08 December 2015

Innovation and Australia’s corporate insolvency laws - The journey to real reform continues

This article was written by Tim Klineberg.

The Turnbull Government’s much-heralded ‘Innovation Statement’ was released yesterday. It contained wide-ranging statements on reforms aimed at fostering innovation across a number of sectors in the Australian economy.

One important reform area is in Australian corporate insolvency law.

Corporate insolvency law reform timetable

The Innovation Statement includes important content for the reform of Australia’s corporate insolvency laws. It is part of an ongoing reform exercise which has followed this timetable to date:

19 December 2014

Productivity Commission Issues Paper on Business Set-Up, Transfer and Closure

20 February 2015

Deadline for submissions to the Productivity Commission

21 May 2015

Productivity Commission Draft Report on Business Set-Up, Transfer and Closure

3 July 2015

Deadline for submissions on the Draft Report

30 September 2015

Productivity Commission Report into Business Set-Up, Transfer and Closure provided to Government (PC Report)

3 December 2015

7 December 2015 (am)

Public release of PC Report

7 December 2015 (pm)

Government Statement on Innovation

Following the ILRB released last week and the Innovation Statement yesterday, this indicative timetable has been set:

First session of Parliament in 2016

Passage of the ILRB. This includes a suite of “procedural” reforms in the ILRB. It does not include substantive reforms to Australia’s corporate insolvency laws.

First half of 2016

Government proposal paper on substantive reform to Australia’s corporate insolvency laws, including consideration of the recommendations made in the PC Report.

Mid-2017

The introduction and passage of substantive reforms to Australia’s corporate insolvency laws, including:

  • reducing the default bankruptcy period from 3 years to 1 year
  • ‘safe harbour’ reform, which provides directors with an additional protection from personal liability for insolvent trading
  • ‘ipso facto’ reform, under which the moratorium on enforcement action will extend to contractual termination rights
  • potentially, further reforms outlined in the PC Report

Comment

The Government has chosen to take a “baby steps” approach to the reform of Australia’s corporate insolvency laws, rather than tackling the substantive reforms in this session of Parliament.

In terms of substantive reform, the ILRB is largely a side show. The main event is outlined in the Innovation Statement and in the boxed sections of the PC Report. 

In the Innovation Statement, the Government has now committed itself to two very important reforms of Australia’s corporate insolvency laws, both of which are canvassed at length in the PC Report and a number of submissions made to the Productivity Commission.

The ‘ipso facto’ and ‘safe harbour’ reforms are well understood and accepted by the market as being supportive of restructuring and turnaround activity. There is still a raft of detail to work through in those two reforms, but they are a positive step and consistent with the Government's innovation agenda.

The balance of the reforms recommended in the PC Report will now be subject to a further "proposal paper" and consultation process. 

To a large extent, this will repeat the process just completed with the PC Report for a number of substantive reforms. We trust that the new consultation will be open to other reforms and submissions not part of the PC Report, as part of a wholesale review of Australia’s corporate insolvency laws and regime.

Productivity Commission report recommendations

The PC Report became public yesterday morning and is a wide-ranging and informative document. The PC Report reform recommendations for Australian corporate insolvency laws can be summarised as follows:

1. THE REFORM AGENDA

The types of Australian insolvency procedures and wholesale reforms proposed to the existing insolvency procedures

Does the Australian corporate insolvency regime require wholesale reform?

No. The PC Report rejects calls for Australia to adopt a Chapter 11-style procedure or other “wholesale changes” to the Australian insolvency procedures.

Will there be a Chapter 11 style procedure in Australia?

This issue appears resolved. Australia will not adopt a Chapter-11 style procedure.

What will be the key Australian insolvency procedures?

Voluntary administration and liquidation will remain the key Australian insolvency procedures, supplemented by a new and simplified “small liquidation” process.

A number of “procedural” reforms to voluntary administration and liquidation have recently been introduced in the ILRB.

2. SUBSTANTIVE REFORMS

Substantive reforms that the Government has confirmed will be introduced in the next raft of corporate insolvency law reforms

‘Ipso Facto’ Moratorium

Insolvency termination clauses are unenforceable during the voluntary administration procedure or during the implementation of a scheme of arrangement.

 

Essentially 'ipso facto' is an extension of the statutory moratorium during voluntary administration to apply to contractual termination rights. The PC Report also recommends that the moratorium apply during the implementation of a scheme of arrangement.

 

Other contractual obligations of the company remain binding and presumably subject to current laws affecting officeholders (including the common law regarding adoption of contracts and the personal liability imposed under statute).

‘Safe Harbour’

A ‘safe harbour’ defence to insolvent trading will be introduced. There are five pre-requisites to attract the defence:

  1. the decision to appoint a ‘safe harbour’ adviser to construct a plan to turnaround the company
  2. the presentation of proper books and records to the turnaround adviser and certification of solvency at time of appointment
  3. the turnaround adviser is "registered" and has at least 5 years’ experience as an insolvency and turnaround adviser
  4. the directors can demonstrate that they took all available steps to pursue a restructuring of the company
  5. the advice given must be proximate to a specific circumstance of financial difficulty

 

The ‘safe harbour’ defence covers a period of trading, not a particular decision. The turnaround adviser is independent and has a duty to terminate the ‘safe harbour’ period if they form the view that a restructure into any form of viable business is not possible.

3. PROMOTING FORMS OF RESTRUCTURING

The PC Report recommendations address specific forms of restructuring which the reforms would support.

“Pre-positioned” sales

“Pre-positioned” sales are negotiated by the directors prior to the appointment of a voluntary administrator, and are either completed prior to the voluntary administration procedure or during that procedure.

