1 year Bankruptcy and Debt Agreement Reform: The Senate Committee Reports

Today the Senate Standing Committee on Legal and Constitutional Affairs issued reports about two separate bills, both intended to reform personal insolvency regimes.

Debt Agreement Reform

Importantly, the Bankruptcy Amendment (Debt Agreement Reform) Bill 2017 (discussed in more detail here) will strengthen the regulation of Debt Agreement Administrators, more closely aligning it to the regulation of bankruptcy trustees.

Another, seemingly less well understood aspect will limit the length of payment arrangements to three years. It is a well intentioned measure, but there is a risk that in practice it will operate to restrict a debtor’s ability to negotiate a Debt Agreement, because many creditors will not vote for a proposal unless it meets a minimum return requirement.

In the Inquiry hearings, one Debt Agreement Administrator referenced a minimum return requirement of 60 cents in the dollar. Using this as an example, a DAA would tell an debtor with liabilities of $70,000 that they need to create a fund of $42,000. A debtor with capacity to contribute $2,000 per month would be able to do this in 21 months – within the proposed three year limit, but a debtor who could only contribute $1,000 per month would need 42 months – outside the three year limit.

It may be that creditors will reduce their minimum return requirements, but if they do not, a measure presumably intended to offer debtors relief may operate in practice to stop some of them from entering into a Debt Agreement at all.

One Year Bankruptcy

The Bankruptcy Amendment (Enterprise Incentives) Bill 2017 (discussed in more detail here) will shorten the default bankruptcy term from three years to one year.

The proposal echoes a previous initiative which allowed some bankrupts to apply for discharge after six months. That measure was scrapped in 2001 due to concerns that early discharge did ‘not reflect the serious nature of the decision to become bankrupt’ and that an ‘easy way out’ acted to ‘discourage debtors from trying to enter formal or informal arrangements with their creditors to settle debts.’

The Government proposes to maintain the current three year term of the income contribution regime – ie two years post-bankruptcy – but will leave trustees without any practical measures to collect information about a debtor’s income in the two years after discharge. Without that information the trustee will be unable to calculate income contributions, none will be collected, and so returns to creditors will diminish.

The Report

The report (available here) does recognise that these issues, and others, were raised in the various submissions – but gives higher weighting to the original policy intentions. The committee recommended:

that the Government give positive consideration to ASIC greater scope to impose director disqualifications, discussed in more detail here.
that the government consider amending the debt agreement reforms to allow debt agreements implemented under a three year cap to be extended by up to two years, by agreement.
identification of a range of specific factors that should be taken into account when setting a maximum payment to income ratio for a debt agreement.
that with those adjustments made, the legislation should be passed.

Other posts about the Bankruptcy and Debt Agreement reforms:

Back where we started? Director disqualification

Last week the Senate Standing Committee on Legal and Constitutional Affairs conducted joint hearings into two separate pieces of personal insolvency legislation. One Bill (discussed here) is intended to implement Debt Agreement Reform and align the regulation of Debt Agreement Administrators to the regulation of bankruptcy trustees, the other will shorten the default bankruptcy term to one year.

Reducing the bankruptcy term to twelve months will implement the second and last stage of the 2016 National Innovation Agenda – improving Australia’s bankruptcy and insolvency laws program (the first stage was the Safe Harbour and ipso facto reform legislation, discussed here).

According to the original proposal paper the one-year bankruptcy measure is intended to promote entrepreneurship by reducing the penalty and stigma associated with business failure.

Notably, although the bankruptcy term will be reduced to one year the income contribution regime will continue to apply for three years – presumably reflecting an intention to maintain returns for creditors. However, as discussed in Q: How does a 3 year contribution regime fit into a 1 year bankruptcy? A: badly in practical terms a bankruptcy trustee will have very limited options to deal with a former bankrupt who ignores requests for information about his or her income, and so it is likely that a one year term will reduce returns to creditors.

