation modified have one more chance to put their arguments via a submission to the committee.

Submissions close 12 July 2017, with the committee due to report by 8 August 2017.

 

 

Arriving in Safe Harbour?

Legislation to implement the Safe Harbour and ipso facto protections was tabled in Parliament today, reflecting a rapid progression from the exposure draft released on 28 March 2017.

The legislation includes some adjustments to the original safe harbour proposals, and very significant and sensible changes to the original ipso facto protection proposals.

Those responsible for the drafting should be commended for the care that they have taken to avoid unintended consequences.

The Safe Harbour protection

The Safe Harbour reform is intended to address a concern that the risk of potential insolvent trading claims was forcing directors to place their companies into administration prematurely, rather than try to restructure them. There are those who will say they have never actually seen a premature administration – but we should not let that objection overshadow the fact that the reforms will certainly lead some directors to take better advice and a more systematic approach to a turnaround, and that has to be a good thing.

Technically the safe harbour protection is a ‘carve-out’ from the insolvent trading liability provisions and not a defence.  However, many will think of it as a defence, because it provides a practical and useful checklist of issues that company directors need to address to ensure that they are not caught by an insolvent trading claim for debt.  Notably, it provides protection only for debt incurred in connection with a course of action ‘reasonably likely to lead to a better outcome,’ and the protection ceases if that course of action ceases.

Well advised directors will create a document, probably specifically identified as a ‘Restructuring Plan,’ that will set out:

  • An objective – preferably a return to solvency or viability, but if not, the ‘better outcome’ that the legislation requires.  If it is a ‘better outcome objective, then presumably there will be an analysis comparing the planned outcome to the expected return from an immediate liquidation.
  • The steps that the directors have taken to ensure that they have taken advice from an appropriately qualified and properly informed adviser.
  • The reasons why the directors are able to conclude that they are properly informed about the financial position of the company, and what they will do to ensure that they remain properly informed.
  • The steps that the directors will be taking to ensure that there will be no misconduct ‘that could adversely affect the company’s ability to pay all its debts.’
  • The reasons why the directors are able to conclude that the company is keeping appropriate financial records, and how they will ensure that continues.
  • A set of actions to deliver the objective, to be undertaken by or under the supervision of the directors.
  • The process by which the directors will measure the effectiveness of the actions and review the plan to ensure that it continues to meet the safe harbour requirements.  Presumably there will be formal milestones, and a series of monthly (or more frequent) reviews involving the adviser if he or she is not directly involved in the turnaround.

The legislation does not provide any guidance as to what constitutes an ‘appropriately qualified’ adviser.  The explanatory memorandum says that the question is not ‘limited merely to the possession of particular qualifications,’ and references:

  • independence
  • professional qualifications
  • membership of appropriate professional bodies
  • professional indemnity insurance to cover the advice being given.

Those well advised directors will likewise avoid falling foul of the disqualifying criteria, by:

  • Paying employee entitlements as they fall due.
  • Keeping tax returns and lodgements up to date.
  • Submitting a Report as to Affairs in the event that the plan fails and the company later passes into formal insolvency administration.

Although the Court will have the discretion to excuse a disqualification, that will occur only in ‘exceptional circumstances’ or where it is ‘otherwise in the interests of justice,’ so clearly it would best to not have to make such an application!

Arguably the most significant development over the exposure draft proposals is an extension to now also provide a similar protection to the holding company of an insolvent subsidiary.

The safe harbour protections apply in respect of debt incurred after the commencement (the day after the amending Act receives Royal Assent) but take into account actions taken before commencement, which means that there will be no need for directors to reconfirm an existing restructuring plan on commencement.

Ipso Facto protection

A wide range of commercial contracts including franchise agreements, leases, licenses and supply agreements will include a clause that allows one party to terminate the agreement if the other party becomes insolvent – even if there is no other default.

Such ipso facto clauses mean that a business is at risk of disintegration if there is a formal insolvency appointment – at the very time when it is essential to try and maintain it as a going concern, to ensure ongoing employment for staff and the best return for creditors.

To address this, the reform proposals included a stay mechanism that would prevent the operation of such clauses. Whilst the exposure draft included a carefully defined and limited stay that would have had a very limited impact, pleasingly, the final version includes a considerably broader stay:

  • The stay will now also offer protection where a managing controller has been appointed – so long as the appointment is over ‘the whole or substantially the whole of the assets of the business.’
  • Perhaps most significantly, the stay will also provide far greater protection,  against termination based on the ‘financial condition’ of the company, with scope for further expansion of the protection by regulation.
  • For Schemes of Arrangement the stay will commence when a public announcement is made, rather than require the actual formal commencement of an application.

