A positive message in softening insolvent trading rules

The Government’s National Innovation and Science Agenda contains some exciting news for directors that recognise entrepreneurial behaviour, writes Professor Bob Baxt. 

There is little doubt that the insolvent trading laws in Australia (namely section 588G of the Corporations Act 2001(the Act)) are the most draconian set of provisions in the western world which legislates to impose liability on directors for incurring debts on behalf of companies in genuine rescue attempts which fail.

Little, if any, leeway is provided for professional directors who take genuine and energetic steps to try to save companies that may be sailing close to insolvency. The risks involved are very severe. There has been pressure to widen the statutory business judgment rule, now contained in section 180(2) of the Act,to ensure that directors who genuinely try to rescue companies should not be punished unnecessarily.

The Australian Institute of Company Directors (AICD) has developed the honest and reasonable director defence as a way to broaden the possibility of protection, or a safe harbour, for directors. This has regrettably not progressed very far. But on Monday 7 December, the Prime Minister Malcolm Turnbull, recognised that it is necessary to trigger some change.

The National Innovation and Science Agenda statement contains exciting news in this regard. It is built on the Productivity Commission’s ,em>Business Set-up, Transfer and Closure Final Report (the draft report was delivered in May 2015). In recommendation 14.2 of the report, the Commission, after discussing a range of alternatives that might be considered to deal with the complex problems that directors face in trying to rescue companies in this context (including a rejection of a US Chapter XI reform) recommended a number of changes to the Act.

It is significant to set out the recommendation in full.

The almost enthusiastic response given to this announcement and the Commission’s report needs to be read carefully in the context of the language. There are a number of stepping stones as to what is recommended in 14.2, and what the legislation might eventually set out once drafted. “Black letter law” drafting often poses significant pitfalls that need to be carefully assessed. But, there is little doubt that the recommendations in this area will be particularly valuable.

Other important statements in the Innovation Statement reflect the thrust of the Insolvency Law Reform Bill (the Bill) introduced on 3 December. The full bankruptcy period will be reduced from three years to one year. “Ipso facto” clauses, which have the purpose of allowing contracts to be terminated, solely due to an insolvency event, will be unenforceable until a liquidator is appointed, if a company is undertaking a restructure.

In addition, readers should reflect on what needs to be established to show that the directors took “all reasonable steps to pursue restructuring”. How careful and detailed will the directors have to be in making a documented and conscious decision to appoint a safe harbour? (What notes and books must be kept in order to ensure that they fall within the guidelines?) How will the directors be able to establish that all the proper books and records have been provided to the adviser? And how will they, together with the adviser, establish the fact that the company was solvent at the time of the appointment of the adviser and needed to implement the safe harbour proposition?

The Commission also suggests that during the period where reconstruction and related matters are being pursued, the relevant directors would retain control of the company, receive independent advice from advisers who were appropriately registered and appointed, and if the advice of those advisers was followed, the directors would not be held liable.

In the Commission’s recommendations it is suggested that the advisers who were appointed in a safe harbour scenario would be disqualified from acting as administrators, receivers or liquidators in any subsequent insolvency of the relevant company. The relevant company would also be required to inform the Australian Securities and Investments Commission (ASIC) and the ASX of the appointment of the adviser.

Insolvency reform bill

The Bill contains worrying provisions, in particular the use of strict liability and reversal of onus of proof provision in the legislation, and careful assessment will need to be made of these matters going forward.

Far too often our courts become very conservative and defensive in applying a wider and more encouraging set of rules and evaluating the reach of proposed legislation, which was aimed to help consumers and others. The fear is that the legislative fabric with which judges are familiar often leads the courts to adopt a rather narrow and less enthusiastic interpretation of legislation than is necessary.

The good news is that we start the new year with a positive message coming from Canberra.

The more generous approach taken in ASIC v Mariner Corporation in the Federal Court of Australia should, in my view, be the norm in evaluating these proposed new legislative initiatives. Justice Beach took a very positive view of how section 180(2) of the Act should be applied. He said he would not second-guess the way directors conducted the affairs of the company in considering a takeover.

This of course is in a different context to the court impression of insolvency and related matters, but it shows a positive view by the courts, towards adopting an entrepreneurial or forward-looking interpretation of how to assess whether directors’ actions are intended to provide for sensible and positive responses from the director community to the challenges that they need to meet.

It is unclear as to when this legislative initiative will actually see the light of day. Together with the reforms, which will be introduced to implement the recommendations of the Murray Report into the Australian Financial System, and other legislation aimed at improving the way in which the corporate regulator will operate and the powers that it will have, the proposed changes will have significant implications for directors and officers and how they need to behave.

The good news is that we start the new year with a positive message coming from Canberra in relation to one of the most difficult and controversial areas of our law. I look forward, as I am sure readers will, to the release of the relevant legislation and an opportunity to consider the way forward with respect to this significant area of the law.

Recommendation 14.2 of Business Set-up, Transfer and Closure Final Report

The Act should be amended to allow for a safe harbour defence to insolvent trading. The defence would only be available when:

  • Directors of a company have made, and documented, a conscious decision to appoint a safe harbour adviser with a view to constructing a plan to turn around the company.
  • The adviser was represented with proper books and records upon appointment, and can certify that the company was solvent at the time of appointment.
  • The adviser is registered and has at least five years’ experience as an insolvency and turnaround practitioner.
  • Directors are able to demonstrate that they took all reasonable steps to pursue restructuring.
  • The advice must be approximate to a specific circumstance of financial difficulty, and subject to general anti-avoidance provisions to prevent repeated use of safe harbour within a short period.
  • The defence would not attach to any particular decision and instead would cover the running of the business and any restructuring actions from the time of appointment until the conclusion of (reasonable) implementation of the advice.
  • If the adviser forms the opinion that restructure into any form of viable business or businesses is not possible, they are under duty to terminate the safe harbour period and advise the directors that a formal insolvency process should commence.
  • The safe harbour adviser may only be appointed in a subsequent insolvency process with leave of the court.