Government submissions on the Government proposals

It seems that there are other concerns. The Australian Criminal Intelligence Commission made a submission which referred to intelligence suggesting:

“reducing the default bankruptcy period from three years to one year may increase the potential for serious and organised crime groups to exploit bankruptcy provisions for their own advantage.”

ASIC also made a submission expressing concern about what it described as the ‘possible unintended consequences’ of the proposed changes. It seems that the measures identified in the original proposals paper as a problematic ‘penalty and stigma’ are measures that the corporate regulator regards as sound policy, intended to keep an unsuitable person away from the ‘controls’ of a company, as well as to provide a deterrent effect.

ASIC told the inquiry that their enforcement activity took into account the fact that bankruptcy triggered an automatic three year director disqualification. They said that if the ‘automatic’ disqualification was reduced to only one year then they might need to take more active steps to seek longer disqualifications, and might ask Parliament to amend the Corporations Act ‘to extend the period of automatic disqualification where the person is an undischarged bankrupt.’

Right back to where we started from?

ASIC provided more detail at the Sydney hearing (the transcript is here). They propose that:

A person who becomes bankrupt should be unable to act as the sole director of a company for three years.
There should an extended disqualification period for ‘egregious conduct.’ It was not clear whether this would apply only to bankrupt directors, or to all directors.
Automatic disqualification should be applied to those involved in ‘repeat conduct’ – four corporate failures in seven years. Again, it was not clear whether this measure would relate to all directors or only bankrupt directors.

Implementation of the ASIC proposals would reverse some of the effects of the proposed bankruptcy changes. The net result would be measures that are a little more targeted, but some would argue that the overall outcome would be close to the position as it is today: back where we started from.

Submission to the Legal & Constitutional Affairs Legislation Committee Inquiry into the Bankruptcy Amendment (Enterprise Incentives) Bill 2017

This is a copy of my submission to the Legal and Constitutional Affairs Legislation Committee Inquiry into the Bankruptcy Amendment (Enterprise Incentives) Bill 2017

Background

The amendments will reduce the default bankruptcy period from three years to one year, which is intended to ‘reduce stigma, encourage entrepreneurs to re-engage in business sooner and encourage people…to pursue their own business ventures.’

The ending of bankruptcy means that a debtor regains legal capacity to travel overseas, act as a director of a company, and incur credit without giving notice of their bankruptcy. As a consequence of the amendment, debtors will regain that capacity two years earlier than they do currently.

The income contribution regime – which currently ends when bankruptcy ends – will be extended to apply for two years beyond bankruptcy. This will maintain the current three year income contribution regime, presumably intended to ensure that the return to creditors is not reduced by the shorter term.

Bankruptcy trustees can only issue an ‘objection’ – which extends bankruptcy – during a bankruptcy. In the two year post-bankruptcy period trustees will therefore be unable to respond to the non-delivery of information or non-payment of contributions by lodging an objection, as they do now.

The effect of the amendments is therefore to remove the very effective and low cost administrative enforcement mechanism by which trustees currently deal with non-compliance in the last two years of the income contribution regime. The only course of action available to trustees will be to report non-compliance with the Bankruptcy Act to the Australian Financial Security Authority (AFSA) for prosecution.

