The Federal Government has introduced its insolvency law reforms to parliament in a move that has been welcomed by leading directors. The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill, which had its first reading on 1 June, would create a safe harbour for company directors from the civil insolvent trading provisions of the Corporations Act 2001.
The Government believes the reforms will strike a better balance between the protection of creditors and encouraging directors to innovate and take reasonable risks. It would also enable more successful restructures outside of a formal insolvency process where doing so would achieve a better outcome, according to the bill’s explanatory memorandum.
“The proposed changes are welcome,” Graham Bradley AM FAICD, Chairman of Stockland Corporation, said. “Australia’s insolvency laws have rightly been described as the most draconian in the Anglo-American system and these changes will take the pressure of severe liability off the shoulders of directors who are working hard to save companies that face serious but not terminal solvency challenges.”
Currently, directors may be personally liable for a company debt if when it was incurred there were reasonable grounds to suspect the company was insolvent or may become insolvent.
The stringency of the law can lead to perverse outcomes, according to David Bayes FAICD, Non-Executive Director of Sigma Pharmaceuticals. “There are many situations where, under the current law, directors are required to place an organisation in effective insolvency even when there are reasonable prospects of trading out of trouble,” Bayes said. “Once insolvency is declared there’s been an almost self-fulfilling conclusion which is often not the best outcome for shareholders and other stakeholders.”
Under the proposed reform, directors would not be liable for debts incurred while insolvent where it can be shown that they were developing or taking a course of cation that was reasonably likely to lead to a better outcome than the immediate appointment of an administrator or liquidator.
Hear more about the proposed ‘safe harbour’ reforms from AICD Senior Policy Adviser Lysarne Pelling on the AICD’s economics podcast, The Dismal Science.
The Australian Institute of Company Directors (AICD) has long championed such a change and is urging the passage of the proposed law. “This legislation would help drive cultural change and encourage directors to take reasonable risks to help a company’s recovery instead of simply placing a company prematurely into voluntary administration because of the threat of insolvency,” Louise Petschler, the AICD’s General Manager Advocacy, said.
At the same time, Petschler notes that the changes would not give directors ‘a free kick’.
“Importantly, under the legislation the safe harbour would not be available for directors when the company is failing to pay the entitlements of company employees when they fall due, or failing to comply with tax reporting obligations,” Petschler said.
A second part of the legislation would make ipso facto contract clauses, which may allow termination of contracts based on certain insolvency triggers, unenforceable in some formal insolvency proceedings. The reform is aimed at allowing businesses to continue to trade after insolvency instead of these clauses scuppering their rehabilitation.
“While imposing a stay on the operation of ipso facto clauses would, to some extent, restrict the contractual rights of individual creditors of distressed companies, creditors as a whole would benefit from the increased prospect of a meaningful turnaround of the business or a higher return should a restructure ultimately be unsuccessful,” the AICD states in its submission on the exposure draft of the legislation.
While strongly supporting the legislation, the AICD has expressed concern that the safe harbour as drafted may not provide directors with sufficient certainty to encourage good faith restructuring.
Specifically, the counterfactual analysis required in asking directors to assess whether the course of action would result in a better outcome than the immediate appointment of an administrator or liquidator is inherently uncertain as it involves predictions about future events, the AICD submission states. In conducting this counterfactual analysis, directors would need to “make decisions in real time, under deadlines and often with incomplete information.” Having these decisions reviewed with the benefit of hindsight sets the bar too high and the AICD would prefer if the safe harbour were based on directors’ ‘rational belief’ that the company’s course of action is reasonably likely to lead to a better outcome.
Nonetheless, parliament should not let the perfect be the enemy of the good, according to Bradley. “While the drafting is not perfect, we should welcome the Government’s response to what has been a long and winding debate for over two decades.”
With the bill introduced, the next stage for the legislation will be the parliamentary debate. There is currently no date set for the commencement of that debate.
Click here to read the AICD’s submission in full.
AICD Policy Adviser Matthew McGirr explains what safe harbour reform entails.