Safe Harbour Finally In Sight For Company Directors

After a “false start” with former Minister Chris Bowen’s 2010 discussion paper, it appears as if Australian insolvency law will be reformed to provide directors with relief against insolvent trading liability if they take prompt and proper steps towards restructuring their financially troubled company.

The announcement

Following years of consideration and debate in the industry, the Federal Government has now confirmed that it intends to amend the current insolvent trading regime to introduce a safe harbour for directors from personal liability if they appoint a restructuring adviser to develop a restructuring plan for a company in financial distress.

The Government’s announcement follows the recommendations of the Productivity Commission (Commission) in its final report released on 7 December 2015 (Business Set-Up, Transfer and Closure) (Final Report) and an earlier discussion paper (Insolvent Trading: A Safe Harbour for Reorganisation Attempts Outside of External Administration) released in January 2010 by the then Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP (Discussion Paper). Notwithstanding that the consultation process in relation to the Discussion Paper was subsequently abandoned by the Government in September 2011, there have been an increasing number of insolvency practitioners and industry representative bodies calling for reform to Australia’s insolvent trading provisions.

The need for a safe harbour

Currently under Australia’s company laws, a company that becomes insolvent is required to immediately cease trading. There is no scope under the current regime for directors to seek to make informal attempts to restructure a company that is insolvent. Any director in breach of this obligation faces civil liability for the debts incurred by the company and, in certain circumstances, the risk of imprisonment.
The burden of Australia’s insolvent trading laws, combined with uncertainty over the precise moment that a company becomes insolvent, has long been identified as a driver behind companies entering voluntary administration, sometimes prematurely. When the prospect of insolvency arises, directors are effectively obliged to place a company into external administration in order to avoid insolvent trading liability. Directors, in particular non-executive directors, are understandably reluctant to risk personal liability notwithstanding that a more appropriate course may be to seek an informal workout.
A successful restructuring or informal work out attempts to restore the financial health of a company through the private agreement of key stakeholders outside of any formal insolvency process. Amendment to the insolvent trading provisions to create a safe harbour is necessary to provide directors with a genuine opportunity to engage with key stakeholders with a view to implementing such a restructuring. The voluntary administration process, which was intended to provide directors with an opportunity to rescue the company, does not generally provide this. Indeed, due to a number of legal and market factors, voluntary administration often signals the death of the company.

The stigma associated with a voluntary administration and other aspects of the current statutory regime will often immediately harm the goodwill and value of the enterprise. By way of example, external administration may trigger defaults in commercial agreements as a result of ipso facto clauses, result in consumers shunning the brand due to concerns as to the long term viability of the company, and suppliers refraining from providing further credit to the company. In addition, the appointment may enable secured creditors to appoint their own insolvency practitioners, which also incurs further expense for the distressed company.
The damage, and in some cases destruction, of the value of the enterprise caused by placing the company into external administration undermines the prospects of the implementation of a successful reconstruction of the company. Consequently, voluntary administration is often used as a de-facto liquidation procedure or as a prelude to liquidation. In contrast, an informal restructure promotes the retention of enterprise value thereby maximising the chances of success of the reconstructed company, or in the event that the company cannot be saved, the potential return to unsecured creditors.

In the Final Report, the Commission highlighted the tension between:

  • facilitating the early appointment of insolvency administrators, when the enterprise value has not been diminished, thereby increasing the probability of a successful restructuring or improved return for creditors; and
  • allowing directors time to turnaround the business such that unless they succeed, by the time an appointment occurs the business has been drained of liquidity and goodwill.

The Commission considered that notwithstanding the empirical evidence which shows that the instances of successful enforcement of insolvent trading actions is quite low, there is a strong disincentive for directors to take what could otherwise be appropriate risks to attempt to restructure the company. It noted that the solution to this problem is to create a regulatory system that enables company directors to make informed decisions, free of any distorted incentives and undue influences, such as fear of liability. Accordingly, the Commission accepted that the current regime stifles the opportunity for successful informal restructuring and that an amendment to the insolvent trading provisions to create a safe harbour is necessary.

