1. On 18 September 2017 the Treasury Law Amendment (2017 Enterprise Incentives No. 2) Act 2017 (the Safe Harbour and Ipso Facto Act) became law.
  2. The Safe Harbour reforms introduced in the Safe Harbour and Ipso Facto Act create a safe harbour for company directors from personal liability for insolvent trading if the company is undertaking a restructure outside formal insolvency processes. The aim of the reforms is to encourage company directors to engage early with financial hardship, keep control of their companies and take reasonable steps to pursue a corporate restructure. The Safe Harbour reforms came into effect on 19 September 2017.
  3. The Ipso Facto reforms introduced in the Safe Harbour and Ipso Facto Act impose restrictions on the enforcement of ipso facto clauses in contracts, to facilitate restructures through voluntary administrations, schemes of arrangements, and during receiverships. The Ipso Facto reforms introduce a stay on the enforcement of contractual rights when a company has entered a formal insolvency process to restructure. The Ipso Facto provisions will come into effect on 1 July 2018 (or earlier by proclamation).

Background to the reforms

The Safe Harbour and Ipso Facto bill stems from recommendations made by the Productivity Commission in its 2015 Inquiry Report: Business Set-Up, Transfer and Closure. As a result of the recommendations in that report the safe harbour and ipso facto initiatives were included in the Federal Government’s national innovation and science agenda in 2015.

The purpose of the reforms is to amend the Corporations Act 2001 to promote a culture of entrepreneurship and innovation and reduce the stigma associated with business failure, to drive business growth and encourage risk. The reforms are also designed to enable viable businesses to continue to trade on in order to recover from an insolvency event.

According to the Productivity Commission, concerns over inadvertent breaches of insolvent trading laws are frequently cited as a reason why early stage investors (also called angel investors) and professional directors are reluctant to become involved in start-ups.

The Safe Harbour reforms

The new safe harbour reforms create a legislative carve-out from the personal liability for debts incurred while a company is insolvent imposed on directors of a company by section 588G(2) of the Corporations Act 2001 (Cth) (Corporations Act). Under the new section 588GA of the Corporations Act, the insolvent trading liability provisions do not apply to a director in respect of a debt if:

  1. At a particular time after the person starts to suspect the company may become or be insolvent, the person starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company; and
  2. The debt is incurred directly or indirectly in connection with such a course of action.

A better outcome is defined in section 588GA(7) of the Corporations Act as “an outcome that is better for the company than the immediate appointment of an administrator, or liquidator, of the company”.

For the purposes of working out whether a course of action is reasonably likely to lead to a better outcome for the company, section 588GA(2) provides that regard may be had to a number of factors including whether the person is properly informing themselves of the company’s financial position, whether they have taken steps to prevent misconduct by officers or employees of the company, whether they have taken steps to ensure the company is keeping appropriate records, whether they are obtaining advice from an appropriately qualified and informed entity, or whether the person is developing a plan for restructure which is designed to improve the company’s financial position.

While the safe harbour reforms do not provide any specification on who may be an “appropriately qualified entity” to provide advice in relation to a restructure, the parliament considered and rejected a proposal that this be limited to registered liquidators, providing directors with increased flexibility in their options for obtaining advice. However, since the onus of proving that the safe harbour should apply lies with the person who seeks to rely on the safe harbour, it would be prudent for directors to take qualified advice from reputable organisations or individuals.

It ought to be noted that a director is unable to rely on the safe harbour provisions in respect of a debt incurred by a company if the company is failing to pay employee entitlements, failing to comply with taxation law requirements, or if the director does comply with the reporting requirements to an external administrator. In addition, a director may not rely on books and records of the company to support a safe harbour position if they fail to permit the inspection of or deliver up the books of the company to an external administrator.

Ipso facto reforms

Ipso facto refers to contractual rights that allow one party to a contract to terminate or modify the operation of a contract upon the occurrence of a particular event. The Ipso Facto reforms are designed to prevent the enforcement of ipso facto clauses which are triggered by a company entering into a formal restructuring process, including administration or receivership. The concern is that ipso facto clauses reduce the scope for a successful restructure of a business, or prevent the sale of a business as a going concern.

The Ipso Facto reforms are designed to prevent companies having their major contracts cancelled and the value of the company’s business significantly impacted or destroyed if they are experiencing temporary financial difficulties. The amendments to the Corporations Act introduced by the Safe Harbour and Ipso Facto Act prevent one party to a contract from terminating a contract simply because of the financial position of the other party. However, the reforms introduced to the Corporations Act do not prevent stop parties from terminating a contract with a company for any other valid reason, including non-payment or non-performance.

The new provisions of the Corporations Act introduce a stay on enforcing rights in circumstances where:

  1. A company enters into a scheme or arrangement (or announces it will enter into a scheme of arrangement) to avoid being would up in insolvency (section 415D);
  2. A managing controller/receiver is appointed to a company (section 434J);
  3. A company goes into administration (section 451E).

The Corporations Act has also been amended to provide the court with powers to override the stay if satisfied that it is appropriate to do so in the interests of justice, and powers to prevent the avoidance of the provisions by ordering that certain contractual rights which have been enforced merely because the company has entered into one of the relevant formal restructuring processes are enforceable only with leave of the Court, and on certain conditions.

The Ipso Facto provisions will not apply to contractual rights prescribed in the regulations, declared in a Ministerial declaration, or set out in agreements made after the commencement of the relevant formal restructuring process.

The Ipso Facto provisions will be an important consideration over the next six months when negotiating new contracts, or renegotiating existing agreements. It is important to note that the new provisions will only apply to contracts, agreements or arrangements entered into from the commencement time of the ipso facto provisions.