Issues with the legislation as drafted

There are no anti-abuse protections – There are no restrictions on access to the shorter period, and no limitation on the number of times a person may access the shorter period.If the one-year bankruptcy is available without restriction then we risk a new form of ‘phoenixing’ whereby individuals incur credit, declare bankruptcy and then one year later repeat the cycle for as long as they wish.
Impact on the workload of AFSA, the DPP, and the Court System – Only a minority of bankrupts will have an actual liability to pay income contributions, but all bankrupts have an obligation to provide information so that an assessment can be undertaken. The course of action that was previously a last resort – referral to AFSA – will be the only available course of action for a trustee to deal with non-provision of information. In that sense the amendments will operate to effectively ‘criminalise’ non-compliance.If referral to the AFSA is necessary for only 2% of the more than 50,000 current bankrupts, there will be at least 1,000 referrals to AFSA for action by the Department of Public Prosecution, each year. It would be an unintended and regrettable consequence if other more serious offences were not properly addressed because DPP and Court resources were unnecessarily diverted.
Lower returns to creditors – Unless AFSA is able to action each and every referral on a timely basis – which seems unlikely – then income contribution collections will diminish. If it becomes widely known that non-compliance is not addressed on a consistent and timely basis then there is the risk that overall compliance will worsen, compounding the original problem.In other words, it seems likely that there will be an adverse effect on returns to creditors.

Suggested solutions

There is no compelling policy justification to proceed with the proposed shortening of the bankruptcy period – and there is a superior policy-based option.

A more direct path to achieve the legislators’ intention

It is not necessary to shorten the bankruptcy period to allow individuals to act as a director, travel overseas, and incur credit. The simplest and most direct way to achieve this is to amend the Bankruptcy Act (and the Corporations Act as regards capacity to act as a director) so that they may do whilst bankrupt, after twelve months have expired.

This would mean that the term of bankruptcy and the term of the income contribution regime would continue to align. This would preserve the current utility of the objection-to-discharge process, thereby maintaining returns to creditors without a significant uplift in the referral of Bankruptcy Act offences to AFSA.

Such a legislative change would clearly contribute to de-stigmatising bankruptcy.

However, if the bankruptcy period is to be shortened, then there should be:

Anti-abuse protections

If the shorter bankruptcy period is introduced then there should be some restriction on a debtor’s ability to access the shorter bankruptcy period, to avoid abuse – including the possibility of personal ‘phoenixing.’

I suggest that a debtor should not be permitted to access the shorter bankruptcy period more than once every ten years – except with the consent of the Court.

Additional administrative remedy to address non-compliance

If the income contribution regime is to extend beyond the term of bankruptcy then we should look for a low-cost administrative process by which trustees can address the non-provision of information or non-payment of contributions, to avoid excessive additional workload for the AFSA, the DPP, and the Court System, and diminution of returns to creditors.

For example, granting bankruptcy trustees the power to issue a notice to a debtor which clearly identifies any non-compliance with the income contribution regime. On receipt of such a notice, the debtor loses the capacity to act as a director, travel overseas, and incur credit (i.e. the current position), until they have remedied the non-compliance.

As a safeguard against misuse, such a regime should be subject to appeal to the Administrative Appeals Tribunal and/or the Inspector-General in Bankruptcy, to provide affected debtors with access to a low cost dispute resolution process.

For some comments on the draft legislation see here.

For my commentary on the Bankruptcy Amendment (Debt Agreement Reform) Bill 2018, also referred to the Senate Standing Committees on Legal and Constitutional Affairs, see here.

Q: How does a 3 year contribution regime fit into a 1 year bankruptcy? A: badly

The legislation to shorten the default bankruptcy term to one year will maintain the three year term of the current income contribution regime. There is no particular policy reason why the two should align, and presumably those responsible believed that maintaining the three year period would maintain returns to creditors.

However, ending bankruptcy at the one year mark will remove a key point of leverage which assists trustees with the collection of information – and income contributions. The absence of any replacement mechanism means that unless there is significant additional resourcing to AFSA’s enforcement function, returns to creditors probably will be affected.

Collection of information

Not all bankrupts will have a liability to pay income contributions – in fact, most will not, but all bankrupts have an obligation to provide information so that the trustee can complete an income contribution liability assessment.

Currently if a bankrupt does not provide the information, the normal course is to file an objection to discharge which extends the term of bankruptcy; usually reversed when the information is received. The more draconian step – which trustees avoid if possible – is to ask the Australian Financial Security Authority (AFSA) to prosecute the debtor.

