The Australian government is working to significantly reform Australia’s current insolvency laws by mid-2017.

The reforms are intended to achieve greater likelihood of business preservation by introducing the flexibility to achieve real turnaround of businesses in crisis.

The proposed changes include:

  • Reduction of the bankruptcy period from three years to one year
  • Introduction of a safe harbour for directors to avoid personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company
  • Unenforceability of certain ipso facto clauses − which allow contracts to be terminated due to an insolvency event − when a company is undertaking a restructure

The proposals represent the most significant set of reforms to Australia’s corporate and personal insolvency laws of the last 20 years. The changes are likely to increase business risk-taking and provide real opportunity for a company in financial distress to effect a turnaround or restructure. This, in turn, is likely to increase opportunities for international investors in the distressed debt market in Australia.

Safe harbour for directors

Under the current regime, a director attempting to restructure a company in financial distress can incur civil and even criminal liability for insolvent trading if the company subsequently fails and goes into liquidation. To avoid that risk, a director will often appoint a voluntary administrator at an early stage, even when the company may be financially viable in the long term.

There is stigma associated with such a formal insolvency appointment and it can often be swiftly followed by a liquidation. The current laws have been criticised for being inflexible, unduly oppressive for directors and stifling of new enterprise and innovation.

Under the proposed new laws, directors will be protected from insolvent trading claims if they appoint a restructuring advisor to develop a turnaround plan for the company. This is likely to open up significant opportunity to restructure the company and ensure its survival. The headline changes are as follows:

  • If a company makes and records a decision to appoint an adviser with a view to constructing a turnaround plan directors will have a defence to insolvent trading – a safe harbour. The defence will commence from the date of the appointment of the adviser.
  • The adviser must be registered and must have at least five years’ experience as an insolvency and turnaround practitioner.
    At the time of the appointment, the company must be solvent (this must be certified by the adviser), although the company can become insolvent during the safe harbour period.
  • The appointment must be for the express purpose of providing restructuring advice focused on the company’s continued solvency and viability.
  • There will be a moratorium on enforcement action during the restructuring period.
  • Implementation: the adviser must certify within one month that there are reasonable grounds to believe that the company is capable of being viable; the adviser’s appointment will end if the company is no longer viable.
  • The directors must demonstrate that they took all reasonable steps to pursue the restructuring as advised by the adviser.
  • The safe harbour will end once the restructure has been implemented or the appointment of the adviser has ceased.

Ipso facto clauses

An ipso facto clause is a standard term of contract. It entitles one party to terminate the contract when the counterparty experiences an insolvency event. This can occur even if all payments are up to date and there is no other breach. Termination of a significant contract could stultify a receiver’s or administrator’s attempts to trade the business as a going concern and preserve value in the business. The exercise of ipso facto rights can trigger the collapse of a distressed company for example, if major suppliers, customers and other stakeholders exercise such a right. Terminating key contracts dissipates value and can prevent the ability to restructure a business as a going concern.

The proposed new laws will prevent a party from terminating a contract under an ipso facto clause based solely on an insolvency event occurring and thus give the company a chance to continue on as a going concern while a possible restructure is implemented.

Certain contracts may be excluded from this restriction, such as prescribed financial contracts. The government is seeking submissions as to which contracts should be carved out from this restriction in the final form of the legislation.

Australia has one of the highest rates of entrepreneurship in the world: between 2006 and 2011 startups (businesses younger than three years old) added 1.44 million full time equivalent jobs to the Australian economy. But entrepreneurs will sometimes fail before they succeed. The new proposed laws recognise this by seeking to promote and support a turnaround culture in Australia and provide real opportunity for a distressed business to be restructured rather than become subject to a formal insolvency appointment. The proposed new regime is likely to generate increased opportunities for international investors to participate in Australia’s distressed debt market. With its relative economic strength and predictable legal system, Australia represents an attractive alternative to the heavily competed distressed debt markets of Europe and the United States.