There have been other very significant changes:

  • Critically, a contractual right to terminate will be indefinitely unenforceable – even after the end of the stay.  This very important amendment means that an ipso facto clause will no longer provide the other party to the contract with a free option to terminate the contract at will.
  • The stay will not prevent a secured creditor from appointing a receiver after an administrator is appointed.  Whilst this may appear at odds with the purpose behind the stay, it is important because will eliminate a potential ‘first mover advantage’ that might otherwise have prompted secured lenders to seek a premature insolvency appointment.

The ipso facto stay will apply to rights arising under contracts entered on or after the commencement (i.e. 30 June 2018 unless there is an earlier proclamation).  Start- ups incorporated after that date will therefore have the full benefit of the changes.  Disappointingly, companies trading today will not receive ipso facto protection, unless they change suppliers or enter into a completely new contract.

Consultation: Reforms to address corporate misuse of the FEG scheme

On 2 May the Senate Inquiry into Superannuation Guarantee Non-Payment released its final report (available here), discussed here.

For restructuring and turnaround practitioners one of the noteworthy recommendations was that:

the government consider amending the Corporations Act to ensure that the priorities in section 556 apply during all liquidations, regardless of whether the business being liquidated was operated through a trust structure.’

Only a fortnight later, the government has released a Consultation Paper: Reforms to address corporate misuse of the FEG scheme.  Pleasingly, one of the issues raised is whether that Inquiry recommendation should be implemented, and so there is the possibility that the law will be amended a great deal more quickly than anyone expected.

Other significant areas of potential reform include:

  • Possible amendments to the Corporations Act so that receivers and liquidators may not deduct any part of their general costs from the proceeds from of realisations of circulating assets – unless employee entitlements have been paid in full.
  • Changes to reinvigorate section 596AB, which has not been used in litigation since its introduction in 2000. Section 596AB provides for criminal prosecution and civil recovery against someone who enters into a transaction with the intention of avoiding the payment of employee entitlement liabilities.  Options here include:
    • Changing the ‘fault element’ from ‘intention’ to ‘recklessness.’
    • Increase the maximum penalty for criminal convictions.
    • Sidestepping the difficulties with proving intent by adding a civil penalty provision based on an objective test.
  • Allowing parties other than a liquidator to initiate recovery action: including FEG, and in some specific circumstances, the Fair Work Ombudsman or the ATO.
  • Preventing abuse of corporate group structures, possibly by implementing a contribution regime similar to that in New Zealand – where parties may apply to Court for a ‘contribution order’ against solvent group members, where it is just and equitable to do so.
  • Modifying the existing director disqualification provisions to target behaviour which impacts FEG – for example reliance on the FEG scheme to pay redundant workers their outstanding employee entitlements where there is minimal or no return of the FEG advances on two more occasions.

However, there are other issues which could helpfully be addressed:

  • The ‘traditional’ view was that a liquidator’s job was to convert all assets into cash, and then allocate that fund in accordance with the priorities in section 556.  A more recent alternative suggests that the section 556 priorities be applied in real time.  That theory arguably results in the difficult proposition that a liquidator should close a business down rather than risk employee entitlements in trading a business on – even to achieve a sale which might avoid the need to pay entitlements at all!
  • Another problematic area is the question as to whether trading losses should be allocated against the circulating or non-circulating asset pools.  Sometimes businesses are knowingly traded at a loss, to improve circulating asset recovery such as the conversion of WIP, or collection of debtors – however there seems to be a view more recently expressed that trading losses should not be allocated against circulating assets.

Interested parties are invited to make a submission by Friday, 16 June 2017.

 

Keep Calm and Follow the (Insol) Rules

This week Insol International – which represents more than 40 national associations and more than 10,000 restructuring professionals – released an updated Statement of Principles for a Global Approach to Multi-Creditor Workouts.

The new release reflects the contributions of Australian workout bankers: Jacinta Nielsen, Gwyn Morgan, Ian Copp and Tim Williams.

The SoP have their genesis in the so-called ‘London Rules.’  Ironically, as Pen Kent, former Executive Director of the Bank of England has explained, at first there were no written rules.  Instead the Bank of England promulgated an ‘unwritten, flexible framework’ with divergence addressed by ‘fireside chats.’

Pen Kent described the four central tenets as:

  • banks should remain supportive on hearing that a company to which they have an exposure is in financial difficulty. In practice, this means that they keep their facilities in place and do not appoint receivers;
  • decisions about a company’s longer term future should only be made on the basis of comprehensive information, which is shared among all the banks and other parties to a workout;
  • banks work together to reach a collective view on whether and on what terms a company could be given a financial lifeline; and,
  • the seniority of claims continues to be recognised, but there has to be an element of ‘shared pain’ i.e. equal treatment for all creditors of a single category.

