Insolvency law reform: directors safe harbour

The Commonwealth Government has introduced the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 into the House of Representatives .

UPDATE: passed by House of Representatives on 22 June 2017, introduced into Senate.

Passed by both Houses on 12 September 2017.

If passed, the Bill will amend the Corporations Act 2001 to create a safe harbour for company directors from personal liability for insolvent trading if the company is undertaking a restructure outside formal insolvency. It will also make certain contractual rights unenforceable while a company is restructuring.

Together, these amendments are intended to reduce instances of a company proceeding to a formal insolvency process prematurely.

The Bil is in response to concerns that inadvertent breaches of insolvent trading laws are frequently cited as a reason that early stage investors and professional directors are reluctant to become involved in a start-up.

The safe harbour amendments will take effect from the day after Royal Assent.

The contract amendments will take effect from the later of 1 July 2018 or the day six months after Royal Assent.

Safe harbour

The new law will give directors a safe harbour from the civil insolvent trading provisions of section 588G(2) of the Corporations Act.

Under the safe harbour, directors will only be liable for debts incurred while the company was insolvent where it can be shown that they were not developing or taking a course of action that at the time was reasonably likely to lead to a “better outcome” for the company than proceeding to immediate administration or liquidation.

This is intended to encourage directors to closely monitor the financial position of the business, engage early with financial distress and then actively take steps to either restructure the business or, if that is not possible, to move quickly to formal insolvency.

Whether a course of action is reasonably likely to lead to a better outcome for the company will vary on a case-by-case basis depending on the individual company and its circumstances at the time the decision is made.

However, the EXplanatory Memorandum notes, hope is not a strategy. Directors who merely take a passive approach to the business’s position or allow a company to continue trading as usual during severe financial difficulty, or whose recovery plans are fanciful, will fall outside the bounds of the safe harbour. Directors who fail to implement a course of action, or to appoint an administrator or liquidator within a reasonable time of identifying severe financial difficulty will also lose the benefit of safe harbour.

As it is intended as a protection for competent directors who are acting honestly and diligently, the safe harbour is open only to directors who have been ensuring that the company complies with its obligation to pay its employees (including their superannuation) and meet its tax reporting obligations.

The protection of safe harbour does not extend beyond the civil liability set out in section 588G(2). During safe harbour, directors must continue to comply with all their other legal obligations such as their director’s duties.

Ipso facto clauses unenforceable

An ‘ipso facto’ clause is a provision that allows one party to terminate or modify the operation of a contract upon the occurrence of some specific event, regardless of otherwise continued performance of the counterparty. The operation of these clauses can reduce the scope for a successful restructure or prevent the sale of the business as a going concern.

Courts will have a discretion to allow or prevent  the enforcement of express rights that amend or terminate a contract because of the appointment of an administrator, presence of a managing controller over all or the substantial portion of a corporation’s property or because an entity is subject to a compromise or arrangement.

This reform is aimed at enabling businesses to continue to trade in order to recover from an insolvency event instead of these clauses preventing their successful rehabilitation.

The provisions in the Payment Systems and Netting Act 1998 will not be affected by the stay provisions in this Bill.

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