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:
- 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.