Safe Harbour

‘Safe Harbour’ and ‘ipso facto’ insolvency reforms – what do they mean and what will they do?

14 December 2017

Important insolvency reforms recently passed into law as a result of the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (TLA Act).

Though royal assent was given to the TLA Act on 18 September 2017, it will be many more months, if not years, before the full impact of the reforms is understood.

So what are the reforms, what is their purpose, and will they achieve it?

Background

The TLA Act introduces new provisions in the Corporations Act 2001 (Cth) which are intended to remedy two long-perceived failings in Australia’s corporate insolvency regime.

First, under Australia’s strict insolvent trading laws, company directors become exposed to personal liability for debts incurred by their company from the moment they reasonably suspect the company is unable to pay its debts on time, unless they act immediately to appoint external administrators.

With mere suspicion of insolvency being enough to require directors to reach for the ‘abort’ button, what may later be found to have been only temporary cashflow issues can bring about the destruction of a business, costing jobs and leaving creditors (who the laws are meant to protect) unpaid.

Secondly, the enforceability of ‘ipso facto’ clauses entitles parties to terminate contracts if an insolvency event occurs in relation to the other party irrespective of whether the other party is continuing to perform its obligations under the contract.

The termination of a company’s contracts if it becomes insolvent reduces the scope for saving its business by way of a re-structure or sale.

Safe harbour for insolvent trading: but is it safe?

The TLA Act introduces a new section 588GA of the Corporations Act headed Safe harbour – taking course of action reasonable likely to lead to a better outcome for the company.’

This section is intended to protect directors of an insolvent company who seek to undertake an informal restructure of their company’s affairs, where this is likely to result in an improved outcome for the company’s stakeholders including (particularly) its creditors – instead of immediately appointing voluntary administrators or liquidators.

However, for directors considering whether to invoke the protection of section 588GA, the ‘safe harbour’ it describes will look more like a maze, with no obvious entrance or exit.

Section 588GA1 protects a director from insolvent trading if, after suspecting insolvency, they ‘start developing one or more courses of action that are reasonably likely to lead to a better outcome for the company’ in respect of debts incurred ‘directly or indirectly in connection with any such course of action.’

The protection is available provided the director commences taking the course of action ‘within a reasonable period’ after developing it, and ceases taking it ‘when any such course of action ceases to be reasonably likely to lead to a better outcome for the company’.

The ‘reasonableness’ (or otherwise) of a course of action taken by the director under this law is, however, left in the eye of the beholder, or more specifically the judge who hears and determines any court proceedings for insolvent trading that may yet be brought against the director.

Apparently to assist directors in navigating their way to this place of safety ̶ yet making it seem even more elusive ̶ section 588GA(2) sets out indicia to which regard may be had (or may not?) by the court: for example, whether the director obtains ‘advice from an appropriately qualified entity who is given sufficient information to give appropriate advice.’ What qualifications will be considered ‘appropriate’? The legislation does not say.

What is certain for company directors, however, is that any attempt to rely upon these laws will be tantamount to an admission by the director that they suspect (or know) their company to be insolvent, thus increasing the director’s exposure to insolvent trading liability.

Whether the ‘safe harbour’ will be a realistic alternative to appointing external administrators will very much depend upon the specific facts and circumstances of each case, and it will likely be years before there are any judicial decisions throwing light upon how these new provisions in the Corporations Act are to be interpreted and applied.

It therefore remains imperative for company directors suspecting insolvency to immediately seek specialist legal and accounting advice.

Ipso facto clauses

Unlike the somewhat dubious ‘safe harbour’ reform, the new provisions in the Corporations Act concerning ipso facto clauses1 are likely to result in significant practical benefits in facilitating the sale or re-structure of a business when a company becomes insolvent.

The new provisions operate by imposing a stay on parties terminating their contracts with a company solely because of the company’s financial position, or because the company becomes the subject of formal insolvency proceedings, including voluntary administration.

The stay on enforcement of contractual rights of termination in such circumstances will complement the moratorium already contained in the Corporations Act on action by creditors, landlords or lessors to recover premises or plant and equipment from a company for duration of a voluntary administration.

Importantly, the stay on enforcement of contractual rights of termination:

  • will end upon the commencement of a winding-up in insolvency of the company (ie upon the appointment of liquidators)
  • will not prevent a party from exercising a right to terminate a contract arising from a company’s failure to failing to perform its obligations under the contract.

The combined effect of these provisions will assist the company in continuing to trade while the voluntary administrators investigate and seek to sell the company’s business or undertake a formal re-structure of the company’s affairs to regain solvency.

However, it will be some time before the impact is felt. Though the ‘safe harbour’ provisions of the TLA Act came into force when royal assent was given on 18 September 2017, the ‘ipso facto’ provisions only come into force on 1 July 2018 and will only apply in relation to contracts, agreements or arrangements entered into after that date.

1 The new provisions in the Corporations Act comprise sections 415D-415FG applying when a company enters a schemes of company arrangement, sections 434J-434M for when a managing controller is appointment, and sections 451E-451H when a company enters voluntary administration.

Disclaimer: This publication contains comments of a general nature only and is provided as an information service. It is not intended to be relied upon as, nor is it a substitute for specific professional advice. No responsibility can be accepted by Rigby Cooke Lawyers or the authors for loss occasioned to any person doing anything as a result of any material in this publication.

Liability limited by a scheme approved under Professional Standards Legislation.

©2017 Rigby Cooke Lawyers

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