Options for reform

In submissions made following Minister Bowen’s Discussion Paper in 2010, participants to the inquiry generally agreed on the need for a form of safe harbour. The focus has therefore been on the appropriate manner of implementation.
The debate in relation to amendments in this area had primarily focused on two possible options for reform. Firstly, the creation of an additional business judgment rule defence to an action for insolvent trading. Secondly, permitting directors to have the benefit of a moratorium from insolvent trading laws in order to pursue an informal workout.

Both options were considered and discussed in the joint submissions produced by the Law Council of Australia, the Insolvency Practitioners Association of Australia (now Australian Restructuring Insolvency and Turnaround Association (ARITA)) and the Turnaround Management Association of Australia in response to the Discussion Paper. The joint submissions supported the adoption of a modified business judgment rule defence in preference to a moratorium. An important reason for this position was that a safe harbour defence is private in nature whereas any form of moratorium would be public and likely to lead to the same difficulties that are currently experienced following the appointment of a voluntary administrator.
The modified business judgment rule defence adopted in the joint submissions would permit directors to pursue proper restructuring opportunities outside of a formal insolvency appointment where, with the benefit of professional advice, they honestly and reasonably believe that such a course of action is in the best interests of the company and its creditors.
An updated version of the business judgment rule was advocated by ARITA during the recent consultation process and is set out in the Final Report. The Commission agreed that a properly constructed safe harbour defence is the best approach ‘to both encourage good corporate governance and improve genuine opportunities for restructure’.

The Productivity Commission’s recommendation

The Commission has proposed that the Corporations Act 2001 (Cth) be amended to provide a safe harbour defence which is available when:

  • the directors have made, and documented, a conscious decision to appoint a restructuring adviser with a view to implementing a turnaround plan;
  • the adviser is provided with proper books and records upon appointment;
    the company is solvent at the time of the appointment;
  • the adviser is registered and has at least 5 years’ experience as an insolvency and turnaround practitioner;
  • the directors diligently pursue the restructuring; and
  • the advice must be proximate 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.

It is envisaged that the defence would provide cover for the running of the company from the time of appointment until the conclusion of the implementation of the restructuring advice. Furthermore, the Commission has recommended that the appointed adviser be obliged to terminate the safe harbour period and advise the directors to appoint an external administrator in the event that a viable restructure is no longer possible.

Our thoughts

Australia’s current insolvent trading laws are regarded by many industry experts and commentators as incredibly inflexible and possibly the strictest in the world. The overwhelming majority of foreign jurisdictions have laws that facilitate attempts at informal restructuring or at the very least do not discourage it. Reform in this area is long overdue and will ensure that Australian law is brought into harmony with the rest of the world.

The decision to introduce a safe harbour defence as opposed to introducing a moratorium is generally seen within the industry as the preferred approach. Given the comprehensive nature of the Commission’s inquiry, one would expect the Government to largely follow the recommendation of the Commission in relation to the actual form of safe harbour defence that is implemented. It is critical that the safe harbour defence intended to be introduced by the Government strikes an appropriate balance between providing support for genuine attempts to restructure the business and protecting the company and creditors from reckless and/or unscrupulous actions.

Jonathon Turner

I strive to deliver expert advice tailored to my clients' objectives, goals and commercial drivers. Excellence is a habit, not an act.

Jonathon Turner Senior Associate

Jonathon has extensive experience in banking, financial services and corporate insolvency litigation, fraud and commercial dispute resolution. He has acted for leading institutions, corporates and insolvency practitioners both domestically and internationally.

Jonathon is a banking, financial services and corporate insolvency litigation expert. He is dual-qualified having been admitted as a solicitor in England and Wales.

He advises a range of clients including leading financial institutions, insolvency practitioners and corporates on a wide variety of contentious and non-contentious matters. He has particular experience of advising on corporate insolvency litigation, commercial litigation, contractual disputes, fraud related matters, breach of director duty litigation, corporate restructuring, security enforcement and cross-border insolvency law.

Prior to joining HDY in December 2015, Jonathon practiced as an associate in the disputes resolution group at Linklaters LLP, London where he specialised in corporate insolvency, banking and financial services litigation. During his time in London he acted in a number of high profile and complex matters arising out of the global financial crisis in 2008. Jonathon has acted in matters before the UK Court of Appeal and UK Supreme Court.

He has produced a number of articles on insolvency, litigation and recovery matters.

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