Safe Harbour Restructuring Plans: Would the Carillion turnaround plan pass muster?

The investigation in the UK into the collapse of Carillion Plc by a House of Commons select committee provides rare public access to the restructuring plan for a large company. Would the plan meet the requirements of Australia’s Safe Harbour regime?

The Collapse of Carillion

Carillion was a UK-headquartered construction company with worldwide operations employing 43,000 staff. It was placed into liquidation on 15 January 2018 following the UK government’s refusal to provide emergency funding,

With only £29 million in cash and creditors of more than £4.6 billion the position was so dire that – according to the select committee report – the company was forced into liquidation because it could not find a administrator prepared to take on the job in light of uncertainty about whether there was enough money to cover their costs.

Investigations into the conduct of the directors and auditors by the Insolvency Service, Financial Reporting Council, Financial Conduct Authority, and the Pensions Regulator are underway. In addition, the House of Commons Work and Pensions Committee launched an inquiry within a fortnight of the collapse.

As discussed here, the 16 May committee report (available here) is scathing in its criticism of directors, auditors, and regulators. The Inquiry has also made public a large number of documents which would not ordinarily be available – most notably including the 100 page turnaround plan.

Australia’s Safe Harbour regime

Australia’s severe insolvent trading laws make company directors personally liable for debts incurred when a company is insolvent.

By comparison the UK’s ‘wrongful trading’ regime imposes liability if directors ‘knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation’ and did not take ‘every step with a view to minimising the potential loss to the company’s creditors.’

The Australian Safe Harbour regime provides company directors with protection against insolvent trading claims but only if their conduct and actions, and the conduct of the company, meet minimum standards.

Would the Carillion plan meet the Australian Safe Harbour requirements?

The plan does articulate an appropriate objective that is clearly a better outcome than liquidation, and it does identify the use of a big 4 accounting firm as an appropriately qualified adviser.

However the plan is silent about any steps the directors had taken to conclude that they are properly informed about the financial position of the company, or that they proposed to take to stay informed. The document identifies a number of actions that have been taken, but it doesn’t really set out a future action plan, identify those responsible for each action, or set milestone dates.

Those omissions may not be fatal – perhaps there were other documents that provide appropriate detail. The biggest difficulty that the directors would have in meeting the Australian criteria is that the forecasts in the plan exclude employee pension contributions from the company budgets, and paying employee entitlements ‘as they fall due’ is a key requirement of the Australian regime.

Too little, too late

Of course the Carillion turnaround plan was never designed to meet the Australian requirements, so it’s not a huge surprise that it doesn’t. But nonetheless, that ‘failure’ highlights that it is essential for directors seeking to access safe harbour to ensure that they have a plan that is fit for that purpose.

In the case of Carillion, history shows that the plan was too little, too late: the company was in liquidation within a fortnight of the plan being finalised.

First published here

Draft ipso facto regulations – for consultation

The final piece of the ipso facto reform is almost in place, following today’s release of a draft-for-consultation version of the regulations.

Ipso facto clauses (also known as ‘termination for insolvency’ clauses, and discussed in more detail here) allow termination of a contract if a party to the contract becomes insolvent – even if there is no other default.

Such clauses can be immensely damaging to businesses that enter formal insolvency administration because essential assets and services can be unilaterally withdrawn: landlords can lock out insolvent tenants, franchisors can withdraw access to franchise systems, and lessors can repossess leased equipment.

It’s true that voluntary administration will ‘stay’ such action – but the effect is only temporary. The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill passed in September 2017 creates a permanent stay – albeit only for clauses in contracts entered into on or after 30 June 2018.

It was always intended that final detail – a list of exemptions – would be left to the regulations (now available here). The most notable aspects are:

The ipso facto stay will not apply to derivatives, margin lending facilities, and invoice finance arrangements. This is sensible, and as expected.
The draft regulations propose an exemption for ‘a contract, agreement or arrangement of which a special purpose vehicle is a party.’ This will be under careful scrutiny: it can’t be intended that the ipso facto stay can be defeated by simply adding an SPV entity to any contractual arrangement.
The stay will not affect contractual rights to combine, set off, or net out, multiple accounts. Again, this is sensible and expected.
As anticipated, there is a specific protection of a secured creditor’s ability to appoint a controller, and step-in rights are likewise protected.

The most significant deficiency in the ipso facto reforms – that the stay will not apply to contracts entered into before 30 June 2018 even if they are modified after that date – remains unaddressed.

Submissions on the proposals may be made until 11 May 2018.

(For those who noticed the photo: I haven’t tried Ipso Facto wines but the Cabernet gets great reviews!)

