Released in April 2016 the Turnbull Government proposed significant reforms to Australia’s insolvency laws, as part of its National Innovation Science Agenda - designed to strike a balance between encouraging entrepreneurship and protecting creditors, and to reduce the stigma associated with business failure.

From this consultation and previous reports, including the Productivity Commission’s ‘Business Set-up, Transfer and Closure Inquiry Report, and the Government’s much-heralded ‘Innovation Statement,’there is a general appreciation that certain features of Australia’s insolvency laws do not facilitate restructuring and may operate to discourage innovation. Therefore, while there is a strong case for reform of Australia’s insolvency laws in order to encourage innovation and a restructuring culture, any reform must be carefully crafted so as to address the weaknesses of the current regime while minimising any potential unintended consequences.

As this is the most significant law reform project in the insolvency space since the Harmer inquiry in the early 1990s, KWM welcomed the opportunity to consult with its client base and across its partnership to make a submission to Treasury on these important issues.

Our submission to Treasury addresses the Proposals Paper’s three most significant recommendations:

Safe Harbour

The Government’s Proposals Paper sets out two alternative models to implement a Safe Harbour for directors, both aiming to facilitate the restructure of businesses. The proposed Model A operates as a defence and relies on a director appointing a restructuring adviser. Whereas, Model B acts as a carve-out of section 588G of the Corporations Act and enables a director to incur debt in an attempt to return a company to solvency within a reasonable time.

Whilst both approaches have respective advantages, neither completely addresses the weaknesses of the current regime. Most importantly, the proposed Safe Harbour models are unlikely to encourage start-up activity or facilitate innovation.

The Proposal Paper’s objective, namely to encourage entrepreneurship, can instead be best achieved by way of some relatively minor amendments to the insolvent trading prohibition. This approach would also provide better protection to creditors and directors during the “twilight zone”.

It is our view that much of the difficult dilemma faced by Australian directors would be resolved if the primary offence of “insolvent trading” was limited to the incurring of a debt in circumstances where the directors have no reasonable basis to expect that debt to be repaid in accordance with its terms. In other words, if the primary offence were detached from the general concept of “insolvency,” this would avoid the unnecessary complexity of establishing an exception to the offence.

You can read KWM’s full response to the proposed Safe Harbour reform here.

Ipso Facto reform

The Proposals Paper recommends to extend the stay which applies in administration to prevent the termination of contracts during the administration period. Ipso facto clauses are provisions in a contract that allow the contract to be terminated solely due to an insolvency event (for example, the appointment of an administrator or receiver).

After the lengthy consultation process to date, there are some easy wins in the Proposals Paper which we endorse. In particular:

  • we strongly endorse, the extension of lpso Facto reform to companies attempting to restructure by scheme of arrangement; and
  • we support the application of an Ipso Facto moratorium during the administration procedure.

In relation to other Ipso Facto reforms, we caution against continuing with the current 'broad brush' approach of making the lpso Facto reform of general application, relying on the identification of specific exclusions. Our submission identifies the difficulty in identifying exclusions to a general Ipso Facto reform. In our view, there are risks of unintended consequences in many key markets if broad-based Ipso Facto reform is introduced without further consultation with key industries and markets.

The complexities involved in defining the current exception for financial contracts is an important example, together with others identified in our submission.

We discussed this reform in detail in a previous alert focusing on the financial contracts exception – you can read this alert here: Termination upon insolvency: Financial markets and Australia's proposed insolvency law reforms.

You can read KWM’s full response to the proposed Ipso Facto reform here.

Watch Tim Klineberg speak to Carson Scott at Sky Business News on what these proposed changes may mean for business:

Reducing the default bankruptcy period

The Government has proposed that the current default period for bankruptcy of three years be reduced to one year. This is intended to “encourage entrepreneurial endeavour and reduce associated stigma”, as the restrictions that would otherwise apply are reduced in application, preventing an individual from being excessively punished for necessary risk-taking or misfortune.

Whilst we are supportive of the concept of encouraging entrepreneurship, before any reforms are enacted we must address what we perceive to be the not inconsiderable downsides of reducing the present bankruptcy period.

You can read KWM’s full response to the proposed Bankruptcy reform here.

The summary above provides a brief insight into some of our key recommendations in response to the Proposals Paper’s three recommendations.