Late last night (11 September 2017), the Senate passed into law the Treasury Laws Amendment (2017 Enterprises Incentives No 2) Bill 2017. The legislation amends the Corporations Act 2001 to create a “safe harbour” for company directors from personal liability for insolvent trading if the company is undertaking a restructure outside formal insolvency and to make certain contractual rights unenforceable while a company is restructuring under certain formal insolvency processes.
The “Safe harbour” provisions come into force when it receives royal assent. The “ipso facto” provisions are scheduled to come into force on 1 July 2018.
What is safe harbour?
When a company was approaching the point of insolvency, its directors were faced with a vexed choice. Do they:
(a) avoid personal liability by engaging the formal insolvency processes (i.e. voluntary administration); or
(b) risk personal liability for insolvent trading by attempting to restructure the company’s affairs themselves (invariably with expert legal and insolvency advice) outside the strictures of the formal insolvency process?
Often the latter course had a good chance of resulting in a better outcome for the company and its creditors. However, the risk of personal liability was often too great so directors appointed voluntary administrations. The chance was lost.
With this legislation, the directors can now attempt to restructure companies without risking personal liability for insolvent trading, provided they do it right. This is the “safe harbour”.
The safe harbour scheme is this:
- the directors develop one or more restructure plans that are reasonably likely to lead to a better outcome for the company;
- “better outcome” means better than an immediate appointment of administrator or liquidator;
- the factors to determine if a plan is reasonable likely to lead to a better outcome are:
- taking steps to ensure the company is keeping appropriate records;
- properly informing oneself about the company’s true financial position;
- taking steps to prevent or against misconduct by the company’s employees, officers and other directors;
- obtaining advice from an appropriately qualified person (a liquidator or a specialist insolvency lawyer); and
- developing a plan that will lead the company to improve its financial position).
- debts incurred whilst the directors are developing and executing their plans (acting with reasonable speed) are carved out from being insolvent trading debts, should the restructure fail.
- The directors lose the benefit of safe harbour if:
- it becomes clear the plan is unlikely to lead to a better outcome;
- the company fails to pay employee entitlements on time (including superannuation); or
- the company fails to lodge tax returns on time.
What is ipso facto?
Many commercial contracts provide that they can be terminated if one party enters into a formal insolvency process (i.e. schemes of arrangement, receivers (and receivers and managers), administration). This style of termination clause is known as an “ipso facto” clause.
Many of these contracts were key to the successful restructure of an insolvency company.
The legislation fetters ipso facto contractual rights during the restructure. Specifically, a right that arises merely because of the formal insolvency process or because of the Company’s financial position cannot be enforced.
The stay operates for the period of the insolvency process, but can be extended by the court (for example in a circumstance where an administration ends because the company has executed a deed of company arrangement). The court can also lift the state if it considers it is in the interests of justice to do so.
This legislation is a game changer – and is long overdue. It provides necessary protection for struggling companies so that attempts can be made to salvage their value, which is ultimately in the interests of unsecured creditors.
If you are a company who relies on, or is subject to, ipso facto clauses, you have about 8 months to review your contracts and processes to prepare for this game changer. If you are a director of a struggling company, you should seek expert advice about your options.
Mitchell Downes, Partner, is a lawyer specialising in insolvency and litigation. He is a professional member of the Australian Reconstruction Insolvency and Turnaround Association and the Turnaround Management Association.