The Federal Government has released the Exposure Draft for the much anticipated introduction of:
- A safe harbour for company directors from personal liability for insolvent trading; and
- A stay on the enforcement of ipso facto clauses in limited circumstances.
Both developments have the potential to increase the ability of a company to avoid formal insolvency and/or restructure in a way that will benefit creditors and members alike. It will also allow for directors to remain in control of companies during such a process somewhat analogous to a US Chapter 11 style process.
The safe harbour is effectively the creation of a defence for a director if the director undertakes a course of action that is reasonably likely to lead to a better outcome for the company and the company’s creditors. Such a defence would be a shield against an insolvent trading claim.
The defence is intended to encourage honest directors to remain in control of a financially distressed company by taking steps to allow it to trade out of its debt or come to a compromise with its creditors in circumstances where there may be a better outcome for the company instead of administration.
The draft legislation states that for the purposes of determining what is reasonably likely to lead to a better outcome for the company, the following non-exhaustive factors are to be taken into consideration:
- Has the director taken steps to prevent misconduct by the company’s officers and employees that could adversely impact the ability to pay the company’s debts?
- Has the director ensured appropriate financial records are being kept by the company?
- Has the director obtained appropriate advice?
- Was the director properly informed of the company’s financial position?
- Was the director developing or implementing a restructure plan to improve the company’s financial position?
The test would appear to be an objective one. However, there is some uncertainty as to who bears the onus of proof. There appear to be words missing from the proposed 588GA(2), and there is a tension between 588GA(3) which refers to the director bearing “an evidential burden” (whatever that means) and the Explanatory Memorandum which suggests the liquidator (or other person) seeking to hold a director personally liable bears the onus of proof. This will no doubt be an issue which will be clarified during the discussion period.
The safe harbour defence will not be available if the company has failed to provide employee entitlements or failed to comply with tax laws.
An ipso facto clause - the Latin translation meaning ‘by the fact itself’ – provides for the often automatic or self-executing termination or amendment of a contract in the event of an insolvency event. That is the insolvency itself (be it appointment of an insolvency practitioner or otherwise) is what triggers the termination of, or right to termination of, an agreement.
Clearly, and has been long lamented, such provisions can be value destructive, especially on administration, and often lead to the demise of the company and underlying business resulting in liquidation.
The stay on ipso facto clauses provided for in the Exposure Draft is anticipated to operate in the Part 5.3A administration regime and Part 5.1 schemes of arrangement.
Commencement of these changes is uncertain but it appears that the changes addressing ipso facto clauses will commence no later than 1 January 2018.
- The proposed reforms provide some protection for directors when seeking to promote informal restructures and assist in the use of both the administration and scheme regimes to achieve better outcomes for all stakeholders.
- The phrase ‘reasonably likely’ will be an inevitable field day for lawyers and time will tell whether the words are tightened or directors will need to rely on judicial consideration.
- Advisors to boards (both restructuring and legal) will play an increasingly important role as they will likely form the backbone of any director’s defence under the new regime.
- The reforms mark a shift, albeit a small step, from the traditional Australian insolvency regime which has been creditor driven to a more debtor friendly system providing directors the ability to remain in control of distressed companies.