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Insolvency Law reform provides safe harbour for drowning Businesses

Current laws

Australia’s corporate insolvency laws have typically been swayed in favour of protecting investors and vulnerable shareholders, placing the weight of duties on company directors. Director’s responsibilities were designed to create business accountability for remaining solvent and to act in the best interest of the company. These duties can include penalties for trading whilst insolvent, personal liability for debts incurred and in extreme cases, imprisonment.

The current insolvency laws, to some extent, impede innovation and treat risk taking as reckless and uncalculated. Therefore, many directors may be inclined to prematurely wind up companies in fear of the above repercussions. Other countries have successfully designed alternative options for managing company failure, and Malcom Turnbull’s ‘Innovation Nation’ law reforms seeks to address the unnecessary stigma attached to “failure” in Australia’s corporate realm.

Unsurprisingly, hindsight for many business owners is a valuable tool for future enterprise, however the current laws are seen as so punitive that many directors of companies that have previously failed are often unwilling to give it a second try.

The proposed reforms

The Financial System Inquiry Report (FSIR) , released on 7 December 2014,[1] identified submissions from stakeholders arguing that the directors should be protected by a ‘safe harbour’, whereby a company in financial difficulty could undertake restructuring efforts without the risk of the directors being penalised for insolvent trading. It was further suggested that these ‘safe harbour’ protections should extend to expert restructuring advisers to protect them from the risk of being considered de facto directors during this restructuring period.

The same report also recognised the effect of ‘ipso facto’ clauses permitting the termination of company agreements when a bankruptcy or insolvency event occurs. These clauses can be a hindrance for companies attempting to trade out of financially unstable periods to achieve long term goals.

Following from the FSIR, the Federal Government announced in December 2015 the National Innovation and Science Agenda (NISA)[2] to improve Australia’s economy in the 21st century. The NISA objective is to direct $1.1 billion worth of funding to encourage capital growth through reformed education, promoting innovation and entrepreneurship and rewarding risk taking in certain circumstances, which is where insolvency law reform comes into play.

The Proposed Insolvency Law reforms include:

  1. Changing the current three year default bankruptcy period to one year;
  2. Introducing a ‘safe harbour’ for directors if they appoint a restructuring adviser for a company in financial difficulty. This will presumably introduce a new defence for directors accused of insolvent trading where they have appointed a restructuring adviser to generate a turnaround plan; and
  3. Making ‘ipso facto’ clauses unenforceable during the period when a company is undertaking a restructure. This is possibly an expansion of the existing limitations in the Corporations Act (for example, section 440B).

 

Bear in mind, these reforms will have their limitations and a high standard for director duties will continue to be valued, such as acting in good faith and in the best interest of the company. The innovative aspect will involve appointing a financial adviser, not an administrator, when a company is still solvent but potentially heading into financial difficulty to “restructure” without insolvency as the trigger. With the right financial advice directors can make superior and well educated choices to prevent winding up, potentially resulting in better outcomes for creditors and potentially reducing the company’s risk of similar issues in the future. This can only really be successful if it is aided by the protection of the newly proposed safe harbour provisions.

The Federal Government is expected to release a proposal paper outlining the specific changes early this year with the intention to introduce legislation in mid-2017.[3] These proposed reforms are expected to encourage businesses to take reasonable steps to restructure and salvage value in a struggling company and reduce the stigma associated with failures.

Benefits of reforms for small business

  • Reducing the bankruptcy period will allow entrepreneurs to re-enter the business world after one year as apposed to three.
  • Ipso facto clauses in agreements will no longer be an obstacle for restructuring businesses. This means businesses can maintain their regular contract work to facilitate the flow of income, whilst seeking financial assistance during a restructure, preventing the risk of stagnant funds on termination of agreements.
  • Safe Harbour provisions will provide scope for directors to manage company affairs, enabling solvent but struggling companies to explore restructuring as an avenue to company stability.
  • Allowing scope for error to new start-up business investors who would previously be reluctant to take on roles as directors because of the risks associated with unintentional breaches of insolvency law.

 

The Federal Governments Innovation proposals to reform the insolvency laws certainly appear to be a step in the right direction for entrepreneurs. It will be interesting to see if these proposed changes will achieve the anticipated outcome of encouraging risk takers and reducing the stigma associated with business failure.

If you need advice for your business please contact our Commercial Team on

E mark.north@chamberlains.com.au

P 02 6215 9100 or 

Or our Insolvency and Reconstruction Team on

E stipe.vuleta@chamberlains.com.au

P 02 6215 9100 or 

[1] Financial Systems Inquiry Final Report, December 2014. http://fsi.gov.au/publications/final-report/

[2] National Innovation and Science Agenda, December 2015 http://innovation.gov.au/page/national-innovation-and-science-agenda-report

[3] Australian Government, National Innovation and Science Agenda http://www.innovation.gov.au/content/fact_sheets

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