On 28 March 2017, the Australian Government announced its proposals to reform the law relating to insolvent trading, and the right to terminate contracts based on insolvency ('ipso facto clauses').

Reforms to the current laws were announced by the Australian Government on 7 December 2015, and public consultation began on the two proposed models for 'safe harbour' for directors to protect against their personal liability for failing to prevent a company from continuing to incur debts while insolvent. These models, together with proposals to deal with 'ipso facto' clauses were outlined in the government's Improving Bankruptcy and Insolvency Laws' Proposals Paper of April 2016 (Proposals Paper) which was subject to public consultation between 29 April 2016 and 27 May 2016.

MinterEllison made a detailed submission on the proposals which can be found here: MinterEllison's submission to the Australian Government.

Impact

According to Kelly O'Dwyer, the relevant Government Minister, the insolvent trading safe harbour reforms are targeted at driving cultural change amongst company directors by encouraging them to retain control of their company, engage early with possible insolvency, and take reasonable risks to facilitate the company's financial recovery instead of simply placing the company prematurely into external administration.

The ipso facto stay reforms are said to be aimed at preventing the operation of these contractual provisions when a company has entered into a formal insolvency process so as to give a greater chance to successfully restructure and increase the likelihood of a sale of the company's business as a going concern.

The Proposals In Detail

Part 1 – Safe harbour for insolvent trading

'Carve out' of insolvent trading liability

New s 588GA establishes a safe harbour which will operate to carve directors out from the civil insolvent trading provisions of s 588G(2).

The key features of the new laws include:

  • Safe harbour provisions to protect directors from liability for debts incurred by an insolvent company if they take a course of action that is reasonably likely to lead to a better outcome for the company and its creditors and the debt was incurred as part of the course of action.
  • Directors will be prevented from using books and information about a company as evidence that they took a reasonable course of action if they have previously not provided these materials to a liquidator or administrator following an appropriate request for the materials.
  • Directors will not be able to rely on the safe harbour in circumstances where the company is not meeting its obligations in relation to employee entitlements (including superannuation) and its taxation reporting obligations.

In the MinterEllison Submission, we suggested a model incorporating elements of both models set out in the Proposals Paper and the proposed new s 588GA is consistent with the recommended alternative model set out in the MinterEllison Submission.

Directors must pursue a reasonable course of action

The safe harbour will protect directors in relation to debts that the company incurs associated with a course of action being taken by directors that is reasonably likely to lead to a better outcome for the company and the company's creditors than proceeding to voluntary administration or winding up.

The protection will apply from the time the director starts to take a course of action after beginning to suspect that the company may become insolvent and will apply until either the course of action ends, the course of action stops being reasonably likely to lead to a better outcome for the company and its creditors or the company enters into external administration.

This will be assessed on an objective basis. The safe harbour will extend to cover a period in which deliberations and preparations for the course of action are occurring, and will depend on the circumstances in each case. The safe harbour has wide application so that it gives directors sufficient latitude to take a course of action that is appropriate in the context of the company's size, nature and complexity.

Relevant factors

New s 588GA(2) provides an indicative and non-exhaustive list of factors to be considered in determining whether a course of action is reasonably likely to lead to a better outcome for a company and its creditors. Namely, these are if the director has:

  • taken appropriate steps to prevent misconduct by officers and employees of the company;
  • taken appropriate steps to ensure the company maintains appropriate financial records;
  • obtained appropriate advice;
  • kept themselves informed about the company's financial position; and
  • been developing or implementing a plan to restructure the company to improve its financial position.

The listed factors provide only a guide as to the steps a director may consider or take depending on the circumstances. However, if a director fails to react appropriately to changed circumstances indicating that the company is not viable, then the director will no longer have the safe harbour protection for any debts incurred from that time.

Better outcome

'Better outcome' is defined in the draft legislation to mean one where the company and its creditors as a whole are better off than the company becoming an externally administered body corporate, including the company going into administration or being wound up.

New debts

If debts become owing to new creditors as part of a director taking a course of action reasonably likely to lead to a better outcome but the directors do not believe that the company can repay the debts in accordance with its terms the safe harbour protection would not apply. Moreover, this is likely to result in breach of other general directors' duties.

Evidentiary matters

Directors will need to be able to adduce evidence which demonstrates that a course of action that was reasonably likely to lead to a better outcome for the company and its creditors was taken. The evidence would need to be able to satisfy the Court that there is a 'reasonable possibility' that the directors were taking a reasonable course of action.

The onus then shifts to a liquidator or other person alleging a breach of s 588G(2), to prove that the safe harbour does not apply because the directors did not take a reasonable course of action.

Ineligibility factors: employee entitlements and taxation reporting

Two circumstances are listed in s 588GA(4) which prevent directors form relying on the safe harbour:

  • where a company does not make provisions for its employees' entitlements (including superannuation); and
  • where a company has not complied with its taxation reporting obligations.

In each circumstance, directors will not be eligible for safe harbour protection if the company is not meeting its obligations to a standard that would reasonably be expected of a solvent company.

Information inadmissible if directors fail to permit inspection

New s 588GB provides for circumstances where directors will be prevented from relying on books or information as evidence to support a safe harbour defence where these materials have been withheld from a liquidator or administrator. This is directed at preventing directors from later using withheld books or information as a part of a safe harbour defence.

