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The government’s proposals paper
The government has released its proposals paper titled Improving bankruptcy and insolvency laws.
1. Reducing the default bankruptcy period
We have previously questioned whether one of the stated objectives of this proposal, to encourage entrepreneurial activity, will be accomplished on implementation.
Some previously reported concerns regarding this proposal have been addressed in the proposals paper.
It is proposed:
- to retain the trustee’s ability to object to discharge and extend the period of bankruptcy to up to eight years for misconduct
- to ensure the obligations on a bankrupt to assist in the administration of their bankruptcy remain even after their discharge
- to separate the obligation to pay income contributions from the default bankruptcy period - income contributions will be payable by a bankrupt for a minimum period of three years
- reduce credit restrictions on a bankrupt to one year, subject to any extension or misconduct
- reduce restriction on overseas travel by the bankrupt to one year, subject to any extension or misconduct
- to consult to align industry and licencing restrictions with the reduced period of bankruptcy
Conclusion
The proposals in our view get the balance right, and should be supported.
2. safe harbour
The government has indicated it intends to pursue the innovative approach of providing directors with a safe harbour option allowing them to retain control of the company while receiving restructuring advice from professional advisers in a framework which still provides for the interests of creditors.
Is the safe harbour necessary?
Our insolvent trading provisions are subject to strong criticism by various interest groups. It is claimed they discourage directors trying to implement restructuring proposals to turn businesses around, they bring about the destruction of value and job losses as a consequence of formal insolvency administrations. However, the prohibition on insolvent trading was introduced to protect creditors from directors disregarding the capacity of the company to repay when incurring debt.
The insolvent trading provisions were amended in 1993 to implement the recommendations of the Harmer Inquiry. The amendments sought to address the identified criticisms of the then existing provisions.
The criticisms included:
- failure to encourage directors to deal with solvency issues in a timely manner
- failure to maintain records
- providing a defence to directors who failed to perform their duties with proper diligence by failing to take a sufficient role in management
- giving a creditor the right to prosecute the claim and excluding the liquidator
The implementation of the current insolvent trading provisions was accompanied by the implementation of the great trade off by the ATO. The ATO surrendered its statutory priority for unremitted withholding taxes. In return the ATO gained the director penalty notice regime to recover these taxes from directors in certain circumstances. The director penalty notice regime has been strengthened in recent years but has failed to incorporate GST.
Insolvency professionals acting as company administrators are personally liable for debts incurred from the time of their appointment to a company. Insolvency practitioners are personally liable for GST incurred by companies to which they are appointed. If directors are not prepared to try to turnaround a failing business with the defences available to them to avoid personal liability, it is little wonder that company administrators have little appetite to seek to implement creative and risky restructuring options with no defences available to them.
Australia’s insolvent trading regime is tougher than the UK’s wrongful trading regime. Neither the United States nor Canada have a statutory insolvent trading regime. Australia’s insolvent trading regime was implemented in conjunction with the director penalty regime and the VA process to encourage directors to act in a timely manner to appoint an administrator. The object of the administration is the management of the business, property and affairs of the company with a view to maximise the chance of the company, or as much as possible of its business, continuing in existence, or if this is not possible to provide a better return to creditors than an immediate winding up.
The VA process for reasons including the capacity of a secured creditor to appoint a receiver in certain circumstances, the enforcement of ipso facto clauses and the personal liability of administrators has not provided the opportunities for business restructuring that was hoped for by its creators.
It is uncertain whether the safe harbour will meet the high expectations its promoters promise. An informal restructuring without statutory imposition of its terms on recalcitrant creditors are very hard to negotiate, implement and administer.
Conclusion
Efforts by the legislature to encourage timely action by company directors to appoint an administrator to maximise the prospects of a successful restructuring of the business and save jobs has been frustrated by the practical impacts of ipso facto clauses, secured creditors retaining the right to appoint receivers and personal liability of the administrator for debts including GST. Change is required but the safe harbour may not be the answer.
The proposals
The government has proposed two models for consideration:
Model A - The defence
This model proposes an additional defence to an insolvent trading claim.
The defence will be available if a reasonable director has an expectation based on advice by an appropriately experienced, qualified and informed restructuring adviser, the company can be returned to solvency in a reasonable period of time, and the director is taking reasonable steps to ensure it does.
The restructuring adviser is required to be provided with access to appropriate books and records within a reasonable period of time to enable them to form a view as to the viability of the business. The restructuring adviser must form an opinion and remain of the opinion that the company can avoid an insolvent liquidation and is likely to be returned to solvency within a reasonable period of time.
The adviser is required to exercise their duties in good faith and in the best interests of the company. They are also required to report any misconduct identified to ASIC.
It is proposed the adviser would:
- be appointed by the company and responsible to the company, not its directors
- not be liable to third parties for an erroneous opinion provided it was honestly and reasonably held
- be excluded from any future formal insolvency appointment
- not be a director or shadow director
The proposals paper seeks input on the qualifications and experience that directors should consider when appointing a restructuring adviser. It is clear a restructuring adviser will need to conduct themselves with the highest degree of professionalism and integrity. It is crucially important that educational, professional, ethical and disciplinary standards and conduct of any professional associations whose membership is accredited as a prerequisite to be appointed as a restructuring adviser be scrutinised thoroughly before accreditation. It is important that accreditation of professional associations for other Corporations Law activities not be simply expanded to include restructuring adviser.
The paper also proposes circumstances in which the safe harbour will not be available.
A concern associated with this proposal is the lack of transparency associated with the costs of the restructuring adviser which may ultimately be borne by creditors. It is likely these costs will be very high. Insolvency practitioners are expected to comply with onerous remuneration reporting requirements.
Further concerns that the government is seeking public input in regard are:
- how will viability be established?
- what is a reasonable period of time to return to solvency?
- what does a return to solvency mean?
Model B - The carve out
This model will exclude a debt incurred from the insolvent trading provisions if:
- it was incurred as part of reasonable steps to maintain or return the company to solvency with a reasonable period of time; and
- the person held an honest and reasonable belief that incurring the debt was in the best interests of the company and its creditors; and
- incurring the debt does not materially increase the risk of serious loss to creditors
The paper suggests the burden of proof should lie with the liquidator to establish that a director breached any of the three limbs of this proposal. We question whether this is appropriate. We consider the directors should bear the burden of proof they have complied with all three limbs.
This proposal does not require the appointment of a restructuring adviser. However, the paper suggests the appointment of an adviser would be considered by a court in establishing that reasonable steps had been taken. It would appear that the qualifications and experience of a restructuring adviser will still need to be formulated under this proposal unless the government is proposing to open the door to the cellar dwellers.
Conclusion model A or model B?
Model B appears to provide a simpler and clearer mechanism. Both models could be subject to criticism regarding the lack of transparency for some creditors of the costs of restructuring advisers. Further, the interests of creditors should not be forgotten when deciding which model to implement.
3. Ipso facto clauses
The proposals paper proposes:
- any term of a contract or agreement which terminates or amends any contract or agreement (or any term of any contract or agreement), by reason only that an ‘insolvency event’ has occurred would be void
- any provision in an agreement that has the effect of providing for, or permitting, anything that in substance is contrary to the above provision would be of no force or effect
The proposed change will apply to all corporate insolvency administrations except liquidation.
It is proposed that affected counterparties will be able to apply to court for relief if they have suffered hardship.
Conclusion
We believe this proposal will be of great assistance in preserving a company’s business while restructuring options are explored. We support this proposal.
If you have any questions in relation to this article, please contact your local RSM adviser or David Kerr.