Insolvency Reform Edition 12 - June 2017 - Ahoy! A safe harbour?

Ahoy! A safe harbour?

View the past edition of the Insolvency Reform newsletter - Insolvency Reform Edition 11 - May 2017 HERE

A safe harbour or formally via a scheme of arrangement or a voluntary administrationThe Treasury Laws Amendment (2017 Enterprise Incentives No.2) Bill 2017 (“the Bill”) was introduced to the House of Representatives on 1 June 2017. The Bill has commenced its journey to approval by both houses of the Parliament.

Lobbying pays

The Bill incorporates some tweaking as a result of lobbying by various interest groups.  The most notable of the changes from exposure draft are:

  • Extension of the safe harbour protection to a holding company.
  • Extension of ipso facto protection to managing controller

The lobbyists for the Australian Bankers Association appear to have had a win in the extension of the ipso facto protection to managing controllers, granting managing controllers the same benefits that were originally only preserved for schemes of arrangement and voluntary administrations. This would appear to entrench a secured creditor’s ability to appoint a managing controller (receiver & manager) in the Australian insolvency landscape.

This is an interesting development. One of the main impediments on the effectiveness of the voluntary administration process as a restructuring mechanism, is the ability of a secured creditor (with a security interest over the whole, or substantially the whole of the company’s property), to appoint a receiver and manager or managing controller during the decision period. Such an appointment will often completely nullify the ability of the voluntary administrator to successfully implement a restructure.

The right of a secured creditor to appoint a receiver was removed in the UK in 2002 to encourage the development of a turnaround culture.

If the Government is serious about developing a turnaround culture, consideration should be given to reforming the secured creditor’s ability to implement this form of appointment.

The enforcement activities of banks have been subject to a high degree of public scrutiny over the past few years. As a result, banks have already dramatically reduced the circumstances in which they will appoint receivers due to reputation risk concerns.  Accordingly, banks may now be more inclined to consider a proposal prohibiting the appointment of a receiver and only allowing the appointment of an administrator.  Insolvency

How safe is the safe harbour?

The Bill will provide directors with a limited window of opportunity to obtain advice and formulate a proposal (a restructuring plan) that will be implemented either informally continuing to use the protection of the safe harbour or formally via a scheme of arrangement or a voluntary administration under the Corporations Act 2001 (“CA”).

The Bill will protect the director from being liable to compensate the company for a debt incurred when the company was insolvent, if the debt was incurred in undertaking a course of action that is reasonably likely to lead to lead to a better outcome for the company and the company’s creditors.

However the conditions a director must satisfy to demonstrate whether a course is reasonably likely to lead to a better outcome, will in our opinion, limit the availability of the safe harbour defence to only very well run companies.

Informal restructuring of a financially distressed entity is extremely difficult. The safe harbour is not a magic spell that will suddenly hypnotise the company’s creditors and make them act in the company’s interests and not their own. Every creditor will have different interests and a statutory mechanism such as a scheme of arrangement or voluntary administration will be necessary to impose the will of a majority on the minority who could hold out in an informal restructuring.

Timely action and value preservation?

The personal liability protection is hoped to encourage timely action that will preserve value through orderly sales of a distressed company’s business, or businesses or restructuring of the company’s liabilities thereby protecting employees (reducing the government’s FEG exposure) and maintaining a viable business that will generate profits and pay income tax.

The proof will be in the pudding. However, it is questionable whether the safe harbour will encourage timely action and preserve value.

Personal liability for insolvent trading and the ATO’s director penalty notice (“DPN”) regime were intended to encourage timely responses to financial stress by company directors.  The insolvent trading provisions have focused the minds of directors of public companies and perhaps led to premature insolvency appointments. However, this does not appear to be the case with small to medium sized enterprises (“SME”) conducted using the corporate form. The directors of many SMEs have their personal assets encumbered to support the company’s borrowings. Being already financially exposed they are more likely to ignore the further risk of personal liability for allowing the company to incur debts whilst insolvent.

The proposition of preserving value is also questionable for a number of reasons.

The ipso facto protection is essential to facilitate value maximisation in schemes of arrangement and voluntary administration. Presently most of a company’s contracts can be terminated on the occurrence of an insolvency event. Without the contracts you have no business and thus nothing to sell or restructure. However, the ipso facto protection will only apply to contracts entered into after the commencement of the Bill. This is not the act of a courageous Government.

