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.


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.

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.

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.


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.


Restructuring: Singapore or Australia?

In March 2017 Singapore enacted a raft of changes to its insolvency and restructuring laws, apparently with the intention of positioning itself as the dominant international debt restructuring jurisdiction for Asia.

There are two key components to the changes, which are operative from 23 May:

  • First, a move away from a predominantly informal framework to a Chapter 11-style regime, via a mechanism that Herbert Smith Freehills describe as a ‘turbo-charged Scheme of Arrangement.’
  • Secondly, adoption of the UNCITRAL Model Law on Cross-Border Insolvency, some twenty years after its introduction in 1997.

Despite its name, the Model Law does not actually prescribe an insolvency law template to apply across all jurisdictions – instead it prescribes processes for the recognition of whatever law applies in the ‘principal jurisdiction’ of an insolvent company. The end result is that the restructuring and insolvency regime of the principal jurisdiction is effectively ‘exported’ to the countries in which the business operates.

In adopting the Model Law, Singapore joins over 40 countries – a list that significantly, does not include either Hong Kong or China.

If the initiatives are successful, Singapore may displace the current incumbent – Hong Kong – as the predominant debt restructuring jurisdiction in the region. This raises the question: how can there be a choice as to which jurisdiction applies?

The answer is that the Model Law relies on an identification of the ‘centre of main interest’ (COMI) of the insolvent company, and then applies the law of the COMI jurisdiction.  In a world where operations may span across several countries, with multiple administrative locations, and shareholders and directors located elsewhere, identification of ‘the’ COMI may be far less black and white than some would think, and there may be more than one COMI to choose from.

It is in this context that Singapore has moved to create a regime that facilitates restructuring.  If the new restructuring regime becomes widely utilised through Asia, then there will be work opportunities for its professionals throughout the region.

Australia has just tabled legislation to implement a safe harbour protection for company directors of struggling companies and protect those companies from the risk of ipso facto termination of their contracts, discussed in more detail here.  When that legislation takes effect in mid-2018, where will we fit in the Hong Kong v Singapore battle?

To US investors and lenders seeking the familiar features of the Chapter 11 approach: cram downs, debtor in possession financing, and so on; Singapore may be the most attractive option.

But there is a notable divergence between the US regime and the Singapore regime, in the protection against ipso facto clauses: clauses which provide a contractual counter-party with the option to terminate if the other party to the contract becomes insolvent.  Chapter 11 provides a debtor with ipso facto protection however the Singaporean ‘turbo-scheme’ only imposes a temporary moratorium on the exercise of those rights.

The ipso facto protections in the yet-to-commence Australian regime are not just closer to the US model, in fact they will be arguably amongst the most comprehensive in the world.

For businesses where so much enterprise value is captured inside legal agreements – and therefore at risk if there is formal insolvency – that the ipso facto protection outweighs any other considerations, Australia may well be a better jurisdiction to restructure than Singapore.  It won’t be a surprise to see Australian restructuring lawyers making travel plans to visit offshore investors and owners, to explain the advantages that our modified regime will offer.


* There is one shortcoming: unfortunately it seems the protection will not apply to clauses in existence before the provisions come into effect, even if they are later modified.

Thanks to Michael Murray for his assistance especially with regard to UNCITRAL, and to Rachel Burdett-Baker for her helpful input and suggestions.

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.

Arriving in Safe Harbour?

Legislation to implement the Safe Harbour and ipso facto protections was tabled in Parliament today, reflecting a rapid progression from the exposure draft released on 28 March 2017.

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:

  • independence
  • 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.

Keep Calm and Follow the (Insol) Rules

This week Insol International – which represents more than 40 national associations and more than 10,000 restructuring professionals – released an updated Statement of Principles for a Global Approach to Multi-Creditor Workouts.

The new release reflects the contributions of Australian workout bankers: Jacinta Nielsen, Gwyn Morgan, Ian Copp and Tim Williams.

The SoP have their genesis in the so-called ‘London Rules.’  Ironically, as Pen Kent, former Executive Director of the Bank of England has explained, at first there were no written rules.  Instead the Bank of England promulgated an ‘unwritten, flexible framework’ with divergence addressed by ‘fireside chats.’

Pen Kent described the four central tenets as:

  • banks should remain supportive on hearing that a company to which they have an exposure is in financial difficulty. In practice, this means that they keep their facilities in place and do not appoint receivers;
  • decisions about a company’s longer term future should only be made on the basis of comprehensive information, which is shared among all the banks and other parties to a workout;
  • banks work together to reach a collective view on whether and on what terms a company could be given a financial lifeline; and,
  • the seniority of claims continues to be recognised, but there has to be an element of ‘shared pain’ i.e. equal treatment for all creditors of a single category.

Notwithstanding the Bank of England’s original intention to avoid written rules, with BoE endorsement, Insol issued the first SoP in October 2000.

