Safe harbour ahead – Government proposes insolvency law reform

On 11 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 was passed by the Senate. The Bill features two key changes to the Corporations Act:

• A safe harbour provision that shields directors from personal liability for insolvent trading where they take and maintain a course of action that is reasonably likely to lead to a better outcome for the company and its creditors.
• Ipso facto clauses that allow contracts to be terminated solely due to an insolvency event will be unenforceable if a company is undertaking a restructure.

The safe harbour provisions took effect on 19 September 2017 and the ipso facto reforms will commence on 1 July 2018 or six months after royal assent.

The safe harbour provisions

The Bill introduces a new section 588GA, which provides a safe harbour for directors where a number of requirements are met. The amendment prevents instances of directors prematurely entering into voluntary administration for fear of penalty, in circumstances where the company may be potentially viable long term.

The first hurdle is establishing that the director, once suspicious the company was or may become insolvent, took a course of action that was reasonably likely to lead to a better outcome for the company and its creditors. The Explanatory Memorandum emphasises that the safe harbour may apply even if the action does not actually lead to a better outcome, it must simply be ‘reasonably likely to’.

A ‘better outcome’ requires that the result is better for both the company and its creditors than if the company had gone into administration.

In assessing the course of action, the Bill provides a non-exhaustive list of considerations, looking at whether the person:

• was taking appropriate steps to prevent any misconduct by officers or employees that could affect the company’s ability to pay its debts;
• was taking appropriate steps to ensure appropriate financial records were kept;
• was obtaining appropriate advice from a qualified entity with sufficient information to give advice;
• was properly informing himself or herself of the company’s financial position; and
• was developing or implementing a company restructuring plan to improve its financial position.

The Explanatory Memorandum notes that this is a guide only. It is not necessary for all of these factors to apply and it may be possible for the safe harbour to apply even where none of these are present.

The person relying on this provision has the onus of proving there was a reasonable possibility the above matters existed. It is important to note that if a person fails to permit the inspection of company books or to provide information when required by a court or the liquidator, these will not be admissible as evidence of that person’s course of action. Once evidence is adduced, the liquidator or other party has the onus of proving the course of action was not reasonable.

The second hurdle in the application of section 588GA is to establish that the debt was incurred in connection with this course of action. However, the safe harbour will end at the earliest of when:

• if the person fails to take any such course of action within a reasonable period after that time – the end of that reasonable period;
• the person ceases to take the course of action;
• the course of action ceases to be reasonably likely to lead to a better outcome for the company and its creditors; or
• the company goes into administration.

The safe harbour will not be available where the company fails to provide for employee entitlements or comply with its taxation reporting obligations to a standard expected of a company that is solvent.

Stay on ipso facto clauses

A common feature in contracts is an ipso facto clause, which permits a party to terminate where there is an insolvency event. This area has been targeted for reform because the inclusion of these clauses often reduces the feasibility of successful restructuring and can stall the sale of a business as a going concern.

The Bill provides a new section 415D and 451E, which implements a stay on enforcing this right where an entity makes an application to enter into a scheme of compromise or arrangement under section 411, or has such approved. However, the application must be for the stated purpose of avoiding the entity being wound up in insolvency. The stay also applies to companies that are placed into administration.

This stay operates from when the application is made, or when the administration begins until:

• the application is withdrawn or is dismissed by the Court;
• the end of the compromise, arrangement or administration; or
• if the compromise, arrangement or administration ends due to a resolution or order to wind up, when the entity is wound up.

In the case of administrations, the stay can also be extended by order of the Court where there is an order limiting the rights of a secured creditor, owner or lessor in place, and it is appropriate in the interests of justice to do so.

The stay does not apply to the enforcement of rights in the following types of contracts, agreements and arrangements:

• those entered into after the day a compromise or arrangement is reached, or the company enters into administration;
• those specified in regulations or ministerial determinations (the Federal Government has released a draft document of excluded contract types); or
• those entered into before the date of the commencement of the law.

The stay does not apply to rights that:

• manage financial risk associated with a financial product that is commercially necessary for the provision of that type of financial product; and
• are specified in a ministerial declaration.

The Court can order that the stay be lifted if it is satisfied the application was not for the purpose of avoiding a winding up in insolvency, or it is appropriate to do so in the interests of justice. It may also order that ipso facto rights are only enforceable with leave of the Court.

The operation of the safe harbour provisions and the ipso facto clauses significantly change the framework of the Corporations Act 2001 and it is expected to dramatically change the way directors approach a company’s solvency issues.

Directors will need to take great care to create an auditable trail of evidence to demonstrate that they are complying with their new obligations to gain the benefit of the safe harbour.

Please contact a member of our team if you would like any assistance responding to these changes.