Important changes to Australia’s corporate insolvency laws

Over the last few years, there has been a significant focus on reforming Australia’s corporate insolvency laws with many of the changes set to come into effect in 2017.

These changes to our current insolvency laws intend to create more favourable economic regulations for small businesses, entrepreneurs and start-ups in order to boost business growth and trade in Australia by encouraging innovation and reasonable risk-taking and helping to reduce the stigma currently associated with business failure.

The Insolvency Law Reform Act 2016 & Insolvency Practice Rules

Following the Productivity Commission’s report in December 2015 investigating the barriers to setting up, transferring and closing a business, the Insolvency Law Reform Act 2016 (Cth) (‘ILRA’) and the Insolvency Practice Rules (‘Rules’) commenced on 1 March 2017 and are set to be periodically brought into effect until 1 September 2017.

The ILRA and the Rules involve numerous reforms to the regulations governing administrators and the administration process, as well as affording greater powers to creditors such as the power to request reports and information from an external administrator, to give directions to an administrator upon resolution, to appoint a committee of inspection, and to remove an external administrator.

However, both ILRA and the Rules have been seen as a missed opportunity to undertake a more comprehensive reform of Australia’s existing insolvency system which currently penalises and denounces business failure.

Reforms to Safe Harbour and Ipso Facto clauses

Presently, the concerns over breaches of insolvent trading laws and the substantial repercussions for directors are regularly referred to as the reason behind investors’ apprehension in getting involved in business start-ups.

On 29 April 2016, the Australian Federal Government announced three major insolvency law reform proposals in its Improving Bankruptcy and Insolvency Laws Proposal Paper (‘Proposal Paper’).

The three major changes are:

  1. Reducing the current default bankruptcy period from three years to one year;
  1. Introducing a 'safe harbour' for directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company; and
  2. Making ‘ipso facto’ clauses, which have the purpose of allowing contracts to be terminated solely due to an insolvency event, unenforceable if a company is undertaking a restructure.

On 28 March 2017, the Australian Government released an exposure draft of legislation that reforms Australia’s insolvency laws and deals with two of the three core recommendations of the Proposal Paper. The first being establishing a safe harbour for directors from civil liability and the second, a restriction on the ability to enforce ipso facto clauses where a scheme is proposed to avoid winding up or an administrator is appointed.

The Government requested comments on the draft Bill by 24 April 2017.

Safe harbour for directors

The draft Bill responds to a longstanding concern for business persons and investors arising from section 588G of the Corporations Act 2001 (Cth), being the civil and criminal liability on company directors who cause a company to trade while it is insolvent.

The draft Bill proposes a ‘safe harbour’ or defence for directors accused of insolvent trading. The essence of the defence is that a director will be protected where the course of action resulting in the insolvent trading was reasonably likely to lead to a better outcome for the company and its creditor.

Limiting the enforceability of ipso facto clauses

A contractual ipso facto clause is a clause that, upon the occurrence of certain events, a party is granted the right to terminate or suspend a contract or modify its operation to impose more onerous obligations.

The enforceability of ipso facto clauses at points of financial struggle or external administration can frustrate attempts to restructure and rectify a company’s financial position.

In response to this concern, the Bill proposes a stay on enforcing the contractual clause as a result of the company either:

  1. Applying to enter into a scheme of arrangement where the company’s application states that is seeks to avoid being wound up; or
  2. Enters into voluntary administration.

The Court will still have the power to enforce the contractual right where it is satisfied that it is appropriate in the interests of justice, or in the case of a scheme of arrangement, the scheme was not in fact utilised to prevent the company being wound up.

Reducing the bankruptcy period to 1 year

The Bill does not make mention of the proposed reduction in the default bankruptcy period from three years to one year as outlined in the Proposal Paper.

During bankruptcy, a bankrupt is restricted from travelling overseas, acquiring certain degree of credit and engaging in other activity that may result in the incurring of further debts. This has a major impact on the promotion of innovation and entrepreneurship within Australia. The existing laws act in a way that effectively knocks down young entrepreneurs and impedes their ability to get back up and pursue further business ideas.

In order to successfully implement the Government’s National Innovation and Science Agenda and encourage Australians to be more agile in reaching out to the global marketplace, it needs to consider all three proposals and consider at a minimum, the following:

  1. The reduction of the bankruptcy period to one year, subject to any extension for misconduct;
  2. The reduction of credit restrictions under the Bankruptcy Act to one year;
  3. The reduction of overseas travel restriction to one year.

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