The amendments to the Corporations Act1 to broaden the ‘safe harbours’ for directors on an insolvency were passed by Parliament on 12 September 20172 and are awaiting a date for commencement.
The intention of the legislation is to “drive cultural change amongst company directors by encouraging them to keep control of their company, engage early with possible insolvency and take reasonable risks to facilitate the company’s recovery instead of simply placing the company prematurely into voluntary administration or liquidation.”3
The legislation is not absolution for past debts incurred by trading while insolvent. Its protections are intended to give directors a new opportunity to incur debts where it is part of the process of moving the company away from insolvency.
A summary of the key reforms are set out below. In essence, under the legislation:
- directors will not be liable for debts incurred directly or indirectly in connection with developing and taking a course of action that is reasonably likely to lead to a better outcome for the company than an immediate appointment of an administrator or liquidator to the company, provided that certain conditions are met (including employee entitlements paid when due); and
- rights in contracts which are triggered by certain insolvency events (known as ipso facto clauses) will have their application stayed while those insolvency processes are ongoing, unless a Court rules otherwise.
The date has not as yet been set for the commencement of the legislation. This is particularly important because the safe harbour will apply only to debts incurred after the date the legislation commences (which will be the day after the legislation receives Royal Assent).
The stay on ipso facto clauses are likely to only take effect from 1 July 20184 and, in general, will only apply to contractual rights pursuant to contracts made after that commencement – that is, ipso facto clauses in contracts entered into prior to commencement will generally remain enforceable.
Amendments made while the legislation was before the Senate mean that the Minister must cause an independent review of the effectiveness of the new regime after it has operated for 2 years. This includes review of the impact on the conduct of directors and on the interests of creditors and employees.
Ultimately, the success of the legislation will depend on whether directors are willing to engage openly at times of potential insolvency and are able to change their risk appetite. We discuss below some of our thoughts as to the likelihood of success of these new measures, including having regard to the size of the entities involved.
We will be releasing further articles on the content of the legislation and these issues.
The new section 588GA(1) of the Corporations Act provides that directors will not be liable for debts incurred directly or indirectly in connection with developing and taking a course of action that is reasonably likely to lead to a better outcome for the company than an immediate appointment of an administrator or liquidator to the company.
The new section 588GA(2) lists five indicative, non-exhaustive, guiding factors to which regard may be had in determining whether a course of action is reasonably likely to lead to a better outcome for the company than an immediate voluntary administration or liquidation. These factors are whether the director is:
- properly informing himself or herself of the company’s financial position; or
- taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all of its debts; or
- taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or
- obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
- developing or implementing a plan for restructuring the company to improve its financial position.
Directors should bear in mind that the safe harbour protection will not apply if a debt is incurred by an insolvent company when it is not substantially complying with payment of employee entitlements (including superannuation) as and when they fall due or its taxation reporting obligations, unless the Court orders otherwise. Another exception to the protection is where a company fails to comply with those employee entitlement payments or tax reporting obligations on two or more occasions (in aggregate) within 12 months leading up to the debt being incurred.
Ipso facto clauses
Ipso facto clauses create a contractual right that allows one party to terminate or modify the operation of a contract solely due to the company’s financial position (including insolvency) or due to the commencement of formal insolvency proceedings, such as on the appointment of an administrator.
Currently, enforcement of ipso facto clauses is possible, despite the company continuing to perform its obligations under the contract.
The new stay on the enforcement of ipso facto clauses will apply where those contractual rights are triggered by the company’s financial position or its entry into a formal restructure, including where:
- a company has come or is under administration;
- a managing controller has been appointed over all or substantially all of a company’s property; or
- a company is undertaking a compromise or arrangement for the purpose of avoiding being wound up in insolvency (under section 411 of the Corporations Act).
Importantly for disclosing entities, such as listed companies, the stay will apply from the time that the company publicly announces that it will be making an application under section 411 of the Corporations Act for a period of 3 months, unless the company makes the section 411 application within the 3 month period or the Court orders an extended application period. The stay will continue to apply until either the application is withdrawn or is dismissed by the Court, at the end of any compromise or arrangement approved as a result of the application, or when the affairs of the company have been fully wound up.
Anti-avoidance provisions have also been built into the amendments to ensure that contractual arrangements which may develop that trigger on circumstances not captured by the current provisions can be responded to quickly to prevent widespread circumvention of the stay.
Will the legislation achieve its stated aim?
We expect that the change in the insolvent trading law will not be treated the same across the corporate spectrum. Small and medium companies, whose directors are more likely to be subject to personal guarantees, will continue to remain in control of their companies for longer, and delay making formal appointments, in an effort to avoid their exposure under personal guarantees. Many will shun the benefit (and cost) of obtaining advice from an appropriately qualified entity given that requirement is not mandatory to satisfy the safe harbour requirements. One suspects that many such directors will not meet the strict requirements of the safe harbour protection outlined above, or will fall foul of the various pitfalls, such as not paying employee liabilities or lodging taxation returns.
On the other hand, directors of larger corporates may well seek specialist insolvency advice earlier than they would currently on becoming suspicious of their company’s solvency. This would be a good outcome so far as the prospects of successful turnarounds of large corporates are concerned. The recent case of Channel 10 and the early engagement of specialist insolvency advisors in that instance could be an indication of the very thing the new legislation hopes to encourage.
The risk for directors of larger corporates relying on the safe harbour arises from the need to be transparent about their suspicions of insolvency (and undoubtedly to document those concerns) early in the process. If directors of large corporates also fall foul of the strict requirements of the safe harbour – again by failing to pay employees or comply with taxation reporting obligations – they will be handing to the liquidator clear evidence of their suspicion as to insolvency, and a breach of section 588G of the Corporations Act.
From a technical perspective, there are several uncertainties in the operation of the provisions, which may or may not be dealt with by the introduction of regulations or declarations made by the Minister.
Ultimately the success of the legislation and its stated aims may rest more heavily on whether directors and companies are willing to spend money in the ‘solvency twilight zone’ to seek appropriate advice and potentially expose themselves by being upfront and honest about the situation which the company finds itself. This will require a shift in boardroom culture in Australia and will certainly not happen overnight.