Surfstitch: Avoiding wipeout?

ASX listed Surfstitch Ltd was placed into voluntary administration by its directors on 24 August 2017, less than four weeks before the safe harbour reforms came into effect on 18 September.

The Australian Financial Review has reported the administrators’ conclusion that the company was in fact solvent when the appointment was made. At first glance it seems surprising that administrators were appointed to a solvent company, but the threshold question is whether:

“in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time”

It is the directors’ opinion at the time that matters, not the conclusions drawn later with the benefit of hindsight – and solvency is not always clear even with the benefit of hindsight.

According to an ABC interview, however one of the directors was not satisfied that Surfstitch was insolvent, and abstained from the vote for administration. This highlights the practical problems that directors face, and underscores one of the advantages that safe harbour now offers: the opportunity to more carefully assess and understand the financial position of the company.

On 4 April creditors will choose between two rival deed of company arrangement proposals. One proposal will see the business sold in return for three-year convertible notes issued by the purchaser, the other will see a debt for equity restructure and later relisting. Trade creditors and employees will be paid in cash under both proposals.

Update: on 4 April the creditors accepted the three year convertible note proposal, putting their faith in a valuation uplift over that period.

Secret Harbour?

Must a listed company disclose that it has taken steps to ‘enter’ the Safe Harbour regime?

Doing so would almost certainly result in the withdrawal of trade credit facilities and thereby cause a liquidity crisis. But the ASX listing rules impose a quite rigorous continuous disclosure regime, requiring disclosure regardless of the damage it may cause to a business.

The update to Guidance Note 8 Continuous Disclosure: Listing Rules 3.1 – 3.1B released this month and available here directly addresses the question, providing very helpful guidance.

Background

Rule 3.1 requires immediate notification to the ASX of:

“any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s security”

Paragraph 5.10 of GN 8 specifically confirms that rules applies to companies experiencing financial difficulties:

“The fact that information may have a materially negative impact on the price or value of an entity’s securities, or even inhibit its ability to continue as a going concern, does not mean that a reasonable person would not expect the information to be disclosed. Quite the contrary, in ASX’s view, this is information that a reasonable person would generally expect to be disclosed.”

Taking steps to enter Safe Harbour is evidence that directors are concerned about solvency. Surely the forming of a view that safe harbour is appropriate falls in the category of information that would have a materially negative impact on share price?

Updated Guidance

The updated Guidance Note directly addresses the issue, explaining that:

“ASX has been asked whether the fact that the entity’s directors are relying on the insolvent trading safe harbour in section 588GA of the Corporations Act requires disclosure to the market”

Updated paragraph 5.10 recognises that Safe Harbour is a conditional carve-out from a director’s potential liability for insolvent trading. GN 8 highlights that the legislation does not include an exemption from disclosure obligations, and so Rule 3.1 continues to apply – but goes on to explain:

“The fact that an entity’s directors are relying on the insolvent trading safe harbour to develop a course of action that may lead to a better outcome for the entity than an insolvent administration, in and of itself, is not something ASX would generally require an entity to disclose”

The guidance recognises that investors would always expect directors of an financially stressed business to consider whether there was a better alternative than an insolvency administration:

“The fact that they are doing so is not likely to require disclosure unless it ceases to be confidential, or a definitive course of action has been determined.”

A practical outcome

This is a very practical position for the ASX to take. Companies can maintain essential confidentiality rather than disclose issues that would almost certainly trigger a crisis of confidence, the freezing of credit facilities, and a severe liquidity crunch.

Safe Harbour: We’ve arrived!

As discussed here, the Senate Economics Legislation Committee concluded its 8 August 2017 report into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill – aka the Safe Harbour legislation – with a recommendation that the bill be passed as tabled.

However, when debated in the Senate tonight there were two sets of proposed amendments.

First, the Government tabled amendments to the proposed ipso facto protections that were intended to strengthen the anti-avoidance regime, most notably measures intended to address ‘self-executing’ clauses – provisions that ‘can start to apply automatically.’ Those amendments were accepted by the Senate.

Secondly, the Opposition proposed their own amendments to:

Change the nature of the safe harbour from a ‘carve out’ to a defence, putting the onus of proof on company directors, rather than on the liquidator. This proposal aligns to the position advocated by ARITA and recommended in the Productivity Commission report.
Turn what were effectively best practice guidelines into mandatory requirements, only allowing the protection to those directors who:
- Keep themselves informed about the company’s financial position
- Take steps to prevent misconduct by officers and employees of the company
- Take steps to ensure the appropriate financial records were maintained.
- Obtain appropriate advice from an appropriately qualified adviser
- Take appropriate steps to develop or implement a plan to restructure the company to improve its financial position.
Mandate a review of the effectiveness of the legislation after it has been in operation for two years.

