Amendment To Australian Insolvency Law: Encouraging Cultural Changes Among Company Directors

Features of Insolvency Law in Australia

Discuss about the Restructuring and Insolvency Draft.

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Insolvency law of the Australia involves two features, and both the features are making the things harder in context of protect and restructure the business in financial difficulties. Voluntary administration is considered as formal mechanism which is designed to assist the organization in lieu of reconstructions. In case companies entered in the administration then parties of the company and suppliers have power to cancel the contract or threaten to do so influencing the factor of protecting the business. As a result, directors generally want to restructure the business informally, but if directors choose this option then they face considerable persona liability under the trading regime of the insolvency. This framework was actually established for the purpose of encouraging the directors to put the company into the voluntary administration.

This new amendment made by the Australian government on 18th September 2018 and this amendment mainly consider the two issues, and it ensures safe harbor for those directors who are involved in the process of reconstruction and also prevent the dealers from using their rights related to the voluntary administration or in a scheme of arrangement by using the IPSO facto[1]. It must be noted that, this amendment provide new opportunities to those companies who want to retrieve themselves from the financial difficulties and need chance of restructuring.

This paper discuss the amendment made by Australian government in context of insolvency law on 18th September 2017, and structure of this paper includes background related to the amendment, difference between current and old provisions of corporation law in this context, and critical evaluation of  the effectiveness of Part 1 of the Amendment. Lastly, recommendations are stated in context of maintenance of current law or previous law. This paper is concluded with brief conclusion which summarizes the key facts of this paper.

The main intention of the legislature while enacting the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017, is to ensure cultural changes among the directors of the company. This is done by encouraging the company’s directors to retain the control, and identify early signs of the insolvencies. Directors must take reasonable risk for the purpose of facilitating the recovery of the company in the liquidation. In other words, directors of the company are willing to take risk related to the business reconstruction before opting for voluntary administration of the company.

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Amendments Made by the Australian Government

This amendment does not pardon the past debts which are incurred in case of insolvent trading. It only provides new opportunities to the directors of the company to incur such debts which help the company to restructure and move away from the insolvency. Summary related to this amendment are stated below:

Directors of the company cannot held liable for the loan taken by them in context of emergent and taking care of the course of action that might ensures better result for the company[2].

Presently, prohibition related to the insolvent trading is contained in the section 588G of the Corporation Act 2001. This section levies responsibility on the directors of the organization to restrict their company from taking any loan at the time of insolvency. Particularly, this section applied on the directors of the organization if:

  • Company is not solvent in such situation when debt is incurred, or company goes into liquidation because of such debt.
  • There must be sound reasons at that time for believing that company is insolvent, or might become insolvent if debt is incurred.
  • The directors of the organization are aware at that time that such grounds are present which reflect company’s insolvency, or any reasonable person who stands in the position of directors get aware about these circumstance.[3]

Generally, there are four type of defenses related to the insolvent trading and these defenses are stated in section 588H of the corporation Act 2001.  Some of these defenses are stated below:

  • Directors of the company have considerable evidences to believe that company was solvent at that time, and remain solvent even though it incurred that debt that it incurred at that time.
  • At the time when debt was incurred, directors of the company had considerable evidences to believe, that they provide responsibility to the competent and reliable person for providing them information in context of company’s solvency…
  • Directors of the company fail to take part in the company’s management because of some strong reason at such time when debt was incurred by the company.
  • Directors of the company took all the necessary actions for the purpose of preventing the company from debt[4].

In context of solvency, legislation prefer cash flow test, under which it is assumed that person is insolvent if he/she cannot pay their loans. However, legislation also shows the relevancy of balance test under which excess amount of liabilities section   over the assets section reflects the insolvency indicator.

On the other hand, new section 588GA of the Corporation act 2001 stated that directors of the company will not be held liable for any debt incurred by the company directly or indirectly in context of developing and taking any course of action that will result in better outcome for the company instead of appointment of an administrator or liquidator in the company on immediate basis[5].

This new section 588GA(2) list down the five non-comprehensive, guiding factors which mainly determine whether course of action taken by directors result in better outcome for the company or not. Some of these factors are stated below:

  • Whether director of the company is informing himself/herself about the financial position of the company in proper manner.
  • Whether director of the company take necessary steps for the purpose of preventing the misconduct that might affect the company’s capability to pay all its debts and liabilities in adverse manner conducted by officers or employee of the company.
  • Directors take necessary steps for the purpose of ensuring that the proper financial records are kept by the company in context of its size and nature[6].
  • Whether director of the company develop or implement any plan for the purpose of restructuring.

However, directors of the company must understand that safe harbor rule does not provide any protection to the directors of the company in case insolvent company incurs debt, which means those companies which fails to comply with the payment related to the employee entitlements. There is one more exception related to this protection that is if company fails comply with the provision in context of employee entitlement payments on two or more than two occasions within the period of 12 months from the date on which debt was incurred[7].