With the income contribution regime extending beyond bankruptcy, trustees will no longer have the ability to extend bankruptcy after the first twelve months. Because the legislation does not introduce any replacement mechanism, the only course of action available to trustees will be to report non-compliance with the Bankruptcy Act to AFSA for prosecution, in effect ‘criminalising’ non-compliance that was previously dealt with administratively.

How often will trustees need to request prosecution?

It seems likely that under the new model there will be greater non-compliance with the rules to provide information:

There will be some debtors who will not realise that they need to notify the trustee of a change of address after bankruptcy, who will simply be uncontactable.
There will be some debtors who won’t open or read correspondence from their trustee, because they are no longer bankrupt.
There will be those who – regardless of the the truth of the statement- will follow the advice of the unscrupulous non-mainstream advisers – to just ignore any correspondence because “the trustee can’t do anything about it.”

If referral to the AFSA is necessary for only 2% of the more than 50,000 current bankrupts, there will be at least 1,000 referrals to AFSA for action by the Department of Public Prosecution, each year.

Perhaps AFSA will have capacity to deal with each and every referral, but if not, returns to creditors will be adversely affected.

Possible Alternatives

If the objective is to allow individuals to act as a director, travel overseas, and incur credit within 12 months of being made bankrupt, then the simplest and most direct way to achieve this is to amend the relevant legislation to permit it – there is no need to shorten the term of bankruptcy.

Such a legislative change would clearly contribute to de-stigmatising bankruptcy.

However, if the length of bankruptcy must be shortened then we should look for a low-cost administrative process by which trustees can address the non-provision of information or non-payment of contributions. This would avoid excessive additional workload for the AFSA, the DPP, and the Court System, and likewise avoid diminution of returns to creditors.

For example, trustees could be given the power to issue a ‘non-compliance notice.’ On receipt of such a notice, the debtor loses the capacity to act as a director, travel overseas, and incur credit (i.e. the current position), until they have remedied the specified non-compliance.

As discussed here, the draft legislation is subject to review by the Senate Standing Committees on Legal and Constitutional Affairs. Submissions can be lodged via the process explained here, but must be received by 31 January 2018.

Commentary on the Bankruptcy Amendment (Debt Agreement Reform) Bill 2018, also referred to the Senate Standing Committees on Legal and Constitutional Affairs is here.

A copy of my submission is here.

Building a better buggy whip? The Debt Agreement Reform legislation

On 7 December the Senate referred an exposure draft of the Bankruptcy Amendment (Debt Agreement Reform) Bill 2017 to its Legal and Constitutional Affairs Legislation Committee.

From their introduction in 1996, Part IX Debt Agreements have provided individuals with a low-cost alternative to bankruptcy. Part of the cost saving structure was a mechanism that operated without the involvement of Bankruptcy Trustees, and it seems that it was originally anticipated that Debt Agreements would be implemented and managed by debtors themselves, their friends or relatives, or by not-for-profit financial counsellors.

In fact, commercial operators leapt into the vacuum, and a new industry was created. Probably in part due to aggressive promotion by those commercial operators, as Michael Murray has identified, today Part IXs almost rival bankruptcy in popularity.

There was significant reform in 2007, with changes intended to adjust the regime to reflect the widespread involvement of commercial operators. These latest reforms (draft legislation available here) some ten years later will further regulate those commercial operators, but there are other, significant changes.

Access to the Part IX process

Probably the most important change is a very significant expansion of access – the maximum asset limit will be doubled, to $223,350.

Restrictions on debtor contributions

Another significant change is the introduction of limits on debtor contributions, with a limit on the time frame over which payments can be made – 3 years – as well as a percentage limit (not yet set) referenced against the debtor’s income. Those limits will apply to original proposals and any later variations. The Official Receiver will also have a new power to reject proposals even within these limits if they would cause ‘undue hardship’ to the debtor – although this is to be used only in ‘exceptional circumstances.’

