The National Innovation Agenda – improving Australia’s bankruptcy and insolvency laws

On 29 April 2016 the Federal Government released a Proposals Paper which follows up on the National Innovation Agenda commitment to improve Australia’s bankruptcy and insolvency laws.

There are three areas of focus:

Reducing the default bankruptcy period from three years to one year

The proposal is more nuanced than a simple reduction in the bankruptcy period.  Critically, the Income Contribution regime will continue to apply for three years i.e. potentially for two years after the bankruptcy itself has ended.  However, there would be no restrictions on overseas travel or incurring credit after the initial twelve month period had expired.

The trustee will retain the ability to object to the bankrupt’s automatic discharge – thereby extending the period of bankruptcy to eight years – but it appears that it would be necessary to file that objection in the initial twelve month period.  Such a change will mean that trustees need to accelerate their investigation to ensure that misconduct is identified before the initial period expires.  It may also mean that in the last two years trustees must collect information and contributions without the benefit of what is currently an inexpensive and practical avenue to ensure compliance.

Safe Harbour

The current insolvent trading regime imposes personal liability on company directors if their company incurs credit whilst it is insolvent.  The practical effect of the regime is that it provides a strong incentive for company directors to place an insolvent company (or a company that may become insolvent) into administration – even though a restructure might offer the prospect of a better return to creditors.

The proposal outlines two alternative methods of dealing with that statutory conflict of interest.  The first approach – Model A – will create a “safe harbour” by establishing an additional defence to the current insolvent trading regime, whereas Model B will create a safe harbour by identifying circumstances in which the insolvent trading regime will not apply.  Probably more significantly, Model A requires the directors to formally engage a “restructuring adviser,” whereas Model B does not.

My own experience with large corporate turnarounds is that the range of issues can be very broad – from balance sheet restructure to operational turnaround – and that in many cases there will be a team of advisers assisting the directors rather than a single person.   I believe that the focus should be on what the directors do, rather than whom they appoint,

A process that requires the appointment of a restructuring adviser will almost certainly trigger the rigorous continuous disclosure requirements that apply to ASX listed companies.  This will present additional challenges in a restructuring because publicity about possible financial difficulties can become self-fulfilling as suppliers rein in credit terms, and customers take their business elsewhere.  For this reason it is important that any Model A approach also includes a prohibition on disclosure, otherwise there is the risk that directors of ASX listed companies will not take advantage of the safe harbour.

Ipso facto clauses

Ipso facto or insolvency event clauses allow contracts to be terminated if there is an insolvency appointment, even if there is no other breach of the contract.

In my view, restricting the operation of ipso facto clauses is the most significant of the proposed reforms because it will make it far easier for administrators and receivers to maintain a business as a going concern without losing the benefit of key contracts

It is essential that the restriction be permanent rather than a temporary stay (which in any event is the current position for voluntary administration), otherwise there is the risk that the clause can be invoked even after the insolvency has been ‘cured’ by a restructuring.

One of the key questions is whether the restriction on ipso facto clauses would operate to prevent a secured lender from appointing a receiver.   Lenders will often waive defaults under loan agreements in the knowledge that the insolvency ground will provide a ‘reserve’ capacity to act.  If the ipso facto restriction eliminates that reserve capacity, then secured creditors may be less willing to waive defaults – which would be problematic for both directors and auditors.    Clearly I have an interest in this point, but it would be disappointing if a law reform intended to encourage restructuring instead had such an effect

The government is seeking feedback by Friday 27 May.  I encourage everyone with an interest in the area to read the Proposals Paper and respond on points that concern them.  For more information: see here.