• The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (Cth) was finally passed by the Senate on 12 September 2017. The Bill will insert provisions into the Corporations Act2001 (Cth) which will:
    • provide ‘safe harbour’ from liability for insolvent trading by directors if their company is undertaking a restructure outside formal insolvency;[1] and
    • make certain contractual rights unenforceable while a company is restructuring under certain formal insolvency processes (‘ipso facto reforms’).
  • The amendments are designed to address the perception that the present insolvent trading laws encourage directors to place companies in external administration prematurely, and deter them from taking the types of risks that might rescue a business and preserve its value.[2] They are intended to encourage honest, diligent and competent directors “to remain in control of a business in financial difficulty and to take reasonable steps to restructure and/or allow it to trade out of its difficulties.”[3]
  • The safe harbor defence took effect on 19 September 2017. The ipso facto reforms will commence at latest on 30 June 2018.

The safe harbour defence

  • The engine room of the new defence[4] is found in s 588GA(1), which prevents s 588G(2) from applying in relation to a person and a debt if:
    • 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
    • the debt is incurred directly or indirectly in connection with any such course of action (including “ordinary trade debts incurred in the usual course of business”)[5] during the period starting at that time, and ending at the earliest of any of the following times:
      • if the person fails to take any such course of action within a reasonable period after that time – the end of that reasonable period;
      • when the person ceases to take any such course of action;
      • when any such course of action ceases to be reasonably likely to lead to a better outcome for the company; and
      • the appointment of an administrator, or liquidator, of the company.
  • Not all debts incurred during the safe harbour period will attract the protection: some will fail to have a sufficient connection with the relevant course of action or the usual course of business, and some will be expressly carved out by subsections (4) to (6), which ‘close the harbour’ to directors in certain circumstances.[6]
  • Judicial analysis of the provisions will no doubt prove interesting. Potential complications can readily be seen when considering:
    • the requirement that the person “starts developing one or more courses of action”: some positive act rather than merely thought appears to be required to engage the provision, but the distinction between the two concepts will likely be the subject of significant debate;
    • the requirement that the course(s) of action be “reasonably likely to lead to a better outcome”:
      • the phrase ‘reasonably likely’ does not require a better than 50% chance of a better outcome than the immediate appointment of an administrator or liquidator, but rather a chance of achieving a better outcome that is not fanciful or remote, but is ‘fair’, ‘sufficient’ or ‘worth noting’.[7] But whose interests constitute those of the company, and which outcome is better for them?[8];
      • is suggestive of an objective test.[9] However, the five enumerated factors in s 588GA(2)[10] are not exclusively objective indicia, which may create obstacles to clear analysis;[11] and
    • varying degrees of clarity exist in the alternatives prescribed by s 588GA(1)(b): when does a person cease to take a course of action? When does such a course cease to be reasonably likely to lead to a better outcome?
  • While offering food for thought on their own, these comments disclose merely preliminary issues that arise on the face of the statute. The questions to be determined on the application of the provisions are likely to prove complex and numerous.

The ipso facto reforms

  • An ‘ipso facto’ clause in a contract allows a party to terminate or modify it upon the occurrence of a specified event (usually relating to the creditworthiness of the other party).
  • Such a clause can pose a serious impediment to the restructuring of companies in financial distress. For example, if a company with a substantial asset base has short-term liquidity problems leading to voluntary administration, an ipso facto clause might allow a major supplier to cancel its contract, rendering any trade-on or meaningful restructure impossible.
  • The lack of protection from such an outcome in Australia’s insolvency regime has been criticised. To counter those criticisms, the new provisions will impose an automatic stay of enforcement of ipso facto rights in the event of a company entering into a scheme of arrangement or voluntary administration, or where a managing controller has been appointed.[12] Such a stay would not apply to liquidations, and it would only operate while the administration or scheme of arrangement is ongoing, ceasing when a party is wound up. Parties will maintain the right to terminate or modify an agreement for another reason, such as a breach involving non-payment.[13] For the purpose of protecting creditors, however, contractual obligations to provide further credit will be unenforceable during the stay.[14]
  • The provisions are aimed at allowing breathing space for a company to trade during a formal restructure, and precluding the dissipation of value that can occur upon the exercise of ipso facto rights. It is not yet clear, however, how they will operate in real terms – or the impact they will have upon lending practices as a commercial reality.