Restructuring Reforms: Safe Harbour and ipso facto

On 28 March 2017 the government released draft legislation for comment, to implement the Safe Harbour and ipso facto reforms, available here.

Safe Harbour proposal – simple, practical and useful

The Government has opted for a carve-out from the civil insolvent trading provisions – a ‘model B’ approach.

Directors will have a ‘safe harbour’ unless it can be shown that they had failed to start a course of action “reasonably likely to lead to a better outcome for the company and its creditors as a whole.”

That immediately raises the question: how will we know whether a course of action is reasonably likely to lead to a better outcome?  Helpfully, the draft legislation set outs what amounts to a checklist for directors, as to whether they are:

  • taking appropriate steps to prevent misconduct that could affect the company’s ability to pay all its debts.
  • taking appropriate steps to ensure that the company is keeping appropriate financial records.
  • obtaining appropriate advice from an appropriately qualified person holding enough information to give appropriate advice.
  • is properly informing themselves of the company’s financial position.
  • is developing or implementing a plan for restructuring the company to improve its financial position.

There is disqualifying criteria: if the company is fails to provide appropriately for employee entitlements, or fails to attend to its obligations to lodge income tax returns or other tax lodgements then the safe harbour is not available – so we can add those to the checklist too.

Ipso Facto – Linkage to an appointment type rather than a state of insolvency?

The draft legislation provides a very precisely phrased stay, which blocks termination on the grounds of two specific types of formal insolvency appointment: voluntary administration and schemes of arrangement.

The legislation is silent about a termination on the grounds of insolvency.  There is an argument that a termination on the grounds of insolvency – which is actually evidenced by the appointment of an administrator – is unaffected by the stay.

Termination at will remains

The implementation of a stay on ipso facto clause enforcement will make it easier for a voluntary administrator to keep a business together – an enhancement over and above the current moratorium – by preventing the termination of contracts simply by reason of the appointment.  But the stay will end when the administration ends, meaning that the underlying insolvency event will provide the other party to the contract with a free option to terminate the contract at will.  Knowing, for example, that a landlord will be able to terminate a lease if they ever receive a better offer will make it challenging to raise finance, secure equity or sell a business.

The better option would be to make the stay permanent, or introduce some kind of override so that if the insolvency has been cured by a restructuring, then it can no longer be relied upon for the purposes of an ipso facto clause enforcement.

Extension to schemes of arrangement

In a theoretical sense the extension of the ipso facto stay to Schemes of Arrangement is significant, because unlike voluntary administration there was no moratorium. In practice however this change will have little impact, because schemes are so slow and so hideously expensive that they are used only infrequently, to restructure the very largest companies.

No ipso facto stay for receiverships

The proposals do not extend the ipso facto stay to receiverships.  Secured creditors will consider whether it is possible to access the stay by the parallel appointment of an administrator, just as they do now to access the voluntary administration moratorium, but [as Paul Apathy has pointed out] this may not be viable.  A better option would be a stay which applies to insolvency rather than nominated appointment types.  Not only would that apply the benefit of the stay to all forms of appointment type, it would avoid an argument that termination on the grounds of insolvency was unaffected.

Impact on a secured lender’s ability to appoint a receiver

In the 2015 NSW Supreme Court Bluenergy decision, discussed in more detail here the Court held that a deed of company arrangement limits a secured creditor’s security to those assets existing when the deed took effect – which means that the charge will no longer capture “future assets” (such as the receivable that is created when stock  is sold).

As a result, the assets captured by a secured creditor’s security will steadily diminish over time.  Currently, secured creditors can avoid the risk of diminution by appointing a receiver when a voluntary administrator is appointed, but they must do so within the 10 day decision period set out in section 441A.

The proposals appear to stop secured creditors making such appointments if relying solely on the grounds of the appointment of a voluntary administrator.

Secured creditors concerned that there is a risk that their security is trapped within a deed of company arrangement may decide that it is in their interests to:

  1. Decline to waive defaults, so that they will not need to rely on an insolvency event to make an appointment
  2. Take care not to alert borrowers that an appointment is possible
  3. Seek to appoint receivers at an earlier stage, to avoid the risk that directors might “beat them to” an appointment.

In other words there is risk that measures intended to promote restructuring may provide secured lenders with reasons to refuse to waive defaults, be cautious about communicating their concerns, and appointing receivers at an earlier time.

Ipso facto commencement

It is proposed that the stay will apply only to contracts entered into after 1 January 2018.  It will therefore operate fully for businesses that start up after that date, but for existing businesses there may be a very gradual transition.

Overall

The draft legislation has appeared earlier than expected, with a short timetable for implementation – it is proposed that the new laws will take effect from 1 January 2018 – which is welcome.  My view is that the safe harbour mechanism is very useful and very practical.  The ipso facto regime has great potential, but there are a number of issues requiring further consideration and analysis, most notably the closing the gap which currently provides counterparties with a free option to terminate at will – even after insolvency has been cured.

The closing date for submissions on the proposals is Monday, 24 April 2017.

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