Current insolvent trading laws stigmatise corporate failure. They effectively force directors to sacrifice companies in order to safeguard themselves against prosecution and impede businesses from trading out of difficult financial situations. The result is not only harmful to companies and individual directors in this situation, it impacts at all levels of the supply chain in every industry across the entire economy, and can be a restraint on growth and employment.
On 12 September 2017, both houses of the Parliament of Australia passed the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill (Bill). The Bill promotes a culture of entrepreneurship and innovation through the introduction of:
- a ‘safe harbour’ which allows directors to incur company debts which would normally trigger a breach of current insolvent trading laws; and
- an automatic ‘stay’ on ipso facto clauses which allows companies entering a formal restructure to continue trading.
The ‘safe harbour’ provision protects directors from contravening section 588G of the Corporations Act 2001 (Cth) (Corporations Act) where a director who suspects the company is insolvent takes a ‘course of action’ that is ‘reasonably likely’ to lead to a ‘better outcome’ for the company and its creditors whilst incurring debt.
‘Course of Action’: Minimum Requirements
In considering the director’s course of action, the Court will examine whether the director:
- ensured proper record keeping;
- prevented misconduct;
- remained informed about the company’s financial position;
- obtained appropriate advice from a qualified entity including a lawyer; and/or
- developed or implemented a plan for restructuring the company to improve its financial position.
These criteria are non-exhaustive; each decision will be made on an objective case-by-case basis with the aim of preventing directors from pursuing fanciful strategies.
Under the Bill a director’s course of action must provide for employee entitlements and lodgement of necessary taxation documents.
The ‘outcome’ of the director’s chosen course of action must be ‘better’ than if the company were subject to external interventions such as entering into liquidation, administration or a scheme of receivership.
The ‘safe harbour’ will begin protecting the director from the period that the director begins taking the course of action to achieve the ‘better outcome’, to when:
a) the course of action has ceased or is no longer reasonably likely to achieve a better outcome; or
b) the company becomes a Chapter 5 Body Corporate.
Ipso Facto Clauses
Ipso Facto clauses are contractual provisions that give a party the right to terminate or vary a contract on the occurrence of, for example, an insolvency event irrespective of continued payment or performance of the contract. The Bill provides that ipso facto clauses are automatically ‘stayed’ for a specified period of time if they are enforced on the basis that the company has entered into a:
- voluntary administration – section 451E; or
- proposed scheme of arrangement – section 415D.
For the purposes of commercial efficiency and certainty, a stay will not apply to:
- rights arising under contacts entered into before the enactment of the Bill; or
- certain kinds of contracts including those associated with specified financial products or made after the compromise, arrangement or voluntary administration.
HHG Legal Group’s Comments
- The ‘safe harbour’ provisions represent welcome relief from unnecessary Government interference and encourage more robust entrepreneurial risk taking which is considered to be beneficial to the economy.
- Nevertheless, there is currently a degree of uncertainty surrounding the ‘safe harbour’. We expect that these uncertainties will be worked out by the Courts over time and, like any area of legal uncertainty, a significant volume of case law is expected to result. The Courts will be called upon to address the limits of the criteria as to what course of action directors may take and what will be held to be a ‘better’ outcome for the company and shareholders as a whole.
Ipso Facto Clauses
- Our view is that the over regulation of Ipso Facto clauses is likely to inhibit economic growth as opposed to their accompanying reforms. Should people be forced to continue to trade with companies facing insolvency, they may need to pass on their increased risk in the form of higher prices. However, it is not the ‘end all’ for companies as they may apply to the Court to lift the stay if it is in the interests of justice.
- If you suspect that your business is dealing with a party that may be facing potential insolvency, our solicitors can provide advice as to the effect of these changes and help mitigate any potential losses.
- If you are uncertain about your legal rights as a director of a company whose solvency is in doubt, you should seek legal and specialist accounting advice, and regularly update that advice as you take steps to manage the company through this time of uncertainty.
This is general information only and does not constitute specific legal advice. If you would like further information in relation to this matter or other legal matters, please contact HHG Legal Group’s Albany office on 9481 2322.