The first two Opposition amendments were rejected, however the proposal for a two-year review was successful.

It appears that the Safe Harbour reforms are still ‘on course.’

Update: the amendments were passed in the lower house on 12 September 2017, the consolidated Bill is available here

Further Update: The Act received Royal Assent on 18 September – so the Safe Harbour is now available to directors.

There is more detail on the Safe Harbour legislation here.

Undercover Administrators?

In 2016 the Dutch Lower House passed legislation which if confirmed by their Senate would initiate quite unique reforms to their restructuring laws.

According to an unofficial translation of the explanatory memorandum, the Continuity of Enterprises Act 1 was intended to facilitate so-called ‘pre-packaged’ insolvency administrations (‘pre-packs’). Pre-packs describe a sale that is negotiated in anticipation of a formal insolvency administration and implemented immediately after the appointment is made, thus structured to bypass some of the issues caused by formal insolvency:

Suppliers shortening or even cancelling credit terms
Key customers switching to suppliers seen as more financial
Key staff seeking alternate employment.

However, pre-packs usually occur without a comprehensive sale program, and so raise questions about whether the best outcome for creditors is achieved. A UK study found that pre-packs provided unsecured creditors with a ‘paltry benefit’ – with no distribution in 60 percent of cases. The same study found that 63% of pre-packs resulted in a sale to a ‘connected party,’ which many Australians would describe as a ‘phoenix.’

Ordinarily, Dutch Courts appoint an insolvency practitioner as a ‘bankruptcy trustee,’ whose conduct and decisions are supervised by a judge of a specialist bankruptcy Court.

Under the proposed reforms, the intended trustee and judge would be appointed up to two weeks before the expected formal appointment. The pre-appointment appointment will allow them to supervise and assess the sale process, thereby addressing some of the questions otherwise raised. The application would be made without any public notice, and there would be no public disclosure of any appointments.

Legislation in limbo

The Dutch Senate had put the legislation to one side, apparently waiting on the outcome of litigation initiated by employees of a company who claimed that a pre-pack sale was a transfer of business, thereby resulting in the automatic transfer of the employees and their entitlements to the acquirer.

The Court found in favour of the employees in June 2017, which means that Dutch employers (and possibly others in Europe, because the ruling reflected an EU-wide directive) will not be able to use pre-packs to rationalise a workforce, or renegotiate employment conditions.

At the time of writing it is not clear whether the legislation will be permanently shelved, or whether it might still be taken forwards, perhaps with modification.

How does that compare to Australia?

In Australia formal insolvency via a voluntary administration is far quicker than the painfully slow (and horrendously expensive) US Chapter 11 procedure, but even a quick administration will last for some months. For that reason, most large restructuring is done ‘informally’ – out of Court – which avoids the issues arising from loss of confidence.

The position under Safe Harbour

As Australia moves towards implementing the Safe Harbour reforms discussed here, one of the questions being raised is whether entering the Safe Harbour regime will require public disclosure.

At first glance it seems hard to think that entering Safe Harbour would not require disclosure, but it is important to remember that directors of ASX-listed companies already have significant disclosure obligations, some of which are discussed here. Those rules impose an obligation on directors to ensure that the market is kept informed as to the financial position of their company. Arguably, if a company is insolvent then that should have already been disclosed, whether there is a safe harbour mechanism or not.

Is there anything in the legislation that requires an additional disclosure?

There are two notable aspects to the Safe Harbour mechanism which suggest that it may have been specifically designed to avoid any additional disclosure. First, there is no requirement for appointment of a restructuring adviser as a pre-condition. Although the involvement of a ‘restructuring adviser’ would bring advantages, it would be a very clear reference point in any later analysis about the adequacy of disclosure.

Secondly, by structuring the safe harbour as a carve out to the existing directors’ duty rather than a defence against a breach, arguably all the directors are doing is continuing to ensure that they comply with their duties, which surely is so unexceptional as to not require disclosure.

Others may have different views, but my own is that it is arguable that there is no need for special disclosure that a board is accessing the safe harbour. That would be a good thing, because advisers will be able to operate ‘undercover’ – with a successful turnaround more likely in the absence of negative publicity.

Senate Inquiry releases Report into the Safe Harbour legislation

The Senate Economics Legislation Committee today released its report (available here) into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 – the Safe Harbour legislation – following referral on 15 June, as discussed here.

The committee acknowledged that a number of submissions had identified potential improvements to the legislation – but it declined to recommend any changes. The Committee noted that there had been ‘broad support’ for the bill, and explained that it had formed the view that matters raised in submissions ‘would best be clarified in regulations.’

