Australia is making several significant reforms to its insolvency legislation – with more changes likely to come – to provide much-needed comfort for directors and to align legislation on ipso facto clauses in order to prevent contractual terminations simply as a result of the commencement of an insolvency proceeding. (See the Productivity Commission Report on Business Set-up, Transfer and Closure (available here)).
In the first of a series of reforms, the Insolvency Law Reform Bill 2016 passed both legislative houses on February 22, 2016. While the latest bill consists of relatively minor changes relating to the provision of information to stakeholders in external administration proceedings and the remuneration and registration of registered insolvency practitioners, it signals the first steps toward more comprehensive changes. The details of the forthcoming amendments are still being debated, but expect them to become effective in mid-2017 and to continue the progress to a more pro-business insolvency regime. The changes most meaningful for U.S. institutional investors and lenders are described below.
In the US, directors cannot be held liable for “wrongful trading,” meaning permitting a company to remain in business outside of bankruptcy proceedings even though the company is incurring debts that it may not be able to pay when due. While this can sometimes lead to the abuse of “deepening insolvency” – meaning the company would have been better off with an earlier Chapter 11 filing – it generally encourages companies to pursue less expensive out-of-court restructuring alternatives. In Australia, however, directors can be held personally liable under certain circumstances for permitting wrongful trading, thus leading directors to commence insolvency proceedings even when there is a prospect for better results in out-of-court restructurings. This is compounded by the fact that even Australia’s insolvency restructuring regime (“administration”) requires the appointment of independent administrators who, themselves, can be held personally liable for new debts incurred during the administration proceedings. Given the expensive and value-impairing nature of many administration proceedings and the understandable reticence of administrators to keep the business operating if they fear they are at risk of personal liability, this often leads to worse recoveries for creditors, including (in our 20+ years of experience with Australian insolvencies) for US private placement noteholders and debt purchasers.
The Insolvency Law Reform Bill 2016 will change this by providing directors with a safe harbor from personal liability for wrongful trading when they engage restructuring advisors to pursue an out-of-court restructuring. Instead of handing the keys prematurely to an administrator in order to avoid risk of director liability, directors under the new regime will be able to consider value-saving options without a gun to their heads. While the details of such protections have yet to be fully established, the safe harbor is a welcome and overdue change.
Another major change will be to adopt the US approach of preventing contractual counterparties from terminating their contracts for a default based on the commencement of insolvency proceedings (so-called ipso facto defaults). Rendering ipso facto clauses unenforceable reduces the leverage that critical lessors, vendors and other counterparties have to effectively shut down a business in administration by terminating contracts that are essential to a continuation of the business As John Brogden, chief executive of the Australian Institute of Company Directors, was quoted in The Australian: “This is a major leap forward for Australian insolvency laws…. The proposed changes — which cover start-ups and existing business — will allow companies to keep trading and have a viable business, rather than simply becoming a carcass for creditors.”
For those who favor the approach of Chapter 11, this is only one small step for man, not one giant leap for mankind. Australia has repeatedly considered – and repeatedly rejected – moving full-scale towards Chapter 11. The fundamental Aussie architecture remains, which is perceived to be good by powerful Australian banking interests but not so good for unsecured creditors, including US institutional investors. Nonetheless, such changes are likely to bring greater flexibility to out-of-court discussions and enhance the ability of stakeholders to preserve value and avoid unwarranted liquidations.
But not yet. While the Insolvency Law Reform Bill 2016 has passed both houses of Parliament, it has not yet been enacted into law – and is only the first step in enacting the recommended reforms. So watch this space for further updates as these and other long overdue pro-business insolvency reforms finally change the lay of the antipodean land.