Notwithstanding the Bank of England’s original intention to avoid written rules, with BoE endorsement, Insol issued the first SoP in October 2000.

The 2016 update does not make major change to the 2000 version:  the most significant amendment is an addition to the second principle “Conflicts of interest in the creditor group should be identified early and dealt with appropriately.”

It must be said that the apparent simplicity of that statement belies the practical extent of the challenge.  Today’s multi-creditor workout can involve parties whose focus is a loan-to-own strategy, which may require an actual or likely default.

There are those who say that a loan-to-own restructuring leads to a more rapid and more economically efficient operational turnaround, and that equity holders who facilitate that are entitled to a commensurate economic return.  My purpose is not to argue one way or the other, but rather to recognise that there is the potential for two mutually exclusive strategies to be in play, and that consequently, resolving such conflict may well be easier said than done!

 


The 50 page Statement of Principles for a Global Approach to Multi-Creditor Workouts II is available here, the principles themselves are:

FIRST PRINCIPLE: Where a debtor is found to be in financial difficulties, all relevant creditors should be prepared to co-operate with each other to give sufficient (though limited) time (a “Standstill Period”) to the debtor for information about the debtor to be obtained and evaluated and for proposals for resolving the debtor’s financial difficulties to be formulated and assessed, unless such a course is inappropriate in a particular case.

SECOND PRINCIPLE: During the Standstill Period, all relevant creditors should agree to refrain from taking any steps to enforce their claims against or (otherwise than by disposal of their debt to a third party) to reduce their exposure to the debtor but are entitled to expect that during the Standstill Period their position relative to other creditors and each other will not be prejudiced. Conflicts of interest in the creditor group should be identified early and dealt with appropriately.

THIRD PRINCIPLE: During the Standstill Period, the debtor should not take any action which might adversely affect the prospective return to relevant creditors (either collectively or individually) as compared with the position at the Standstill Commencement Date.

FOURTH PRINCIPLE: The interests of relevant creditors are best served by co-ordinating their response to a debtor in financial difficulty. Such co-ordination will be facilitated by the selection of one or more representative co-ordination committees and by the appointment of professional advisers to advise and assist such committees and, where appropriate, the relevant creditors participating in the process as a whole.

FIFTH PRINCIPLE: During the Standstill Period, the debtor should provide, and allow relevant creditors and/or their professional advisers reasonable and timely access to, all relevant information relating to its assets, liabilities, business and prospects, in order to enable proper evaluation to be made of its financial position and any proposals to be made to relevant creditors.

SIXTH PRINCIPLE: Proposals for resolving the financial difficulties of the debtor and, so far as practicable, arrangements between relevant creditors relating to any standstill should reflect applicable law and the relative positions of relevant creditors at the Standstill Commencement Date.

SEVENTH PRINCIPLE: Information obtained for the purposes of the process concerning the assets, liabilities and business of the debtor and any proposals for resolving its difficulties should be made available to all relevant creditors and should, unless already publicly available, be treated as confidential.

EIGHTH PRINCIPLE: If additional funding is provided during the Standstill Period or under any rescue or restructuring proposals, the repayment of such additional funding should, so far as practicable, be accorded priority status as compared to other indebtedness or claims of relevant creditors.

 

Poles & Underground

One of the issues raised in the Carnell Report – or more correctly, the ASBFEO Small Business Loans Inquiry Report – was a concern about a perceived conflict of interest arising from investigating accountants being subsequently appointed as receivers.

The report noted that “Some, who submitted to the Inquiry, are concerned about the investigating accountant’s ability to recommend a course of action, such as a receivership, and then being appointed by a creditor to that role.”

To address the concern the report recommended:

(R10) “Banks must implement procedures to reduce the perceived conflict of interest of investigating accountants subsequently appointed as receivers. This can be achieved through a competitive process to source potential receivers and by instigating a policy of not appointing a receiver who has been the investigating accountant to the business.”

Those whose responses to R10 argued against the mandatory appointment of a ‘stranger’ because of the additional costs and disruption to the management of the business will be interested in a recent decision of the Federal Court: Walley, in the matter of Poles & Underground Pty Ltd (Administrators Appointed).

It appears (it is not completely clear from the judgement) that it was the directors of a company who appointed as administrators two restructuring & turnaround practitioners that had previously conducted an independent business review for the company’s bank.

Prompted by a question at a creditors meeting the administrators (by then the liquidators) had recognised a potential conflict of interest, and quite properly applied to Court for directions, at their expense.

Noting that the liquidators had already repaid their fees for the IBR engagement, and that no creditor had raised any objection, the Court allowed the liquidators to continue in that role because the liquidators’ ‘substantial knowledge’ of the affairs of the company was ‘likely to assist in the efficient conduct of the liquidation’ and would be a benefit to creditors as a whole.