The reform agenda for Australia's restructuring and insolvency regime has now received the views of the Productivity Commission, in the context of its wider review of Business Set-Up, Transfer and Closure. A draft report published on 21 May 2015 sets out a number of recommendations that, while mostly not new to the reform agenda, will be relevant to restructuring and insolvency professionals in the not-too-distant future.
The key highs and lows of the draft recommendations - with some of our own reactions - follow. Overall, the Commission does not recommend wholesale change - instead, targeted reform is proposed, with the themes of promoting a more active turnaround culture and reducing the cost of insolvency when a business does fail.
U.S. Chapter 11 is a no-go
As a starting point, the Commission does not recommend wholesale adoption of the U.S. "Chapter 11 bankruptcy" regime. That regime is seen by the Commission as not representing a substantial improvement on the existing Australian regime, in terms of speed and cost. That may well be right, but the Commission does not tackle the central point of US Chapter 11, being the "debtor in possession" model (as distinct from the external administration model used in Australia).
While a wholesale adoption in Australia of U.S. Chapter 11 bankruptcy is not attractive, a little deeper consideration of the merits of the debtor in possession model by the Commission would be worthwhile - it is the prospect of that model creating great value for creditors, rather than time and cost savings relative to voluntary administration, that should drive decisions on the merits of US Chapter 11 for Australian insolvency.
Ban the ispo facto clause
The Commission is, however, attracted to cherry-picking some of the features of US Chapter 11. A central recommendation is to implement a ban on reliance on "ispo facto clauses" in contracts during voluntary administration (being clauses that entitle a counterparty to terminate simple because of insolvency). This reform has long been mooted, and is not a surprise. If implemented, it certainly would assist in protecting distressed companies as going concerns while being restructured.
Safe harbour for directors from insolvent trading
Moving on from US Chapter 11, the Commission has recommended adoption of a safe harbour from insolvent trading. Consistent with proposals previously considered by other reform bodies, the recommendation is to adopt a safe harbour from liability where a company's directors retain an approved turnaround advisor for purposes of considering the company's position and attempting a restructure.
The Commission's recommendation contains gaps - the safe harbour will only be useful if it also protects directors from continuous disclosure liability (in the case of listed companies) and tax liabilities, which is not presently contemplated in the draft recommendation. This is easily remedied, although the ATO might prefer to hold on to the director penalty notice regime.
The safe harbour concept is not a bad one, but it is unlikely to change existing practices amongst more sophisticated participants in the market, who already manage insolvent trading risk effectively.
Safe harbour - a bridge to a pre-pack?
The Commission then parlays safe harbour recommendation into a further recommendation that a trade sale of the company's business agreed during the safe harbour period are binding on a subsequently appointed administrator, unless the sale is to a related party or not for "reasonable market value". This is evidently intended to facilitate something like a "pre-pack" procedure.
This is good thinking, if not perfect at this point. It may be that a better formulation of the recommended procedure would be to reverse the Commission's proposal, i.e. permit an administrator to accept a safe harbour negotiated sale without risk of criticism of the administrator, unless the administrator reasonably believes the sale to be to a related party or for a material under-value. This would provide some greater flexibility for the independent administrator and would reduce the risk of abuse of the procedure.
Administration only for the "potentially" but not "actually" broke
The Commission then recommends that administration should only be able to be initiated by "potentially" insolvent companies, but not those that are actually insolvent - if an administrator determines a company to be actually insolvent, it should proceed into liquidation. This recommendation is unattractive. Fundamentally, administration is about restructuring troubled companies, many of which will be actually insolvent - the ability to cram down a compromise on dissenting creditors through a deed of company arrangement may well enable a return to solvency.
A better approach would be to amend the procedure to allow both "potentially" and "actually" insolvent companies. This way, early intervention by an administrator is an option (promoting early action and the possibility of a better outcome), but so is late intervention.
Tightening the screws on receivership
Finally, the Commission recommends a modification to the obligations of receivers, to make the "market price" obligation under section 420A, Corporations Act subject to an obligation to not cause unnecessary harm to the interests of creditors as a whole. The Commission then recommends that any sale of the business by a receiver be subject to a vote of all creditors, unless the receiver is satisfied that there will be no surplus of funds following payment of the secured debt.
This recommendation is difficult, in that there is a natural tension between a receiver's obligation to run a robust process for a business and the risk of that business' value deteriorating during the time needed to run that robust process - there will be times when the best outcome will be to pursue a very quick sale. As well, the recommendation conflates the receivership and administration processes - meetings of creditors are obviously not a feature of the receivership landscape.
More fundamentally, receivership is a remedy for a secured creditor to realise secured assets – it is not a process that is concerned with creditors as a whole or reconstruction of a business. The protections already afforded to ordinary creditors as a whole by section 420A and section 433 already deliver protection to those stakeholders from misuse of the receivership process. It is difficult to see a case for adding to those protections (or modifying them in a way that confuses the situation further).
This recommendation, really, flirts with the possibility of simply doing away with floating charge receivership altogether, in favour of administration only, in order to maintain a more collective approach to insolvency and restructuring - this was done in the United Kingdom over a decade ago, and has promoted further positive developments in that market such as the "pre-pack". That reform, however, like adoption of a debtor in possession model as used in U.S. Chapter 11 bankruptcy, seems a bridge too far at this stage for the Commission.
Requests for further input
Insum, the Commission's report is a good step for the insolvency market in Australia - it is thought provoking, and deploys some lateral thinking not unduly tethered to existing practices, which is to be applauded.
As to next steps, the Commission has called for market participant feedback on its draft recommendations and on a number of other issues, such as the prospect of regulation of the insolvency of trusts and the establishment of an "insolvency panel" similar to the Takeovers Panel (a proposal on which we have previously published).