However, two exceptions are available to directors:

  • who prove that they did not possess the relevant books or information and there were no reasonable steps that could have been take to obtain the materials; and
  • where a liquidator seeking the books or information does not notify directors that a failure to provide the books or information will prevent them from being later used by the directors as evidence in relation to the safe harbour.

Liquidators will be required to notify directors that a failure to provide books or information about the company will prevent directors from using them as evidence as part of a safe harbour defence.

Part 2 – Stay on enforcing ipso facto termination rights merely because of arrangements or restructures

The MinterEllison Submission also looked closely at the proposals to limit the operation of 'ipso facto' clauses, and placed them in the context of similar provisions in the USA and Great Britain. The proposed legislation addresses many of the issues we raised.

Ipso facto clause stay during schemes of arrangement and voluntary administration

Subject to certain exceptions where ipso facto clauses are inherently necessary to the operation of a contract, clauses which allow a contract to be terminated or varied solely due to the fact that an 'insolvency event' has occurred, would be stayed during a formal restructure in the context of:

  1. voluntary administration under Part 5.3A (new ss 451E–451G); and
  2. schemes of arrangement or compromise under Part 5.1 (new ss 415D–415F).

However, a counterparty maintains the right to terminate or amend an agreement with the debtor company for any other reason, including for a breach involving non-payment or non-performance. It follows that if a company does not have the ability to rectify payment default, for example, the counterparty will continue to be free to terminate on that basis.

The counterparty creditor will not be required to continue to provide credit to a debtor company while the stay on termination is in effect. The ability to require immediate payment in return for continued supply addresses one of the main concerns raised in the MinterEllison Submission.

Exceptions to the stay

The stay does not apply in relation to rights:

  • in a type of contract specified in regulations or a ministerial determination;
  • of a kind prescribed in the ministerial determination;
  • in agreements made after the order approving a scheme of compromise or arrangement for a Part 5.1 body or beginning of the voluntary administration of a company;
  • that manage financial risk associated with a financial product that is commercially necessary for that type of financial product.

Lifting the stay

The Court will have discretion to allow a right to be enforced if doing so would be appropriate in the interests of justice. The Court will also have the discretion to restrict the enforcement of other rights in an agreement if it appears likely that those rights will be exercised merely because of an insolvency event.

Interim orders

Before deciding an application for the stay order, the Court may grant an interim order for one or more rights under a contract, agreement or arrangement not to be enforced against the Part 5.1 body or company (as the case may be), but cannot require an applicant for an order to give an undertaking as to damages as a condition of granting an interim order.

Context A – Schemes

New s 415D provides a stay against the enforcement of rights which would allow a contract to be terminated or amended if a 'Part 5.1 body' makes an application to enter into a compromise or arrangement or has such an application approved by the Court under s 411.

However, the rights will only be unenforceable where the application under s 411 states that it is being made so that the Part 5.1 body can avoid being wound up in insolvency.

Ipso facto provisions in contracts will not be enforceable against a Part 5.1 body from the time the Part 5.1 body makes an application to the Court under s 411, until either:

  • the application is withdrawn or is rejected by the Court; or
  • once the compromise or arrangement finishes, unless this occurs because the Part 5.1 body is to be wound up, in which case the stay will operate until the party is wound up.

The stay on enforcement does not apply to rights:

  • in contracts, agreements or arrangements entered into after the day a compromise or arrangement is approved;
  • that are found in the kinds of contracts or agreements prescribed in regulations or a ministerial declaration;
  • of a kind prescribed in a ministerial declaration;
  • that manage financial risk that are associated with a financial product that would be commercially necessary for the provision of that type of financial product.

Context B – Voluntary administration

New s 451E(1) provides a stay against the enforcement of rights which would allow a contract to be terminated or amended merely because a company is under administration.

Ipso facto provisions in contracts will not be enforceable against a company from the time the company enters into administration until the administration ends unless:

  • the administration ends because the company is being wound up, in which case the rights will not be enforceable until the time the company is wound up; or
  • within 7 days of the administration ending, the company makes an application to the Court to extend the period for which the rights will not be enforceable, in which case the rights will not be enforceable until:
    • either the application is withdrawn or the Court rejects the application; or
    • the order of the Court extending the period ceases to apply.

A Court may extend the period for which a right is not enforceable against a company if:

  • a s 444F order limiting the rights of secured creditors is in force for the benefit of the company;
  • the court is satisfied that doing so would be in the interests of justice; and
  • the applicant for the extension is the same as the applicant for the s 444F order.

The stay on enforcement does not apply to rights:

  • in contracts, agreements or arrangements entered into after the day the company enters administration;
  • that are found in the kinds of contracts or agreements prescribed in regulations or a ministerial declaration;
  • of a kind prescribed in a ministerial declaration;
  • that manage financial risk that are associated with a financial product that would be commercially necessary for the provision of that type of financial product.

Further consultation and review

The Australian Government has invited submissions on the Exposure Draft Bill and exposure draft explanatory materials, which are due to be provided to the Treasury by Monday, 24 April 2017.

MinterEllison will be reviewing the consultation documents in more detail and will provide our considered views on any issues arising out of the proposals in our submission to the Treasury.