The reform proposes to make ‘ipso facto’ clauses allowing contracts to be terminated solely due to an insolvency event unenforceable if the company is undertaking a restructure.
The amendment would give safe harbour to directors of companies in dire straits that take action reasonably likely to lead to a better outcome for the company and its creditors.
Aim of the reforms is to combat current insolvency law focus on ‘stigmatising and penalising failure’ and instead promote a culture of entrepreneurship and innovation.
On 28 March 2017, the Minister for Revenue and Financial Services, the Hon Kelly O’Dwyer MP, released draft legislation proposing changes to Australia’s insolvency laws. The release also included an explanatory memorandum and explanatory statement for public consultation in relation to the reforms which, if passed, are scheduled to become effective on 1 January 2018.
The explanatory memorandum states the aim of the reform is to “promote a culture of entrepreneurship and innovation which will help drive business growth, local jobs and global success”, and steer Australia’s current insolvent trading laws away from putting “too much focus on stigmatising and penalising failure”.
The two main amendments proposed are:
- the provision of safe harbour for insolvent trading in instances where a director is taking a course of action that is reasonably likely to lead to a better outcome for the company and its creditors (Insolvent Trading Safe Harbour); and
- the stay on enforcing ‘ipso facto’ clause rights to amend or terminate an agreement merely because of an insolvency event except in certain circumstances (Stay on Ipso Facto Clauses).
Insolvent Trading Safe Harbour
A new section 588GA of the Corporations Act 2001 (Cth) will establish protection for directors of insolvent companies against personal liability for contraventions of the insolvent trading provisions under section 588G(2).
The changes will provide protection in relation to debts that a company incurs associated with a course of action taken by directors that are reasonably likely to lead to a better outcome for the company and the company’s creditors than proceeding to voluntary administration or winding up.
This amendment hopes to address the cultural concern of directors taking their companies into voluntary administration not for reason of having determined that their company is insolvent or after all reasonable avenues have been exhausted, but for fear of being held personally liable for the company’s actions (if it is deemed at a later date to have been trading whilst insolvent). It hopes to encourage directors to take all reasonable final opportunities to bring their company out of difficult situations before surrendering the wheel to administration.
Stay on Ipso Facto Clauses
The second reform is a series of proposed changes which ultimately provides a stay against the enforcement of rights that would allow a contract to be terminated or amended merely because of a formal insolvency event (‘ipso facto’ clauses). The amendments apply in relation to entities entering into a Part 5.1 scheme of compromise or arrangement, and also to companies placed into administration.
This will assist with the aims of the safe harbour amendments proposed above. It will allow directors to more easily steady the course of their company as they may be immune from the detrimental effects of terminated contracts merely due to a scheme of compromise or arrangement. Further, it will hope to provide a greater survival rate for innovative companies that face difficult financial circumstances or other situations such as simple poor timing of incurred debts.
There are circumstances when such ipso facto rights may be enforceable, as under the new laws the Court will have discretion to allow or prevent enforcement of the rights in certain circumstances. This includes where a contract is associated with a financial product and enforcement of the rights would be commercially necessary for that type of financial product.
Although not yet made into law, the proposed amendments make interesting suggestions for the situations faced by directors managing companies in difficult financial circumstances. The changes will hopefully encourage reasonable last resorts to be exercised by honest directors in such situations, with a lessened presence of the current reluctance to act for fear of being held personally liable.
The proposed amendments are open for public consultation with submissions due by 24 April 2017. All submissions can be sent to email@example.com.
Post by Jack Guthrie and John Kell