Taking the leap

As foreshadowed the Australian Government has announced proposed changes to insolvency law. Innovation in legislative reform should be encouraged, so we welcome and support this Federal Government initiative.  The changes are aimed at encouraging entrepreneurship and innovation. The changes are described as improvements, however this is not as clear as suggested.

Reducing the default bankruptcy period to one year

The default bankruptcy period is currently three years.

The benefit of the proposed change is to further destigmatize bankruptcy. Bankruptcy is a rehabilitative process that enables an individual to make a fresh start after the expiration of the bankruptcy period having been released from their debts. Bankrupts are also prohibited from acting as a company director or managing a company whilst an undischarged bankrupt. Reducing the bankruptcy period to one year will enable individuals to return to entrepreneurial activities sooner.

The main disadvantages of the proposal are:

  • Income contributions if payable by the bankrupt will only be payable for one year instead of three years. The well advised bankrupt who is provided with benefits by third parties will significantly benefit from this proposal at the expense of creditors.
  • Will creditors perceive one year as an appropriate time for the removal of bankrupts from the market.

Bankrupts who fail to comply with their obligations will still risk having the bankruptcy period extended by way of an objection to discharge by the trustee.

The proposed change makes sense and if properly crafted will be beneficial. It is not a panacea. Bankrupts will still lose their homes as most SME business loans are secured by the family home. However the changes must protect the market from rogues.

The director safe harbour

Balancing risk and reward is claimed to be the rationale for this change.

The insolvent trading regime is frequently claimed to discourage entrepreneurship, investment by angel investors and the participation of professional directors in business start-ups. The proposed change will provide a safe harbour for directors from personal liability for insolvent trading by engaging a restructuring adviser to formulate a turnaround plan.

It is probable that the benefits of this proposed change in isolation have been oversold. There is little non anecdotal evidence available to support the claimed impact on entrepreneurship of the insolvent trading regime. Nor is there any evidence of viable companies failing as a result of the insolvent trading regime. Interestingly the insolvent trading provisions were amended in the early 1990’s in conjunction with the voluntary administration provisions and ATO director penalty notices to encourage timely action by directors to avoid insolvency and save businesses.    

The devil will be in the detail of this proposal.

  • Who will qualify as a restructuring adviser, ARITA members, bankers, accountants, lawyers, debt advisers?
  • Can creditors be compelled to extend credit to a company in a safe harbour?
  • Will secured creditors’ rights be restricted?
  • How will turnaround advisers be remunerated?
  • Who will have regulatory supervision of the process and the turnaround advisers? The court or ASIC?

In our opinion this proposed change is unlikely to have much impact on the majority of companies. Most trading companies are SME’s for whom this process will be too costly. Most financing of SME’s is supported by security granted over the family home. It is unlikely this will change for the foreseeable future.

As restructuring specialists, we have been long term advocates for encouraging directors and business stakeholders with financially distressed businesses to seek specialist advice sooner, rather than later. Acting in a timely manner enables all alternatives to be considered and the best option implemented. In the SME sector, this simply just does not happen early enough. This is primarily because most often family assets are at stake and emotions and pride are front and centre. We don't under estimate the significance of the decision by the director of an SME to consult with a restructuring specialist in such circumstances. However, we know from experience that all stakeholders will be better off, most often financially, but also emotionally if this is done.

We believe the proposal as outlined will be problematic in seeking to address this issue.

This is a proposal for the big end of town, that is, large corporates, large advisory firms, private equity and other venture capital providers. Only time will tell if this proposal when implemented has any material impact on encouraging business turnarounds.

We consider broader changes are required to encourage entrepreneurship, facilitate the survival of businesses and increase outcomes for all stakeholders.  These changes include:

  • Removing personal liability from company administrators for debts incurred during a voluntary administration.
  • Considering the changes made to secured creditor rights in UK insolvency law said to have encouraged the development of a turnaround culture.

Unenforceability of ipso facto clauses

This change is welcome and highly likely to increase the survival rates of businesses subject to the voluntary administration regime.

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

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