In practical terms that appears to eliminate any possibility that the ipso facto stay will be extended to apply to contracts entered into before the commencement, which in my view (as discussed here) is a very significant missed opportunity.

There was a single recommendation “The committee recommends that the bill be passed.”

Submission to the Senate Inquiry into the Safe Harbour and Ipso Facto Legislation

[This is a copy of my submission to the Senate Economics Legislation Committee Inquiry into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017]

My Background

I am a Chartered Accountant and former registered liquidator, with more than 25 years’ experience in financial and professional services at Nab, ANZ Bank, and Ernst & Young.

In my current role I lead complex loan workouts across the Institutional and Corporate platforms at Nab, and I am member of the ARITA Vic./Tas. State Committee and ARITA National Board.

I very much appreciate the opportunity to provide a submission to the Inquiry into the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017, which for clarity represent my personal views, and is not made on behalf of either my employer, or ARITA.

Summary

In my view those responsible for drafting the legislation should be commended for the care that they have taken to balance different policy objectives and minimise unintended consequences, resulting in a package of very meaningful and worthwhile reforms.

My submission has a single focus, the commencement of the ipso facto protections. The reforms are so beneficial that I believe we should move away from the proposed very gradual implementation, and implement them more quickly.

Issue: that the ipso facto protections will be introduced only very gradually

The ipso facto protections will apply only in respect of rights under contracts entered on or after the commencement (refer Explanatory Memorandum 2.99).

That means that companies incorporated after the commencement will have comprehensive protection against ipso facto clauses. By contrast, companies in existence prior to the commencement will not receive the benefit of ipso facto protection, unless they enter into a completely new contract.

Many contractual counter-parties currently holding ipso facto termination rights will avoid entering into new contracts. Instead they will seek to vary existing contracts, to preserve those termination rights. Those with greater negotiating leverage are most likely to be successful, i.e. by definition, extension will be more likely to occur where there is an imbalance of power. There will be some cases where contracts with ipso facto termination rights continue in existence for many years – with variation after variation after variation – and for most businesses, in practical terms the implementation will therefore be gradual.

There may be some argument for maintaining the position of those who currently hold ipso facto termination rights, to recognise freedom to contract and avoid retrospectivity – but there can be no other policy reason to deny the very clear benefits of ipso facto protection to all businesses.

The argument for limiting ipso facto protection

My understanding is that the limitation of ipso facto protection to only those contracts entered on or after the commencement date reflects a policy objective to avoid the retrospective removal of contractual rights that parties have independently negotiated.

The argument against limiting ipso facto protection

There was no suggestion that the Safe Harbour reforms be only available to those directors appointed after the commencement date – even though the safe harbour regime impinges on an individual creditor’s right to make an insolvent trading claim. I believe that reflects a clear recognition that the benefits of safe harbour are so significant that they should be universally available. Exactly the same argument applies in relation to ipso facto protection – the benefits are so significant that they should likewise be universally available.

If there is a residual concern about taking away rights that parties have independently negotiated, that should be balanced by consideration of three other issues:

First, ipso facto termination rights are something that a well-informed party would avoid if possible. They are more likely to exist in a contract where one party is less well-informed as to the risks they engender, and/or where there is an imbalance in negotiating position – such that a party cannot refuse their inclusion. We should be cautious about protecting rights that may have been secured through knowledge imbalance or power imbalance.
Secondly, ipso facto clauses provide a right to terminate where there is no other default. By definition therefore, they are only useful to a party that has suffered no loss or damage. There may be an argument to preserve the rights of a party that has suffered loss or damage – but it is harder to mount an argument to protect the rights of a party that has not suffered any loss at all, especially where the exercise of those rights may cause significant damage to the other party.
Finally, it should be noted that there is no way for employees to understand whether an employer’s contracts are protected against ipso facto. Similarly, there is no way for those who trade with a company to understand whether their credit risk is exposed to ipso facto termination.

Suggested solution

There are some circumstances where ipso facto termination rights should be maintained, and these have been recognised in the legislation. For those circumstances where it is appropriate to provide ipso facto protection, the legislation should be amended so that it applies to all contracts in existence before, on, or after the commencement.

If this is cannot be practically achieved, a compromise would be to follow the precedent in the Unfair Contracts legislation, and provide ipso facto protection to contracts entered into, or renewed or modified, after the commencement.

There is more detail on the issues that the Senate Inquiry will be considering here. All of the submissions are available here.

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. A copy of my submission is available here.

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.

This blog provides more detail on the issues that the Senate Inquiry will be considering here. A copy of my submission is available here.

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