 

The reforms would introduce protections making it more difficult for sale transactions to be “overturned” using liquidator powers in a subsequent winding-up of the company. If the sale did not involve related parties, statutory presumptions would apply protecting the sale unless it could be proven to be for less than market value.  

 

The protections would not apply if related parties were involved in the sale.

Schemes of arrangement

As noted above, the ‘ipso facto’ reform proposed by the PC Report would extend the moratorium on termination to companies proposing a scheme of arrangement to creditors.

Restructuring through the voluntary administration procedure

An additional duty and reporting requirement would be introduced for voluntary administrators. This requires them to certify within one month of appointment that the company, or a large “component entity of it”, can be restructured.

 

If no certification is given, the voluntary administrator must convert the voluntary administration process to a liquidation.

A check and balance to targeting illegal ‘phoenix’ activity

A counterpoint to the “pre-positioned” proposals is the proposal of a unique ‘director identification number’ for directors.

 

This is intended to assist in the monitoring of changes of control of companies and increasing the ease of identifying changes akin to ‘phoenix’ transactions, as opposed to genuine “pre-positioned” sales.

4. “SMALL LIQUIDATION” PROCEDURE

The PC Report recommendations focus on the compliance costs and fees involved in smaller scale liquidations, proposing reforms to streamline the winding-up process for those companies.

New “small liquidation” procedure

Introduction of a new, specific procedure to liquidate companies with unrelated creditors of less than $250,000.

 

Reduced procedural reporting and timing requirements to streamline the winding-up process for small companies, subject to creditors’ rights to vote for a traditional liquidation procedure and ASIC oversight.

 

The public purse should meet the costs of small, unfunded liquidations through the ASIC Assetless Administration Fund.

“Pre-positioned” sales of small businesses

The “small liquidation” procedure would have similar “pre-positioned sale” provisions to voluntary administration, to facilitate the sale of those businesses as going concerns.

5. FURTHER REVIEWS RECOMMENDED

The PC Report recommends future reviews of specific aspects of the corporate insolvency procedures which are not the subject of specific reforms in the PC Report.

The future role of receivership?

An independent review of receivership to report by 30 June 2017, focusing on the utility of the procedure to protect the value of the secured property, as a means of enabling secured creditors to manage individual loans and to consider the impact of the receivers’ actions on the “overall wellbeing or insolvency of the company”.

 

The appointment of a committee of unsecured creditors to oversee the conduct of a receivership, with powers to apply to Court to seek relief in relation to a receiver’s fees.

Employee entitlements reforms

A future review of the Fair Entitlements Guarantee (FEG) in 2021. Specifically, consideration of reforms to enable the Commonwealth to play a more active role in insolvency procedures as a creditor once it has funded employee liabilities under FEG.


Implications

The Innovation Statement confirmed that ‘safe harbour’ and ‘ipso facto’ reforms will form part of the Australian corporate insolvency landscape in future. However, many aspects of those reforms will require further debate. Also, it remains to be seen whether the other recommendations in the PC Report will be adopted by the Government in future reforms.

Two elements of the additional PC Report recommendations in particular will attract contentious debate.

The role of insolvency practitioners

The first is the expanded role for insolvency practitioners in key areas of the procedures if reformed as proposed by the PC Report:

  • As restructuring advisers appointed by directors pre-insolvency to attract the 'safe harbour' protections.
  • Certifying that companies can be “viable businesses” during the voluntary administration procedure.

There will be a variety of views regarding this and the attendant costs to the restructuring process.

The role of receivership

The second is the review and prospective reform of the receivership procedure.

The Harmer reforms enacted in 1993 added a statutory duty of receivers to take reasonable care when selling property under section 420A of the Corporations Act 2001 (Cth). However, the powers of receivers appointed under Australian security instruments have remained largely untouched since then.

The Productivity Commission’s Issues Paper opened a debate on whether receivers’ powers should be qualified and subject to additional oversight. One of the draft recommendations in the Issues Paper was introducing a duty of receivers “to not cause unnecessary harm to the interests of creditors as a whole” and to curtail the exercise of receivers’ control powers outside the normal course of the company’s business to a vote of unsecured creditors.

The backlash against these proposed reforms was sufficiently strong to encourage the PC Report to water down its proposals for receivership reform. In place of that is a recommendation for a separate independent review of the procedure which may yet result in receivership reform being back on the agenda. The future role of receivership in Australia may remain under scrutiny as part of the ongoing reform debate.

The process from here

In initiating the Productivity Commission process and incorporating the consultation with industry into its legislative reforms, the Government has put corporate insolvency law reform firmly on the legislative agenda. It seems that genuine reforms to Australia’s restructuring and insolvency regime, long overdue, are now within reach.

The Innovation Statement acknowledges the breadth of the future reform task required in corporate insolvency. In addition to the commitment to ‘safe harbour’ and ‘ipso facto’ reform, the Government has now committed to considering “all” of the recommendations made in the PC Report.

The Government has committed to a timetable for the introduction of future reforms, which is outlined on the Turnbull Government’s National Innovation and Science Agenda (NISA), published at http://www.innovation.gov.au/. This allows room for further consultation and debate with industry, and a significant lead-in time which is invaluable for genuine, substantive reforms. There are other reforms which may also be incorporated into this extended debate, including in relation to takeover, FIRB and taxation which could lend further support to the Australian restructuring environment.

We look forward to the continuing debate around these important issues as our law reforms take shape.


For more insights on the Australian Government's National Innovation and Science Agenda, see:

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