Alignment to bankruptcy

There are a number of changes that will align the regulation of Debt Agreement Administrators to the regulation of Bankruptcy Trustees. Debt Agreement Administrators will be required to:

Consider whether a debtor has committed any offences under the Bankruptcy Act and, if so, refer the matter to the appropriate authority.
Follow the same funds handling procedures as Bankruptcy Trustees, with failure to constitute an offence.
Maintain ‘proper books and records’ to the same standard as Bankruptcy Trustees, with failure to constitute an offence.
Obtain and maintain appropriate professional indemnity insurance to the same level as Bankruptcy Trustees.
Refrain from charging expenses to the debt agreement fund unless there is specific prior disclosure in the Debt Agreement.

The Inspector-General’s investigation and inquiry powers will be extended to encompass ‘any conduct of a Debt Agreement Administrator’ and the grounds on which the IG can issue a ‘show cause’ notice – seeking a written justification of continued registration – will also be expanded.

Brokers, referrers, and conflicts of interest

The explanatory memorandum refers to concerns that ‘an unscrupulous administrator is in a position to exploit a debtor’s lack of knowledge,’ and several measures appear intended to address this:

Proposed Administrators will be required to disclose broker or referrer information to the debtor, and creditors.
The Debt Agreement Administrator and related entities will be unable to vote on the acceptance of the proposal, or any resolution to modify or terminate the debt agreement.
It will be an offence for a Debt Agreement Administrator to provides creditors with an incentive to vote in a certain way.
Debtors will be able to seek termination of the debt agreement where an administrator has committed a breach of duty.

Professionals only!

The industry will be fully professionalised – only a registered Debt Agreement Administrator or registered Bankruptcy Trustee will be able to administer a debt agreement – but this is really only a symbolic change, because in practice these are the only parties who do such work now.

A better buggy whip?

The changes impose additional work on Debt Agreement Administrators, most notably the requirement to investigate and report offences. That additional work will probably translate to additional costs, which will be charged to the deed fund and ultimately be borne by creditors. Whilst that represents a shift away from the low cost objective that led to the introduction of Part IX, it is otherwise hard to argue against changes which do no more than align to the standards currently imposed on Bankruptcy Trustees.

But however worthwhile the changes are, they may have limited practical impact. If the one-year bankruptcy discussed here is implemented then it is hard to see why many debtors would bother with a Debt Agreement. It seems likely that the unscrupulous ‘non-mainstream advisers’ will tell their clients that they can simply ignore any efforts that a bankruptcy trustee will make to assess and collect income contributions in years two and three – which means that a twelve month bankruptcy will be not only far quicker but also far ‘cheaper’ than a three-year debt agreement.

Submissions

The committee is seeking submissions by 16 February to gather stakeholder feedback on ‘issues of concern’ and to allow the committee ‘to consider expert views on impacts,’ and is due to report by 19 March 2018.

Update: The first (and only, at the date of writing) submission to the inquiry, by Vivien Chen, Lucinda O’Brien and Ian Ramsay, provides a link to their thoughtful & structured analysis on insolvency reform. ‘An Evaluation of Debt Agreements in Australia’, available here.

Detoured? One year bankruptcy referred to committee

In one sense it is surprising that the Senate referred the Bankruptcy Amendment (Enterprise Incentives) Bill 2017 to Committee on 30 November 2017. The tiny Bill (only ten pages long) really only contains one measure – shortening the statutory bankruptcy period from three years to one year – which presumably Senators either support, or not. But the legislation was tabled in Parliament without any prior consultation, and so consultation now via the committee process is welcome, and appropriate.

The reduction in the bankruptcy period means that unless an objection is lodged, bankruptcy will end after twelve months. Individual debtors will then again be able to act as a director of a company, travel overseas, and incur credit without having to disclose bankruptcy. Significantly though, they will remain subject to the income contribution regime for three years, as is now the case.

