The Productivity Commission published its final report on Business Set-up, Transfer and Closure on 7 December 2015. A copy of the final report is available here.
The final report recommends a number of changes to Australia's corporate insolvency laws and follows public consultation on the Productivity Commission's draft report released in May 2015.
The release of the final report came shortly after the Government's innovation statement announcement, which picked up a number of key proposals from the draft report. The publication of the Productivity Commission's final report, together with the innovation statement, signifies real progress toward substantive corporate insolvency law reform and foreshadows further public discussion, consultation and scrutiny in the area.
The final recommendations – what did the Productivity Commission recommend?
The Productivity Commission's overarching conclusion on Australia's corporate insolvency framework is that specific reforms are warranted, but that there is no case for wholesale change. In a move which likely be unpopular with Chapter 11 proponents, the Productivity Commission rejected adopting the United States' Chapter 11 restructuring regime.
The Productivity Commission has recommended the following specific reforms to Australia's corporate insolvency laws, with the expressed objective of providing a genuine opportunity to restructure economically viable companies or, if this is not possible, an efficient, effective and orderly process for winding up the company:
- Voluntary administration certification: An Administrator must certify, within one month of appointment, that he or she has reasonable grounds to believe that the company (or a large component entity of it that may emerge following a restructure) is capable of being a viable business in order for the administration to continue. If the Administrator cannot certify this, the Administrator is under a duty to convert the administration into a liquidation.
- Safe harbour defence for directors: A 'safe harbour' defence to insolvent trading be introduced. The final recommendation is that the directors appoint an appropriately qualified safe harbour adviser, who certifies that the company was solvent at the time of his or her appointment, and the directors be able to demonstrate that they took all reasonable steps to pursue a restructure. The defence applies for the period of the adviser's engagement until implementation of the advice is complete. The appointment of the turnaround adviser would not be disclosed publicly.
- 'Pre-positioned' sales: Introduction of a 'pre-positioned' sale mechanism. The sale would be subject to review by the subsequently appointed external administrator. There is a presumption in favour of the validity of the sale if there are no related parties involved.
- Unenforceable termination clauses: 'Ipso facto' termination clauses be unenforceable if the relevant termination event is the occurrence of a scheme of arrangement or the appointment of a voluntary administrator. A supplier may apply to the court for an order that the contract be terminated if continuing supply will cause hardship.
- Scheme of arrangement moratorium: Introduction of a voluntary administration-style moratorium on creditor enforcement action during the formation of schemes of arrangement.
- Simplified 'small liquidation' process: A separate liquidation process be available for companies with liabilities to unrelated parties of less than $250,000. Liquidators for these assignments would be drawn from a pool of providers selected by tender to ASIC (and subject to review every five years).
- A review of receiverships: An independent review of the provisions of the Corporations Act 2001 relating to receivers and the practices of receivers in the market.
The final recommendations reflect the Government's policy objective of increasing productivity and economic growth by fostering entrepreneurial activity. However, the legitimacy of those recommendations is undermined by the lack of empirical data on actual outcomes produced by Australia's existing insolvency laws.
Voluntary administration certification
The Productivity Commission has modified its draft recommendation that the voluntary administration procedure be only be available to solvent companies - a number of submitters pointed to the practical difficulty of determining solvency and the fact that an insolvent company may have an underlying viable business.
The problem the Productivity Commission perceived was that the statutory voluntary administration procedure, frequently used by hopelessly insolvent companies without sufficient resources to perform a restructure, is tainted with a self-fulfilling stigma that the company is doomed to fail, with a voluntary administration being an inevitable precursor to a liquidation and no path to rescue and recovery. The threshold practical difficulty with the draft recommendation was that a real time solvency determination may be difficult to make. Further, even a hopelessly insolvent company may have an underlying viable business that may be preserved, restructured or otherwise rescued with the benefit of the statutory moratorium on creditor action provided during the voluntary administration process.
The Productivity Commission's final recommendation on the reform of the voluntary administration process swaps the concept of solvency for viability, and it is otherwise unclear to the authors how this improves the position or addresses the underlying problem the Productivity Commission identified. The final report is silent on how the proposed 'viability' certification interacts with the occurrence of the second meeting of creditors (and the decision to be made by creditors at that meeting) or the possibility of entering into a Deed of Company Arrangement.