The 2016 update does not make major change to the 2000 version:  the most significant amendment is an addition to the second principle “Conflicts of interest in the creditor group should be identified early and dealt with appropriately.”

It must be said that the apparent simplicity of that statement belies the practical extent of the challenge.  Today’s multi-creditor workout can involve parties whose focus is a loan-to-own strategy, which may require an actual or likely default.

There are those who say that a loan-to-own restructuring leads to a more rapid and more economically efficient operational turnaround, and that equity holders who facilitate that are entitled to a commensurate economic return.  My purpose is not to argue one way or the other, but rather to recognise that there is the potential for two mutually exclusive strategies to be in play, and that consequently, resolving such conflict may well be easier said than done!


The 50 page Statement of Principles for a Global Approach to Multi-Creditor Workouts II is available here, the principles themselves are:

FIRST PRINCIPLE: Where a debtor is found to be in financial difficulties, all relevant creditors should be prepared to co-operate with each other to give sufficient (though limited) time (a “Standstill Period”) to the debtor for information about the debtor to be obtained and evaluated and for proposals for resolving the debtor’s financial difficulties to be formulated and assessed, unless such a course is inappropriate in a particular case.

SECOND PRINCIPLE: During the Standstill Period, all relevant creditors should agree to refrain from taking any steps to enforce their claims against or (otherwise than by disposal of their debt to a third party) to reduce their exposure to the debtor but are entitled to expect that during the Standstill Period their position relative to other creditors and each other will not be prejudiced. Conflicts of interest in the creditor group should be identified early and dealt with appropriately.

THIRD PRINCIPLE: During the Standstill Period, the debtor should not take any action which might adversely affect the prospective return to relevant creditors (either collectively or individually) as compared with the position at the Standstill Commencement Date.

FOURTH PRINCIPLE: The interests of relevant creditors are best served by co-ordinating their response to a debtor in financial difficulty. Such co-ordination will be facilitated by the selection of one or more representative co-ordination committees and by the appointment of professional advisers to advise and assist such committees and, where appropriate, the relevant creditors participating in the process as a whole.

FIFTH PRINCIPLE: During the Standstill Period, the debtor should provide, and allow relevant creditors and/or their professional advisers reasonable and timely access to, all relevant information relating to its assets, liabilities, business and prospects, in order to enable proper evaluation to be made of its financial position and any proposals to be made to relevant creditors.

SIXTH PRINCIPLE: Proposals for resolving the financial difficulties of the debtor and, so far as practicable, arrangements between relevant creditors relating to any standstill should reflect applicable law and the relative positions of relevant creditors at the Standstill Commencement Date.

SEVENTH PRINCIPLE: Information obtained for the purposes of the process concerning the assets, liabilities and business of the debtor and any proposals for resolving its difficulties should be made available to all relevant creditors and should, unless already publicly available, be treated as confidential.

EIGHTH PRINCIPLE: If additional funding is provided during the Standstill Period or under any rescue or restructuring proposals, the repayment of such additional funding should, so far as practicable, be accorded priority status as compared to other indebtedness or claims of relevant creditors.


Loan workouts: insights from the UK


In the UK, the handling of financially stressed business customers by RBS’ Global Restructuring Group (the loan workout unit) has been highly controversial, and attracted a great deal of media attention.

However, very few disputes between borrower and lender have actually progressed through to final judgement, until the December 2016 decision in Property Alliance Group Ltd (PAG) v The Royal Bank of Scotland plc.

In that case the borrower claimed (amongst other things) that RBS had breached a duty of ‘good faith’ in its conduct of the loan workout.

In the judgement the Court held that there was no such common law duty in the UK, and so there could be no breach – but is there such a duty in Australia?  That’s a difficult question: one academic said the answer was “incoherent”!   Perhaps the answer does not matter, however, because the Australian Code of Banking Practice includes a requirement to “act fairly and reasonably.” *

The decision will be of interest to Australian lenders and their advisers, even more so because the conduct at issue goes to the heart of allegations about ‘constructive default’ that have been raised in the PJC Inquiry into the Impairment of Customer Loans and the forthcoming Senate Select Committee on Lending to Primary Production Customers.


PAG is a property investment and development business – still trading today – that operates primarily in the North West of England.  It borrowed money from RBS, and entered into a series of interest rate derivative products (‘swaps’) prior to 2009.

In the aftermath of the GFC LIBOR fell significantly and by December 2009 sat at 0.60%, and consequently the swaps were ‘out of the money’ by more than GBP9m.  A fall in the value of PAG’s real estate portfolio, on top of the liability for the break cost, resulted in a loan to valuation ratio of more than 90% – and led to a transfer to GRG.  After extensive negotiations in June 2011 the swaps were closed out a cost of GBP8.2m.  Part of that cost was absorbed by RBS, but most of it was funded by an additional loan.

PAG remained under the control of GRG until July 2014 when it refinanced to another lender, shortly after initiating the legal proceedings against RBS.