Safe Harbor Protection

After considering both the stigmas, it can be said that amendments made by government in lieu of insolvency law open new restructuring ways for the organizations threatening insolvency. Under the safe harbor rule, protection is provided to the company’s directors and they can avoid their personal liability in context of insolvent trading and for debts incurred for conducting reasonable action which likely to result good. Before this amendment, corporation Act impose duty on director to continuously monitor and reassess their position, as they also bear the risk that if test conducted by them is not satisfied then they become personally liable for the company.

There are number of small and medium companies whose directors are involved in providing the personal guarantee and for longer period of time they will endure in their company’s control, and they stay in making the formal appointments for the purpose of avoiding their disclosure under personal guarantees. There are many directors who reject the advantage of gaining the advice from expert by stating that condition is not compulsory for the purpose of satisfying the requirements under safe harbor. Some other directors do not even meet the compulsory necessities of the safe harbor rule which are stated above[8].

On the other side of the coin, directors of the larger organizations seek proper advice on insolvency from the specialist at earlier stage for the purpose of clearing their suspicion in context of company’s solvency. This would consider as good result so far as to forecasts the successful restructure of the large organizations. Risk related to the directors in large organizations relies on the requirement of safe harbor that is needed to be transparent in lieu of their suspicion about company’s solvency at the initial stage of the process. In case directors of the large organizations fail to fulfill the strict requirements of the safe harbor such as they fail to pay employees or comply with the taxation reporting obligations, then they provide direct and clear evidence to the liquidator related to their suspension about insolvency. It is considered as breach of section 588G of the Corporation Act 2001. 

There are different doubts in the operations of the provisions which might deal with the regulations introduction. Ultimately the legislation success depends on the fact whether companies and their management want to spend amount for the purpose of seeking appropriate advice and also state the honest situation about the company. This requires flowing of culture of the boardroom in Australia and this will surely not happen overnight[9].

Difference Between Current and Old Provisions of Corporation Law

New amendments in the insolvency law of the Australia provide new hope of restructuring to the directors and companies. Safe harbor rule provide necessary protection to the directors and also state list which ensure that appropriate action taken by directors of the company lad to better outcome. However, this new amendment does not provide any provision which cross check that directors comply with these stated provisions such as expert advice and other mandatory provisions. Legislature must provide provisions through which administrator can check whether directors complied with these stated provisions or not. In this if administrator is not able to check whether directors complied with the necessary conditions or not then actual sense of this legislation will lost.

There is no need to reenact the previous law, but one feature of the previous law is efficient and that is creditor’s protection. This provision of the previous law must be incorporated in the new amendments made by the legislature. This new amendments does not provide any provision for ensuring the protection of the creditors and it is necessary to insert provision which ensure creditors protection in situation action taken by directors fail to lead better outcome and organization goes into insolvency.

Legislature must consider the situations of the directors of small and medium sized firms in this context, and those directors also who provide personal guarantee. As, there are number of small and medium companies whose directors are involved in providing the personal guarantee and for longer period of time they will remain in the control of their companies.[10]

Conclusion:

After considering the above facts, it can be said that amendments related to the safe harbor rule ensures the protection of the directors from the personal liability incurred in context of insolvent trading. Safe harbor rule provide necessary protection to the directors and also state list which ensure that appropriate action taken by directors of the company lad to better outcome. This amendment provides new hope to those directors who want to restructure the company but take their steps back because of the personal liability threat.

References:

Allens, (2017). Restructuring & Insolvency. Available at: https://www.allens.com.au/pubs/insol/cuinsol10apr17.htm. Accessed on 13th April 2018.

Apathy, P. spencer, S. & Fillipin, L. (2017). Australian government releases draft insolvent trading and ipso facto legislation. Available at: https://www.herbertsmithfreehills.com/latest-thinking/australian-government-releases-draft-insolvent-trading-and-ipso-facto-legislation. Accessed on 13th April 2018.

Corporation Act 2001- Section 588G.

Corporation Act 2001- Section 588GA.

Corporation Act 2001- Section 588H.

Cowell Clarke, (2017). Safe Harbor: Protection for directors from insolvent trading laws. Available at: https://www.cowellclarke.com.au/news/safe-harbour-protection-for-directors-from-insolvent-trading-laws. Accessed on 13th April 2018.

 DSS law, (2017). Important changes to Australia’s corporate insolvency laws. Available at: https://dsslaw.com.au/important-changes-australias-corporate-insolvency-laws/. Accessed on 13th April 2018.

Federal Register of legislation, (2017). Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017. Available at: https://www.legislation.gov.au/Details/C2017A00112. Accessed on 13th April 2018.

KWM. Innovation In The Boardroom – How Safe Is The Harbour?. Available at: https://www.kwm.com/~/media/library/Files/Knowledge/Insights/au/2016/06/02/kwm-response-australian-government-insolvency-laws-safe-harbour-innovation-baordroom.ashx?la=en. Accessed on 13th April 2018.

Winter, J. & slattery, (2017). The new safe harbour insolvency laws – basics for directors and commercial contracting. Available at: https://www.lexology.com/library/detail.aspx?g=b30d648d-08bb-4b40-bf04-83e139778f90. Accessed on 13th April 2018.ccessed on 13th April 2018.