Further the Bill’s explanatory memorandum (“EM”) specifically states “Safe harbour does not affect any obligation of a company (or any of its officers to comply with any continuous disclosure obligations under the law … or any continuous disclosure rules imposed by a market operator which apply.”  The market is all knowing. When there is blood in the water the sharks will appear.

The navigator?

The EM contains a discussion on getting advice from appropriately qualified advisers. Registered liquidators and members of ARITA ticking all of the boxes for the qualities expected by the reasonable person of a qualified adviser. Despite this the Government has continued its campaign against insolvency professionals by inviting advisers of all kinds to perform this very important role.

Appropriately qualified is used in the sense of “fit for purpose” and is qualification agnostic. The person appointing the adviser is responsible for determining if the adviser is appropriate. The appointee should consider

  • Nature, size and complexity of the business;
  • Adviser’s independence, professional qualifications, good standing and membership of appropriate professional bodies;
  • Adviser’s experience
  • Level of adviser’s professional indemnity insurance.

The discussion states the qualifications of an adviser will vary on a case-by-case basis.

  • Small business, simple structure
    Lawyer, accountant or other technical adviser perhaps with experience in insolvency.
  • Larger or more complex business
    Properly qualified, special insolvency or turnaround practitioner who is a member of a professional insolvency or turnaround association, or a specialist lawyer.
  • Large complex business
    Team of turnaround specialists, insolvency practitioners, law and accounting firms.

Considering the lack of transparency associated with the activities and costs of the appropriate advisers it is surprising that the Government has failed to be more prescriptive of their qualifications and experience. Contrast the Government’s position regarding legislative changes directed at insolvency practitioners. Further, the lack of specificity appears to be at odds with ASIC’S position with respect to pre-insolvency advisers.


Removing the more extreme penalties for business failure may foster entrepreneurship. However, from a creditors perspective they wish to ensure the corporate form is not misused by the unscrupulous. Only time will tell if unsecured creditors and other affected stakeholders will give the safe harbour and ipso-facto changes their blessing. Unsecured creditors disadvantaged by these changes will have the political critical mass to wind back the changes if they choose to act.

The safe harbour provides an additional defence to a claim for compensation for allowing the company to incur a debt when insolvent, subject to satisfying certain conditions, to directors. The protection appears extremely limited.

The protection will expand the window of opportunity for directors to explore restructuring options. A diligent director will have been fully informed of the company’s affairs and is likely to have already commenced discussions with advisers, financiers and creditors before the company becomes insolvent.

The lack of courage to apply the ipso facto restrictions on all contracts immediately will mean the provisions utility will be extremely restricted.

The main financial penalty for directors of SMEs of business failure is the impact of third party security for company borrowings. A director of an SME may still lose the family home if the business fails safe harbour or no safe harbour.

We remain concerned about the Government’s attitude to registered insolvency professionals which is highlighted by the lack of specificity of qualifications for qualified advisers and the tensions this may create for ASIC in its efforts to crack down on pre insolvency advisers in the SME space.

The Governments continuing failure to undertake a wholesale independent review of both corporate and personal insolvency law and practice is extremely disappointing. Instead of a considered set of proposals for creating a genuine turnaround culture and an insolvency law fit for the 21st century we are considering further piecemeal legislative changes to 20th century statutes that are unlikely to achieve the stated objectives of the changes.

Stop Press: ASIC user pays

The Government has succeeded in pushing through the Senate its ASIC Supervisory Cost Recovery Levy Bill 2017 and related bills. The Bill implements the Government’s political strategy to avoid a Royal Commission into the conduct of Banks. Australia’s 700 plus registered liquidators will bear the cost personally of these changes.

How would any other business react to being asked to pay a tax on every transaction whether they are paid or not and not be able to recover the tax from the customer? Do law enforcement officers have to pay for their badges?

The Government has chosen not to recognise that other stakeholders also make use of ASIC’S processes to regulate and discipline registered liquidators. Instead it has chosen to placate the complaints of a noisy minority of stakeholders whose views are represented by a disproportionate number of members of Government’s backbench who believe the insolvency profession is full of rogues and scoundrels.  The user pays system adopted is most likely to lead to a further reduction in registered liquidator numbers, the avoidance of the performance of unpaid court appointments and decline in the quality of work performed on formal insolvency administrations. This will in time impact on the perception of the Australian insolvency law regime and economy broadly. Time will tell.

Despite its best efforts, ARITA has been unable to convince the Government of the very serious implications this policy will have on registered liquidators and ultimately the Australian economy.

If you have any questions in relation to this article, please contact your local RSM adviser or David Kerr.

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