The legislation implements the final phase of the 2016 National Innovation Agenda – improving Australia’s bankruptcy and insolvency laws proposals paper, discussed here, intended to promote entrepreneurship by reducing the penalty and stigma associated with business failure. Notably, despite being intended to reduce stigma associated with business failure, the shorter term will apply to all bankrupts – not just the circa 16% (per the September 2017 quarter statistics) who are business bankrupts.

The major criticisms of the changes are:

It will make bankruptcy ‘too easy’ – Debtors may be tempted to incur additional credit to update household items or take a holiday, knowing they can declare bankruptcy rather than repay. Notably, there are no anti-abuse mechanisms to limit access to the shorter period – for example to first time bankrupts only.
Trustees will not have enough time to properly investigate a bankrupt’s affairs and file an objection to extend bankruptcy, before the twelve months expires.
Collecting contributions after bankruptcy has ended will be more difficult and more expensive. In practical terms the ‘threat’ of an objection is a simple and inexpensive leverage point for trustees to calculate and collect income contributions.
There is no grandfathering – perhaps surprisingly, bankruptcies on foot at the commencement date will be shortened to the twelve month term – and so the changes will have retrospective effect.

The deadline for submissions to the inquiry is 31 January 2018.

An earlier post on this topic: Shortening Bankruptcy

Comment on the draft legislation is here and a copy of my submission is here.

For my commentary on the Bankruptcy Amendment (Debt Agreement Reform) Bill 2018, also referred to the Senate Standing Committees on Legal and Constitutional Affairs, see here.

Shortening Bankruptcy

Bankruptcy reform legislation, available here, was today tabled in Federal Parliament – notably without the prior release of an exposure draft.

The legislation addresses the second and last part of the reforms outlined in the 29 April 2016 National Innovation Agenda – improving Australia’s bankruptcy and insolvency laws proposals paper, discussed here.

The headline measure is a two-year reduction in the period for which a person is ordinarily bankrupt.

Currently an individual debtor will be bankrupt for a three year period, which can be extended by two or five years (depending on the severity of the ‘wrongdoing’) if the trustee lodges an ‘objection to discharge:’ a total of five or eight years.

The reform will shorten the initial term to one year, however the objection increments will increase by two years, to four and seven years. In other words, the current extended five and eight year period arising where an objection is lodged, will be maintained.

The reduction in term is perhaps not as significant as it first sounds. True, debtors will be able to travel overseas, be appointed as company directors, and incur credit when the twelve month period expires. However, they will still need to provide information to the trustee and pay any income contributions for three years (or five or eight years, if an objection is lodged) just as they do now. For that reason, in many cases the end of the bankruptcy period will not means the end of interactions with their trustee.

The changes will present challenges to trustees:

They will need to accelerate their investigations to ensure that if appropriate they can lodge an objection to discharge in that initial twelve month period, or they will miss the opportunity forever.
They will need to obtain information and secure payment of post-bankruptcy income contributions without the benefit of the objection-to-discharge regime – which currently provides a simple and inexpensive administrative point of leverage.

Perhaps most affected by the reforms will be those businesses that promote and administer ‘Debt Agreements’. Debt agreements were introduced in December 1996 to provide a simpler and lower cost alternative to bankruptcy, for debtors whose income and assets did not justify the costs of a ‘Personal Insolvency Agreement.’ Their use has grown in the twenty years since then: in 2016 more than 12,000 debtors took the debt agreement option. With bankruptcy cut to just one year, it seems likely that many debtors will decide that bankruptcy is an easier and cheaper alternative to a debt agreement.

There is one aspect of the reforms that will surprise many: the one year term will apply to bankruptcies on foot at the commencement date. As a result, the changes will be retrospective, to the advantage of individual debtors. The decision to make the change retrospective provides a clear contrast to the approach taken with the ipso facto reforms in the first phase, which were not retrospective, to the disadvantage of corporate debtors.

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

[First published on Linkedin.com on May 24, 2016]

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.