Safe harbour defence for directors
The safe harbour recommendation is targeted at the perceived problem that director personal liability for insolvent trading encourages directors to appoint a voluntary administrator when a company is in financial difficulty, rather than to take sensible risks while continuing to trade the company out of financial difficulty. Not all submitters agreed that this problem exists in practice.
The Productivity Commission rejected suggestions that the safe harbour mechanism be available to protect directors from other sources of personal liability - for example, the ATO Director Penalty Notice regime - which may render the opportunity to take sensible risks in reliance on the defence less attractive to directors.
'Ipso facto' termination clauses
In response to the draft recommendation, the vast majority of submitters supported the recommendation that 'ipso facto' termination clauses be unenforceable if the relevant event is the appointment of an administrator or a receiver, or if the company is in 'safe harbour'. The Productivity Commission was unmoved by the argument that the rights of counterparties are equally as important in an insolvency scenario.
The final recommendation refers to the appointment of an administrator or the occurrence of a scheme of arrangement as the relevant ‘non-enforceable events’. The appointment of a receiver is not included as a non-enforceable event and the final report is silent as to reason why. The inclusion of the 'safe harbour' has also been removed on the basis that the safe harbour will not be a public process (as was proposed in the draft report).
The proposed reform leaves open the question of whether or not, if ipso facto clauses are rendered unenforceable, counterparties could build in contractual protections to permit the renegotiation of key terms on insolvency (e.g. by swapping from existing supply terms to cash on delivery, or cash on account). This aspect of the recommendation would require careful consideration prior to any implementation in law.
A review of receiverships
The Productivity Commission has sensibly discarded its draft recommendation that receivers be subject to an additional duty to "not cause unnecessary harm" to the interests of creditors as a whole, including putting the continuation of the company, or the preservation of the company as an ongoing concern for sale purposes at risk, and that a sale outside of the ordinary course of business be subject to a majority vote of all creditors. The majority of submitters did not support this quite radical proposal which would have (as a submitter noted) turned receiverships into de facto voluntary administrations and likely to cause an increase the cost, and reduce the availability, of secured credit, and may place receivers in a difficult position vis-à-vis the company's secured and unsecured creditors.
However, the final report still has receiverships in its sights and has recommended an independent review of receiverships, arguing that receivers should still consider the impact of their actions on the “overall wellbeing or insolvency of the company”.
The additional recommendation that unsecured creditors be able to form a committee that has standing to challenge the professional fees charged by a receiver is unlikely to be popular among insolvency practitioners.
Suggestions that were not adopted
A number of submissions suggested changes that were not adopted by the Productivity Commission in either the draft or final report. These included:
- a broad and detailed examination of Australia's insolvency laws to evaluate areas for reform (equivalent to the Harmer Report);
- an alternative dispute resolution regime to deal with enquiries and complaints about the conduct of insolvency practitioners; and
- an insolvency expert panel (equivalent to the Takeovers Panel) that could deal with, among other things, applications to extend the voluntary administration period.
The problems perceived by the Productivity Commission are based on anecdotal commentary in the submissions, not by quantitative information, and the submissions to the Productivity Commission were not always unanimous as to the existence and extent of those perceived problems. It is difficult to justify significant changes to the existing laws without understanding their current operation in practice. Conversely, a comprehensive review may establish that appropriately targeted change is highly desirable. The release of the final report has set the scene for further specific investigation and consideration.
The Productivity Commission has sought to accommodate the views of a large group of stakeholders in its final recommendations, with the result that the recommendations lack cohesion and a practical, pragmatic focus. However, between the final report and the innovation statement, there is a clear intention to move from Australia's purported focus on creditor outcomes to a more US-style business rescue culture.
It is clear that the Productivity Commission's final report signals further progress toward reforming Australia's insolvency laws, and has been a valuable exercise for exploring current issues in the field. As it is, however, an area that does not lend itself to speedy reform, the next step may be some time away – no doubt, the progress from recommendation to legislation will be one involving significant further discussion and consultation.