Who should read this eBrief:
- Company Directors, Accountants, Financial Advisors
Recent changes to Commonwealth legislation have significantly reformed the law relating to corporate insolvency practices, and have created new provisions designed to give greater flexibility to companies in financial distress. The key elements of change include providing a “safe harbour” for directors from the consequences of insolvent trading, and preventing the operation of “ipso facto” clauses (in certain circumstances) which can provide companies with breathing space when trying to trade out of a difficult financial situation.
Company in Financial Distress?
The new laws provide additional flexibility and options available to directors of companies in financial distress. It may not be necessary, or appropriate, to simply place a company into liquidation, or appoint a voluntary administrator.
Corporations Act 2001 (Cth) Reforms
On 19 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth) commenced as Australian law. The reforms created by the new law aim to promote solvent company restructurings in two main ways:
- Introduction of safe harbour provisions; and
- A stay on ipso facto clauses and rights.
The new legislation provides avenues to directors to avoid unnecessary and premature external administration of companies, and promote entrepreneurship and innovation in the corporate sphere to preserve company value and maximise shareholder and creditor returns.
What is ‘Safe Harbour’?
Under sections 588G and 588M of the Corporations Act 2001 (Cth) (the Act), a director of a company may be held personally liable for debts incurred by the company if the company is insolvent, or becomes insolvent by reason of incurring the debt, and at that time, there were reasonable grounds for suspecting the company was, or would become, insolvent.
The ‘safe harbour’ provisions took effect from 19 September 2017. They provide directors with a defence against personal liability for insolvent trading under sections 588G and 588M of the Act provided that the directors develop and take a course of action that is reasonably likely to lead to a better outcome for the company than an external administration.
However, the safe harbour protections do not apply to a failure to pay employee entitlements and provide or lodge all returns, statements or other documents required by the Income Tax Assessment Act 1997 (Cth). The protection also only applies to debts incurred in connection with the course of action proposed by the directors.
The benefits of the safe harbour provisions include:
- The ability for directors to seek advice from suitably qualified entities for assistance in trading out of financial distress or otherwise avoiding insolvency;
- Alleviation of threats of personal liability for insolvent trading;
- Avoiding the destruction of value inherent in entering a formal insolvency process; and
- Allowing directors breathing space in which to seek advice and make properly thought-out decisions and implement plans to improve the financial position of the company.
What are the changes to ipso facto clauses?
Unlike the safe harbour provisions of the insolvency law reforms, the new law regarding ipso facto clauses came into effect on 1 July 2018.
An ipso facto clause is a provision in a contract that allows one party to unilaterally terminate or modify a contract upon the occurrence of a specific event. In the context of insolvency law reform, the most common event which would trigger the ability of one party to terminate a contract is the entry of a corporate party to the contract into some form of external administration, such as liquidation, voluntary administration, or the appointment of a receiver or manager over the assets of the company.
An example of an ipso facto clause might be found in a supply contract, where a clause gives a wholesale supplier the right to terminate the contract where a retailer customer enters voluntary administration or has a winding up application commenced against it.
The new law applies to contracts entered into on or after 1 July 2018. It renders an ipso facto clause unenforceable if it is triggered merely because:
- The company is entering into voluntary administration;
- The company is entering a scheme of arrangement for the purpose of avoiding being wound up in insolvency; or
- A managing controller or receiver has been appointed overall, or substantially all, of a company’s property.