Three elements to the claims

PAG claimed that the swaps were mis-sold.  Instead of providing a hedge as represented, PAG argued, in fact they left PAG in a worse financial position than otherwise.

PAG’s claim also involved the widely reported allegations that LIBOR had been manipulated by RBS and other LIBOR participants.  PAG said that it was unfair that RBS knew of the manipulation, but PAG did not.

The last claim, and the part most relevant to this discussion, was that by transferring management of PAG into GRG – and by what occurred after that transfer – RBS had breached an implied duty to act in good faith.

What did the RBS workout team actually do?

Arguably, GRG (referred to by some critics as the Grim Reaper Group!) did not quite live up to its apparently fearsome reputation (discussed in more detail here).

GRG did not appoint an Investigative Accountant, or appoint receivers.  It did obtain updated valuations and seek a one-off debt reduction to improve the LVR, but even the  deputy Chairman of the borrower, who lead the negotiations for re-financing, described RBS’s role amongst other things as ‘reasonable’, ‘friendly’, ‘helpful’ and ‘constructive.’

Alleged breach of good faith #1 – the transfer to GRG

PAG claimed that the stated reason for its transfer to GRG control was a pretext: it said that it had little need to restructure because there was ‘no risk of default.’  PAG said that the real reasons for transfer were to stifle anticipated litigation over the swaps mis-selling, and to extract as much revenue from PAG as possible.

The Court held that there was no contractual right to be managed by a particular team, and so it was open to RBS to transfer management control to GRG, and there was ‘substantial documentation’ which showed the transfer clearly as being within RBS policy.  Secondly, the Court found that at the time of the transfer RBS was not really aware of PAG’s mis-selling complaints, and so could not have made a decision to attempt to stifle them.

Finally the Court said that there was simply no evidence that there was an intention to extract as much as possible from PAG.

Alleged breach of good faith #2 – retention in GRG

PAG claimed that it was ‘wrongfully retained’ in GRG, to impose a 100% ‘cash sweep’ in order to maximise value for RBS and (continue to) deprive PAG of funds for litigation.

The Court held that there was simply ‘no evidence’ to support those contentions.  The Court accepted that RBS policy required an updated valuation before the customer could be returned to the frontline team, and information about an associated entity.  RBS’ failure to address these reflected a far more mundane reason: overwork.

Alleged breach of good faith #3 – Demanding an unnecessary and onerous ‘Security Review’ at PAG expense

The Court said that the requirement for a security review was not capricious, it was a condition of the very significant new lending that RBS provided to fund the close out the swaps.

Alleged breach of good faith #4 – Calling for updated valuations of PAG’s portfolio in both 2010 and 2013.

There was a clause in the loan documents that allowed RBS to call for an update of valuations at borrower expense, but it had opted not to exercise this right until 2010, and then again in 2013.  The Court held that the decision to seek valuations was not ‘capricious’ – the bank needed valuations to make an informed assessment as to whether PAG met the criteria for transfer back to the front line, or refinance by another bank.

Alleged breach of good faith #5 – applying improper pressure on the valuers to manipulated the result of the 2013 Valuation

It was true that RBS had raised queries about a draft valuation, which had led to a 1.5% reduction in the valuation, and thereby increased the amount of the payment that PAG had to make to improve the LVR.  However, the valuer had not challenged the legitimacy of the questions, and there was nothing in the valuer’s evidence to suggest that he had been placed under improper pressure.

Alleged breach of good faith #6 – a threat to appoint receivers

It was clear that there had been discussion about the possible appointment of receivers – although it was less clear what the context was.   The Court accepted that an RBS staff member did threaten to appoint receivers, and that ‘the incident amounted to an improper threat,’ but found that single incident by itself did not justify a conclusion ‘that the alleged implied duties were breached.’

Bank wins 3 – nil

PAG was unsuccessful on all counts.  The Court held that RBS had a ‘non-advisory’ role, and that the terms of the contract between PAG and RBS prevented PAG from claiming otherwise, and so the misspelling claim was doomed.

The rejection of the LIBOR claim was comprehensive.  The Court said that linking a transaction to the LIBOR rate did not automatically give rise to any implied representation, but in any event there was no evidence that PAG had relied upon such representations.

Finally, even though there is no general duty of good faith under English law, the behaviour complained of would not have breached any hypothetical breach.

What should Australian Lenders and their advisers take from the decision?

The judgement is unusual in revealing some of the inner workings of a loan workout team – but what it does reveal is fairly mundane.  It highlights that banks are best prepared for challenges to conduct by having policies that set out what is expected, and ensuring that where discretion is exercised there is contemporaneous documentation to explain how it was exercised.


*My thanks to Michael Murray of Murrays Legal for guiding a non-lawyer through the complex issues of good faith!

Update: For more recents developments please see The beginning of the end? The RBS – GRG saga

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.


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.