What the market thinks Industry Comments

So what does the market think of the proposed reforms? The Review  interviewed a range of  academics, bankers and insolvency practitioners about Minister Bowen’s reforms. The clear message is that they are welcome. Professor Fisher and others see the need for further reform to promote business rescue − so watch this space.

David Brereton
General Manager Lending Services Australia and New Zealand Banking Group Limited

I am supportive of the Government’s decision to reverse the effect of the High Court decision in Sons of Gwalia. The reversal restores the traditional priorities given to creditors and removes the uncertainty which is hanging over the market and which was having a negative impact on the availability of credit generally and for companies in genuine need of restructure specifically.

The increase in the number of companies in financial distress means that now is the appropriate time for Australia’s insolvent trading laws to be reformed. There is much to be said for the modified business judgement rule and the Government’s four proposed elements of the rule. We would also like to see further detail as to what will qualify as advice from an “appropriately experienced and qualified professional” eg will the professional need to be an adviser external to the company or can it be someone appointed by the company as a chief restructuring officer? There may be merit in trying to introduce the CRO concept, but in any event some codification of appropriate qualifications in the law would add clarity.

Gwyn Morgan
Executive Director and Head of Asset Restructuring and Risk Management, Westpac Institutional Bank

These are important reforms and I think almost every interested organisation will welcome the Government’s proposal to consult with them on improving Australia’s insolvency regime.

Specifically, the intention to provide the directors of companies with some form of “safe harbour” during legitimate workouts, rather than see the destruction of enterprise value when formal insolvencies occur, will be welcomed by directors, lenders, shareholders and insolvency practitioners.

The decision to legislate to reverse the effect of the Sons of Gwalia decision is important and will ensure that Australian listed companies can borrow competitively in world markets. Over time this reform should see an easing in the cost of credit and more offshore lenders willing to participate in unsecured syndicated loan facilities to Australian companies.

The reforms and the reversal of Gwalia will bring Australia into line with the rest of the western world and in my view the Government is to be commended for this and ensuring Australia’s insolvency regime remains one of the best there is in providing all stakeholders the greatest opportunity to turn-around stressed companies.

Professor Richard Fisher
General Counsel University of Sydney & Adjunct Professor in the Graduate School of Government

Recognising that informal workouts play an important role in preserving troubled businesses is a significant milestone in the development and reform of Australia’s corporate insolvency law. This acknowledgment by Minister Bowen in the Foreword to the Discussion Paper on options to review the insolvent trading laws, whilst extremely welcome, should sound the call for a more general consideration of the legislative environment which would be best calculated to promote such workouts. Beyond the insolvent trading provisions, attention should also be given to, at least, the shadow director provisions and their impact on the willingness of major creditors to involve themselves in the detail and management of an informal workout. In the case of public listed companies, the continuous disclosure rules can adversely affect the capacity of those companies to conduct, say, confidential discussions with their financiers about ongoing support whilst they work their way through any financial difficulties. These are but some further issues which could also be addressed in the course of Australia giving sensible consideration to a legislative environment which will promote informal workouts. If the Minister accepted that challenge, it would put Australia at the forefront of law reform in this area.

Professor Rosalind Mason
Head, School of Law, Queensland University of Technology and consultant to Henry Davis York

As a market economy, Australia offers businesses the opportunity to profit from their success, but also to risk failure. The inevitability of financial failure by some businesses makes efficient and effective insolvency laws a critical element in any system of business regulation. Insolvency law is closely linked to economic policy. In recent decades there has been an emphasis upon the rescue of viable businesses rather than upon too hasty liquidations. This close relationship between law and economics is evident in the proposed reforms to Australia’s insolvent trading laws and the competing interests of debtors (more correctly in this case, of directors of debtor companies) and the interests of many other parties such as creditors, shareholders and customers.

