The Reform Proposals

The corporate law reform package announced by Minister Chris Bowen on 19 January 2010 has three elements – the reversal of the effect of the High Court’s decision in Sons of Gwalia, a discussion paper canvassing reform to Australia’s insolvent trading laws, and a series of amendments refining the operation of existing insolvency provisions.

Sons of Gwalia

In the Sons of Gwalia case, the High Court decided that in an insolvency the Corporations Act allowed certain claims by shareholders to be treated equally with the claims of the company’s creditors.

Minister Bowen has announced that the Corporations Act will be amended to reverse the effect of this decision. As a result of the changes, compensation claims by aggrieved shareholders against the company will be subordinated to those of the company’s general creditors.

The Minister has identified the three principal reasons for making this reform as:

  1. the concern that the decision was restricting access to, and increasing the cost of, debt financing for companies;
  2. the additional costs and uncertainty in a formal insolvency process caused by the Sons of Gwalia decision; and
  3. “the decision’s potential negative impact on business rescue procedures”.

It is not clear at this stage whether the reforms will be limited to shareholder claims, or whether they will be broadened, as is the case overseas, to “derivative claims” (for example, where the shareholder sues the auditor and the auditor cross claims against the company), claims by shareholders against related entities (for example, the shareholder suing the operating subsidiary of the publicly listed company for aiding and abetting that company’s breach of disclosure obligations) or to the claims of subordinated creditors (for example, holders of subordinated bonds who claim that they were induced to lend the subordinated debt due to the company’s misleading and deceptive conduct).

It is anticipated that the legislative amendments will be placed before Parliament in the first half of this year.

Insolvent trading discussion paper

By issuing the discussion paper, Minister Bowen is seeking the view of stakeholders on the operation of insolvent trading laws in the context of attempts outside of a formal insolvency process to save a financially troubled company. The paper identifies the policy objectives of Australia’s insolvent trading laws and provides a balanced discussion on how those laws operate in the context of an informal workout or restructuring.

The first option is to maintain the status quo. This option will appeal to those who consider Australia’s insolvent trading laws work efficiently and do not unduly inhibit restructuring attempts (or those who consider a reorganisation should be undertaken within a formal insolvency process).

The second option is for an additional defence to be made available in relation to insolvent trading liability that centres on the business judgement rule but which has a number of additional objective criteria. The “business judgement” aspect of the defence would be met if the decision to continue trading was made by the director in exercising a business judgement made in good faith, for a proper purpose and which was rationally believed, on an informed basis, to be in the best interests of the company. To make out the defence, the following additional elements would also need to be satisfied:

  • the financial accounts and records of the company present a true and fair picture of the company’s financial circumstances at the time;
  • the director was advised on restructuring by an appropriately experienced and qualified professional with access to the company’s accounts and records, on the feasibility of, and means for, ensuring that the company remains solvent, or that it is returned to a state of solvency within a reasonable period of time;
  • it was the director’s business judgement that the interests of the company’s body of creditors as a whole were best served by pursuing the restructuring; and
  • the restructuring was diligently pursued by the director.

A director seeking to rely on the defence will need to establish both objective and subjective elements and would need, in effect, to cover each of the above four points.

The third proposed option would be for the directors to secure the benefit of a moratorium protecting them from insolvent trading liability while they attempt an informal restructure of the company. To secure this, the directors would need to inform the market, including existing and potential new creditors, that the company was insolvent and intended to pursue a workout outside of external administration.

Analysis of this option within the discussion paper centres on the ability of creditors, acting collectively, to bring the moratorium to an end, the preconditions for the commencement of a moratorium (for example, could directors secure the benefit of a moratorium if they are unable to ascertain whether the company is solvent or not), and on the length of the moratorium.

Other reforms

A number of additional minor reforms are proposed which essentially tidy up inconsistencies and minor technical deficiencies. These changes include:

  • making creditor lists available electronically;
  • a requirement to notify creditors of a material breach of a deed of company arrangement;
  • permitting ASIC to appoint a replacement liquidator when there is a vacancy in office; and
  • facilitating electronic communications with creditors.