Directors in Australia face an onerous duty to prevent their company from trading whilst insolvent and failure to do so may result in them being personally liable for compensation.

Australia’s insolvent trading regime is one of the most punitive in the developed economies and has been increasingly out of sync with the restructuring trends globally.

Concerns over inadvertent breaches of insolvent trading laws are frequently cited as a reason early stage investors are reluctant to get involved in a startup. Our insolvency laws put too much focus on penalising and stigmatising failures. More often than not, entrepreneurs will fail several times before they make it and will usually learn a lot in the process.

The Government’s National Innovation and Science Agenda aims to help entrepreneurs succeed with a cultural shift to encourage Australians to take a risk, leave behind the fear of failure and be more innovative and ambitious. Creating a culture of innovation means striking a balance between promoting productivity and discouraging reckless risk-taking.

As part of the Government’s insolvency law reform, the insolvent trading Safe Harbour provisions commenced on 19 September 2017 and the Ipso Facto provisions (where contracts provide for automatic termination on insolvency events) will be effective as of 1 July 2018. These reforms are generally welcomed as it provides a better opportunity for companies to restructure by encouraging directors take early intervention action to arrest financial deterioration and formulate a recovery plan.

The Safe Harbour provisions provide directors with an exception from insolvent trading liability where they are developing a course(s) of action which is ‘reasonably likely’ to lead to a ‘better outcome’ for the company than administration or liquidation. It should be noted that the Safe Harbour provisions will operate as an exception to the insolvent trading regime rather than a defence. A director seeking to rely on these provisions will bear the ‘evidential burden’ (lower threshold) rather than the ‘burden of proof’ to point to evidence that suggest a reasonable possibility of the existence of a better outcome.

Safe Harbour is not available if the directors (or the company), amongst other things, do not (i) keep proper books and records, (ii) properly provide for employee entitlements (including superannuation), (iii) keep tax reporting up-to-date and (iv) obtain advice from an ‘appropriately qualified’ restructuring advisor. The combination of these conditions, particularly (ii) and (iv), is likely to result in Safe Harbour being used only by medium to large businesses as these may be too onerous for small businesses in financial difficulty to satisfy.

However, if a financially distressed listed company is required by its continuous disclosure obligations to disclose that its directors are relying on Safe Harbour, then this may destroy value and undermine any restructuring plans. Failure to comply with continuous disclosure obligations may lead to criminal and civil liability for the company and its directors/officers including a spectre of shareholder class actions. Also, if reliance on Safe Harbour is disclosed to creditors and then the company goes into liquidation, this may result in potentially a whole host of voidable transactions for the liquidator to pursue, for example, unfair preference against the ATO.

The key to any successful restructuring is (i) ensuring financial records and reporting are up-to-date and accurate, (ii) early identification of the issues during financial difficulties, (iii) obtaining the appropriate advice and (iv) formulating and then implementing a restructuring plan.

HLB Mann Judd provides tailored restructuring and risk advisory services. Our experienced team has a proven history of successfully assisting our clients through financial and operational difficulties. As a full service national firm, we can provide businesses with comprehensive health checks and tailored strategic financial solutions.

The Ipso Facto provisions are intended to restrict counterparties from exercising contractual rights solely as a consequence of the company entering into administration, scheme of arrangement or receivership. Generally, an ipso facto clause allows one party to terminate or modify the operation of a contract upon the occurrence of an insolvency event and are common in all type of commercial contracts.

It should be noted that the Ipso Facto provisions are being grandfathered and will only apply to contracts entered into after commencement which will create different regimes and likely to encourage parties to amend rather than enter into new contracts so as to retain the benefit of exiting ipso facto rights.

The Ipso Facto provision tries to emulate the moratorium provided under the US Chapter 11 bankruptcy regime to ‘lock-in’ suppliers to assist in maintaining business as usual conditions for the company’s trading during an administration, scheme of arrangement or receivership. This is intended to minimise the unnecessary destruction of value and create a better opportunity for a successful restructure.