However, in a global economy, Australia’s insolvency law and policy is also of concern to parties in other jurisdictions. This was evident in CAMAC’s 2004 report on rehabilitating large and complex enterprises in financial difficulties in which our voluntary administration regime was compared with the United States’ Chapter 11 system for corporate rehabilitations and which included commentary on the impact of our insolvent trading laws. Pressure to adopt a Chapter 11 regime for the sake of an homogenous approach in market economies to corporate rehabilitation should be avoided, given the way in which our insolvency laws are so embedded in our commercial, financial and societal systems. However, amending our insolvency laws to avoid unnecessarily precipitous action by directors to place a near insolvent business into an external insolvency administration is welcome.

Chris Honey
Partner McGrathNicol

Whilst I am not convinced that the current insolvent trading legislation has led to company directors prematurely appointing administrators, a move towards a modified version of the business judgement rule is to be welcomed.

Mention has been made that the current voluntary administration regime does not provide a workable solution for the rescue of larger companies and that a change to the insolvent trading legislation would make it easier for the boards of these companies to restructure their businesses outside of highly damaging insolvency. The collapse of a number of large businesses over the last ten years has shown that it is often a lack of accurate, meaningful, financial information on the true position of the company, a failure to truly understand the underlying business and the inability to direct the actions of executive directors that has limited the ability of non-executive directors to drive the necessary restructure of the business at an early enough stage.

Whilst the focus has been on ways of protecting directors while they seek to restructure a business outside of insolvency, one critical area that would help preserve value for the business should it enter formal insolvency, has again been overlooked. The issue of ipso facto clauses remains as relevant today as it has been during the numerous inquiries into the Australian insolvency regime over the last dozen or so years. We have still yet to see any proposals to limit or modify their application in order to prevent major destruction of value for creditors and shareholders.

Steve Sherman
Managing Partner, Ferrier Hodgson

One of the core tenets of the investment landscape is that shareholders accept the risk of investing in a company because there is a possibility of sharing the business’s profit and growing value. Trade creditors do not stand to benefit from a company’s profit – if they find themselves with exposure to an at-risk company they can end up in a precarious position. It is the recognition of the risk faced by creditors that wins them a spot ahead of shareholders in the queue for returns from insolvent companies.

The 2007 High Court decision on Sons of Gwalia created uncertainty around that principle. Through Ferrier Hodgson’s experiences on Sons of Gwalia – first as administrators and later as deed administrators – we know that the decision resulted in increased complexity, greater costs and increased creditor claims, all contributing to a reduced return to creditors. Over the longer term, the decision may have led to higher costs of finance for Australian businesses and the demand for greater security from non-traditional lenders: business in this country would have become increasingly difficult.

While we are pleased to see renewed market clarity with the proposed changes to the Sons of Gwalia decision, we also recognise that the rights of shareholders to sue companies for false or misleading conduct outside the liquidation regime needs to be protected. We will wait to see the details of the Government’s amendments to the Corporations Act on this point.

David Winterbottom
Partner KordaMentha

The High Court decision in the Sons of Gwalia case quite simply had a detrimental effect on the ability to restructure insolvent companies. Further, the decision created greater uncertainty as to the quantum and timing of returns to creditors. The reforms should provide a much more efficient and effective environment for restructuring in insolvencies.

The reform to insolvent trading laws will be most effectively served by the modification of the business judgement rule, allowing a court to apply the law to the particular circumstances of each instance. Further, the exposure of insolvency practitioners involved in the process needs to be addressed – does this expose the insolvency practitioner to a greater risk if the advice given fails to return the company to solvency?  Should the liability of an insolvency practitioner be limited to those circumstances where the insolvency practitioner has been grossly negligent? 

Another area where consideration is required is the independence of the insolvency practitioner – if he or she gives the restructuring advice, but the company ultimately ends up insolvent, should the insolvency practitioner be precluded from being appointed to the company on the basis of lack of independence? If so, there will be a great loss of knowledge and an increase in cost as another insolvency practitioner will have
to spend time (and fees) gaining this knowledge.

There should be reform to the ability of contracts to be terminated due to an insolvency event − the termination of these contracts can destroy much of the value in certain companies, thus significantly reducing returns available for creditors.